Calculated Risk is doing a series of blog entries describing the Really Bad Scenario.  This is not, as the author is quick to point out, an exercise in examining what will happen in the "worst case scenrio," but rather to look at historical precedents for the current global economic picture to get, well, really bad.  And the latest analysis is on sovereign debt (see Ireland's latest problems in that department below).  Calculated Risk poses the possibility of nearly half (45%) of all countries that have "large outstanding sovereign debt" default in the next 2-3 years.

So, who defaults? A simple method is to choose the 45% of countries with large sovereign debts (over $50 billion) that currently have the highest cumulative probability of default. They are assumed to default in the same order as implied by their cumulative probability of default at 6/30/10 from CMA: Greece, Argentina (again), Portugal, Ireland, Spain, Italy, Turkey, Indonesia, Belgium, South Africa, Thailand, South Korea, Poland, Brazil, Mexico and Malaysia.

This involves about $5.6 trillion of debt in default, about 16% of all sovereign debt. If historic trends repeat themselves, it all happens within about two years of the first default (Greece), and 11 home currencies are involved. At the low end recovery rate of 31% of face value, there are about $3.8 trillion of losses. This is about 2-3 times the amount currently embodied in credit default swap pricing which we calculated in Part 4 ($1.3-1.8 trillion).

But then, since this is a really bad scenario, Japan defaults too. This might occur because of a global economic slowdown, a rise in general risk premiums and interest rates raising Japan’s debt service (this could take longer, Japan’s average maturity is 5-6 years), Japan’s banking system being affected by defaults elsewhere in the world, lack of political will to make reforms, or several other mechanisms.

This is a scenario that must make policymakers' stomachs turn.  But the argument from the author is that this is what could happen, because it has happened in the past.  Read the post here.