Defaulting banks - where will it stop?

[Jan Klimkowski]

The "bond vigilantes", ugly parasites spawned by free market capitalism, amoral creatures driven by greed, creating nothing of value, just pain and misery, are back:

'Bond vigilantes' offload gilts as UK plunges into the red

• Investors spooked by £4.3bn rise in UK borrowing

• Fears of runaway budget deficit push bonds yield to 4.1

The financial community punished the pound and the gilt market after figures published today showed Britain had plunged further into the red by borrowing £4.3bn last month.

Investors took fright at the prospect of a runaway budget deficit and sold government bonds, or gilts, pushing the yield to 4.1%. That in turn makes government borrowing more expensive, and it also lifts the long-term
interest rates that Britons pay for mortgages, which are tied to gilt yields.

It also brought the issue back to the forefront of the political debate in Britain: the Conservatives are advocating tougher action to cut the deficit while the government backs a softer approach to protect the recession-hit economy.

"The market is upset about that – every*one wants to know what the government plans to do," said Jim Leaviss, head of fixed interest at M&G *Investments. "We need to do something, otherwise we're in big trouble."

Leaviss runs a website called Bond Vigilantes – reviving a term coined in the 1980s in the United States when activist investors sold bonds en masse, pushing yields up, and forcing cuts in the US deficit.

"The bond vigilantes are the most important people in the capital markets right now – they're back and they'll punish the weak," said Gary Jenkins, a credit analyst at Evolution Securities.

"The bond market… is the single most important market and will determine what the other markets will do: the key question is: will sovereign countries be able to finance themselves at a rate that's reasonable? If so, markets will develop. If not, everyone has a problem."

The bond vigilantes are punishing countries with high budget deficits, such as Britain, the US, Greece, Spain, Italy and Portugal, on concerns about their ability to recoup loans. Far from declaring themselves speculative opportunists, the punishment comes against "governments that have lost control of their public finances", Leaviss said, as he warned governments to get public spending under control.

"We're reflecting the reality that developed nations need to sort out their budget problems. Otherwise, there's potential default, or inflation," he said.

Investors criticise western governments for not using the boom years to run extra-large budget surpluses, as now they need extra billions of pounds to cope with an ageing population and the consequences of the credit crunch. The UK plans to raise £220bn this year.

"The solution is austerity," Leaviss said. "Governments will be forced to cut public sector wages and increase retirement ages. It's going to be fairly nasty for individuals who live in countries with debt problems – growth will be lower and standards of living will be eroded."

Investors are also losing faith in the politicians' ability to cut their debts to the levels they have promised. "With further strikes planned to hit Greece it still looks nigh on impossible to expect that it can shrink its budget deficit to 3% of GDP from 12.7% of GDP last year by the end of 2012," said Jane Foley, research director at Forex.com.

After a few days of calm, the cost of insuring British, Greek, Spanish and Portuguese debt against default rose again, according to data from Markit. Greek bond yields also leapt after a German official said that "not a penny" should be lent to Greece. The comments contrast with the EU's assurance last week that it would stand by the country.

"The EU politicians should speak in one voice if they want the bond market to calm down," Jenkins said.