Dubai, Greece, Spain: Who’s Next, Illinois?

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In our December 4 post, we wrote:  “At this point, we can’t know whether or not Dubai is a stand-alone situation.  As a firm believer in the cockroach theory, however, we suspect that having seen one Dubai, we can be reasonably confident that there are many more lurking in the darkness.”  We had no idea how quickly some of those cockroaches
would surface.

Technically the effective default of Dubai World was not a sovereign default.  A great many investors in the development of Dubai, however, did rely on an implied government guarantee.  It is now an open question how the tens of billions of dollars in claims will be settled in an environment with few precedents for such defaulted debt resolution.

This week PIGS have been prominent in the financial news.  This inelegant acronym refers to Portugal, Italy, Greece and Spain, all countries whose debt is seen as increasingly endangered.  Some argue that the name should include another “I” to position Ireland in its rightful place at the trough.

Within just the last few days the major rating agencies have downgraded the debt of both Greece and Spain.  Japanese and Irish Finance ministers, Fujii and Lenihan respectively, warned of future dangers if their countries’ budgets were not soon repaired.  Ratings officials have even threatened the formerly sacrosanct AAA ratings of the U.S. and the UK, whose balance sheets have grown perilously and whose assets have deteriorated markedly with the acquisition of otherwise unsaleable collateralized debt obligations.

Of course, there may be a vast gulf between ratings downgrades and actual defaults, but these ratings agency actions highlight a growing nervousness about the ability of an increasing number of countries to pay their debts.  This week’s headlines are all the more remarkable in light of the huge stock and bond market gains since their respective lows many months ago.  They clearly indicate that considerable instability lurks beneath the improving veneer of the worldwide financial condition.

Also this week Illinois joined the ranks of California and Michigan in the ignominious group of states whose debt ratings have been reduced.  We expect membership in that club to continue to grow.

Most investors would be surprised to learn that sovereign debt defaults are not an uncommon phenomenon.  Carmen M. Reinhart and Kenneth S. Rogoff, co-authors of This Time Is Different, elaborate in detail on what they categorize as “eight centuries of financial folly.” Their comprehensive history chronicles the surprising frequency of government defaults.  In keeping with the principle of “forewarned is forearmed,” investors would be well advised to know what has repeatedly led to past episodes of debt default.

We have warned for several quarters that a great many corporate and municipal bonds are likely to default before we bring down the curtain on this financial crisis.  (See our post on September 28, 2009 “Why Not Buy Bonds?”)  Concern about such defaults is certain to grow as the imperiled financial condition of governments and major institutions becomes increasingly manifest in the months ahead.

Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to or call (520) 529-2900 to speak with one of the Portfolio Coordinators.