2
$\begingroup$

According to an article I read, one of the steps that was used to contribute to the Greek downfall was that bankers downgraded the bonds of the country. This immediately makes the interest rates (“yields”) on the bonds go up, making it more and more expensive for the country to borrow money or even just roll over the existing bonds.

I don't understand the impact this has. Why it makes it more expensive for the country to borrow money? And what is "roll over existing bonds"?

Also what are the warning signs in the economy that this is happening? Is a weak currency one sign?

$\endgroup$
3
$\begingroup$

Here's a non-technical answer:

Bonds are a form of debt. What the issuer is selling is essentially a promise to repay the principal (i.e. whatever price the buyer paid) and some interest to the buyer. (Note: since we're talking about debt, you could also think of the buyer as a lender.) In return, the issuer gets to use the money from the sale for whatever current projects needed funding in the first place.

Skirting some technical stuff, assume the yield is the same thing as the interest rate. When lenders think there's a higher risk of not getting their money back, they'll either 1) not lend in the first place, or 2) if they do lend, demand higher a higher interest rate to compensate them for the higher probability of not getting repaid.

When someone downgrades your credit, it's a statement about you: they believe you're at a higher risk of not fulfilling your promise to repay the lender. So any lender that does decide to take a risk and loan you money (i.e. buy your bond) is going to be in situation #2 above: they'll demand you pay more interest on the loan (here, higher bond yield) to compensate them for your riskiness. That makes borrowing more expensive for you since you now have to pay a higher interest rate than you would have if you had better credit.

Rollovers are a type of reinvestment.

At the heart of the matter, credit downgrades happen when lenders lose faith in your ability to fulfill your promises. This happens for a multitude of reasons.

As an example, S&P's 2011 downgrade of U.S. debt happened because they believed 1) that the pattern of running deficits most years might eventually put the U.S. at risk of not repaying (that is, the debt-to-GDP ratio might not be sustainable), and 2) that political leaders lacked a credible plan to tackle the problem.

$\endgroup$
  • $\begingroup$ So then discrediting a government (claiming they are not capable of repaying the bond promise) causes bonds to be a less attractive purchase - scares people away - thus inhibiting a governments ability to raise money through bonds. So they raise the interest rates to attract buyers which is expensive because it's lost money to pay the high interest back. Then they still need money (since they can't get enough through bonds) and so they run to the central bank to borrow, becoming wildly indebted to them. Is this correct? $\endgroup$ – erotavlas Jul 16 '15 at 3:24
  • $\begingroup$ @erotavlas The last comment about central banks is a separate issue. If the government in question didn't raise enough funding via bond sales, there are multiple ways of obtaining it. In Greece's case, it had access to the IMF and to the ECB. Becoming "wildly indebted" is only one possible path. $\endgroup$ – Pat W. Jul 16 '15 at 12:12

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.