Tax Analysts Blog

Who's Afraid of Risky Government Debt?

Posted on Nov 23, 2009

No less than four articles in this morning's papers discuss rising risks on debt issued by governments of developed nations. In the Wall Street Journal you can read ("EU's Weakest Draw New Scrutiny") about the rising cost of insuring debt issued by the struggling Irish and Greek governments. This insurance -- available through derivatives known as credit default swaps -- would be far costlier if there wasn't an implicit guarantee of a bailout from fellow EU countries that also use the Euro as their currency.

The Financial Times reports ("Bets Rise on Rich Country Defaults") on rising volumes and rising costs of insuring against defaults on government bond defaults. Don't worry about risky mortgages or corporate debt. According to analyst Gary Jenkins (quoted in the article): "The biggest single risk hanging over the bond markets is the rapid rise in public debt in the industrialized world."

Also in the FT , columnist GillianTett ("Will Sovereign Debt Be the New Subprime?") challenges the conventional wisdom that investing in government bonds is "risk-free." She worries about a sharp decline in bond values (that follows from a sharp rise in interest rates) that is likely to occur when central banks start selling their vast holdings of government securities. ("Some smart hedge funds are betting on just that," writes Tett.) Then commercial banks and insurance companies holding these bonds would suffer huge losses.

Finally on the front page of the New York Times ("Wave of Debt Payments Facing U.S. Government") we are warned about skyrocketing interest costs the U.S. government faces. Currently, the government debt load has minimal impact on the budget because interest rates are low. Over the next few years as interest rates rise, the doubly whammy of higher rates and sky-high debt levels will hit the federal budget like a sledgehammer. This observation is not news to folks familiar with the budget (see chart below), but it is good for theTimes to keep reminding readers -- and Congress -- about these dull facts that will dominate federal policy making for at least the next decade.

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