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Using Professor Peabody's "Way Back Machine" To Deal With EU Debt

Those of us of a "certain age", might recall a cartoon segment on "The Rocky and Bullwinkle Show", about a canny canine, Professor Peabody, who had devised a time machine. The name of his erstwhile student /sidekick escapes me, at the present, but each episode involved the pair going back into history, and "explaining" how the outcome of a given event came to be.

Even before the results of the EU bank "stress test" were released, I'd read more than a few articles pointing to various bond sales by banks around the EU taking place with a minimum of turmoil, or drama, as "proof" that things were nowhere NEAR as bad as the doomsayers were suggesting.

Alas, and alack, as usual, it pays to dig a bit deeper than the headlines if one hopes to get a clearer, and more accurate picture of what's going on. While purusing, I ran across an interesting tidbit that goes a long way in explaining the "success" of the recent bond sales.

Immediately after Russia's default, the only way that Russian banks were able to access the credit markets was via what were called "puttable notes". These are bonds that are sold with a put option attached, giving purchasers the right to "put" the bonds back to the issuer before maturity.

According to the article,

"The cost of insuring bonds sold by banks in Spain, Italy and Ireland has risen by more than two thirds in the past six months, CMA prices for credit-default swaps show. Just as in Russia after the 1998 default, puttable bonds have become one of the only financing sources for the banks, which received a report on their financial health today from European regulators."

The plus side to the issuers is getting a cheaper price on the cost of the debt, since the risk is substantially lower. The downside would be the need to immediately raise replacement funds, should the bonds by put back to the issuing banks.


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