Business News

Can you trust debt dramatists?

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by Peter Switzer

The elephant in the room the doomsday merchants believe everyone is ignoring is the debt pile up that has gone on following the market crash of 2008, which has been co-tagged, rightly or wrongly, the Global Financial Crisis.

I have identified this as the major concern for 2011 with particular focus on Europe’s bank and sovereign debt challenges. I also am worried about the incompetence of European officials to adequately deal with the economic problems — they seem to need the market to go schizo before they will address an issue.

Worst-case scenario

At its worst, if the debt issue is not treated objectively, as the New York Times put it the growing debt burden will strangle governments and their banks. But this is a worst-case scenario and there’s no proof that this is happening across Europe but it’s happening in Ireland and Greece.

Portugal will probably face the same fate with the yield on Portuguese 10-year bonds recently hitting a high of 7.1 per cent. You might be thinking “so what?” but it’s important.

As the New York Times put it: “The cost of insuring the debt of banks in Italy and Spain has risen sharply, and the euro has hit a three-month low against the dollar.”

Debt concerns

More worrying for the market was a report by the European Commission that suggested holders of senior bank debt might have to cop a loss when a bank fails. Now that won’t apply to the one trillion euros in existing bank and sovereign debt in the euro zone but it raised concerns about Europe’s troubled economies and banks getting money in the future at affordable rates.

That was one point of view I read but then I read the following in the New York Times.

“It is clear that the debt which will take a haircut is the current debt, not the future debt,” said Willem Buiter, chief economist at Citigroup, who on Friday published an 80-page report explaining why debt restructuring in Greece, Ireland and Spain was inevitable. “All bank and sovereign debt is now at risk — that is the reality.”

In Ireland, pressure is building for holders of senior bank debt to take losses, and the Greek government has had to deny rumors that it has approached its creditors about revamping its own debt.

You can see why the stock market will have a governor on it until the Europeans can make clear statements on how the debt crisis will be handled that don’t spook the market.

Keep an eye on Spain

And the important spotlight is on Spain, which came into the crisis with low government debt levels but as their banks buckled under the collapse of real estate prices, the government came to the sector’s defence.

To me, Spain is the main game that the EU bail out officials have to get right — if they muck this up then stock markets will find it hard to defy gravity.

Newspapers and negative commentators can always find experts who say the debt is unsustainable but that doesn’t tell us what it means for economies. For example, Spain in trouble could mean another dip into recession or its growth going from three per cent down to one per cent and its stock market going sideways. The debt problem doesn’t have to create Armageddon.

Who to believe?

I go back to Goldman Sachs’ predictions of a US economy growing at five per cent and the stock market going up over 20 per cent in 2011. Now, these guys would have put their risk calculations of a debt problem in Europe into their forecasts.

The question you have to ask yourself is — do you believe the hotshots from Goldman, BlackRock and their ilk or some debt dramatist academic with a blog or some short-selling hedge fund manager who is trying to manipulate the market?

Hotshots can be wrong as we saw in 2008 but so can academics with a penchant for media attention, which could one day be seen as infamy if their scary predictions prove ungrounded.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Wednesday, January 12, 2011