Investors have renewed their obsessing over the risk of sovereign default, as fear creeps back into the market that contagion will lead to a replay of the financial crisis and the return of a recession. While sovereign debt defaults are frightening, they are actually quite common and may not lead to the worst-case scenario that many are expecting. Here are seven facts about sovereign debt defaults that might surprise you.
TUTORIAL: Credit Default Swaps: Introduction
The PIIGS countries - or Portugal, Italy, Ireland, Greece and Spain - are on everyone's watch list as having the greatest risk of sovereign default. These five countries have a mixed historical record of sovereign default over the last 200 years, with Ireland never defaulting on its obligations and Italy only once during a seven-year period in World War II. (For many emerging economies, issuing sovereign debt is the only way to raise funds, but things can go sour quickly. For more, see How Countries Deal With Debt.)
Portugal has defaulted four times on its external debt obligations, with the last occurrence in the early 1890s. Greece has defaulted five times and has spent a total of 90 years in this status since achieving independence in the 1820s.
Spain holds the record on the PIIGS list and has defaulted six times, with the last occurrence in the 1870s. If you extend the date range back another three centuries and start in 1550, the default count rises to 12.
There are a number of countries that have pristine record of paying on sovereign debt obligations and have never defaulted. These nations include Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, Switzerland and England.
Don't think that these countries skated through the last 200 years without financial problems, because endemic banking crises were a common occurrence. England has suffered 12 banking crises since 1800 or an average of about one every 17 years.
3. The U.S. Has Defaulted on Debt (Technically Speaking)
Although the conventional wisdom is that the United States has never defaulted on its sovereign debt obligations, there have been some instances that may qualify under a strict and technical definition.
In 1790, the United States passed a law that authorized the issuance of debt to cover the obligations of individual states in the union. Since some of this new debt didn't start paying interest until 1800, some purists consider this a technical default.
Many issues of U.S. government bonds issued prior to the 1930s contained a gold clause under which bondholders could demand payment in gold rather than currency. In 1933, President Roosevelt and Congress decided that this promise was against "public policy" and obstructed the "power of the Congress" and ended this right. The issue was litigated and ended up before the Supreme Court, which ruled in favor of the government.
In 1979, the government could not make timely payments on portions of three maturing issues of treasury bills due to operational problems in the back office of the Treasury Department. These payments were later made to holders with back interest.
4. Ground Zero
Ground zero for modern sovereign debt default seems to be in South America and Central America where Venezuela and Ecuador share the dubious honor of 10 defaults each. (For related reading, see Why Bad Bonds Get Good Ratings.)
Brazil, which today is one the fastest growing of the emerging economies, has defaulted nine times, while Costa Rica and Uruguay have disappointed foreign investors nine times as well over the last 200 years.
Another oasis of financial strength today is China, which has trillions of dollars in reserves and suffered only marginally during the recent recession. China has defaulted only twice, both times during times of external and internal conflict.
The Western Powers sometimes reacted with military force when a country decided not to pay back money that was borrowed. In 1902, Venezuela refused to pay on its foreign obligations and after negotiations failed to resolve the issue, Britain, Germany and Italy imposed a blockade on Venezuela.
The conflict escalated quickly and a number of Venezuelan ships were sunk or captured, ports were blocked and coastal areas were bombarded by the Europeans. The U.S. eventually intervened to mediate and after several years of negotiation Venezuela combined its outstanding debt into a new issue, added back interest and made payments until the issue matured in 1930.
Some sovereign defaults are intentional and are not necessarily due to a lack of financial resources. In February 1918, the new government in Russia repudiated all debt issued by the previous Tsarist government. Bondholders have long memories and this default officially lasted until 1986, when Russia settled with British holders of this paper. In 1997, an agreement was reached with French bondholders as well.
The Bottom Line
Sovereign debt default is a terrifying thought to many investors and the dread is only amplified in the current environment of financial gloom that pervades the market. Investors that examine the issue more rationally, and in the context of the history of such events, will realize that the global financial system has seen this before and survived. (For related reading, see The Risks Of Sovereign Bonds.)
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