Soverign Default Risk

Perspective is very important for a risk manager. That is because lack of perspective leads to many of the largest mistakes.in thinking about the cause and likelihood of loss events.

Regarding the US debt ceiling manufactured crisis, there is very interesting perspective on the issue of the US Federal Debt in an article in the NY Times.  The story links the current Tea Party movement all the way back to Jefferson and Madison.  It seems that the US has always had a major faction strongly opposed to big government and government debt.

However, Riskviews would suggest that some have taken a valid disagreement about the size of government and the level of debt and used that to manufacture a crisis that has the potential to create a second major global recession of the size and scope of the one we have not yet recovered from.

But if you have read the story of the 1930’s history, you will see that is exactly what happened then.  Government policy and actions during the 1930’s took several major turns as the economy staggered up and down.  To this day, there is no agreement of whether one set of government actions or the movements in the opposite direction were the cause or the solution to the problem.

We seem destined to repeat the same sort of lurching process to find our way out.

In fact, we will never know which really works – spending or austerity – to help with a bad part of the business cycle.

Another great source of perspective on Sovereign Default is the Reinhart, Rogoff book This Time is Different.  The book goes through hundreds of years of history and dozens of sovereign defaults.  One of their main conclusions is that sovereign default is usually a politically driven event, rather than a financially driven event.  The drama in Greece follows the historical patterns described in the book.  The involvement of the rest of the EU in the Greece situation is unusual, but not at all unique.

Reinhart and Rogoff make the case that sovereign defaults are mostly political, rather than economic.  That is the thinking that seems to motivate S&P in their downgrade decision on the US debt.  S&P says that

we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.

But it is unclear to RISKVIEWS whether there is not also a major long term economic problem for most of the G20 economies.  The demographic imbalances may prove the downfall of one or several of the major economic powerhouses of the past 50 years.

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3 Comments on “Soverign Default Risk”

  1. altmanzscore Says:

    Nice explanation. Its difficult to analyse properly without reference. I hope this would become popular as reference handbook for finance manager/analysts.

  2. altmanzscore Says:

    Nice explanation. It a difficult analyse properly without reference and hope this book will be popular among finance managers and analysts.

  3. jimlynch9999 Says:

    It’s pretty clear S&P is more concerned about the political environment than the financing, considering the $2T error it brushed off.
    A number of prominent politicians proclaimed that default was not a big deal. Minority Leader Mitch McConnell bragged that the showdown we just saw would be repeated in 2013 and indefinitely beyond.
    I think the rating agency just got tired of watching the kids play too close to the cliff.
    I’ve written a lot about his at http://actuarialopinions.wordpress.com.


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