I have to admit, I’m writing today’s article as much for myself as for you…
I want to get caught up with what’s happening in the world, particularly in Europe, and writing is a terrific way to do so as it forces me to thoroughly research issues via multiple global media sources and not simply rely on the US “mainstream media” for my news; (after all, I want to provide you with the best and most accurate content possible!).
And I personally don’t watch much “mainstream news” other than CNBC from time to time…with a 3 and a 5-year-old and all of the horror/violence/sadness/negativeness that’s reported on the nightly news, it is not really an “appropriate” family activity!
So what’s going on in Europe?
You have probably heard by now that Standard & Poor’s, the now-infamous ratings agency, downgraded the credit ratings of France, Italy, and seven other European countries last Friday.
But what does this mean?
Well, apparently…not much! Usually you would expect this to mean that it would be harder for France to borrow money because it would be more expensive for them, much like if you were trying to borrow money to buy a house but you had not-so-great credit… you would need to pay a higher interest rate to your bank to compensate them for your higher “credit risk”.
So since France’s credit was just downgraded, typically you would expect France to have to pay a higher interest rate to its “bank” (its bond-holders), too.
But let’s take a look…that is not what’s happened to France at all!
France sold €8.6 billion ($10.9 billion) in short-term debt on Monday. And the yields (the interest rates charged by investors who purchased the debt) on those bonds actually fell, which implies that France’s “bank” (its bond-holder investors) actually still see the country as a good credit risk.
But why? Isn’t the euro zone imploding and suffering stagnant-at-best growth, high levels of unemployment (Spain’s unemployment rate is 20%+!), and staggering levels of debt…? What gives?
Well, it could be that the downgrade has already been priced into the bond market…it’s not like France’s fiscal report card is a big mystery. Rather, it is public knowledge and Standard & Poor’s has shown (repeatedly…) that they are often, if not always, “late to the party” (they completely missed the subprime mortgage crisis, for example, until being literally forced to downgrade the mortgage-backed securities in late 2007). So one possibility is that this downgrade was already expected by the market and factored in, and the actual downgrade by S&P was a “non-event”.
Anyway, apparently France received a pass from the market, but Portugal certainly did not….Portugal was among the nine euro zone countries to be downgraded by S&P, but they were actually downgraded to below investment grade…to “junk” status!
And their bond auction on Monday reflected this downgrade as much as France’s did not—according to the UK’s Telegraph, “Portugal’s borrowing costs jumped to record highs on Monday…Yields on benchmark 10-year government bonds rose nearly 2.3%, or 228 basis points, to 14.198% in afternoon trade.”
(14% return…not too shabby if you can actually get it!)
Which brings me to Greece…
Greece has a €14.4 Billion bond maturing on March 20, 2012, that it can’t afford to pay in full. It is frantically working with private investors to try to come up with some sort of “haircut deal” (You’ve probably seen this in the news as the “PSI Deal”…”Private Sector Involvement”).
This is a fancy way of saying that Greece is trying to get its investors to voluntarily write down at least 50% of their investment.
This is rather like if you asked your bank to write down your mortgage payments by 50%…how receptive would your bank likely be to this “deal”?
As you can imagine, these private investors (primarily hedge funds) have been less-than-excited about this “write-down 50%, take a voluntary loss” deal, and Greece has now sent some of its top officials to the US for talks with the International Monetary Fund (IMF).
Greece is trying to obtain another “rescue loan” (it received 8 billion euro last month, but that’s not enough…) from the European Union (EU), the IMF, and the European Central Bank (ECB) so that it can make its March 20th payment and not default, but the EU/IMF/ECB will not agree to the loan unless Greece can negotiate the voluntary “write-down” deal.
So what will happen?
Greece is insolvent. But no one wants to see a “disorderly default” (as honest of a solution as that would be!). All of these “make the write-down voluntary” games are being played to avoid the inevitable default from affecting the insurance companies, too, and creating another 2008-style global financial crisis.
(The insurance companies, much like AIG, have issued insurance, good ol’ “Credit Default Swaps” on these Greek bonds which they will have to pay out on unless the bondholders voluntarily agree to accept a partial default).
Not to be too morbid, but this is somewhat like a suicide clause in a life insurance policy, whereby the insurance company doesn’t have to pay if certain conditions are met. So if someone voluntarily agrees to accept a “default” or “partial default” on their Greek bond investment, then the financial insurance company is absolved from paying. Ugh. This is what our world financial markets have degenerated into!
1000 words later and I’ve barely scraped the surface…we haven’t even begun to discuss the EFSF (that was downgraded, too…), LTRO, and more…and most importantly, why you care about all of this!
But more on that tomorrow, along with your questions (please send them in if you have them—I love hearing from you!).
I’m so glad you liked the free special report and Louis James’ interview — I’ve gotten great feedback on both; thank you so much. I will work on more of those in the very near future!
To your financial success,
— Kung Fu Girl