Comments on: Greece: The bull case A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: DanHess Tue, 07 Sep 2010 04:48:07 +0000 Marcus, yes, it is true that bonds are senior to stocks in the event of bankruptcy but there are many ways that bonds are ‘junior’ to stocks.

(1) After bonds and taxes are paid, every penny of additional profit belongs to stockholders. This is unlimited upside. Microsoft understood this when they issued debt recently and promply bought their own stock. If Microsoft’s business does well, its bondholders enjoy none of the benefit. Meanwhile, since the chance of an MSFT bankruptcy is nil (with cash far exceeding its debt), its bondholders are senior in no meaningful sense.

(2) As long as debts are paid, every bit of a company’s assets belongs to shareholders. For many companies, these cash assets, factories, buildings, land holdings, machines and patents have enormous value. It has been noted that McDonalds is an enormous real estate company first of all. With the exception of cash, all of these assets trend upward in value with inflation.

(3) Shareholders run the company, as long as it is solvent. Therefore they can make decisions to benefit shareholders at the expense of bondholders. Suppose business plan B has a 50% chance of a 10x return and a 50% chance of bankrupting the company? Let’s do it! This is obviously a good idea for shareholders and a horrible idea for bondholders, but too bad for bondholders. The number of seats in boardroom of a solvent company reserved for bondholders is zero.

Folks wouldn’t be singing bonds praises as loudly if markets had been allowed to function freely in 2008 and 2009. Investment bank bonds would have taken a bloody bath and we would have seen what (3) above really means. With this round of bailouts, we have now taken things one level up, to sovereign debt. Bailing out sovereign debts (by money printing, “monetary policy a l’outrance” as per Keynes) leads to inflation, so bondholders can’t expected to be protected from their mistakes like last time.

By: TFF Tue, 07 Sep 2010 00:39:49 +0000 Thanks for the correction, John.

Still, that doesn’t alter my fundamental point. There are risks to ALL types of investments. Fund managers generally arrange their offerings along a linear continuum, but that doesn’t capture the complexity of the reality.

Imagine a decade of global growth but domestic turmoil, with round after round of “stimulus” and “unemployment aid” and “homeowners aid” and “retirees aid” feeding a growing debt monster. At some point the house of cards collapses, with bondholders taking a massive haircut and the dollar collapsing in value as the Fed prints money to pave over the mess.

In such a scenario, would US Treasuries (or corporate dollar bonds) or well-capitalized multinational stocks weather the storm better? I don’t know how likely that scenario is, but I’m pretty sure that a 2.75% 10-year yield doesn’t adequately pay me for that risk.

By: johnhhaskell Tue, 07 Sep 2010 00:22:55 +0000 @y2kurtis: there is no Federal requirement that the states run balanced budgets. Vermont has no such requirement and is still a state; furthermore you seem to understand that California has a large budget deficit and a large stock of government debt yet has not been expelled from the Union. Check yourself before you wreck yourself.

@TFF equity can be reinstated after a bankruptcy. General Growth Properties is a particularly large, high profile and recent example.

By: TFF Sun, 05 Sep 2010 22:50:41 +0000 Marcus, neither stocks nor bonds are truly “tangible”. Can’t eat them, drive them, or live in them.

A bond is a promise to fork over a certain amount of currency at a certain point in time. Even if there is no formal default, the purchasing power of that bond is not guaranteed. If I buy a $50k 20-year bond I will be unhappy if, at the end, if that $50k is merely enough to buy an economy sedan.

A stock represents partial ownership of an ongoing concern. That stock is worth nothing if the business ceases to be profitable, however (especially for a multinational corporation) the long-term value of the stock is not tied to any currency. It is tied to the value of the business.

Finally, sovereign debt is different from corporate bonds. When corporate bonds default, the stock is worthless. Sovereign states default on their debt LONG before the country is worthless.

By: Marcus180 Sun, 05 Sep 2010 01:31:34 +0000 Couple of corrections:

IMF View: The sovereign default of Greece is different than anything we have seen in the past few decades. The main reason being that its currency is Euros instead of its own true local currency.

The implications are twofold. One is that in the past few decades sovereign defaults have been accompanied by severe currency depreciations. The IMF piece is assuming default and remaining in the EURO. The true path for Greece lies with default and devaluation (they need the devaluation to restore competitiveness).

Now,as with the previous cases of sovereign default and currency devals, is if Greece leaves the Euro, then its default on EURO debt would have a massive positive effect on its Debt Stabilizing PB.

I seem this all the time. It is assumed Greece would only default and not need to devalue (ie leave the Euro all together).They need to do both!

Finally, the assumption of low interest rates is ridiculous. Greece is currently backstopped by the ECB. If that wasnt the case, Greece would be rolling over debt at very high interest rates, which would lead it to default. So the IMF assumes the ECB will guarantee Greek debt for a very long time.


Bonds could be in a bubble, but lets be clear about your alternative stores of wealth.

1) Real Estate: We have had a housing bubble that extended from the US to parts of Europe and many other countries. So buy real estate where there isnt a bubble popping.

2) Stocks: Sorry, but here you cannot tell be stocks are a more tangible asset than bonds. Bonds are senior to stocks in a company’s capital structure. So if there is a default by a company, the stocks should go to zero or near zero and creditors take their haircut. Bonds are a better store of wealth than stocks (maybe not a better investment at a particular point in time).

By: TFF Fri, 03 Sep 2010 19:02:32 +0000 Well put, Dan!

The promises won’t be upheld. It isn’t yet clear HOW the default will materialize, but something has to give. (Pension promises, bond payments, and/or inflation.)

By: y2kurtus Thu, 02 Sep 2010 15:03:42 +0000 Fantastic Comment Dan,

To weigh in I’ll actually guess that it will be a “semi-sovereign” default… that will get that ball rolling.

I honestly belive that California will refuse to balance their structually unbalanced budget… that they will actually increase social spending (by majority vote.) That they will vote not to increase taxation (which requires supermajority vote.)

They will then become the first state to openly challenge the authority of the federal goverment which constitutionally requires states to balance their budgets.

The bond market will punish them with rates even higher than they currently are forced to pay and rather than roll over their bonds as they mature on a vollentary basis they will make all outstanding bonds perpetual. They will pay the interest but not the principal. It will be a default by any definition but they will spin it as something softer… they may even offer a boost in coupon payment to quiet the outrage among investors.

The real question is will there be any market for the new state debt… that’s where things could get really interesting… could state regulators require that state chartered banks hold a certin percentage of muni debt? How about university endowments… could they be forced to buy state debt? Public penison could be forced to buy state debt. The list goes on and on.

The only thing I am truely sure of is that it will be an increasingly interesting world in the fixed income arena!

By: DanHess Thu, 02 Sep 2010 10:12:39 +0000 When will we get a nice, proper first world sovereign default to blow up the bond market? All this waiting around like being stuck in purgatory.

The worldwide bond bubble is a cancer that extends across most of the developed world through all of my favorite countries. We have known for some time that it cannot end well, and yet it just keeps getting worse.

The giant flaw is that so many consider bonds to be stores for their wealth when in reality they have no intrinsic value (unlike commodities, real estate, stocks, etc).

If tangible things suffer in market price, they always have their underlying utility to carry them through.

If debtor companies or homeowners can’t pay, you can repossess tangible goods but if sovereign bonds default, there is no recourse.

The greatest wealth destruction in world history is presently occurring in terms of “savings” being plowed into current consumption via the conduit of Federal deficit spending that is not investment. If nothing permanent is being created then how will all that wealth ever be extracted?