How to Tell a Nation Is at Risk
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By FLOYD NORRIS
Columnist
The New York Times
July 15, 2010
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.”
After that analysis, using a system he developed with a company called Risk Metrics, Mr. Altman’s ranking of European governments now differs a little from conventional wisdom. He sees Britain and the Netherlands as the safest governments, ahead of Germany. Greece is at the bottom, of course, with Italy, Portugal and Spain looking better than it does, but not particularly good.
Looking at corporate strength, he argues, does a better job of forecasting debt problems than do traditional macroeconomic indicators, such as gross domestic product growth and debt levels relative to G.D.P.
That analysis is sharply at odds with much current political discourse, which focuses on debt-to-G.D.P. levels and purports to see disaster looming for both Britain and the United States if something is not done immediately to restore fiscal discipline.
It may seem odd to talk of businesses bailing out governments, when the reverse is what appeared to happen over the last couple of years. But government credit, in the end, is based on its ability to collect taxes. A healthy private sector will provide the taxes, if they are to be provided at all.
That is something the bond rating agencies understand, but it is also the opposite of a traditional ratings practice, which was to treat a country’s debt rating as a ceiling for the ratings of companies from that country. In fact, the reverse has something to be said for it.
The old ceiling view did make sense under some circumstances. Defaulting governments have sometimes required companies to default as well, as a way of protecting dwindling foreign currency reserves at a time of crisis.
The overseas debt of most countries is denominated in currencies the governments cannot print and its citizens do not use, which is one reason crises can sneak up on traditional analyses. Argentina’s debt-to-G.D.P. ratio was about 50 percent, recalled Albert Metz, a managing director of Moody’s, shortly before the nation defaulted in the 1990s. The currency collapsed, and the ratio tripled overnight.
That distinction is one that has gained less attention than it should. In practice, it means that a crisis such as Argentina experienced, or as Thailand did a few years later, cannot sneak up on such nations as Britain, which borrows pounds, or the United States, which borrows dollars.
Greece did not face that risk either, because it borrows euros. But it cannot print the currency, so new credit could dry up. It was that threat that forced the crisis.
There is another lesson of the recent crisis that should be understood. The obligations of a country’s financial sector are, in extremis, contingent obligations of the government. Allowing the financial system to collapse is simply not an acceptable alternative.
Much of the rhetoric about the new financial reform bill in the United States dealt with politicians claiming, or denying, that future bailouts would be prevented. The real answer hinges on whether the new regulatory regime, combined with the lessons bankers should have learned, will prevent a new financial crisis.
If not, there will be bailouts, whatever laws are passed. Or at least there should be. The world tried going without them in the 1930s. It did not work out well.
It is profoundly discouraging to see American politicians screaming that TARP — the bank bailout — is to be blamed for deficits. In fact, the bailout worked. Had something like it not been done, the debt of the United States government might be lower now, but the nation’s credit would be far worse.
Federal debt, as reported, has skyrocketed during the Obama administration. But a large part of that stems from decisions made years before most Americans knew who Barack Obama was, and certainly before he had any power. Those decisions were made by banks and brokers. They were made by Fannie Mae and Freddie Mac when they were not under direct government control.
Other parts of the spending come from efforts to keep the economy from collapsing under the weight of the proof that those earlier decisions were horrendously bad ones.
The economic debate now should be focused on keeping the federal government from someday being similar to Greece, with a weak private sector and a bloated government that cannot collect taxes to meet its obligations.
There is no risk of that in the near term. The United States government can print dollars to avoid default, but it is not having to do so. It can borrow at low rates because investors around the world still trust it.
To keep that trust in the longer term, the economy must grow. It is possible, though not proved, that significant new stimulus is needed. If it is, that spending, too, will partly be to clean up messes made before.
The American economy currently is doing better than it would sound from the rhetoric on both sides of the political spectrum. The two demonstrable signs that the recovery has slowed are in areas — housing and cars — where temporary stimulus programs were artificially spurring growth. It was obvious that there would be brief declines when those programs expired.
But pessimism is intense. There was talk of depression just before the latest stock market rally began, and surveys of investors show levels of bearishness normally seen only after years of market declines. In fact, the market is up sharply from early 2009, and about 20 percent above where it was a year ago.
In Washington, nobody seems to want to see good news. When government employment rose because of Census hiring, that was dismissed as obviously temporary. Now that the Census Bureau is letting people go, that is seen as bad economic news.
The left wants more stimulus spending, and sees economic optimism as playing into the hands of its opponents. The right wants proof that President Obama is doing a bad job, which it hopes will lead to large Republican gains in November, and sees economic pessimism as in its best interests.
In fact, there are few signs of a double-dip recession. As Daniel Gross asked in Slate this week, “Retail sales are up, and credit card debt is down. Why is that bad news?” Americans are spending about 5 percent more than a year ago, even with this week’s retail sales numbers that were pronounced disappointing by some. But it appears that the spending is coming more from those who can afford it than from those who need to borrow.
The important goal now is a healthy economy, and there are signs that it is arriving. Corporate profits were surprisingly strong in early 2010, and early second-quarter reports are encouraging.
It is the success, or failure, in obtaining that goal that will determine whether there is a real crisis in federal debt. |
