Sovereign defaults

Sovereign default: two terrifying words for every cossetted generation of financiers. But defaults can, and do happen – and not just to subprime borrowers such as Belize and Ecuador. France shrugged off foreign creditors eight times between 1500 and 1800, while Spain defaulted 13 times between 1500 and 1900. How these notes ever attracted the sobriquet “risk-free” is a mystery. While corporate debt markets have been pricing in the mother of all meltdowns for months, government bonds have not. And, yet, defaults are bound to increase. The first reason is obvious: deteriorating public finances. The cost of recapitalising banks has blown a hole through many a national budget already weakened by falling tax receipts. A Bank of England study three years ago found that sovereign crises erupt in recessions, when external debt has been over two-thirds of gross domestic product, and where the fiscal deficit exceeds about 2 per cent. Each of those boxes gets a tick.