By: Dr. Mike Campbell
In their heyday, junk bonds were the hottest financial property on the planet. Junk was largely re-invented by Michael Milken in the 1970s from bonds known as “Fallen Angels”; the poetic name given to an investment grade bond issue from a respectable corporation which fell on hard times.
Milken’s insight was to understand that bond issues from smaller corporations which did not have the pedigree to be considered as investment grade seldom defaulted. He determined that, whilst these non-investment grade bonds did fail, their rate was not substantially higher than that seen for investment-grade bonds, but the yields that they offered were substantially higher and there was lots of money to be made. Junk bonds were used to feed the corporate take-over and merger fever that gripped the world in the 80s.
The ratings Agency Moody’s has just down-graded its rating of some Irish banks to Junk status. This move will make it harder (i.e. more expensive) for the Irish government to raise money through bond issues since the banks are largely in state hands, following the banking collapse when the Irish property bubble burst. The move has also put pressure on the Euro which has weakened by 2.12 cents against the Dollar today (Monday) to 1.4218.
The IMF and the EU have both stated that they believe that the Irish Republic is making “good progress” on overcoming its economic challenges. The whole point of the EU/IMF bailout of Ireland was to ensure that it would not default on its debts, so possibly Irish banks could be seen as a good investment opportunity in the current climate. The only difference between “investment grade” and “junk” is perceived risk.