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The Markets and Sovereign Debt - 5 Cents
Posted by: Mark Nichols

30 Nov 2011

The Markets and Sovereign Debt


Its interesting to see the stock market fluctuate so much based on the news. When the US government struggles to handle its debt problems, the US market indexes go down. When another story about struggling Greece, Italy, Spain, and Portugal hits the news, the indexes drop some more. They swing back up when theres news of a deal. Usually the deal is in the form of a loan from an oversight body, or reduced interest rates so these in-debt countries can borrow money more cheaply. The deals being made so far have not actually solved many or any of the fundamental problems that governments are spending too much money.


MF Global and Sovereign Debt


MF Global was a company run by John Corzine, former New Jersey governor. As its head he began buying up tons of risky European debt from countries such as Greece, Italy, Spain, and Portugal. Its considered risky because these are the countries closest to default on their loans. Default would mean Corzines investments wouldnt pay out and his firm would stand to lose a lot of money. The ratings agencies saw what he was doing, considered it risky, and downgraded his company to junk status. Once his company was rated as junk, it was much more difficult to get the loans needed to operate on a day-to-day basis. He needed loans to operate because his company had $1.4 billion in equity leveraged against $44.4 billion in liabilities. The stock tanked and they couldnt raise money through selling off a part of the company. Bankruptcy was declared. This opinion piece in the New York Times provides some good info.


Has Italy defaulted? Has Greece defaulted? No and no. So his big bet couldve worked out. He just needed to take it a little slower. And of course, the European community wouldve had to come through for him.


Analysis of Countries Debt


For all our sakes I hope every country can get their financial house in order, if only because confidence in governments financial well-being impacts confidence in the equities market in general. Why are stock markets that reflect mostly private business so intertwined with government financial responses? I suspect in part because countries have central banks that play a role with loans to other banks, which in turn can impact liquidity (available cash to transact business). Maybe another reason is related to taxes - if a government has money problems it might have to increase taxes on businesses to make up the difference, which would lead to less profit. There are likely more reasons but I havent researched this issue. Regardless, there is a link between the two systems (private business and government).


One confirmation of the link is a common metric used to analyze a countrys economic health: the Debt to GDP ratio. Debt usually means government debt (excluding private debt). GDP can be calculated differently, as shown in Wikipedia and Investopedia, but basically its the size of the economy (including the impact of government - thus GDP is a blending of private and public money). The Debt to GDP ratio is usually expressed as a percent - 60% would mean if debt is 6 trillion, GDP is 10 trillion (in a given year).


Whats a good Debt to GDP ratio? There appears to be no consensus (maybe we need a new metric - one that does a better job of indicating ability to pay back the debt!). Heres an article that talks about the ratio and generally encourages countries to get into financial shape. Japan has a ratio over 200%! Italy, Greece, Portugal, and Ireland also have bad ratios. Heres the Wikipedia site showing all countries 2010 ratios. The US is around 62%. Heres a website with tons of cool debt-related graphs.


What to Do While Countries Are Figuring Things Out


Play the markets ups and downs, baby! Sell an index fund after the markets have reacted to good news; buy one after the reaction to bad news is over.


Just kidding... sort of. If you have play money to work with, why not give it a try?



© 2011 Dime Brothers
Category: Finance/Business    

Reader Comments:

Markets are up
Today the US stock indices rose 4%+ after central banks (including the US) agreed to lower borrowing rates for other countries.

And from this article comes a quote I could've made up but didn't have to:

"It is a short-term solution," said Jack Ablin, chief investment officer at Harris Private Bank. "The bottom line on any central bank action is that it papers over the problems, buys time and in some respects takes pressure from politicians. ... If nothing's done in a week, this market gain will disappear."
30 Nov 2011

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