Imagine a subprime-like collapse, but at the level of countries

Financial markets tanked yesterday, primarily because of fear that some nations may default on their debt. Among them are the rudely named PIIGS (Portugal, Italy, Ireland, Greece, Spain) and STUPID (Spain, Turkey, UK, Portugal, Italy & Dubai) with Portugal, Spain, and Greece the most worrisome.

This is not just an internal matter for those countries. Vast amounts of credit default swaps have been bought and sold on their debt, just like what happened with subprime and securitization of mortgages. Since CDS aren’t regulated and not sold on open markets, no one really knows where the risk is, who has it, and if they could pay in event of a default.

Business Insider lists 15 countries with the mostly expensive credit default swap spreads. The STUPID PIIGS aren’t even close. Venezuela is worst, with Argentina close by.

But those two countries are on their own. Several of the others are members of the EU and this greatly complicates things. If one of them goes down, it could bring down the Euro with them or cause major fissures in the EU.

The Venezuela CDS spread is now 1008 bps. (As a comparison, Greece is about 380 bps, and the US 20.)

Translation: It now costs about 10% or $1 million a year to insure $10 million of Venezuelan debt against default for five years. Venezuela must now offer 10 percentage points more than high-rated bonds. This also lowers the value of existing bonds as their price drops to return whatever the current yield is. Venezuela’s recent sales of bonds denominated in US dollars followed by a devaluation relative to the dollar makes things even more precarious for them.

But the focus is on those EU countries now as sovereign defaults there could cause a major currency to wobble.

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