Sovereign default experiences are a staple in international finance. Here are a couple bits of information from a vast literature.
First, from Asonuma (2009):
…we cover stylized facts of serial defaults, especially some features di¤ering by
countries history of defaults. Figure 2 reports external debt-to-GDP ratio, bond spreads and credit
ratings. Bond spreads of past defaulters, except Chile and Egypt, are higher than those of non-
defaulters given external debt-to-GDP ratio7. Past defaulters tend to su¤er higher spreads on the
newly issued bonds in the future after default, even if they have the same level of foreign debt relative
to GDP as before. Similarly, past defaulters have lower credit ratings than non-defaulters.
It is apparent that precarious debt intolerance situation of Argentina is more severe than one
of Malaysia9. Since Argentina is representative of many countries with a weak credit history and
Malaysia is representative of countries with a sound credit history, this result reects that the debt
thresholds of countries with a weak credit history are lower than that of countries with a sound credit
history. In other words, the default probability of countries with a weak credit history is higher than
one of countries with a sound credit history, given the same level of debt-to-GNP.
Figure from Asonuma (2009).
Something to keep in mind, when next you hear someone say with equanimity that a small, or “technical”, default would be no problem. (These are often the same people who say that crowding out — higher interest rates due to accumulating debt — are a problem. This strikes me as an internally inconsistent worldview, but internal consistency I am told is the hobgoblin of small minds.)
More on sovereign debt restructuring/default from Willem Buiter/Citi.
What about orderly restructuring. As many have noted, restructurings are anything but smooth processes. Professor Anne Krueger, who was appointed DMD at the IMF by President G.W. Bush, characterized sovereign debt restructurings as “Messy or Messier”, noted that one could reduce the messy nature of restructurings by either a sovereign debt restructuring mechanism (kind of a chapter 11 for countries), or further use of collective action clauses. I’ll let readers guess if either of these two mechanisms apply to US sovereign debt.
Finally, in my one of my first forays into YouTube land, let me bring people’s attention Douglas Holtz Eakin’s view on the debt ceiling debate.
[Full disclosure: Holtz-Eakin was Chief Economist on CEA staff during the time I served on the staff of the CEA, during the first months of the G.W. Bush administration]
Update, June 2, 2pm: From Bloomberg/BusinessWeek:
Treasuries fell as Moody’s Investors Service said it expects to place the U.S. government’s Aaa rating under review for possible downgrade if there is no progress on increasing the statutory debt limit in coming weeks.
“The debt limit has to be raised or it’s going to bring a severe blow to the U.S. economy,” Jason Rogan, director of U.S. government trading in New York at Guggenheim Partners LLC, a brokerage for institutional investors. “I don’t think it’s anything too shocking to the market.”