Tag Archives: Bonds

Ex. Goldman Chief Economist Comment on European Debt Crisis

Former Chief European Economist Erik Nielsen at Goldman Sachs takes an in-depth look at what’s going on in Europe at the moment, before he’s joining the Italy based bank UniCredit as Chief Global Economist in September. Nielsen is obviously worried.    

“..there is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming..”

Erik F. Nielsen

Finally, the big boys at Wall Street is getting the message: The financial crisis in Europe is about to turn into a political crisis. If that happens, the consequences will be severe and unpredictable. Here’s what former Chief European Economist at Goldman Sachs, Erik Nielsen’s latest thoughts on the subject – entertaining, as always.

The following article is syndicated by www.eurointelligence.com:

The frontlines in the battle over what to do with Greek sovereign debt has shifted, highlighting a new and uncomfortable intra-European split.

The original frontline was drawn between, on the one side, a majority of market participants, academics and commentators, and on the other side, the entire class of European policymakers.

Most market participants and other private sector analysts have long argued that the debt levels are unsustainable under any reasonable set of assumptions for growth and interest rates and that debt relief therefore would be needed. Referring to past debt crises and the first principle of fairness, they concluded that relief should and would be shared broadly among all the creditors, including bondholders, who might suffer a loss of maybe 50% of their claims.

On the other side of this argument stood the united front of policymakers. Originally, they all claimed that there would be no need for debt relief because Greek policy reforms alone would do the trick. They were not persuasive. Through their more recent actions, however, they have since acknowledged the need for debt relief by lowering the interest rate they charge on their own loans to Greece. But they have kept arguing that the bonds would not be restructured.

The casual observer would be forgiven for thinking that the world has turned on its head:  Here is the community of market participants arguing for haircuts on the bonds.  And here are the governments – representatives of taxpayers – insisting that private bondholders be protected at the implicit expense of Europe’s taxpayers.

There is good reason for the official sector’s insistence on avoiding a bond restructuring.

However, there is good reason for the official sector’s insistence on avoiding a bond restructuring. Greek bonds do not include collective action clauses, and they are distributed widely to domestic and foreign holders.  Worse, there is no reliable information on who exactly owns what, including who has bought and who has sold protection on these bonds.  The ECB’s Lorenzo Bini Smaghi has rightly suggested that the aftermath of the Lehman default might look like a walk in the park compared with a forced restructuring of Greek bonds. Some have argued that since about 90% of the bonds have been issued under Greek law, the Greek parliament could simply change the law and impose haircuts on the existing bondholders; a highly questionable preposition since retroactive legislation would run counter to any normal modus operandi in democratically ruled market economies.

The political winds throughout Europe have begun to swing towards fringe parties with a more sceptical – if not outright hostile – attitude to European cooperation.

Left with no practical way of including in an orderly way the private creditors in the burden sharing, the official sector is now contemplating further relief, including via longer maturities and maybe still lower interest rates, while insisting on further measures to speed up the inevitable policy adjustments in Greece.  However, as the political winds throughout Europe have begun to swing towards fringe parties with a more sceptical – if not outright hostile – attitude to European cooperation, the appropriateness of involving the private creditors for a fairer sharing of the burden has now been accepted by several governments, led by Germany.

With a disorderly attempt at restructuring still ruled out, the idea of voluntary participation of bondholders through a maturity extension, possibly under the vaguely defined Vienna Initiative, has been introduced. The Vienna Initiative aims as keeping banks involved in crisis countries. Importantly, while a voluntary maturity re-profiling would be unlikely to provide much,if any, net present value reduction, it might provide sufficient political cover to keep taxpayers involved for the heavier lifting.

I suspect that the ECB has concluded that the generally improved economic and financial outlook justifies a return to normal monetary policymaking. 

Strangely, this reasonable and gentle call for private sector involvement has met strong opposition from the ECB.  Having no explicit vote in the system, the ECB has threatened a practical veto by suggesting that voluntarily re-profiled bonds might not be eligible as collateral under its repo system.  Surely, if that were to be the ECB’s final word, then no bank would voluntarily participate, and the attempt to include even modest private sector participation would end right there.

Why would the ECB now throw a spanner in the wheel for what appears to be a perfectly reasonable compromise to involve most of the bondholders – and recalling that they have before made important exceptions to the treatment of debt in their collateral set-up?  I suspect that the ECB has concluded that the generally improved economic and financial outlook justifies a return to normal monetary policymaking.  Therefore, they now want to send their extraordinary and at times quasi-fiscal measures back to their rightful owners; the governments.  This means that governments need to adjust their policies, and when help is needed for one of the member states, it is to be provided via implicit or explicit tax transfers by other members, not the ECB.

There is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming if additional taxes have to be transferred.

Erik F. Nielsen

I have a lot of sympathy for that argument. But there is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming if additional taxes have to be transferred. And if, God forbid, the financial crisis indeed were to be followed by further political tensions with the potential to drag euro zone member states away from the common good, and towards nationalism, then the ECB could soon find itself back with policies much more uncomfortable than the acceptance of collateral of bonds which the holders have voluntarily accepted in place of their holdings of shorter bonds. Wanting to do the right thing, there is a real risk that the ECB is moving too fast towards the exit door right now.


Erik F. Nielsen is the former Chief European Economist at Goldman Sachs. 

He’ll join Unicredit as Global Chief Economist in September.


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Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics

The Pros & Cons of Credit Default Swaps

The CDS market, currently perceived as the most toxic market of all, has existed for nearly 20 years. But most people have only just begun to understand what all the fuzz is about. Said as simple as possible; a CDS is a kind of  insurance a lender buys to secure oneself against a possible default by the borrower. These insurance contracts usually has a maturity period between 1 to 10 years, and usually prized as a percentage of every 10 million units (dollars, euro, yen). A new research paper shred a little more light on this rather unknown market.

“In general, CDS trading has lowered the cost of issuing bonds and enhanced the liquidity in the bond market. Nevertheless, CDS trading has also introduced a new source of risk.”

Ilhyock Shimy/Haibin Zhu

According to the two researchers employed by the Monetary and Economic Department of the Bank for International Settlements, CDS trading has lowered the cost of issuing bonds and enhanced the liquidity in the bond market. The positive impact is stronger for smaller firms, non-…nancial …rms and those fi…rms with higher liquidity in the CDS market, while the negative is that companies included in CDS indices must face higher bond yield spreads than those not included.

The rise and fall of the credit derivatives market is considered the single most important event in the global credit market in the past decade.

Even thou it has existed for nearly 20 years, no one has paid much attention to it.

Until it blew up like an Icelandic volcano in 2008 and covered the whole world with a black cloud of hidden financial risks, that is.

By then the credit derivative market had swollen up to a huge, unmeasurable, uncontrollable market, with an estimated value of more than 60 trillion dollar. Credit-default swaps is one of the most traded credit derivatives, making up almost 90% of the totals.

According to the new research, the notional value of this market have been cut in half since the peak in 2008.

A Short Lesson

By the way – to compare a CDS with a credit insurances is not quite accurate:

A (CDS) is a swap contract and agreement in which the protection buyer of the CDS makes a series of payments (referred to as the spread) to the protection seller and, in exchange, receives a payoff if a credit instrument (typically a bond or loan) experiences a credit event. In fact, it’s a form of reverse trading.

The simplest credit-default swap is a bilateral contract between the buyer and seller of protection. The CDS will refer to a “reference entity” or “reference obligor”, usually a corporation or government.

The reference entity is not a party to the contract. The protection buyer makes quarterly premium payments—the spread —to the protection seller.

If the reference entity defaults, the protection seller pays the buyer the par value of the bond in exchange for physical delivery of the bond, although settlement may also be by cash or auction.

A default is referred to as a “credit event” and include such events as failure to pay, restructuring and bankruptcy.

So, with that out-of-the-way, I’ll go on.

A Double-Edge Sword


The CDS contracts have been perceived as the main root of all evil in the credit market because of its complex distribution of risk.

The new research paper by Ilhyock Shimy and Haibin Zhu do not confirm, nor dismiss the allegation.

They point, however, to the fact that the CDS market have both positive and negative impact on the financial markets in general.

This is their main findings:

“First, we …find strong evidence that CDS trading is associated with lower cost and higher liquidity for new bond issuance in Asia. This is consistent with the hypothesis that CDS trading helps create new hedging opportunities and improve information transparency for investors. Noticeably, this result is contrary to similar studies based on US data. This contrast provides supporting evidence for our conjecture on the jump-start e¤ect in Asia.

“Second, we …find that the positive impact of CDS trading on the bond market tends to be more remarkable for smaller fi…rms and non-f…nancial …firms. In addition, those …rms with higher liquidity in the CDS market bene…t more in the primary bond market in terms of cost and liquidity.”
“Last, we also …nd that the impact of CDS trading on the bond market is di¤erent during the crisis period. The global …nancial crisis that occurred during the sample period o¤ers a good case study to examine the behaviour of the CDS and bond markets under distress and their linkages. Our analysis shows that, at the peak of the global …nancial crisis, those firms included in CDS indices had to face higher spreads than those not included in CDS indices, above and beyond the general increase in credit spreads observed in the bond market during this period. This suggests that CDS trading could be a double-edged sword: it also introduces new sources of shocks to the bond market.”

Here’s a copy of the full report.

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EU: No Bail In, Just Eternal Bailouts

It ought to be a happy day for the bondholders of the world. The informal Eurogroup decided Sunday that the Irish rescue plan will not bail in senior bank bondholders and force them take a “haircut” on their liabilities. A decision likely to make precedence for the many bailouts to come. However, Germany and France insist on a bail in facility to be implemented when the 750 billion euro bailout fund, created in May this year, becomes a permanent stabilizing mechanism when it expires in 2013.  But this will only apply for debt issued thereafter. The brilliance of this solution is;  since bond issuers and bond investors, pretty much, are one and the same big banks – it becomes an eternal bailout mechanism.

“The rescue plan stands as a forceful response to vulnerabilities in the banking system.”

Dominique Strauss-Kahn

As usual, the IMF-boss Dominique Strauss-Kahn provides us with valuable insight. It is indeed a forceful response to vulnerabilities in the banking system. First; they’re now protected for two more years. And second; if anyone should default on their loans issued after 2013, and forced to take a so-called “haircut,” there will be a permanent bailout mechanism available so that the bailed in banks can be bailed out again. Pure genius!

The EU countries and the International Monetary Fund (IMF) will provide up to €85 billion under the Irish package, which may be drawn down over a period of up to 7½ years, the informal Eurogroup said last night.

About €50 billion is aimed at bolstering Ireland’s public finances. Of the remaining 35 billion, 10 will be used to recapitalize Ireland’s demolised banking system, and 25 will be put in a contingency fund to provide the banks with additional support if necessary.

The IMF will contribute with a total of 22,5 billion. This include three bilateral loans from the UK, Sweden and Denmark.
Along with the rescue package comes a 15 billion austerity package to be distributed amongst the Irish citizens over the next four years.

The interest rates for the loans will also vary on the different parts of the package. ( But is in general close to 6%,  according to the statements).

Merry Christmas!

The EU leaders have almost scared the bond investors to death with their talk of bailing in bondholders to make them share the burden of the supersized debt bubble they’ve been creating over the years.

But at a press conference last night after the informal Eurogroup and EU’s finance ministers had endorsed the Irish rescue package at an emergency meeting, Olli Rehn said:

“I’m aware that the Irish authorities are considering certain discounts for the subordinated debt but there will be no haircut on senior debt, not to speak of sovereign debt”.

Adding: “The programme rests on three pillars. First, there will be an immediate strengthening and comprehensive overhaul of the banking sector. Second there will be an ambitious fiscal adjustment to restore fiscal sustainability of the sovereign. Third, there will be substantial structural reforms enhancing economic growth, especially in the labour market.”

The aim in the banking measures is to create a smaller and more robust financial system with a stable financing structure.

“It notably includes higher minimum regulatory requirements, plus a capital injection early on to bring capital ratios above the minimum. Moreover a new and rigorous stress test will be conducted based on a severe scenario and moreover, new legislation on insolvency and bank resolution will be introduced.”

Neiter this legislation will not include haircuts on senior debt, according to Mr. Rehn.

So, the major holders of Irish (and other sovereign) bonds can enjoy another big fat Christmas bonus.

(See: The Precious Irish Bondholders – Here’s The Full List)

Deutsche Bank has already decided to hand out the biggest bonuses ever this year to its executives.

Bailing In The People

Now – here’s some of the Christmas gifts for ordinary Irish people:

Labor market:

*Reduce national minimum wage by €1.00 per hour

* An independent review of the Registered Employment Agreements and Employment Regulation Orders.

* Reform of the unemployment benefit system

* Streamline administration of unemployment benefits, social assistance and active labour market policies.

* Reform of activation policies:
A: Improved job profiling and increased engagement;
B:  More effective monitoring of jobseekers’ activities with regular evidence-based reports;
C: The application of sanction mechanisms for beneficiaries not complying with job-search conditionality and recommendations for participation in labour market programmes.

Health Care:

* Medical Profession: Eliminate restrictions on the number of GPs qualifying, remove restrictions on GPs wishing to treat public patients and restrictions on advertising.
* Pharmacy Profession: Ensure the recent elimination of the 50% mark-up paid for medicines under the State’s Drugs Payments Scheme is enforced.


* Savings in Social Protection expenditure through enhanced control measures.

* Increase the state pension age to 66 years in 2014, 67 in 2021 and 68 in 2028.

Public Service:

* Reduction of public service costs through a reduction in numbers and reform of work practices.
* A reduction of existing public service pensions on a progressive basis averaging over 4% will be introduced.
* New public service entrants will also see a 10% pay reduction.
* Reform of Pension entitlements for new entrants to the public service
A: including a review of accelerated retirement for certain categories of public servants and an indexation of pensions to consumer prices.
B: Pensions will be based on career average earnings.
C: New entrants’ retirement age will also be linked to the state pension retirement age.

* A reduction in pension tax relief and pension related deductions
* A reduction in general tax expenditures
* Excise and other tax increases
* A reduction in private pension tax reliefs
* A reduction in general tax expenditures
* Site Valuation Tax to fund local services
* A reform of capital gains tax and acquisitions tax
* An increase in the carbon tax

The Enormous Growth Potential

In a joint statement IMF managing director, Dominique Strauss-Kahn, says the rescue plan stands as a “forceful response to vulnerabilities in the banking system”.

And for once, I totally agree with Mr. Strauss-Kahn.

“By shielding Ireland from the need to go to the markets for a considerable period of time, this support places financing at Ireland’s disposal on more favourable terms than it could obtain elsewhere for the foreseeable future,” the statement says.

(Just to be precise: It’s the Irish banks that are being shield)

“This programme articulates a clear strategy for tackling today’s problems and for harnessing the enormous growth potential of this open and dynamic economy.”

The enormous growth potential?

I better stop now, or I might write something rude and offensive.

You can read the full Iris government/IMF statement for your self here.

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