U.S. Default: Sovereign And Local Government Debt Defaults Extremely Rare

How National Debt Default Affects You
Share
Copy

While legislators describe the potentially catastrophic effects of a U.S. default on its debt or its growing budget deficit, past examples of sovereign default show other countries can recover in shorter periods than expected.

Jamaica, the only country to default in 2010, compares "favorably" with its peer countries in terms of GDP per capita and Human Development Indicators, according to credit rating agency Fitch Ratings.

The Caribbean country has a population of 2.7 million and a GDP of $13.8 billion. The total debt of its central government as a percentage of its GDP is 107.6 percent, according to Fitch.

Sovereign default events are rare. Since the mid 1990s Fitch has recorded a total of eight sovereign defaults, including the Jamaican default event. The list of sovereign defaults includes Indonesia and the Russian Federation, both in 1998; Argentina (2001); Moldova (2002); Uruguay (2003); the Dominican Republic (2005) and Ecuador (2008).

Even more infrequent are municipal or local governments defaulting on their debt.

Guy LeBas, chief fixed income strategist with Janney Capital Markets, said Orange County, Calif., which defaulted in 1994 following some financial mismanagement, may be the most prominent county that has defaulted in recent history. He said several municipalities defaulted during the Great Depression.

The city of Vallejo, Calif. declared bankruptcy in May 2008 and payments on its general fund debt service have been paid at less than contractual rates since July 1, 2008. The general fund is just one part of the city's $175 million in debt and lease obligations, mostly for capital improvement projects, such as street improvements and water projects, according to its website.

LeBas said it is likely most of the Vallejo's bonds were insured by municipal bond insurers, so bondholders are mostly receiving payment.

Eduardo Borensztein, regional economic advisor at the Southern Cone department of the Inter-American Development Bank, said there is "a lot of confusion about defaults."

He said the traditional definition of a default is when a country fails to make a payment on time or there is a change in the terms of original debt that implies a loss of value for its creditors.

"So if it can't make a payment according to the original terms, it's considered a default," he said.

In a paper for the International Monetary Fund, Borensztein found that from 1824 to 2004, Latin America was the region with the highest number of defaults: 126. Africa came in second with 63 episodes of defaults during that period.

Analyzing these cases, he found that default episodes do not have a long-term impact on credit ratings or borrowing costs.

Of course, for the United States, a default would be a different story because of the sheer size of its economy, among several other factors, Borenzstein said.

"It has the highest credit rating, so going down even one notch has big implications," he said. "U.S. debt is used as collateral for other contracts and considered pretty much risk free. I don't think anyone can have a good sense of the consequences of a default."

Richard Zeckhauser, professor of political economy at the Harvard Kennedy School, said it is also unlikely that United States will default on its debt. He said Greece, which many credit agencies had predicted would default, at least has Germany, or other European Union countries, to possibly help "bail it out."

"We unfortunately don't have a Germany. There's no one else to rescue us," Zeckhauser said. "Our biggest creditor is China and I don't think they'll come to our rescue."

Join the Discussion
You are using an outdated version of Internet Explorer. Please click here to upgrade your browser in order to comment.
blog comments powered by Disqus
 
You Might Also Like...