The Economic Fallout From Bombing Iran
“Nobody’s announced a war, young lady,” President Barack
Obama said in New York on March 2, wagging his finger at an audience
member who decried the possibility of U.S. military action against Iran.
“But we appreciate your sentiment.” The crowd cheered, and a smile
crossed the president’s face.
It’s too soon to say when, or
whether, the long-simmering dispute over Iran’s nuclear program will
erupt in armed conflict. “There is still a window that allows for a
diplomatic resolution,” Obama said before meeting with Israeli Prime
Minister Benjamin Netanyahu on March 5. A raft of Western economic
sanctions against Tehran, including a looming embargo on Iranian oil
exports to the European Union, has made the country’s rulers more
willing to “recommence negotiations without preconditions, which isn’t
something they were amenable to last year,” according to Karim
Sadjadpour, an Iran analyst at the Carnegie Endowment for International
Peace. War with Iran in 2012 “is plausible but not probable,” he says.
The
economic case against war is strong. Jitters about instability in the
Middle East have caused the price of Brent crude to rise some 9 percent
since the beginning of the year. Even a limited conflict with Iran—the
second-largest oil producer in the Organization of Petroleum Exporting
Countries, after Saudi Arabia—would jack up insurance premiums on oil
tanker traffic through the Persian Gulf. Iran exports 2.5 million
barrels per day, and OPEC lacks the spare capacity to make up for the
likely loss of Iranian supply in the event of an attack, according to
Robert McNally, president of the Rapidan Group, an energy consulting
firm. That’s a formula for an oil shock far more painful than what
global consumers are currently experiencing. “What we see now is a
market that is very fearful and very tight,” says McNally, a former
senior director for international energy at the National Security
Council. “In those conditions, it doesn’t take much to send the cost of
oil soaring.”
Just how high prices might climb if war breaks out,
and the broader consequences to the world economy, depend on two
factors: whether military action is initiated by Israel or by the U.S.,
and how Iran responds. A strike conducted by Israel, which has limited
air power, might be over in a matter of hours. It would target the four
main Iranian nuclear facilities the world knows about, but there’s no
guarantee that Israel’s bombs would be able to penetrate Iran’s deepest
underground sites. An attack carried out by the U.S. military, on the
other hand, would be longer and more extensive, according to Matthew
Kroenig, a nuclear security expert at the Council on Foreign Relations.
He believes a two-week U.S. bombing campaign could wipe out not just
Iran’s nuclear program but also its air defenses and some missile
capabilities. The Pentagon’s newest generation of 30,000-pound
“bunker-buster” bombs are thought to be capable of pulverizing targets
as much as 200 feet below ground. “There’s a lot of confusion between
what an Israeli strike would do and what an American strike could do,”
Kroenig says. “Israel would set Iran’s nuclear program back between one
and three years. The U.S. can set it back 10 years.”
The costs of
doing so could be steep, however. If the U.S. attacks, “the Iranians
might feel they have less to lose” by retaliating aggressively, says
Michael Makovsky, foreign policy director of the Bipartisan Policy
Center in Washington. Tehran might attempt to sabotage oil facilities in
Saudi Arabia and southern Iraq, launch missiles into Israel, or deploy
small attack vessels to harass tankers in the Arabian Sea. The nightmare
scenario would be a move by Iran to choke off access to the Strait of
Hormuz—most likely by unleashing its stockpile of 2,000 mines—through
which as much as 40 percent of the world’s seaborne oil travels. The
U.S. has warned that such a step would provoke an all-out assault on
Iran’s military. Would Tehran take that risk? “If Iran concluded its
regime were threatened, it might try to make the conflict as big as
possible, as quickly as possible, to bring other powers in to mediate,”
says McNally.
An analysis by the Rapidan Group predicts that a
targeted airstrike on Iran, followed by a token Iranian response, would
cause oil prices to jump $23 a barrel before settling back down. (As of
March 6, Brent crude was trading at $122 a barrel.) A more protracted
conflict, if it involved even a brief closure of the strait, might cause
oil prices to spike by more than $60 a barrel. “It would be the biggest
geopolitical disruption in the history of the global oil market,”
McNally says. Ed Morse, global head of commodities research at Citigroup (C),
estimates that if oil were to reach $150 a barrel, the U.S. would lose
two percentage points in economic growth, enough to turn the nascent
recovery into a recession.
The dilemma for the Obama
administration is that the alternatives might be even worse. “If we
don’t have this confrontation now, but we end up with a nuclear Iran, we
have to factor in the consequences of dealing with a nuclear arms race
in the Gulf,” says Anthony Cordesman of the Center for Strategic and
International Studies. At a minimum, the Pentagon would need to invest
in new anti-missile technologies and maintain a sizable footprint in the
region, just as it is winding down two wars there. “It could have a
major impact on the U.S.’s interest in reducing defense spending,” says
Cordesman. And because a nuclear Iran would make the Middle East and the
world less stable, living with the bomb also means living with higher
oil prices for an indeterminate future. “The worst outcome for the
global economy, by far,” says McNally, “would be a hostile,
nuclear-armed Iran.”
The bottom line:
A protracted conflict with Iran could drive oil prices up by more than
$60 a barrel, especially if Iran closed the Strait of Hormuz.
By Romesh Ratnesar on March 08, 2012
Credit Markets: The Default Deluge
This year will see a record volume of default in corporate debt, in line with expectations, as the U.S. continues to be the epicenter of economic and credit-market weakness
Following the end of the summer, the final stretch of 2009 offers a good
opportunity to take stock of the events that roiled the economy this
year and assess the tone of the financial markets for the rest of the
year.
Buoyed by an encouraging stream of positive economic data, sentiment in
the financial markets has been relatively upbeat. Much of the recovery
has stemmed from the monetary and fiscal stimulus the government pumped
into the financial system in copious amounts to revitalize critical
pipelines of money and credit.
However, this year will see a record volume of default in corporate
debt, in line with expectations. In the first eight months of 2009 a
total of 216 corporate issuers defaulted (both nonfinancials and
financials), affecting rated debt worth $523 billion. If this pace
continues, the global default tally will reach 324 in 2009, the highest
annual total in 28 years—since the inception of our data series on
defaults. The volume of debt affected by these defaults also soared to a
record high.
Other key takeaways from the year thus far:
• The U.S. is the epicenter of economic and credit-market weakness. At
the beginning of the year our 12-month forward baseline prediction for
the U.S. speculative-grade default rate was 13.9% by yearend, with an
upper bound of 18.5% and a lower bound of 10.0%. The default rate hit
10.4% in the 12 months ended in August 2009, giving us reason to believe
it is headed toward our predicted range by the end of the year.
Corporate default incidence (by count) within the population or rated
companies has been highest in the U.S., which blazed ahead with 158
defaults in 2009 (through Sept. 16). Of the remainder, the EU recorded
15, the other developed markets (mainly Canada) 12, and the emerging
markets 31.
• Consumer discretionary sectors lead the global default count, though
industrials and housing-related sectors also are reporting numerous
casualties. Companies in leisure/media are in the lead globally (mainly
because of the U.S.), with 53 defaults in 2009 (through Aug. 31). Next
in line is the aerospace/auto/capital goods/metals category (35
defaults), followed by forest products and building materials (26
defaults), and consumer/service (24 defaults). When factoring in only
speculative-grade ratings, homebuilders and forest products led with a
global default rate of 18% for the trailing 12 months ended in August.
• Defaults continue to emerge from the lowest rungs of the ratings
ladder. This is true not only in a single year but also on a cumulative
basis. More than four-fifths (86%, or 187 entities) of this year's
defaults year-to-date emerged from the speculative-grade domain, with an
initial rating of BB+ or lower.
• Companies with an original rating of B face maximum default risk
exposure. Among this year's defaulters, entities with an initial rating
in the B rating category (which includes B+, B, and B-) accounted for
the largest number of defaults, at 122. Next in line were entities with
an initial rating in the BB rating category, with 54. Companies with a
first rating of CCC+ or lower accounted for 11 of this year's total
default count.
• An avalanche of low-rated rating originations during the credit boom
indicates that considerable default risk still resides in the pipeline.
For example, a total of 1,340 new speculative-grade ratings were
originated globally from 2006 through the first half of 2009, of which
only 100 have defaulted. This indicates a survival rate of 92.5%, which
is expected to erode over time as more casualties occur and more issuers
age. It is difficult to pinpoint the exact timing for such casualties
because forbearance measures can delay the day of reckoning,
particularly as financing conditions ease.
• The flow of distressed-debt exchanges has accelerated substantially
and likely will reach an all-time high in 2009. Plummeting liquidity and
deteriorating fundamentals set in motion a flurry of corporate
distressed exchanges. In part, the increase reflected a pragmatic
reaction to the shortage of financing options in the throes of the
financial crisis. Of this year's 216 defaults, 81 were defined as
distressed exchanges, by far the single leading default trigger across
both developed and emerging markets. With $71.0 billion in rated debt,
Ford Motor (F) was the largest issuer (by par volume) so far in 2009 to implement a distressed exchange. CIT Group (CIT), with $42.1 billion, came in second.
• By contrast, formal bankruptcy filings have been lower. The liquidity
crunch created several bottlenecks for exit financing options and
hastened the use of alternative pragmatic strategies, including
prepackaged bankruptcies, distressed exchanges, and standstill
agreements. Only 54 formal bankruptcies have been recorded globally this
year, of which 48 were in the U.S., affecting rated debt worth $150.5
billion. With $53 billion in rated debt, General Motors was by far this
year's biggest bankruptcy, followed by Charter Communications, with
$22.5 billion.
•Troubled leveraged buyouts (LBOs) from prior years remain a fertile
source of defaults this year. The actual volume of LBOs has dropped
precipitously, totaling only $21.9 billion in the U.S. in the first half
of 2009, compared with a peak of $433.7 billion in full-year 2007,
according to Standard & Poor's Leveraged Commentary & Data.
Moreover, in contrast with 2006, new deals in the U.S. are increasingly
being funded with higher equity contributions and smaller shares of
senior debt. Nevertheless, prior-year deals continue to emerge as
casualties. In Europe, for example, 42 of 48 defaults recorded in the
first half of 2009 were LBO-related.
From Standard & Poor's RatingsDirect
businessweek
From Standard & Poor's RatingsDirect
businessweek
