74.1% yield on 2-year Greek government bonds | Hacker News Reader

74.1% yield on 2-year Greek government bonds

bloomberg.com

55 pointsfriism65 comments

http://www.bloomberg.com/news/2011-09-12/greece-s-risk-of-de...

98% chance of default makes them essentially expensive lottery tickets at this point.

Not really, if Greece defaults, bonds will still hold certain value (like half of the original price or so). So not really a lottery ticket.

Also 98% chance seems pretty high especially when Germany and France are going to do everything to avoid this because their banks are heavily invested in Greek bonds.

Indeed to both ... but Germany and France can't bail out all the PIIGS. Spain is probably outright impossible and Italy is out of the question. And that's ignoring the willingness of the citizens of the former to indefinitely fund the profligate ways of their southern neighbors; I'm not sure how responsive the French government is or has to be to its electorate but I gather the German system works well enough. (Plus don't forget that German GDP or what it export growth just flattened....)

But Spain and Italy are in a much different situation than Greece or the other smaller "peripheral" Euro economies. Basically, Greece needs a bailout or must leave the Euro. Italy needs non-insane monetary policy:

http://krugman.blogs.nytimes.com/2011/08/07/a-self-fulfillin...

http://krugman.blogs.nytimes.com/2011/09/11/the-spanish-pris...

You're probably right, they'll make some principal payment, perhaps even par -- but in what currency? If it's drachmas, you're getting a claim on the various things Greece exports. Hence views on the value of greek bonds are increasingly driven by views on the prospects for the olive oil market. After three millenia of maturation, this is now considered a commodity market with little potential for pricing power . . .

P.S. The Germans may, at some point, prefer to bail out their banks, as there they have some capacity to draw a line and call a halt.

The _real_ question is the implications of a Greek default / euro withdrawal on European political integration. The Germans care a great deal more about that, and are probably prepared to pay a very high price for it. The question comes down to, how much of others' welfare states must they underwrite, and how much will they underwrite.

>P.S. The Germans may, at some point, prefer to bail out their banks, as there they have some capacity to draw a line and call a halt.

I think Germany is loving this crisis. The number it's doing on the Euro has been incredible for their export economy. I suspect they'll do whatever they need to to keep this going as long as possible.

That's about the only benefit they're seeing, and it doesn't compensate for the risk they'll take on when (ultimately) asked to bail out a number of countries.

German politicians or the German people? Last I heard the latter have not been very happy about having to bail out the entire euro sector.

Big German businesses. I suspect that pulls in many of the politicians in as well. Of course most of the people hate it, it doesn't help them at all and their tax money is financing it.

There is no legal basis for kicking Greece out of the euro. None of the relevant treaties have any provision for member states kicking another state out of the monetary union or a member state leaving of their own accord. I think there is a provision for a state to leave the EU, but only of its own accord and not by force, and they'd have to leave the EU not just the monetary union. So if its going to be legal, there'd have to be some amendments made to the treaties.

Of course, Greece could just turn its back on the treaties, ditch the euro, re-instate the drachma, convert all debt obligations to drachmas and go on its merry way devaluing the drachma against the euro. But they would no doubt face retaliation from an angry EU and will likely get hit with stiff trade barriers on Greece exports as punishment (in which case devaluing the drachma would have limited effect).

I think the more likely outcome will be some kind of debt restructuring, a situation where the foreign bondholders (who own almost 60% of the debt) will have to finally face up to their losses.

Restructuring would force recapitalization of national bank systems, and could well force recapitalization of the ECB. It's hard to see how that goes down without a German subsidy.

That's probably fine as a one-off event, but of course this situation is basically writing the rules going forward. And a default / restructuring would also force reconsideration of the "risk-free" status afforded euro sovereign debt by the EBC and national regulators. Actually reflecting risk would introduce yield and liquidity differentials among euro sovereigns, with Germany essentially becoming the benchmark. Ignoring that risk would perpetuate the moral hazard temptations, and under a precedent of Germany underwriting the risks.

So either the euro becomes the deutchesmark, or Germany underwrites the deficit risks of the euro countries. Not easy to see how that gets resolved.

>Also 98% chance seems pretty high

and what is the alternative? To pay back with 74% of interest? In real money (ie. euro/dollar)? The only possible non-default way is several times inflation of Greek currency.

None of this changes how much Greece has to pay (unless they issue new debt). The actual Euro yield is based on the face value of the bond, which doesn't change. This is just the market saying that the bonds are worth considerably less than their face value.

Unfortunately the Greek currency is the Euro, and the Greeks can't print more of it. A moderate amount of inflation at the start of this whole mess could possibly have headed off the looming disaster, but it would certainly take way more than the Germans could ever tolerate now.

Printing money to service debt will most likely drive inflation higher, in turn driving up interest rates investors will demand from government bonds.

This escape route from a towering debt burden was tried by German post-WW1 governments, and lets just say it didn't go very well. It's the reason the Bundesbank is the way it is now.

Clearly the interest rate paid relates to past inflation rates, but if the goal is to pay off the national debt not just borrow more a little inflation can help things along.

Say inflation is 2% interest rate is 2% over inflation (or 4%) and the bond is for 10 years. 1.04^10/1.02^10 = 1.2143. Now compare that to 3% and major assumption you still need to pay out 2% over inflation well you get 1.212 which is a lower cost. At the same time your debt servicing costs drop. Now it's true that you may need to pay a fraction more than 2% in interest but for small positive increases in inflation it can reduce debt servicing costs significantly. For this to really work well your new debt needs to be well below your debt servicing costs AND you need to hold mostly long term bonds is rarely the case for country’s with debt issues.

Unfortunately, few nations are trying to pay off their national debts and are more focused on maximizing their ability to borrow which is another story.

I was horribly unclear there.

The moderate, potentially politically feasible inflation would have served to overcome nominal price stickiness and helped Greece transition to a slightly lower standard of living gracefully, one they could actually sustain without borrowing based on their production.

The unfeasible inflation would just be a backdoor default, and not really any worse than a real default except to the extent that the EU laws prevent Greece from actually defaulting. This would also entail adjustment in living standards.

The horrible option that would result in hyperinflation would be continuing to live beyond their means and using inflation to pay off the debts they were continuing to accumulate. I totally agree that that wouldn't end up solving anything.

Can you explain this in lehmans?

If I asked you for $100 and your mother asked you for $100, you'd charge me more interest, because I'm [hopefully] a higher risk [from your point of view].

The interest paid on bonds is directly related to the risk of holding the bond (or, the perceived risk). A high interest rate (which the government pays) is the only way the government can get people to buy its bonds, because it's considered a high risk.

It pretty much means that, people aren't expecting Greece to be able to pay back its debt in 2 years. Which is really bad, normally, short term bonds have lower rates (because the risk is lower)...but now, even at 2-years, people see huge risk.

People want 75% interest on, what is essentially, a 2 year loan. Compare that to other parts of the world where you're taking 3% on 20 years....20 years is a long time, anything can happen, but even over such a huge difference in time scale, greece is a much, much, higher risk.

Thanks. If I bought these bonds and they actually paid back, if get a 75% return? So, how is risk calculated...quantitatively or more gut?

Yes. It's kind of a "double-or-nothing" casino game.

The yield is determined by the free market, it's the amount that Greece has to (promise to) pay for anyone to take them. It's not determined by a formula afaik, just based on current events and the state of the country's finances.

I don't think you can invest (or rather, speculate, this is too crazy to call investing) in these as normal retail investor though.

To be clear, the yield is determined by the free market as the price they pay for the bond. If the bond was originally priced at $100, with a 1% coupon payment (the amount the government or bond issuer will pay you in interest), if the resale value goes down to $50 in the open market, then the yield has doubled to 2%, since a new owner of the bond only had to pay $50 to get the same $1 coupon payment while holding the bond.

Regardless of whether the bond has a coupon payment or not the face value of the bond is due at maturity. In your example the $1 coupon is still paid but in two years you also get $100 back on your $50 purchase (netting 20+%apy).

Of course if the government defaults on your bond you get maybe on $1 coupon and end with a net loss of $49.

Ah yes, you're correct. So my yield is way off. Thanks for the correction.

Remember that rates are always given as annual rates. If you buy $100 in two-year bonds, in two years you get about $303 back, or ($100 * 1.74^2).

Is that a subtle play on words?

The word is "layman's". Lehman Brothers is the investment bank that collapsed in 2008. Cute typo.

The simplest translation, though: The market believes that if you were to loan money to Greece for two years, there's only about a 33% chance that you'll get your money back.

(That's 1.74^(-2) assuming risk-neutrality and a risk-free rate of 0%, which is depressing but sure makes calculations easier. In reality, the math is much more complicated, as nobody is actually neutral to asset risk, and you have to consider pseudo-defaulting via inflation, and the fact that bonds aren't entirely worthless after a default, etc.)

> The word is "layman's". Lehman Brothers is the investment bank that collapsed in 2008. Cute typo.

Maybe a Lehman has become a measure of the scale of financial failure.

"Greek defaulting would be 12.72 Lehmans."

Now I am convinced the questioner probably was asking for this figure too. How many Lehmans equals Greece defaulting?

Actually, 0.39 Lehmans.

Greek debt is around $240 billion and Lehman assets were around $613 billion.

Of course, that number does not even consider that countries only partially and temporarily default, instead of fully and permanently like limited corporations, and that everyone who owns Greek debt has had a generous advance warning. This is really a comparatively minor crisis.

We have it then. A Lehman is a term of measuring crappy financial situations and is worth $613B.

So, a correct use would be like "Don't worry, our national debt is only 25 Lehmans."

To me, a country defaulting sounds worse than a bank going under. Does the inability of Greece to raise capital have greater indirect costs and knock-on effects than the failure of Lehmans?

Sure. This is a HUGE opportunity to make a buck! BUY, BUY BUY!! No cash, borrow and BUY! Leverage baby leverage! Were going to make a killing on this! Oh... sorry, I see you actually meant layman's...

It'll be pretty bad because regulators have dealt with failing banks before but the EU has never had to deal with a member state defaulting and does not really have any institutions to deal with it. I'd says this disaster will probably end up being about 10 Lehmans in magnitude, though the fall of the Lehman brothers was only part of the financial crisis.

The collapse of Lehman brothers was an event that threatened the stability of the global financial system. The default of Greece is a minor nuisance that is mainly relevant because of fear that Italy and Spain might be next.

I'd say it's about half a Lehman, give or take a Countrywide.

Now, I'm not very knowledgeable about the world of finance, but what I'm curious about is, what happens if Greece defaults? Like if you default on a bank loan, the bank takes your house. On those lines, if (when) Greece defaults and I have some government bonds, I would get like a government office desk or something? (or some physical object that is of equivalent value to the amount I have bonds for)

The Greek government doesn't currently have have enough tax income to pay for all the spending it does. If it defaulted nobody would be willing to lend it money so it would have to reduce spending even more and the politicians would get lynched. However, as a sovereign state there would normally be no other downside to defaulting except that people won't lend you money in the future.

However, I believe that one of the requirements for membership in the EU is that you promise that you won't default on your debts. How this will play out in practice, I have no idea.

Just because you default doesn't mean no one will lend to you in the future. Greek has defaulted many times in the recent past.

They will have to pay a much higher rate in the future. Making default expensive.

Government debt is almost always unsecured.

For some reason this is hardly ever discussed. But I guess we can look to the situation in Argentina which defaulted in 2002. Oddly, there doesn't seem to have been long-term adverse consequences, most investors took a haircut or lost their money. The country had a deep depression for a couple of years but have been doing pretty well recently. I hope someone with more information can chime in on this.

When you take out a loan say for a car, you put the car as collateral. This is called a secured loan. When you charge something to your credit card you don't put up any collateral. This is called an unsecured loan. Government bonds are of the unsecured type so you don't get anything if they don't pay.

Default has a pretty loose definition, but what will most likely happen is some kind of debt restructuring (which people will interpret as a default), e.g. extending the maturity on bonds, writing off some parts of the debt, paying out a lower coupon rate, etc. Basically, german and french banks (who hold a big chunk of the debt) will lose a pile of cash.

If I wanted to risk a few hundred dollars in propping up the Greek government, is there an easy way to this? Or is there a minimum investment way larger than I'd like to commit and/or only open to licensed brokers only?

(Apologies for stupid newbie investor questions... I read about this stuff in the news, but I have no idea how it actually works.)

You'd need to get a brokerage account that allows you to trade sovereign bonds. (I think TD Ameritrade might do). And from there it should be a straight shot.

The only problem is that if you invest only a few hundred bucks, trading commissions (~$20 to buy and sell) eat up a big portion of your (potential) returns. For example, if you invest $200 and come out of your trade even (selling bonds back to the market for $200), you still pay $20 in trading commissions, so you'd be already down 10% on your trade. In other words, you'd need to be up 10% on your trade (which is very nice) in order to just compensate for commissions.

Does buying existing bonds help prop up the Greek govt? Remember - they don't get any money from that transaction.

If you want to help prop up the Greek govt, you probably have to give it money, that is, buy new bonds from it. It's probably not offering to pay 74% on such loans. And, given the yield of current bonds, it's probably not even bothering to try to sell bonds.

Does buying existing bonds help prop up the Greek govt? Remember - they don't get any money from that transaction

Well in some sense... if you create demand for the existing bonds then you create confidence in them, and hence drive down yields on the next round of bonds that get issued.

This could get ugly, Greece is a gonner and the crises is now extending beyond the so called PIIGS to Italy, the eight largest economy in the world. Another financial crisis worse then 08's but without a central political authority with the power to shore things up. The shock will be felt worldwide.

Sorry to be nitpicky, but Italy is the first I in PIIGS, the second being Ireland.

oops, you're right, though I should have mentioned that even France is being affected now, the 5th largest economy.

There was a great quote about France's economic reliability in Michael Lewis' recent Vanity Fair piece:

<< The idea he and his fellow dissident German economists have cooked up is to split the European Union in two, for financial purposes. One euro, a kind of second-string currency, would be issued for, and used by, the deadbeat countries—Greece, Portugal, Spain, Italy, and so on. The first-string euro would be used by “the homogenous countries, the ones you can rely on.” He lists these reliable countries: Germany, Austria, Belgium, the Netherlands, Finland, and (he hesitates for a second over this) France.

“Are you sure the French belong?”

“We discussed this,” he says seriously. They decided that for social reasons you couldn’t really exclude the French. It was just too awkward. >>

http://www.vanityfair.com/business/features/2011/09/europe-2...

Sorry to be even more nitpicky, but... in what sense is it not the other way around?

Originally it was just PIGS, standing for Portugal, Italy, Greece, Spain. Ireland got into financial trouble later on, and was then inserted into the acronym, forming PIIGS. No idea why it got added to the middle, but Italy was definitely in there first, so by convention they get listed in that order.

You are incorrect. It was Portugal, Ireland, Greece and possibly Spain. Greece is deep in trouble, Ireland had to borrow from EU and UK earlier this year and its economy is in deep trouble, i.e. people emigrating in droves trouble, not sure about Portugal but I think they got some bail out money too. Italy is a very recent addition, only last month, and has not had any bail out money and hopefully will not require any because it is too big to bail out.

The acronym was first used in 2007, as far as I can tell, and Ireland was added to it in 2008. The most recent crisis Italy is going through is indeed a recent addition, but it is by far not the first crisis, and the acronym is much older than this. Here is an example of usage in an article from 2008, before the shit Ireland was in was exposed:

http://www.thedailybeast.com/newsweek/2008/06/28/why-pigs-ca...

Italy does not have a deficit problem, it has a political problem. And everybody knows who it is.

I'm shocked that Italy is the eighth largest economy. I kind of thought they were one of those where the major industry was tourism.

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nomin...

Italy has a whole lot of little manufacturing companies. And some big ones, too, but really an incredibly resilient manufacturing ecology.

it is in fact also in the top ten exporters http://en.wikipedia.org/wiki/List_of_countries_by_exports

An awful lot of very desirable things get manufactured in Italy and they have an economy that is roughly the same size as California's ($2,112,780M for Italy, $1,911,822M for California):

http://en.wikipedia.org/wiki/Comparison_between_U.S._states_...

They also are number 5 in terms of international tourism (France being top):

http://en.wikipedia.org/wiki/World_Tourism_rankings

An interesting list I found the other day:

Automotive: Ferrari, Alfa Romeo, Maserati, Lamborghini, Lancia, Fiat

Agricultural and construction equipment: Iveco, New Holland, Case [CHN is the 2d largest agricultural manufacturer in the world and the third construction]

Motorbikes: Piaggio (Aprilia, Moto Guzzi, Vespa), Ducati, Cagiva [Piaggio is the world's 4th largest motorcycle manufacturer and the largest European one]

Bicycles: Bianchi is the world's most prestigious brand of racing bikes.

Technogym: official supplier of the Olympics

Shipbuilding: Fincantieri is one of the world's largest ship manufacturers having built cruises for Carnival, Cunar, Disney, Holland America, etc. Ferretti luxury motoryatchs. Filippi Boats, the world's premier racing shells

Manufacturing: Pirelli (tires), Indesit is Europe's second largest manufacturer of home appliances Candy Group owns Hoover Europe Chicco, toys Finmeccanica (Helicopters (Augusta), Missiles DeLonghi: appliances, owns Kenwood

Technology: STMicroelectronics Europe's largest semiconductor company and the world's fifth (after Intel, Samsung, Texas Instruments and Toshiba) Thales Alenia Space, Europe's largest satellite manufacturer, is an Italian/French consortium NHIndustries (Helicopters) Eurofighter, Alenia

Fashion: Armani, Prada, Gucci, Fendi, Bulgari, Salvatore Ferragano, Ermenegildo Zegna, Versace, Valentino, Borsalino, Dolce & Gabbanna, Diesel, Bennetton, Mandarina Duck

Eyewear: Luxottica is the largest eyewear company in the world. It owns Ray-Ban, Sunglass Hut, LensCrafters, Oakley. It manufactures pretty much every luxury brands in the world.

Sports: Lotto, Kappa, Diadora, Geox, Fila, Nordica, MOMO

Music Fazionli Pianos are widely regarded as the finest in the world

Food: Parmalat is the world's largest dairy products manufacturer Autogrill is the world largest catering company (airports, train stations) Ferrero (Nutella, Ferrero Rocher, Kinder and tic tac among others) Barilla: World's largest manufacturer of pasta

Wine: Italy produces the largest amount of wine in the world

Beverages: Martini, Campari, Cinzano, Maraschino

Arms: Beretta, Benelli, Perazzi (precision guns frequently used in olympic competitions)

Petroleum: Eni (including Agip) Europe's Third largest oil refiner. Market value of 100 Billion Euros Enel is the third largest electricity provider in the world

Finance: Unicredit - Capitalia is Europe's second largest bank Intesa Sanpaolo is Europe's third largest bank Assicurazioni Generali is the world's fifth biggest insurance company

Media: Mediaset, Panini

Italy is the second largest producer of movies in the western world after the USA.

Federico Fellini, Vittorio De Sica, Martin Scorcese, Sergio Leone, Roberto Rosellini, Bernardo Bertolucci, Roberto Benigni, Pier Paolo Pasolini, Dario Argento, frequent collaborations with Italian Americans like Brian De Palma, Francis Ford Coppola, Nicolas Cage, Leonardo Di Caprio, Al Pacino, etc.

Why is the one year yield even higher? I thought two year is higher risk? Opportunity for arbitrage here?

http://www.bloomberg.com/apps/quote?ticker=GGGB1YR:IND

There are certain risk profiles where it'd make sense. For example, if you think that a default is most likely to happen within the next 6 months or not at all, then the 2-year bond has about the same default risk as the 1-year bond, but locks in the high interest rate for longer, so has more potential upside.

Greek banks own a lot of Greek government debt.

How has there not been a run on Greek banks yet?

It means they're bankrupt.

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