A safe asset for Eurozone QE: A proposal
Luis Garicano, Lucrezia Reichlin 14 November 2014
The ECB seems to be edging towards QE, but faces a quandary on what to buy. This proposal suggests that the ECB buy ‘Safe Market Bonds’. These would be synthetic bonds formed by the senior tranches of EZ national bonds combined in GDP-weighted proportions. The ECB would merely announce the features of the synthetic bonds it will purchase. The market would create the bonds in response to this announcement, thus avoiding new EZ-level institutions or funds.
As Europe moves closer to deflation, the ECB is gradually inching towards outright quantitative easing (QE) – increasing the monetary base through purchases of government bonds (Draghi 2014). But undertaking such purchases confronts a problem. There is no Eurozone ‘government bond’ to purchase. Were the ECB to purchase the debt of all member countries, it would end up with a large amount of debt on its balance sheet, making it impossible for a country to default without triggering very large redistribution.
Macroeconomic policy Monetary policy
Eurozone QE, Safe Market Bonds, ECB, quantitative easing, unconventional monetary policy, diabolic loop, doom loop, sovereign debt, safe assets, savings glut, risk weights, bank capital
Linking banking crises and sovereign defaults in emerging markets
Irina Balteanu, Aitor Erce 12 November 2014
The feedback loop between banking crises and sovereign debt crises has been at the heart of recent problems in the Eurozone. This column presents stylised facts on the mechanisms through which banking and sovereign crises combine and become ‘twin’ crises. The results point to systematic differences not only between ‘single’ and ‘twin’ crises, but also between different types of ‘twin’ episodes. The timing of ‘twin’ crises – which crisis comes first – is important for understanding their drivers, transmission channels, and economic consequences.
The feedback loop between fiscal and financial instability has been at the core of the recent turmoil in Europe (Acharya et al. 2014). In some countries, systemic banking crises triggered fiscal distress due to the magnitude of bank rescue operations (for example, in Ireland). In others, substantial sovereign debt tensions, leading to successive sovereign downgrades, severely weakened domestic financial systems (for example, in Greece).
Financial markets International finance Macroeconomic policy
twin crises, debt, sovereign debt, sovereign default, banking crises, financial crisis, doom loop, Eurozone crisis, emerging markets
A 100-year perspective on sovereign debt composition in 13 advanced economies
S. M. Ali Abbas, Laura Blattner, Mark De Broeck, Asmaa El-Ganainy, Malin Hu 27 October 2014
There has been renewed interest in sovereign debt since the Global Crisis, but relatively little attention has been paid to its composition. Sovereign debt can differ in terms of the currency it is denominated in, its maturity, its marketability, and who holds it – and these characteristics matter for debt sustainability. This column presents evidence from a new dataset on the composition of sovereign debt over the past century in 13 advanced economies.
Why sovereign debt composition matters
Academic, policy, and market interest in sovereign debt has spiked since the 2008 Global Crisis. Researchers have sought to place the post-Crisis synchronised build-up in sovereign debt ratios in advanced economies within a longer-term/historical context, drawing comparisons with debt surges during the Great Depression, debt consolidations in the aftermath of World War II, and more.1
Economic history Financial markets Macroeconomic policy
sovereign debt, global crisis, original sin, debt maturity, currency risk, financial repression, debt sustainability
Sovereign-debt relief and its aftermath: The 1930s, the 1990s, the future?
Carmen M Reinhart, Christoph Trebesch 21 October 2014
To work towards resolving Europe’s ongoing debt crisis this column looks to the past. From the recent emerging market debt crisis (1980s-2000s) and the interwar episode of the 1920s-1930s we learn that debt write-downs and defaults are able to be postponed but not prevented. Punishment for default is temporary, sometimes followed by a renewed surge in borrowing that leads to another crisis.
Since 2008 Europe has been mired in a combination of economic depression, financial crisis, and public and private debt overhangs. Greece was the first advanced economy to restructure its debt in more than a generation, and the ongoing depression in Europe’s periphery has already surpassed the economic collapse of the 1930s by some markers. In most advanced economies record private debt overhangs are unwinding only slowly, while the steady upward march in public debts continues largely unabated.
Economic history Financial markets International finance
sovereign debt, crises, restructuring, sovereign debt crisis
Structural reform lowers country risk
Christopher Findlay, Silvia Sorescu, Camilo Umana Dajud 29 August 2014
Countries facing rising risk premiums on their debt have recognised the need for structural reform, but some politicians have argued that austerity is necessary in the short run because structural reform takes too long. This column argues that financial markets can bring forward the benefits of structural reform, and therefore that such reforms should be given greater weight in the package of crisis responses.
In late 2008, financial stress became widespread and perceptions of risk hit new highs. Concerns related to contagion among countries also had an increasing effect on premiums and increased the financing cost for many economies. The response to this problem was austerity – to stress the importance of getting the fiscal situation, and thereby the levels of debt of those countries with this problem, under control.
structural reforms, risk premiums, Credit Default Swaps, sovereign debt
It takes more than two to tango: Cry, but not for Argentina, nor for the holdouts
Jeffrey Frankel 22 July 2014
The US court ruling forcing Argentina to pay its hold-out creditors has big implications. This column argues that some of them are particularly worrying. The court ruling undermines the possibility of negotiated re-structuring of unsustainable debt burdens in future crises. In the future, it will not be not enough for the debtor and 92% of creditors to reach an agreement, if holdouts and a New York judge can block it. This will make both debtors and creditors worse-off.
US federal courts have ruled that Argentina is prohibited from making payments to fulfil 2005 and 2010 agreements with its creditors to restructure its debt, so long as it is not also paying the few creditors that have all along been holdouts from those agreements. The judgment is likely to stick because the judge (Thomas Griesa, in New York) told American banks on 27 June that it would be illegal for them to transfer Argentina’s payments to the 92% of creditors who agreed to be restructured, and because the US Supreme Court in June declined to review the lower court rulings.
Development Global governance
US, sovereign debt, Argentina
Banks, government bonds, and default: What do the data say?
Nicola Gennaioli, Alberto Martin, Stefano Rossi 19 July 2014
There is growing concern – but little systematic evidence – about the relationship between sovereign default and banking crises. This column documents the link between public default, bank bondholdings, and bank loans. Banks hold many public bonds in normal times (on average 9% of their assets), particularly in less financially developed countries. During sovereign defaults, banks increase their exposure to public bonds – especially large banks, and when expected bond returns are high. At the bank level, bondholdings correlate negatively with subsequent lending during sovereign defaults.
Recent events in Europe have illustrated how government defaults can jeopardise domestic bank stability. Growing concerns of public insolvency since 2010 caused great stress in the European banking sector, which was loaded with Euro-area debt (Andritzky 2012). Problems were particularly severe for banks in troubled countries, which entered the crisis holding a sizeable share of their assets in their governments’ bonds – roughly 5% in Portugal and Spain, 7% in Italy, and 16% in Greece (2010 EU Stress Test).
sovereign debt, financial crises, banking, banks, bonds, sovereign default, credit, bank lending, risk-weighting
Saving the euro: self-fulfilling crisis and the ‘Draghi put’
Marcus Miller, Lei Zhang 26 June 2014
Like banks, indebted governments can be vulnerable to self-fulfilling financial crises. This column applies this insight to the Eurozone sovereign debt crisis, and explains why the ECB’s Outright Monetary Transactions policy reduced sovereign bond spreads in the Eurozone.
In surveying eight centuries of financial folly, Reinhart and Rogoff (2009) observed that:
International finance Monetary policy
ECB, eurozone, sovereign debt, financial crises, sovereign debt crisis, Outright Monetary Transactions, European sovereign debt crisis, self-fulfilling crises
Privatisation and debt: Lessons from Greece’s fiasco
Paolo Manasse 31 January 2014
Sales of state-owned assets have been proposed as a way for highly-indebted countries to ease the pain of fiscal consolidation. This column argues that, despite the potential merits of privatisation in terms of long-run efficiency, in practice it is unlikely to improve short-run fiscal solvency. Since governments rarely alienate control rights, the efficiency gains from privatisations are often small. Moreover, financial markets may not fully reflect these gains – particularly during a financial crisis. The implication is that the Troika policy of linking financial assistance to privatisations is inappropriate and self-defeating.
In the midst of the European debt crisis, it is tempting to think that high-debt countries could alleviate the recessionary impact of the budget-consolidation process by selling (poorly managed) assets and stakes in their state-owned enterprises (SOEs), and by using the proceeds to buy back their debts (Hope 2011). In addition to providing a cushion for ongoing adjustment programmes and improving solvency, privatisations are deemed to entail long-term efficiency and welfare gains by attracting foreign direct investment and managerial expertise, thus spurring competition and growth.
Financial markets International finance
sovereign debt, privatisation, debt, Greece, European sovereign debt crisis