Sovereign debt bubble thread

[Jacob]

Yeah. It's kind of depressing to accept that languish in aggregate prefers to think the worst of people

You're kinda guilty of that, you know.

Me?

I'll cop to thinking the worst of a few specific people

[citizen k]

In Shocking Development, ECB Demands Impairment For Senior Spanish Bondholders; Eurocrats Resist

In a landmark shift in its bank "impairment" stance, the WSJ reports that "in a sharp turnaround" the ECB has advocated the imposition of losses on senior bondholders at the most "damaged" Spanish savings banks, "though finance ministers have for now rejected the approach, according to people familiar with discussions." The WSJ continues: "The ECB's new position was made clear by its president, Mario Draghi, to a meeting of euro-zone finance ministers discussing a euro-zone rescue for Spain's struggling local lenders in Brussels the evening of July 9. It marks a contrast from the position the central bank adopted during the 2010 bailout of Irish banks--which, like Spain's, were victims of a property meltdown--when it prevailed in its insistence that senior bondholders in bailed-out banks shouldn't suffer losses." Needless to say, if indeed the fulcrum impairment security is no longer the Sub debt, but Senior debt, as the ECB suggests, it is only a matter of time before wholesale European bank liquidations commence as the ECB would only encourage this shift if it knew the level of asset impairment is far too great to be papered over by mere pooling of liabilities (think shared deposits, the creation of TBTF banks, and all those other gimmicks tried in 2010 when as a result of Caja failure we got such sterling example of financial viability as Bankia, which lasted all of 18 months). It also means the European crisis is likely about to take a big turn for the worse as suddenly bank failures become all too real. Why? Senior debt impairment means deposits are now at full risk of loss as even the main European bank admits there is no way banks will have enough assets to grow into their balance sheet.

Obviously, the ECB's 'revolutionary' suggestion will be met by harsh criticism at the FinMin level across Europe because if taken seriously it would mean the threat of wholesale bank runs. Sure enough, as the WSJ reports:

    The ministers rejected the advice out of concern that financial markets would react badly to the decision. A draft of the rescue agreement, which will provide as much as EUR100 billion ($122.5 billion) for the Spanish banking system, requires Madrid to force losses only on shareholders and junior bondholders in banks receiving bailout money, and doesn't mention creditors higher up in the pecking order.

    A spokesman for the European Commission, the EU's executive arm, said: "It is clear that senior bondholders won't be involved in burden sharing."

    The ministers' decision confirmed a pattern in the euro zone for dealing with bank troubles, in which senior bondholders have been spared even in the most brutal failures. But the ECB's shift may also be a sign that the tides are turning on the issue, as the euro zone embarks on a fundamental overhaul of the way bank failures are dealt with within the currency union.

    During the July 9 meeting, Mr. Draghi argued in favor of including senior bank creditors in burden sharing between taxpayers and investors in the case of Spain, three people familiar with the discussions said. Two said Mr. Draghi favored forcing losses on senior bondholders only when a bank was pushed into liquidation.

Of course, if Senior bondholders are impaired, even in one-off instances, revisionism, primarily out of Ireland will hit a fever pitch, where everyone will demand an answer why Ireland had to bailout Senior debt holders, while Spain, and soon Italy, will get away with bank impairment.

    But a chief reason ministers decided not to make more privileged bondholders take losses was the Irish precedent, two people said. Dublin has had to pump more than EUR60 billion, equivalent to around 40% of its annual gross domestic product, into several struggling lenders, forcing it to request a EUR67.5 billion bailout from other European countries and the International Monetary Fund in 2010.

    Forcing senior creditors to take losses in Spain would raise more questions in Ireland about why taxpayers were forced by the EU to take on the huge burden of repaying high-ranked bondholders.

So while Europe vacillates, there is still not definitive method to restructure failed and failing banks:

    "We have general company law [on bankruptcy cases], but we have so far no bank-specific law," said Karel Lannoo, chief executive of the Brussels-based Centre for European Policy Studies.

    The EU is now trying to rectify this situation and in June proposed a new legal framework for dealing with failing banks, which is cited in the Spanish bailout accord as a model. Crucially, the new rules would force national authorities to force losses on--or "bail in"--all creditors, for instance by converting debt into shares, when a bank has to be recapitalized by its governments.

Yet the question of why the ECB would even propose this revolutionary shift to all out impairment remains: after all, as anyone who had done even one Chapter 11 corporate case knows, at the end a company's assets must be just greater than its liabilities for fresh start restructuring: something that the banking sector has not seen once since the Lehman collapse.

And while such a return to reality would mean the potential to actually fix the situation, it would also mean the possibility of not only continent-wide bank runs, but all out balance sheet impairments courtesy of daisy-chained balance sheets, where one bank's liabilities are rehypothecated as another banks' assets in a virtually infinite loop, and where even the tiniest impairment causes the house of cards to fall.

Draghi is well aware of this, and the only reason he could bring it up is if he knows that absent full loss recognition, initially at selected venues, but gradually everywhere, there is simply not enough cash-good assets for the European financial system to "grow into its balance sheet."

The only question is how long until depositors, whose €10 trillion in cash makes the backbone of European bank liabilities, also figure out that their cash is backed by worthless assets, and then how long until they decided to, well, simply withdraw it...

[Tamas]

holy shit.

But if that is true, why european stocks aren't tanking? DAX has been open for like 15 minutes.

[Sheilbh]

The WSJ article that's based on is a bit less excitable though it's still important:

ECB Shifts View on Bond Losses
By GABRIELE STEINHAUSER in Brussels and BRIAN BLACKSTONE in Frankfurt

The European Central Bank, in a sharp turnaround, has advocated imposing losses on holders of senior bonds issued by the most severely damaged Spanish savings banks, though finance ministers have for now rejected the approach, according to people familiar with discussions.

The ECB's new position was made clear by its president, Mario Draghi, to a meeting of euro-zone finance ministers discussing a euro-zone rescue for Spain's struggling local lenders in Brussels the evening of July 9. It marks a contrast from the position the central bank adopted during the 2010 bailout of Irish banks—which, like Spain's, were victims of a property meltdown—when it prevailed in its insistence that senior bondholders in bailed-out banks shouldn't suffer losses.

The ministers rejected the advice out of concern that financial markets would react badly to the decision. A draft of the rescue agreement, which will provide as much as €100 billion ($122.5 billion) for the Spanish banking system, requires Madrid to force losses only on shareholders and junior bondholders in banks receiving bailout money, and doesn't mention creditors higher up in the pecking order. A spokesman for the European Commission, the EU's executive arm, said: "It is clear that senior bondholders won't be involved in burden sharing."

The ministers' decision confirmed a pattern in the euro zone for dealing with bank troubles, in which senior bondholders have been spared even in the most brutal failures. But the ECB's shift may also be a sign that the tides are turning on the issue, as the euro zone embarks on a fundamental overhaul of the way bank failures are dealt with within the currency union.

During last Monday's meeting, Mr. Draghi argued in favor of including senior bank creditors in burden-sharing between taxpayers and investors in the case of Spain, three people familiar with the discussions said. Two said Mr. Draghi favored forcing losses on senior bondholders only when a bank was pushed into liquidation.

This would mean that senior creditors would be safe in cases where a bank was merely being downsized—so far the most common way national authorities have chosen to deal with struggling banks. In Spain, in any case, larger banks are expected to continue operations after restructuring and wouldn't have been affected.

A spokeswoman for the Frankfurt-based ECB declined to comment on the July 9 discussions with finance ministers. She stressed that the ECB wasn't a signatory to the bailout deal between the euro zone and Madrid, which was a matter for the governments involved. "National authorities regulate bank-resolution processes," the spokeswoman said, adding that the ECB only provided advice, which "aims to ensure that the treatment of senior bondholders is in line with EU rules."

Imposing losses on bondholders reduces the amount of money taxpayers need to inject into struggling banks. One euro-zone official said the desire to avoid putting more public money at risk than necessary was one reason behind the ECB's change of heart since 2010. The ECB's new stance can also be explained by the different scenarios, including the existence of a bank-restructuring framework for Spain that didn't exist for Ireland, and the fact that the Irish government, unlike Spain's, guaranteed much of its banks' debts.

But a chief reason ministers decided not to make more privileged bondholders take losses was the Irish precedent, two people said. Dublin has had to pump more than €60 billion, equivalent to around 40% of its annual gross domestic product, into several struggling lenders, forcing it to request a €67.5 billion bailout from other European countries and the International Monetary Fund in 2010.

Forcing senior creditors to take losses in Spain would have raised more questions in Ireland about why taxpayers were forced by the EU to take on the huge burden of repaying high-ranked bondholders.

One element likely to increase pressure to force losses on senior creditors is a plan, agreed by euro-zone leaders at a summit last month, to soon allow the euro zone's bailout fund to directly recapitalize failing banks—instead of lending the funds, as at present, to the banks' host governments. That would put European taxpayer money directly on the line for saving banks in other countries. Officials from rich northern countries, led by Germany, have said that taking joint responsibility for bank rescues is possible only if recapitalizations don't create major losses—a strong case for putting a heavier burden on private investors.

In fact, European Union rules on how to deal with bank failures are murky. There is no harmonized legal framework for closing or restructuring banks that run into trouble. Rules on state support for banks seek to limit the amount of taxpayer money a government can inject into one of its lenders so the aid doesn't amount to unfair subsidies.

Normal insolvency procedures, meanwhile, are ill-suited to deal with banks that are closely tied into the wider financial system and where defaulting on creditors can easily trigger fears about other firms. The untangling and selling of assets during a regular bankruptcy also takes time, which is usually in short supply when a bank threatens to fail. "We have general company law [on bankruptcy], but we have so far no bank-specific law," said Karel Lannoo, chief executive of the Brussels-based Center for European Policy Studies.

The EU is now trying to rectify this situation and in June proposed a new legal framework for dealing with failing banks, which is cited in the Spanish bailout accord as a model. Crucially, the new rules would force national authorities to force losses on—or "bail in"—all creditors, for instance by converting debt into shares, when a bank has to be recapitalized by its governments.

EU officials claim that taxpayer money would have been unnecessary in most bank rescues in recent years had the new rules already existed. But the "bail in" proposal hasn't been approved by EU governments and, even then, is foreseen to come into effect only in 2018. That's far too late for Spain, which is expected to recapitalize its banks by the end of the year.

— Stephen Fidler in Brussels contributed to this article.
Write to Brian Blackstone at [email protected]

Edit:  Here's the FT blog's take on it:

The bail-in Spain — ECB edition
Posted by Joseph Cotterill on Jul 16 09:01.

Banking crisis U-turn of the year?

From the WSJ's Gabriele Steinhauser and Brian Blackstone:

The European Central Bank, in a sharp turnaround, advocated imposing losses on holders of senior bonds issued by the most severely damaged Spanish savings banks—though finance ministers have for now rejected the approach, according to people familiar with discussions.

The ECB's new position was made clear by its president, Mario Draghi, at a meeting of euro-zone finance ministers discussing a rescue for Spain's struggling local lenders in Brussels the evening of July 9...

In the July 9 meeting, Mr. Draghi argued in favor of including senior bank creditors in burden-sharing between taxpayers and investors in the case of Spain, three people familiar with the discussions said. Two said Mr. Draghi favored forcing losses on senior bondholders only when a bank was pushed into liquidation.

That's the central bank 'arguing in favour' of what is still a highly rare event in markets — and an unheard-of event in the eurozone — which the ECB itself once feared would wreck financial stability.

A few thoughts...

1. This condition of "only when a bank was pushed into liquidation". That's about where the policy-maker consensus is, though resolution isn't quite bankruptcy law. The reason it's been so rare for the holders of senior unsecured bank debt to take losses is that normally they've ranked pari passu with a bank's depositors in bankruptcy. Governments have tried to pick their way around that problem. Amagerbanken, a Danish bank, imposed a 41 per cent loss on senior bondholders last year, under a government wind-down of assets.

But even with the liquidation rider — for the ECB to advocate senior burden-sharing as a central bank, right now in the crisis, and in Spain, would be remarkable.

2. Liquidity and liquidation of Spanish banks. The July 9 meeting was about Spain. If Draghi was talking about taking bail-ins all the way up to senior unsecured debt, that's a sign that the ECB is ready for some banks to be declared 'non-viable'.

As last week's draft bailout MoU already stated:

Banks that are deemed to be non-viable will be resolved in an orderly manner... Orderly resolution plans should be compatible with the goals of maintaining financial stability, in particular by protecting customer deposits, of minimising the burden of the resolution on the taxpayer and of allowing healthy banks to acquire assets and liabilities in the context of a competitive process.

(Incidentally, it's intriguing to re-read this now and note that senior creditors weren't mentioned as protected alongside depositors...)

It would be quite a grasping of the nettle.

After all, the ECB must know very well that some Spanish banks have likely been continuous borrowers from its crisis liquidity ops since they started in 2007. One problem with a bank's liquidation would be managing down this liquidity. Another might be ensuring that other (stronger) banks don't remain long-term borrowers because the bail-in precedent drives up the cost of private funding.

3. The ECB would also be talking about senior bail-ins in resolution long before 2018. That's when formal EU powers to impose senior burden-sharing are supposed to come into force, and not before, as per rules unveiled just one week before Spain first asked for a bank bailout.

So, 2018 isn't set in stone. We sort of knew this already, and wondered about it during Spain's initial bailout request. We pointed to these official guidelines for bank recaps by the EFSF, for whom 2018 wasn't set in stone either:

Where appropriate, additional conditionality could draw from the future EU bank crisis resolution framework, which will be proposed by the Commission after summer. In particular, such a conditionality could include requirements to enhance the supervisory toolbox in the three crucial phases of crisis management identified (preparation, early intervention and resolution) such as recovery and resolution plans, early intervention tools for supervisory authorities, asset separation tools, bail-in tools.

At that time, we were being told how silly we were for believing that the losses of Spanish banks would be big enough to need any bail-in, even of junior bank debt.

Well, the sub-debt burden-sharing arrived, as did the "asset separation tools," a bad bank. While finance ministers rejected senior bail-ins "for now" as the WSJ puts it — it all looks more malleable than ever.

4. Not least, the ECB is leading on senior debt bail-ins just as it might become the eurozone-wide bank supervisor. As the WSJ also mentions, governments might come round to full burden-sharing the more they see it as a way to minimise the loss they'd face on holding equity in direct ESM bank recaps. There's been some loose talk of 'resolution' as a condition for these direct recaps, when they come into force in 2013 or 2014 (the timeline really isn't clear). ECB advocacy of senior bail-in narrows it down a bit, again well before 2018.

It's also worth remembering what Draghi said about "democratic accountability" for the ECB, if it takes up the supervisor role. Senior bank bond bail-ins would mean accountability to taxpayers who'd otherwise bear banks' risk, we suppose...

5. Finally — Ireland, the ghost at the table. From the WSJ story, on the finance ministers' rejection of the ECB:

Forcing senior creditors to take losses in Spain would have raised more questions in Ireland about why taxpayers were forced by the EU to take on the huge burden of repaying high-ranked bondholders.

Well, as P O Neill has already pointed out, path dependence isn't a policy.

Though it might show why retroactive change to Ireland's bank bailout is tricky. Ireland also seems to be cursed special because the government backstopped so much senior unsecured bank debt (in the Eligible Liabilities Guarantee scheme).

So what about all that Spanish (or Italian) government guaranteed bank debt?

This entry was posted by Joseph Cotterill    on Monday, July 16th, 2012 at 9:01    and is filed under Capital markets. Tagged with bank bonds, bank resolution, burdensharing, ecb, ireland, senior debt, Spain, spanish banks.

[MadImmortalMan]

Liep saved 9 grand.

Denmark avoided massive euro bill

EuropeNews 15 July 2012
By Nicolai Sennels

Every single Dane would have had to pay nine thousand euro if we had voted yes, when we voted about the Euro in 2000. At that time 53.2 percent voted no, 46,8 percent voted yes - a relatively close call. The politicians and commentators that urged and threatened us to vote yes back then still owe us an apology.

Denmark avoids 45 billion euro bill because of not having the Euro.

"Economists calculate that Denmark would have had to dole out an additional 338 billion kroner if it had adopted the euro Economists are claiming that it was fortunate Danes voted against adopting the euro in the 2000 referendum. ...

"It was smart then but it has shown to be even smarter than we had thought," Christian Bjørnskov, a lecturer in international economics at Aarhus University, said. ...

The calculations show that had Denmark been in the monetary union it would have had to pay 338 billion kroner to bailout other Eurozone members. This sum consists of 87 billion kroner and 95 billion kroner, respectively, for to the two financial stability funds, the ESM and the EFSF. Denmark would also have had to contribute to the European Central Bank's purchase of government bonds from the troubled countries. This would have amounted to 156 billion kroner.

"There is no-one else to pay the bills except the euro countries and we are exempt because we never adopted the euro," Bjørnskov said, adding that the common currency had problems from the start. "The euro is a construction that encourages countries to behave irresponsibly, since eurozone countries are liable for each other's debt, regardless of the political promises they make."

[Admiral Yi]

That's pretty dishonest.  The bailout funds are supposed to be loans, not grants.

And the part about paying money to the ECB makes no sense at all.

[The Minsky Moment]

Every single Dane would have had to pay nine thousand euro if we had voted yes,

High quality financial journalism there.

[alfred russel]

An even more extreme example than Ireland is Slovenia, who are expected to need a bailout soon.  Their debt to GDP is under 50%.

First, by global standards a debt to GDP is quite high. Western democracies are able to borrow so much because they are considered safe. Slovenia was a part of Yugoslavia.

Second, the nature of government accounting means there are truly massive off balance sheet liabilities that are not being recorded. There are reasons not to record them: for example, the liabilities are based on laws that can be changed. However, as we have seen, countries seem more willing to default on debt obligations than adjust payment schemes to pensioners. These massive liabilities can be funded if economies stay healthy, but it is unrealistic to believe they can if economies tank. Hence we have the current situation in Spain.

[Admiral Yi]

Fredo: I believe the riddle to Spain's relatively low debt/GDP and poor credit rating is explained mostly by provincial debt.  Similar situation to Argentina right before they defaulted.

[MadImmortalMan]

Fredo: I believe the riddle to Spain's relatively low debt/GDP and poor credit rating is explained mostly by provincial debt.  Similar situation to Argentina right before they defaulted.

Any idea what the real figure would be if they combined the national and provincial debts together?


I wonder what ours would be if you added up the states with the federal...

[alfred russel]

Fredo: I believe the riddle to Spain's relatively low debt/GDP and poor credit rating is explained mostly by provincial debt.  Similar situation to Argentina right before they defaulted.

And the implicitly guaranteed bank liabilities, along with the rest. I don't think it is so much a riddle: the way finances are organized in most western states, sustained unemployment of ~20-25% will break the government. We are beginning to creak at just 8% unemployment and our own currency.

[The Larch]

Afaik Spanish debt includes the regional one (which is peanuts when compared to the national one), if I understood you right.

[Admiral Yi]

Any idea what the real figure would be if they combined the national and provincial debts together?


I wonder what ours would be if you added up the states with the federal...

Someone posted an article in this thread with exact numbers, but you would have to slug through 30 pages to find it.

Don't quote me on this, but I think the Spanish central government might explicitly guarantee provincial debt.  Obviously that is not true in the US.

[Iormlund]

I don't know about explicitly but the central government is certainly on the hook for regional imbalances. It is also the sole source of income of regions (except Basque Country and Navarre that have their own tax authorities).


In any case I'd say the main factor driving for higher rates is the combination of EZ exit uncertainty and the likely depressionary spiral we're in, not the amount of debt itself. Even adding bank liabilities and regional debt it would be manageable with a sound economy.

[Sheilbh]

Second, the nature of government accounting means there are truly massive off balance sheet liabilities that are not being recorded. There are reasons not to record them: for example, the liabilities are based on laws that can be changed. However, as we have seen, countries seem more willing to default on debt obligations than adjust payment schemes to pensioners. These massive liabilities can be funded if economies stay healthy, but it is unrealistic to believe they can if economies tank. Hence we have the current situation in Spain.

All of your post's fair.  Do you think it's the cause of market concern about any of these countries (Greece, Portugal, Spain, Ireland, Italy, Cyprus and Slovenia) - while countries like France and the UK are borrowing at negative interest rates?

Any idea what the real figure would be if they combined the national and provincial debts together?

The full Spanish debt is around 80% - their provincial system's different though.  They haven't federalised taxes for example.  If you do Zero Hedge maths then I think you get around 130%.  Obviously you shouldn't.