Another Year of Living Dangerously

CHICAGO, Feb. 1 /PRNewswire/ -- "A buyers' market in government bonds is forcing some countries to perform a balancing act between expansionary fiscal policies and the need to rein in spending. Not surprisingly, this squaring of the circle is a tough challenge for nations with weaker macroeconomic fundamentals or greater exposure to external imbalances," says Adolfo Laurenti, deputy chief economist at Mesirow Financial, in his January issue of Themes on the Global Markets, available at http://www.mesirowfinancial.com/economics/laurenti/themes/globalmkts_0110.pdf

In his January newsletter, Laurenti looks at some recent cases of strain on sovereign risk in Iceland, Dubai and Greece. He describes the lessons to be learned from these countries, in particular, about the quality of governance and the risks of globalized financial markets. And he points out the important insights to be gained for the dollar and the outlook for U.S. domestic interest rates.

"The Icelandic situation was somewhat unique, considering that each of the three major, local banks carried a balance sheet greater than the national GDP of the country, with heavy exposure to the tumbling real estate market in the United Kingdom."

"In Dubai, matters were different. There, the crisis was not triggered by one sector, but by one company - the government-owned conglomerate, Dubai World. Not unlike Freddie Mac and Fannie Mac in the U.S., Dubai World was in all effects a private corporation which was widely perceived as being guaranteed by the local authorities. Operating like a sovereign equity fund, the company used leverage to buy concentrated stakes in business ventures - illiquid by nature. Once sources for funding dried up, Dubai World failed to rollover its debt in November 2009, and was left with default as the only option. Authorities in Dubai and at the federal level in the United Arab Emirates (UAE) played a game of chicken about a possible bailout, which left investors confused about what the actual outcome might be."

"There are three lessons that can be learned from the events in Iceland and Dubai.

• A sound government budget position does not necessarily translate into sound macroeconomic fundamentals. Public finances were fine, both in Iceland and in Dubai, yet government coffers were out-matched in both cases by the unraveling of gigantic financial institutions, either private or semi-public in nature.
• Financial crises hit fast; in both cases, it took just a few days for the financial architecture to collapse, and take with it the 'real economy;' no longer just the financial sector. At that point, policymakers faced financial, economic and political hurdles nearly impossible to surmount.
• Moral hazard matters. Too-big-to-fail is a reality that is priced into the valuation of assets and institutions of which governments cannot let go. Global investors take government guarantees seriously, yet in too many cases, policymakers fail to rein in risk-taking by large institutions with easy access to cheap funding."

"Greece differs from Iceland and Dubai because it represents a more traditional case of a country running into trouble for its burgeoning external debt. In another sense, though, Greece matters because it epitomizes the economic woes of several European countries, both in the euro area and recently among members of Central and Eastern Europe."

"Clearly, we do not believe that the situation in the U.S. is anywhere close to any of the aforementioned cases. The risk of default on the federal debt is simply not in the cards. Despite the deterioration in our fiscal position, the U.S. Treasury remains, relatively speaking, in decent shape. If anything, the financial crisis has reinforced the idea of the dollar as a safe haven. Yet, we strongly warn against fiscal complacency. The real risk is a loss of financial leadership due to a lack of fiscal discipline, which might cost us a ramp-up in long-term rates. This is a more realistic scenario than the one suggested by the doomsayers, and one over which we may have some control. But will Congress have the will to act proactively and decisively?" concludes Laurenti.

The January issue of Themes on the Global Markets, as well as archived issues, can be found at mesirowfinancial.com.

Mesirow Financial is a diversified financial services firm headquartered in Chicago. Founded in 1937, it is an independent, employee-owned firm with more than $30 billion in assets under management and 1,200 employees in locations across the country and in London. With expertise in Investment Management, Investment Services, Insurance Services, Investment Banking, Consulting and Real Estate, Mesirow Financial strives to meet the financial needs of institutions, public sector entities, corporations and individuals. For more information about Mesirow Financial, visit its Web site at mesirowfinancial.com.

SOURCE Mesirow Financial

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