“Serial default is a surprisingly universal phenomenon, including the advanced economies” (Carmen Reinhart)

FOREWORD: A conversation in the middle of the financial turmoil

The old rules of sovereign defaults still apply even to the rich countries and particularly to the “graduated” economies, those who “stepped” from emergent market status to the OECD club in the last twenty years.

The bond markets overreacted last week of April and first week of May to debt risk regarding the so called PIIGS,  particularly Greece and Portugal who attained historical peaks in probability of default, cost of credit default swaps and  bond yields.

In last Sunday, May 9, EU turned to ‘Nuclear Option’ to halt Euro and CDS market speculation with a massive 750  billion euro loan package from the EU (governments pledged a €440bn in credits and guarantees and €60bn from the  EU’s balance of payments facilities)  and the IMF (with a contribution of  €250 bn) in an attempt to stave off a severe  lack of market confidence in the European common currency and neutralize the risk of a serial default crisis in the more  vulnerable eurozone members. A huge package of $900 bn, more than the $700 bn TARP in 2008 against the financial panic.

Bold action saved the euro from a trip heading towards extinction. But debts didn’t disappear. No magic, despite politics. This package is on top of the €110bn rescue package for Greece. Also the ECB stands ready to buy government bonds in sterilized interventions on secondary markets and reactivates extra US dollar liquidity facilities and unlimited fixed rate offerings on three months loans. German chancellor Angela Merkel, meanwhile, lost biggest state elections in North Rhine-Westphalia and with it the majority in the Bundesrat (the Upper House in Germany). Probably Merkel’s tactics about Greece was a factor for CDU’s election defeat this Sunday.

Suddenly, a severe near-default crisis in a small economy like Greece and a surge in risks of default in other small economies like Portugal and Ireland generated an additional potential “cost” of  €860 bn on top of the Great Recession skyrocketing costs already done. In a bold move Monday Portugal sorted out from the TOP 10 ranking of highest default probabilities of CMA Datavision and Greece step down from the first place.

In the middle of this political and financial turmoil, EXPRESSO and janelanaweb.com blog interviewed professor Carmen Reinhart, from University of Maryland, and co-author with Kenneth Rogoff of the most important research analysis about debt cycles and default patterns in history. “This time is different” (Princeton University Press; September 2009), their last book on financial history, is a reference today. Recently several academic papers and conferences from Reinhart and Rogoff developed the methodology and the findings of the bestseller.

Crisis reality “show” just confirmed the pattern, from the first episode in Iceland to the turmoil in Dubai, the symptoms in Ireland, and most recently the near default in Greece and the high risks in Portugal.

As Rogoff wrote May 5 in the Financial Times: “Professor Reinhart and I found that international banking crisis are almost invariably followed by sovereign debt crises.”

At the heart of the present risk of serial default crises is a surge – as professor Reinhart referred in this interview – in external debt from governments and particularly businessmen and bankers that thought the “great moderation” was forever. In their business strategies and minds crises were unpleasant “things” of the past. “This time” growth and financial leverage was forever. Until 2007, when subprime gray swan appeared in the lake. Abruptly. As always.

Edited in San Francisco, May 10


Carmen Reinhart is the most widely read woman in economics, when measured by citation counts, says David Warsh, from the Economicprincipals.com, an independent weekly. She was born in Cuba and left the country with her father and mother in 1966 for the United States. In the 1980s she was chief economist at Bear Stearns, the global investment bank that collapsed in the financial panic of 2008. She worked also in high positions at the Federal Reserve Board. From 1996 she teaches at University of Maryland. Her collaboration with Rogoff dates from 2001, when he began a two-year term as chief economist at the IMF. He hired Reinhart to be his deputy.

FAST SUMMARY by Carmen and Vincent Reinhart
5 Realities against 5 Myths about the European debt crisis

1- This debt crisis is not new
2- Small economies in default can launch major financial turmoil
3- Fiscal austerity usually doesn’t pay off quickly
4- The borrowing bender is not specific of the eurozone
5- It’s a mistake to think that a default crisis can’t happen “here” (in a rich country or even in a great power)

Source: The Washington Post, Sunday, May 9, 2010

INTERVIEW by Jorge Nascimento Rodrigues (c) May 2010

QUESTION: Professor you refer that historically that’s not possible to detect a well-established sequence of “phases” in global crises. Regarding the ongoing Great Recession can we expect a sovereign default “phase” in this apparent final period?

ANSWER: Yes. Yes. Absolutely.

Q: Politicians, even economists and academic researchers, argue that that will not happen this time. Circumstances are different today, they say. Sovereign defaults would be extreme events, black swans, from the past. “That’s ridiculous!” they argue.  So, why to talk today about the distant 1500s or the 1800s when external debt crises were frequent in  advanced economies including the world powers of the time?

A: Well, Greece’s last default episode only ended in 1964. “Only” 46 years ago. We had defaults in developed economies as well after the WWII. The same occurred with great recessions. We have not seen crises at global level in the last 70 years in advanced economies. Therefore I’m not surprised that we forgotten such severe financial crises. Also the possibility of an extreme event like a default or a partial default. As we refer in our research serial defaults on external debt is a surprisingly universal phenomenon, including among now advanced economies in an earlier era.

We had a real shift

Q: So, it’s always the same problem. People think this time – their time – is different…

A: Regarding this global crisis I have told in 2005 that we are waiting a financial meltdown in the US and UK. About defaults there’s not a rule that it cannot happen in Europe or elsewhere as well. We referred that it is important to study very long time horizons to understand crises and recidivism. Declaring a premature victory over vulnerability to default crises – or other crises – is a recurring error. We saw how the “great moderation” period was decidedly short.

Q: Can we say the risk of sovereign defaults shifted in the last decades from the so-called Third World to the rich countries of OECD club?

A: Yes. We saw a growth in time of the level of external debt in advanced economies. We saw recently in the period 2003 to 2009 that the debt leverage in advanced economies just took off. The same in emerging economies of Europe.  We had a real shift. On the contrary the emerging markets on the all turned less vulnerable.

Q: Can we say that in the eurozone we have a co-movement of 4 or 5 countries with a certain synchronicity to a risk of default?

A: The common fact in Portugal, Spain, Ireland and Greece – and less in the case of Italy – is a surge in external debt. I mean a real SURGE! It’s why I pinpoint the performance of that period 2003-2009. It was a period of external expansion in debt, also in high income economies. The most extreme case was Iceland which I and Rogoff emphasized in our work. But the reason why you see a co-movement of these European countries is the total external debt. This is important even for Ireland and Spain that followed particularly conservative fiscal policies.

I’m not surprised with the market reactions

Q: In the case of Ireland the total external debt to GDP ratio is so extreme, above 1000% at the end of 2009. How it happened?

A: In the Chartbook of “This Time is Different” I mentioned that private debt become public debts. That’s why I am not surprised with this reaction from the markets. When you combine external public debt with the private one you just got this situation. The external private debt is huge in these countries. Italy is less affected. Its private sector didn’t go in a spiral bench.

Q: In the case of Portugal the private external debt is above 160% of GDP. Particularly the banking system went through a surge of debt. The overall external debt to GDP ratio for Portugal is 230 per cent. Anyway below the Irish level or the British one. Now shifting from the so-called PIIGS to the UK. In the middle of this turmoil in London due to the hung  parliament that emerged from last week general elections, analysts began to refer a critical situation in the UK with an  external total debt to GDP ratio of more than 400%, larger than the majority of the PIIGS. Also a public deficit to GDP ratio of “greek” style. London is near a red alert?

A: Well regarding UK it’s more complicated. UK is a financial world center. But we have a problem indeed in the  eurozone and in the UK and US. The surge in borrowing and borrowing, and particularly in the private sector, developed a big problem. They didn’t take in account the “externalities” of this extreme leverage process. Like the pollution problem.  People didn’t take in account externalities. All this process was unchecked. So the risk debt of following into a trap was huge.

Even after IMF programs we had defaults

Q: Reading your book it stroked me that Portugal was one of the economies with a huge potential for graduation from emerging market status, even the country from 1979 till 2008 with the highest change in institutional investors ratings - 32.8%. Second to none. How it happened that Portugal risks now de-graduation?

A: The risk following into the trap I mentioned is the answer. The plain obliviousness to the all issue about the debt cycles put at risk the graduation. Graduation from serial default is a prolonged process and has been characterized by setbacks even after several decades. We pinpoint that twenty years is a minimum length of time to speak of graduation from any kind of crisis. A weak threshold – as the current financial crisis in numerous advanced economies attests. Recidivism occurs often even after many decade gaps. Just remember that the last IMF program in a “peripheral” advanced economy of the eurozone was in 1984 for Portugal.

Q: But IMF programs – and this is the last question -, like those we saw today in Hungary, Latvia, or just beginning in Greece, are not a wall to recidivism?

A: The role of IMF programs has become important in recent years in helping graduation from emerging market status.  But, as you know, there are numerous examples of default even after the implementation of IMF programs. Indeed there are many cases where even an IMF program is not enough to solve the problem. Examples in middle income economies in recent decades included Argentina (2000-2001) or Turkey (1980-1982).


- Peak of share of advanced economies in sovereign defaults (including of serial variety): more than 40% in the 1810s; more than 30% in the 1850s and the 1940s;

- Duration of “tranquil time” between two crises of external default for countries with high income status: for more than 65% of the frequency distribution the “tranquil time” was less than 20 years;

- High income countries median number of years since the last external default: 104 (more or less a century);

- Worst cases since the last external default crisis ended: Hungary (40 years); Greece (46 y); Germany, Austria and Japan (less than 60 y);

- Best cases since the last external default crisis ended: Denmark, UK, US, France, Sweden, Netherlands;

- Top advanced countries with a decrease in institutional investors ratings change from 1979-2008: Japan, US, UK;

- Top middle and low income countries with the highest decrease in institutional investors ratings change from 1979-2008:   Venezuela, Nigeria and Argentina;

- Top 10 high income countries with the highest increase from institutional investors ratings change from 1979-2008:  Portugal, Spain, Denmark, Finland, Greece, Korea, Singapore, Sweden, Hungary and Italy;

- Top 5 middle income economies with the highest increase from institutional investors ratings change from 1979-2008:  Poland, Turkey, Chile, Morocco, and Romania.

Source: “On Graduation from Default, Inflation and Banking Crises: Elusive or Illusion?”, Rong Qian, Carmen M. Reinhart  and Kenneth Rogoff, NBER Macro Annual Conference, April 9, 2010


(External defaults since 1800s in high and middle income European countries)

Austria: 7 episodes (1802-1815, 1816, 1868-1870, 1914-1915, 1932-1933, 1938, 1940-1952); France: 1 episode (1812); Germany (Prussia, Hessen, Schleswig-Holstein, Westphalia): 4 episodes (1807, 1812-1814, 1850, 1932-1953); Greece: 5 episodes (1826-1840, 1843-1859, 1860-1878, 1894-1897, 1932-1964); Italy: 1 episode (1940-1946); Netherlands: 1 episode (1802-1814); Poland: 3 episodes (1936-1937, 1940-1952, 1981-1994); Portugal: 4 episodes (1828, 1837-1841, 1850-1856, 1892-1901); Imperial Russia: 2 episodes (1839, 1885); Russia after implosion of Soviet Union: 2 episodes (1991-1997, 1998-2000); Spain: 5 episodes (1809, 1820, 1831-1834, 1837-1867, 1877-1882); Sweden: 1 episode (1811-1812).

Source: This time is different Chartbook: Country Histories on debt, default and financial crises. March 2010.

7 Responses to ““Serial default is a surprisingly universal phenomenon, including the advanced economies” (Carmen Reinhart)”

  1. [...] uma «matrioska», vai revelando novas bombas de destruição massiva (depois do “lixo tóxico” agora é o risco de default em série em diversos países desenvolvidos, com destaque para a própria zona [...]

  2. [...] surpreendentemente universal, incluindo os países desenvolvidos”, refere em entrevista (versão completa, em inglês, aqui) Carmen Reinhart, especialista americana em história financeira da Universidade de Maryland, e a [...]

  3. [...] a sua monumental obra ‘This Time is Different’ (publicada em 2009), a que já nos referimos noutros artigos, apontam para o agrupamento em determinados períodos em que mais de 30% dos países estiveram em [...]

  4. [...] interviewed professor Reinhart recently – you can read the interview here. Now, we listen to the academic [...]

  5. [...] um estudo histórico feito pela investigadora Carmen Reinhart – que entrevistámos (versão em inglês) sobre esse tema – e pelo professor Kenneth Rogoff, a linha vermelha, nos países desenvolvidos, para a dívida [...]

  6. [...] ponto de viragem” similar ao limiar histórico de que falaram Carmen Reinhart e Kenneth Rogoff em uma análise de dois séculos, a que já nos referimos. Acima daquele limiar dos 90-100% estarão, até final do ano, a Grécia (124,9%), Itália (118,2%) [...]

  7. [...] numa investigação sobre a história de defaults em países desenvolvidos e em países emergentes [a que nos referimos], que primeiro apontaram este evento aparentemente [...]

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