Saturday, November 1, 2014

07/15/2011 The Sovereign Debt Crisis Learning Curve *

For the week, the S&P500 declined 2.1% (up 4.7% y-t-d), and the Dow fell 1.4% (up 7.8%). The S&P 400 Mid-Caps sank 2.9% (up 7.6%), and the small cap Russell 2000 fell 2.8% (up 5.8%). The Banks sank 4.2% (down 11.3%), and the Broker/Dealers fell 4.1% (down 15.7%). The Morgan Stanley Cyclicals dropped 2.8% (up 2.6%), and the Transports sank 3.7% (up 4.6%). The Morgan Stanley Consumer index declined 1.4% (up 2.0%), and the Utilities fell 2.0% (up 5.8%). The Nasdaq100 declined 2.0% (up 6.3%), and the Morgan Stanley High Tech index dropped 3.6% (down 2.2%). The Semiconductors sank 5.7% (down 5.3%). The InteractiveWeek Internet index fell 2.7% (up 1.7%). The Biotechs dropped 2.7% (up 10.6%). With bullion surging $49 to another record high, the HUI gold index jumped 5.9% (down 0.9%).

One-month Treasury bill rates ended the week at zero and three-month bills closed at one basis point. Two-year government yields were little changed at 0.35%. Five-year T-note yields ended the week down 14 bps to 1.44%. Ten-year yields fell 12 bps to 2.91%. Long bond yields declined 3 bps to 4.25%. Benchmark Fannie MBS yields declined 7 bps to 3.89%. The spread between 10-year Treasury yields and benchmark MBS yields widened 5 to 98 bps. Agency 10-yr debt spreads were little changed at negative 7 bps. The implied yield on December 2012 eurodollar futures declined 6 bps to 0.84%. The 10-year dollar swap spread declined slightly to 13.75 bps. The 30-year swap spread declined 3 bps to negative 33 bps. Corporate bond spreads widened. An index of investment grade bond risk widened 5 bps to 97 bps. An index of junk bond risk jumped 32 bps to 491 bps.

Debt issuance remained slow. Investment-grade issuers included Capital One $3.0bn, JPMorgan $1.75bn, Marsh & McLennan $500 million, PPL Electric Utilities $250 million.

Junk bond funds saw inflows of $1.3bn (from Lipper). Junk issuers included Level 3 $1.2bn, Dynacast $350 million, WM Finance $300 million, GFI Group $250 million, Examworks $250 million, Kratos $115 million, and El Pollo Loco $105 million.

Convertible debt issuance included Electronic Arts $550 million.

International dollar bond issuers included Buenos Aire $1.05bn and Metalloinvest $750 million.

German bund yields dropped 13 bps to 2.69% (down 27bps y-t-d), and U.K. 10-year gilt yields declined 12 bps this week to 3.08% (down 43bps). Greek two-year yields ended the week up 268 bps to 31.64% (up 1,940bps). Greek 10-year note yields rose 66 bps to 17.06% (up 460bps). Italian 10-yr yields rose 49 bps to 5.75% (up 94bps), and Spain's 10-year yields jumped 38 bps to 6.05% (up 61bps). Ten-year Portuguese yields declined 29 bps to 12.22% (up 564bps). Irish yields surged 110 bps to 13.74% (up 469bps). The German DAX equities index fell 2.5% (up 4.4% y-t-d). Japanese 10-year "JGB" yields dropped 9 bps to 1.09% (down 3bps). Japan's Nikkei declined 1.6% (down 2.5%). Emerging markets were under pressure. For the week, Brazil's Bovespa equities index dropped 3.3% (down 14.2%), and Mexico's Bolsa declined 0.9% (down 6.2%). South Korea's Kospi index fell 1.6% (up 4.6%). India’s equities index declined 1.6% (down 9.5%). China’s Shanghai Exchange increased 0.8% (up 0.4%). Brazil’s benchmark dollar bond yields declined 3 bps to 4.03%, and Mexico's benchmark bond yields fell 3 bps to 3.96%.

Freddie Mac 30-year fixed mortgage rates dropped 9 bps to 4.51% (down 6bps y-o-y). Fifteen-year fixed rates sank 15 bps to 3.65% (down 41bps y-o-y). One-year ARMs declined 6 bps to 2.95% (down 79bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 3 bps to 5.05% (down 42bps y-o-y).

Federal Reserve Credit increased $4.8bn to a record $2.859 TN (36-wk gain of $578bn). Fed Credit was up $451bn y-t-d and $543bn from a year ago, or 23.5%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 7/13) increased $5.4bn to $3.451 TN. "Custody holdings" were up $100bn y-t-d and $337bn from a year ago, or 10.8%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – surpassed $10 Trillion for the first time, now having doubled in 4.5 years. Reserves were up $1.591 TN y-o-y, or 18.8%. Over two years, reserves were $3.055 TN higher, for 44% growth.

M2 (narrow) "money" supply surged $88.7bn to a record $9.253 TN. "Narrow money" has expanded at a 9.1% pace y-t-d and 7.7% over the past year. For the week, Currency slipped $0.4bn. Demand and Checkable Deposits jumped $48.5bn, and Savings Deposits surged $45.5bn. Small Denominated Deposits declined $3.3bn. Retail Money Funds slipped $1.5bn.

Total Money Fund assets rose $9.7bn last week to $2.696 TN. Money Fund assets were down $114bn y-t-d, with a decline of $119bn over the past year, or 4.2%.

Total Commercial Paper outstanding jumped $21.3bn to $1.232 Trillion. CP was up $263bn y-t-d, or 42% annualized, with a one-year rise of $135bn.

Global Credit Market Watch:

July 14 – Bloomberg (Garth Theunissen): “The euro’s fate may lie in the hands of Italian bondholders as the region’s debt crisis threatens to envelop the Mediterranean nation, according to Credit Agricole Corporate & Investment Bank. …Italy’s government debt burden, the euro area’s largest at 1.8 trillion euros ($2.6 trillion), dwarfs those of Greece, Ireland and Portugal, which already received bailouts, and Spain, which has the next-highest borrowing costs… ‘If Italy gets to the point where its debt auctions start to fail and it loses access to the market, it becomes difficult to imagine who would have the kind of money that would be required to rescue it,’ said Luca Jellinek, head of European interest-rate strategy at Credit Agricole… ‘It’s undoubtedly bigger than the current scope of the EFSF.’”

July 14 – Bloomberg (Abigail Moses): “Greece has about a one in 10 chance of sidestepping default, according to credit traders who are betting the country will be crippled by $490 billion of debt -- more than $40,000 for every man, woman and child. Investors who bought 10-year Greek debt last year have lost almost half their money, with yields soaring to more than 17% as the budget deficit swelled by 28% since January. A $155 billion bailout hasn’t stopped the nation’s debt from becoming riskier than Venezuela…”

July 11 – Bloomberg (Marcus Bensasson): “Greece’s state budget deficit widened to 12.8 billion euros in the January to end-June period, from 10 billion euros in the year-earlier period, according to an e-mailed statement from the Athens-based Finance Ministry today. Net budget revenue fell 8.3% to 21.8 billion euros, the ministry said. Spending was up 8.8%...”

July 13 – Bloomberg (Daniel Kruger and Dara Doyle): “Ireland joined Portugal and Greece as the third euro-area nation to have its credit rating reduced to below investment grade as European Union finance ministers struggle to contain the region’s sovereign debt crisis.”

July 14 – Bloomberg (Jody Shenn): “Relative yields on government-backed mortgage securities that guide loan rates for U.S. home buyers are hovering at about the highest in almost two years as debt crises in Europe and America roil global credit markets and boost the volatility of benchmark interest rates.”

July 11 – Bloomberg (Angeline Benoit): “Spain’s Castilla-La Mancha region requested an urgent meeting with the Finance Ministry about its “extremely serious” fiscal situation as the nation’s borrowing costs reached a record on concern about debt-crisis contagion. ‘The deficit is much higher than what we were told, the situation is extremely serious,’ the region’s president, Maria Dolores de Cospedal, told Onda Cero radio in an interview today. In the first quarter alone, the deficit reached 1.7% of gross domestic product compared with an annual target of 1.3%,” said Cospedal, elected on May 22 when the opposition People’s Party ended three decades of local Socialist rule.”

July 11 – Bloomberg (Lorenzo Totaro and Elisa Martinuzzi): “Italy’s market regulator moved to curb short selling after the country’s benchmark stock index fell the most in almost five months and bonds tumbled on investor concern the nation may be the next crisis victim.”

July 14 – Bloomberg (Mary Childs and Sapna Maheshwari): “Apollo Global Management LLC’s CKX Inc. postponed a $360 million bond offering to repay bridge financing as credit markets weakened, leaving Goldman Sachs Group Inc. and Macquarie Group Ltd. stuck holding the ‘American Idol’ television show owner’s short-term loans.”

July 14 – Bloomberg (Jack Jordan): “The selloff triggered by Greece and Italy’s debt crisis is cutting demand for Russian government bonds to the lowest level in 18 months. The Finance Ministry sold 4% of its 30 billion-ruble ($1.07 billion) offering of notes due 2021 yesterday, the smallest proportion since January 2010, central bank data show. Demand fell short after the government offered an average yield of 7.9%, the top of its guidance range though below the 8% yield the securities traded at the previous day.”

Global Bubble Watch:

July 12 – Bloomberg (Jeff Kearns and Nina Mehta): “Increasing use of options by asset managers may help boost U.S. equity derivatives volume about 8% to 4.2 billion contracts this year for a ninth straight annual record, according to research firm Tabb Group LLC.”

Currency Watch:

For the week, the U.S. dollar index was little changed at 75.126 (down 4.9% y-t-d). For the week on the upside, the Swiss franc increased 2.6%, the Japanese yen 1.9%, the Canadian dollar 1.0%, the New Zealand dollar 0.9%, the British pound 0.48%, and the Singapore dollar 0.1%. On the downside, the Norwegian krone declined 2.6%, the South African rand 2.6%, the Swedish krona 1.6%, the Mexican peso 1.0%, the Australian dollar 1.0%, the Brazilian real 0.8%, the euro 0.8%, the Danish krone 0.7%, and the Taiwanese dollar 0.4%.

Commodities and Food Watch:

The CRB index added 0.8% (up 4.1% y-t-d). The Goldman Sachs Commodities Index rose 1.2% (up 9.8%). Spot Gold jumped 3.2% to $1,594 (up 12.2%). Silver surged 6.9% to $39.071 (up 26.4%). August Crude gained $1.04 to $97.24 (up 6%). August Gasoline rose 1.2% (up 28%), and August Natural Gas rallied 8.1% (up 3.2%). September Copper was unchanged (down 1%). September Wheat jumped 6.7% (down 12%), and September Corn surged 9.2% (up 12%).

July 13 – Bloomberg (Justin Doom): “U.S. consumers are poised to pay the most ever for their breakfast orange juice as inventories dwindle. …retail orange-juice prices have climbed to the highest level since reaching a record in March 2009. Stockpiles of the frozen beverage slid 40% in the 12 months through May…”

China Bubble Watch:

July 12 – Bloomberg: “China’s new loans exceeded estimates in June and foreign-exchange reserves jumped by $153 billion in the second quarter, bolstering the case for more increases in bank reserve requirements. New loans were 633.9 billion yuan ($98bn), compared with the 622.5 billion yuan median estimate in a Bloomberg News survey of economists. M2… rose by a more-than-forecast 15.9%, and foreign-exchange reserves climbed to $3.2 trillion.”

July 13 – Bloomberg: “China’s June housing transactions rose 31% from May as homebuyers defied government curbs and developers posted gains from sales in smaller cities. The value of homes sold last month increased to 499.2 billion yuan ($77 billion)… Housing sales in the first half climbed 22% to 2.1 trillion yuan from a year earlier… More developers are selling homes in so-called third and fourth-tier or less affluent cities which haven’t introduced local restrictions or are immune to nationwide measures targeting speculators, who usually buy in bigger metropolitan areas… Investment in Chinese real estate rose 33% to 2.6 trillion yuan in the first six months from a year earlier… New property construction in the first half climbed 24% to 994.4 million square meters.”

India Watch:

July 14 – Bloomberg (Unni Krishnan and Chinmei Sung): “India’s inflation accelerated, sustaining pressure on the central bank to tighten monetary policy this month… The benchmark wholesale-price index rose 9.44% in June from a year earlier after a 9.06% jump in May…”

Asia Bubble Watch:

July 13 – Bloomberg (Eunkyung Seo and Rose Kim): “South Korea’s unemployment rate stayed at the lowest level in half a year as the economic expansion spurred hiring in the manufacturing sector. The jobless rate was at 3.3% in June…”

Unbalanced Global Economy Watch:

July 13 – Bloomberg (Angeline Benoit and Emma Ross-Thomas): “Spanish Finance Minister Elena Salgado said the nation might need to endure even deeper spending cuts next year than those approved by Parliament yesterday as it battles to stave off Europe’s debt crisis.”

July 13 – Bloomberg (Ilya Arkhipov): “Russia and members of the Eurasian Economic Community, a grouping of former Soviet republics, are seeking to loosen the dominance of U.S. credit-rating companies and may set up an independent rival next year. Prime Minister Vladimir Putin has said he’s an ‘ardent supporter’ of the plan because Russia’s debt grade is an ‘outrage’ that lifts corporate borrowing costs and increases risks. The nation’s sovereign credit rating was last raised by… Moody’s… in 2008 to Baa1, the third-lowest investment grade, one step above Brazil and four below China. ‘It’s madness to trust American rating agencies,’ Sergei Glazyev, the group’s deputy general secretary, said… ‘The market is objectively interested in new reference points.’”

U.S. Bubble Economy Watch:

July 13 – Bloomberg (Alex Kowalski): “Prices of goods imported into the U.S. dropped in June for the first time in a year as oil and food expenses retreated… Compared with a year earlier, import prices rose 13.9%, the biggest 12-month advance since August 2008…”

July 14 – Bloomberg (Dan Levy): “Lender delays in processing home-loan defaults will push as many as 1 million U.S. foreclosure filings from this year to 2012 or beyond, casting an ‘ominous shadow’ on the housing market, according to RealtyTrac Inc.”

Central Bank Watch:

July 13 – Bloomberg (Jeannine Aversa and Joshua Zumbrun): “Federal Reserve Chairman Ben S. Bernanke told Congress the central bank is prepared to take additional action, including buying more government bonds, if the economy appears to be in danger of stalling. ‘The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support… The Federal Reserve remains prepared to respond should economic developments indicate that an adjustment of monetary policy would be appropriate.’”

July 14 – Bloomberg (Vivien Lou Chen): “Federal Reserve Bank of Dallas President Richard Fisher said central bank efforts to boost the economy have reached their limits and the U.S. faces a ‘fiscal reckoning’ that only lawmakers can resolve. ‘Our great country now finds itself in a very difficult predicament,’ Fisher… said… ‘Congress can no longer carry on as before, oblivious to the deleterious effect of spending our, and the successor generations’, money with unfunded abandon… There may be some things the chairman mentioned this morning -- those are tinkering at the margin… We’ve exhausted our ammunition, in my view’ and expanding the Fed’s balance sheet from about $2.7 trillion to more than $3 trillion ‘might spook the marketplace… I do not personally see the benefit of more monetary accommodation even if the economy weakens further… Again, there’s so much liquidity out there, the question is, ‘What is the trigger to put it to work?’’”

Fiscal Watch:

July 14 – Associated Press (Christopher S. Rugaber): “The federal budget deficit is on pace to break the $1 trillion mark for the third straight year, ratcheting up the pressure on the White House and Congress to reach a deal to rein in spending. The deficit totaled $971 billion for the first nine months of the budget year, the Treasury Department said… Three years ago, that would have been a record high for the full year. With three months to go, this year's deficit will likely top last year's $1.29 trillion gap, according to the Congressional Budget Office. But it is expected to come in below the record $1.41 trillion reached in the 2009 budget year. The budget year ends Sept. 30.”

Muni Watch:

July 14 – Bloomberg (William Selway): “U.S. state tax revenue rose 12.5% in the first two months of last quarter from the same period a year earlier, evidence that governments are rebounding from the strains brought on by the recession, a report found.”

California Watch:

July 14 – Bloomberg (Michael B. Marois): “California is considering seeking a bridge loan from Wall Street ahead of an Aug. 2 deadline for raising the federal debt ceiling, in case talks fail and send the bond market into turmoil, Treasurer Bill Lockyer said. Proceeds from the loan would be used to help pay the state’s bills until Lockyer can sell an estimated $5 billion of so-called revenue-anticipation notes, or RANs, scheduled for late August.”

The Sovereign Debt Crisis Learning Curve:

During the second-half of his reign, Alan Greenspan became fond of trumpeting the U.S. economy’s newfound resiliency. This was a theme peppered throughout his “Age of Turbulence” memoir, published in the pre-crisis year 2007. Greenspan cited computer and telecommunications technologies; monumental productivity advancements; a flexible workforce; the financial system’s superior capacity to effectively invest limited savings; and, of course, enlightened policymaking.

Back when I wrote more colorfully, I was fond of saying, “Financial crisis is like Christmas.” In hindsight, it would have been more accurate to write “private-sector financial crisis is…” Whether it was banking system debt problems from the early-90s; the series of “emerging” market Credit collapses; the unwinding of LTCM leverage; the bursting of the tech Bubble; the 2002 corporate debt crisis; or the spectacular collapse of the mortgage/Wall Street finance Bubble - the Fed would reliably respond to each and every crisis with the “gift” of reflationary policymaking.

And, no doubt about it, “inflationism” was the market gift that kept on giving. Crisis, in the Age of Activist Central Banking, created momentous opportunities to harvest speculative returns. Those that best understood and exploited these dynamics (our era’s “titans of industry”) accumulated incredible fortunes – and vast AUM (assets under management).

It’s becoming increasingly apparent these days that public (government) debt problems are a whole different kettle of fish. Rather than a “gift”, they instead present extraordinary challenges for both policy making and the markets. European policymakers are today at a complete loss. In Washington, politicians are making a sad mockery out of responsible debt management – and the markets have yet to even lower the boom.

From my analytical vantage point, the U.S. economy’s “resilience” was always more about New Age Finance than it was some New Paradigm economy coupled with sagacious economic management. The Fed’s pegging of short-term interest rates, along with timely market interventions, created powerful incentives for private-sector Credit expansion - in the real economy and throughout the financial sphere. System Credit, resilient as never before, was at the heart of it all. Over years evolved a most powerful dynamic encompassing a historic private-sector Credit boom and speculative financial Bubble - both backstopped by the GSEs and aggressive fiscal and monetary management.

Wall Street finance provided the nucleus of the private sector Credit boom: asset-backed securities, mortgage-backed securities, “repos,” derivatives, CDOs, CLOs, etc. New Age risk intermediation - “Wall Street alchemy” – created seemingly endless “safe” higher-yielding and liquid securities, the perfect fodder for the mushrooming “leveraged speculating community.” The structures both of the financial architecture and policymaking incentivized aggressive leveraging by the hedge funds and proprietary trading desks. And when the markets occasionally caught the leveraged players overextended and vulnerable, Washington was quick with market bailouts. These dynamics nurtured history’s greatest expansions of “private” sector debt and system leverage.

Of course, Fed rate cuts played a pivotal role in prolonging the Credit Bubble. Greenspan’s asymmetrical approach – transparent little “baby-step” tightening moves and aggressive rate-slashing in the event of mounting systemic stress – was a godsend for leveraged speculation. The critical role played by the GSEs has never received the Credit it deserves. Beginning with the faltering bond Bubble in 1994, the GSE’s became aggressive (non-price sensitive) buyers of MBS, mortgages and miscellaneous debt instruments anytime market liquidity became an issue (when the speculators needed to deleverage). GSE assets expanded $151bn (24%) in 1994, $305bn in 1998, $317bn in 1999, $242bn in 2000, $344bn in 2001, $240bn in 2002, and another $245bn in 2003. With effectively parallel “activist” central banks backstopping the markets – the Federal Reserve and the GSEs down the road - the mortgage finance Bubble inflated to historic proportions. This dynamic will not be repeated in our lifetimes.

Sovereign debt crises are altogether different in nature to those “private” affairs that we’ve become rather comfortable with over the years. Keep in mind that crises of confidence in private debt securities are quite amenable to rate cuts, the public sector’s explicit or implicit assumption/guarantee of private obligations, and system Credit reflation through public debt issuance and central bank monetization. If sufficiently determined to do so, policymakers have the capacity to resolve about any private debt issue. And, of course, the short-term benefits can be irresistible: i.e. buoyant asset markets, reduced unemployment, bolstered confidence, economic expansion, inflating tax receipts and reelection (or, in the case of central bank chairmen, hero status).

The great longer-term costs – which can remain “long-term” as long as policymakers perpetuate Credit Bubble excess – include mispriced finance, dysfunctional markets, the misallocation of resources, increasingly fragile financial and economic structures, social disquiet, geopolitical risks, and an unmanageable accumulation of public-sector debt and obligations. Importantly, the mechanisms that work all too well in dealing with private debt crisis are not readily available come that fateful day when the markets question the creditworthiness of the government’s debt load.

There is more attention paid these days to sovereign debt ratios and such. At about 150% of GDP, Greece finances were (belatedly) recognized as an unmitigated disaster. At 120%, Italy is too vulnerable. Here at home, the National Debt Clock shows federal debt surpassing $14.3 TN. Federal borrowings have expanded at a double-digit to GDP rate for the past three years, with total debt increasing more than $5.0 TN in short order. There is today no realistic prospect for meaningful fiscal reform.

And while Europe is briskly moving up The Sovereign Debt Crisis Learning Curve, complacency still abounds here at home. And the more hideous things appear in Europe and Washington, the more confident our markets become that policymakers will soon come to their senses and resolve the ugliness. Such wishful thinking is a holdover from the good old private debt crisis days.

Avoid thinking in terms of sovereign debt in isolation. The massive accumulation of public-sector debt is almost without exception symptomatic of deep systemic problems. Whether we’re discussing Greece, Spain, Italy, the U.S. or Japan, enormous deficits and public debt loads are reflective of a post-private-sector Credit Bubble environment. This is a critical issue. Not only are governments running up huge debts, the underlying economic structure has already been heavily impaired from years of Credit abuse. And as much as policymakers hope and intend for their borrowing, spending and monetizing programs to promote sound economic and financial recoveries, the reality is that expansionary policies exacerbate deleterious Credit Bubble effects. It’s a case of aggressive monetary stimulus thrown at systems already way out of kilter.

The empirical work of Carmen Reinhart and Kenneth Rogoff demonstrates conclusively that heavy debt loads negatively impact growth dynamics (they have found 90% of GDP an important threshold). This is no earth-shaking revelation, especially if one comes from the analytical perspective that huge accumulations of public debt are generally associated with an extended period of private and public sector Credit excess. And years of Credit-related excesses will almost certainly foment acute financial fragilities and economic impairment.

It’s no coincidence that the greatest expansion of public debt comes late in the cycle when the economy’s response to additional layers of debt becomes both muted and uneven. Indeed, a precarious dynamic evolves where enormous amounts of (non-productive) government debt are required just to stabilize increasingly fragile economic structures. In the meantime, late-cycle stimulus will most certainly distort and dangerously inflate highly speculative securities markets – especially when higher market prices are the direct aim of policy.

There was a Financial Times column today that posited that Italy’s problem was that it was stuck with the ECB rather than the Federal Reserve! If only the Fed were purchasing Italian sovereign debt as it does Treasurys, Italian debt service costs and deficits would be much lower. Crisis resolved. Well, monetary policy certainly does play a critical role in sovereign debt Bubbles and crises.

Back in the autumn of 2009, Greece could finance its massive deficit spending program for two-years at less than 2%. Portuguese yields were about 125 bps and Ireland 175 bps. Spanish and Italian 2-year yields were around 1.5%. The Fed’s, ECB’s and global central bankers’ moves to slash interest rates to near zero were instrumental in the marketplace’s accommodation of unprecedented government debt issuance at artificially low yields. The European “periphery” markets were part of the expansive Global Government Finance Bubble. And the market perception that monetary policy would ensure ongoing low sovereign debt service costs was instrumental in the market disregarding – and mispricing - Credit risk throughout the eurozone. Even last spring, after the Greek crisis’ initial eruption, markets held to the assumption that policymakers would sustain low sovereign borrowing costs and insulate bondholders from significant losses.

Not only has monetary policy fostered the rapid expansion of government debt at artificially low rates, it has also set the stage for a very destabilizing change in market perceptions. Particularly after many years of interventionist policymaking (throughout the protracted private Credit boom), the markets naturally turn complacent when it comes debt crisis risks. Yet as Europe is confronting these days, there are limited available options when crisis finally arrives at sovereign debt’s doorstep. At some point, fiscal and monetary stimulus comes to the inevitable end of the road. At some point, markets say “no mas,” "não mais," "non piu" or "no more."

Piling on additional government debt is then no longer a solution, inaugurating the debilitating and depressing “austerity” cycle. And, as we continue to witness here at home, having the central bank monetize federal debt only worsens market distortions and delays desperately-needed fiscal (and economic) reform. As much as there was an element of certainty in the marketplace with regard to the mechanics of private-sector debt crisis resolution, sovereign debt Bubbles and crises just seem to foment uncertainty. Policymakers are destined to look incompetent, while markets will appear fickle and unstable. Meanwhile, fragile recoveries will turn increasingly vulnerable. And throughout, there will be a growing disconnect between what the markets have come to expect from policymakers and what they can now realistically deliver.

As witnessed in Greece, Ireland, and Portugal, there comes a point where the market recognizes debt trap dynamics and begins to price in sovereign risk. And it is not long into this process of risk re-pricing that the marketplace comes to view huge debt loads as unmanageable albatrosses. This destabilizing process has now commenced with Spain and Italy. Once unleashed, sovereign debt crisis momentum can prove difficult to contain.

To be sure, the debt situation in these economies remains manageable only as long as the markets are content to finance sovereign borrowings at monetary policy-induced low rates. Or, stated differently, Italy’s (and others’) debt load is viable only if the marketplace disregards risk. Well, the market is today rather keen to risk and debt dynamics - and has been determined to push borrowing costs significantly higher. This not only imperils the government debt and Credit default swap (CDS) markets, but casts an immediate pall on the Italian and European banking sector with their huge exposures to increasingly problematic sovereign debt. As an analyst quoted in the Financial Times put it, “A banking sector is only as strong as its sovereign.”

European Credit and inter-bank lending markets are faltering. The resulting de-leveraging and de-risking – and tightened general finance - will likely further pressure markets, overall confidence and economic activity – adding further pressure to the unfolding debt crisis. And as China and Asian central bankers witness the spectacle of an unraveling Italy, they must view the unfolding U.S. debt debacle with heightened trepidation. Perhaps this was on ECB President Trichet’s mind this past weekend when he referred to “the global debt crisis.”