Too Big To Nail

— Financial history is littered with examples of creditors getting stiffed by debtors. It’s why interest is charged on loans. You need some incentive to compensate you for the (usually) small probability of not getting your money back.

— The risk of not getting your money back leads to, hopefully, better investment decisions. A debtor should have a good business plan or a sound existing business in order to convince their creditor to give them money.

— But in Europe, the bureaucrats are trying to turn the concept of risk upside down. Greece, Ireland, Portugal and Spain have clearly borrowed too much. They do not have the capacity to repay the loans.

— The market knows it too. That’s why yields on government bonds in the Eurozone’s peripheral countries are rising again. As the WSJ reports:

‘The European sovereign debt crisis is revving up again after Portugal sold its full allotment of two-year bonds, but at an elevated interest rate. Most analysts expect that Portugal could soon join Ireland and Greece in the EU ICU.

More troubling, however, is the rising chatter of a possible restructuring for Greek and Irish debt. Greek bonds, in particular, have sold off dramatically, especially at the shorter-end. The yield on two-year Greek government debt is above 15%, according to Tradeweb, which is higher than the yield on Greek 10-year debt, which is 12.7%.

Irish two-year sovereign debt is sporting 7.95% yields and its 10-year debt is yielding 9.4%. By comparison, Portugal’s two-year debt yields 6.1% and its 10-year debt is yielding 7.5%. Those yields are not considered sustainable in terms of funding Portugal’s debt requirements.’

— Let’s be honest, they’re not sustainable for any country with enormous debt levels. Yet those in power are doing everything they can to avoid default.

— Trying to avoid default is an honourable thing to do, both at a personal and sovereign level. But when all of society must suffer to pay for the sins of a few (idiot bankers in Ireland or corrupt and free spending politicians in Greece) the concept of honour sounds less appealing.

— It is often pointed out that the problems are the fault of the borrowing countries. They lived beyond their means for years, so now it’s time for payback. It’s not fair that the thrifty and hard working Germans must pay for others’ profligacy. And it’s a fair enough argument…on the surface.

— But who made the loans? The German banks did. German citizens worked hard and saved. They put their money in the bank…and the bankers squandered their savings by making loans that were all out of proportion to traditional risk/reward considerations.

— So who is to blame? Those with their hands out hardly believing their luck over the amount of funds on offer? Or those providing the loans – not knowing or caring if they would ever be paid back?

— Surely it’s incumbent on the lender to do proper due diligence? That was how banking used to work. Maybe they did though. Maybe they just worked out that the Eurozone experiment was too big and too important to fail. They could lend what they liked to whom they like and reap the profits, knowing that the borrowers would not be permitted to default.

— That’s how it’s played out so far. But judging from the rising rates on government debt, defaults and debt restructuring won’t be too far off. Let’s give it two months, shall we?

— Greece is first in line. And once one country decides to finally stiff their bankers, others will quickly follow. Then, the European banking system will be seen to be insolvent.

— Speaking of insolvency, did you notice that Pimco, one of the worlds largest bond funds, just cut it’s holdings of US government debt to zero? Pimco boss Bill Gross thinks yields will rise after the Fed winds up its QEII money printing scheme in June.

— For all the talk of inflation and coming hyperinflation, the US 10-year bond yield is still only 3.62%. That’s a big jump from late last year, but no reason to go and buy a wheelbarrow to collect you weekly pay.  Not yet anyway. If yields continue rising above the 4% threshold (and they will at some point) its time to really worry about the ability of the US economy to continue to levitate.

— Moving closer to home, its good to see insider trading alive and well. Yesterday, we’d just finished writing an in-depth review of the Australian media sector, in which the Channel Ten shenanigans featured heavily.

— So when we saw the stock had fallen by around 4.5% (mostly in late afternoon trade) we thought there must’ve been an announcement. Nope, nothing.

— But this morning came news that Seven is commencing proceedings against Ten and soon-to-be (or maybe not) CEO James Warburton.

— We wonder whether ASIC will take the time to find out who was behind the heavy selling in Ten yesterday afternoon, and why? They probably won’t though…too big to nail?

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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The man in the shadows
The man in the shadows

If your on this site you probably have similar interests to myself and as such might be interested in reading this-

I hate to sound like a spammer but I have been lurking hear for a very long time so please don’t think I’m just wantzing in.

I also know that this isn’t really on the right topic of the article in question but, still, I thought you may be interested.

Biker Pete
Abolish negative gearing? Yes, quite interesting, MITS. What would happen to house construction? Increase, decrease, stay the same? If it decreased, or stayed the same (falling, at present) could that affect housing supply as populations rose? If it resulted in less homes built, would prices go up, down, or remain the same?* I wonder what would happen to rents? Would they rise, fall, stay the same? It’s said that Keating’s decision to drop negative gearing created higher rents. Some contest that, arguing rents would have risen anyway. While we’re discussing this, what about abolishing capital gains tax, as in NZ?… Read more »
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