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Institutional Structures are Useless for Creditors in a Crisis

March 21, 2013

One of our key assertions on sovereign credit assessment in the book Stories in Credit Analysis is that a creditor should not draw comfort from the protection afforded by institutional structures in a country. Institutional structures will fray during a crisis. We had asserted that is better for creditors to forecast the likelihood of a crisis occurring than trying to forecast what happens after that- things will not go as per the script. This thesis has been amply confirmed by the happenings at Cyprus. Creditors who drew comfort from the institutional mechanisms of the EU would have been shocked to see a solemn contract in the form of deposit insurance being torn apart during the current crisis. The same thing happened in the US when the US government screwed the creditors of General Motors during the GM bankruptcy episode. Noble notions such as “property rights” were given a quiet good bye.

Hence our quarrel with rating agencies who in their sovereign rating exercise give considerable weightage to the institutional framework of a country. Our belief: it does not matter if the country is the US or China- when a credit crisis happens, creditor rights will be chipped away. So, instead of drawing foolish comfort from institutional structures, a creditor is better off predicting the likelihood of a crisis happening and basing his investment decisions based on that assessment.

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From → Credit Analysis

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