In early October 2008, I wrote about the concept of sovereign bankruptcy in the context of Iceland’s banking crisis, and that we should get used to the idea of a country declaring bankruptcy. The following weeks saw Iceland’s crisis result in the collapse of its currency and stock market, and nationalization of banks.
A year later, media outlets such as The Economist and WSJ are buzzing about sovereign bankruptcy once again, as the subsidiary of the Dubai emirate Dubai World is extending its payment deadlines. The ruling family of Dubai has sworn off ultimate liability for the debts, claiming that they are the shareholders and not jointly and severally liable, but this has nonetheless ignited talk worldwide about the issue of sovereign bankruptcy.
Of course, the United Arab Emirates have plenty of money — it’s Dubai that is facing liquidity problems. And I think the problem is more an issue of “subprime meltown, part 2″ than defaulting on sovereign debt, with the amounts at a paltry 10% of Lehman’s obligations when it filed for Chapter 11 last year. Dubai also has a number of cushions unavailable to many debtors over the past few years as the “Too big to fail” institution of the Middle East. The emirate of Dubai may feel compelled to bail out Dubai World; Abu Dhabi, as the oil-rich capital of the UAE, may feel compelled to bail out Dubai; and other interested parties in the region may feel compelled to further help Dubai, such as the Saudis, if things get even worse. (There are also some who think that Abu Dhabi’s mass purchase of Dubai bonds is to limit possible Saudi influence over Dubai.)
But “too big to fail” is supposed to apply to multinational institutions, not sovereign states — modern states in today’s world are “too big to even contemplate failure” — until now. Commentators are now worrying that Iceland and Dubai may only be the beginning, and the New York Times has a graph that shows the scope of debts by at-risk countries.
On top of this, there is the risk that developed, industrialized countries such as Portugal, Spain, Italy, or even Japan — which now has public debt in excess of 200% of it’s GDP with poor future prospects for growth — could default on debt in the near future. All of this is bringing us into a world that makes the future impossible to forsee with any accuracy, and sovereign bankruptcy could bring us into unknown territory far beyond what Lehman’s collapse showed us.