Tuesday, July 19, 2011

Debt Ceiling Dilemma

Peter Klein of the Independent Institute says that he is "a bit surprised no one has brought up William English’s 1996 AER paper, “Understanding the Costs of Sovereign Default: American State Debts in the 1840′s,” which provides very interesting evidence on US state defaults." My response is that I'm VERY SURPRISED no one has bothered to look at the data freely available on EH.NET (gathered by myself, Dick Sylla, and Jack Wilson) that shows that the prices of Pennsylvania bonds (and other defaulting state bonds too) plummeted from the low 90s (par = 100) to the low 70s in just 6 weeks in early 1841. That was an era, btw, when banks did not have to mark to market and when state bonds were not an important part of the portfolios of most financial institutions. In other words, Klein is right that the default of state governments in the 1840s was not catastrophic but it was pretty bad and any significant drop in Treasury bond prices today would be much more severe.

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