Sovereign debt bubble thread

[Zanza]

Okay, so "unfired" means that you fire it once to show you mean it. Gotcha.

And let's assume investors believe the ECB will do so again if necessary and don't ask for higher risk premiums for certain countries. Would not the effect be that the interest spread narrows to zero, as all countries are presumed to be equally risky now? Wasn't that presumption one of the reasons that allowed Greece to build such a mountain of debt in the first place?
To me, that market distortion takes away one of the incentives for fiscal prudency, namely the risk of higher interest rates.

That leaves the last party to the sovereign debt crisis, our Eurozone governments. Which have a terrible track record at doing painful structural reforms when it is much easier to buy off voters with easy money. How would the ECB enforce compliance when the governments know fully well that they will get bailed out in the name of the greater Euro well-being if necessary? Or if the ECB would publicly say that it doesn't cover a certain country anymore, wouldn't we see an immediate implosion of that country as it would immediately lose the ability to borrow from anyone? I mean who would still lend money to say Portugal if the ECB publicly declares that it considers Portugal hopeless because of non-compliance? That's a nuclear weapon, not something they can actually use.
You seem to have much more faith in our governments than I do.

And your caveat that certain areas need subsidies for a while is contradicted by the history of other federations such as Belgium, Germany, the USA and I assume Canada, where it has been the same states that pay and the same states that receive money for decades without any incentive for the receivers to ever change. I don't see how the cost of that would have been lower. It would have been perpetual and high.

[The Minsky Moment]

I am not sure what that means. Care to explain? I am not even sure whether you would have fired at public or private debt with that bazooka. Or both.

Greek debt was only 300 billion euro as late as 2010.  That is a small fraction of Eurozone GDP.

So in 2010, let's say the Eurzone puts up a rescue fund, that buys out all outstanding debt at 90%, writes off 150, and then sells back 120B with a long-term fixed rate of 10-20bp over bunds.  In return Greece agrees that until the 120 is paid back it shall not exceed a balanced budget -- exclusive of interest -- without approval from the Eurozone.  Problem solved.

Private debt has never been the concern with Greece.  Private debt/GDP ratios are lower than: Denmark, France, Austria, Germany, Netherlands, Sweden and the UK, among others.

[Zanza]

Greek debt was only 300 billion euro as late as 2010.  That is a small fraction of Eurozone GDP.

So in 2010, let's say the Eurzone puts up a rescue fund, that buys out all outstanding debt at 90%, writes off 150, and then sells back 120B with a long-term fixed rate of 10-20bp over bunds.

Okay.

In return Greece agrees that until the 120 is paid back it shall not exceed a balanced budget -- exclusive of interest -- without approval from the Eurozone.  Problem solved.

And how would they have balanced their 10+% primary deficit? Without painful austerity of the kind we see now which is considered a German diktat and shrinks their economy making the debt crisis worse?
And why would they do that in the first place? Once their debt is reduced, why would they not exceed their budget balance again? After all, they are credit-worthy again and as a sovereign state, the EU has no means to stop them.

Private debt has never been the concern with Greece.  Private debt/GDP ratios are lower than: Denmark, France, Austria, Germany, Netherlands, Sweden and the UK, among others.

Okay, so your bazooka would only have solved the Greek part of the Eurozone crisis?

[The Minsky Moment]

And how would they have balanced their 10+% primary deficit?

Even with the half-ass plan in place, the primary deficit shrunk to under 3 percent by 2011.  If one assumes reasonable positive knock-on effects from solving the debt problem in '10, it isn't hard to imagine a position of near primary balance.

Once their debt is reduced, why would they not exceed their budget balance again?

The reorganized debt could include a priority clause over all new issue debt, and a blow-up clause, that if Greece exceeds certain triggers without E-Zone permission, penalties would apply.

Of course, no solution to the Greek public debt problem short of exit from the Euro can possible succeed long run without addressing the current account/competitiveness problem.  That was always the tricky part.

Okay, so your bazooka would only have solved the Greek part of the Eurozone crisis?

The first shot would have solved that problem.  You can always reload.

[citizen k]

Forget The "Bazookas": Here Come The "Tomahawks" And "Howitzers" - An R-Rated Walk Thru The Greek Endgame

We have already provided much cold, hard, clinical facts on the hypothetical Greek EMU exit on countless occasions before. Yet Jefferies' David Zervos has done it with such peculiar aplomb which we have not encountered before, that we felt compelled to share with it readers. Zervos' Paulsonesque 'apocalyptic' flair shines particularly when analyzing what happens at T-0, i.e., June 16, i.e., the day before Greek election day, i.e., the last Greek free call option on physical euros if all hell breaks loose: "On June 16th why wouldn't every Greek go to the bank with a sack and ask for the cash. Why hold Euros into the 17th? By that logic why not get them out earlier in case they shut the ELA pre-election. From the north's perspective, one could argue that Merkel should shut the ELA right now. Allowing the Greek people to access all their Euros physically, while still holding the option to default on June 17th, is insane. She and the ECB would NOT be acting in the best interest of the Eurozone if they let this happen - there would be 300b in Target2 losses to split up between 16 member NCBs if the Greeks choose to leave after taking out all the Euros." So where does the chaos from a Greek bank run and exit lead us, as Zervos puts it. "The end is of course ECB printing, Eurobonds and every developed market central bank dumping massive liquidity into the global financial markets as systemic risks rise - QE, LTROs, Currency swaps, and every funding facility under the sun come into play. The path to this end game will be bumpy, but make no mistake, the developed market central banks will dump so much fiat on the system to cover the losses, that risk free real rates will plummet to levels so negative that anyone left holding cash or cash equivalents will see massive destruction of real wealth. We may have to push risk assets a bit lower from here, but the global central banks will be firing howitzers and tomahawks very shortly, not bazookas! And you best be owning some risk when those bad boys are launched!!"

Of course, owning fiat-based assets in a system that is about to be drowned in what effectively amounts to infinitely more fiat, makes one wonder: what will be the point owning risk if the "currency" in which risk is denominated becomes meaningless virtually overnight?

Which is why we are happy to paraphrase Zervos: "And you best be owning some hard, real assets when those bad boys are launched."

Extracted from Jefferies' David Zervos: No ELA, No Euros! The End!

So lets "run" through the mechanics of a Greek bank run. As the Greek people begin to smell a Greek exit and a conversion of their hard earned Euro deposits back to Drachmas, they will withdraw Euros from Greek banks. So the Greek banks will head to the BoG with some dubious collateral to beg for Euros to pay depositors. The BoG takes the collateral, gives it a minuscule haircut, and draws Euros via the ELA. This of course creates an increase in BoG Target2 liabilities. The BoG then sends the Euros to the Greek bank and the Greek bank then gives the Euros to the hard working Greek depositor standing in line waiting to empty the account.

Importantly, Greek banks ONLY run out of Euros if the ECB can justify a shut down in funding to the BoG ELA facility or the Greek banks directly. Now, as we heard last week, the ECB has already stopped OMOs with 4 Greek banks (which one could safely assume are the big ones). So the ONLY thing standing between a Greek depositor and his/her Euros is the ELA. No ELA, no Euros!! And, as mentioned above, the ECB has once before threatened to turn off NCB access to Euros via the ELA in the case of Ireland. So there is a precedent for this to happen again!

Now we have to look at the conditions under which the ELA could be turned off by the ECB. Looking back to the Irish case, it was the potential for a default on senior bank debt that triggered the ECB threats to the central bank of Ireland. As the rules stand, ELA lending can only be done to "sound" institutions. So the ECB in theory can shut down all lending, including ELA, if the NCB is failing to abide by the rules. And clearly, Irish banks that default on senior debt are easily proven NOT sound!

In the case of Greece, in the middle of a bank run, will it be hard to prove that banks are not sound? Hardly! But more importantly, the soundness of the Greek banks is 100 percent dependent on the 65b Euro capital injection coming as a part of the previous government's agreement to the MoU (Memorandum of Understanding, or what Tsipras calls the Memorandum of Barbarity).

That 65b is the ONLY reason why Greek banks have a chance of being deemed sound. Without the 65b, there is no way anyone could claim the BoG is lending to sound institutions and there is no way the ECB could continue to authorize the BoG to lend under ELA.

And that takes us squarely to Mr Tsipras, SYRIZA, the MoU/MoB and the Greek election. It will be very easy for Merkel and company up north to lay out a case for an ELA shut down for the BoG if the MoU is discarded by the Greek voters via a win for Tsipras! In a sense, Merkel's phone call on Friday to the Greek president was just that. It was actually the same call that was made to the Irish president a while back - and of course the Irish balked, caving to the German demands. At that time however there wasn't an Irish presidential vote. This time, with Greece, Merkel's message is really to the Greek people. And what is that message exactly? Vote for Tsipras and I turn off the Euros. Or, in other words, choosing Tsipras means choosing to leave the Eurozone. Of course, Greece could vote for Tsipras, discard the MoU, repudiate the dni8ceebt (including Target2 debts), still use the Euro and stay in the EU - but they would become Montenegro! The chances of that however are zero. The Greeks will want to print and control their destiny if they get cut off. No ELA will almost surely bring back the Drachma. And doing so would, in Merkel's view, be the choice of the Greek people. At least that's how it will be sold to the rest of Europe.

The problem for Merkel is that the Greeks will understand this and run the banks BEFORE June 17th - it is happening right now. On June 16th why wouldn't every Greek go to the bank with a sack and ask for the cash. Why hold Euros into the 17th? By that logic why not get them out earlier in case they shut the ELA pre-election. From the north's perspective, one could argue that Merkel should shut the ELA right now. Allowing the Greek people to access all their Euros physically, while still holding the option to default on June 17th, is insane. She and the ECB would NOT be acting in the best interest of the Eurozone if they let this happen - there would be 300b in Target2 losses to split up between 16 member NCBs if the Greeks choose to leave after taking out all the Euros. If she gives the directive to shut off the ELA early she will at least keep the Target2 losses to 150b. And she will be telling the Greek people that if they vote for Tsipras, their Euros in the bank will not be available. This is a dangerous game for sure! But this way she can also blame the Greek voters for an exit, and hide behind ECB rules that imply access to funding can only be done to sound institutions. With this strategy she can have the Greeks decide on the 17th to keep the MoU, get the 65b and have access to their 150b Euros OR abandon the MoU, watch their Euros turn to Drachmas and leave the Eurozone. She didn't kick them out, they chose to leave!! Of course the few weeks leading up to the election with ELA turned off and a multi week Greek bank holiday would make for some crazy headlines.

As I said in Friday's piece, deciding what to do with the ELA for the BoG as we head into the Greek election "is the most important decision in the history of EMU". By turning it off, Merkel might scare the Greek people into complying, as she did with the Irish. By leaving it on, she makes it much easier for the Greeks to vote Tsipras and leave the rest of the zone to pay. She also makes it much more likely she will have to cave to Tsipras' demands.

The stakes are high, and while the decision is crucial for Greece, and their creditors, there are even bigger second order issues in play. A Greek run will certainly cause the Spanish and Italian folks to question the access of their respective NCBs to ECB funding and the ELA. It will be VERY hard to argue that Italian banks are sound if 100s of billions in deposits flow to Germany! And why wouldn't every Eurozone resident put their hard earned money in the safest bank possible if we start to see Greek depositors threatened? As soon as retail sniffs that there is a chance of a loss, a full scale Eurozone bank run ensues. If the Germans can turn off the Greeks or the Irish, could they turn off the Italians?

The Germans have tried to play hard ball for 3 years. Every time it backfires and the Fed and ECB have to ride to the rescue with bazookas. My money is on the Germans going to battle with Tsipras. And in the end we create a Greek exit and a bank run throughout the periphery. The endgame looks like what I described in the commentary entitled "Angie ain't it time we said goodbye". In that analysis the Italians and the Spaniards, through the chaos of bank run and Greek default, force the Germans to wrap their debts via Eurobond or some sort of system wide European bank deposit scheme. In actuality, the Rajoys and Tremontis of the world may even try to incite a run in Greece - it gets them the German wrap they have always dreamed of! Using Greece as a pawn in the big Eurobond chess game is dangerous, but likely effective!

So where does the chaos from a Greek bank run and exit lead us. The end is of course ECB printing, Eurobonds and every developed market central bank dumping massive liquidity into the global financial markets as systemic risks rise - QE, LTROs, Currency swaps, and every funding facility under the sun come into play. The path to this end game will be bumpy, but make no mistake, the developed market central banks will dump so much fiat on the system to cover the losses, that risk free real rates will plummet to levels so negative that anyone left holding cash or cash equivalents will see massive destruction of real wealth. We may have to push risk assets a bit lower from here, but the global central banks will be firing howitzers and tomahawks very shortly, not bazookas! And you best be owning some risk when those bad boys are launched!!

http://www.zerohedge.com/news/forget-bazookas-here-come-tomahawks-and-howitzers-r-rated-walk-thru-greek-endgame

[DGuller]

Inflation is out of control as it is.  How did we get from punch bowls to bazookas to howitzers in the space of a couple of years?  At this rate, central bankers will be having ICBMs at their disposal next year.

[MadImmortalMan]

The Bernanke asteroid strike!!!111

[Iormlund]

Okay, so "unfired" means that you fire it once to show you mean it. Gotcha.

Of course. How else are investors going to believe you are serious? Fortunately Greece is small potatoes, unlike the real objectives of the bazooka: Spain and Italy.

And let's assume investors believe the ECB will do so again if necessary and don't ask for higher risk premiums for certain countries. Would not the effect be that the interest spread narrows to zero, as all countries are presumed to be equally risky now? Wasn't that presumption one of the reasons that allowed Greece to build such a mountain of debt in the first place?
To me, that market distortion takes away one of the incentives for fiscal prudency, namely the risk of higher interest rates.

I'm operating under the assumption that the objective is to save the Euro and thus parallel to the bazooka long-term solutions for the imbalances would be undertaken (partly under the reforms-for-bazooka agreements).

That leaves the last party to the sovereign debt crisis, our Eurozone governments. Which have a terrible track record at doing painful structural reforms when it is much easier to buy off voters with easy money. How would the ECB enforce compliance when the governments know fully well that they will get bailed out in the name of the greater Euro well-being if necessary? Or if the ECB would publicly say that it doesn't cover a certain country anymore, wouldn't we see an immediate implosion of that country as it would immediately lose the ability to borrow from anyone? I mean who would still lend money to say Portugal if the ECB publicly declares that it considers Portugal hopeless because of non-compliance? That's a nuclear weapon, not something they can actually use.
You seem to have much more faith in our governments than I do.

But that boat sailed years ago. What you say you fear is exactly what happened when someone told investors that every state was to bail out its banks on its own.

And your caveat that certain areas need subsidies for a while is contradicted by the history of other federations such as Belgium, Germany, the USA and I assume Canada, where it has been the same states that pay and the same states that receive money for decades without any incentive for the receivers to ever change. I don't see how the cost of that would have been lower. It would have been perpetual and high.

Not if those reforms are as effective as we are told. We'd all be Germans.

If further integration is not your thing, then the bazooka might not make sense. Just limit your losses, return to the DM and re-capitalize German banks. Or alternatively do nothing and face the same question years later, as Merkel did. It's just that the price of whatever the final choice is will be more expensive now (especially if someone does something stupid and Greece is forced out of the EU).

[Admiral Yi]

To make it a little more clear Zanza, Joan's bazooka is Germany writing a check for $200 billion.

[citizen k]

At G8, President Obama Suggests Germany Stop Austerity and Start Spending (ECB Likely to Start Quantitative Easing)
21 May

This is a puzzling headline at the New York Times and MSNBC: "G8 lean toward Obama growth, not Merkel austerity"

Obama growth? Apparently, the New York Times and MSNBC have forgotten about John Maynard Keynes and Sir John Hicks, the fathers of borrow and spend policies to get out of a recession. Not to mention Paul Krugman and his followers. Besides, the U.S. growth model is sluggish and nothing to brag about it.

"President Obama for the first time gained widespread support for his argument that Europe, and the United States by extension, cannot afford Chancellor Angela Merkel's one-size-fits-all approach emphasizing austerity."

When President Obama says "growth," he really means more stimulus spending. President Obama is pleading with Germany's Angela Merkel to open her heart purse strings and spend, spend, spend to help the EU change its downward momentum. That is, the time isn't right for cutting government spending (there is NEVER a good time for austerity for Keynesians).

Bear in mind that this is a path the U.S. and European Union have already followed, adding trillions of dollars of ruinous debt to the West's economies, without any growth in jobs or the economy to show for it.

But why is President Obama appealing to Germany? Is it because they have positive account balances as a percentage of GDP unlike much of Europe?

http://confoundedinterest.wordpress.com/2012/05/21/obama-wants-germany-to-stop-austerity-st-curse-of-being-fiscally-well-managed-and-act-reckless-like-the-u-s-and-greece/

[Sheilbh]

To make it a little more clear Zanza, Joan's bazooka is Germany writing a check for $200 billion.

Well so far the bailouts of Greece, Ireland and Portugal have hit around €400 billion.  From what I've read everyone expects at least Greece and Portugal to need another round, and maybe Ireland too.  The way those bailouts have been handled, however, hasn't dealt with the confidence issue which is problem that I think has increased costs over the last 2 years.  The target of the bazooka, after all, is Italy and Spain. 

It wasn't just Obama.  Cameron, Monti and Hollande all asked for a policy change, but that seems different from what the article's describing.

Edit:  The Eurocrisis reminds me of when banks were getting special liquidity from the Fed and Treasury.  Except they never decided to resolve the issue through something like TARP or in the UK the odd nationalisation, so the crisis just drags on and gets more and more costly while never actually being solved.

That is, the time isn't right for cutting government spending (there is NEVER a good time for austerity for Keynesians).

Someone really, really needs to read some Keynes

[MadImmortalMan]

Someone really, really needs to read some Keynes

Yeah like Keynesians. Yi has a point. They tend to be all over the Keynes when it's stimulus time, but even when it's not stimulus time, they think it's stimulus time. They're like crack addicts, and they are using Keynes' name to do evil. It makes rational economists look foolish because they're at the whim of dumbass politicians.

[Sheilbh]

I don't remember any out and out Keynesians calling for massive spending or tax increases in the 00s or 90s.

Edit:  I should add that I think the West in general's moving into a far more straitened time than the 90s or 00s.  So I think we should be passing lots of reforms of pensions, benefits, healthcare and those sort-of permanent costs which in my view matter far more in terms of budget balance.  But there are economies with space for further stimulus right now, so long as those reforms are being passed, it's certainly the case in the UK.

[Tamas]

Inflation is out of control as it is.  How did we get from punch bowls to bazookas to howitzers in the space of a couple of years?  At this rate, central bankers will be having ICBMs at their disposal next year.

You know what I am going to say on this, so I won't bother typing it.

[Zanza]

That leaves the last party to the sovereign debt crisis, our Eurozone governments. Which have a terrible track record at doing painful structural reforms when it is much easier to buy off voters with easy money. How would the ECB enforce compliance when the governments know fully well that they will get bailed out in the name of the greater Euro well-being if necessary? Or if the ECB would publicly say that it doesn't cover a certain country anymore, wouldn't we see an immediate implosion of that country as it would immediately lose the ability to borrow from anyone? I mean who would still lend money to say Portugal if the ECB publicly declares that it considers Portugal hopeless because of non-compliance? That's a nuclear weapon, not something they can actually use.
You seem to have much more faith in our governments than I do.

But that boat sailed years ago. What you say you fear is exactly what happened when someone told investors that every state was to bail out its banks on its own.

So what you say is that reality shows us that it wouldn't work.

Not if those reforms are as effective as we are told. We'd all be Germans.

East Germans.

If further integration is not your thing, then the bazooka might not make sense.

I very much start to doubt that. I am slowly turning into Nigel Farage and I think so is the German electorate. Europe will be truely fucked if Germany develops anti-bailout or even anti-EU parties. 

Just limit your losses, return to the DM and re-capitalize German banks. Or alternatively do nothing and face the same question years later, as Merkel did. It's just that the price of whatever the final choice is will be more expensive now (especially if someone does something stupid and Greece is forced out of the EU).

Pff, we can do something much more cynical: We wait until the Southern nations drop out of the Euro by themselves. Our industry currently benefits from the low value of the Euro. Why give that up?