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When a Bond Is Not a Bond

Interest-Rates / International Bond Market Jun 25, 2015 - 05:34 PM GMT

By: John_Mauldin

Interest-Rates

By Jared Dillian

I don’t know anything about Greece. I actually make it a point not to.

What I’ve found over the course of my career is that the closer people get to an issue, the worse their predictive power is. The forest-for-the-trees phenomenon. Like all the economists who do nothing but watch the Fed, every piece of data, every speech. Their track record in predicting interest rate moves is worse than everyone else’s!


I deliberately try to be dumb about things.

Some of my friends and clients know a lot about the Greek negotiations. There is a lot to know. I try to keep it simple:

  1. The Greeks are communists
  2. Everyone is incentivized to get a deal done, unless
  3. The Greeks overplay their hand

There. Now I know everything there is to know about Greece. At the time of this writing, there was no deal in place, but it was starting to look promising.

Promising Isn’t the Word

People are starting to figure out that Greece is probably better off just defaulting and going back to the drachma. Painful, yes, but better than this perpetual bailout purgatory where everyone loses. Greece doesn’t make the necessary reforms, and Europe just keeps throwing good money after bad.

Which leads me to the point of this essay—if Europe bails out Greece once again, will they ever realistically pay it back?

Of course not. Everyone knows this.

Then it’s not really debt, right? It’s just aid. It’s a gift.

I think it’s time that people start being honest about what is going on here. This isn’t a rescue package, with covenants. It’s an aid package. If Europe wants to pay for Greece to pay all its civil servants (and its surprisingly large military), then fine. As we are starting to see, they’re less willing to do so when Varoufakis acts like a punk.

What does the profession of economics say about aid?

I’m not sure, actually. Though it seems that (in my experience) giving aid to countries stunts their growth. Five years of free trade is doing more for Africa than 50 years of aid ever did. I have some theories about charity in general, mainly that most of it has real externalities. So if you keep giving money to Greece, it’s only going to become dependent on… you get the picture. I am starting to sound like George Will.

What we do know is that if the Greek government issues more 10-year bonds—it will never pay them off. And it can’t refinance. So who would buy such a bond? It will default eventually, right?

That is the interesting question.

You see, as long as Europe (Germany) is willing to shovel cash into the money pit and call it debt, not aid, they will keep Greece afloat, and Greece never defaults, and nobody ever has to realize losses on Greek bonds, on which the recovery rate will surely be zero.

They are putting the pretend in “extend and pretend.” You pretend that Greece can pay it back, so if you’re a bank, you can keep the bonds marked at par on your balance sheet. So the accounting value (par) is different from the market value (60 or whatever), which is different from the economic value (zero).

Everything finds economic value eventually.

In my career, I’ve never seen anything like this. Sure, I’ve seen companies refinance that shouldn’t have been able to refinance, but that pales in comparison to this. It’s not debt. It’s aid.

Aid!

My guess is there are geopolitical concerns at play here too. I saw a headline the other day about Washington being concerned that Greece was going to end up in Moscow’s orbit. Too late! They are communists.

I will go a step further and say that in 10 years’ time, Greece will be a less pleasant place to visit. I am beating around the bush. I think it will be a very unfree place.

Please Help

Saw an article on Quartz recently about peer-to-peer lending. Apparently people have done some quant magic on it and determined that the actual words in the loan application can determine whether you default or not. Seriously.

So these words…

God
Payday loan
Mistake
Hospital
Difficult
Behind
Bad
Lost
Give me a chance
Please help
I promise
Mother
Will not
Will allow

… indicate that you’re a deadbeat.

And these words…

Worth
Excellent credit
Lower interest
After-tax
Minimum
Graduate
Wedding
Student Loan
College

… indicate that you’re good for the money.

Pretty cool, huh? Someone is going to make a lot of money on this. We’re talking about hundreds of basis points of edge.

So, back to Greece.

Which words are they using?

“Marxism” wasn’t mentioned in the article, but I’d wager it belongs in list number one.

Jared Dillian

The article The 10th Man: When a Bond Is Not a Bond was originally published at mauldineconomics.com.
John Mauldin Archive

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