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Warning on health of private sector

June 7, 2010

By Guy Dinmore in Florence, published on June 7, 2010

New research demonstrating a close correlation between the probability of default among listed European companies with the risk of sovereign default should serve as a warning to governments implementing austerity packages to avoid harming the private sector, according to Edward Altman, New York University professor of finance.

Presenting his draft findings to the International Risk Management Conference in Florence, co-organised by the European Commission’s Joint Research Centre, Prof Altman said the health of the private sector was an important factor in sovereign default risk.Research into nearly 1,600 listed companies in eight European countries found a close correlation between the median probability of default over five years with five-year credit default swap spreads.

The results threw up four groupings of two countries each in terms of corporate rankings, with Greece and Portugal most at risk, followed by Italy and Spain, then France and Germany, and least at risk the UK and the Netherlands. Prof Altman noted however that the correlation did not appear to apply in the UK where the CDS spread was nearly twice as great as the median probability of corporate default.
“If austerity programmes kill productivity in the private sector you are cutting your own throat,” he said. “Governments must nurture the private sector.”

“The health of the private sector should not be ignored in assessing sovereign risk,” he added.

Oliviero Roggi, chairman of the annual conference and a Florence professor of corporate finance, said the research was important in broadening the traditional macro indicators used to evaluate sovereign risk.

Prof Altman told the Financial Times that he was not optimistic in the long term that Greece would be able to avoid defaulting on its debt despite the 750m euro EU rescue package.

Til Schuermann, a vice president of the Federal Reserve Bank of New York and an architect of the successful Scap bank “stress tests” in the US, suggested he believed a Greek default was a possibility. “What is the impact if there’s a Greek default?” he asked. “Hopefully (US) banks are asking themselves this.”

Conference participants, including EU researchers and bankers, did not interpret his words as meaning US regulators thought a default was likely. But they said US banks and regulators were discussing the possible impact of a default by Greece high on a list of stress scenarios.

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