Just as China grapples with the scale of economic waste induced by heavy monetarism, Europe has that old 2011 feeling again of financial waste. Mario Draghi’s July 2012 promise to “do whatever it takes” was taken by banks and financial “investors” as a free-for-all to ride severely discounted sovereign debt to tremendous profit. They did so much of that the ECB got mad at them last year for “forgetting” to lend to anyone else.
So it was too for the poster child of all this European financial disharmony, Greece. However, under this new Draghi-regime where “reach for yield” is significantly boosted by “buy all PIIGS for price appreciation too” it’s as if this is a brave new world. When the Greek government somehow floated new bond issues only eight months ago, I said:
Greek bond yields have been steadily dropping ever since Draghi’s promise, but it strains reason to see new Greek bonds trade to the same yield as that of Hungary, Dominican Republic or even Sri Lanka. All three of those countries hold higher ratings than Greece (though the “big” news is that Moodys might upgrade Greece to less junk status), but far more importantly none of them have defaulted in the past three years. The Greek government managed to do it twice…
In other words, there is tremendous political risk attached to the ability of Greece to repay debt, not the least of which is external. And that repayment itself is almost akin to a sanctioned check kiting. With another looming election, that can only rise, particularly with the opposition parties raising their standing in the polls.
I called it then a “pump and dump” no different than what became all-too-common in the US of penny stocks during the dot-com era – the key difference was that this sovereign bond version was sanctioned by “lawful” activity (in the form of a spoken sentence). The ECB goosed expectations that Greece was likely never going to live up to. That risk alone, whether the worst ever happens or not, argues for increased yield not the small spreads that they were able to come to “market” with. Yet, both offerings were severely oversubscribed as restraint and pure common sense were nowhere to be found; the “market” looked upon Greece in April of this year as little different than France or Belgium.
With the “pump” in place, the “dump” may have started a little early (again, political risk):
The price of Greek three-year notes, sold in July as part of the nation’s reintegration into bond markets, fell to a record today as political turmoil threatened to derail its recovery. The slump pushed yields on those securities above 10-year rates for the first time…
The yield on Greece’s July 2017 notes climbed 182 basis points, or 1.82 percentage point, to 8.29 percent at 4:44 p.m. London time. The price of the 3.375 percent security fell 3.88 or 38.80 euros per 1,000-euro ($1,241) face amount, to 88.89.
Bonds with so little risk in this age of ECB “guarantees” should not lose more than 11% par value in eight months. Such an occurrence might upset the entire view of the “value” of that still-unspecified ECB “promise”, an effect that might be far, far worse than just returning Greece to its 2010 starting point. The accumulation of all that PIIGS debt, again in what cannot be overstated, took place with the implicit understanding that there was very little price risk. That was why the last stress tests featured an “adverse” scenario of bond prices in December 2013. The latest in the Greek bond “market” has already blown through that.
Investors have such short memories whereupon the “reach for yield” is all that matters. Nations that default so spectacularly usually are shut out of bond markets for more than just a calendar turn or two. The difference, of course, is the ECB. With that implicit/explicit guarantee, bond investors have bid any and all debt under that umbrella without much regard to any realistic sense of risk. This is even more basic than arguing over whether recovery exists or not – in other words the Greek economy may well have stopped contracting and found a bottom, but that does not erase the high risk attached to any credit derived therein. The most basic foundation of finance is risk/reward, yet here we have it completely obliterated.
There is a term in finance for when an intermediary openly and actively entices investors to ignore all means of sense in order to purchase the securities of a very risky prospect without inhibition: pump and dump. Greed is not good; it is a monetarist tool.
Bubbles are nothing more than rationalizations contrary to all common sense, a description that almost perfectly fits the European bond “market.” How long before “contagion” makes an “unexpected” return appearance?