Morgan Stanley Says Government Defaults Inevitable

Published on 08-25-2010 | Bloomberg

Investors will face defaults on government bonds given the burden of aging populations and the difficulty of securing more tax revenue, according to Morgan Stanley.

“Governments will impose a loss on some of their stakeholders,” Arnaud Mares, an executive director at Morgan Stanley in London, wrote in a research report today. “The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take.” The sovereign-debt crisis is global “and it is not over,” the report said.

Borrowing costs for so-called peripheral euro-region nations such as Greece and Ireland surged today, resuming their ascent on concern that governments won’t be able to narrow their budget deficits. Standard & Poor’s downgraded Ireland’s credit rating yesterday on concern about the rising costs to support nationalized banks. The yield on Greek debt rose to more than 900 basis points above that of Germany today, the most since the European Union and International Monetary Fund created a 750 billion euro ($948 billion) bailout package in May.

Mares said debt as a percentage of gross domestic product is a false indicator of an economy’s health given it doesn’t reflect governments’ available revenue and is “backward- looking.” While the U.S. government’s debt as a percentage of GDP is 53 percent, one of the lowest ratios among developed nations, its debt as a percentage of revenue is 358 percent, one of the highest levels, the report said.

Double Dip

“Outright sovereign default in large advanced economies remains an extremely unlikely outcome, in our view,” the report said. “But current yields and break-even inflation rates provide very little protection against the credible threat of financial oppression in any form it might take.”

Mares didn’t identify which nations may default. He once worked at the U.K.’s Debt Management Office and is a former senior vice-president at credit-rating company Moody’s Investors Service.

“Note that a double-dip recession would not invalidate this conclusion,” Mares’ report said. “It would cause yet further damage to the governments’ power to tax, pushing them further in negative equity and therefore increasing the risks that debt holders suffer a larger loss eventually.”

Yields on German and U.S. benchmark securities sank today as investors sought the safest assets. Greece’s so-called yield spread over German debt was at 932 basis points as of 2:18 p.m. in London, short of the 973 basis point record set on May 7.

“The conflict that opposes bondholders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well-aligned with those of influential political constituencies,” such as elderly voters and their claims on pensions and health insurance, Mares wrote.