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February 16, 2009

Comments

Yvonne

Michael,
I feel a litle like the guy from the Financial Regulator Ad who didn't know what a tracker mortgage was, but what exactly is a government bond and why should we be 'excited' about them?

Michael Taft

Yvonne, it is a pretty arcane area but important nonetheless. In effect, Government bonds are borrowings. We borrow through bonds. If investors refuse to buy them we can't borrow and, therefore, we go broke (especially as our deficit is now running €20 billion +). Of, if we can only sell the bonds at very high rates, the cost of our borrowing goes up - paid for by the taxpayer (rather than a school or a hospital or measures to keep people in employment). The flip side of this is that if we can sell bonds at low rates, our borrowing is less costly leaving the state with more money to invest.

On RTE news this evening we got treated to the same argument (with a big old graph) about how our bond rates are increasing (i.e. our borrowing costs) and how this was going to sink the economy; how we had to slash public expenditure to to 'incentivise' investors to buy bonds. All this missed the point - our borrowing costs are increasing because no one trusts our banks.

It isn't a sexy topic, but it's vital nonetheless. I only hope that I was able to convey that - but I have to admit that I don't usually get into bond issues and, so, am probably not the best in explaining the real reprucussions of the Right's arguments.

That make any sense?

James

I think this is a great post Michael, extremely helpful. I mentioned before that I found it bizarre how frequently the growing spread between Irish and German bonds (a significant metric to be sure) was being highlighted compared to radio silence, relatively speaking, on the equally important trend in absolute yields. Your argument about the cause of the growing yields having less to do with things budgetary is fairly persuasive too.

What are the implications of this for any potential nationalisation of the other banks though? And why should the markets have cared about the nationalisation of Anglo given that we already owned its liabilities via the guarentee?

Niall

Long term gilts have moved out further to 5.76% today
http://www.ise.ie/app/bondDailyIndex.asp

Consider this return in light of dis inflation of say 3% for each of 2009 & 2010. A real return of nearly 9%

Something is very rotten.

Paul O'Mahony (Cork, Ireland)

Thank you very much for the education.
Much appreciated.

Barry

Is is also possible that both statements are true:

1. The banks caused this and the guarantee was a massive blunder.

2. Current levels of governemnt expenditure on public sector wages and pensions are unsustainable.

What then?

Smoke

Great post Michael.

Libero

I agree with the comment from Barry: proving that the bank guarantee is a big negative for Irish bonds does not prove that the level of government expenditure is somehow not also a major issue.

I think Morgan Kelly got it right in the Irish Times today. The bank guarantee was indeed a public policy disaster with a real impact on our state's ability to borrow. But the example of "Brian" walking in to see the bank manager would still make for grim reading even if he hadn't guaranteed his mates' gambling debts.

James

Libero,

"...proving that the bank guarantee is a big negative for Irish bonds does not prove that the level of government expenditure is somehow not also a major issue."

I presume by "the level of government expenditure" you mean the gap between expenditure and revenue - which could obviously be addressed on either the expenditure or the revenue side (or both).

If we only consider the budgetary issue then it seems hard to explain why Ireland's bonds are grouped with those of countries with dramatically worse net public debts (i.e. Greece, Italy, Portugal, Spain). It would make more sense if our bonds were being hurt by the far higher private sector (above all bank) liabilities.

This surely raises questions about the strategy, being pursued by the government and promoted by many economists, of fiscal retrenchment and deflation. We're told that fiscal retrenchment is necessary a) to prevent us getting shut out by the bond markets and b) to facilitate a wider deflation to restore our competitiveness. But if excessive private sector, rather than public, debt is what is discouraging people from lending to our government, then deflation is no help at all, because it inflates the real burden of existing debt.

Michael Taft

James, as to why should the markets care about Anglo-Irish; I can't claim any great insight into the mind of the international bond investor but one explanation might be this: first, the bank guarantee was to have solved our problems; our banks don't need capital; our banks need capital but the state won't be providing; okay, the state will provide some of it; what the hell, the state will provide all of it; we'll give some to Anglo-Irish; no we won't, we'll nationalise it. Now, what about AIB and BoI. It's no so much the particular act of nationalising Anglo-Irish, I'm guessing, bur rather the lead up which contained smugness, then arrogance, the confusion, then ignorance, the headless chicken time. It raises legitimate questions re: the rest of the sector.

But, and here I take Niall's point, there is something strange going on here. On paper, there is no way that EU countries with ratings below Ireland's AAA status should be getting bond yeilds. I can't put my finger on it.

As to the effect of wholesale public ownership - depends on who does it with what strategy. There may be a short-term hit but once it sinks in that we have rid ourselves of the concrete block, there's no reason why the bond market shouldn't settle down (fingers crossed).

Yes, Barry (and welcome if this is your first comment on the blog), it is possible that both points are true independently of each other. However, I was trying to assess their impact on the bond markets through an examination of the indices. I found evidence for one, not much evidence for the latter. That, of course, doesn't mean they won't dovetail into a perfect storm some time in the future. Just that since last year, it apparently hasn't been the case.

Again, Libero, I take your point. But as I said, I was only examining causal explanations for bond fluctuations. In this regard, you might be interested in the post I put up today.

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