Monday, November 29, 2010

Bondholders Win Again v Taxpayers in Ireland, Continuing 3 Year Winning Streak; and Germany's Call for Some Form of Free Markets Takes a Hit Over the Weekend

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I won't spend much time on the well telegraphed Irish* bailout - just as I won't about the coming Portuguese bailout and I assume not too far off Spanish bailout.   What we saw over the weekend was yet another victory in a stirring string of bondholder versus taxpayer.  Somehow we have created a world where the bondholder cannot lose (only exceptions the past 3 years have been General Motors and Lehman Brothers) - every financial or sovereign debtholder on the globe has the moral hazard in place that they can invest without fear of losses.  The taxpayer will bear the brunt - heads you win, tails you still win.
  • Under pressure to arrest the threat to the currency before markets opened and prevent contagion engulfing Portugal and Spain, EU finance ministers endorsed an 85 billion-euro ($115 billion) loan package on Sunday to help Dublin cover bad bank debts and bridge a huge budget deficit.

*a quick aside - who exactly is being bailed out here?  Not so much "Ireland, Inc" but the bondholders.  And who are the main bondholders?  Banks.   Even more incestuous is the banks being bailed out are many times headquartered in countries providing a good part of the bailout funds.  See how circular it is?


Further, the 'temporary' (3 year) bailout fund, has now been made permanent.  Viva Bailout Globe.

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Perhaps more sad was a little mentioned 'loss' this weekend - that is the leader of some form of functioning free markets, the United States socialist democratic Germany was rebuked per the language coming out aside the bailout.  Here is the backstory as I've touched on within some earlier pieces - part of the panic of late is the mere idea that Germany indicated it wanted private investors to bear risk starting in 2013.  Perish the thought!!!
  • ........ talk of private investors having to take losses, or "haircuts," on the value of sovereign bonds, helped drive Ireland over the cliff.
Yes indeed, they would have to be subject to the same risks we as peons are... bad investments could lead to losses.  The horror of it all.  The bond market did not like this idea... after all it adds to 'uncertainty' and if you follow American politics you know every problem in America is now due to uncertainty - certainly nothing to do with decades of structural imbalances.

So these flightly investors who demand the taxpayers of the world make sure they never lose a penny by buying bonds in countries with high risk, stamped their feet.  And it looks like Germany lost this weekend and now we will have a 'case by case' review post 2013.  Granted that adds more uncertainty... but let's not let dogma get in the way of a good backstop.
  • ....euro zone officials agreed that after 2013, bondholders could face losses in future bailouts, but only on a case by case basis, taking into account guidance from the International Monetary Fund and its experience in previous debt crises. This was a caveat that France had advocated as a way to calm investor anxiety. 
  • Berlin had wanted the automatic involvement of the private sector in sovereign debt defaults, while Paris preferred a more flexible system. 

Translation - we are going to live under a mirage that private markets still matter.  However, the private market is so trained on moral hazard (which Alan Greenspan let out of the genie bottle in the late 90s with the bailout of Long Term Capital Management), it refuses to parlay its dollars into any market it can now actually lose money.  
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So to review, in normal functioning markets risk has a price.  In the golden world of bond investing every bond on earth seems to now be backstopped by a central bank or rescue authority.  Hence everything is mispriced, because moral hazard runs through every vein of our 'free markets'.  This mispricing is seen as "a sign the markets are functioning and all is well".   You sitting there with your silly Etrade account are subject to risk.  If however you were one of the globe's oligarchs you do not face such issues - everything is a one sided trade.  Except after 2013.  When Germany wanted a free market to actually exist ... but that was too extreme per the push back this weekend.  Instead it looks like bondholders will still be taken care of because surely we know when the can is kicked to 2013 'case by case' will mean 'well we need to make an exception on this one... and that one... and that one too...".  

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