The PIIGS 10 Year Bond Problem

We all know why the PIGs have needed to source temporary financing/bailout funds from the EU-IMF  – it was just too expensive to continue borrowing vital operational funds through the bond markets (the usual route). Think of it this way. When investors (say, big German/French/Belgian/British banks) buy €1bn worth of Greek bonds, they’ll get €1bn back in 10 years + interest @ X%. This X% is the ‘yield’ (premium) to the investor but the ‘excess cost’ to Greece of issuing the debt/bond (i.e Greek borrowing)

Why would the ‘yield/cost’ go up?

  • Investors HATE risk. Risk costs money and risky investments aren’t likely to attract many takers.
  • Greek bonds are VERY risky because with all this talk about haircuts (slicing a chunk off the €1bn principle) to European bank debt in the PIIGS, investors may think that government debt could be next for the chop (in some way or another)
  • Buyers of Greek bonds will need encouragement for taking on more risk i.e a higher premium (a higher X%)
  • This means that investors buying Greek debt will demand more – and Greece will have to pay more. Greece can’t afford to pay more interest because it comes out of the funds that pay for the to day to day running of the Greek economy. Pressure on the flow of that cash could cripple the economy (and, you never know, cause a revolution).
  • So, Greece can’t borrow that way – it needs a bailout from the EU-IMF (or, more specifically, the ‘troika’ – the European Commission (EU), European Central Bank (ECB) and International Monetary Fund (IMF).

Interestingly, for each recipient of EU-IMF aid, the ‘tipping point’ (the cost or bond ‘yield’ at which countries was forced to ask for help) was different.

PIIGSty compares the situation then with the situation now, in October 2011 (approximated and rounded figures via Trading Economics).

On average, prices of 10 year bonds (cost of borrowing the usual way remember) have actually increased (its more expensive) across the three PIGs since the various bailouts were initiated (-4.5%). Greece has deteriorated significantly (obviously, considering the need for a 2nd €110bn bailout in July). Ireland and Portugal have coincidentally declined by approximately equal levels (-1.5%).

The tipping point for the PIGs have proven to be between 7%-10% (Greece 2 being the exceptional case) – this compares with current levels of 5.16% for Spain and 5.41% for Italy (and 1.77% for Germany).

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