Wednesday, May 05, 2010

Moody's: Debt 'Contagion' Could Infect U.S. In as Little as 3 Years

They're calling it a 'contagion' in Europe: the fear that weaker governments are poised to default on their debt instruments. It started with Greece a few months ago as it became clear that the Mediterranean country would be unable to make its multi-billion Euro bond payments, which are due later this month. But the uncertainty around sovereign debt extends to all of the "PIIGS" -- Portugal, Italy, Ireland, Greece and Spain.

Today the panic continued to ripple through the European financial system as investors assessed the exposure of banks, insurers and other private entities to sovereign default.

The euro fell to a 14-month low on the dollar and one-year low on the yen, raising concerns over the currency’s reserve status... The pressure on the euro came as investors continued to fret over the fiscal position of Greece and other countries on the periphery of the eurozone and as protests in Athens against austerity measures designed to rein in the country’s deficit turned violent.

Yield on 10-year Greek debt reached a new high, and the price of insurance on Portuguese and Spanish debts also set records. Ratings agency Moody’s warned Lisbon’s credit rating could be cut further.

The 'contagion' is reflected in the increasing prices for credit default swaps (CDS), which serve as 'insurance policies' against defaults. If you want to buy 'insurance' that pays off if Greece defaults on its bond payments, you'll pay more today for CDS than you paid yesterday.

Portugal, Ireland, Spain and Italy -- in that order -- are the next highest default risks if CDS prices are to be believed.

And what of the U.S.? Could the 'contagion' spread to our shores?

According to the rating agency Moody's, our own debt shock may hit as soon as 2013.

...In the wake of the financial crisis and recession, Moody's Investors Service has brought new transparency to its sovereign ratings analysis — so much so that 2018 lights up as the year the U.S. could be in line for a downgrade if Congressional Budget Office projections hold.

The key data point in Moody's view is the size of federal interest payments on the public debt as a percentage of tax revenue. For the U.S., debt service of 18%-20% of federal revenue is the outer limit of AAA-territory, Moody's managing director Pierre Cailleteau confirmed in an e-mail.

Under the Obama budget, interest would top 18% of revenue in 2018 and 20% in 2020, CBO projects... But under more adverse scenarios than the CBO considered, including higher interest rates, Moody's projects that debt service could hit 22.4% of revenue by 2013.

...a financial market shock from higher interest rates could precede the threat of a downgrade. In other words, investors might be less forgiving of U.S. fiscal policy than Moody's.

For instance, markets began pricing in a Greek default as a real possibility well before Standard & Poor's downgraded that nation's debt rating to junk last week.

...The [CBO's] outlook assumes discretionary spending restraint, broad-based tax hikes and well-behaved interest rates. Nevertheless, it sees debt reaching 90% of GDP in 2020, up from 53% at the end of 2009.

Some observers describe the CBO's projections as 'wildly optimistic'.

Just as the housing meltdown caught many 'experts' unaware, so too could a sovereign debt crisis. As investors demand higher premiums (interest payments) to offset higher risks, the U.S. would suffer catastrophic financial damage in the form of unacceptably high interest payments on existing debt.

Put simply, President Obama and Democrats in Congress have set the country on a course for fiscal disaster. They've spent trillions on bogus "Stimulus", "Omnibus Spending" and 99-week Unemployment programs. The result is that there's no breathing room in the current federal budget. A single unexpected event -- a financial meltdown in Europe, a massive terrorist attack, a huge natural disaster -- any one of a number of scenarios could lead to a financial calamity.

Vote accordingly in November.

Related: Photos: War on the streets of Greece as public sector unions and Communists rebel against austerity measures.


tarpon said...

The EU is selling each other their bogus paper.

Phil said...

Doug, I'm always impressed by the charts and graphs you bring to make your case. I just found what appears to be a great resource in gathering data like this. Who knows, maybe it will make your job easier. The Wolfram Alpha program is described at the 5:20 mark in this video.