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Opinion

Tensions run high over sovereign debt haircuts

Banks might refuse to underwrite and distribute sovereign debt at risk of principal reduction.

The new year started uneasily in the debt markets, with 10-year Greek government bonds yielding 12.57% – higher than in the depths of the initial sovereign debt panic last May and Irish 10-year governments yielding 9%. Investors’ nerves are jangling as they await the next test of European policymakers’ capacity to contain the damage from the continued deleveraging of the western financial system.

Deutsche Bank points out that combined government and financial debt, which rarely ran above 100% of the GDP of the US, UK, or Europe until the mid-1990s, still stands at unprecedented levels as the fourth anniversary approaches of the financial crisis that began in the summer of 2007. In core Europe combined government and financial debt now stands at 164% of GDP; in the US, it is at 191%; it is at 213% for the UK and 214% in the European periphery. It would seem to be a lot to hope for that the western economies can grow robustly so as to make these debt levels look more comfortably sustainable.

Most debt market participants expect that in 2011 there will be repeats of the occasional closures of the capital markets that borrowers had to cope with in 2010.

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