Sovereign debt bubble thread

[Zanza]

Germany will for the first time sell two-year bonds on Wednesday that won't make scheduled interest rate payments

http://blogs.wsj.com/eurocrisis/2012/05/22/germany-to-sell-zero-coupon-bonds-for-first-time/?mod=google_news_blog

Next step should be to demand a fee for being allowed to buy a bond.

[Sheilbh]

Hasn't Germany said that for several years now? Why should our position change just because France gets a new government? 

The Guardian quoted an analyst from Investec on much the same:

Germany risks appearing a bit like Jim Trott in the Vicar of Dibley, 'no, no, no, no, no.....yes'. It remains firmly against common bond issuance and measures to increase the lending power of the European Stability Mechanism (ESM) such as granting it a banking licence or lending directly to banks. All are likely proposals at today's leaders' meeting, and some way of boosting the firewall is required fairly soon. The OECD and the IMF both joined the chorus calling for greater fiscal liability-sharing yesterday. But the single currency probably has to be closer to the end of the cliff before Germany's 'no' turns to a 'yes'.

My worry with this is that by that time it may not be enough.

[Tamas]

what's the problem with a common euro bond?
I know it would be suicidal for Germany in the current conditions, but surely nobody proposes to have it without seriously overhauling the way EU finances work?

This should be the perfect timing of curbing the independence of national central banks and governments in regards to fiscal policy. Austerity, if you will. Rationalization, say I.
And, the transitional period could be eased with the issue of eurobonds, and the growth programs launched in the perifery by them.

But noooo, they just draw a line in the sand, and will only rush to some hasty half-assed solution when we will be about to burn.

[Zanza]

There is no will for further fiscal integration anywhere. And frankly, as the right to set the budget is the core competency of parliaments, I am wary to give that authority to the EU commission or Council. The democratic deficit on EU level means they shouldn't have that competency.

[Sheilbh]

what's the problem with a common euro bond?
I know it would be suicidal for Germany in the current conditions, but surely nobody proposes to have it without seriously overhauling the way EU finances work?

Why would it be suicidal for Germany?  What do you mean by the way EU finances work?

German objections are that it removes the incentives for countries to deal with their debt and has a moral hazard issue.  In addition German borrowing costs would rise.  Those are all true but I think the fiscal pact has put those incentives in place anyway and the moral hazard problem doesn't over-worry me because I think the alternative is a collapse of confidence in the Euro.

[Tamas]

If they leave everything as is, except that euro countries will be abe to issue bonds guaranteed by germany, we will postpone the crash by a decade. Maybe two. But when it happens, Germany will go down too.
Why? because no greek leadership, or spanish for that matter, will fix their state if they dont have to. Plenty of evidence for that.

[Zanza]

My worry with this is that by that time it may not be enough.

And our worry is that all those premature bazooka shots wouldn't solve anything in the medium or long-term and maybe even make it worse and more expensive in the long-term.

[Sheilbh]

If they leave everything as is, except that euro countries will be abe to issue bonds guaranteed by germany, we will postpone the crash by a decade. Maybe two. But when it happens, Germany will go down too.
Why? because no greek leadership, or spanish for that matter, will fix their state if they dont have to. Plenty of evidence for that.

That's not what Eurobonds are though.

I'm not willing to predict a year or two down the line far less a decade or two.

And our worry is that all those premature bazooka shots wouldn't solve anything in the medium or long-term and maybe even make it worse and more expensive in the long-term.

This is where we disagree.  I think the fiscal pact and structural reforms will be important in solving the long-term problems - though not sufficient the European banking sector's a problem that needs addressing long-term.  But that that may come to nothing if the short-term crisis is allowed to continue escalating.

[Iormlund]

This should be the perfect timing of curbing the independence of national central banks and governments in regards to fiscal policy. Austerity, if you will. Rationalization, say I.

Everyone seems to agree on curbing the other guy's sovereignty. When it comes to their own ... If this crisis has taught us anything is that Europeans are not over nationalism.

Truth is a workable Euro means confederated Europe. And that can't be a step by step program because European institutions are largely irrelevant so politics naturally devolve to national interests. We would need an elected president, a meaningful parliament divided along ideological lines and so on to start the process not as an eventual goal.

I'm not willing to predict a year or two down the line far less a decade or two.

Even a month or two could completely change the picture at this point.

[Tamas]

This should be the perfect timing of curbing the independence of national central banks and governments in regards to fiscal policy. Austerity, if you will. Rationalization, say I.

Everyone seems to agree on curbing the other guy's sovereignty. When it comes to their own ... If this crisis has taught us anything is that Europeans are not over nationalism.

Truth is a workable Euro means confederated Europe. And that can't be a step by step program because European institutions are largely irrelevant so politics naturally devolve to national interests. We would need an elected president, a meaningful parliament divided along ideological lines and so on to start the process not as an eventual goal.

I'm not willing to predict a year or two down the line far less a decade or two.

Even a month or two could completely change the picture at this point.

I agree completely.

[Crazy_Ivan80]

If they leave everything as is, except that euro countries will be abe to issue bonds guaranteed by germany, we will postpone the crash by a decade. Maybe two. But when it happens, Germany will go down too.
Why? because no greek leadership, or spanish for that matter, will fix their state if they dont have to. Plenty of evidence for that.

That's not what Eurobonds are though.

that's what they would be in reality.
Free money for states that don't deserve it.
I will refer here to the belgian situation (again): The only reason the walloon part of the country isn't the third-world shithole it should be is because of unlimited flowing from the north (unchecked) to the south, as well as a lot of money from the European Union. Since WW2 the southern part of the country has only managed to decline despite all those innumerable billions in transferts, handouts, investments, structural funds and what-else. The southern part of the country hasn't even bothered to present a balanced bugdet yet... or ever since it was granted the ability to actually make a budget. And why should they? The north (flanders) and the EU pay the bills anyway.

That is what eurobonds would be in the real world: Germany paying for the other forever. With such a possibility it's almost worth it to just let the thing crash, take the hit, rebuild and be rid of the southrons/northrons (depending on your georaphical location)

[Admiral Yi]

Germany will for the first time sell two-year bonds on Wednesday that won't make scheduled interest rate payments

http://blogs.wsj.com/eurocrisis/2012/05/22/germany-to-sell-zero-coupon-bonds-for-first-time/?mod=google_news_blog

Next step should be to demand a fee for being allowed to buy a bond.

US has been issuing zero-coupon bonds for some time.  Not that revolutionary.  Interest is implied by the discount to par they are bought at.

Although it is still possible for bonds to pay negative interest at issue.  I think Japanese govt. bonds are paying negative interest.

[Sheilbh]

The Commission proposal for Eurobonds (supported by Hollande, the IMF, OECD, Draghi, Monti, Barosso and, in a slightly adapted form, the German Economic Wise Men) only covers 60% of GDP and those bonds have senior status.  It's not total debt mutualisation.

Here's Martin Wolf's on the particular problems of the Eurozone and how Eurobonds help address it:

One of the questions raised in the subsequent discussions is why the possibility of illiquidity-induced default (as in the Spanish sovereign debt market) should be any different in impact from the possibility of a devaluation and inflation (as in the gilt market).

I have three suggested answers.

The first is that the chance of illiquidity in the government bond markets is an additional risk. A freeze on liquidity may drive a solvent sovereign into default: we are then in the world of multiple equilibria. Thus a sovereign that could perfectly well avoid default if it had market confidence is, in the absence of a central bank, vulnerable to a run. The bonds of governments that lack their own central banks are exposed to an extra risk, in exactly the same way that the liabilities of banks without lenders of last resort are also exposed to risks that banks with lenders of last resort do not face.

The second answer is that investors believe they will be able to get out in time if a particular bond becomes vulnerable to inflation. Inflation is, initially at least, a slow-motion form of default for conventional bonds. Alert investors may well feel confident in their ability to escape in time. Defaults are a different matter. These may be sudden and so difficult to anticipate. Moreover, the loss of value in the case of a default is inherently unpredictable, being vulnerable to legal and other risks, while inflation is relatively predictable and also has no legal implications.

The third answer is that the risk of inflation or devaluation is, for an investor with domestic currency assets and liabilities, neutral for the balance-sheet. That is, it should not affect the relationship between the two sides of the balance sheet. This being so, neither inflation nor devaluation should expose the investor to increased risk of bankruptcy, which is always highly disruptive. But suppose a Spanish investor owes euro liabilities and holds Spanish government bonds subject to default risk (unlike, say, sterling bonds, which are exposed to inflation and devaluation risk). Such an investor is exposed to significant balance sheet risk associated with the chances of illiquidity-induced default.

For these reasons and those in the previous posts, as well as the evidence, it seems clear that eurozone sovereigns are exposed to risks that sovereigns with floating exchange rates and central banks are not.

...

A second and less radical possibility would be to create a class of debt that is liquid in all circumstances. This would be some form of eurobonds or eurobills. These would cover a substantial portion of all the outstanding government debts (maybe, up to 60 per cent of each country's GDP, this being limit set in the Maastricht treaty). All members would issue joint and several guarantees of such eurobonds and the European Central Bank would use such bonds (and bills) in all its market interventions. Being collectively issued and guaranteed and senior to all other public debt, these bonds would be safe. Moreover, the ECB would promise to keep this market liquid if necessary.

[Zanza]

I'm not willing to predict a year or two down the line far less a decade or two.

But you expect Germany to act very quickly and show bold leadership by signing up for an open-ended indefinite height scheme that will have influences on the budget perpetually without a way to opt out again? 

[Zanza]

The Commission proposal for Eurobonds (supported by Hollande, the IMF, OECD, Draghi, Monti, Barosso and, in a slightly adapted form, the German Economic Wise Men) only covers 60% of GDP and those bonds have senior status.  It's not total debt mutualisation.

Here's Martin Wolf's on the particular problems of the Eurozone and how Eurobonds help address it:

One of the questions raised in the subsequent discussions is why the possibility of illiquidity-induced default (as in the Spanish sovereign debt market) should be any different in impact from the possibility of a devaluation and inflation (as in the gilt market).

I have three suggested answers.

The first is that the chance of illiquidity in the government bond markets is an additional risk. A freeze on liquidity may drive a solvent sovereign into default: we are then in the world of multiple equilibria. Thus a sovereign that could perfectly well avoid default if it had market confidence is, in the absence of a central bank, vulnerable to a run. The bonds of governments that lack their own central banks are exposed to an extra risk, in exactly the same way that the liabilities of banks without lenders of last resort are also exposed to risks that banks with lenders of last resort do not face.

The second answer is that investors believe they will be able to get out in time if a particular bond becomes vulnerable to inflation. Inflation is, initially at least, a slow-motion form of default for conventional bonds. Alert investors may well feel confident in their ability to escape in time. Defaults are a different matter. These may be sudden and so difficult to anticipate. Moreover, the loss of value in the case of a default is inherently unpredictable, being vulnerable to legal and other risks, while inflation is relatively predictable and also has no legal implications.

The third answer is that the risk of inflation or devaluation is, for an investor with domestic currency assets and liabilities, neutral for the balance-sheet. That is, it should not affect the relationship between the two sides of the balance sheet. This being so, neither inflation nor devaluation should expose the investor to increased risk of bankruptcy, which is always highly disruptive. But suppose a Spanish investor owes euro liabilities and holds Spanish government bonds subject to default risk (unlike, say, sterling bonds, which are exposed to inflation and devaluation risk). Such an investor is exposed to significant balance sheet risk associated with the chances of illiquidity-induced default.

For these reasons and those in the previous posts, as well as the evidence, it seems clear that eurozone sovereigns are exposed to risks that sovereigns with floating exchange rates and central banks are not.

...

A second and less radical possibility would be to create a class of debt that is liquid in all circumstances. This would be some form of eurobonds or eurobills. These would cover a substantial portion of all the outstanding government debts (maybe, up to 60 per cent of each country's GDP, this being limit set in the Maastricht treaty). All members would issue joint and several guarantees of such eurobonds and the European Central Bank would use such bonds (and bills) in all its market interventions. Being collectively issued and guaranteed and senior to all other public debt, these bonds would be safe. Moreover, the ECB would promise to keep this market liquid if necessary.

Maybe I misunderstand him, but I don't see anything on Eurobonds in the first paragraphs, but a lot on a lender of last resort. That's a different, independent thing as far as I understand it. The ECB could be a lender of last resort without Eurobonds.