From Bono to Bonos or “Still Haven’t Found What I’m looking For”!

Location Date: 
July 12, 2011

Last night felt like a blast from the past. Bono and U2 performed in Toronto to a sold out crowd of loyal fans that spanned the generations and genders of our multi-cultured city. In full disclosure, the good folks at Scotia Capital footed the bill – thanks Patrick!



Of course, like many people market watching these days, it was hard to totally get into the mood.  Bono’s reminders of the many problems in the world (albeit delivered in a spirit of hope, humility and strength) forced me back to Europe and the mess that is now building into a full blown crisis.The first thing that greeted me this morning was news that rates in Spain – the bonds there are called BONOS – I am not joking – are now heading up with the 10 year bond yielding  5.8% (up 35 bps in the last 5 days) and at one point over 6% this morning – the highest since 1997 pre-Euro!

Like the “Claw” last night, the stage in Spain is set for fireworks. Spain’s problems are quite different from Italy in that its debt burden is focused on households and corporates (banks and non banks) due in no small part to the massive construction boom and bust associated with the Spanish real estate bubble. The problem in Spain is their banks, and in particular the cajas along with chronically high levels of youth unemployment. Like Bono’s Ireland, extremely poor lending practices and inept bankers are largely to blame for the pain in Spain. Any wonder then that the ECB rate hike last week was viewed as a punch in the face to Spain given that 90% of Spanish mortgages must now also move up – just great!! As an aside, I am still shocked at Trichet’s rate hike – his ECB has roughly €200 BN of Greek debt and an €80 BN of capital base.  Why would the ECB raise rates?  It will face insolvency itself by helping peripheral country debt move to default. At the same time the ECB saying it is looking to support these same countries??  Just dumb.

Many commentators are putting the blame on Moody’s (for their Portugal downgrade) or on Merkel for suggesting private bondholders take a haircut, or on whatever for the bout of contagion. Regardless, Spanish Prime Minister Zapatero correctly pointed out that the debt issues can only be solved “with a firm, co-ordinated, clear and rapid European response.” The problem is Europe does not have the institution to actually do this – the ECB is certainly not the solution! But they better get their act together quickly to stem the negative psychology. When confidence is lost, look out below! 

This challenge is amplified by the need for a large amount of refinancing in Spain and elsewhere (see chart below courtesy of SG Economics). At current markets rates the problem only gets tougher.  One solution being tossed around now is to bump up the size of the EFSF to cover off this contingency. I am not sure if this would pass in Germany and elsewhere – the good news is the IMF is likely in for 30% now with Ms. Lagarde at the helm. We would now be getting close to TARP levels but then that would not be a big surprise – it is just as big a problem.



Jim McGovern

P.S. Moody’s just downgraded Irish debt – you can’t keep up with these guys!