Wednesday 12 January 2011

A huge success

I am with Paul Krugman. Calling this last public debt auction a success, just shows how desperate we are. A few more of these successes and the debt burden will be insurmountable.

One thing that kind of insults my intelligence is the idea that the auction was a success because demand was 3 times higher than supply. These are specialized journalists. They are supposed to know that interest rates are inversely related to prices. If there is a huge demand for our debt at higher interest rates that means that this so called 'excess demand' was not interested in buying the debt at the price we were asking for. This is not excess demand.

When I was trying to sell my house at € 150 000, I received dozens of offers of € 100 000 or even less. Was I supposed to be happy because there was so much demand for my house? I ended up selling it for €120 000. What kind of excess demand is this that forces us to lower the prices instead of increasing them?


  1. Exactly. I can't even add any comment on this. It seems so obvious and however, so ignored.

  2. I have some notes do add to this, if I may:

    1. The majority of the "journalists" covering economical/financial subjects are poorly educated and never worked in the markets to even know what they are talking about, therefore, they are not speciallized (by far!). Everyday we see pure barbaric-written news in all Portuguese media with the most stupid remarks that are not even close of what happens in reality;
    2. Based on point 1, I can only add that because of the lack of specialization, most of the economical news are previously "cooked" and given to the journalist for printing. That's how we explain the "success" of the debt auction... pure make-up for media;
    3. Another symptom of the lack of specialization of Portuguese "journalists" is that they have a very bad time even copying the news coming out of other sources (like Bloomi, Reuters, etc) and you can see a lot of times very big mistakes being made because of lack of comprehension of the context of the rest of the news;
    3. It should be mandatory for the educational system in Portugal to have the students, in the last year of the "degree", placed in broker houses/investment banks to learn the tricks of the trade. Therefore they would learn what happens in reality, instead of what happens on the books. This should be valid for every degree in Management, Economics, Finance, etc etc;

    Finnaly, and regarding the post itself, any one with more than one brain cell knows that if you're indebting yourself at a rate higher than you can grow, you are condemning yourself for the future... unfortunately we have our Nobel prizes losing their time with such basic things.. but anyway... someone must be paying for it!

  3. Reading the news yesterday, however, one is intrigued. The results of the auction were followed by gains in several stock markets and rises in the Euro and the Pound and a decline in commodities. So either journalists assigning the auction's "success" the responsibility for these developments are mistaken (financial news seem to suffer from permanent and inherent ad-hoc theorizing) or the markets reacted "irrationaly". What am I missing here?

  4. Pedro,
    It was good news because the rate coming out of the auction was lower than what was expected. It was a bad rate because it is much too high and likely unsustainable, and definitely not a success. But the "news" part was good. Stock markets and financial prices respond only to the news part, not to the absolute level.
    A word of caution: never try to interpret what happened in any given day in the stock market or in exchange rates as a response to anything sensible. In any given day there are hundreds of things that can move markets up and down.

  5. Thanks, that makes sense. On the "word of caution", I can't agree more. That's what I meant with the "ad-hoc theorizing" of financial journalism: "this was caused by that", etc.

  6. Interpreting the news...

    1. we are told that Portugal placed 599 million at 6.716% for 10 years while the previous auction commanded a rate of 6.8086%. The result is that Portugal has saved 10 million in interest payments.

    2. we are also told that Portugal placed 650 million at 5.396% for 4 years while the previous auction commanded a rate of 4.041%. The result is that Portugal will pay an extra 40 million in interest payments.

    I thought interest payments matter for assessing the debt sustainability but of course I am open to other interpretations.

  7. Francesco,
    A suggestion: you should post your comment as a post, not a comment that will be overlooked by most.

  8. @Francesco Franco

    Just a small remark:
    I believe that the use of the word "save" is innapropriate in this context. If you're going into debt you're only spending... you can spend less or more, but you're allways spending.
    This type of fallacy is also very recurrent in the news, as the term is used to show a better prespective of a bad thing.
    Think the correct term should be something like "avoid spending".

    Regarding you post, I couldn't agree more (with the above exception). Debt sustainability is what we should aim at, but there are a few things to have in mind.

    One of the things is that the government is taking the loss in the present (on the 10yr sale they received roughly 538Mio, on a future liability of 599Mio plus 4.8% interest for the next coming 10 years). The loss of this deal is booked in the 2011 book year, but the interest to be payed over the next 10 years will be of 4.8%, the bond's coupon.
    For the buyer of the bond, the yield they are getting is of 4.8% in the next 10 coming years and a capital gain in the future equivalent of the remaining 1.9%/year (the difference between the payed price - 86.91 - and the price they will receive in maturity 100%.

    Therefore, if the government budget is counting on this present loss (wich I believe it is), everything will be "fine", because the future cost of money will allways be of 4.8%, with the obvious exception of 2011 (wich the government points out to be around 5% average).

    Please feel free to comment (critics are welcome).

  9. @Paulo Cesar Martins

    I followed RR advice and posted the comment with your suggestion on "save".

    I am sure your numbers are correct but can you explain me what you mean by "fine"?


  10. Hello again,

    The bond in question has a coupon of 4,8% which is a "fine" rate for 10 years. (US Treasuries 10year average in the last 10 years was 4,29%.

    Of course that we are still financing above our growth, but that would be another story...

  11. "It was good news because the rate coming out of the auction was lower than what was expected."

    Ricardo Reis, if you look at the auction results here, you can confirm that the "weighted average yield" of the OT2020 would always be lower than the previous auction (6,8%) because the government's "stop yield" was 6,759%.

    For the OT2014 the "stop yield" was 5,440%, much higher than the yield of the previous auction (4,041%).

    This shows that the government implemented a excelent media strategy since everyone was only looking at the 10year bond, the market's reference.

  12. What you can take from the results is that there was demand below the market prices, enough to fill the needed government requirement (minimum 300Mio in each bond) in the 10yr bond. This is somehow a success, as the mkt was doing well above 7% in the morning.

    The conclusion we can take from the relative success of the 10yr and the relative failure of the 2014 is that the mkt is looking at the short term as being the most riskier and therefore, requires a higher yield.

    P.S. Just FYI, I've been trading huge amounts of Senior Caixa Geral bonds (the 5.125, 2014) way above 7%.