Thursday, 6 January 2011

Default risk rises to top of worry list

Two things make me write on this. First, M Barnier the French EU economics commissioner will be putting out a 'consultation paper' on ways the taxpayer can be shielded  from bank crises. 'We are pursuing the idea of a debt write down or conversion to stabilise a failing bank and reduce the need for public funds' is his quote in AEP's piece in today's DT. This is Eurospeak for bond defaults with the bondholders left to take the hit.

Assessing credit risk, pricing credit default swaps and valuing defaulted bonds is what investing in bonds is all about and M Barnier the bond market has been doing this for hundreds of years. Also M Barnier there is no such thing as a free dejeuner. Remove a bond's government guarantee, its credit risk rises, investors demand a higher credit premium to compensate, the bond price falls and its yield rises. Thus Portugal managed to sell €500 mn of 6 month bills yesterday but had to pay twice the interest rate it paid in September!

The canny Swiss central bankers are doing what I recommended to our lot on Irish debt. Don't take it as OMO collateral at any price! Would we followed the same hard nosed approach but of course as good Europeans, mugs is a better description, we are obliged to take Eurocrap in our OMOs.

AEP also points out that Merkel lost her majority in the Bundesrat 2 days after agreeing to bank roll the Greek bailout! Pity we dont have some MP's who are not pre-occupied with their expense claims and put their country's needs first.

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