James Hymas Quoted in Winnipeg Free Press

Joel Schlesinger of the Winnipeg Free Press was kind enough to quote me in a piece titled Roller-coaster times, published 2011-8-20:

Surprisingly, the rating agencies still have enough authority to give markets a good shake as S&P demonstrated, recently downgrading U.S. debt from AAA, its highest rating, to AA+, the second highest credit rating.

The downgrade really means nothing in terms of default risk, says James Hymas, president of Hymas Investment Management, Inc., a Toronto-based fixed income investment firm.

“The chance of default has increased from 0.01 per cent to 0.015 per cent,” he says. “The difference between AAA and AA+ is something that’s more a matter of perception than something that can actually be measured.”

Call it a shot across the bow of U.S. lawmakers.

The U.S. debt downgrade was only a side dish to the main course of financial worries that have driven markets over the past few weeks, Hymas says.

“The real story was the debt crisis in Europe with the European Central Bank starting purchases of Spanish and Italian bonds,” he says. “That had the effect of forcing people to focus their attention on the bond portfolios and to a large extent they decided that Europe was getting too risky for them and they wanted to hold the U.S. debt.”

At the moment, the market is selling these bonds, not buying them. European banks and other large investors have these bonds on their books and want to unload them. The ECB is stepping in to buy up the unwanted bonds to help stabilize the European banks because just the prospect of default on Spanish and Italian bonds affects their ability to do business, Hymas says.

“A big piece of the puzzle is liquidity because a bank keeps a liquid reserve of investments and in the course of its business it might need to borrow $100 million for a short term and it might want those bonds as collateral to get a loan from another institution,” he says.

“The trouble is, what if you own Greek bonds, for instance, and your usual counterparties aren’t accepting those as collateral?”

And liquidity is important to banks. Greek bond defaults are one thing, but default worries about Italy and Spain’s bonds — much larger fish — are another. If financial institutions become worried enough about one another’s investment books, liquidity in markets can dry up — as we saw in 2008.

But Hymas says while the problems are real, they don’t necessarily lead to a major calamity until there’s a major shift in perception all at once. It’s a ‘Wile E. Coyote moment’ — to quote New York Times financial columnist and economist Paul Krugman.

“You’ll remember from the cartoons that Wile E. Coyote is always running off cliffs, but he doesn’t start falling until he looks down,” he says. “The way crises finally come to light is when investors as a group suddenly look down.”

Arguably, we have been having those moments every other day in the markets of late, Hymas says. This has led to volatility in both the bond and stock markets.

“We have this daily risk on and risk off in the marketplace,” Graham says.

Stock indices can be up 500 points one day — the risk is on — and down 400 points the next — the risk is off.

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