A troubling story from Bloomberg is yet another clue that all is not well in the debt markets. The story reports:
Derivatives insuring Novo Banco SA debt won’t pay out after the Bank of Portugal’s imposition of potential losses on bondholders. A panel of three lawyers unanimously ruled that a governmental intervention credit event hadn’t taken place, supporting the dominant view of an International Swaps & Derivatives Association committee, according to a statement from the trade group… The decision may erode the appeal of credit-default swaps as it was the first test of 2014 rules designed to boost protection against losses imposed by governments or regulators.
The number of contracts affected by the ruling isn’t exactly huge, at $397 million. But it’s the principle that’s troubling. It means that central banks that are restructuring the balance sheets of troubled European banks – and there a lot of those – can impose losses on bondholders without triggering a “credit event”. Which means that insurance you bought on your bonds, the credit default swaps you thought protected you against loss, well … they don’t.
It’s not exactly like the fire department burning down your house for a marshmallow roast – and then telling you that your insurance doesn’t cover fires started by the fire department. But it seems pretty close, doesn’t it?
And you wonder why there are so many distressed bond issuers out there? Bondholders are starting to realise there is no such thing as a risk-free rate of return. And while all the attention will focus on the $29 trillion in corporate debt created since 2009, spare a thought for sovereign debt as well.
Investment grade government bonds are treated like cash by many companies. You find them listed as “cash or cash equivalents” on the balance sheet. For highly liquid short-term securities, this is probably a pretty safe assumption. But for longer maturities… and for a world stuffed to the gills with government debt, what do you think?
By the way, what I think is that interest rates will eventually rise again, whether central bankers like it or not. And bonds being bonds, when yields rise, prices fall. Bond buyers beware.
Category: Economics