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The “PIIGS” are in Play…What do they have to do with interest rates?

The Fed program to buy mortgage-backed securities was put into place in December 2008 in an effort to stimulate home-buying and refinancing.  By becoming the major purchaser of MBSs (mortgage-backed securities) the Fed purposefully created demand for these securities when there was none.  By increasing the demand on MBSs they drove up their price, which in turn drove down the yield that they were paying investors.  This in turn drove down interest rates on conventional mortgages (mortgage rates follow the MBS yield).  All in all they purchased 1.25 trillion dollars worth over a 16-month period.  In fact, at times they were 70% of the demand.  Everyone (including this Mortgage Professional) thought that, as soon as they backed out of this program, rates would naturally bounce up at least a point–maybe even more.  So, what happened?

Europe happened.  They have been coined the “PIIGS,” which stands for Portugal, Ireland, Italy, Greece, and Spain. These five little “PIIGS” have brought the US market and the world-wide markets to their knees.  You cannot help but hear about the riots in Greece every time you turn on the news.  The cause is multilayered, but it can be boiled down to two things:

  1. easy, cheap money
  2. accountability on the part of each nation within the Union

The easy money was provided by the World Bank in the form of cheap loans, which are now starting to come due; and Greece’s total government debt is at 115% of GDP, which means they don’t have the money to repay it.  Greece’s federal deficit is now in excess of 14% of GDP, based on some reports (the European Union allows for a maximum of 3%). Don’t think that they are alone in their pain.  The other 4 little PIIGS are also racking up the debt, and we most certainly will fall into the same trap that Greece is in now.  The European Union says that its members must remain under 60% of GDP for all federal debt.  However, Greece is currently at 115%, and projections are for it to hit 149% by 2014!  Unfortunately, they have company:  Portugal’s total federal debt  is at 85% of GDP, and Italy’s is at 112%

Accountability is what is lacking in the European Union at this time, and we as Americans should take heed.  The European Union is based upon a single currency with multiple countries involved.  Normally, when a country is in trouble as Greece and the other PIIGS are, they would have their currency devalued, thereby increasing their exports and stimulating their economy; but the countries within the European Union do not have this option.  Frugal countries like Germany are left to take up the slack for countries like Greece and the other PIIGS, but this is not a sustainable course of action.  Fundamentally, the problem is that, although these countries all share a common currency and monetary policy, they don’t share  a common and sustainable fiscal policy

So, what happens to the US stock market?  Why are we so affected by what is happening across the pond?  I believe that the current rate of spending in the US is not sustainable; the American investor realizes this and realizes that the PIIGS crisis is a window into our future and, therefore, investors are afraid. This is causing investors all across the world to look to quality investments like US treasuries and MBSs. This is what caused rates to drop last week. However, as of the writing of this article the IMF has approved a 1 trillion dollar bailout for the European Union.  This move, dubbed the ” nuclear option,” has the stock market set to rebound; but, unless the “PIIGS” change their ways,  we will soon be back to square one.  Long term this is just a band-aid; and, if they don’t change their ways, we should keep these interest rate levels in place for a while.

This crisis proves that out-of-control spending and borrowing can only lead to financial ruin.  Therefore, we as Americans need to look at the similarities of how the “PIIGS” have run their countries and how we as a country have been running ours.  Our national debt is at 80% of our GDP, which is not far behind most European Union countries.  I believe that the reality of what is happening in Europe is a wake-up call for us.  Let’s not hit the snooze button.

John McClellan 5-10-2010

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