Friday, July 16, 2010

Sovereign debt risk and the private sector

Which governments will not be able to pay their bills?

The ones with private sectors that are not doing well enough to bail out the government.

That should be one lesson of the near default this year of the Greek government. Government finances are important, but in the end it is the private sector that matters most.

If so, those who focus on fiscal policy may be missing important things. Spain appeared to be in fine shape, with government surpluses, before the recession hit. Now Spain is being downgraded and has soaring deficits.

“Academics and market practitioners have not had an impressive record of predicting serious financial downturns or of providing adequate early warnings of impending sovereign economic and financial problems,” says Edward Altman, a professor at New York University who has long studied debt defaults by companies and governments.

Mr. Altman’s answer is fairly simple: “One can learn a great deal about sovereign risk by analyzing the health and aggregate default risk of a nation’s private corporate sector, a type of bottom-up analysis.”
Read the rest here.

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