[p2p-research] Part 2. How Often Have Sovereign Countries Defaulted in the Past?

[Ryan]

  Sent to you by Ryan via Google Reader: Part 2. How Often Have
Sovereign Countries Defaulted in the Past? via Calculated Risk by
CalculatedRisk on 7/10/10
CR Note: This is part 2 in a series on sovereign debt issues by
reader "some investor guy". Here is Part 1: How Large is the
Outstanding Value of Sovereign Bonds?

Sovereign bonds have been defaulting for almost as long as there have
been sovereign bonds. The problems go back many centuries. A good
overview created for the IMF is “The Costs of Sovereign Default” by
Eduardo Borensztein and Ugo Panizza. Some countries are “serial
defaulters”, with a long history of sovereign defaults. Many have
defaulted on sovereign debt five times or more.

Click on graph for larger image in new window.

Here is a chart showing the number of countries defaulting each year
from 1824 to 2003. The raw data comes from S&P. Charts were created by
the Some Investor Guy.

As you can see, there are some years with no defaults at all, and other
years with many. Defaults tend to come in clusters, and the behavior of
lenders often changes substantially after defaults. In the Volatility
Machine, Michael Pettis asserts that sovereign default contagion
follows predictable patterns, and that contagion is primarily due to
investors in the first defaulting country also having investments in
other countries which are vulnerable. This is especially the case with
leveraged investors.

In the seemingly “quiet period” from 1945 to 1959, there was just one
sovereign default. Interestingly, this was also a time with a number of
very angry foreign investors. This time period was the peak of
expropriation of foreign assets. There were at least 25
nationalizations and expropriations of foreign assets. Many were by new
members of the Soviet Bloc, and by newly independent colonies (Source:
Michael Tomz, Stanford, working paper).

For you ubernerds who want to see which countries defaulted each year,
here they are. I’ve broken them down into three periods to make the
charts more readable.

1820 to 1920 (click on chart for larger image) 1920 to 19801981 to
2003The underlying causes of default (such as rises in interest rates,
wars, commodity price collapses, and simply borrowing too much money)
have been diagnosed for many episodes. Proximate to the default, any of
the following six financial changes might occur:

1. Government revenues fall far below history or forecast;
2. Expenses aside from debt service rise far above history or forecast;
3. Interest rates rise substantially; due to inflation, credit spreads,
illiquidity, or other causes
4. Demand for bonds suddenly drops or disappears (a sudden stop);
5. Exchange rates move, making payments on foreign denominated bonds
much more expensive (currency risk), and,
6. A government simply decides not to pay, even though it has the
capacity to pay (repudiation).

Paolo Manasse and Nouriel Roubini studied sovereign default risk and
concluded that many guidelines used for estimating when default was
likely did not perform well, primarily because those guidelines looked
at separate risks. For example, total government debt exceeding 200% of
GDP is often used to indicate stress. However, some other circumstances
may make the problems much less severe (like having a growing economy
and no foreign denominated debt). Other factors might make it much
worse (like high inflation).

CR Note: This is from "Some investor guy". Over the next week or so,
some investor guy will address several questions: What are market
estimates of the probabilities of default? What are total estimated
losses on sovereign bonds due to default? What happens if things go
really badly and what are the indirect effects of default?

Here is Part 1: How Large is the Outstanding Value of Sovereign Bonds?

Next in the series, Part 3. What are the Market Estimates of the
Probabilities of Default?
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