So now Spain is the cause of the snail paced economic recovery in the USA.  I guess blaming George W Bush has run out of steam.  What is perfectly clear is that President Obama´s resort to Keynesian “pump priming” has not done its magic.  Yes, he stopped the bleeding in 2009, but so far has made no headway in generating  jobs for 8 million laid off in 2009.  Job growth in the USA for the last three years has barely kept up with population growth. 

But since Spain has been named the new “bad” guy and Spain’s main problem is an unsustainable interest rate for sovereign debt or government bonds, I will discuss bonds.  A bond is simply a fancy IOU.  I had an uncle who was a deaf mute but rose in the government printing business to become an engraver at the Bureau of Engraving, you know, where they make the dollars.  They also print Treasury bonds and my uncle was one of the meticulous artists who engraved metal plates for printing them.  I used to accuse him of having his own plates to print dollars whenever he ran short.   The bonds are very impressive but have no more value than a chit. 

Stocks and bonds are essentially two ways for borrowers to raise capital, either for investment or operations.  The difference is that a stock or share represents a part ownership in the borrower while a bond is a loan. Stocks are valued by the expected earnings of the borrower since share holders gain from those earnings.  If the borrower’s prospects are good, then the price of the share goes up.  If bad, then it tanks.  The bond’s value depends on the ability and propensity of the borrower to repay the loan.  The price also varies with changes in the interest rates.  If interest rates go up than new bonds are much more valuable than old bonds at old, lower interest rates.  If rates go down the old bonds are more valuable. 

The usual return on a bond is called its “yield” which is calculated on the bond’s interest rate and price at purchase.  I found when working on Wall Street that stock traders tend to think “horizontally” while bond traders tend to think “vertically.”  Stock traders also seemed to be more dynamic and active while bond traders seemed to be less aggressive.  That was until the “mortgage backed securities” (MBS) boom.

MBS became the highest earning financial instruments on sale in the decade up to 2007.  And they were considered to have “no risk” since housing prices seemed to rise forever and paying the mortgage was about the most secure repayment one could find.  But when housing market prices flattened and then started to fall, the bond rating agencies using algorithms based on home prices started to devalue these hot investments to near junk quality.  This sparked the “Great Financial Meltdown” of 2008 and the “Great Recession” of 2009.  Needless to say, the error made was concentrating on home prices and not watching repayment rates. 

Now the same agencies that brought us the “Great Recession” are downgrading sovereign debt.  What gall, after getting the mortage backed securities wrong, the rating gurus aimed higher, now they would cause chaos by downgrading sovereign debt, i.e. debt incurred by national governments.  The mind boggles, who in their right mind give any credence to these guys who were so totally wrong on MBS?  Perhaps the most comic act in this truly comic opera was when one rating agency downgraded US Government debt.  The ridiculous became the sublime.  US Government debt is backed by the “full faith and credit” of the USA.  In other words as along as there is a USA the debt is good.

Not satisfied with pointing out patches on Uncle Sam’s pants the rating agencies turned with vengence on European sovereign debt.  And here they have one point, the countries who use the Euro cannot print their own money so they are constrained in being able to repay loans (Uncle Sam just keep the presses rolling).  But true to form the rating agencies are using the wrong algorithms and coming up with the wrong ratings.  One test is how much a country’s debt is in comparison to its national income.  But here Spain rates better than most EU countries.  And now the rating agencies are casting aspersions on Germany’s rating. 

Here we go again, led into disaster by bad rating agencies using faulty algorithms.  Will we ever learn?