Reinhart and Rogoff on Debt and Growth

Carmen Reinhart and Ken Rogoff have an interesting op-ed in today’s FT: you can read it here.

14 thoughts on “Reinhart and Rogoff on Debt and Growth”

  1. One concern for Ireland must be whether our fiscal discipline will be rewarded. We are mentioned in every article in the international press that refers to possible sovereign default. This suggests to me that we are one of the first dominos in the chain of potential contagion.

    Brian Lenihan said in his speech introducing NAMA that he was operating on figures which showed the banks to be solvent. He said that if the banks weren’t solvent then the nation isn’t solvent which is unthinkable. However, if the country is insolvent then we better get our heads out form under the pillow and start thinking hard about how this is going to play out.

    If the risk of sovereign default increases substantially then we may need to choose a pre-emptive form of sovereign default, i.e. withdrawing form the bank guarantee and implementing a bank resolution scheme. This is a last resort but we need to be ready to “shoot the hostage” if that is what the situation demands.

    I get nervous posting about such things on the internet so I don’t expect the Government to talk about it. However, I do hope and expect that they are thinking about it. I also hope that all the bank employees and others involved in cleaning up the banking mess around the country and reforming Anglo can see that the fuse is getting shorter.

    Rogoff & Reinhart: “One common mistake is for governments to “play the yield curve” – as debts soar, shifting to cheaper short-term debt to economise on interest costs. Unfortunately, a government with massive short-term debts to roll over is ill-positioned to adjust if rates spike or market confidence fades.”

    Is there a risk of this scenario with NAMA bonds? I note that the DoF/NTMA appear to be trying to implement a solution where the sovereign bonds backing NAMA can be rolled over without the consent of NAMA bondholders. (This is still very opaque which is not reassuring.) However, even if the consent of NAMA bondholders is not required is there not a danger that the value of NAMA bonds on the markets may collapse crippling our banks.

  2. @zhou
    “One concern for Ireland must be whether our fiscal discipline will be rewarded. We are mentioned in every article in the international press that refers to possible sovereign default. This suggests to me that we are one of the first dominos in the chain of potential contagion.”
    Well, to be fair to Mr. Lenihan, the DoF (not things I like to do) and Mr. Honohan, between them they have managed to move us from under the spotlight. We are not in the relegation zone at the moment – Greece is the word and it appears to be raining in Spain… good results still needed.

    re: short end of the curve.
    I’ve been banging on about rollover risk for a good while now. NAMA, as we currently understand it, provides the clearest example of rollover risk (though it is not alone, as the t-bill and commercial paper programs are substantial):
    1. The banks cannot sell the NAMA bonds in case the counterparty they sell them to wants to be paid back rather than rolling over.
    2. The banks cannot be let go bust as their other creditors would get the NAMA bonds leading to 1.
    3. The banks themselves could force a crisis on the state either by 1 above or through no fault of their own – a generalised European credit crunch (perhaps as a result of a sovereign failure elsewhere?) leading to a spike in euribor on a rollover date.

    These are credible risks. Incredibly, we have no risk analysis in the business plan that covers the funding side of NAMA. All the emphasis has been on the asset side.

  3. @YM

    I imagine the NAMA bonds thus:

    NAMA SPV bond (NSB) is backed by 6 month NAMA Bonds / Treasury Bills(NTBs).
    NSB’s can only be redeemed after 10/15/20 years. In the meantime NSBs pay out the yield from the NTBs.
    This seeks to reduce the roll-over risk insofar as if NTBs collapse then the holder of NSBs cannot refuse to roll-over the debt. However, if NTBs collapse in value then surely NSBs suffer a similar collapse and institutions who rely on them will collapse. Therefore, it would appear to be in everybody in Ireland’s interest for the banks to offload the NSBs to external non-systemic third parties asap.

    Perhaps somebody else can shed a little more light on this?

  4. @zhou
    Goodness, that’s a very complex structure.

    It requires selling the T-bills in the open market, which I thought the NAMA bonds were supposed to avoid?

    It also would mean that the debt is on balance sheet as the NTBs backing the NSBs would be part of the GGD. No?

    So I don’t see it as likely.

    I don’t think there is the possibility of sovereigns (or semi-sovereigns) collapsing in value in bank asset terms. While the market might take a dim view of them, as long as the coupon is being paid, they can be held at par (i.e. long-term economic value…). They will be accepted as such by the ECB (short of a ratings collapse…).

    I still see the simplest solution to be ten-fifteen year floating rate bonds pegged to euribor (maybe paying an annual average, rather than resetting at a fixed date?), callable by the issuer, but not redeemable before the final date.

    It would make sense to have this as subordinate debt (i.e. sovereign subordinates), but I think that is unlikely…

  5. “It requires selling the T-bills in the open market, which I thought the NAMA bonds were supposed to avoid?”
    I would see the SPV holding the NAMA bonds/T-bills.

    “It also would mean that the debt is on balance sheet as the NTBs backing the NSBs would be part of the GGD. No?”
    I presume it will be designed to stay outside the calculations for the growth and satbility pact but this is part of our debt one way or the other as has been flagged by Eurostat.

    “I still see the simplest solution to be ten-fifteen year floating rate bonds pegged to euribor (maybe paying an annual average, rather than resetting at a fixed date?), callable by the issuer, but not redeemable before the final date.”
    I suppose we should already know by now. Was this not clarified at the time of the bank shareholder NAMA votes?

  6. @zhou
    “Was this not clarified at the time of the bank shareholder NAMA votes?”
    No.

    “I suppose we should already know by now.”
    Yes!

  7. There is a very interesting piece here http://ftalphaville.ft.com/blog/2010/01/28/136761/the-coco-mortgage-coming-soon/

    The coco title might be new but the idea of a bank and a house buyer partnership purchase is not. David McWilliams had a similar idea about a year ago http://www.davidmcwilliams.ie/2009/01/28/a-mortgage-plan-that-will-save-a-whole-generation

    Although Andrew Haldane and David McWilliams both approach the mortgage issue from different angles, the central point both of them share is that the way we pay for and deal with property at the moment is at least half the problem..

  8. zhou_enlai
    I see that you appear to have changed your mind. It is never too late to realize the truth. Whatever it may be. You have taken a certain position and I mean no personal disrespect but you must realize that your stance has encouraged others in their support for the government position, whatever that maybe. You have demonstrated that the bond situation is unknown and that is to your credit also.

    The banks are and will remain crippled. I fail to understand why an apparently honest and intelligent person cannot see that. Your anonymity should have ensured that you can speak freely? What is the obstacle to admitting that “we blew up the banks”? It has been Gov policy under Haughey and since to grow them aggressively, without thought as to the damage possible. Well here we are now. Or rather here we are two years after they went bang.

    We have now decided to borrow into the teeth of deflation. In addition to the NAMA money, we have taken on deficits that are also financed by borrowings! Perfect storm? This is sheer lunacy, given the world wide destruction of capital.

    Do you and others not realize what has been happening? Look at Japan. They suffered from a credit bubble and the consequences have lasted for 20 twenty years! Their population is declining, but their sov debt, albeit domestically funded, is colossal. No one else will fund it now! Where are they going to go? How can Ireland avoid that fate?

    The USA disguised their own depression but it has been evident since 1999. They blew the largest bubble ever in an attempt to get the last remaining cream. Did they ever! There is no upside. Interest rates are crucial to your calculations yet it is clear that by keeping them low we fall into the Japanese trap. We all know what happens if they rise. Yet rise they might, especially as those who have creamed off genuine capital are ready to start buying up defaulted assets. To get those, they need rates to rise! What happens to
    Ireland then?

    You seem to be willing to consider the default option? It deserves a whole blog!

    We are now part of a setup that restricts our room to maneuver amid declining activity in FIRE business where English is the prime qualification. No other skills required.

    What are webuying with NAMA? Land? WE own it already! What a true mess!

  9. At first debt is productive, but after a while indiscipline takes over and malinvestment occurs. Debt increases without long term value being added. If it stopped the economy recovers quickly and growth resumes, with the loss of some of the malinvestment. But if it goes on, there is a danger that it will only stop when no one wants or can afford more debt as now. Then debt remains to be paid off but all the malinvestment will now need to be liquidated in a falling market where few will borrow to buy. This process can take a long time to “reach an equilibrium”. Just like the Japanese.

    This is past a crisis. It is now a disaster that requires clear knowledge of external and internal factors. And everything we know is bad, except that the Gov have taken some moves in the right direction. All else is bad tending to much worse.

  10. “The UK and Ireland account for about 23% of oustanding Greek debt…”

    FT, page 6, today

    I suppose if I was an Irish bank I would load up on Greek debt too. Pays a decent rate and if it goes belly up, well its likely that Ireland gets dragged down the toilet with it in any event.

  11. From the FT article “One common mistake is for governments to “play the yield curve” – as debts soar, shifting to cheaper short-term debt to economise on interest costs. Unfortunately, a government with massive short-term debts to roll over is ill-positioned to adjust if rates spike or market confidence fades.”

    The above describes Irelands “strategy” which is pure folly and then as Christy observes our bankers, who seem to be more addicted to gambling than Las Vegas crap shooters run off and load up on Greek bonds? Unbelievable. As an Irish person I feel the noose tightening around our collective necks. What happens if people start to move deposits out of Greek banks to safer havens? What would happen here, would people accept the government “guarantee”. I don’t want to be unpatriotic but I think we all know.

    One aside, Irelands response to the above mess is not to answer the telephones spurious strikes dressed up as work to rule so that full pay is forthcoming. . Talk about living on mental reservations. Buying up 650 “ghost estates” (NAMA) is economic suicide.

  12. Bill Gross of PIMCO gets in on the act:

    http://europe.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/Investment+Outlook+February+2010+Bill+Gross+The+Ring+of+Fire.htm

    The Reinhart/Rogoff book speaks primarily to public debt that balloons in response to financial crises. It is a voluminous, somewhat academic production but it has numerous critical conclusions gleaned from an analysis of centuries of creditor/sovereign debt cycles. It states:

    The true legacy of banking crises is greater public indebtedness, far beyond the direct headline costs of bailout packages. On average a country’s outstanding debt nearly doubles within three years following the crisis.

    The aftermath of banking crises is associated with an average increase of seven percentage points in the unemployment rate, which remains elevated for five years.

    Once a country’s public debt exceeds 90% of GDP, its economic growth rate slows by 1%.
    Their conclusions are eerily parallel to events of the past 12 months and suggest that PIMCO’s New Normal may as well be described as the “time-tested historical reliable.” These examples tend to confirm that banking crises are followed by a deleveraging of the private sector accompanied by a substitution and escalation of government debt, which in turn slows economic growth and (PIMCO’s thesis) lowers returns on investment and financial assets. The most vulnerable countries in 2010 are shown in PIMCO’s chart “The Ring of Fire.” These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years’ time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth.

    Mr. Gross puts us in the “Johnny Cash is King” bracket.

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