Sovereign finance


Note: for work on Banking Union and bank restructuring, see financial sector

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June 2015: Comment on the wisdom of taking the Greek banks and their mostly small depositors hostages in the escalating fiscal dispute between Berlin, Madrid (mind the Spanish elections in late 2015) and Athens (German). With the help of a little bit of game theory you will understand that rising ECB lending to Greek banks that result from the politically caused bank run is undermining, rather than helping, fiscal hardliners positions. In February or March 2015 it would have been still easy to stop the Greek bank run with open mouth policies. Clear political statements would have confirmed the obvious, namely that Europe since late 2014 with the start of the SSM, the proposal for the SRM and the formulation of the Bank Resolution and Recovery Directive BRRD has a more or less complete, while still implicit, system of deposit insurance. This implies that those very Greek deposits under EUR 100K are protected, just as next door in Bulgaria and Cyprus they were in previous crises, when the banks failed and governments were unable to protect depositors and the Eurozone or the European Union helped out. The Bulgaria case shows that the protection promise holds even in the Grexit case. Moreover, unlike in Cyprus, there are no bail-inable funds left in Greek banks to pay back the ECB. So it is better in the self interest of fiscal hardliners to stop the Greek bank run, reduce their potential exposure from bank deposit rescue operations, thus improve their negotiation position and focus on the fiscal policy items on the agenda. 

May 2015: Comment on the Bund rout(German), i.e. the tension created by a combination of overvaluation via ECBs QE and the lack of liquidity at such price levels. Nobody in Europe can afford rates to shoot up a la Japan 2003 to reach market equlibrium, so expect the bond market weather to remain stormy.

April 2015: Interest rate comment for Dr Klein, the leading German corporate housing finance broker, called 'capital markets on steroids' paraphrasing the effects of ECB quantitative easing (German, p. 10).

September 2014: interest rate comment (Deutsch) for Hypoport AG. Hypoport, the Berlin SDAX firm where I have my office, is dominating corporate housing finance brokerage in Germany and the largest B2B broker (fee originators 2 banks/insurers) for retail housing finance in Europe.

July 2014: Short comment (in German) on the decision to make ESM funds retroactively available for bank recapitalization in 'individual cases'. Clearly, the motive is to make room for compensatatory interventions, e.g. benefiting Ireland for the rude disruption of the country's sovereignty in October 2010, when a coalition of politicians from countries with large investors in Anglo Irish Bank senior unsecured debt forced the Irish sovereign to absorb their losses. Is there no better way to solve this de-facto bilateral issue than to change the rules of the ESM and open the ESM up for abuses in other cases? See also the 8 banks 8 countries bank restructuring study covering Anglo Irish Bank. Compare the armtwisting of Ireland with the complete neglect of the Danish decision, also in October 2010, to bail in senior unsecured investors in the case of Amagerbanken.

October 2013: Comment on the Olivier Blanchard's of this world who demand higher inflation rates and decide to ignore their credit implications and feedback loops. Nominal debt restructuring can't be avoided since real debt reduction through inflation only works in a predominantly long-term fixed rate capital market environment. Fixed rate contracts dominated markets indeed when the world entered the high-inflation phase of the 1970s after decades of low inflation and tight financial regulation. Today, the most vulnerable consumer, corporate and sovereign balance sheets are funded by variable rate lending, with the United States which still enjoys a global borrowing privilege probably being the only exception of relevance in both sovereign and mortgage finance. The dominance of floating rates in today's world implies that borrowing cost will jump immediately as investors will try to avoid being taxed through higher inflation levels. Where Blanchard therefore ends up with his argumentation is not an implicit, but rather an explicit expropriation strategy as in order to make his proposal work he needs to hold in particular short-term rates permanently artificially low. 

February 2013: Moodys belatedly decided to perform a U-turn on its sovereign rating methodology and to start downgrading sovereigns that try to socialize debt through inflation rather than actively reducing it. I had argued in my January 2012 handelsblatt article, english version, in the context of S&Ps decision on France that the rating agencies so far held view that sovereigns should be given credit for being able to inflate debt away was de-facto selecting macroeconomic strategies, rather than evaluating their impact on investors. 

What we are seeing currently seems to be nothing less than the beginning of a tectonic shift in rating agency methodology, which in the past had always rejected to consider market risk as what it is: a stealth variant of credit risk. In a low-growth environment the message to policy makers is clear: hard debt restructuring decisions can't be avoided, and it doesn't matter much in that regard whether your country is inside or outside a currency union.

August 2012: Keith Mullin at IFR Thompson has picked up the amortizing bond proposal here and here, as Ireland has announced amortizing bond issues to fund her National Treasury Management Agency. Also, Chris Whalen has covered the issue in his Institutional Risk Analytics newsletter in August.

Starting to get tired of Eurozone proposals? Here is another one, addressing incentive problems of the European Redemption Fund (ERF) proposal by the Sachverstaendigenrat. In this I call for scheduled amortization for all government debt issued in the Eurozone, which is the standard practice in finance for other debt funding long-term investment, for instance mortgages. Obviously those that think that governments do not die and debt should be perpetual will not like it. Please read it together with my proposal for a catastrophic / tail risk eurozone bond insurance scheme run by the ESM, which clearly should impose limits on bond instruments covered. One of the issues I see with the ERF as proposed is a distorted pricing structure, with absolutely no incentive for high-debt beneficiaries to amortize other than Eurozone-imposed law. Or would you voluntarily amortize your cheapest loan? Good luck with enforcing that.

January 2012: Handelsblatt comment on the rating agencies' sovereign credit rating approach that systematically ignores inflation and devaluation risk for investors, hence creates a policy bias against low-inflation currency zones. deutsch as published, and slightly longer english version.

An indirect exchange in Handelsblatt with Allianz SE on EFSF partial sovereign bond insurance: my suggestion to focus on a catastrophic loss instead of
first loss insurance here, reaction by Allianz followed a week later.

August 2011: CEPS paper in which I call for a Eurozone partial sovereign bond insurance scheme instead of blue ('Euro') bonds. Partial bond insurance builds on principles already agreed on during recent rescue operations, such as catastrophic risk protection for investors, while reducing the moral hazard contained in the full insurance provided by blue bonds. It strikes a compromise between moderating fiscal cost for net guarantee sponsors and reducing marginal cost of funds for net guarantee beneficiaries to economically sustainable levels. The EU Commission btw dubbed my proposal 'purple' bonds.

March 2010 Comment on the reasons for Germany's ambiguity in dealing with the Greek debt problem.

February 2010: This was the birthday of the PIGS debate... FT Alphaville Blog entry on German bank exposure in sovereign credit in what shortly afterwards were called PIGS countries. A few days later Barclays Capital responded with a grand tableau of covered bond issuer exposures in these countries. German and other public covered bond issuers had effectively since the liberalization of the Luxemburg covered bond law in 1998 played the role of bond insurers for peripheral sovereigns, subsove-reigns and public corporations.