“This Time, It Is Not The Usual Suspects Such As Brazil And Mexico Who Are In the Worst Positions. Instead, It Is the Industrialized Nations”

There have been a slew of articles recently on the risk of sovereign defaults.

The threat of sovereign defaults is not surprising. In fact, BIS – the world’s most prestigious financial agency, nicknamed the “central banks’ central bank” – warned in December 2008 that the bailouts and other bank rescue programs were putting nations were transferring risks from private companies to nations.

As I noted at the time:

BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.

In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don’t have, central banks have put their countries at risk from default.

While sovereign credit default swap spreads narrowed for a while after the BIS report, they are starting to widen again. See this, this, this and this.

So who cares whether Dubai, Iceland or Bulgaria default on their debt?

It might not be such a small economy which goes down in flames.

As Mitu Gulati notes :

At some point, sovereign borrowing inevitably reaches a level at which repayment becomes difficult (especially when the private sector bailouts don’t work). That point was perhaps reached roughly a month ago when Dubai had a default (it was corporate debt, but of a corporate entity where the government was a major holder). That produced concerns about the viability of other nations and the ratings downgrades of the debt of other nations (Greece being the most prominent).

All of this has produced much concern about whether the world is on the brink of another major financial crisis, this time with sovereigns. And if the sovereigns default, there is no one to bail them out (except perhaps the IMF, but it does not have limitless funds).

In a series of radio interviews with Bloomberg, Lee C. Buchheit, a partner at Cleary Gottlieb in New York, and the guru of sovereign debt, explains the current state of affairs. Even if you have no interest in sovereign debt or the potential for another global crisis, Buchheit is worth listening to just for the elegance with which he delivers his lines. One of the things about these interviews that stuck out was Buchheit’s explanation for why this particular sovereign debt crisis, if it occurs, will be different. This time, it is not the usual suspects such as Brazil and Mexico who are in the worst positions. Instead, it is the industrialized nations who have borrowed so very heavily to fund their bailouts.

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