BIG PIC­TURE

WHEN IT COMES TO NA­TION STATES SPEND­ING BE­YOND THEIR MEANS, GREECE IS ONCE AGAIN DOM­I­NAT­ING HEAD­LINES. BUT THE BIRTH­PLACE OF WEST­ERN DEMOC­RACY HAS PLENTY OF COM­PANY — AND WE’RE NOT JUST TALK­ING ABOUT OTHER MEM­BERS OF THE CLUB KNOWN AS EUROPE’S PIIGS (PORT

National Post (Latest Edition) - Financial Post Magazine - - COLUMNS & DEPARTMENTS -

Coun­tries are rack­ing up big­ger and big­ger debts even while trum­pet­ing the Age of Aus­ter­ity.

Re­mem­ber all the talk about delever­ag­ing that came af­ter the credit bub­ble burst and sub­jected the world econ­omy to the worst fi­nan­cial cri­sis since the Great De­pres­sion? The talk was cheap be­cause no­body bought into it. In­deed, all ma­jor economies to­day have higher debt lev­els rel­a­tive to GDP than be­fore the so-called Age of Aus­ter­ity started.

What kinds of dol­lars are we talk­ing about? Ac­cord­ing to the McKin­sey Global In­sti­tute, to­tal world li­a­bil­i­ties have in­creased by a whop­ping US$57 tril­lion since 2007 . Gov­ern­ments are the worst of­fend­ers, in­creas­ing their col­lec­tive debt by US$25 tril­lion at a 9.7% com­pound an­nual growth rate over the past seven years.

Cor­po­ra­tions have done a bet­ter job of man­ag­ing the im­pulse to bor­row, in­creas­ing li­a­bil­i­ties by only US$18 tril­lion since 2007 . But here is the re­ally bad news. The best of the bunch still ap­pear des­tined to be ham­mered by credit rat­ing down­grades thanks to out-of-con­trol public spend­ing, say an in­ter­na­tional group of debt mar­ket an­a­lysts.

“Our re­search has un­cov­ered a dis­turb­ing is­sue,” says Colom­bian risk man­age­ment ex­pert Felipe Restrepo, who re­cently signed on to teach fi­nance at West­ern Uni­ver­sity’s Ivey Busi­ness School. He points out that when a down­grade on sovereign debt is is­sued, the sys­tem de­ployed by credit rat­ing firms will trig­ger re­lated pri­vate­sec­tor down­grades that are not based upon com­pany fun­da­men­tals. This re­sults from the so-called sovereign ceil­ing rule, which was de­signed to limit the credit rat­ings of com­pa­nies to lev­els no higher than those war­ranted by their na­tion state.

Although this rule is not strictly ap­plied, it has cre­ated a sig­nif­i­cant link be­tween the rat­ings of sovereign debt and the debt of public cor­po­ra­tions, but only for firms with the same or bet­ter rat­ing as a gov­ern­ment. In other words, fol­low­ing a sovereign down­grade, a coun­try’s health­ier firms tend to be ar­bi­trar­ily pe­nal­ized with a lower credit rat­ing, which in­creases their cost of cap­i­tal. And this does not hap­pen as of­ten or as quickly to higher-risk firms.

As a re­sult, sovereign debt down­grades ac­tu­ally en­cour­age cap­i­tal to flow away from a na­tion’s best busi­nesses at a time when the econ­omy most needs the pri­vate sec­tor to help stim­u­late sta­ble growth.

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