The Next Public Debt Crisis Has Arrived


In July of 2009, while the smoke from the global financial bonfire was still thick in the air, I wrote for this website about another crisis of massive proportions just looming on the horizon: the Global Crisis in Public Debt.

Three years later, the news of defaults, bankruptcies, debt forgiveness requests, receiverships, and bailouts are in the news every day. Across the globe, sovereign entities – from US cities to European nations – are suffering under staggering debt loads, decimated revenues and intense pressure from the very capital markets that they should be able to turn to for refuge. Last month, Jefferson County, the largest in Alabama, moved forward with their bankruptcy proceedings over the objections of the Wall Street banks. Suffolk County in New York declared a financial emergency. The Financial Times has an interactive map showing all but 12 U.S. states with budget shortfalls for 2012. Eleven U.S. cities, counties and villages have filed bankruptcy since 2008, plus 21 municipal non-government entities (e.g., utilities, hospitals, schools, etc.), according to the Pew Center on the States.

This crisis for cities, states and nations, like so many other financial crises, has its root in the free flow of credit that existed during the preceding economic boom years. The market prices of assets rose steadily. Rising valuations, especially based on improving revenues from robust economic activity, led to rising income streams for governments. This encouraged governments to borrow more, perhaps often to expand services – and the bureaucracy required to deliver them – and sometimes to improve infrastructure and make capital investments.

At the same time, rising market prices for financial assets encouraged more savers and investors into the market. In the US, the flow of cash to Wall Street was further encouraged by favorable tax treatment for the earnings on retirement savings and municipal bonds. The steady influx of new money produced an increasing supply of investable funds, which drove demand for sovereign and municipal debt (in addition to the mortgage-backed securities).

This process was driven more by the financial services industry than the real economy. As of March 5, 2012, the Federal Reserve Bank of New York reported more than $5,000,000,000,000 ($5 trillion) in overnight securities financing – that’s money that makes money but nothing else – that’s more than 20% of US GDP sitting around, not creating jobs, not building infrastructure, just sitting. Since the investment of securities financing is virtually all done electronically, it creates very few jobs. What it does produce is a boost in revenues for bankers – which they can translate into often lavish bonuses.

The financial sector also adds to its profits from issuance fees, trading fees, underwriting fees, etc. Then there’s “Market Risk Trading,” a euphemism for letting anyone buy a contract to gamble on the probability that Greece won’t be able to repay their debt or that you will miss a mortgage payment. Anyone can buy that contract, even the arsonist next door who has a say in whether or not Greece gets access to capital. In the end it is the borrowers who will suffer the consequences because they will be unable to refinance their debt and the gamblers who will win by withholding financing in anticipation of the insurance payout.

At the end of June 2009, only Italy, Turkey and Brazil were covered by more credit default swap contracts than JP Morgan Chase and Bank of America.   Goldman Sachs, Morgan Stanley, and Wells Fargo Bank all had more credit derivate coverage than the Philippines.   

Entered the Top 1,000 for credit default swaps after 2009

Reference Entity

Debt as %GDP

CDS* as %Debt




New Jersey



New Zealand









Kingdom of Saudi Arabia



Lebanese Republic



Arab Republic of Egypt



*CDS are credit default swaps, financial contracts that pay off if the named (reference) entity experiences a credit event like a ratings downgrade or a missed payment.
[Abu Dhabi also appears in the 2012 list of the top 1,000 entities named in credit default swaps at DTCC, but debt and GDP data are not available.]

What was a potential default problem in 2009 has become reality in 2012. In 2009, gross credit default swaps outstanding for the debt of Iceland were equal to 66 percent of GDP, and around 18 percent for Portugal. As these countries struggle with their debt, the global banks – primarily the US banks – sell credit derivatives and stand to collect enormous payments – whether or not the defaulting countries receive any support or bailouts from international donor organizations. The reason is that most credit derivatives contracts pay out on “credit events.” A “credit event” can be something as simple as a downgrade from Moody’s or Standard and Poor’s – whose managers testified before Congress that credit rating changes can be bought. Standard & Poor’s executives admitted in 2008 that they were being forced to relax rating requirements to improve revenues. If, for example, $69 billion worth of credit derivative payoffs are available on a Greek default then how much could the owner of a credit swap afford to pay for a rating change?

The absurdity of rating Egypt more credit worthy than Australia is only part of the story. The sad fact is that Wall Street banks can sell more credit risk protection than there is credit risk. If all the public debt of a country is $1 billion, it means that country has borrowed $1 billion in public capital markets.  But   Wall Street banks are buying and selling more credit risk insurance than there is credit risk. This is the same problem I wrote about in 2008 that we saw in the Treasury bond market – when you sell more bonds than exist these trades are called “naked” sales or “phantoms”. A similar problem in stocks contributed to the 2008 crash.

There are more cities, counties, states and nations in financial trouble   According to the Bank for International Settlements, there were $615 trillion in Over-The-Counter (OTC) derivatives contracts outstanding worldwide at the end of 2009. That's about 9 times global GDP.  In other words, the entire world would have to work for 9 year just to produce enough to pay off the derivatives – before we had a dime left over to pay off the original debts.

In this environment, the sovereign debt crises may produce something scarier than anything we have experienced in the past. The use of credit derivate products has increased the chance of a default turning into a global catastrophe. It won’t be enough to pay off the debt owed by one of these sovereigns. That payoff will be magnified by the value of the credit derivatives. These derivatives will have a multiplier effect on every sovereign debt default or “credit event.” The table at the end of this article only includes the credit derivatives warehoused with the Depository Trust and Clearing Corporation in the US – there is no source of information on the real magnitude.

A crisis in sovereign debt would cause problems not just within those nations, states or cities but also for the global financial institutions who sell default protection through the credit derivatives markets. The bankruptcy of Jefferson County (AL) threatens to take down muni-bond insurer Syncora Guarantee (who, by the way, is suing JPMorgan Chase over losses in mortgage-backed securities saying that JPMorgan Chase misrepresented the loans to obtain the insurance). Another such institution was Ambac Financial Group, Inc., which I described in an article published here months before the original prediction of the global crisis in public debt. Ambac – like Berkshire Hathaway – was in the business of guaranteeing the payments of public debt (and mortgage backed securities). Ambac filed for bankruptcy in November 2010.  With Ambac gone, Berkshire is next in line to pay because of Warren Buffett’s credit default swaps.

Policy makers have had few options available across the globe to combat this crisis. The European Union Commission is attempting to control the amount of credit insurance being sold by limiting the sale of “naked” credit default swaps.  A proposal was approved by the European Parliament on November 15, 2011 to restrict the sale of credit insurance to any buyer who “does not have ownership of the underlying government debt.”    The limited regulation passed by the EU Parliament allows the sale if the buyer has ownership in something vaguely related to the sovereign debt – like allowing the purchase of swaps on Italian government debt if the buyer owns shares of an Italian bank. French President Sarkozy said in January that he would propose “special levies on naked credit default swaps.”  The imposition of fines or taxes (levies) has not eliminated similar activity in stock and bond markets in the US, though it is at least a start which is more than US regulators have done.

Meanwhile, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner continue to load the helicopter with dollar bills to finance the payouts with freshly-minted U.S. dollars. They sell us the fantasy of free-market capitalism while laying down a labyrinth of financial rules and regulations allowing a dozen or so politically connected banks to reap the rewards while avoiding the risk of failing, US financial institutions have been placing losing bets through unregulated derivatives markets only to be bailed out as “systemically important” – a euphemism for “too politically connected to fail.” The rest of the world is taking steps to stop the damage. When will the US government step up to the plate?

Sovereigns named in most credit default protection*
2009 2012 2009 2012
Sovereign Entity Debt % GDP Debt % GDP CDS % Debt CDS % Debt CDS change 2008 to 2012*** Region
REPUBLIC OF ICELAND 23.0% 130.1% 315.2% 40.4% -2,322,155,904 Europe
REPUBLIC OF ESTONIA 3.8% 5.8% 206.7% 193.4% 844,012,716 Europe
UKRAINE 10.0% 44.8% 194.5% 28.9% -23,102,981,592 Europe
REPUBLIC OF KAZAKHSTAN 9.1% 16.0% 144.0% 57.5% -3,440,253,859 Europe
REPUBLIC OF BULGARIA 16.7% 17.5% 100.6% 112.5% 4,163,215,975 Europe
REPUBLIC OF LATVIA 17.0% 44.8% 92.4% 62.3% 3,369,945,521 Europe
BOLIVARIAN REPUBLIC OF VENEZUELA 17.4% 38.0% 80.7% 45.9% 5,646,959,440 Americas
STATE OF QATAR 6.0% 8.9% 76.4% 55.4% 5,040,787,988 Europe
RUSSIAN FEDERATION 6.8% 8.7% 72.7% 55.7% 4,966,368,803 Europe
REPUBLIC OF TURKEY 37.1% 42.4% 56.1% 32.5% -43,726,859,566 Europe
REPUBLIC OF LITHUANIA 11.9% 37.7% 42.7% 28.8% 3,438,691,822 Europe
REPUBLIC OF PANAMA 46.4% 41.7% 36.7% 37.1% 989,207,525 Americas
REPUBLIC OF THE PHILIPPINES 56.5% 49.4% 36.6% 28.8% -10,157,402,334 Asia Ex-Japan
REPUBLIC OF PERU 24.1% 21.9% 34.1% 41.1% 7,324,285,482 Americas
ROMANIA 14.1% 34.0% 31.2% 20.6% 6,566,917,982 Europe
REPUBLIC OF CHILE 3.8% 9.4% 30.9% 21.2% 2,719,694,915 Americas
IRELAND 31.5% 209.2% 28.2% 22.5% 27,767,560,886 Europe
UNITED MEXICAN STATES 20.3% 37.5% 23.7% 20.2% 50,658,161,703 Americas
REPUBLIC OF SLOVENIA 22.0% 45.5% 22.5% 23.0% 3,206,639,043 Europe
REPUBLIC OF HUNGARY 73.8% 76.0% 21.6% 47.1% 37,403,179,311 Europe
REPUBLIC OF SOUTH AFRICA 29.9% 35.6% 21.5% 24.6% 17,010,145,334 Europe
ARGENTINE REPUBLIC 51.0% 42.9% 18.7% 17.2% -2,448,737,614 Americas
FEDERATIVE REPUBLIC OF BRAZIL 40.7% 54.4% 18.2% 13.0% 14,703,918,548 Americas
PORTUGUESE REPUBLIC 64.2% 72.1% 15.9% 25.2% 39,897,746,989 Europe
REPUBLIC OF COLOMBIA 48.0% 45.6% 15.9% 14.9% 1,221,052,625 Americas
SLOVAK REPUBLIC 35.0% 44.5% 12.8% 19.3% 5,533,166,393 Europe
KINGDOM OF SPAIN 37.5% 68.2% 11.9% 16.9% 101,554,412,387 Europe
REPUBLIC OF KOREA 32.7% 22.9% 11.8% 20.0% 22,088,912,724 Asia Ex-Japan
REPUBLIC OF CROATIA 48.9% 60.5% 11.5% 19.9% 5,612,474,098 Europe
HELLENIC REPUBLIC (Greece) 90.1% 165.4% 11.1% 13.6% 34,488,989,840 Europe
REPUBLIC OF INDONESIA 30.1% 24.5% 11.0% 16.1% 13,723,880,843 Asia Ex-Japan
MALAYSIA 42.7% 57.9% 9.7% 7.8% 4,044,633,137 Asia Ex-Japan
KINGDOM OF DENMARK 21.8% 46.9% 9.3% 17.2% 12,665,229,924 Europe
STATE OF FLORIDA 3.2% 17.9% 8.1% 16.8% 2,787,096,121 Americas
REPUBLIC OF AUSTRIA 58.8% 103.3% 7.9% 21.3% 38,904,764,846 Europe
REPUBLIC OF ITALY 103.7% 120.1% 7.9% 14.6% 171,818,588,038 Europe
KINGDOM OF THAILAND 42.0% 45.6% 7.1% 6.5% 1,675,447,429 Asia Ex-Japan
SOCIALIST REPUBLIC OF VIETNAM 38.6% 54.5% 6.4% 5.9% 3,717,696,305 Asia Ex-Japan
CZECH REPUBLIC 29.4% 39.9% 6.0% 11.5% 7,793,110,452 Europe
REPUBLIC OF POLAND 41.6% 56.7% 5.9% 9.7% 25,523,188,448 Europe
REPUBLIC OF FINLAND 33.0% 49.0% 5.7% 17.3% 12,868,084,419 Europe
THE CITY OF NEW YORK ** 7.5% 4.3% 8.4% 3,555,950,000 Americas
STATE OF NEW YORK 4.2% 24.8% 4.3% 5.3% 1,215,398,707 Americas
KINGDOM OF SWEDEN 36.5% 36.8% 4.1% 15.0% 15,665,446,384 Europe
KINGDOM OF BELGIUM 80.8% 99.7% 3.9% 15.1% 49,607,728,521 Europe
STATE OF ISRAEL 75.7% 74.0% 3.4% 7.0% 7,093,224,168 Europe
STATE OF CALIFORNIA 3.9% 18.3% 3.2% 12.7% 8,068,160,000 Americas
FEDERAL REPUBLIC OF GERMANY 62.6% 81.5% 2.1% 4.5% 75,770,481,300 Europe
KINGDOM OF NORWAY 52.0% 48.4% 1.6% 6.3% 5,953,647,323 Europe
KINGDOM OF THE NETHERLANDS 43.0% 64.4% 1.6% 5.3% 19,494,129,128 Europe
PEOPLE'S REPUBLIC OF CHINA 15.7% 16.3% 1.5% 3.7% 49,294,027,432 Asia Ex-Japan
FRENCH REPUBLIC 67.0% 85.5% 1.5% 6.8% 108,226,300,245 Europe
47.2% 79.5% 1.2% 3.6% 51,470,774,560 Europe
JAPAN 170.4% 208.2% 0.1% 0.8% 67,160,972,268 Japan
UNITED STATES OF AMERICA 60.8% 69.4% 0.1% 0.2% 19,471,174,892 Americas
*List from Depository Trust and Clearing Corporation. [] Dubai was also on this list, but debt and GDP data were not available.
**2012 GDP for City of NY was calculated by subtracting all other MSA output from state GDP.
*** Lower totals may indicate that some credit default swap contracts have been paid off.
Countries in Italics had not failed to meet their debt repayment schedules before 2008 (Reinhart and Rogoff 2008); Thailand and Korea received IMF assistance to avoid default in the 1990s.


Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Dr. Trimbath’s credits include appearances on national television and radio programs and the Emmy® Award nominated Bloomberg report Phantom Shares. She appears in four documentaries on the financial crisis, including Stock Shock: the Rise of Sirius XM and Collapse of Wall Street Ethics and the newly released Wall Street Conspiracy. Dr. Trimbath was formerly Senior Research Economist at the Milken Institute. She served as Senior Advisor on United States Agency for International Development capital markets projects in Russia, Romania and Ukraine. Dr. Trimbath teaches graduate and undergraduate finance and economics.

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State problems affect federal budget

Bloomberg's Brian Barry writes on Jan 9, 2013 how the fiscal problems in the states are trickling UP to the federal level:

"The fiscal outlook for many states is unsustainable. This eventually may influence the politics of the national budget, both directly (through battles over federal measures to help troubled states) and indirectly (through voters’ attitudes toward government)."

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Read the report and it

Read the report and it basically talks about yet another layer of debt that will have to be paid by tax payers due to mismanagement and making promises that can't be kept. Unfortunately at this point we have 2 choices which are both bad: Continue to believe in the FED, allow it to print money to pay off these debts and live with the inflation and continue with the robbing of the middle class to pay off upper class investors, or, Pop the bubble and all suffer through a 10 to 20 year depression. Either way middle class loses.

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Coming to America

Although this article includes a listing of foreign countries, the problem of sovereign debt is also coming home to roost in the US cities. Stockton, Detroit, Harrisburg -- cities of all sizes are in trouble. For a look at an even more sinister side of the role Wall Street played in putting these US towns in jeopardy, check out Matt Taibbi's blogs at Rolling -- from the interest rates earned by municipalities to what you pay on your personal debt, the "market" rate is not determined fairly.

If you have a WTF (or HFS) moment, post a reply here.


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CDS is the root of sovereign debt problem?

Without CDS, the heavy indebted countries would still be in trouble.

Also, both Japan and US have very relative low CDS level because they control their own currencies and can print money to avoid credit events (outside of congressional refusal to raise the US debt ceiling). But that does not mean these two countries will not face serious problems when the bond market raises the prices of these countries' bonds.

The root cause is the debt itself and not the derivative based on the debt. And be sure not to rescue any banks or firms that bet wrong on CDS; they have to be wiped out.