The European sovereign debt crisis stands as the latest in a long line of similar crises. Argentina in 2001. Russia in 1998. Mexico in 1994. The list goes back into history. Debt crises are about as natural as earthquakes, but this time there is something different — and possibly more dangerous.
The European nations are linked in a network of debts, as Bill Marsh recently illustrated in the New York Times with a beautiful piece of graphic art. Greece and Italy are prominent; Ireland, Portugal and Spain lurk ominously nearby. France and Germany seem exposed, too, as does the U.S.
The image is like a complex wiring diagram for a ticking debt bomb. Yet what it shows may be less important than what it leaves out: a largely invisible network of ties among institutions around the world, which could ultimately cause global financial chaos.
This hidden network has been created by institutions that buy and sell unregulated credit-default swaps. These are essentially insurance contracts on bonds; in the event of a default on the bond, the seller of the swap promises to pay the buyer the bond’s value.
Credit-default swaps are mostly arranged “over-the-counter,” not traded on any exchange or recorded by any central information repository. This explains why Marsh’s map couldn’t show the links they create.