The Financial Times quotes Gillian Tett of Geonomica on the peculiar fact that sovereign risk is now priced higher than corporate risk:
For the first time, the market has started to price in a bigger probability of default among industrialised countries than among investment grade companies.
More specifically, it now costs more to insure the combined risk of default of Europe’s developed nations, including Germany, France and the UK, than it does the combined risk of Europe’s top 125 investment grade companies, according to the Markit indices....
Markit’s iTraxx Europe index of 125 companies was yesterday trading at 63 basis points, or $63,000 to insure $10m of debt over five years. This compares with 71.5bp, or $71,500, for Markit’s SovX index of 15 European industrialised nations. This development reflects the market’s current obsession with sovereign risk.
The UK, a Group of Seven nation, has seen the cost to insure its debt rise to double that of some of its leading companies. The UK CDS has jumped by 40bp to 83bp since September, which compares with Unilever at 29bp and BP which is 38bp.
This is peculiar. If states get to the verge of bankruptcy, they will tax corporations aggressively (Obama’s proposed $90 billion tax on big banks is a short across the bow of sorts). Large multinational corporations can insulate themselves against a Greek bankruptcy or even a UK bankruptcy, but not against the bankruptcy of a large number of sovereigns.
The very high cost of credit default protection against sovereigns may reflect the risk management requirements of banks who are increasing lending to weaker sovereigns and buy credit protection as a matter of course against some part of their book. Nonetheless, the explosion of risk premia on some sovereigns, e.g., Greece, if extended to the UK and other major players, could bring down the whole financial system.
If hypothetically the US sovereign began to show risk premia like those of Greece–a most unlikely event–the enormous and rapidly-growing bank portfolios of government securities would be devaluated and bank capital would collapse. This is, once again, a most unlikely eventuality. But it is at least conceivable that the world might go not with a whimper, but a bang.
