FINANCIAL CRISIS CROSSES OVER FROM SUB-PRIME TO SUPER PRIME Solvency of governments is in danger

In the beginning was the distrust in the financial system. Without proceeding to make a true analysis of the crisis, governments and banks tried to inject money and confidence in the markets to avoid the recession. In spite of a flood of money unprecedented in history, trust did not come back to the markets.

These results seem surprising for authorities, who won"t admit that the current level of debt, both governmental and private, is not sustainable. Based on data from the Bureau of Economic Analysis and the Federal Reserve, John Kemp, Reuters analyst, shows that private debt in the United States increased 22 times since 1975, three times faster than the GDP.

According to Kemp, the only exit out of the current crisis is the large scale bankruptcy of over indebted corporations, the cancellation of some debts and inflation. Why inflation? Because it represents the quickest and "safest" way to reduce the real burden of debt. This is why, regardless of the signals given by the central banks, inflationist monetary policies are a sure thing.

Exactly for this reason, the price of government bonds has entered a powerful downward trend. In the case of the United States, since the historic low logged on December 18th, 2008, the yield of 10-year bonds grew by 26.6% until last weekend, and that of bonds with a 30-year maturity grew by 30,6% (see chart). This is the largest price drop in the last 22 years, according to a piece of news by Bloomberg, and the trend of yield growth has accelerated since the inauguration of Barack Obama.

The drop in price for government bonds is not limited to the American market. Bloomberg writes that German bonds with a 10-year maturity have seen the largest price drop in the last decade.

Germany"s and US ratings don"t seem to be threatened, for now, by these evolutions of the government-bond market. The same can"t be said about Spain, Greece and Portugal, which were recently downgraded by Standard & Poor"s. Their governments have of course, expressed disappointment and have considered the rating agency"s decision unfair. Local businesspeople, however, are more realistic in their evaluations.

"Italians, Spanish, Greeks, we all lived in paradise, spending what we didn"t have. It was a fantasy world", said Greek ship owner George Economou, executive manager of DryShips Inc., for New York Times. Unfortunately it wasn"t just Italians, Spanish and Greeks that thought they could develop by spending what they didn"t have. All the countries in Eastern Europe have adopted this "strategy", in hope of reaching the European lifestyle standard more quickly.

If the decisions that rating agencies have made lately can be justified as being attempts at regaining their long lost credibility, the market did not wait on their opinion on the value of bonds issued by Greece. Their spread against the German bunds grew by close to 300 bp, as shown by data in Financial Times, and the government in Athens is forced to resort to short term financing-only, because of the great interest rates it is facing.

If European countries which have a coastline on the Mediterranean Sea were never renowned for their tax discipline, expectations for members of the Anglo-Saxon block, at least during the periods where they didn"t have socialist governments, were far higher. This is no longer the certainty it once was. Paul Mason, economics editor at BBC, writes on his blog that "rumors concerning a rating cut for Great Britain are warranted", and the market has proof that "Great Britain bonds are not being traded according to an AAA rating ". It seems that Tony Blair"s and Gordon Brown"s new Labor is ready to repeat the "performance" that the old labor had in the seventies.

Analysts from ING show even France"s rating (author"s note. AAA for now) is in danger, as recession will determine a drop in budget revenues and force an increase in government borrowing, according to a Bloomberg article. The European Commission estimates a state budget deficit of 5,4% of the GDP for France in 2009, and French state bonds are being traded at record spreads against the German ones.

The worsening of the financial and economic crisis will not only put into question the superprime status of government debts, but that of private ones as well. When announcing the results for Q4 2008, Executive Manager of Capital One, one of the biggest issuers of credit cards in the USA, announced that a large number of extremely high FICO scores (author"s note: superprime) have entered bankruptcy at a greater rate then prime clients. This statement shows that FICO credit scores, which the Romanian Credit Bureau will introduce in Romania as well, might not be reliable enough in circumstances of severe economic and financial crisis.

Similarly to the economic and monetary models, which still encourage us to deny the obvious onset of recession, the performance of scoring models proves that the current framework of economic and financial analysis can no longer handle reality.

The energy with which the authorities are struggling to prove the opposite would be better spent elsewhere. Will they be able to force their "will" on the markets, as they have been trying to assuage us for more than a year now? Albert Einstein gives us a clue when it comes to answering this question correctly: "The problems we are facing today can not be solved by the minds that created them ".

Note: The article represents the author"s point of view, does not reflect or imply the opinions of the institution that employs him and does not represent an investment recommendation.