03 December 2010

QOTD: Soverign Debt Backstop Doesn't Negate Risk

From the Daily Reckoning:
Now, such action [providing sovereign backstop to liquidity] can slow contagion, to be sure, but can it stop it? As the sovereign steps in to provide ever more explicit guarantees for the financial system, this places the sovereign in the front line, facing investors who may still desire to reduce credit risk. Just because credit risk has been assumed by the sovereign does not in any way imply that the risk has disappeared; rather, it has merely changed form, from private to public. Debt which investors previously thought would be serviced via private sector economic activity, such as the generation of corporate cash flows to service corporate debt, or the generation of household incomes to service household debt, now must be serviced by the government, which implies that it must be paid for out of future tax revenue.
The first part of a two part article is a great explanation into just how risk, debt, and default all play an interesting part in navigating freedom, markets, and economics.

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