Spain - Out Damned Spot

Via Mark J. Grant, author of Out of the Box,

“And it is a mark of prudence never to trust wholly in those things which have once deceived us.”
                      -Rene Descartes
If you own the debt of Spain; sell it. If you are thinking about buying their sovereign debt; don’t. I hope that is clear enough. I don’t believe that I have left out any corner of my thinking or that there is any wavering on my part. All of the new Spanish debt will carry Collective Action Clauses which gives Spain the right to force bondholders to their knees. This is reminiscent of Greece and we should have all learned the lesson from that experience. Then there is what Spain certainly might do which is to retroactively pass CAC’s when expedient for the nation so that all Spanish debt could include these clauses. The clear signal here is that Spain is in serious trouble or CAC’s would not be an issue and that the State will put it to bondholders if necessary. Spain has benefited from Draghi’s “Save the World” plan which was by far the best move of the European Union in 2012. Yields are down, the central bank is the backstop and the ECB’s promise has limited the interest that each nation in Europe has to pay for their debt.
Yet there are two sides to this coin and that is that not only will interest rates affect the sovereign debt of a nation but the absolute amount of debt can also play havoc with the finances of a nation. The Wall Street Journal reports this morning that 90% of Spain’s national pension fund has now been utilized in buying Spanish debt of various sorts and class. This means that $77 billion has now been spent on propping up Spanish debt while another $7 billion has been withdrawn in cash. The pension fund is effectively out of money now and how they will fund their social security system is anyone’s guess. Spain plans to issue $270 billion of new debt in 2013 which is up from $242 billion in 2012 or a 10.5% increase. Even as the pension fund buying is unable to continue, the Spanish banks are up to their eyeballs in Spanish debt and the losses at the Spanish banks continue to mount. It is my opinion that Spain will be forced to the till at the ECB and the EU and that the amount of financing that will be demanded will cause rancor in the fiscally disciplined nations. For all of these reasons I have concluded that Spain is a disaster in play and their debt should be avoided or sold.
The United States
The Fed’s recent minutes provide a notable change of course in their policy. On one hand it is a positive as the Fed is slowly coming to terms with the fact that there are limits on what it can do and that monetary policy is not an endless charade. On the other hand it is a marked change from what they have told all of us before which calls out their promise to keep rates low well into 2014 so that political/economic expediency could reverse their prior promises. The slope is certainly slippier but at least there seems to be a recognition that the ballooning of their balance sheet has repercussions. Yet the $95 billion of monthly buying of Treasuries and mortgages continues for now, the supply of new issues is limited and the recent back-up in long yields is at least partially off-set by the free-floating capital that is still resident in the fixed income markets. This can also be said for the equity markets and a real decision by the Fed to curtail their buying programs could set-off a sell-off in both markets. Some accumulated cash may be in order while Municipal Bonds represent the best value currently in the marketplace. The sword hangs in the balance while severe economic problems in Europe may also booster both the Dollar and demand for U.S. securities. I would not be in a rush to jump too far now as the forward picture is far from certain.
“There are negotiations being made that are going to answer all of your questions and solve all of your problems. That's all I can tell you right now.”
                        -The Godfather


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