Sovereign debt bubble thread

[Sheilbh]

Incidentally the EU is supposed to issue its report on banking union next month, due for implementation by the end of the year.  Here's an update from the FT:

Searching for common ground on a European banking union
Posted by Masa Serdarevic on Aug 15 14:56.

With the EC set to outline its proposals for a European banking union in less than a month's time, leaked documents detailing the initial discussions indicate differences of opinion remain as wide as ever.

A key area of contention seems to be delegation of banking oversight tasks. From Bloomberg (our emphasis):

The ECB should have a core set of central powers to oversee all banks in the 17-nation currency bloc while delegating some tasks to individual countries, under one option favored by the U.K. and European Union economic policy officials. The ECB supports a similar "light touch" approach that would leave day-to-day supervision for most banks in the hands of national authorities, the documents show.

Another approach, backed by officials working on EU financial rules, would require the ECB to take major oversight decisions for all banks, the papers show. Officials opposed to this approach say it could compromise the central bank's reputation and perceived independence, according to the documents, which include EU-level and U.K.-based analysis of the policy debate.

"Light touch" versus "major oversight"? That's quite a gulf and no sign of a bridge.

But at least there seems to be agreement that the ECB would "directly supervise" banks that have actually been bailed-out:

The ECB could become the day-to-day supervisor for euro- area banks considered systemically significant worldwide or within Europe, as well as for lenders that tap euro-zone rescue funds, according to the documents. The papers show that the central bank agrees that it should directly supervise institutions receiving EU bailouts and could delegate daily supervision of small banks to national regulators. The central bank would be able to override decisions taken by local authorities, according to the proposals.

And the UK wants to see other banks move to the new regime over the next three years (unless they need to be bailed out sooner) according to the docs.

Then there is the question of accountability. All policymakers are agreed that the ECB will have to be publicly accountable for its bank-supervision decisions. But the Commission also wants to give the European Parliament a say, whereas London prefers some kind of oversight role for national parliaments.

Checks and balances will need to go in multiple directions:

These calls for accountability must be balanced by measures to preserve the ECB's independence as central bank and monetary- policy setter, according to the documents. As the banking-union plan takes shape, EU lawyers are examining how to make sure the ECB does not have an unfair advantage over other regulators because of its autonomy, the documents show. The central bank will need to remain insulated from political interference as it takes on its new powers.

There's also a Dutch/British clash, regarding who these new rules should cover and how the costs of the bank bailouts are shared. Unsurprisingly, the UK wants just be the 17 euro nations to be affected. The Dutch disagree, and have also called on the new bank supervisor to "carry out stress tests and for investors to take losses before accessing capital from the euro rescue fund".

Perhaps even more difficult is the question of how countries not part of the euro will fit in:

There's also debate on whether non-euro nations will be able to participate in board meetings of the new single supervisor and related joint activities. If non-euro members are allowed as observers, the U.K. would like all EU nations to be included, while the European Commission favors granting access only to countries that have committed to join the common currency eventually, the documents say.

Coming less than a month before the Commission is expected to present its proposals on September 11, these documents are unlikely to soothe markets.

From a friendly trader, despairing at the lack of agreement:

In a taste of the obstacles ahead, a leaked report on the initial discussions shows significant differences of opinion.
Does it cover Banks in the EU27 or EZ17? Is it a "light touch" ECB sharing powers and responsibilities with national Regulators, or an all powerful ECB? And then what is the oversight set-up for such an ECB? Does the ECB cover ALL EZ banks? or just the "systemically important", or even just the "rescued" ones....?

It's still unclear what level of detail the EC's proposals might contain. Mario Draghi didn't give away too much when he addressed the EU parliament last month:

"We should expect from the commission a strong proposal, a strong proposal that would put the ECB in a position to carry out its duty with effectiveness, rigor, independence and without risk to its reputation."

But we should at least get some kind of feel for the scope of ECB involvement and how its relationship with the European Banking Authority might work. Still, Mariano Rajoy's hopes for a banking union to be approved at the December EU summit are likely to prove over-optimistic.

With the Dutch elections and the German constitutional court decision on ESM both due on September 12, expect bumpy week markets.

It's worth noting that 'systemically important' bit is, I believe, because Germany especially doesn't want the regional banks regulated by Europe.  The trouble is its precisely those types of regional banks that, from my understanding, needed to be bailed out in Germany and are causing such problems in Spain.

[Admiral Yi]

Actually I agree with your first point Shelf.  It was stupid to roll over private debt with official debt that was nonreducible.  Should have performed the tonsure first.

Your second point about Greece's negotiating position I don't buy.  Germany could hold the eurozone hostage just as easily as Greece.

Your third point about excessive austerity in the creditor countries I disagree with as well.  One ratings agency has already put Germany on negative outlook (or is it a watch list?).

Strange that in the current context a fiscal deficit of 3% of GDP gets described as austere.

[Sheilbh]

Your second point about Greece's negotiating position I don't buy.  Germany could hold the eurozone hostage just as easily as Greece.

Indeed.  As I say the programs need to show that they can work so that Germans keep faith with the Euro just as much as Greeks - though Germany's position is closer to Italy and Spain.  They can block policies they don't like without the nuclear option.

Your third point about excessive austerity in the creditor countries I disagree with as well.  One ratings agency has already put Germany on negative outlook (or is it a watch list?).

But why are they paying such low rates?

I don't think you can have it both ways.  Either they're paying record low rates because of the dangers of Eurozone break-up - such as a Greek exit, or they're paying record low rates because markets have faith in their creditworthiness.  If it's the former more steps need to be taken to limit the damage/save the Euro (the IMF are now publicly saying that Europe needs banking union and a far larger firewall), if it's the latter they can slow the pace.

As I say even if they went to the comparatively leisurely fiscal consolidation of Osborne (praised today by John Chambers for his serious fiscal and growth policies ) I think they'd retain market faith.

I think it helps that all of Europe has some form of Parliamentary government.  They can and have to pass budgets - austerity doesn't involve 3D chess the way it does in the US.

I think the rating agencies are useless to be honest.  They downgraded France and they're now paying the lowest rates ever and, like the UK, Switzerland and Germany, even experienced negative interest rates on their debt.

Strange that in the current context a fiscal deficit of 3% of GDP gets described as austere.

I think it assumes a return to normality at some point, a deficit of around 3% is generally sustainable in a period of average growth.  There's other conditions though - debt to GDP down to under 60%, for example - leeway of 1% of GDP during a recession.  It's a dangerously pro-cylical policy in my view.

[Admiral Yi]

But why are they paying such low rates?

The same reason the US is paying nothing: there's no where else that people can park money with a reasonable expectation they will get it back.

But this expectation is not a galactic constant.

[Iormlund]

Tell me how Greece's program is different from a traditional IMF program.  I don't see it. 

It's quite huge, actually. IMF programs make use of monetary policy to provide room for growth via exports. In this crisis, absurd monetary policy is the most important factor dragging economies to the bottom.

[Sheilbh]

The same reason the US is paying nothing: there's no where else that people can park money with a reasonable expectation they will get it back.

But this expectation is not a galactic constant.

No, if anything that reason is very worrying. 

But I think a better solution would be for them to submit multi-year deficit reduction plans to, say the EC, who taking account their debt and deficit sets a timetable for implementation of the fiscal plan rather than a flat 2 year period.  There's simply no need for the Dutch to head into a recession and for the government to fall because they couldn't agree on a budget that would meet the fiscal pact by next year.  So the pact should have been designed that if you're reducing a deficit of, say 8%, you should be able to take longer than reducing a deficit of 4%.

As I say multi-year plans are possible in Parliamentary systems (in the Netherlands competing parties actually submit their manifestos to the equivalent of the CBO to be costed before an election).  So George Osborne can credibly say 'we'll reduce the deficit this much over this four year Parliament etc.', I think that option should be available for Euro leaders too.

[Admiral Yi]

So the pact should have been designed that if you're reducing a deficit of, say 8%, you should be able to take longer than reducing a deficit of 4%.

So you want to reward spendthrifts?  That's a terrible idea.  As mentioned before, bond investors don't hand out extra credit points for the amount of pain you expeirience.

[Admiral Yi]

It's quite huge, actually. IMF programs make use of monetary policy to provide room for growth via exports. In this crisis, absurd monetary policy is the most important factor dragging economies to the bottom.

Actually a few IMF programs in Latin America have involved fixing the exchange rate to cure hyperinflation, but generally I concede the point.

However, an article in The Economist on a comparison of Japan's Lost Decade with the Eurozone leads me to believe that EU monetary policy is not quite as post-Weimarish as the conventional wisdom suggest.  I could be wrong though, some of those Economist graphs are a litte tricky to read.

[The Minsky Moment]

No clue.  The only assets I've seen mentioned in print are the lottery and the Athens airport. Obviously if Greece doesn't own 50 billion worth of assets it's unreasonable.  Do you have any evidence that suggests that true other than my inability to list them?

Athens airport - net income is about 100 million euro/yr and the government owns 55%.  So even if they could get 10x earnings that would get them to about 1% of the way to 50 billion.   State lottery, revenue was at 400 million euro for last year statistics available (2006).  Maybe it could fetch a few billion euro.

Most of what is left is land, and some loss-making state companies.  The essential problem is that doing a fire sale in the middle of a depression.  At best you can expect to get liquidation value and given that Greek assets are not so enticing for global risk averse investors, maybe not even that.

What do you mean there's no realistic path to recovery?  Go back and re-read your own article about the deflationary spiral.  It's a very specific linkage between deleveraging and money supply.  It's not, as your posts often suggest, a generalized tendency of contracting economies to contract forever.

I'm not referring to debt deflation a la Fisher.  I'm referring to the fact that the Greek economy is structurally uncompetitive which is a key fundamental factor driving the fiscal problem.  In in this context that the deal has to involve pro-growth policies from the center to ease the structural adjustment.   Putting the entire brunt of structural and fiscal adjustment would mean forcing the public sector to become a net saver while savaging the private sector ability to spend.  That's a formula for cutting GDP in half.

[Sheilbh]

So you want to reward spendthrifts?  That's a terrible idea.  As mentioned before, bond investors don't hand out extra credit points for the amount of pain you expeirience.

Your morals are showing

I want there to be some flexibility - determined by the Commission - so that a country's fiscal consolidation reflects their levels of debt and deficit (so for example the guys with 40% debt but bad banks and a high deficit may take longer to adjust than the guys with 90% debt but solid banks and a much smaller deficit - who of those two is the spendthrift?).  I think their policies should be decided based on that much politics and bond market response, not a general Euro-wide policy.

[Admiral Yi]

Your morals are showing

I want there to be some flexibility - determined by the Commission - so that a country's fiscal consolidation reflects their levels of debt and deficit (so for example the guys with 40% debt but bad banks and a high deficit may take longer to adjust than the guys with 90% debt but solid banks and a much smaller deficit - who of those two is the spendthrift?).  I think their policies should be decided based on that much politics and bond market response, not a general Euro-wide policy.

It's a refutation of *your* moral POV that the object of the excercise is to distribute the pain evenly.

Which you have jettisoned in this current post, so we can put the issue behind us.

[Admiral Yi]

I'm not referring to debt deflation a la Fisher.  I'm referring to the fact that the Greek economy is structurally uncompetitive which is a key fundamental factor driving the fiscal problem.  In in this context that the deal has to involve pro-growth policies from the center to ease the structural adjustment.   Putting the entire brunt of structural and fiscal adjustment would mean forcing the public sector to become a net saver while savaging the private sector ability to spend.  That's a formula for cutting GDP in half.

I'm afraid you lost me after structurally uncompetitve Joan.

[Sheilbh]

It's a refutation of *your* moral POV that the object of the excercise is to distribute the pain evenly.

Where have I said that? I'm not even sure what you mean.

[Admiral Yi]

Where have I said that? I'm not even sure what you mean.

What other possible argument is there for allowing a large deficit country more leeway than a small deficit country?

[Sheilbh]

Where have I said that? I'm not even sure what you mean.

What other possible argument is there for allowing a large deficit country more leeway than a small deficit country?

The reasons I gave.  Overall debt and economic situation, to which I'd possibly add debt sustainability.  If you include those factors I think there's plenty of reasons and they should be part of the factors - as well as credibility of proposals presented to the Commission (I imagine Berlusconi's plan may be viewed with some scepticism) - that give a reasonable timeline.  Most important though is that this is an artificial political policy, it should be as flexible and able to accommodate and reflect reality as possible rather than a one-size-fits-all.

Once everyone's at the same size of deficit, roughly, those terms of the fiscal pact should operate and the same process should begin with reducing debt levels in countries above the limit.