PIG Bonds Looking Like Dogs to Investors

by Paul Springer

The debt crisis in Europe is like a high stakes game of musical chairs – which nation will be the next to default when the music stops?

It’s hard to tell which country is in the worst shape, but bond trading reveals increasing concerns with debt issued by Portugal, Ireland and Greece. Financial Times reports that trading volume has dived as market players gird themselves for blowback from a possible bailout of Greece. Today, Reuters reported that Standard & Poor’s cut Greece’s rating, making it the lowest-rated country in the world by its standards.

While opportunity exists to buy distressed sovereign debt at a discount, many big traders are fleeing the venue.

Large banks have backed away almost entirely, according to The Guardian:

Figures from the Bank of International Settlements (BIS) show French, German and UK banks have embarked on a mass exodus from Greece, Portugal, Spain and Ireland, in what analysts see as an effort to bolster their balance sheets and conform to new rules designed to protect financial institutions from going bust.

It’s one big mess where any one party’s actions can have drastic effects on another’s situation. Now France and Germany are jockeying to maintain their own interests in the face of a Greek restructuring according to The Guardian’s analysis of players, including France’s finance minister Christine Lagarde:

[Lagarde] and her German counterpart, Wolfgang Schäuble, have been blamed for blocking a restructuring of Greek debt to maintain the solvency of their own banks.

Last week Schäuble reversed Berlin’s previous opposition and put forward a restructuring plan that involved Greece’s major private sector lenders, including banks. But he is understood to have met stiff opposition from Paris.

In this maelstrom of competing interests, Bloomberg reports that credit default prices are rising fast, partly driven by fears that no solution can be found for Greece’s problems:

Swaps on Ireland soared 32 basis points to 745, Portugal climbed 28 to 770 and Greece jumped 47 to an all-time high 1,610, according to CMA. The Markit iTraxx SovX Western Europe Index of swaps on 15 governments jumped 8.5 basis points to 219, approaching the record 221.75 basis points set Jan. 10.

Bloomberg added that the cost of insuring European corporate bonds also increased:

Contracts on the Markit iTraxx Crossover Index of 40 companies with mostly high-yield credit ratings increased 8 basis points to 408, the highest since March 17, according to JPMorgan Chase & Co. The index is a benchmark for the cost of protecting bonds against default and an increase signals deteriorating perceptions of credit quality.

Dow Jones reported last week that Moody’s analysis suggests that a Greek default could bring about a domino effect including defaults for Ireland and Portugal.

Ominously, Dow Jones notes, a restructuring of Greek debt could backfire unless it avoids a downgrade of the debt:

Key to any voluntary swap of Greek debt would be avoiding a so-called credit event or downgrade of Greek debt by ratings companies, which could force the ECB to end its liquidity provision to Greek lenders. That in turn, could spark a local banking crisis by cutting off Greek banks from much-needed funding.

And Reuters finds that Cyprus could get sucked into the vortex with Greece, thanks to exposure to Greek debt.

The whole thing may blow over, but there’s a good chance it could just blow up instead. For a view from the dark side, read economist Megan Greene’s guest blog post at The Guardian. Greene says it’s shake-up or break-up for both the EU and the Euro, both of which she says could implode amidst political infighting:

If fiscal union is not on the cards, the only other option is eurozone breakup. Imbalances in the euro area will pull the monetary union apart. This could either take place all at once, or it could involve peripheral or core countries peeling off from the eurozone individually.

A eurozone breakup would result in a widespread series of defaults, bank runs, capital controls and periods during which countries (and their banks) would be frozen out of the markets. It would be extremely messy.

While the average investor in the U.S. can do nothing to alter the course of these developments, now is a good time to take a hard look at any global or international investments involving foreign debt – or equity for that matter.

Editor’s note: This story has been updated from an earlier version today.

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