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The BBC is reporting that the EU has decided on Private Investor hair cuts on Sovereign bonds holdings, going forward.  This is part of the replacement funding mechanize for 2013 and post bail outs.

The EU is also planning on building into these new rules, a sovereign debt priority clause.  This is significant.  Lets use one of the PIIGS (Portugal, Ireland, Italy, Greece, Spain) for an example scenario.

If a PIIGS nation needs a bail out in the future, it will have to force a haircut on its private debt investors.  If, after receiving funds from the EU, the PIIGS nation runs into further trouble, and needs a second bail out, it has to default on its prier “Sovereign” debt, while continuing to pay the first bail out funds back.  This is putting the EU Sovereignty ahead of the State Sovereignty.

This will crush the sovereign debt markets, as the private investors have to evaluate the reality that Sovereign risk exists “Pari passu” with Corp debt.  This is going to quickly change the valuation metrics on some Sovereign debt, and also some Corporate debt.  Do you want to hold debt on a company with very little debt, high cash levels, and real positive cash flow like Microsoft? Or do you want to hold Spanish debt with unemployment at 20%, a fleeing younger generation escaping the future tax load that is already their responsibility?

I find it ironic that the European Union appears to be hell bent on destroying their fragile union with Sovereign robbing rules that put the future EU bail out funds ahead of anyone else.  The changes being suggested by the EU will have trickle down effects in the US market, as US Corporate companies with solid balance sheets find new buyers of their debt offerings.

While the current binge in high yield bonds continues, it is actions like this, that will drive the AAA Corporate bonds to all time low yields.

Pari Passu, Microsoft is a better debt risk than Spain.  The market will quickly address this new spin on “Sovereignty” destruction.