The Second Debt Storm.

Who will bail out the countries that bailed out the world's corporations?

SAN FRANCISCO (MarketWatch) -- The financial crisis never really went away.

The debt mountain that brought down some of the world's biggest banks and dragged the international financial system to the brink of disaster has simply shifted to governments. Now it's threatening countries around the globe -- and, if left unchecked, could rip the very fabric of Europe's economic system and wreck economic recoveries in the U.S., China and Latin America.

The impact on markets has been severe. The euro has slumped more than 12% against the dollar since the sovereign-debt crisis flared in southern Europe. Gold has marched to new highs as investors seek a safe haven and, perhaps most alarming, it is now more expensive to buy insurance against national default than it is to insure against corporate failure.

"The sovereign-debt crisis spun out of control in the past week, and we see no easy way to resolve it," said Madeline Schnapp, director of macroeconomic research at TrimTabs Investment Research.

Some investors and analysts are increasingly concerned that governments may be no more capable of repaying their debts than the banks and insurance companies they saved. And, they warn, if a major country comes close to default, it could trigger a financial meltdown that would eclipse the panic that followed the bankruptcy of Lehman Brothers in 2008.

The world has seen sovereign debt crises before. Latin America, Africa and Asia have all experienced upheavals sparked by excessive debt. These crises were all accompanied by stunted economic growth, inflation and weak stock market returns, which make it even harder to pay off debts. As investors and government officials ponder the current state of affairs, they see ominous signs that the developed world may be facing a similarly bleak future.

"The problem of the western world is that we have too much debt," said Daniel Arbess, who manages the Xerion investment strategy at Perella Weinberg Partners. "Rather than reducing our debt, we've been moving it from one balance sheet to another."

"All we're doing is shifting chairs on the deck of the Titanic," he added.

Europe's bailout

Some governments have started to respond to market pressure, with the U.K. pledging billions of pounds in spending cuts this week. Spain and Portugal also unveiled austerity measures. But the problem is so big that investors remain wary. Check out Portugal's plans.

Stock markets plunged and credit markets shuddered last week on concern Greece and other indebted European countries like Portugal and Spain might default. See the story on market impact.

"What's happened on a corporate level is now happening on a national level. The first nation to experience this is Greece, but other nations will, too," Schnapp said.

To stop Greece's debt troubles turning into a run on the euro and a global stock market rout, the European Union unveiled an unprecedented package of almost $1 trillion in emergency loans, stabilization funds and International Monetary Fund support on Sunday.

In the days that followed, the European Central Bank bought the government debt of Greece and other countries on the periphery of the region's single-currency zone, such as Portugal, Spain, Italy and Ireland, investors said. Such a drastic step has been shunned by the ECB until now. Read about the market response on Monday.

"Temporarily the crisis in terms of liquidity has been averted, but the underlying problem hasn't gone away," Schnapp added. "Giant debt and expenditures by governments are still there." TrimTabs cut its recommendation on U.S. equities to neutral from fully bullish on Sunday, in the wake of the European bailout.

Protection

The sovereign crisis has been brewing for months. For much of the financial crisis, investors worried about financial institutions defaulting, rather than sovereign nations. But that pattern has been upended.

In early February, the cost of insuring against a sovereign default in Western Europe exceeded the price of similar protection against default by North American investment-grade companies. That was the first time this had happened, according to data compiled by Markit from the credit derivatives market.

The move "symbolizes how credit risk has been transformed from corporate to sovereign risk, as the solution to the financial and economic crisis was government intervention," Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch, wrote in a note to investors at the time.

Since then, the cost of insuring against sovereign default in Western Europe has climbed further, hitting a record of 169 basis points on May 7.

The European bailout pushed that down to 120 basis points on Tuesday. But that's still more expensive than default protection on North American corporate debt which cost 100 basis points on Tuesday. (In the credit derivatives market, 100 basis points means it costs $100,000 a year to buy default protection on $10 million of debt for five years).

'100%'

Market Edge: Debt Crisis Enters Second PhaseThe global debt crisis is in its second stage as governments deal with the debt absorbed from the private sector, and record gold prices have been reflecting these worries, according to SCM Advisors strategist Max Bublitz. Laura Mandaro reports.

While much of the concern has focused on Western Europe, unsustainable government debt is a global problem. And it is developed world governments that are accumulating the biggest debts, not emerging market countries -- a big change from previous sovereign crises.

"Looking beyond the immediate crisis in Europe, I am particularly worried about the next stage involving the U.S., the U.K. and Japan," Xerion's Arbess said. Debt to GDP ratios in the world's advanced economies will top 100% in 2014, 35 percentage points higher than where they stood before the financial crisis, the IMF estimated last month.

Three percentage points of this increase came from government bailouts of financial institutions, while 3.5 percentage points was from fiscal stimulus. Another four percentage points has been driven by higher interest on government debt and 9 points came from revenue lost from the global recession, according to the IMF.

"Public finances in the majority of advanced industrial countries are in a worse state today than at any time since the industrial revolution, except for wartime episodes and their immediate aftermath," Willem Buiter, chief economist at Citigroup Inc. /quotes/comstock/13*!c/quotes/nls/c (C 3.92, -0.17, -4.16%) and former member of the Bank of England's Monetary Policy Committee, wrote in a recent note on sovereign risk.

Even though the current epicenter of the crisis is focused on the euro zone, the overall fiscal position of the single currency area is stronger than that of the U.S., the U.K. and Japan, he noted.

"Unless there is a radical change of course by those in charge of fiscal policy in the U.S., Japan and the U.K., these countries' sovereigns too will, sooner (in the case of the U.K.) or later (in the case of Japan and the U.S.) be at risk of being tested by the markets," Buiter said.

Ultimately, these countries face the risk of being "denied access to new and roll-over funding, that is, of being faced with a 'sudden stop,'" he warned.

Economic drag

Once government debt levels approach 100% of GDP, things can get tricky. That's because a lot of a country's income from taxes and other sources has to be spent on interest payments.

John Brynjolfsson, chief investment officer at global macro hedge fund firm Armored Wolf LLC, illustrated the point with a simple example. With debt at 100% of GDP, interest rates at 3% and real economic growth of 3%, all the extra income collected by a country would be used to pay interest on its debt.

If a lot of government debt is owned by foreigners, like the U.S., the money leaves the country rather than being invested in more productive ways. This dents economic growth.

A study published this year by economists Carmen Reinhart and Ken Rogoff found that, over the past two centuries, government debt in excess of 90% of GDP produced economic growth of 1.7% a year on average. That was less than half the growth rate of countries with debt below 30% of GDP.

The Greeks' debts a lesson on corruption

IF someone wants to get a driving licence or a building permit, all that he or she needs to do is to fill a little envelope with some money and give it to an officer to smoothen the process.

A filled envelope can work wonders: businessmen could win bids for public contracts or hire lowly paid illegal workers. Does this sound familiar? However, this isn't what goes on anywhere near home.

This is about the day-to-day life in Greece, which has slipped to the brink of bankruptcy and is now getting aid from the big brothers in the euro zone. The reason Greece has sunk so deeply into a whopping debt problem is because of its ballooning budget deficit, which is equivalent to 13.6% of its gross domestic product (GDP), although the actual ratio could be higher, according to Eurostat.

Economics textbooks tell us that a country's budget deficit will start yawning when the government spends more than it earns, that is what it collects in tax revenue. But in Greece, even the man in the street who has never studied economics knows the root cause of the debt crisis, which is roiling their country, is corruption plus cronyism.

According to the Wall Street Journal, a Transparency survey shows that last year, 13.5% of Greek households paid bribes of €1,355 (RM6,775) based on last year's exchange rate on average.

In an article titled Tragic Flaw: Graft Feeds Greek Crisis, the newspaper said ordinary citizens handed out cash-filled envelopes to get driver's licences, doctor's appointments and building permits, or to reduce their tax bills.

In the past three years, senior politicians had resigned or been investigated over allegations that included taking bribes for awarding contracts, employing illegal workers and selling overpriced bonds to public pension funds, the report noted.

Cheating the government, especially on taxes, is widespread in Greece. Government procurement bribery and political patronage have bloated the Greek government's spending, and pervasive petty bribery eroded its authority over taxpayers, the newspaper wrote.

“The core of the problem is that we don't have a culture of civic society,” Stavros Katsios, a professor at Greece's Ionian University who specialises in economic crime, was quoted by the journal as saying. “In Greece, complying with the rules is a matter of dishonour. They call you stupid if you follow the rules,” he added.

In 2007, the government was found to have sold billions of euros of overpriced complex securities to public pension funds, resulting in large loss es at the funds. The shortfalls have to be covered by the government, and that widened the budget deficit further.

Economists estimate one quarter of all taxes owed are not paid in Greece. The newspaper quoted a senior government official as saying that if an individual or company owes €10,000 in taxes, they slip €4,000 to the inspector, keep €4,000 and pay €2,000 to the Inland Revenue.

Clearly, it is a classic example of plundering the public coffers. Back home, there is mounting concern about Malaysia's budget deficit after the two stimulus packages to revive the economy. Compared to Greece, Malaysians could probably breathe a sigh of relief that the country is still a long way from where the Greeks are now.

The country's budget deficit swelled to 7.7% of last year's GDP but the ratio is expected to drop to around 5.6%. Malaysia isn't in that alarming stage at all. That said, the debt crisis in Greece should raise alarm bells about the ugly fact that there are some similarities between the situation facing the Greeks and us.

One of the differences is that Malaysians are lucky enough to have oil money to replenish almost half of the country's coffers. Imagine if we were without the oil money, would the country's deficit still be so manageable? Could the government continue running the country the way it is doing today?

At a conference organised by the Associated Chinese Chambers of Commerce and Industry of Malaysia, YTL Corp Bhd's Tan Sri Francis Yeoh told the audience that he didn't need to know the former British Prime Minister Tony Blair to win the bid for Wessex Water.

What about his experience at home? Did it contain a hint which he didn't share with the audience?

Written by Commentary by Kathy Fong (The Edge Daily)