Bonds question

07734

This might be a very silly question, but is the state not allowed buy their own bonds back on the open market at whatever discount they are trading at? Or are they obliged to redeem at face value?

Scofflaw

07734 wrote: »

This might be a very silly question, but is the state not allowed buy their own bonds back on the open market at whatever discount they are trading at? Or are they obliged to redeem at face value?

I have a feeling that technically, that works out as a default. Seems daft, but there you go.

cordially,
Scofflaw

Nijmegen

It could be done, and given how far the rules have been bent in years gone by why not.

But where do you get the money from...?

Hayte

Nah you can buy back your own bonds. Or buy a call option on a bond if you think the interest rate will go down.

It gets a bit more complicated when you have situations like Anglo and their bond buyback program. The ECB blocked it a while ago because pretty much all the money in Anglo came from the ECB anyway. They objected on the grounds that they weren't in the business of lending money to states and state banks who then buy back their own bonds. Thats basically like borrowing even more money from the ECB.

I'm pretty sure that during the run up to the whole "EU is gonna burn in 10 days" rhetoric on this forum, people went nuts when Germany could only sell like half of its 10 years. I'm fairly sure they bought back the rest.

Scofflaw

Hayte wrote: »

Nah you can buy back your own bonds. Or buy a call option on a bond if you think the interest rate will go down.

It gets a bit more complicated when you have situations like Anglo and their bond buyback program. The ECB blocked it a while ago because pretty much all the money in Anglo came from the ECB anyway. They objected on the grounds that they weren't in the business of lending money to states and state banks who then buy back their own bonds. Thats basically like borrowing even more money from the ECB.

I'm pretty sure that during the run up to the whole "EU is gonna burn in 10 days" rhetoric on this forum, people went nuts when Germany could only sell like half of its 10 years. I'm fairly sure they bought back the rest.

Probably, but it wouldn't be at a discount, and it wouldn't be on the open market.

OK, say Ireland has a debt of €180bn, a deficit of €20bn, and there are bonds worth, say, €10bn maturing end 2012, currently available at a discount of 20% on the market.

With no bond buy-back, Ireland has to borrow to meet its deficit (€20bn) and the bond rollover (€10bn). So it needs to borrow €30bn for 2012.

On the other hand, it can buy €10bn of outstanding debt for €8bn, which it then doesn't have to roll over - which says to me that its borrowing needs would be only €28bn - €20bn for the deficit and €8bn for the bonds.

So much for the sovereign. I don't see how the same doesn't apply for Anglo. If it has €20bn to be rolled over at the end of 2012, it needs to borrow €20bn in ELA from the ECB to do that. If it can buy that €20bn for €15bn, surely it only needs to borrow €15bn - its borrowing reliance on the ECB goes down, not up.

I mean, it's pretty much the ultimate in insider trading, of course, because you only need to make the right noises about not repaying a particular issue, then buy it up yourself - but other than that, where's the catch?

cordially,
Scofflaw

Hayte

Scofflaw wrote:

I don't see how the same doesn't apply for Anglo. If it has €20bn to be rolled over at the end of 2012, it needs to borrow €20bn in ELA from the ECB to do that. If it can buy that €20bn for €15bn, surely it only needs to borrow €15bn - its borrowing reliance on the ECB goes down, not up.

They have already done this lots of times. I have only looked in depth at the 2010 subordinated debt buybacks which in one instance were negotiated down to 1/5th of face value.

When you say it like this, it makes it sound like a magic way to sink interest rates on bonds but its not that simple. The debt holder has to agree to writing off a fraction of the debt. The other limitation is that Irish banks now have much stricter tier 2 capital requirements so they cannot blow all their capital reserves buying back their own debt.

There are even stricter limitations imposed by the fact they would be doing it with ECB money. The ECB obviously takes a dim view of going hogwild with debt buybacks because they will leave state banks with lower capital reserves, which makes them more vulnerable to financial shock.

Scofflaw

Hayte wrote: »

They have already done this lots of times. I have only looked in depth at the 2010 subordinated debt buybacks which in one instance were negotiated down to 1/5th of face value.

When you say it like this, it makes it sound like a magic way to sink interest rates on bonds but its not that simple. The debt holder has to agree to writing off a fraction of the debt. The other limitation is that Irish banks now have much stricter tier 2 capital requirements so they cannot blow all their capital reserves buying back their own debt.

There are even stricter limitations imposed by the fact they would be doing it with ECB money. The ECB obviously takes a dim view of going hogwild with debt buybacks because they will leave state banks with lower capital reserves, which makes them more vulnerable to financial shock.

I can see that limitation in respect of the banks, but in respect of the sovereign?

cordially,
Scofflaw

Hayte

Scofflaw wrote: »

I can see that limitation in respect of the banks, but in respect of the sovereign?

cordially,
Scofflaw

In Ireland? Essentially the same thing since Anglo is wholly state owned. If it buys back 10 billion of subordinated debt for 2 billion, it strengthens the bank's balance sheet by 8 billion...by immediately wasting 2 billion in taxpayer money.

The government issues bonds through the NTMA so exchange the state bank for the NTMA for more or less the same effect. It won't be exactly the same since the entities are regulated different with different mandates but you get the idea.

Scofflaw

Hayte wrote: »

In Ireland? Essentially the same thing since Anglo is wholly state owned. If it buys back 10 billion of subordinated debt for 2 billion, it strengthens the bank's balance sheet by 8 billion...by immediately wasting 2 billion in taxpayer money.

The government issues bonds through the NTMA so exchange the state bank for the NTMA for more or less the same effect. It won't be exactly the same since the entities are regulated different with different mandates but you get the idea.

No, still not with you. In Anglo's case, they're entirely state owned, so spending €2bn of taxpayers' money saves €10bn of taxpayers' money. In the case of Irish sovereign bonds, the same, surely.

cordially,
Scofflaw

Hayte

It doesn't work like that.

That €10 billion in the example we are using is a hole. Its money the bank owes in say, 10 years time (the principle) with biannual interest payments between now and then. The €2 billion is cash that the bank has right now (even if it is borrowed from the ECB but hopefully you get the idea).

If you pay €2 billion of actual cash to write off 80% of a €10 billion debt that won't be actualized in 10 years time, you are trading €2 billion in current assets for €10 billion less in (long term) liabilities. To put it another way, you are trading a problem you have to deal with later, for a problem you have to deal with right now. There are times when its a good idea to make that trade for strategic purposes.

But cash is not the same as cash flow. So what does it mean if you blow all your cash to reduce your long term debt burden to zero? Congratulations I guess! You now have zero long term liabilities. But you haven't got any cash so congratulations again! You are now illiquid!

Sponge Bob

Scofflaw wrote: »

I have a feeling that technically, that works out as a default. Seems daft, but there you go.

Absolutely not.

Scofflaw

Hayte wrote: »

It doesn't work like that.

That €10 billion in the example we are using is a hole. Its money the bank owes in say, 10 years time (the principle) with biannual interest payments between now and then. The €2 billion is cash that the bank has right now (even if it is borrowed from the ECB but hopefully you get the idea).

If you pay €2 billion of actual cash to write off 80% of a €10 billion debt that won't be actualized in 10 years time, you are trading €2 billion in current assets for €10 billion less in (long term) liabilities. To put it another way, you are trading a problem you have to deal with later, for a problem you have to deal with right now. There are times when its a good idea to make that trade for strategic purposes.

But cash is not the same as cash flow. So what does it mean if you blow all your cash to reduce your long term debt burden to zero? Congratulations I guess! You now have zero long term liabilities. But you haven't got any cash so congratulations again! You are now illiquid!

Thanks. That makes more sense - slightly less sense the closer the bonds are to maturity, although to be fair the discount also tends to be smaller. But, again, it applies to banks, whereas the original question was about sovereign debt.

cordially,
Scofflaw

Hayte

The NTMA issues government bonds and trades them on the Irish Stock Exchange. And yeah, they can do buybacks but they usually only do it under very controlled conditions - i.e. like when the bond has very little left outstanding. Part of that is because they operate under a public mandate and there are certain things they are forbidden to do.

The NTMA is a strange organisation that works a bit like a merchant bank subsidiary of the government. So when you talk about states and banks and the differences in how they operate, ultimately it all has to go through some bank or bank like entity on an exchange.

Scofflaw

Hayte wrote: »

The NTMA issues government bonds and trades them on the Irish Stock Exchange. And yeah, they can do buybacks but they usually only do it under very controlled conditions - i.e. like when the bond has very little left outstanding. Part of that is because they operate under a public mandate and there are certain things they are forbidden to do.

The NTMA is a strange organisation that works a bit like a merchant bank subsidiary of the government. So when you talk about states and banks and the differences in how they operate, ultimately it all has to go through some bank or bank like entity on an exchange.

I think the "certain things they are forbidden to do" may be what we're looking for here.

cordially,
Scofflaw

Hayte

Yes. I think that when you strip away the jargon it goes something like this:

Do as many buybacks as you want as long as its your own money and your own skin. If its borrowed money or someone else's money, you owe a duty of care to not spend their dosh recklessly.

But the answer to the OP's question is that yes, the government can buy back its own bonds, but is limited in how much and how frequently it can do so, because they would be doing it with your money. Whilst it may stymie the cash outflow of the government over the long term, its not worth spending all the cash it has right now if it means the government doesn't have funds in the short term, or if it doesn't have cash that it needs to spend right now.

Is it better to redeem at full value? Yes. Its always better to pay your debts on time and in full. If you can do that, then other market players begin to trust you and your bonds start commanding higher prices. Theres simply more demand for them and the safety they provide. Bonds with a high price (because they are safe) have low interest yields. Thats a hallmark of a strong government and a strong domestic economy. At the very least, its a hallmark that your government and economy is stronger than everyone else's. When you have to make compromises about how much you pay back and when, then thats a hallmark of a government trying to get back to a position of strength. Our government is doing it slowly but its not there yet. Time will tell. And in the meantime, nobody make any sudden movements which could flip the boat.

Farmer Pudsey

There is another reason why it is very hard to buy your own discounted bonds. You can only buy bonds that are for sale ie most owner's may not be sellers. Say 2013 bonds are tradeing at a 25% discount as you start to buy them you begin to create a market for them. The discount may reduce now you have to buy them borrowed money which you are paying 6-8% intrest per year so you are not saving anything. Also I presume when you buy you own bonds they no longer exist so that if we started to buy Anglo bonds the more we buy the more valuable what is left becomes