As the European debt crisis continues, the insatiable need to raise NEW debt drives the PIIGS (Portugal, Ireland, Italy, Greece and Spain) back to the bond markets to raise more capital. This is the direct result of running structural budget deficits for long years of times (i.e. spending more than you earn).
Traditionally, the “spread” between what Germany pays (the soundest Euro country) and what the weakest country pays have been limited by the fact that the weaker countries had the implicit backing of the stronger countries, similar to the manner in which Fannie Mae and Freddie Mac were able to borrow just above the US Treasury rate for equivalent maturities since it is assumed that the US government would bail out these quasi-public companies if it all ever went wrong (it has, to the tune of >$400B). Now, however, the gap is very large as cited here:
But after hitting euro lifetime highs of 7.3 percent in the secondary market last Friday, the yield on Portugal’s benchmark 10-year bond has come down to just below 7 percent at Tuesday’s settlement, with traders citing ECB purchases.
These countries are basically insolvent when they have to pay 7% on new debt, which is what a (rational) private buyer would demand as a risk premium to take on the newest, riskiest paper.
But it isn’t going to be that high. Why? Because governments are going to step up and buy these bonds. Japan is now planning on buying 20% of Ireland’s next bond issue, according to this article. I can only imagine how well this is going to go down for Japan’s politicians when Europe begins circling the drain; it is a nice show of solidarity but Japan has their own debt crisis without inter-twining it with Europe’s.
This is similar to when Chase bank, under Bill Daley (the brother of Chicago’s mayor), decided to buy up an Illinois bond issue that might have otherwise demanded stiff premiums to attract (rational) private buyers. When the rational buyers leave, it is time for governments and politically-connected entities to step in, I guess. Until it all falls apart.
Cross posted at Chicago Boyz