Non-Intersecting Sets?

Searching for politically acceptable policies is fine if the set considered intersects with market-acceptable solutions. Can the Italian bond market be stabilised without mobilising the ECB balance sheet?

The alternative instruments available are essentially a combination of support from reluctant secondary market interventions by the ECB and potentially the EFSF (including its new SPIV) and a credible Italian commitment to cutting the (small) budget deficit. The trouble is that the ECB will not commit to open-ended secondary market support, and is in any event intervening at interest rates which are too high. The EFSF is severely constrained in the short-run and the new arrangements to extend its balance sheet are stuck on the runway. Italy appears to have rejected an IMF standby (or not), and it could hardly have been big enough to matter anyway.

Early fundraising for the EFSF went reasonably well but Monday’s issue was a disaster. The spread over bunds is now outside France, Belgium next stop, has risen over 100 bps since the market debut and lenders have been unnerved by the continuing re-definitions of the status and mission of this supranational borrower. Klaus Regling’s pilgrimage to Beijing the previous week failed to secure any commitment to the new borrowing vehicle and the old one could be on negative watch before France. In any event a balance-sheet-constrained vehicle will always be tested. A bail-out fund paying large spreads with continuing uncertainty about its structure and mission, and which competes with sovereigns in the market, is in danger of itself contributing to instability.

The €350 billion required by Italy over the next year to fund roll-overs and the prospective deficit may not be forthcoming even with a credible new fiscal adjustment programme. Worthy long-term measures to raise the potential growth rate in Italy will not inspire bids at bond auctions. There may be no equilibrium rate above 6% or so.

European policy could be characterised as seeking sequentially the set of previously unthinkable measures needed to stop the rot and continually falling short. Working backwards, the bond and interbank markets could be stabilised by the following shock-and-awe package, with lots of moral hazard: 

– Hard default for Greece and for any other countries (not including Italy or Spain) which need them, calculated to make them unambiguously solvent on exit from their programmes.

– Compulsory re-capitalisation for the banks

– An ECB reverse tap in the Italian bond market

If this set of actions is politically infeasible, and if no lesser package will work at this stage, the inference is inescapable and will be drawn soon.

64 replies on “Non-Intersecting Sets?”

@Colm McCarthy

“the inference is inescapable”

I do believe those four words hit the nail on the head.

What we are witnessing isn’t economics – it is politics (particularly the politics of defending German and French interests to the detriment of all others and the USE dreams of the unelected EU ptb) and it is shaping up to be a disaster.

Margins beginning to increase on Italian bonds. Silvio ain’t the issues as the post on the excellent article by Daniel gros shows. And still we get the Bundesbank worrying about inflation….

@ Colm McCarthy

“Hard default for Greece and for any other countries (not including Italy or Spain) which need them.”

Do you think Ireland and/or Portugal need to?

Who/what do you think should decide that they do?

Searching for politically acceptable policies is fine if the set considered intersects with market-acceptable solutions.

One of these days, public opinion is going to decide that being “market-acceptable” isn’t actually very important anymore. That placating legions of cocaine fuelled, risk addicted, tantrum throwing 27 year olds is not an appropriate basis for public policy.

When that day comes, we may find that “politically acceptable” and “market acceptable” become mutually exclusive sets.

“One of these days, public opinion is going to decide that being “market-acceptable” isn’t actually very important anymore”
Public opinion decided that long ago(any poll on bailing out unsecured bank bond holders would show that comprehensively), but public opinion is not very important in these matters.

For anyone interested in the repo margin increase on Italian bonds, the spread over Germany is now about 5.7%. The basket usually trades between 0.5 and 0.7% wider than Germany, and may widen further, so 4.5% over basket would be about 5.2% over Germany.

Wht if neither Sarkosy or Merkel returns to power in 2013 – what then?

Are you foolish enough to think like a *tribe* and not take into account
what ticks the clock in Berlamount.

In German thet say; *kosta was es will* the euro is Germans pre-requisite. It will therefore take whatever it costs to bring down the spreads for Italy and the periphery.

Don’t forget there is a lot of GOLD still unutilized as one foolish leader called for a *bazooka*.

What was it Sherlock Holmes said:

“when you have eliminated the impossible, whatever remains, however improbable, must be the truth”

It seems to me that that an Irish restructuring is becoming more and more likely due to events in the rest of the Eurozone.
– Draghi says we are now facing a mild recession, and the Irish recovery is wholly contingent on international conditions
– The EFSF is finding it hard to issue bonds
– Any spare cash is likely to be thrown at Italy rather than the peripherary.

I am quite concerned to know that this likely default/restructuring will be smooth.

In the circumstances, one can only hope that the DoF has fully finalised plans for default which allow them a certain degree of flexibility in their approach. It is also to be hoped that their solution will enable them, by having a domestic solution ready, to avoid the worst conditions which the Troika/Fr/Ger will try to impose if they are allowed to have too much input.


It is clear that the EU/ECB/Fr/Ger have resisted the hard default option up to now.

They have iopted for default by increments to ensure:
(a) that reforms actually take place [under duress], and
(b) that moral hazard is avoided, and
(c) that they squeeze every drop of blood out of the stone that is the troubled nations, so that they can be seen to do right by their own nations.

These concerns will apply even if a more aggressive default is allowed.

At the same time, default by increments is on the table so there is quite a carrot for the troubled nations to play ball.

Now the crisis has escalated and previous unwillingness in Germany to allow the ECB to change gear must be called in to question. The end of their game of chicken with the peripherary is approaching and, after the G20 flop, they have just discovered that they are driving a Fiat the same as the Italians. At this stage, the only fiat worth a damn is the ECB’s fiat.

Italian 2-year yield now over 7%, Italian curve inverted from 3-10 years. 10-year yield 7.40% (closed at 6.75% last evening).

If the PIIGS get forgced out of the Euro then the euro will likely strengthen. Therefore, why would any state holding euro denominated debt seek to prevent the PIIGS from exiting the euro?

Merkozy and Juncker were playing a dangerous game when they raised the prospect of Greece leaving the Euro.

Under the Treaty there is no provision for exit from EZ.

One would need to create a treaty clause to allow exit by a member in default or whatever.

Until then all you’ve is nonsense!

Since when is a default not a ‘market acceptable’ solution?

Defaults have happened in the past and they’ll happen in the future.

Italy has a primary surplus & a large debt. Combine that with a leader with considerable negotiation skills (I might not like him but he’s a political phenomena) & bondholders might have reason to believe that their booked profits on Italian bonds might be reduced significantly.

The Italian nation could offer a deal:
forced roll-over of debt at German rates or default whereby the bondholders will suffer a haircut and wait for years for payout i.e. until a negotiated settlement has been reached.

Getting the ECB to lead the bondholders in dealing with Italy by having the ECB buying Italian bonds an masse seems to be the bondholder strategy. Luckily that is blocked for now.

@ Jesper

“The Italian nation could offer a deal:
forced roll-over of debt at German rates or default whereby the bondholders will suffer a haircut and wait for years for payout i.e. until a negotiated settlement has been reached.”

Fair enough. What happens at the bit where the ECB goes ‘but you signed your sovereign signature not to do anything like that. So if you threaten the bondholders we will entirely withdraw our support for you and your banks.’

The Irish spread against Italy has come in tremendously. Fair play to the Taoiseach. I presume this will be on the main RTE news.

Linking to yesterday’s discussions, it seems to me that Colm McC is now aligning his wives with those of Gideon Rachman.

What to do? Buy dollars?

Breaking Newz

Russian Mars space-craft goes off course ….

Seven_of_9 informs me that The Borg are not responsible; ’twas The Federation wot done it as they are very concerned about possible CONTAGION from European Earthlings – hence the FIREWALL around Earth at the mo. Dismay in Frankfurt as they were all looking forward to Breakfast on Pluto in the new year …

Good conclusion by Colm McCarthy, but excellent play by Draghi.

Strategy, –Let the Italian bonds rise until the German and French governments start to beg the ECB to intervene.

That point is very close.

70% of the Italian debt is owned by Italian nationals or Italian banks.The average maturity of the debt is 7 years.Italy is very close to balancing its budget and could be there next week.
Italy has been going from crisis to crisis most of its existence as a nation and is still one of the richest country in the world.
Italians will pull through again.

I think Colm is right…hard defaults are inevitable. The head of the IIF said today…
“The IIF has said previously that more than 90 percent of banks would take part in the deal it is brokering, but Dallara declined to be as specific, saying only that he expected «strong participation», reiterating an earlier comment.

“We will make a lot of progress in the next few weeks, but unfortunately the final offer is also dependent in part on the new three-year programmme being developed between the European Commission, the IMF and Greece,» Dallara said.”

I think you can interpret that as….we might get there, then again we may not.
In any event it is not enough…as Buiter indicated, they need at least an 85% cut to make the debt sustainable over a reasonable period.

@Gavin Kostick,

you’re highlighting the tricky part. The way I see it the ECB is in position where it has to choose between things it doesn’t like:

Bondbuying – Which is not popular with several members of the ECB
A negotiated solution (restructuring, default or whatever word people would be comfortable with).
Alternatively hope that Italy can continue to service its debts without modifications or support.

A negotiated solution might be possible to do in such a way where liquidity does not have to be cut off. Or it might not. I think it is possible but I’m also fairly sure that a few hedge-funds will try to block any and all deals.


On the ball: The Hedge Funds & a few Wall Streeters appear to have Herr Geithner, and the EZ financial/political class by the proverbial CDS balls. In such an assinine universe there is no such thing as a ‘credit event’ .. but whatever about the derivatives death star being humanely triggered – mouldy oul dynamite and nitro left too close to a volcano will eventually spontaneously combust …. getting pretty close I would say … and inevitable since the derivatives boys and gals in the financial system starting playing with themselves … as distinct from providing a useful service to the real economy and society …

Just reading: “The UK has the third largest bank excposure to Italy at $73.7bn”

Who are first, second and fourth? Germany, France and Italy (in whatever order) or some others?

@Joseph Ryan

Are you sure it was Germany and France who were begging the ECB to intervene? I had assumed that because he didn’t resign immediately yesterday that what’s been going on today was a sharp reminder to Silvio by putting the pressure on his colleagues. Get out him now or face further turmoil – you have been warned.

Whoever it was, the message obviously got through or the ECB are simply back now from their awayday and have finally switched their Blackberries/iPhones/Samsungs on. You can just picture the scene:

Mario’s PA Helga: Hello Mr Draghi. Did you have a good awayday?

Mario: Oh… just a bit or role playing with Angie, Chrissy and Nik. Anything much happening?

Helga: I don’t think so but there are 74 voicemail messages from the Italian President.

Mario: WTF?!!

Helga: Oh, and there were these three envelopes I found in your desk drawer. They’re from JCT. He says to open the first one marked ‘Italy’ today, the one marked ‘Spain’ next week and the one with ‘France’ written on it at the end of the month.

Mario: A**anculo!

Helga: Would you like a cup of tea? Ah g’wan. G’wan g’wan g’wan.

A bit of old irish for poor Greece

Mairg a threigeas a thighearna.

Woe to him who abandons his lord.

Roubini (@Nouriel) on twitter:
“Levered EFSF/SPV are turkeys that will not fly;ECB doesnt want 2 be LOLR & treaty says illegal. So only option 4 Italy is Debt Restructuring”

Thanks for that.

It has the potential to go beyond a sovereign debt crisis judging by the behaviour of very large Spanish and Italian banks on the issue of recapitalization….
Nov. 9 (Bloomberg) — Banks in Europe are undercutting regulators’ demands that they boost capital by declaring assets they hold less risky today than they were yesterday.

“Banco Santander SA, Spain’s largest lender, and Banco Bilbao Vizcaya Argentaria SA, the second-biggest, say they can go halfway to adding 13.6 billion euros ($18.8 billion) of capital by changing how they calculate risk-weightings, the probability of default lenders assign to loans, mortgages and derivatives. The practice, known as “risk-weighted asset optimization,” allows banks to boost capital ratios without cutting lending, selling assets or tapping shareholders.”

In other words…fiddle the numbers.

From Roubini
“First, the recent debt exchange deal negotiated to bail-in Greece’s private creditors was an outright rip-off for the country: The net present value (NPV) debt reduction was formally only 21% when the country needs at least 50% debt relief, based on RGE’s analysis of debt sustainability. And even that 21% headline is not a true measure of debt relief as a massive sweetener for creditors in the form of a Brady-style principal collateral guarantee will increase Greece’s gross public debt by another €30 billion. So, doing the math right and considering a likely rather than optimistic exit yield, the true debt relief for Greece out of this deal is at best close to zero or, at worst, possibly an NPV increase in its debt burden.”

I think this is important if it ever came time for Ireland to negotiate a default.
Looking at what the Greeks were able to manage wouldn’t bode well for any Irish negotiations with short sighted Eurocrats.


If I were Draghi, I would sit tight with minimum intervention.

You would be amazed how interventionist the non-interventionists can become where the floor barriers are going to break.

And I am referring to Germany and in particular Herr Schauble. He will not be sitting easy as Italy goes to 9%. He will be getting lots of calls from German banks and german industrialists worried about their exports when the euro crashes.

If Roubini feels that Italy must restructure its debt on the basis that its government debt is c.120% of GDP with its strong household savings, reasonably healthy banking sector and modest government deficit, where does that leave poor old Ireland? We have similar levels of government indebtedness but with a hugely overleveraged consumer, zombie banking system and large fiscal deficits.

The Italian situation doesn’t appear to me to be so bad. I do feel they have more of a liquidity issue than solvency. Certainly they are more solvent than Japan by most major metrics but lack Japan’s domestic savings base willing to finance the government indefinitely at low rates.


Roubini thinks it applies to us too. He tweeted a link to that September article again today as follows:

I show orderly exit from EZ with conversion of euro debts into new currency: Greece example applies to all other PIGS

@ All

In case you missed it on the Roubini thread, following is a hurriedly corrected Google Translate version of the FAZ report of the handing over of the annual report of the German Council of Economic Experts.

“Angela Merkel is sceptical about the Council of Economic Experts proposed European “debt redemption fund” pact to tackle the debt crisis in the euro-zone. The model raises a number of constitutional questions, the Chancellor said on Wednesday at the handing over of the autumn report of the Advisory Council to the Federal Government.

The economists had proposed in its annual report that the euro countries outsource their debt that goes beyond the Maastricht limit of 60 percent of their GDP into a sinking fund with joint liability. Merkel said that a number of changes to the Treaties would be necessary. Moreover, such a concept in the operative management was “not possible under any circumstances.” She maintained her negative attitude towards a common liability for the debt of the euro countries.

The head of the Council of Experts, Wolfgang Franz, said that the proposed sinking fund differs significantly from common euro government bonds (€ bonds). The Fund would be abolished in accordance with strict guidelines to reduce debt in 20 to 25 years itself.

The economist Beatrice Weder the Mauro pointed out that the backing of gold reserves in the sinking fund had nothing to do with the discussion at the G20 summit in Cannes of a proposal to use foreign reserves to strengthen the current euro rescue fund EFSF. The idea of ​​the fund related to something else: “These are individual debt instruments. They are backed by their own security, “said Weder di Mauro. [Comment: In short, joint and not several and joint responsibility for participating countries]

The wise-men contradicted the assessment of the Chancellor that the proposal is legally vulnerable. The debt settlement pact could withstand a review by the Federal Constitutional Court, says the report.

Germany’s Economics Minister Philipp Roesler said the euro zone would be quickly converted into a stable union with stricter rules. Debt should not be collectivised but said the FDP leader. The proposals of the Coalition for an easier immigration of foreign skilled workers and more tax equity would enhance growth. [Comment: A bit late in the day to discover this!]

The wise-men expected 2012 only an economic increase of 0.9 percent to 3 percent this year. In a further tightening of the debt and banking crisis, the experts warn of disastrous consequences for the world economy: “In case of stagnation of world trade, Germany would fall into a recession.”

Interesting times!


Jurgen Habermas in May 2010

In our day, the German elites are enjoying the return to normality as a nation-state. The morally defeated nation that was once compelled to self-criticism is no longer anxious to speed up the quest for its place in the post-national configuration. In a globalised world, everyone has to learn to incorporate others’ points-of-view into his own. One political symptom of our dwindling willingness to learn that lesson is the German Constitutional Court’s verdicts on the Maastricht and Lisbon treaties, rulings that cling to dogmatic and outmoded legal conceptions of sovereignty. The solipsistic and normatively depleted mindset of this self-absorbed colossus in the middle of Europe can no longer even guarantee that the European Union will be preserved in its wavering status quo.

Accompanying CARTOON by Joep Bertrams highly relevant to TODAY.

A bit off topic but in some sense relevant…

An article in the IT states that AIB refuses to go along with the Government and reduce the variable rate on mortgages.

Does anyone find it odd that a 98% shareholder in a company cannot have its policies followed by its appointed Board of Directors.

All for one and one for all???

“German chancellor Angela Merkel has said the proposed referendum in Greece last week showed that domestic policies in one country now impact on the entire euro zone.

“What we got in Cannes [where the European Summit was held] was the feeling that there is no such thing any more as domestic policy making,” Dr Merkel was cited as saying in an interview today.

“Domestic is what’s inside the currency area. Greece can no longer decide all by itself the issue of whether it should hold a referendum or not.”

So what do we need 160 guys in Kildare street for if there is no such thing a domestic policy making.

“In Sarkozy’s vision, the euro zone would rapidly deepen its integration, including in sensitive areas such as corporate and personal taxation, while the remainder of the EU would be left as a “confederation,” possibly expanding from 27 to 35 in the coming decade, with enlargement to the Balkans and beyond.

Within the euro zone, the critical need would be for core countries to coordinate their economic policies quickly so that defences could be erected against the sovereign debt crisis.”

Maybe PR Guy can translate 😀

Might be a worth a new thread, but Wynne Godley’s prophetic 1992 essay “Maastricht and All That”, is being passed around Gavyn Davies at the FT, John Cassidy at the New Yorker, and others. Scary words for the situation of all the PIIGS countries:

“If a country or region has no power to devalue, and if it is not the beneficiary of a system of fiscal equalisation, then there is nothing to stop it suffering a process of cumulative and terminal decline leading, in the end, to emigration as the only alternative to poverty or starvation. I sympathise with the position of those (like Margaret Thatcher) who, faced with the loss of sovereignty, wish to get off the EMU train altogether. I also sympathise with those who seek integration under the jurisdiction of some kind of federal constitution with a federal budget very much larger than that of the Community budget. What I find totally baffling is the position of those who are aiming for economic and monetary union without the creation of new political institutions (apart from a new central bank), and who raise their hands in horror at the words ‘federal’ or ‘federalism’. This is the position currently adopted by the Government and by most of those who take part in the public discussion.”


That is an extraordinary quotation that you attribute to Merkel

“Domestic is what’s inside the currency area. Greece can no longer decide all by itself the issue of whether it should hold a referendum or not.”

What is the source?

I wonder if she would be prepared to reissue the quote as follows:

“Domestic is what’s inside the currency area. Germany or Greece can no longer decide all by themselves the issue of whether they should hold a referendums or not.”


“A bit off topic but in some sense relevant…An article in the IT states that AIB refuses to go along with the Government and reduce the variable rate on mortgages.Does anyone find it odd that a 98% shareholder in a company cannot have its policies followed by its appointed Board of Directors. ”

I think it says it all when a bank (owned by the people) feels absolutely free to raise a punitive ‘tax’ on its clients, with no end in view except hastening its return to the mad free market), but the actual democratically government lacks the courage to raise legitmate taxes from its own citizens, in order to redistibute the pain of a banker generated crisis.


The cost of the debt for most struggling to meet mortgage repayments is not the critical issue its the absolute size of the debt. I appreciate that this is somewhat obvious but the media’s insistence on talking about the increase in the average monthly mortgage repayments on rate increase announcement days to me is always very telling.

It tells me that the general media still don’t just get it. The recent average savings of c€50 per month on a rate reduction for the average tracker mortgage holder is not going to make one iota of a difference for the vast majority of struggling folk. The uncomfortable truth is that the c€1,500 average repayment is not manageable – the €50 or €60 saving per month is light years away from making any appreciable difference.

I accept that the AIB stance is equivalent to giving the two fingers to the Govt and the Regulator but one wonders what the public interest Directors are saying internally at the AIB Board or are they simply going through the motions and happy to collect the fee.

@Yields or Bust

I have watched at close quarters where honest ESOP directors have been conned iinto thinking they had a moral duty to behave like asset strippers, so I was never surprised that ‘public interest dorectors’ (at least one of whom was a professional lobbyist) went native so quickly.


Source I think was live blog at Telegraph.

Extraordinary all right. No pretense any more.


There is no such animal as a ‘public interest director’ in Irish company law. They are simply political appointments, of safe bland conservative pairs of hands, to non-executive director positions on certain boards of directors.

The primary responsibility, in extant law, of such non-executive directors is to the well-being of the company on whose board it sits. Period.

The illusion of ‘public interest’ is just that; an illusion – a smokescreen.

Funny, this is probably the last place on earth where I would have expected someone to quote J. Habermas. – Just kidding –

Funny to see a seasoned economist speak out what I, a economy hobbyist, describe since 1,5 years as ‘The Incrementalists’, who ruin entire economies and endanger the very fabric of civilization with their god damn gradualism.

The biggest sinners of all, Angela Merkel. How dare this woman with a DDR PhD in Physics, and a Honecker history in ‘Propaganda and Agitation’ focussed on the youth, to come out with statements such as The peace in Europe should not be taken for granted! followed by a phletora of blah blah Franco-German centric views on this currency, the Euro, that is worshiped by some to the extend of fanaticism.

How dare these people to call the ghosts of war to emphasize their Gradualism as, what else, the one and only possible solution?

P.S. I can not give you a link to that particular Merkel quote, but can tell you that this is exactly what she said in her speech to the german parliament before they voted on the EFSF. I watched it live on the Internet.

@Joseph Ryan

“Domestic is what’s inside the currency area. Germany or Greece can no longer decide all by themselves the issue of whether they should hold a referendums or not.”

That is indeed a shocking statement. The quote is from an interview Merkel did with Deutsche Presse-Agentur, which can be found here

Merkel follows up with this

‘This decision had ramifications for all of us because the dependability of decisions taken by the 17 was suddenly endangered. All the other 16 were just as affected by this referendum decision.’

Now I always viewed the Greek referendum as just a self-preservation political manoeuvre by Papandreou, however the general principle to be able to hold a referendum on pertinent issues is very important, and it is the principle that Merkel attacks here, saying that EU17 “decisions” cannot be “endangered”. She then goes on to argue for treaty change that would in Ireland require a referendum.

If there is to be a two-track Europe, it is time for Ireland to join the UK, Denmark, Sweden etc on the outer track, and leave the inner track to narrow-minded incompetent authoritarians like Merkel.

@ DoD

“They are simply political appointments, of safe bland conservative pairs of hands, to non-executive director positions on certain boards of directors.”

Not even safe in many cases . Many are incompetent. Survey the post Holocaust Irish financial sector.
And they only leave after the damage is done

Speaking today, Alan Cook said that the appointment was part of the Group’s ongoing process of Board refreshment


Corporate Governance on Boards of Directors in Irish Financial & Semi-state or Quango is essentially a ‘Game of Pass the Insider’ [including well connected insiders from academia] – and it is systemic and has not changed one whit since Sept 2008. This represents one of the most serious institutional impediments to recovery …

At least four board members of BoI presently in situ were in situ pre-2008 – to take just one example – and I could go on … and I’ve done of bit of work in this area in an earlier life. How Ms Spectacles was allowed to survive after a multi-Billion three card trick with Shawn_ee I’ll never know – but maybe someone knew too much or significant others knew who knew etc … FG, via Minister Richard Bruton, promised that members of all state boards would be requested to resign within 6 months – nothing happens – bit of fiddling at the edges. Not a single senior executive manager in the financial sector has been fired – where dodgy_cubed becomes embarassing – big silent pay off facilitated by the LegalEagles is the usual end.

All this is incredibly damaging to real hard working boards in the real economy.

@Georg R. Baumann

This is simply what I observe.

Corporate Gov in Finance and State pre crash = Corportate Gov in Finance and State now StatSig**********************************

No significant change. Incredible!

@Brian G

“She then goes on to argue for treaty change that would in Ireland require a referendum. ”

There’s always the possibility she’s assuming Ireland won’t be in the Eurozone by the time these treaty changes come around… I heard the word ‘pruning’ of the EZ the other day.

D o’D on the mark indeed! The culture of the insider in practice.

And on the Merkel thing….anything but democracy!

Comments are closed.