I'd Lend My 401K to a Bowery Wino — If...

Euros at an angle
Thomas Northcut | Photodisc | Getty Images
Euros at an angle

I would lend my 401K to a Bowery wino—especially at 7 percent interest—if someone with deep enough pockets promised to take me out at par.

The big news in European sovereign debt markets this morning is Portugal's 'successful' bond auction: Lisbon was able to sell €1.25 billion in debt.

On a yield basis, investors priced the Portuguese 10 year notes at 6.71 percent.

The Financial Times points out that the auction cleared below the critical "7 percent threshold" —above which level, "the government has acknowledged is unsustainable".

The 6.71 percent rate represents a nearly ten basis point improvement in Portuguese borrowing costs from the last auction, on November 10, 2010, when Lisbon paid 6.80 percent.

Not surprisingly, the Portuguese were eager to trumpet the accomplishment.

Again, from the FT: "After the auction Lisbon said that the 'clear conclusion' to be drawn was that the country had no need to seek an international financial bail-out. 'Faced with this result, there is no need' for outside help, Fernando Teixeira dos Santos, the country’s finance minister, said."

Here's the contrarian view: The institutional guys on the buy side have already priced in the bailout.

Bond prices—and therefore yields—are fundamentally about pricing risk. If markets assume that the debt will be backstopped, the value of the cash flows will be priced accordingly.

If that is true, in this case, it means that investors don't believe that the Germans, and their allies, can muster the political will to implement the collective action clauses that haircut bondholders in the event of a bailout or restructuring agreement by the ECB/IMF.

For that matter, does anyone remember the narrow yield spreads that Fannie Mae and Freddie Mac were trading at over treasuries?

Bondholders were betting that Uncle Ben and Uncle Hank would indemnify them against any losses.

And—after Fannie and Freddie went into receivership—that's precisely what happened.

It's not crazy to think that this auction indicates precisely the opposite of what the finance minister says it does.

Let's not forget, sovereign states are really no different than any other entity.

A finance minister seeking to reassure the bond markets about the stability of his nation's precarious fiscal situation is fundamentally no different than a CFO attempting to reassure the stock market about a 'onetime' accounting charge: Both guys are just talking their own book.

As the English are so fond of saying: Well he would say that, wouldn't he?


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