Paying Attention to European Crisis Resolution Developments

Even as we are distracted by political upheavals at home, the debate on how best to reorient the euro zone’s bailout mechanisms continues.   The proposal gaining most traction, with at least a degree of German support, is to allow countries in difficulty to use EFSF funds to buyback their own debt on the secondary market.   The initial focus is on Greece, but any new mechanism should be available in time to Ireland.   (Wolfgang Munchau provides a critical analysis here.)

The attraction of buybacks is that they allow a country to reduce the face value of outstanding debt without a formal default.   A disadvantage is that they can be gamed by bondholders: it makes sense for bondholders to hold out for a higher price if a buyback is really expected to improve creditworthiness.   One partial solution that I mentioned previously is for countries to buy back the debt accumulated by the ECB through its Securities Markets Programme (see here).  

Writing on Friday before the latest developments, Arthur Beesley reminds us of the stakes:

[T]he debate merits serious attention across the political spectrum in Dublin. Political activity for the next . . . weeks will centre on the election, but neither the Government nor the Opposition can afford to lie low on this front.

The debate on Greek debt takes place amid an intensive negotiation of key reforms to the European Financial Stability Facility (EFSF) rescue fund, including lower interest rates. Any inattention here would hamper Ireland’s argument for a rate cut, which is already difficult. But the Irish dimension does not end there, far from it.

.  .  .

[S]etting the election date brings clarity as to when a new government is likely to take office. From the perspective of European talks, the timing is tricky enough. Polling day is March 11th. EU leaders are working to make final decisions on EFSF reforms and a new permanent bailout fund at a summit only 13 days later.

There will be time – just about – to install a new taoiseach. By then, however, the really tough talking may well be done.

40 thoughts on “Paying Attention to European Crisis Resolution Developments”

  1. @John McHale

    No reason whatsoever not to have this general election on February 18. Weeks can cost billions at the mo ………

  2. This is the EU after all, so there will be some sort of fudge that won’t satisfy anyone; the outcomes that are often reasonably sustainable are where all parties are equally p1ssed off. But Mr. Beesley is correct; the broad politiical parameters of EU-changing deals of this nature are generally agreed well in advance of a summit. Officials are left to beaver away in the interim to hammer out the details. Every effort is made to avoid leaving anything substantive for political decision in the run-up to, or at, the summit. The effort at the summit is focused on putting an agreed gloss on what has been agreed for public consumption – domestically and internationally.

    It probably doesn’t matter very much if Ireland lacks a coherent government – or just has a new one in place – as Ireland is in the treatment room, the physicians are murmuring in the corridors and the programme of treatment won’t be hammered out in the presence of the patient. And there are other patients with more serious pathologies.

    When one sees the extent to which our current crew of public representatives is prepared to put factional interests before the national interest – and that goes for them all – it’s probably better that these decisions will be taken by others.

  3. “The attraction of buybacks is that they allow a country to reduce the face value of outstanding debt without a formal default. A disadvantage is that they can be gamed by bondholders: it makes sense for bondholders to hold out for a higher price if a buyback is really expected to improve creditworthiness.”

    True, which suggests to me that the only way to get any real benefit from a buyback is for the debtor to game the system in the opposite way, saying in effect: here’s your chance to get rid of that junk you’re holding; you may not get a better one. There has to be a credible threat of default, which does the same work as an outright default.

    I’ve found it difficult to have a worthwhile conversation with opponents of default because, all too often, it’s not clear whether their objections are moral or pragmatic. I’m not sure they know themselves. But in some cases it seems that the real objection is to explicit, unilateral default; give ’em a fig-leaf and their modesty evaporates.

  4. Will Buybacks allow us to default to the level that is necessary?

    When it comes to defaulting/restructuring what ever you like to call it, the main issue for Ireland is that it needs to be a large enough one to reassure future investors that Ireland can afford to pay the sovereign debts and whatever bank debts finally become crystallised as sovereign debt.
    We need to do the calculations that every Irish economist seems to be afraid of their lives to do.
    We need to work out the total of the national debt plus the off balance sheet stuff (nama, ICB etc.) Plus all the bank debts and then we need to put that number over our GDP.
    Given that “conventional wisdom” is that anything above 120% is where you start getting in to the notgetoutable Scenario, the difference is how much we need to default.
    Or are people suggesting that we should have smaller incremental defaults?

  5. EFSF is probably really only South of 400bn. They might up it. Say they did to 500bn.

    But Irish bonds at 80, split 50/50 the profit with EFSF and Ireland gets to purchase at 90.

    If Ireland has been allocated enough to buy back say, 80bn approx, then 10% of that gets you roughly 8bn reduction in outstanding debt.

    Then you’ve got to start persuading someone to buy more Irish debt if you have to issue it.

    At some point all the talk about “teams” going to negotiate with Europe will have to morph into talk about WTF the crack “team” think they are in a position to threaten Europe with. Might be useful if participant on this site could attempt to nudge that along a bit so it doesn’t suddenly occur to people after the new government has been elected.

    Election campaigns should discuss things that are relevant.

  6. Bidding the ECB for Irish (or any other) bonds at less than they paid runs up against the issue of ECB capital adequacy – the bonds are presumably being carried at cost?

  7. Colm,
    I presume the ECB is buying at secondary market prices — quite a gift to sellers otherwise. The suggestion is that they sell back to the issuing sovereign at cost.

  8. John

    The sugestion I heard was they split the discount with the sov. IIt actually pushed Greece wider at end of last week.

    BTW, I failed to draw anyone into a discussion on the CB “printing” – and the implications for the national debt on an earlier thread. Buiter is all over it with a big note today.

    Time for a thread?

  9. In what ways is this better than the traditional IMF route of a credit line coupled with debt restructuring and fiscal reform?

  10. @Eureka
    Here’s my take.
    Say our bonds trade at a discount – say 40% – based on the market’s belief that we may well default. We owe 100 but people only think they’ll get 60. They’d take 60 today. However, if we don’t default we should – in theory – pay back 100% of the money owed and the discount ends up becoming zero when the bonds are repaid.

    If we can buy back the bonds today then we pay 60 to the current holders and the 100 debt goes away, since we now owe it to ourselves. We make the trading discount a real result.

    Of course, we need another new source of cash to do this and – as mentioned – the threat of default needs to be kept in the background. In business the money is usually sourced from somewhat outside the preexisting population.

  11. Here is a link to the new Buiter report on the Emergency Liquidity Support from the Central Bank. Thanks to grumpy for the pointer.

    For those who do not have the time to go through the entire report, the FT’s alphaville has the guts of it here.

    One question: Why is it only considered “printing money” if the eurosystem has to cover losses that can’t be covered by the Irish State? I am not aware that the ECB is sterilising the effects of the ELA operations.

  12. @Hugh Sheehy.
    Thanks for that. I hope I haven’t picked this up wrong but say the yield on the bond is 3.8% and I buy it back using money i’ve borrowed at 5.8% – unless I get a significant discount I could actually end up worse off?

  13. Money line from Buiter:
    The inclusion of the CBI’s ELA on the Irish general government balance sheet would increase the gross general government debt by about €49bn, or 31% of GDP. In principle, net debt figures for the Irish general government would be unaffected, as the liability would be compensated by an asset of the same amount by the nature of double-entry bookkeeping. Should the valuation of the collateral and therefore the assets involved in the ELA repo-operations be above ‘fair value’, there is certainly a possibility that net (general government) debt figures would also increase.

  14. Eureka, 

    If bonds are yielding 8% plus in the secondary market, then the discount would leave you better off, but you are right the gain is eaten into by the cost of borrowing — and even more so given any (ridiculous?) sharing of gains that might be demanded by the EFSF itself (as pointed out by grumpy above).

  15. I can’t see why the 3%(ish) spread between EFSF funding and Irish interest charge isn’t retained in the SPV as a loss reserve. Although it’s not my preferred approach, I’d suggest the loss reserve would be remitted to Ireland on exiting the mechanism and used to reduce national debt.

    It’s hard to see why Irish taxpayers should be filling other EU states exchequers at this time.

  16. Using the EFSF in this way will break the ‘no bailout’ rule, so there will have to be benefit-sharing, a cap on the fund available, strict fiscal rules on any sovereigns assisted, no QE , etc. I reckon this might be a fudge Chancellor Merkel thinks she might be able to persuade her increasingly cranky voters to accept – and she’ll be meeting a lot of them this year with elections in 11 lander.

    But am I alone in thinking this will generate huge volatility in the sovereign bond market? If there’s a hint that the EFSF is gong to assist a sovereign yields will collapse to increase the buyback price. This could bring down yields in all of the peripherals, but if any of these sovereigns makes a move to issue more of its own debt given these yields, they’ll shoot up again. And they’ll shoot up in any event if the market thinks the EFSF is playing duck’n’drakes with it.

    This could create a roller-coaster and even the solid EZ members could see their yields moving up.

  17. “One question: Why is it only considered “printing money” if the eurosystem has to cover losses that can’t be covered by the Irish State? I am not aware that the ECB is sterilising the effects of the ELA operations.”

    Presumably the argument is that default by the Irish state, unable to borrow the euros or obtain euros from tax receipts to plug the hole in the CB balance sheet, leaves the hole as printed money (if the EZ governments don’t step in and fill it.

    My guess at the quality of collateral offered to the CB leads me to regard this as partly de facto printing already. Without it I think the banks were gone.

  18. @ JMcH

    “One question: Why is it only considered “printing money” if the eurosystem has to cover losses that can’t be covered by the Irish State? I am not aware that the ECB is sterilising the effects of the ELA operations.”

    I think the clue is in the last observation. As I understand it, if the CBI provides ELA because of the run on Irish deposits it finishes up that foreign banks have deposits with the CBI rather than with the Irish banks. But these are not deposits with the Eurosystem i.e. they are not guaranteed by the ECB, they are therefore akin to an interbank liability and that is not “printing” money in the sense of printing euros that the Eurosystem will stand over. In fact the note suggests that ELA is deposits with some subsidiary of the CBI. The note asks the interesting question do the foreign banks know they have CBI credit exposure or do they think they have euros?

  19. @JMcH

    Actually he could be making a loose distinction in that Eurosystem can mop up as and when so printing there is temporary. In contrast I doubt the Irish CB would be in a position to mop up anything much given that the market suspects it may be unable to honour its obligations. That makes its printing rather more of a one way street.

  20. @JMcH/Grumpy

    And he is making the very general point that, if you don’t stick to the rules, but instead let each national bank create as many euros as it pleases, then you can end up with high/hyper inflation just like the USSR did. Indeed if one bank breaks the rules then others may be more likely to. For example, what’s now stopping the Portuguese Central Bank from using the emergency facility to ease financing needs at local banks rather than go to the IMF?

  21. The water is rising inexorably. What’s the betting there will be one seat less on the ECB Board by the end of the year ?

  22. @ Tull

    The ELA is to do with the flight of Irish deposits so I presume it finishes up with foreign banks having CBI deposits.

  23. An attempt to understand from the remedial class. Close?
    Paul gave me €600 in 2009 at 4% to be paid back in full in 2014. In 2011 I run into trouble and I’m not sure if I can pay him back. My friend EFSF tells me not to worry and that Paul will take €500 now. My friend EFSF tells me that he will lend me the €500 to pay to Paul and EFSF will only charge me 5.8% for it.
    He tells me that the 5.8% interest rate is fair because if anybody else was to take on Paul’s debt they’d be looking for an 8% yield on it.
    So my friend lends me the money and then tells me that he wants half of the €100 that I saved in the whole transaction.
    I’m beginning to think that my friend is setting me up to fail. I’m starting to think that the €50 split is to cover him for when I can’t pay him back. And I’m also beginning to think that my friend’s only interest is in ensuring that Paul gets paid back more than I can afford.

  24. @ BW II

    I was speculating that it may not be foreign banks that are the source of the CB deposits. Might it be a source closer to home, perhaps NTMA.

  25. @Eureka
    Close. You can leave the yield percentages out of it…makes it easier to understand.
    We borrowed 700 from Paul and promised to pay him 1000 in 2014. Today, he thinks he’ll be lucky if we can pay him back 700 (or any other number) because we’re broke. Mr EFSF tells Paul he’ll give him 700 today. Paul takes the money and runs, and now we owe Mr EFSF. Mr EFSF tells us that we now only owe him 800, that he won’t make us pay the full 1000, but he won’t let us away with only paying him 700. If we managed not to go broke we would ultimately have had to pay Paul 1000. Now we only owe 800. A more generous benefactor might have let us only owe 700, in theory.
    (corrections, please)

    On the other question. If the German exchequer starts taking on liability for more and more debt then German yields will go up, yes. It may already be happening.

  26. There is already a buyer of bonds – the ECB. It looks keen to allow someone else take on its sovereign risk. Will a transfer of that risk to some other
    entity make any difference to the final investor? Maybe not. We’d need a lot more detail to make an assessment. And there is quite a variety of schemes that could be conjured up.
    Most ideas ideas i’ve seen just involve transfers of risk. Of course that can involve a subsidy through raising the contingent risk. I can’t see the
    fiscally more responsible countries being too happy about that.
    Will any new scheme involve the transfering of risk from the final investors to the public sector? But that is the reverse of what I thought the fiscally responsible countries have tried to achieve into end 2010.
    At the end of the day, the value of bonds is determined first and foremost by any solvency risk, less who owns them. Go out and buy 10, 20, 30 % of the market. As long as investors are holders of risk, and there is a market (not much of a one these days by the way) solvency risk – if there is a threat – will be dominant.
    @ Joe you say the advanage is the reduction of the face value of outstanding debt “without a formal default”. It also would likely raise the immediate interest rate burden, etc. We’d really need an economic analysis of the costs and benefits (as other entries above allude to), and try to understand at the same time how markets actually work these days. That requires a bit of thinking maybe beyond a brief blog entry.
    I don’t understand ‘gaming’ (maybe you can explain). That for me typically requires some informational advantage. Those most likely to have it are the governments. Fine – some government or the ECB is convinced there will be no default. Let it go buy debt. For now, the current ideas seem in large part driven by the ECB’s desire to cut risk, and find some reason for someone else to carry the can.

    Indeed, official buying of bonds has at times has been justified by officials as allowing orderly sales of risky debt, at other times as likely to somehow “normalise”.markets. And now some see yet more official buying as the saviour of the spendthrift. But as Grumpy above suggests, the savings “the reduction of the face value of outstanding debt” doesn’t amount to that much.

  27. @ Ciaran

    ‘I don’t understand ‘gaming’ (maybe you can explain). That for me typically requires some informational advantage. Those most likely to have it are the governments’

    With respect, you are surely pulling our legs. Did our banks disclose their true financial position to the government in September 2008 ? If they had done so, could they have expected to receive the guarantee ?

    Assymetric information is pervasisive. Gaming, or illegitimate manipulation, may extend from the ‘saling close to the wind’ of loose professional standards eg auditors, to outright fraud such as Ponzi schemes. Isn’t it Minsky who showed that that all economic booms eventually end up with pyramid selling ?

    The collected works of Nobel Prizewinner Joe Stiglitz includes such essays as ‘Credit rationing in markets with imperfect information’ ‘ The basic analytics of moral hazard’ and ‘On the impossibility of informationally efficient markets’. One doesn’t have to grasp the mathematical proofs to see how central insider knowledge is.

    For those willing to entertain genuninely critical persepctives, Yves Smith’s ‘Econned’ provides a comprehensive review of maket manipulation in the global financial services industry. Framing Finance by Alex Preda is very enlightening on the role of speculation, as a kind of tribute gathering, in modern capital markets.

    The behaviour of global banks is unlikely to be more socially responsible than those of Irish banks. Any proposed European Crisis Resolution Scheme will naturally be subject to heavy, covert lobbying. Behind the public statements, deals will always be done.

  28. @ Hugh Sheehy.

    Thanks for the links.

    I had read them but don’t we need to add the 49 Billion 31 % of GDP from the Central Bank revelations (not GNP) plus anything else since last November.

    We need to update the Data.

    At the time John Mchale was contending that default was not inevitable perhaps these new additions may change minds?

    Also, As of yet I havent seen our total admitted debt exposure as a percentage of GNP.

  29. @paul quigley
    “With respect, you are surely pulling our legs. Did our banks disclose their true financial position to the government in September 2008 ? If they had done so, could they have expected to receive the guarantee ?”

    I will raise this question here yet again. A very simple – it seems to me – way to ensure that the banks were being upfront at the time of the guarantee, would have been to make sure that it was dependent on full disclosure. The fact that it wsn’t implies that:

    a) those who drafted it were stupid.

    or

    b) they knew the real state of the banks but decided the dripfeed method of releasing that information to the public was a better option than having a guarantee they could easily and legally renege on.

    I believe it was the latter – but have no idea why they chose that option.

    Sinn Fein and Joe Higgins and other independents will do well in the elections because they have a simple message, which the public can easily grasp. “Why should ordinary taxpayers carry the debt of private institutions”. Vincent Browne has asked that question virtually every other night for the last two years, and each time the conventional parities struggle to explain. It was FGs Coveneys turn last night.

    @JmcH
    “The proposal gaining most traction, with at least a degree of German support, is to allow countries in difficulty to use EFSF funds to buyback their own debt on the secondary market. ”

    Apologies for straying on topic here but I don’t understand why there any difficulty with a country buying back it’s debt if it is on a open market. It would appear to be silly not to if it is substantially cheaper to do that.

  30. @ AMcGrath

    “Apologies for straying on topic here but I don’t understand why there any difficulty with a country buying back it’s debt if it is on a open market. It would appear to be silly not to if it is substantially cheaper to do that.”

    The difficulty is that the country has to borrow the money. It is saying “please lend me money so that I can buy my own bonds”. I can fully understand why the lender’s permission would be needed.

  31. @BWII
    I’m not sure why it should be against the ECB interests – but surely the IMF would hardy object to their funds being used like that. BTW we are talikng here anout sovereign debt?

  32. Eurointelligence today with a comment felevant to this thread on why debt buyback won’t work:
    “Why bond repurchases won’t work

    Mark Schieritz has an excellent blog post this morning, in which he explains why bond repurchases won’t work. Suppose the EU gives a low-interest loan to Greece to buy bonds, which, say, currently trade at 70. This loan would constitute a net transfer of wealth from the EU to Greece. This action alone would increase demand for the bonds, so that the price will rise. Assume the EFSF gave so much low-interest finance to Greece that Greece would become solvent again. In that case, the bond prices would rise back to 100.

    (This is a similar argument as why only unanticipated inflation has an economic effect, while correctly anticipated inflation would be mostly neutral. And since the EU-bond repurchase programme is certainly anticipated, given all the discussions, Schieritz’ argument is correct. It won’t have any macro effect – perhaps some micro-effects as higher bond prices may help privatisation. Paul Krugman also makes the point that the Latin American experience shown that market-led debt repurchase operations do not work.) ”
    http://www.eurointelligence.com/index.php?id=581&tx_ttnews%5Btt_news%5D=3017&tx_ttnews%5BbackPid%5D=901&cHash=f28ecfa297

Comments are closed.