Lend not unto him that is mightier than thyself; for if thou lendest him, count it but lost.
UBS AG cites this passage from Ecclesiasticus 8:12 in a fascinating look at sovereign debt defaults, bank crises and bond restructurings dating back to ancient Greece. Funny, that, given Europe's current debt crisis began in the same country, though more than 2,000 years later.
The point of the report, done by emerging markets analyst Costa Vayenas at UBS in Zurich, is to discuss the lessons from defaults of the past, and what investors might learn. Among the findings is that so-called haircuts on debt holdings ranged from a low of 18 per cent to as much as 70 per cent, with the average almost 50 per cent, with the swap coming between two and 10 years after problems surfaced.
UBS cites a well-documented case from 377 BC to 373 BC to illustrate how the ancient Greeks learned that sovereign defaults occur in clusters. In that case, 11 of 13 states defaulted on loans from the Temple of Delos, not exactly the equivalent of the Fed but the lender of last resort nonetheless. Some 90 per cent of the money had to be written off, UBS notes.
"After that bad experience, it was thought safer to avoid lending to the sovereign and instead make loans to wealthy individuals, collaterized by land," Mr. Vayenas wrote. (Ouch, isn't that real estate?)
No surprise here, but creditors learned time and time again over the centuries that sovereign credit was risky.
"The King of England triggered a huge financial crisis when he defaulted in 1345 on loans from his Italian bankers," Mr. Vayenas said. "In more recent times, from 1500 to 1900, the empires, kingdoms and principalities that were the predecessors of today's European states were no strangers to the odd payment difficulty. Spain defaulted 13 times, France eight times, Portugal six times, the German states six times, Austria five times, Greece four times and Holland once."
Developed countries generally had a much better track record in the last half of the last century, though emerging economies were far different.
"The Achille's heel of these emerging market sovereign debt crises has been that either the sovereign, or the constituencies that the sovereign cares about (banks, households, corporates), owed debt in foreign money," Mr. Vayenas said.
"This is money that the sovereign cannot print - it has to be obtained abroad, either through income from exports or by borrowing new foreign currency aborad. This is similar to the situation that existed for much of history where the sovereign needed to find gold or silver to pay back debt."
The report cites several modern debt and banking crises, running from Argentina and Chile to the Philippines, Russia and the Ukraine. And, of course, Mexico, which got a little help from U.S. President Bill Clinton.
Harvard University professor Kenneth Rogoff, co-author of This Time Is Different - a historical analysis of sovereign defaults - said Wednesday Greece could still have to restructure its debts, despite receiving a bailout from the EU and the IMF. While Mr. Rogoff predicted the euro will likely survive the current crisis, a few euro zone countries will probably have to restructure their debts.
Investors, Mr. Vayenas wrote, should take note of five things:
- Debt defaults tend to come in clusters.
- Debt not issued in the country's own currency - that means it can't print the money - is far risker than credit issued in a currency "where the government can simply switch on the printing press."
- Bondholders don't have much power.
- There is no "universally agreed" template for restructuring. You kind of make up the rules as it goes along.
- The current crisis is different. Strapped countries now aren't the emerging markets of past crises, but rather "rocks in the storm" such as the euro zone nations, the U.S., Japan and Britain.
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