The same applies to the FX income stream facing foreign investors, and then there are risks such as the possible introduction of capital controls, which will not count as defaults as long as debt is serviced on time in the domestic currency of the sovereign without discrimination between domestic and foreign investors. Although it is important to bear all this in mind, it is nothing new. Furthermore, it does not constitute a major problem for the functioning of capital markets as long as the default probabilities of sovereigns seen to be providing so-called risk-free assets are perceived to be so low at the relevant maturities that they can largely be ignored. The question we are faced with is whether this is still the case and what the future will bring in this regard, given that both the market and the rating agencies perceive an increase in sovereign risk. The jury is still out, but my current prediction is that, in the foreseeable future, the supply of risk-free assets according to this definition will be very significantly greater than zero. Advanced countries with grade-A ratings are and will be issuing a lot of debt in the near term, and the high price that the best-perceived sovereign debt is carrying is a reflection of strong demand rather than weak supply. In spite of everything we have gone through, there has been no sovereign default of any advanced country apart from Greece since the interwar period.
But equally I think they can see that when a bank is failing it is in everyone’s interests to resolve the situation quickly and cleanly. I hope that they will be reassured by the extensive safeguards we are now proposing, including the guarantee that no creditor will be made worse off in such a split than they would have been in a conventional insolvency and protection of netting and set-off. Finally, the financial turmoil has also revealed the need for better international crisis management. The experience of Lehmans has shown once again the problems that arise in the insolvency of a large international bank with operations in many countries. We also saw in late September and early October the danger emerging, of the banking equivalent of the old beggar thy neighbour policy on currency depreciation, as individual countries began to guarantee their own banks’ debt. On the other side, recent events have also demonstrated how effective international action can be: the coordinated interest rate cuts on the 8th of October; the provision of dollar liquidity by central banks and the adoption of national measures to support banks at international meetings during the weekend of 11/12 October. International groups such as the Financial Stability Forum (FSF) have already started to take action. It has begun to develop a practical checklist of issues and principles that should guide the management of a distressed cross-border institution.