Dubai jolted the markets. Greece gave the wheel a spin. The ratings agencies joined the game and now everyone is looking at the possibility of sovereign debt downgrades, with the triple-A rating of the US and the UK under fresh scrutiny. Let us remember, the only reason to downgrade debt, be it the debt of a corporate or a country, is because you think the possibility of default has moved a step or two closer.
In the last few decades we have seen defaults from Russia and Brazil, but until the US subprime debacle and the global credit crunch unleashed government printing presses in the UK, Europe, and the US, no one seriously thought countries like the UK and the US could possibly be viewed as potential defaulters. That role was reserved for developing economies which got ahead of themselves.
Mike Larson, an editor and real estate markets specialist with Weiss Research, which is famously pessimistic on the state of the US, UK, and European economies, has been warning for some time now that far from there being little risk when governments go about “bailing out, backstopping, insuring and stimulating their financial sectors and economy” (his excellent phrasing, not mine), the risks are building all the time. “Our stance: If you borrow and spend too much, all you’re going to do is to transform a Wall Street debt crisis into a Washington debt crisis.” (And a London debt crisis, and so on…)
Without doubt this is a topic that is tailor-made for anyone interested in whipping up a little market hysteria. But there are some grim facts out there to give credence to a certain amount of anxiety. In his recent column in Money and Markets (Sovereign Debt Defaults the Next Shoe to Drop?), Larson points out that the cost of credit default swaps (CDSs) on Dubai government debt (never mind its arm’s length property development company, Dubai World) had virtually doubled, from 257 basis points before the crisis, to 545 basis points by early December 2009.
The cost of insuring $10 million of Dubai government debt now requires an annual premium of $545,000. Viewed from the provider’s standpoint, that looks on paper like a tasty premium but it would take a really gung ho hedge fund manager to reach for a slice of that particular pie. However, Dubai, as top money managers reiterated at the Reuters Investment Summit, is just an indicator of the underlying sovereign debt problem. The scale of its debt was hardly systemic (other than as yet another shock to a groggy global banking system) even before its neighbor Abu Dhabi agreed to bail it out.
Spain’s credit outlook has been downgraded to negative and Greece’s rating has been cut. The US and the UK are under a vague kind of notice as regards their AAA rating status and investors are looking to see how countries get to grips with their debt mountains. One key sign of this was the recent poor response to the $13 billion auction of 30-year US Treasury bonds, pushing up bond yields to interesting levels. The game still has a long way to run for the developed economies and while the markets may continue to improve, the huge scale of developed-world debt is going to be a drag even on buoyant economies—assuming there are any…
- Why Printing Money Sometimes Works for Central Banks, by Paul Kasriel
- Viewpoint: Justin Yifu Lin, Coping with the Crisis: Risks, Options, and Priorities for Developing Countries
- Banking and Financial Services [sector profile]
Tags: banking , central banks , global imbalances , sovereign debt