Today Germany had a failed bond auction. The terms of its failure were simply that not enough people turned up and no one wanted to buy. The rate was customarily low its just no one came to the shop. Why?
It was not that the buyers were asking for a higher rate of return to cover perception of greater risk. German bonds are preceived as virtually risk free. So this failure was not like the failures in Greece, Spain and Portugal. But they are related. What the failure tells me, is that the Bond buyers are beginning to think they don’t want safe and unrewarding German bonds, they want to buy much ‘riskier’ and therefore much more luractive bonds. And are beginning to feel it is ‘safe’ to consider buying them.
I put riskier in comas because if they bond market really thought they were as risky as the interest rates suggest, buyers would continue to stay away as they have been. So for me to be correct the Bond buyers must think something about euro bank and sovereign bond risk, has changed.
On the face of it the ECB is saying how it is going to stop buying so many bonds. It wants countries and banks to go back to the market. Which would means them forming and orderly line to agree to punitive rates dictated by the bond men. High rates to cover the hign risk the bond men would point out.
But at the same time the IMF has said it wants to raise its bail-out fund to a trillion dollars and the ECB has said, reluctantly its true, that it is still there as a saviour should a real crisis develope. Put the two together and it is almost a license to fleece. Charge for the ‘risk’ but relax knowing should anything really blow out, you have forced the big daddies to promise to make you whole.
The Bond buyers have facilitated and encouraged pressure from the IMF, the FED, Mr Obama and the big banks to forced the ECB to realise it IS GOING to bail out anyone and everyone. At least in the short term. And for this market hsort term is all that seems to matter.
In many ways the Euro bond market is being engineered as the perfect money making set-up. Countries told they are hugely risky and forced, therefore, to pay exorbitant interest, on shorter and shorter term debt. Spain did sell €5.5 billion but only in 12 and 18 month bonds yesterday, Ireland sold €o.8 billion in 10 year bonds but at 5.5%, Hungary was hurting only selling €140 Million in 3 month and Greece sold €1.7 billion in 13 WEEK (Globally there is pressure on all countries away from long term forcing them down to the short end where debt has to constantly rolled over and over). But at the same time, for the bond market to agree to work at all, governments have been forced both by the market but also by the policies of captured politicians, to guarantee that ultimately there is no risk of loss over the duration of the short term bonds.
What has happened in a way is that risk itself has been artificially and lucratively split in two. There is the ‘face-value’ risk of a bond defaulting. And that is the risk that sets the interest that must be paid. But then there is the actual risk that the cost of the default, the loss, would actually be felt buy the bond holder. And that risk is much much lower because of the CB guarantee to rescue any major defaulter.
Thus we have set up a new bond market. One quite different from the old one. In this one there are two risks. The risk we pay the bond holder for – high risk/high interst. And the real risk the bond holder is actually running – low because the CB will cover him in event of a major problem. The debtor pays high interst on risk the bond holder isn’t really running. The ECB – ie you and me and our children – is running that risk instead. The Bond holder pockets the profit. We run the risks he is being paid for.
Note that a small problem on debt that is never in any danger of default – German debt for example – will not benefit from CB intervention. The benefits of CB guarantees are only for higher risk, higher rreturn debt. There is therefore an incentive to buy ‘riskier’ debt.
It’s a bond buyer License to print money. And they even get someone else to do the printing.
The eurozone’s €440bn sovereign rescue fund will be operational by the end of the month and expects to be awarded a coveted triple A credit rating in August, its new head has said.
Spelling out details of how the European Financial Stability Facility would operate, Klaus Regling, chief executive, said: “We will be ready to act whenever the politicians tell us to act.”
In an interview with the Financial Times, Mr Regling said the fund was a temporary crisis mechanism but could be extended beyond its intended three-year lifespan if any loans to eurozone governments were outstanding.
Many investors have doubted whether the fund would earn a triple A credit rating – a badge of credibility meaning it could borrow at the best possible rate. Only a minority of the eurozone members backing the fund have a triple A rating.
Maybe I'm not completely awake yet, but this looks like classic credit enhancement to me. Bundle together a load of BBB risks, and hey presto they are AAA .
FT this morning
Salut Frog2,
Agreed. It looks VERY like credit enhancement. Only if Germany is assumed to be the main backer does it rate AAA.
AAA these days seems less a financial rating and more a political one. AAA chance that the politicians will think it too big to fail.
What I shall look out for is what rating it gets from the Chinese agency. They are now going around saying they are the only really believeable agency!
Hi Golem
I'm fascinated by this Chinese credit rating agency, which I saw in one of your previous posts. I've tried to find a webpage address, but I'm obviously looking in the wrong place.
Could you please post a link.
Hi RichGB
Front page of FT, 'World' section —
FTalphaville link
No time to see a direct link to it. One thing I noticed last night is that the three western Agencies are getting worried about Liability.
Thanks frog2.
RichGB
I am the reason you can't find it. I mis-spelt it in the blog (now fixed) It is Dagong NOT Dagone. Sorry. Not sure if it was finger or brain trouble.
Here's the link to the agency web site.
http://www.dagongcredit.com/dagongweb/english/index.php
Frog2,
Yes, the liability thing is quite interesting. It would force the agencies to do some real due diligence.
Hi Golem,
Glad to see that the blog is continuing!
Now 13 week Debt, that is scary!
I've often heard that the UK has the benefit of most of its debt being relatively long term 10, 25 years etc. Is this gradually being eroded by the trend of the markets to buy shorter term debt? Do you have an idea of the fraction of UK debt in different length bonds and how this has changed over the past year?
jms452
On Rating Agencies' liability.
In the event of a Big One, their capital and reserves would be nowhere near big enough to meet claims, and if they had insured — the insurer would be in the same situation.
Talking of insurers did you see that Pimco is now offering what is being refered to as 'Black swan' insurance. Selling CDS to cover in the event of another BIG dislocation?! I think Citi was the first to start this idiocy. I mean irony doesn't being to to cover it, does it!
The Master CDS against all other CDS writers going bust , how many angels could dance on the head of that pin !
This whole process is all about the suspension of disbelief. So long as the music plays the players continue just as before. If the system crashes some time, nobody is to be blamed, because (nearly) every one of the players is in it together.
Check this out. It isn't remotely related to this post but it will be well worth a look for most of your readers, if only to see how financial news was reported on the telly during the 70s…
http://www.bbc.co.uk/blogs/adamcurtis/2010/07/predator_vs_aliens_ii.html
TAM
I never met James. But I did meet and interview Teddy. He was GREAT.