Subprime sovereign debt- That’s the latest we are hearing from the financial world. The other day on CNBC, there was a discussion on how the next big downfall in the financial world could be nations not being able to pay off their debts. Two countries that dominated all discussions on the subject were Iceland and Greece. Not to mention that there are several other nations also sailing in the sinking ship.
The discussion on this subject gathered steam with the crisis situation recently faced by Dubai. Just like some financial organisations are “too big to fail”- wasn’t this terminology very commonly used to justify the bailing out of several financial institutions, governments (countries) are also perceived to be “too big to fail”, so help was bound to come and Dubai got it from Abu Dhabi .
But the question is, it’s not one nation that’s facing this situation. Several nations, particularly the European nations are in trouble (Spain, Ireland among others)- who is going to bail out whom? Will there be a situation where nations will have no rescuers and will be left to default? Sub-prime mortgage had the power to bring down a big financial institution (Lehman Brothers) and trouble several others (Fannie Mae, Freddie Mac and most of the banks). The impact of a sovereign default is best left to imagination in an already fragile financial and economic atmosphere. Letting a government default has severe repercussion for not only the defaulting country but also the associated countries and parties.
Why are several countries on the brink of sovereign default? What has caused them to be in a situation that could take a toll on their image and reputation and would also result in them being part of history-in the list of defautler nations?
It all began with the subprime mortgage crisis in the US which had ripple effects world over on account of exposure of institutions to securities of US origin. In order to save the financial world from irreparable damage, governments resorted to bail outs that have burdened them with so much debt that they are now themselves on the brink of a credit crisis. Not only that, in order to pep up the economy, governments world over provided stimulus packages adding to their burden. It is estimated that support given to banks in the UK, USA and euro-zone during the present crisis amounts to US$ 14 trillion and that, of course, does not include the trillions more of ‘stimulus’ spending that has taken place. All of this has led to an explosion of debt.
Japan has debt over 170 times of GDP and the US is also accumulating debt. White House estimates the deficit for the next 5-years to total to $ 4.97 trillion. Possible default by a small country like Dubai send shivers down the spine of financial markets world over; just imagine what a possible default by Japan or US lead to.
While economic recovery is gradually being witnessed with government support, it has come at a cost. A cost that will impact the world in the future. The question is, is the world ready for yet another shock if and when it comes.
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