Investors hve rushed from private debt to public debt in a flight to safety – but is sovereign debt really safer? This is the question that Gillian Tett asked in yesterday’s Financial Times and I agree with her that the answer might be, No!

Private debt has been risky, of course, because private investments were so highly leveraged. A small absolute fall in value had drastic consequences due to the high leverage rates. Public debt was safer because it was more fully backed tax revenue streams. That was true then (in the rearview mirror, as Tett puts it), but it may not be true looking ahead.

The problem is that government policy makers needed to de-leverage the financial sector without causing a collapse of the economy. This was accomplished, especially here in the United States, by leveraging up the public sector to compensate for de-leveraging the private sector.

This has worked pretty well (judging by the recent growth figures) although not as well as you might have hoped (judging by the unemployment data). Still de-leveraging the private sector without the debt-financed public sector expansion would have resulted in much worse macroeconomic results.

But here’s the problem. If we remember the principle that leverage increases risk, then we must acknowledge, as Tett does here, that this means that private sector risk has been shifted to the public sector — and to public sector debt in particular. The current returns on this debt do not seem to take this risk into account.  And that’s a problem — possibly a big one — as I explain in the forthcoming Globaloney 2.0