Time to copy 1953 German Debt Write-Off?

golfwallah

A Tyrant Named Miltiades! wrote: »

No. The creditors (i.e. asset managers in banks) are repaid, and the ESM borrows longer money from the markets. The Greek debt is, in effect, evergreened.

Similarly, if IMF and GLF debt is transferred into the ESM, the original redemotions are met, but a new obligation is created to private-sector investors via the ESM, with long maturities, or further refinancing.

None of this affects ESM member governments nor their government debt. The NPV of Greek debt is irrelevant to them, they aren't lending it.

I would have thought that borrowing and lending was a zero sum game, where gains in one area are cancelled out by losses elsewhere at some stage.

What you are talking about looks like "funny money" or a "three card trick", unless you can explain clearly and simply how losses on repayment by taking out a new obligation somewhere else can be made up. Are we talking about interest free loans or what? Someone has to be losing something here - presumably the ESM?

golfwallah

golfwallah wrote: »

What you are talking about looks like "funny money" or a "three card trick", unless you can explain clearly and simply how losses on repayment by taking out a new obligation somewhere else can be made up. Are we talking about interest free loans or what? Someone has to be losing something here - presumably the ESM?

No the ESM doesn't make a loss since the ESM always passes its borrowing costs onto the debtor with a token margin.

The only 'trick' lies in the fact that the ESM does not borrow money at the same profiles as it lends on. In other words, the average maturity on Greece's obligations to the ESM might be 30 years, but the average maturity on the ESM's own obligations might be ten years. That's because financial intermediaries engage in a process called maturity transformation, whereby they fund longterm lending with cheaper, short-term funds.

For this reason, the ESM can prolong the maturity on a debt and reduce the NPV burden on the debtor without suffering any loss themselves, especially when all they really have to do is break even.

The ESM can also purchase debt from other holders of Greek debt, such as the ECB and the Greek Loan Facility (EU Govts) and do the exact same thing... lengthen the maturities, and fund the purchase by cheap lending which is constantly being redeemed on the ESM's side.

Not only do the lengthened maturities increase the Greek debt sustainability, but the interest rates will probably be considerably lower.

dlouth15

A Tyrant Named Miltiades! wrote: »

No the ESM doesn't make a loss since the ESM always passes its borrowing costs onto the debtor with a token margin.

The only 'trick' lies in the fact that the ESM does not borrow money at the same profiles as it lends on. In other words, the average maturity on Greece's obligations to the ESM might be 30 years, but the average maturity on the ESM's own obligations might be ten years. That's because financial intermediaries engage in a process called maturity transformation, whereby they fund longterm lending with cheaper, short-term funds.

For this reason, the ESM can prolong the maturity on a debt and reduce the NPV burden on the debtor without suffering any loss themselves, especially when all they really have to do is break even.

The ESM can also purchase debt from other holders of Greek debt, such as the ECB and the Greek Loan Facility (EU Govts) and do the exact same thing... lengthen the maturities, and fund the purchase by cheap lending which is constantly being redeemed on the ESM's side.

Not only do the lengthened maturities increase the Greek debt sustainability, but the interest rates will probably be considerably lower.

I might not fully understand what you are saying here but what it looks like is you are saying that the ESM borrows short to lend long. They have the advantage of being backed by sovereign states and this brings down their borrowing costs.

But at the same time would it not be the case that extending maturities to their debtors incurs risk and this risk has a cost? The ESM does not know what borrowing from the markets will cost in 30 years time.

This is why long term borrowing is generally more costly than borrowing short term - the market prices in the risk associated with long term borrowing. Banks also borrow short term to lend long term but in doing so they take on that risk the cost of which they pass on to borrowers. The risk of default also increases with the length of borrowing and this risk has to be taken into account.

Although, with the case of the ESM, there's no headline cost to the tax-payer in the ESM extending maturities, it looks to me like there are costs nevertheless though politically it is easier to hide them.

dlouth15

dlouth15 wrote: »

I might not fully understand what you are saying here but what it looks like is you are saying that the ESM borrows short to lend long. They have the advantage of being backed by sovereign states and this brings down their borrowing costs.

But at the same time would it not be the case that extending maturities to their debtors incurs risk and this risk has a cost?

This is why long term borrowing is generally more costly than borrowing short term - the market prices in the risk associated with long term borrowing. Banks also borrow short term to lend long term but in doing so they take on that risk the cost of which they pass on to borrowers. The risk of default also increases with the length of borrowing and this risk has to be taken into account.

As far as banking supervisors and financial markets are concerned, ESM/EFSF securities carry a 0% risk weighting, although the longer-term securities carry a coupon to reckon for inflation risk, and these may even trade at a discount eventually, but that doesn't affect the ESM/EFSF or the their guarantors.

Investors don't really look too deeply behind the security. Nobody knows whether a particular issue will go into refinancing Irish, Greek, Cypriot, Spanish or Portuguese bonds, or whether it will be used to recapitalise some German bank that hasn't yet run into difficulties. All that ultimately matters is the ESM/EFSF's risk weighting.

Therefore, for example, the last EFSF 30-year bond issue carried an implied reoffer yield-to-maturity that was the same as the German 30-year bund. Although for reasons stated earlier, you wouldn't expect ESM/EFSF 30-year issues to be common. They have to diversify their lending pools out of prudence, but they will generally have shorter-term obligations than the dates on their financial assistance to Eurozone members.

Although, with the case of the ESM, there's no headline cost to the tax-payer in the ESM extending maturities, it looks to me like there are costs nevertheless though politically it is easier to hide them.

There are political risks associated with Eurozone membership, and with ESM membership, absolutely. But perhaps this is where risk shifts from the realms of financial mathematics into art. What is clear, is that investors in ESM/EFSF debt have never believed there was a credible default risk, and that isn't about to change.

NorthStars

McWilliams makes some good points here.
Someone has to call a halt to the German dictatorship of the EU.
I'll say one thing, Merkel has, at the moment, what Hitler never got....

http://m.independent.ie/opinion/columnists/david-mcwilliams/we-best-get-working-on-a-plan-b-as-the-next-recession-will-kill-the-euro-31377957.html

golfwallah

NorthStars wrote: »

McWilliams makes some good points here.
Someone has to call a halt to the German dictatorship of the EU.
I'll say one thing, Merkel has, at the moment, what Hitler never got....

http://m.independent.ie/opinion/columnists/david-mcwilliams/we-best-get-working-on-a-plan-b-as-the-next-recession-will-kill-the-euro-31377957.html

McWilliams does make some good points as you say but sometimes errant members of an organisation, like naughty children, just push things too far and display a total unwillingness to change their ways.

In the case of Greece, confirming what many suspected, it has now become open public knowledge that there are massive problems with corruption, black economy, poor tax collection, inefficient and expensive public services, underfunded pensions, etc., etc. and crippling borrowings that enable political leaders to avoid changing things for the better. I'm not saying the rest of the EU states don't have problems in the same areas but the scale and depth of these long running problems are huge by comparison in Greece.

The problems in Greece are such that it will take many years to sort them out - but at least these things are out in the open now and, hopefully, Greek leaders will begin to tackle them seriously. Won't be easy and, for some entrenched issues, may involve leaders putting their personal safety on the line, I would think.

Thankfully, German Chancellor Angela Merkel is also showing that she has a heart (somewhere deep inside) in this latest TV interview in which she said that

she is prepared to consider some form of debt concessions to Greece once its latest reforms are worked out.