If another reminder is needed that we should all pay more attention to the bond market, the Greek debt crisis provides one.
It’s not like we really want to learn the ins-and-outs of the fixed-income business; just like we’re not all that inclined to study the melting temperatures of Arctic sea ice or the design of Toyota’s gas pedals. It’s just that these lessons keep getting forced upon us. The financial crisis has given us all (pun warning) a crash course. Indeed, it’s the gift that keeps on giving, in so many ways, like the unemployment rate for one, a chunk of the deficit for another.
After all, it was the bond market that went haywire first back in the spring of 2007, as this Wikipedia entry illustrates, long before the much-smaller stock market. Indeed, the Dow sleepwalked past 14,000 until mid-October and returned above 13,000 as late as May 2008. Google stock charts are here. We wish Google bond charts were as readily available, but they aren’t.
This morning, Europe’s smaller-country sovereign-debt drama is big news all around, and with good reason. (I call it “Greek” above for short. The other name, PIIG, for Portugal, Ireland, Italy and Greece, isn’t very nice; indeed, Barclays has stopped using it in its research notes.)
As The New York Times calmly states on page one:
Just as America’s recession begins to ebb, trouble is brewing in Europe that may prolong a downturn on the Continent and ricochet through the global economy as it struggles toward a recovery.
This is a terrific chart.
The FT strikes a scarier tone.
Fears of sovereign debt contagion across the eurozone sent European markets sharply lower on Thursday as negative sentiment spread to Wall Street with US markets also hit by worse than expected jobless data.
A truly educational slide show from the FT is here.
The Wall Street Journal even invokes the “S-word,” which I think is apt:
Many are beginning to worry that Greece could be the next “subprime”—referring to a debt situation that appears initially to be contained but that quickly spreads. It also focuses attention on the massive amounts of debt racked up by governments around the globe, including the U.S.
That this is serious business, the Journal makes clear (my emphasis):
Behind the turmoil are worries that a collection of European countries including Portugal, Ireland, Greece and Spain, known derisively as PIGS, won’t be able to finance budget deficits that have ballooned to around 10% of gross domestic product. That has sparked fears that Europe’s decade-old monetary union could unravel.
This sentiment spilled over into markets on Thursday. Although the European Commission had signed off on Greece’s budget plans the day before, confidence was shaken at the same time by a stumble in a Portuguese bond sale and Spain’s raising of its budget-deficit forecasts.
In a week where we’ve read so much about federal budgets and projected deficits, it would be nice if there had been more explanation about how the U.S. situation compares.
Floyd Norris gets us started on putting the U.S. in the picture:
In the United States now, some states, including California, are in severe financial straits. California represents a larger part of the American economy than Greece does of the European one, but even if it did default it would not create a national debt crisis, and Washington could provide help.
And he provides such good background on the euro, and the great dilemma at the core of that structure, that it makes me wonder why I bothered with grad school.
At the heart of the problem is Europe’s unwillingness more than a decade ago to choose either unification or separation. It wanted economic unification and continued political independence of nation states.
As a corollary to the above, the Greek drama also shows that as long as we’re providing more scrutiny to the bond markets, we might as well do the same for credit default swaps, the insurance products that are supposed to provide protection against bond defaults, except when they don’t.
It’s clear the CDS market, even after the AIG bailout, still needs more scrutiny and transparency, not to mention regulating—look how procyclical it is, as the Journal reports:
The credit-default swaps on debt of Greece and Portugal soared, indicating more worries about a default, investors became more alarmed. That often sets off a cycle of more CDS buying. Prices of government bonds issued by Spain and Portugal sank along with their stock markets, while the cost to insure these bonds against default using credit-default swaps soared.
All good stuff.
I’d just point out that the bond market problems really moved to prominence only when the stock market caught on.