Buiter's report on sovereign insolvency.

January 19, 2011 1:01 PM By Citi

New research from Citi's Chief Economist Willem Buiter analyzes the deterioration in public finances of the world's major advanced economies, arguing conditions suggest "there are no absolutely safe sovereigns." In the piece, "The Debt of Nations," Buiter said the risk of sovereign default is "manifest" in Western Europe, particularly Greece, Ireland, Portugal and Spain, and sovereign credit issues will weigh on many countries, including the United States and Japan, as well as their banks.

Bloggers and journalists have been parsing the note. The New York Times (free registration), which also spoke to Buiter, focused on his point that it is increasingly likely that investors holding bank and sovereign debt in Europe will face losses. "It is clear that the debt which will take a haircut is the current debt, not the future debt," he told the paper. "All bank and sovereign debt is at risk - that is the reality."

In his note, Buiter said there are no reasons why even multiple sovereign defaults or a serious banking crisis would cause the European monetary union to collapse, yet "the political economy of monetary union suggests that such risks are indeed present."

The FT Alphaville blog examined Buiter's proposed reforms aimed at ending current turmoil in Europe, including a much larger liquidity facility for stressed sovereigns, mechanisms for restructuring of the unsecured debt of European Union banks and recapitalization of the systemically important ones, and mechanisms for restructuring of the debt of insolvent Euro area sovereigns. "In our view, a break-up of the Euro area remains most unlikely," Buiter wrote in his note. "However, in the absence of a package of measures like [these], there is a non-zero risk that the Euro area will cease to exist in its current form or in its entirety."

Buiter identified countries outside the Euro area -- United Kingdom, Japan, Hungary and the United States -- as also vulnerable, facing higher cost of capital if they fail to address their public debt burdens. "It is in our view only a matter of time before the US sovereign will only be able to fund itself through debt issuance at significantly higher interest rates, reflecting either inflation risk from eventual monetization of public debt and deficits, or sovereign default risk, or both," he wrote.