Making the bond holders pay


by David Malone

Today the European bond debacle continues with Portugal being pushed ever closer to having to accept bail out money from the EFSF and Irish CDS costs shooting to the moon.

The Portuguese Prime Minister, Mr Socrates keeps insisting, as all Prime Ministers do, that his country is not in any need of a bail out, has marvelous prospects for growth and is ahead of its targets for cutting government spending and debt. In short, another political miracle worker, from the sterling mold of his Greek and Irish counterparts.

What I find interesting however, is not the political theatre of desperate half lies and rose tinted twaddle but the complete lack of coordination evident between what nations are saying and what the European Commission is saying. Nations are willing to lie and cheat, swap immediate debts for later ones even if they will perforce be larger, or just hide them completely if they are given the chance to do so. All in the name of convincing the ‘Bond Market” to buy yet more bonds and give their nations just one more gasp of air.

But at the same time as some European Nations are forced to grovel to the bond market, the European Commission announced last week that it has further advanced its plans to force bond holders to take some of the losses in any future bank or sovereign default.

I personally am very much in favour of bond holders taking their share of any losses and would love to believe that the Commission has finally found a scrap of courage. But I find myself doubting that things are that simple.

If it is that simple and the Commission has finally found some backbone then I marvel at how they spurned all earlier moments and chose this one to get tough with the Bond Buyers. Why now, when Portugal, Ireland and Greece are all getting hammered by punitive rises in borrowing costs (those that can still borrow at all) and even more punitive costs of insuring any debt they do sell, plus having Spain and Italy’s future hanging by a thread as they come grovelling to the bond market this week trying to sell yet more of their debt? At the very least it seems the left hand has no idea what the right is doing. It seems a very odd moment for the Commission tell the bond buyers, that in future, they will be expected to take a loss on any new bonds they buy.

As I say, I am very much in favour of such a policy. I think it is essential. I just find it difficult to believe our glorious leadership is really doing it.

By threatening the bond holders with having to take losses in any future crisis – and we all know there is going to be one, the Commission is either making a public show of force, even at risk of hastening Spain and Italy into a crisis if their bond auctions fail or the rates they have to pay become so usurious that it is clear they too are doomed to seek a bail out, or the Commission’s threat is a sham.

I seriously wonder if the Commission’s threat is a piece of theatre designed not to really make the bond holders take their losses but rather to pacify us restive proles. Our politicians know how angry people are becoming, knowing that they are being forced to pay all the losses, including those which should be paid by the bond holders, while the bond holders are being treated as untouchable aristocracy. I seriously wonder if the Commission and ECB could have struck a deal with the bond holders, who after all are the “Too Big To Fail” Banks and the Pension and Insurance companies.

I find myself imagining a deal whereby the Commission/ECB said, lets find away so that it appears that you are taking a loss when in fact you will be still getting paid well over the odds. Let’s quietly agree a geneous price, we can sound tough, you can look aghast, and the public will be lulled back to sleep. Once the public unrest has been soothed, we can then announce “extensions to the EFSF bail out fund” which is more public funded bail outs for the banks/bond holders, and no one will notice or care.

All it would take to make this work is to split the difference between the full price the bond holders paid for their bonds and what they would have to sell them for on the open market if a default were allowed to happen. The Bond holders would be seen to be taking a loss which would pacify the public and make our politicians seem to be doing the right thing. BUT in actual fact they would be colluding with the bond holders to make sure the loss they took was far smaller than they should take.

In other words there would be a thieves agreement NOT to mark to market but to rig the price once again in the bond market’s favour. You could argue, of course, that all restructuring works by an agreement between debtors and their creditors so for the government to make a deal is perfectly as it should be. I would simply argue that I think the terms will be found to be very generous indeed.

Now I have NO evidence for this AT ALL. I am just wondering at the incongruity of Portugal, Spain and Italy all hanging by a thread at the whim of the Bond buyers while the Commission appears to be threatening the self same bond buyers with taking losses on any bonds they might buy.

The political theatre of the moment is that nations like Portugal, Italy and Spain are all getting hammered at the bond market. All of them are watching their borrowing costs spiral up and out of control. All those nations will be quick to tell you how they are getting their debts and borrowing needs down. But they don’t need new or higher borrowing to still sink. The looming debt crisis for European nations isn’t new debt but rolling over old debt. And if, every time they come to roll over their mountain of old debt, the new cost of that debt is higher than the old rate, then they will sink. And that is what has been happening so far this year.

Why have the rates been going up and up? I don’t think it is because the Bond buyers have assessed the state of the countries involved and found them in a more parlous state than they were before Christmas.  Nothing has become materially worse in just those few weeks. I think is is simply that the Bond buyers have looked at the sheer amount of debt that needs to be sold, both European, American, sovereign, bank and corporate and realized there is just too much debt for sale and not enough cash with which to buy it. Someone is going to get left without a buyer.

In such a market the buyers do not need to rush to buy nor buy as much as the sellers need them to. The buyers can take their time and watch as desperate nations offer to pay higher and higher rates in an effort to get to the front of the queue.

The Spanish and Italian bond sales will be critical. If the rates continue up as they have been and the ECB is forced to buy the bulk then the water we are in will start to simmer rather faster than people are expecting.



David Malone is the author of the book Debt Generation. You can read and listen to excerpts from his book here: