Nouriel Roubini's Global EconoMonitor

RGE’s Wednesday Note – Sovereign Debt: The Developed World’s Next Big Problem?

This week we look at a topic we’ve been following closely of late—the deterioration of sovereign balance sheets in several advanced economies and the looming threat of debt downgrades. Later this week, RGE will release to our clients a paper examining this issue in greater depth.

In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to foes. The severe recession, combined with a financial crisis during 2008-09, worsened the fiscal positions of developed countries due to stimulus spending, lower tax revenues and support to the financial sector. The impact was greater in countries that had a history of structural fiscal problems, maintained loose fiscal policies and ignored fiscal reforms during the boom years. Going forward, a weak economic recovery and an aging population is likely to increase the debt burden of many advanced economies, including the U.S., UK, Japan and several eurozone countries.

In 2008-09, the stance of these governments to do “whatever it takes” to backstop their financial systems and keep their economies afloat soothed investor concerns. But if countries remain biased toward continuing with loose fiscal and monetary policies to support growth rather than focusing on fiscal consolidation, investors will become increasingly concerned about fiscal sustainability and gradually move out of debt markets they have long considered “safe havens.”

Most central banks will withdraw liquidity starting in 2010, but government financing needs will remain high thereafter. Monetization and increased debt issuances by governments in the developed world will raise inflation expectations. These governments will have to offer higher real yields or investors will move to more attractive emerging markets. Some countries will continue to witness increased credit default swaps. Higher yields and interest cost on debt will also hurt economic growth—by crowding out private consumption and investment, and reducing government’s productive spending. Several factors will likely influence investors’ perception about sovereign risk—a country’s debt financing ability, its status as a “safe haven” relative to other developed economies, politicians’ commitment to undertake fiscal reforms, exchange rate movements, and the debt maturity structure.

The UK, Spain, Greece and Ireland will face sovereign risk pressures, especially if their fiscal imbalances are not addressed immediately. Some eurozone members are quickly approaching their debt sustainability limits as deleveraging through devaluation is not an option for these countries. Countries like Germany—whose fiscal imbalances have deteriorated largely due to the economic and financial downturn—might have a greater capacity to stabilize their debt ratio. The U.S. and Japan might be among the last to face investor aversion—the dollar is the global reserve currency and the U.S. has the deepest and most liquid debt markets, while Japan is a net creditor and largely finances its debt domestically. But investors will turn increasingly cautious even about these countries if the necessary fiscal reforms are delayed. The U.S. is a net debtor with an aging population, weaker economic growth and risks of continued monetization of the fiscal deficit. Japan’s aging population and economic stagnation will reduce domestic savings.

Developed economies will therefore need to begin fiscal consolidation as soon as 2011-12 by generating primary surpluses by a combination of gradual tax hikes and spending cuts. However, an aging population, a sluggish economic recovery and higher unemployment will keep governments’ entitlement spending high and revenues subdued. These factors might also make tax hikes politically challenging. Fiscal consolidation efforts might not be strong until the bond vigilantes signal shifting to safer assets. To achieve credibility, governments will need to pass binding legislation enforcing tighter fiscal belts when their economies begin to recover on a sustained basis.

13 Responses to “RGE’s Wednesday Note – Sovereign Debt: The Developed World’s Next Big Problem?”

PeterJBJanuary 13th, 2010 at 6:30 pm

Speaking about talking to myself (I have no problem with this, er, really;]:Jaime Dimon, CEO of JPMorgan Chase — and perhaps the nation’s most powerful banker — told reporters after this morning’s first hearing of the Financial Crisis Inquiry Commission that “using tax policy to punish…is a bad idea.” Furthermore, he said, “all businesses tend to pass costs onto customers.”I repeat: ” Furthermore, he said, “all businesses tend to pass costs onto customers.”Not so: I run my service company where my fees were quoted competitively and were quoted let me say at: x$ per hour/ per diem Plus say costs (detailed) at +5%Go down to the restaurant and you will find a menu with costed items.In such business, charges are clearly defined and competitive (in most cases unless your contact inside gives you an carte blanche)BUT:Go to a bank for a housing loan at say 3.7% over 25 years and deliver up your deposit of say, $100,000 cash.Now, all of a sudden for the first time and even second time buyer, you are faced with, YES, costs that are passed on to the sucker (consumer) and backed by government! Legal costs, search costs, stamp duties, interest of interest, secretarial costs, and it goes on until your $100,000 deposit has been reduced to say, $75,000.THIS is no risk business, of course if your mortgage is full recourse and legally bound to your assigns, 3 levels of guarantors, heirs and whoever you are related to ad infinitum (as it is in the Land of Oz).So Dimon is correct, for the elite business, those that are connected to “leadership” which must be defined as no risk enterprise and where this is confirmed in reality as when these businesses need some cash, it is eagerly given, FOC, in unlimited (and secret transactions) coupes / tranches acquired from the tax payer.Insurance, labour intensive industries, banking, armament, military contractors, security, etc., are all such industries ie NO RISKSo, let us redefine what is going on here:Some businesses, such as those that are closely and intimately associated with “leadership” from a broad class of industries, are treated as NO RISK businesses and pass all costs onto to the consumer and if found in difficulty, will be granted FOC cash infusions from the general coffers of the governing Nation.All other businesses must a priori, take their chances without any support from government, such as small businesses in Australia, and be at the mercy of every feral politician, tax collector, cheat, thief, liar, local government authorities and bureaucrats and other officials that have interests in similar businesses. These are called the Risk Industries.Yes, so Dimon is partly right. So now, the definition of Risk and non-Risk enterprise must be elaborated upon and quantitatively assessed for imbalance.And, Mr. Dimon, “Tax Policy” is always, a priori, used to punish… as it legalizes the deals done by the “let’s do lunch crowd”…Ho hum

The AlarmistJanuary 14th, 2010 at 7:59 am

OK, put it this way … businesses that are successful for the long run pass all costs through to customers in one form or another at some time or another.There is merit to the Obama “fee” idea, especially if he simply calls it the price for the call option that was given to the major banks. Don’t know why they didn’t think of that before, especially since I have been saying it here for quite some time.

blinds manJanuary 13th, 2010 at 10:34 pm

the year was 1974… net..World Trade Center walkPetit’s most famous work was his performance which he executedat the World Trade Center in Manhattan. It was dubbedthe “Artistic Crime of the Century,” by Time Magazine.. net ? the ground people looked up and wondered, “does he have a net?”like themselves but 1300 feet from the ground he did not and i thinkthat is what let them know that he really cared about what hewas doing and so, after he was arrested, they gave him the keysto the towers. (which he had already stolen/claimed, so to speak)..”WalkingOn August 7, 1974, shortly after 7:15 a.m., Petit stepped off the South Tower and onto his 3/4” 6×19 IWRC (independent wire rope core [5]) steel cable. He walked the wire for 45 minutes, making eight crossings between the towers, a quarter mile above the sidewalks of Manhattan. In addition to walking, he sat on the wire, gave knee salutes and, while lying on the wire, spoke with a gull circling above his head.”…”Petit was warned by his friend on the South Tower that a police helicopter would come to pick him off the wire unless he got off. Rain had begun to fall, and Petit decided he had taken enough risks, so he decided to give himself up to the police waiting for him on the South Tower. He was arrested once he stepped off the wire. Provoked by his taunting behaviour while on the wire, police handcuffed him behind his back and roughly pushed him down a flight of stairs. This he later described as the most dangerous part of the stunt.[7]His audacious high wire performance made headlines around the world. When asked why he did the stunt, Petit would say “When I see three oranges, I juggle; when I see two towers, I walk.”..when there is no net, balance is required, near perfect balance is critical as there are no second chances.where there is a net balance is of secondary importance or perhaps a hindrance and detriment? but is it art? does it have what it takes to capture the heart./s of the / paying customers?.keywords: risk – art – gut – heart. bread and circuses, wherethe net? what net? what horse?

PeterJBJanuary 14th, 2010 at 3:26 am

Aye blindman, indeed.An enterprise sans Risk is no business; not even monkey business; it’s a scam, er, ask Bernie Madoff.Mr Dimon and friends naturally sought to lower risk so as to 1. be more attractive to Shareholders, Partners, etc., 2. to make greater profits so that their organizations could grow and become more influential 3. to influence “leadership” and all the feral that hangs off that lot, and 4. to satisfy their own agenda, or IOW to have their “privilege” by their own hand. It’s all really just natural human behaviour except for the fact that as their orgs were “businesses” by admission, they were subjected to Risk.IOW, it was unnatural for these orgs to be bailed out with public money due to the fact that Risk had won the day! But, they were.So those organizations of which we speak, are not businesses; they are scams and should not be given constitutional or even non-constitutional protection from unseen risk-events that may (will) arise in future times.Even the fact that these orgs are so large and so influential is a life threatening fact as they, by the rules of Law (those that have been conveniently thrown out the window [for them] more or less permanently), have morphed into a completely new type/classification of emergent phenomenon, which are not considered under normal Laws up to this date. I repeat, these orgs are not businesses as we know the term to mean, define, imply, regulate, etc.Does anyone of “leadership” even have any idea what he/she is dealing with here? Does even Mr Dimon and his peers know that which they have created? Do any of the consensual brethren of the ever faithful sword yielding priests known as economists, bureaucrats, experts, bankers, Congressmen, etc., know what is going on?The answer is clearly NO! A new phenomenon has emerged; an alien, which is set to devour humanity and the eager hand of ignorant leadership, and all the feral that hangs off it, wants to accommodate its feeding frenzy despite not having one idea as to what is going on. All while Madame Pelozi takes delivery of her new 757.The wage earners of the World are being told to financially support an industry, which despite its affairs, du jour, being “risk-free” cannot turn a profit without free subsidies, no interest financing, cash grants, influential assistance (privilege), tax free benefits, open doors to God, secrecy; in fact, they, despite being given the keys to the World’s coffers, just can’t turn sustainable growth and profits!Why? Simply put, because they ain’t “businesses” by definition!And, they’re slack slippery slicks that have risen to their own levels of incompetence and are being supported by “leadership” that is not mandated for this purpose! (Peter’s Principle)I might define this as a fungal parasite that has eaten all there is but intends to keep feasting until the host dies or better, eradicates this fungoid in one big cough and spit.There is nothing we know greater than the human spirit; it just only rises to the occasion at that moment just prior to us being destroyed and flung into the abyss. This time will be no different.Note: fungal matts, corporations, collectives, banks, institutions and organizations, etc., are not human and therefore do not possess the human spirit, a priori, despite being made up of former human beings!Ho hum

GuestJanuary 15th, 2010 at 3:11 am

hah was waiting for someone to say it…hence Blindman’s and PeterJB’s defiance… RESPECT!!but, when its time to move on.. its time to movei think we’ve (I) learnt A LOT from this siteit has served its purpose.. remember TPTB evolved from time to timeto surviveWE should toothere’s a lot of other good sites, they cant close em all, if they try??i believe that is when the long waited revolution will start”they can kill websites, but behind these websites are bloggers, with living ideas,thoughts, knowledge… and ideas can not be killed MR WHom Ever you are”

blindmanJanuary 15th, 2010 at 7:27 am

Tell All the Truth but Tell It SlantTell all the truth but tell it slant-Success in Circuit liesToo bright for our infirm DelightThe Truth’s superb surpriseAs Lightning to the Children easedWith explanation kindThe Truth must dazzle graduallyOr every man be blind-emily dickinson (1830-1886)for what it is great synthesis / summation pjb!

PeterJBJanuary 15th, 2010 at 2:37 pm

Speaking about the fungal parasitical matt that is in extremis and has done everything to save itself, above all other interests by unconstitutionally appropriating national coffers for its own interests when it is clear and beyond any doubt, that this industry, is merely bankrupt:”Elimination of the Federal Reserve’s role in supervision would severely undermine the Federal Reserve’s ability to obtain in a timely way and to evaluate the information it needs to conduct its central banking functions effectively,” according to the paper.” of the World’s Head Banker due to its and its members’ total and complete bankruptcy would rid the World of a known parasite and would force a complete review of the malpractices and abuses by the “leadership” paradigm leading to a more society representative “socio-economic order far more in consistency with the Constitution of the USA where no better better form of Government, in its original format of essence and intent has ever existed and would lead to a far stronger structure upon which to build the future for all peoples in a free and healthy society.The FedRes fights for itself and has done since Paulson, and Benanke dogging behind, went to Pelosi’s offices crying for help in the name of saving the whole global economy. They lied as it was the banking system led by the FedRes that was under the threat of bankruptcy by its own hand! This is clear.The battle rages between a bankrupt risk free (sic) central banking system and the Constitutional USA. Both cannot co-exist and we must make a choice. Benanke understandably makes his choice.Fungal matts should not rules humanity, a priori!Man must govern themselves. Basic physics really!Keywords: fungus | Constitution | Parasites | govern | Man | men | govern | FedRes | Bankrupt | humanityHo hum

PeterJBJanuary 15th, 2010 at 3:20 pm

Talking about “stunning failures”, er, Krugman (I am really impressed these days as he appears to have joined the plan – just as I was coming to the opine that Nobel Prizes were THE status of failure):”And this disaster was entirely self-inflicted. This isn’t like the stagflation of the 1970s, which had a lot to do with soaring oil prices, which were, in turn, the result of political instability in the Middle East. This time we’re in trouble entirely thanks to the dysfunctional nature of our own financial system. Everyone understands this — everyone, it seems, except the financiers themselves.”What you got, instead, was witnesses blurting out: “Yes! I admit it! I’m clueless!”And this guy heads a BIG bank: “There were two moments in Wednesday’s hearing that stood out. One was when Jamie Dimon of JPMorgan Chase declared that a financial crisis is something that “happens every five to seven years. We shouldn’t be surprised.” In short, stuff happens, and that’s just part of life.”You know that you are doomed when you here such things! (Never mind an iceberg or two – full steam ahead!)And talking about the pitfalls of SEX and its role in the global bankers bonus (GBR):”Still, Mr. Dimon’s cluelessness paled beside that of Goldman Sachs’s Lloyd Blankfein, who compared the financial crisis to a hurricane nobody could have predicted. Phil Angelides, the commission’s chairman, was not amused: The financial crisis, he declared, wasn’t an act of God; it resulted from “acts of men and women.” line: The world’s top industries are run by morons and all deserve the ‘Whankers of the Year Award’.Ho hum

blindman tooJanuary 15th, 2010 at 8:29 pm Wrecked the Economy?Politics + Current AffairsForeclosure PhilYears before Phil Gramm was a McCain campaign adviser and a lobbyist for a Swiss bank at the center of the housing credit crisis, he pulled a sly maneuver in the Senate that helped create today’s subprime meltdown.— By David CornJuly/August 2008 IssueWho’s to blame for the biggest financial catastrophe of our time? There are plenty of culprits, but one candidate for lead perp is former Sen. Phil Gramm. Eight years ago, as part of a decades-long anti-regulatory crusade, Gramm pulled a sly legislative maneuver that greased the way to the multibillion-dollar subprime meltdown. Yet has Gramm been banished from the corridors of power? Reviled as the villain who bankrupted Middle America? Hardly. Now a well-paid executive at a Swiss bank, Gramm cochairs Sen. John McCain’s presidential campaign and advises the Republican candidate on economic matters. He’s been mentioned as a possible Treasury secretary should McCain win. That’s right: A guy who helped screw up the global financial system could end up in charge of US economic policy. Talk about a market failure.Gramm’s long been a handmaiden to Big Finance. In the 1990s, as chairman of the Senate banking committee, he routinely turned down Securities and Exchange Commission chairman Arthur Levitt’s requests for more money to police Wall Street; during this period, the sec’s workload shot up 80 percent, but its staff grew only 20 percent. Gramm also opposed an sec rule that would have prohibited accounting firms from getting too close to the companies they audited—at one point, according to Levitt’s memoir, he warned the sec chairman that if the commission adopted the rule, its funding would be cut. And in 1999, Gramm pushed through a historic banking deregulation bill that decimated Depression-era firewalls between commercial banks, investment banks, insurance companies, and securities firms—setting off a wave of merger mania.But Gramm’s most cunning coup on behalf of his friends in the financial services industry—friends who gave him millions over his 24-year congressional career—came on December 15, 2000. It was an especially tense time in Washington. Only two days earlier, the Supreme Court had issued its decision on Bush v. Gore. President Bill Clinton and the Republican-controlled Congress were locked in a budget showdown. It was the perfect moment for a wily senator to game the system. As Congress and the White House were hurriedly hammering out a $384-billion omnibus spending bill, Gramm slipped in a 262-page measure called the Commodity Futures Modernization Act. Written with the help of financial industry lobbyists and cosponsored by Senator Richard Lugar (R-Ind.), the chairman of the agriculture committee, the measure had been considered dead—even by Gramm. Few lawmakers had either the opportunity or inclination to read the version of the bill Gramm inserted. “Nobody in either chamber had any knowledge of what was going on or what was in it,” says a congressional aide familiar with the bill’s history.It’s not exactly like Gramm hid his handiwork—far from it. The balding and bespectacled Texan strode onto the Senate floor to hail the act’s inclusion into the must-pass budget package. But only an expert, or a lobbyist, could have followed what Gramm was saying. The act, he declared, would ensure that neither the sec nor the Commodity Futures Trading Commission (cftc) got into the business of regulating newfangled financial products called swaps—and would thus “protect financial institutions from overregulation” and “position our financial services industries to be world leaders into the new century.”>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>Subprime 1-2-3Don’t understand credit default swaps? Don’t worry—neither does Congress. Herewith, a step-by-step outline of the subprime risk betting game. —Casey MinerSubprime borrower: Has a few overdue credit card bills; goes to a storefront lender owned by major bank; takes out a $100,000 home-equity loan at 11 percent interestLending bank: Assuming housing prices will only go up, and that investors will want to buy mortgage loan packages, makes as many subprime loans as it canInvestment bank: Packages subprime mortgages into bundles called collateralized debt obligations, or cdos, then sells those cdos to eager investors. Goes to insurer to get protection for those investors, thus passing the default risk to the insurer through a “credit default swap.”Insurer: Thinking that default risk is low, agrees to cover more money than it can pay out, in exchange for a premiumRating agency: On basis of original quality of loans and insurance policy they are “wrapped” in, issues a rating signaling certain slices of the cdo are low risk (aaa), medium risk (bbb), or high risk (ccc)Investor: Borrows more money from investment bank to load up on cdo slices; makes money from interest payments made to the “pool” of loans. No one loses—as long as no one tries to cash in on the insurance.>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>It didn’t quite work out that way. For starters, the legislation contained a provision—lobbied for by Enron, a generous contributor to Gramm—that exempted energy trading from regulatory oversight, allowing Enron to run rampant, wreck the California electricity market, and cost consumers billions before it collapsed. (For Gramm, Enron was a family affair. Eight years earlier, his wife, Wendy Gramm, as cftc chairwoman, had pushed through a rule excluding Enron’s energy futures contracts from government oversight. Wendy later joined the Houston-based company’s board, and in the following years her Enron salary and stock income brought between $915,000 and $1.8 million into the Gramm household.)But the Enron loophole was small potatoes compared to the devastation that unregulated swaps would unleash. Credit default swaps are essentially insurance policies covering the losses on securities in the event of a default. Financial institutions buy them to protect themselves if an investment they hold goes south. It’s like bookies trading bets, with banks and hedge funds gambling on whether an investment (say, a pile of subprime mortgages bundled into a security) will succeed or fail. Because of the swap-related provisions of Gramm’s bill—which were supported by Fed chairman Alan Greenspan and Treasury secretary Larry Summers—a $62 trillion market (nearly four times the size of the entire US stock market) remained utterly unregulated, meaning no one made sure the banks and hedge funds had the assets to cover the losses they guaranteed.In essence, Wall Street’s biggest players (which, thanks to Gramm’s earlier banking deregulation efforts, now incorporated everything from your checking account to your pension fund) ran a secret casino. “Tens of trillions of dollars of transactions were done in the dark,” says University of San Diego law professor Frank Partnoy, an expert on financial markets and derivatives. “No one had a picture of where the risks were flowing.” Betting on the risk of any given transaction became more important—and more lucrative—than the transactions themselves, Partnoy notes: “So there was more betting on the riskiest subprime mortgages than there were actual mortgages.” Banks and hedge funds, notes Michael Greenberger, who directed the cftc’s division of trading and markets in the late 1990s, “were betting the subprimes would pay off and they would not need the capital to support their bets.”These unregulated swaps have been at “the heart of the subprime meltdown,” says Greenberger. “I happen to think Gramm did not know what he was doing. I don’t think a member in Congress had read the 262-page bill or…..”….”Whatever you call it, for three decades they had us convinced that the success of the financial sector should be measured not by how well it provides financial services to actual consumers and corporations, but by how effectively financial firms make money for themselves. It sounds crazy when you put it that way, but stripped to its bones, that’s what they pulled off.”.,dwp_uuid=3010b7e0-ffa1-11de-921f-00144feabdc0.html?nclick_check=1.”Mr Blankfein, whose bank has become a lightning rod for public anger at Wall Street, bore the brunt of the panel’s questions. He mounted a robust defence after being asked whether part of his business was akin to selling a car with faulty brakes and then buying an insurance policy. But he added: “Anyone who says I wouldn’t change a thing, I think, is crazy.”The Goldman boss said that he and his rivals had been insufficiently sceptical of loose credit standards.“We rationalised [it] because a firm’s interest in preserving and growing its market share, as a competitor, is sometime blinding – especially when exuberance is at its peak.”Mr Angelides, a former California treasurer appointed head of the panel by Congress last year, told the witnesses on the first day of public hearings: “We’re after the truth . . . the hard facts . . . we’ll use our subpoena power as needed. And if we find wrongdoing, we’ll refer it to the proper authorities.” “.comment: lying to congressional panelists is only illegal whenyou are sworn in, right?also, screwing the pig in front of congress ( in public ), metaphorically, is not illegal, right?as in, ” we ate our own cookies and choked” when in reality theyate someone else’s cookies and that someone else choked and diedand now they are collecting on the insurance. they designed thewhole thing, lobbied for it, had it written into law, invested init collected on it and now they don’t know what happened and nevercould have imagined the dangers of loose credit. really?perjury. where have you gone mark mcguire?.

11b40January 16th, 2010 at 11:30 am

Thanks for this summation.In reality, these congressional hearings do more long-term harm than good, exposing our ‘leadership’ as just a bunch of toothless old cartoon tigers, grandstanding for the cameras and having no real positive effect.I am reminded of the tobacco company executives who sat there and lied to us all on c-span. What happened to them? Nothing, that’s what. Just like what will happen to these banking executives. They can lie all they like, then go home and get back to the same old game.Independent Contractor