Could We Be Next?

Most every country has some debt and they cover that debt by issuing various forms of financially indentured instruments called bonds. In this country, we use Treasury Bills/Bonds (often referred to as T-bills and Treasuries) to float our debt. In the U.K., they have something called Gilts or Gilded-edge bonds.

In the U.K., just like in the U.S. with our bonds, Gilts are sold at auction on a pre-announced date. This morning (while we were sleeping), 1.75 billion pounds worth (or 2.55 billion dollars worth) of new Gilts were slated to be sold; but there were few buyers (See Full Story). This meant that the potential buyers were being scared off by an increasingly perceived risk that the U.K. would default on the terms of those bonds. That concern over risk is a direct result of all the debt that Prime Minister Brown and the U.K. government have been accumulating in trying to fight this recession. Sound familiar?

Every bond that is ever sold, whether it be a government or a corporate bond, has at least four key elements that are important to the buyer: the Issue Date, the Face Value, the Term, and the explicit Interest Rate. The Term is the period of time, in months or years, that the bond holder will be paid interest payments. Sometime this is referred to as the "Life" of the bond. The amount of each interest payment that a bond holder will receive is based on the explicit Interest Rate on the face of that bond. At the end of the Term, based on the Issue Date, the bond issuer will (should) buy back the bond from the current bond holder at its Face Value. If any of those terms are not met, the bond is said to have been defaulted on. Being in default is very similar to not paying your mortgage payments.

The Face Value of a bond is sort of like the "asking price" of that bond and, not necessarily the price that it will be sold for at it's auction. Usually, the Face Value is a round number like one thousand dollars; or, in the U.K., a thousand pounds. If the intended buyer or buyers of a bond senses risk, they will be less likely to buy that bond at its Face Value. At auction, when the risk is high, the bonds could bid down and sell for substantially less than their Face Value; or, worse yet, buyers won't even buy the bonds.

When a bond sells at less than Face Value, it is said to have been sold at a "Discount." When a bond is sold at "discount" is offsets the buyer's risk in two ways. First, when a discounted bond comes to Term, a profit is realized when the bond issuer has to buy back that bond at it's Face Value; a price higher than that of the original discounted price. Secondly, the holder of the discounted bond will be paid at the Interest Rate that is specified on the face of that bond. Because they bought the bond at a discount, the "effective" or implicit interest rate will be much higher than if the bond had been purchase at its full Face Value.

The fact that those U.K. Gilts failed to attract enough buyers should scare the hell out of us. We are floating trillions of dollars in debt by selling our Treasury bonds. If we don't have buyers to buy our bonds, it's the same as us not being able to get a bank loan to "tide us over" for our continuing operations. Even if we do have buyers, it will take more and more bonds to be issued in order to get the same amount of borrowed money. As a result, and at best, our government will have to pay higher and higher amounts of interest on our debt. At worst, with no buyers, we could literally go bankrupt for the lack of enough funds to keep our country going.

The Chinese, the biggest buyers of our bonds and our debt, have already expressed their concern over the risk associated with the high deficits that we are accumulating (See Full Story).

Mr. Obama and his gang should look at what happened in the U.K. as a clear warning signal. We need to stop all this excess spending, right now; or we, too, could find ourselves without buyers for our bonds and, consequently, in very serious trouble. And no amount of Leno appearances will save our tails if that happens!