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Gov’t Paper

In Le Gardien on December 7, 2009 at 3:51 AM

In this version of Le Gardien, we spotlight not the commercial paper market, but the government paper market; and more specifically the sovereign debt market as a bubbling area for potential concern.

Gillian Tett, a prominent ahead-of-the-curve writer at Financial Times, has featured an article outlining concern for sovereign debt risk levels escalating across banking portfolios worldwide. Prescriptively, Ms. Tett is recommending that government-issued paper, or IOUs, ought to be accounted for more stringently in considering G-20 capital provision requirements — read Could sovereign debt be the new subprime? from November 22, 2009.

Most prominently, just after Thanksgiving, Dubai World, a subsidiary of conglomerate Dubai Inc, announced it is pushing for a refinancing of terms on its sovereign debt issuances, that is, it’s government paper already issued.

Indeed, debt obligation strains related to government borrowing across the globe have been swirling since mid-2007. The recent news from Dubai is reminiscent of French bank PNB Paribas’ restriction and postponement of lender claims against its ABS-securities back in 2007, the time period when U.S. housing markets began collapsing together in concert across the so-called “Sand States”, in harmony from Nevada to Florida.

Expectation, in this Dubain case, is that CDS-insurance contract spreads on Dubai bonds ought to widen. Additionally, volatility measures coupled with the Middle Eastern market would be expected to brim upwards as well. Recent reports are shedding light on just how exposed this “blowup” could prove to be collaterally-speaking — read this New York Times article here for primer.

Dubai-related debt level relative to the rest of the world can be seen in a useful graphic comparing the Union nations versus the leading debt-ridden nation in the world, Zimbabwe, alongside the United Arab Emirates.

Importantly of note, all these ratios are trending upwards in a negative direction.

From a time-series perspective, the U.S. is entering another suggestively similar debt run-up period that is interesting to put in context by judging things graphically. In Figure 2, we plot public debt as a percentage of GDP to provide just this viewpoint.

Figure 3 shines light on a time-series more specific to banking-oriented recession in the U.S. Here there is a cataloging of indexed run-ups in debt-to-GDP as pertaining to the Panic of 1907 with peak year 1907, the Great Depression with peak year 1929, the S&L Crisis with peak year 1990, and the Sub-Prime Crisis with peak year 2007. For instance, for the current crisis the peak year is referenced as t=2007 and t-4=2003.

As one can visibly spot above, debt levels as a share of GDP almost always jump immediately post business cycle peak.

“Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”

– Louis Brandeis, 67th U.S. Supreme Court Justice

Light as virus disinfectant and crime deterrent is a powerful notion that Judge Brandeis understood in the context of the banking environment of the early 1900s.

For some backgound on understanding just how he acknowledged power during the Panic of 1907 period, read more of the Brandeis papers that are available on-line sponsored through the University of Lousiville.

For a more insightful understanding of the 1929-period in risk management lows, watch the brilliant video on the period in the PBS documentary The Crash of 1929.

Niall Ferguson’s The Ascent of Money offers a focused and concise round effective in explaining the S&L Crisis.

Similarly, Simon Johnson, MIT economics professor, is critical and on-the-money in explaining the narrative of the most recent financial crash at BaselineScenario.com.

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