In a blog posted on 22/09/2011 I suggested that in order to contain the contagion of the sovereign debt crisis, Italy, Spain and other major countries could tap their domestic markets which enjoy a high saving ratio and would be much more stable than International Institutions.
This blog is to elaborate on the potential use of such issues.
The launching of such bonds could be undertaken now even if the funding program for the rest of the year is already covered. The funds would be used to prevent the outstanding bonds in the secundary markets yielding more than say 5.5 to 5,75%. Taking into account the marketing expenses to place in the retail market the overal cost would reach say 4%. Therefore the current discounts would present profit opportunities.
The gradual replacement of International Investors by domestic savers and Institutions would stabilise the market of the sovereign bonds of the States concerned.
The ECB would no longer be the sole supporter of the secundary markets of the States concerned.
Finally, the more important objective would be to shield the major States concerned from contagion from Greece. If this is achieved a more realistic restructuring of the Greek Debt could be contemplated with a significant haircut (50 %).
The markets are longing for remedies which look credible.
Saturday 24 September 2011
Thursday 22 September 2011
Sovereign Debt Crisis in the EU: A new approach
In order to contain the risks of contagion of a possible default by Greece followed by Portugal and Ireland, the current consensus involves,
- the need to substantially recapitalise the Banks in particular the systemic ones,
- the unswerving commitment of the ECB to purchase in the secundary market whatever amounts of sovereign bonds from Italy and Spain are needed to prevent their yields to exceed 6% p.a. and
- the unlimited provision by ECB of liquidity to the Banks against collateral.
The judgment underlying the prescription summarized above, is that a default by Greece and other small countries would contaminate the sovereign debt of Spain and Italy. In turn this would have a devastating impact on several systemic EU banks.
The suggestion explained in this Blog argues that if contagion can be contained - that is the assurance that Italy Spain will not default - then the situation of the systemic Banks in the EU should not be a major concern. For example if it is established that Italy will not default, then it becomes clear that one of the top French Banks has been unduly savaged by the market and that it does not need that much fresh capital.
The suggestion also stipulates that what creates a risk in the sovereign debt market is the fact that a significant proportion of the debt is held by International Institutions which are volatile, fearful of any rumor and essentially destabilising: 39% for Italy, 44% for Spain, 55% for France, 57% for Belgium,72% for Ireland, 75% for Portugal, 78% for Greece. The main exception is the USA - 48% - since it benefits from the dual position of issuer of the world reserve currency, and main recipient of the emerging economies exports, in particular the BRICS.
A short term solution would therefore involve the issue by major States (France, Italy, Spain) in their domestic markets of War Loan type of bonds.
The issues would yield a small but not insignificant coupon (2,75 to 3% p.a. ?) carry some tax advantages (marginal rebates), possibly prizes - to add some lottery excitement -.
They would be placed by all retail networks, Banks, Post Office, Savings Institutions, under a program launched with patriotic undertones.
The proceeds of such domestic bond issues would be used to redeem or buy in the secundary market (initially at a discount) the bonds held by International Investors.
It is clear that the sovereign debt domestically held poses much less of a risk, as the situation of Japan shows. Its sovereign debt amounts to 200% of GDP but it is mainly held domestically. This is one of the main reasons why it is not the subject of a market panic.
In admittedly oversimplified terms, it is unlikely that a State would default to its domestic creditors when it has the power to tax them.
Over the past decades, International Institutions have increased their holdings of sovereign debt thanks to the globalisation of the financial markets, coupled with the convenience for Investment Banks to go to the wholesale market for the placement of huge amounts of bonds.
As a result domestic pools of savings have been neglected. Traditionally, several continental countries enjoy significant savings ratios. And yet in current conditions, private investors simply do not know where to invest: insignificant interest on deposits, declining stock markets, fragile and illiquid real estate markets with the exception of major capital cities where the prices are overinflated.
In short, private investors may well be very interested to subscribe.
If not as advocated by JP Fitoussi G Galateri and P Well (Fiancial Times of 15/09/2011) they could be coerced to do so as a last resort measure.
Once the fear of default by a major sovereign issuer has been dispelled, the various countries of the EU would still have to put their budgets in order. But they would do so without the feverish pressure of the international markets.
Moreover the enhancement of the sovereign debt would improve the standing and borrowing conditions of the corporations and the Banks of the States concerned.
Many Banks wouls still need additional capital but the threat of having to set up provisions for billions of sovereign debt holdings, would have been neutralised.
- the need to substantially recapitalise the Banks in particular the systemic ones,
- the unswerving commitment of the ECB to purchase in the secundary market whatever amounts of sovereign bonds from Italy and Spain are needed to prevent their yields to exceed 6% p.a. and
- the unlimited provision by ECB of liquidity to the Banks against collateral.
The judgment underlying the prescription summarized above, is that a default by Greece and other small countries would contaminate the sovereign debt of Spain and Italy. In turn this would have a devastating impact on several systemic EU banks.
The suggestion explained in this Blog argues that if contagion can be contained - that is the assurance that Italy Spain will not default - then the situation of the systemic Banks in the EU should not be a major concern. For example if it is established that Italy will not default, then it becomes clear that one of the top French Banks has been unduly savaged by the market and that it does not need that much fresh capital.
The suggestion also stipulates that what creates a risk in the sovereign debt market is the fact that a significant proportion of the debt is held by International Institutions which are volatile, fearful of any rumor and essentially destabilising: 39% for Italy, 44% for Spain, 55% for France, 57% for Belgium,72% for Ireland, 75% for Portugal, 78% for Greece. The main exception is the USA - 48% - since it benefits from the dual position of issuer of the world reserve currency, and main recipient of the emerging economies exports, in particular the BRICS.
A short term solution would therefore involve the issue by major States (France, Italy, Spain) in their domestic markets of War Loan type of bonds.
The issues would yield a small but not insignificant coupon (2,75 to 3% p.a. ?) carry some tax advantages (marginal rebates), possibly prizes - to add some lottery excitement -.
They would be placed by all retail networks, Banks, Post Office, Savings Institutions, under a program launched with patriotic undertones.
The proceeds of such domestic bond issues would be used to redeem or buy in the secundary market (initially at a discount) the bonds held by International Investors.
It is clear that the sovereign debt domestically held poses much less of a risk, as the situation of Japan shows. Its sovereign debt amounts to 200% of GDP but it is mainly held domestically. This is one of the main reasons why it is not the subject of a market panic.
In admittedly oversimplified terms, it is unlikely that a State would default to its domestic creditors when it has the power to tax them.
Over the past decades, International Institutions have increased their holdings of sovereign debt thanks to the globalisation of the financial markets, coupled with the convenience for Investment Banks to go to the wholesale market for the placement of huge amounts of bonds.
As a result domestic pools of savings have been neglected. Traditionally, several continental countries enjoy significant savings ratios. And yet in current conditions, private investors simply do not know where to invest: insignificant interest on deposits, declining stock markets, fragile and illiquid real estate markets with the exception of major capital cities where the prices are overinflated.
In short, private investors may well be very interested to subscribe.
If not as advocated by JP Fitoussi G Galateri and P Well (Fiancial Times of 15/09/2011) they could be coerced to do so as a last resort measure.
Once the fear of default by a major sovereign issuer has been dispelled, the various countries of the EU would still have to put their budgets in order. But they would do so without the feverish pressure of the international markets.
Moreover the enhancement of the sovereign debt would improve the standing and borrowing conditions of the corporations and the Banks of the States concerned.
Many Banks wouls still need additional capital but the threat of having to set up provisions for billions of sovereign debt holdings, would have been neutralised.
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