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Why Would Anyone Buy A Spanish Bond? Part 3

The Eurozone’s descent into chaos is starting to get repetitive — though with each iteration the numbers do get scarier.

Back in 2010, for instance, the crisis was already almost a year old and Spain looked like the most likely post-Greece domino. In Why Would Anyone Buy a Spanish Bond? and Why Would Anyone Buy a Spanish Bond? Part 2 the discussion went like this:

Meanwhile, Spain’s credit rating is Aa2 (Moody’s third-highest) and its 10-year bonds yield 5.2%. Which takes us back to the question that has been nagging euro-skeptics for over a year: Why would anyone buy a Spanish bond? Is it reasonable to lend money for ten years at such a low rate to a country facing this much uncertainty — in a currency bloc that’s under this much stress?

The only conclusion is that when the markets look at Spanish debt they see German debt. In other words, they expect Greece to be bailed out via a German guarantee of its debt, and they expect this deal to then be extended to Spain. That’s not unreasonable, given the other options.

Here we are a year later, Greece is still imploding, and Spain (along with Italy) looks like a logical next victim. Automatic Earth just published a good explanation of why this is so, noting among other things that Spain’s total (i.e. public and private) debt is almost as high as a percent of GDP as that of the US, which is to say catastrophically high, and its real estate market has imploded while its banks have yet to take the related losses.

Last week the market demanded a 7% yield on new 10-year Spanish government bonds, up from 5% a year ago. Yet the bonds did sell, which once again raises the question of why anyone would buy such paper. For an investment bank or broker, loading up on these bonds risks the fate of MF Global, which was destroyed not by exotic derivatives but by the drying up of funding sources when it was revealed that it held a lot of European sovereign debt.

Even if you insure such bonds with credit default swaps you’re no more “hedged” than the holders of Greek debt who “voluntarily” accepted a 50% haircut last month, without triggering the insurance.

So why do it? Two reasons. First, there’s not much else to do with large amounts of cash if you need a positive nominal return. Say you’re a pension fund that has promised plan beneficiaries a ludicrous 8% annual return. Where else are you going to put your capital? Brazil or China maybe, but that would be hard to defend if it goes wrong. And you can’t own only US Treasuries, since they don’t yield enough and in any event your trustees would wonder why they were paying you to make such timid and simplistic decisions.

Second, as noted above, if you assume Spain and Italy are too big to fail, as everyone says they are, then Germany will have no choice eventually but to bail them out. Whether this happens through direct “foreign aid”, loan guarantees or bond purchases by the European Central Bank, the net effect is to turn Spanish and Italian bonds into German bonds.

That will degrade Germany’s balance sheet, of course, but maybe not catastrophically. Lending to a less than AAA Germany might still, so goes the buyer thought process, be a good move at 7%.

So the question then becomes, what will Germany look like when it’s responsible for the rest of Europe’s debt. Put another way, what would Europe’s average interest rate be if everyone was responsible for everyone else’s debt? We won’t know the answer, of course, till we get there, but 7% seems like way too little compensation for the stress of this journey.

12 thoughts on "Why Would Anyone Buy A Spanish Bond? Part 3"

  1. Jason, re Europeans going on holiday in August. I worked in the Netherlands for five years and that is what I observed whilst I was there (key people go on holiday for say three weeks at a time, and nobody will call them whilst they are on holiday if there is a problem that they might be able to help with). What I also observed is that they have a much better work/life balance; which is to say, they have their work, and they have their life. and they draw the line very clearly between them. That, I think, is healthy. I think you are confusing and conflating private work/life balance with State (governmental) fiscal irresponsibility.

    1. Sorry J, but I don’t follow you at all. If a block of work is not getting done, then you are going to lose sales. Someone that has been around a while certainly deserves 3 weeks of vacation per year, but do they all have to take it one time? None of them take one single day at Christmas? Or do they get 6 or 7 weeks a year off. How did that work out for GM, Chrysler, etc., lol?

      If you want to go live at some utopian based farm, I sure you could get a great work/life balance, albeit at a lower standard of living. I didn’t vote for this global economy we’re in, but here it is. The party is over for the USA and EU. You have to outperform the Chindians or you are welcome to sit a home all day long, every day.

      If you are familiar with B.F. Skinner, he is most known for the infamous ‘Skinner Box’. However, he also gets into the logic of a shorter work day. The logic is, a well managed, highly motivated worker can get just as much done in 6 hours, as they now accomplish in 8 hours. Other writers have said basically the same thing with the observation that the time to do a task expands to fill the time allotted to do it. But you still have to show for work 5 days a week.

      I o.k. with your friends in Holland working part time, in order to maximize their work/life balance, and they should get part time pay as well. Otherwise they bankrupt the corporation/government office that employs them.

  2. About 8 or 9 years ago my company was clearing the necessary regulatory hurdles to start selling a product in Europe. I think it was in June, and the other company that was advising us said we really had to move quickly to avoid a huge delay. They said that not only does France and much of the rest of Europe go on vacation the month of August, it is now (as of 8 years ago) starting in late July as well!!

    I always wondered how they could get away with that crap, including the early retirement ages and all the other benefits. I guess the piper is piping, lol. Why would anybody, other than a captive, throw money into that black hole?

  3. It’s all in the VAT for Spain. Spain is the “Florida” of the EU. Although some penny-pinchers hike of to Cyprus and Croatia, Spain had their black market housing boom in the south. Regardless of the debt issue, Spain will survive strictly on the tourist trade. I remember living in Costa Del Sur years ago and wondering what attracted so many millions of people to Spain daily through Barcelona. It’s the sun, fun and culture. Spain is simply to lazy to do anything to move itself into the black so their dependency on the tourist euros and vacationers will likely continue until the unfortunate day comes when Germany bails them out. Ay Caramba!

  4. It is very hard to save the situation in Europe. Put all the bankrupt nations together, Belgium, Ireland, Greece, Portugal, Iceland, Spain and maybe Slovakia, it will result in a BIG PISS. Just flush the debt away and start all over.

  5. Cuba had the bay of pigs… I’d like a wall of PIIGS. Purely as a novelty, one of my office walls papered entirely with soon-to-be-worthless PIIGS bond certificates.

    So, to answer the question, “Why Would Anyone Buy A Spanish Bond?” I would… but only at a novelty wall-paper price.

  6. I own a little land, 6 acres more or less. I’m trying to learn how to farm organically with no prior experience. This is both a spiritual and survival driven lifestyle. I have accepted the fact that when the dollar collapses and the food shortages are rampant, desperate people will over run my farmette and devour everything in sight including me. At least I was able to do some of God’s work, using my muscles under the big sky breathing in the fresh air. Prepare for the worst, Pray for the best. +

  7. Anybody thinking South America as an exit strategy? I have property in Colombia. There the economy is on fire, enormous growth. Still a tad dangerous for gringos, but my wife is from there. The peso COP is extremely strong. In my opinion, although you can not escape the global economy anywhere, SA seems to be the most insulated continent because of their relatively untapped natural resources, especially food, oil, and precious metal mining.

  8. If I were a German individual or government, I’d offer Greece a bailout, so long as in return, I received something equal in exchange, such as a Greek island, some of the most beautiful real estate in the world. Greece has many valuable assets that a German stuck in a cold climate would be willing to buy.

  9. I like Chris’s comment but that’s a discussion for another day. However, when I say to people that 2.5 billions Chindians want an SUV, a TV and a Mc Mansion and that’s what Western economy expects and how are we going to find the resources, nobody wants to talk to me. Some say; human ingenuity is infinite, we’ll find a way. We’ll see. Regarding Spanish bonds, I’ll give you an analogy. In the first part of the 90’s I bought an 8.5% Italian Gov bond at par. A year and an half later I was losing 50% of my capital, devaluation! I made it back by buying stocks but nowadays, even at 7.75% I wouldn’t touch an Italian, Spanish or whatever bond with a ten foot pole. This being said, Italy didn’t disappear during the 90’s.

  10. The equation is so undeniable and so scarily simple to understand and yet the Economists and their politician mouth pieces will never get it. Not until it’s too late. They’ve been trained in 19th century economic ideology!

    The equation is this:
    Infinite growth + exponential population growth – Finite resources = Total collapse.
    The logic is undeniable. Nothing changes the outcome of this equation. What word do you hear our of every Politcians and Economists mouth on a dalily basis? “Growth”. They truly believe that it’s sutainable to infinity. Growth is death. Growth is the short term solution and the long term cliff. Not even that will work now. When we finally realise and understand this equation then we may have a future. Until then we are on what I like to call the road to “Mexico city”. In a few years though Mexico city will look good.
    Countries are already way beyond their sustainable limits in terms of population and resources. We are destroying the building blocks of life on this planet. The debt crisis is merely the popping of the air bubble we have all been breathing for the last few decades. The fun really starts when the resource crunch hits and that is coming fast. No amount of meetings and get togethers and treaties, QEs and other nonsense will change the fact that resources are finite and there are simply too many people. Countries must move away from the global economy and 100% electrical and oil driven societies and back to small self sustaining communities. Probability of this happening? Zero.

  11. I might buy Spanish bonds with someone else’s money or perhaps if I had a printing press and could just create money out of nothing. Apparently MFG, the Fed, and I think a lot alike 🙂

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