LBS: Private-Sector Involvement “a good idea”

Karl posted a link to yesterday’s speech by Lorenzo Bini-Smaghi.  I would focus on his theme  that debt restructuring is a good idea but that it should be used as a last resort, rather than pre-emptively.  Some relevant quotes:

The point I would like to make is that having the private sector actively involved in preventing and resolving sovereign crises is a good idea.

and later

This is why such restructuring should only be the last resort, i.e. when it is clear that the debtor country cannot repay its debts.

and

Where is the problem? The problem emerges when debt restructuring is carried out not as the last resort but as a preventive tool, even becoming a precondition for receiving (or providing) financial assistance, a point mentioned in some official circles since mid-October 2010. Debt restructuring would be a way to tackle not only dramatic cases of insolvency but also any difficulties countries face in accessing the financial markets.

Accordingly, the speech usefully boils down the argument to its essence –  at what point should policymakers insist on private-sector burden sharing vis-a-vis sovereign debt?  LBS provides reasons to argue that it is too early to close off other options; others will judge that it is better to eliminate the debt overhang now.

35 thoughts on “LBS: Private-Sector Involvement “a good idea””

  1. What does LBS think about private sector bail-ins for private debt? Alternatively, does he feel that the risks of sovereign default should be increased for countries at the threshold through continued bail-outs of unguaranteed bank bondholders?

  2. I don’t agree that there’s anything much to the speech. Would anyone bother with it if, for example, it was the work of an Irish lecturer? I think not. It gets attention only because the man speaks for a powerful institution.

    But this is a question worth addressing: at what point should policymakers insist on private-sector burden sharing vis-à-vis sovereign debt? My suggested answers would be:

    When it is clear that the burden of debt represents a serious drag on the economy’s growth prospects. In the Irish case, if trying to pay off the debt results in a sustained increase in emigration, then we have to shout stop.

    Or:

    When it is in the interests of the creditors themselves, who must apply the same logic that leads a bank to ease the terms of a loan, on the principle that getting half the loaf you are owed is better than no bread.

    I don’t delude myself that these are particularly good answers, but I’d like to see more thoughtful people than LBS giving theirs.

  3. @Colm

    Don’t choke on your cornflakes but LBS had this to say “the basic rationale behind involving private creditors when a debtor is in distress is straightforward and uncontroversial: creditors and investors should bear the consequences of their decisions as fully as possible and should not rely on taxpayers’ money to be bailed out. The underlying reason has long existed: a bailout by taxpayers today may encourage risky lending by private investors in the future”

    Isn’t the problem with sovereign debt though that it is not black and white when debt becomes unsustainable. Arguably any level of debt is sustainable. Even 500% debt:GDP is sustainable if you roll up interest, hold out for inflation and have a debtor that’s willing to take on debt for generations.

    What Greece is doing right now is pegging the concept of sustainability with the sort of society they want. Sure they can pay back their debt if they sell €50bn of state-controlled assets and implement more austerity (that is reduce employment in the public sector, increase taxes and the tax net, reduce social welfare including pensions). For Greece and nations generally burdened with debt, they need to come to a consensus about whether the measures required will mean an acceptable society.

  4. @ Philip Lane

    ‘Accordingly, the speech usefully boils down the argument to its essence – at what point should policymakers insist on private-sector burden sharing vis-a-vis sovereign debt?’

    When it is proven economically, socially and politically undeliverable.

  5. @ All

    The speech by LBS might be seen in its correct light against the background of this recent view from Berlin of the German Minister for Finance.

    http://tinyurl.com/6527knf

    Trichet has now confirmed the limit to which the ECB would be prepared to go.

    http://www.bloomberg.com/news/2011-06-06/trichet-gives-first-signal-endorsing-bond-rollovers-to-stem-greek-crisis.html

    The entire debate hinges on the wording that will be agreed for Article 12 of the draft treaty establishing the ESM i.e. will it be confined to Article 12.1 – a general statement – as it should be or will Berlin get its way and make the fundamental error in relation to PSI which LBS identifies.

    With the announcement by all three major credit rating agencies that anything other than what Trichet outlines would be treated as a credit event, it seems to me unlikely.

    The euro is at its highest level for some time and peripheral bond spreads are falling.

  6. Jagdip:

    starting from here, is it ECB policy to demote sovereign bondholders to the benefit of bank bondholders? Where, if so, is the cost/benefit calculus to support this policy?

    LBS has never, in his innumerable effusions, addressed this question to my knowledge, nor have any of his ECB colleagues.

    Most clearly in the Irish case, this is a question that must now be addressed. If the hedgies get paid, the sovereign bondholders are at greater risk. Is the ECB happy about this?

    A case can be made for the view that losses now for bank seniors would create more trouble than a down-the-road re-scheduling risk for sovereign holders, with consequent market re-entry barriers. But where has any defender of current policy made this case?

  7. What people seem to be missing is LBS’ point that Greece continues to run an enormous fiscal deficit, it isn’t really trying to live in the real world.

    A system which would allow such countries to minimise the effects of past excesses whilst getting official support for the continuation of these excesses is surely fantasy stuff. And that seems to be what the “defaulters” (the seeming majority in these parts) regard as a reasonable ask.

    However, if Greece seriously tackled its excesses and then it transpired that it was hopelessly unable to service its debts, then we are at last resort time.

    Interesting that Morgan Kelly and LBS sing from the same humn sheet. Morgan argued that sovereign default was the ultimate anathema to be avoided at all costs. He urged an immediate elimination of the fiscal deficit in pursuit of that aim.

  8. This is a useful thread because too many people seeem to get high on bond market mechanisms while apparently ignoring the underlying problem.

    Greece is in a situation where the well-off, and unionised workers in the public sector together with beneficiaries of closed shops in the private sector, are strongly resisting change.

    There is a tax amnesty that is expected to only generate €2bn this year compared with much higher estimates of unreported income.

    The country has yet to achieve a primary surplus and the banks are exposed to a sovereign default.

    The State is reported to own 75,000 commercial properties that the IMF says could be valued at €280bn.

    The current plan is to raise €50bn from privatisations.

    In a default situation, external cash would still be required and what would be the point when the powerful groups would continue to fight to retain the status quo?

    There are no quick solutions; it took Ireland more than 25 years to end extensive tax evasion.

    However, early restructuring is not a panacea.

  9. @ Colm McCarthy,

    Mr Bini has previously given some views on who pays for bank failures.

    “Moreover, given the decentralised structure of the regulatory and supervisory systems, the impact of a banking crisis is ultimately absorbed by the national budgets. The Irish crisis shows the danger of a fragile banking system becoming interwoven with fragile public finances.

    To reduce the dependence of the euro area as a whole on local events the link between a country’s public finances and its national banking system needs to be severed. This link stems from the assumption – mistaken as we shall see – that regulation and prudential supervision must be carried out at national level because ultimately the country’s taxpayers have to bear the costs of any bank failures. ”
    http://www.ecb.europa.eu/press/key/date/2011/html/sp110311.en.html

    So we should probably dig a bit deeper and pay Ulster Bank, NIB, BOSI and KBC losses 🙂

  10. Do we not need to stand back and consider the fundamental differences between Ireland on one side and Greece and Portugal on the other? The latter have serious structural and governance problems with little potential to grow their way out of this mess; Ireland has much less severe structural and governance problems and has a much greater potential to grow its way out of the current mess. But the ECB is much more on the hook with regard to Ireland via its ‘lquidity’ – effectively indefinite funding – support for the Irish banking system than it is via its bank and bond market support in Portugal and Greece.

    This is no way seeks to understate the challenge involved in unwinding the ECB’s ‘liquidity’ support, securing adequate replacement funding and converting the state recap of the banks – borrowed from the official lenders – into a genuine investment that may be realised – thereby reducing the sovereign debt burden. Nor does it seek to understate the challenge structural and governance reform imposes.

    But these challenges are much more tractable that the structural and governance challenges confronting Greece and Portugal. That is why some ‘forbearnace’ fudge will be concocted for these two, but Ireland will be expected to soldier on.

    However, the ball of ‘unwinding liquidity support’ is in the ECB’s court – and in that of senior EZ politicians.

  11. @MH

    Privatization is not a one way street in terms of benefit to State coffers:

    The State is reported to own 75,000 commercial properties that the IMF says could be valued at €280bn…..

    Even if the Greek managed to get the full €280 billion for these assets, it loses the rental income generated by them. Or alternatively it then has to pay lease/rent for these buildings if it is currenlt the tenant.

    The same holds true for Ireland or indeed any other country.

  12. @DOCM
    re Tricket remarks on bloomburg

    While Trichet said he’s against imposing losses on creditors, he indicated he’d approve of financial institutions maintaining their level of outstanding credit. “That is not a default,” he said at an event in Montreal late yesterday. “That is something the ECB would consider appropriate.”

    This is a good opportunity for Ireland to replace the bank bonds in ILP/Anglo/INBS with 10-30 year State bonds.
    They are after all bust institutions or non banks. If Trichet says its not a default, then now is the time.

  13. @ Joseph Ryan

    Yes, it only restructures (fixes?) the balance sheet. It does not address the fiscal imbalance as the savings on debt interest will be cancelled by the loss of revenue on the assets sold.

    It emphasises that the real problem with Greece is not that it owes too much but that it is spending too much. And this is exactly what LBS is saying, to give Greece balance sheet relief is far too premature, the real priority is for it to live within its means.

  14. @ All

    eh, just saw this:

    “”The company [IL&P] will write down as much as €840 million of subordinated bonds by offering to buy back debt for 20 cents in the euro under Government plans to share losses with junior bondholders.

    The move will leave about 100 Irish credit unions nursing losses of about €20 million.

    The credit unions received the Irish Life and Permanent bonds as part of a €35 million compensation package offered by stockbroking firm Davy for earlier losses on perpetual bonds sold by the firm.

    The Irish League of Credit Unions said that it was “very disappointed” with the severity of the burden-sharing on the company’s 10-year bond. The league went to “great efforts to explain to the Government how credit unions came to be holders of this bond and that it would be most unfair if they were to face losses on this bond seeing as this bond was meant to shore up losses already suffered”, a spokeswoman said.”

    WTF?

  15. @ Hennigan

    Your joking right? Against the billions or euros that we paid out to bond holders, we’re supposed to be concerned that credit unions lose €20 million. If this is the extent of it, it shows that the scaremongering about the damage to credit unions was all nonsense.

    One also has to ask who in their right minds in the ILCU thought that ILP subdebt was the appropriate instrument to take in compensation from Davy’s.

  16. @ Karl

    i think the issue was that they were missold on the perpetual nature of the original bonds, not the “bank credit” part, so this was a suitable replacement. This method would also, in theory, have seen them regain 100% of original notional in 10yrs time, vs a hefty write down even on this settlement if they took the immediate cash offer (which some chose to do).

  17. @KW
    re Credit Unions:

    If this is the extent of it, it shows that the scaremongering about the damage to credit unions was all nonsense.

    One also has to ask who in their right minds in the ILCU thought that ILP subdebt was the appropriate instrument to take in compensation from Davy’s.

    +1

  18. @ Joseph Ryan

    What Trichet said was that he would “approve of financial institutions maintaining their level of outstanding credit”. That seems clear enough to me.

    By the way, you and others on this blog thread may be interested in the video of the meeting between the Economic and Monetary Affairs Committee of the EP and Juncker/Rehn yesterday. It was a very interesting exchange. About one hour and a half starting from the 8 p.m. point in the video. A bit tedious but highly informative and, most importantly, an indication of what is happening in the real world and especially between now and the end of June.

    http://tinyurl.com/5rjan7j

  19. Nobody seems to get it.
    Ask yourself why interest income on sovergin debt cannot be repaid at least at current values of the paper.
    Its because we have deindustrialised to the Club of Rome specifications – this has indeed improved the environment of northern Europe and America but this industry and pollution has been merely exported to China and filled 2nd world European countries and regions of America with the detritus of over consumption as global capital has been run down using the mechanism of tempory debt extraction.
    Why does the core need a synthetic agrarian periphery based on “services” to provide its banks with revenue ?
    Because its domestic industry is not dramatically wealth creating – its needs to recycle BMWs and other consumer items to the edge – relying on debt to continue this farcical dance.
    Consumption does not create wealth and in the long run cannot service exponential interest.
    However once the banking class can run faster then the other person fleeing from the Bear then they can create a feudal monetarist nest building Nirvana.
    This grossly autistic bondholder debate is becoming tiresome – its just one of the mechanisms of extraction , it is not the reason for the extraction.
    What has economics become ? a offshoot of the finance industry ?
    Finance has no skill in wealth creation – at best it is merely a utility , why must we give executive powers to persons who visualize the economy as a mere extraction mechanism propped up with nicely balanced clean balance sheets ?
    Something is very very rotten in in this cave of false choices.

  20. Speaking of ‘extraction’.

    How long till the extensive and widely geographically distributed ‘fracking’ style extraction of Gas (and the associated necessary sale of Coillte to private enterprise) is proposed as a TINA route out of austerity? Not long at all I’d imagine.

  21. @ Karl

    from the SBP…

    “”Ironically, market sources said this weekend that the bonds on which the credit unions had suffered the initial losses ultimately performed better than the IL&P bond that was designed to compensate the credit unions.”

  22. @ Karl Whelan

    You are correct; I was joking!

    The Government is correct to force losses on junior bondholders even though some private pension funds may be hit again.

    My comment was a reflection of my ennui with the common obsession that the bond issue is a proverbial silver bullet — which of course it isn’t.

  23. @ B Eoin B,

    “The move will leave about 100 Irish credit unions nursing losses of about €20 million.

    The credit unions received the Irish Life and Permanent bonds as part of a €35 million compensation package offered by stockbroking firm Davy for earlier losses on perpetual bonds sold by the firm.”

    Are the CU’s 20m losses based on the notional value of the ILP subbies or the market value when they received them? I hope the CUs are watering the magic beans Davy gave as part compensation; it’s far too early to write those off.

  24. Irish. NOW.

    ECB. Devalue. Print a few trillion.

    Deauville is a clearly visible wasteland certain for those who wait in delusion.

  25. As I understand it, once you know that some form of default is inevitable, then the sooner you restructure and provide certainty for all, the better.

    If LBS’s (and others’) concern held genuine concerns that a country must show a willingness to repay as much as possible then it should be possible to provide for repayment of the full amount subject to ability to pay while fostering recovery.

    However, LBS’s real concerns and ideologies are somewhat different.

    His position that it is never acceptable for a sovereign to default on its own debt, or to allow default on the unguaranteed debt of its banks, until the countries funding the IMF tell them it is ok to do so:

    “The only way to protect taxpayers in “virtuous” countries is to avoid over-indebted countries from easily getting away with not repaying their debts; the payment of debts should be enforced, through sanctions if need be. When countries go off track they can receive financial assistance only in exchange for strict adjustment programmes, including asset sales, which allow these countries to remain solvent. Respect for contracts is the one of the key principles underlying the market economy. It is also the basis of monetary union between sovereign countries.”

    LBS prefers involuntary default and sovereign receivership to negotiated default.

    Why?
    – Firstly, LBS appears to be another version of the Gold Standard lovers of previous times.
    – Secondly, LBS is not willing to contemplate policies that effect the rules of capitalism which allow for losses because LBS believes that is a wealth transfer and wealth transfers which are innately wrong. [This is a core point – LBS believes the rich should remain rich notwithstanding their bad investments.]
    – Thirdly, LBS considers himself to be more politically aware than politicians as to the consequences of certain actions.
    – Fourthly, LBS wants to use the crisis to force Europe closer together – he believes in the stick rather than the carrot.
    – Fifthly, LBS has been on the ECB board while the ECB has arguably acted beyond its mandate to the point where the ECB will require recapitalisation if things take the natural course of events. LBS does not want to face the consequences of the ECB’s actions.
    – Sixthly, LBS has been on the ECB board while the ECB has played a leading part in the drama that may well destroy the Euro and therby destroy the prospect of further European integration for the foreseeable future. Again, LBS does not want to face the consequences of the ECB’s actions.
    – Seventhly, LBS represetns the central bank of a country which relies on its ctizens’ private wealth for its credit rating. As such, a blow to european private wealth and private creditors could be a particularly serious blow to Italy.

    In my personal opinion as a lay man, LBS is disingenuous in his opposition to “preventative private sector involvement”. However, worse than that, he is a world class fool who is spending his time wishing things were otherwise than they are. That makes him a most dangerous man.

    @colm mccarthy
    +1 re unguaranteed debt.

  26. Also, one should note that LBS’s “virtuous” countries only become sovereign creditors because it is in their economic interest to do so in order to prevent their private sector from having to pay the legal and moral price of theri reckless investments.

  27. http://www.bbc.co.uk/news/world-us-canada-13685707

    US President Barack Obama has said the European debt crisis cannot be allowed to threaten the global economy, following White House talks with German Chancellor Angela Merkel.
    ….

    Speaking at a joint White Hosue news conference on Tuesday Mr Obama said Greece’s debt was “significant” but said the country was undertaking “difficult steps” to improve its situation.

    He said the country must make structural reforms to make its economy more competitive in attracting foreign investment.

    And he warned of an “uncontrolled spiral” if the eurozone countries were allowed to default on their debt.

  28. @ Ahura

    here’s the background to it:

    http://www.thepost.ie/story/text/ojgbqleykf/

    Seems like par amount of 54mio, taken on at a discount in 2008 with a then-market value of 35mio, although the rest of the figures don’t really add up to the 20 cents on the Euro buyback offer (ill try and see where they traded in the market in mid-2008, that’ll help the maths involved).

    However, it seems like the 20mio loss is an additional loss to some some already taken provisions. The real problem here is the sweeper clause being proposed by ILP, makes not taking up the offer a very dangerous choice.

  29. In other LBS related news, there is news that France will use its veto to prevent a reduction in the Irish interest rate unless Ireland agrees to increase corporation tax.

    http://www.irishexaminer.com/ireland/france-likely-to-use-veto-on-irish-rate-cut-157172.html

    You may recall that LBS made the suggestion that Ireland should offer to increase its corporation tax rate in exchange for a rate reduction.

    It is unclear if LBS will be unhappy with Ireland not getting a reduction as it will reduce Ireland’s capacity to repay the bailout monies.

    A corporation tax increase in exchange for a rate reduction would have been perfect from LBS’s point of view. It would have damaged our medium to long term prospects rather than our short term prospects, and the reduction in rates would have lessened the chance of a default.

  30. Apologies Phillip

    Previous should have read

    ‘Accordingly, the speech usefully boils down the argument to its essence – at what point should policymakers insist on private-sector burden sharing vis-a-vis sovereign debt?’

    When CURRENT SITUATION HAS proven economically, socially or politically undeliverable.

    Which I think it will prove to be – economically as things are.

  31. Thanks Eoin,

    The numbers in the linked article look a bit wonky. I would have expected 20% of 54million to be a bit more than the 4.6m indicated in the article.

    It looks to me that the CUs only have themselves to blame. They agreed to the compensation and chose not to sell. I’m not sure if their risk management extends much beyond not leaving the keys in the safe.

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