sovereign debt

Claire Jones

Among the timeliest pieces of economic research produced this year has been the Committee for the Global Financial System paper that identified a “vicious circle between the conditions of public finances and those of banks”.

The reluctance of Mr Sarkozy to spend French taxpayers’ money to prop up the country’s lenders for fear that this may cause France to lose its triple-A rating, further hurting those same investments,  is just one example of this vicious circle.

It could be seen as embarrassing for regulators that they allowed banks to treat high-grade sovereign debt as though it was risk free, given that it has since been proven to be anything but.

Hervé Hannoun, the deputy general manager of the Bank for International Settlements and former Banque de France deputy, offered his take on regulators’ treatment of sovereign debt on Wednesday. Those hoping for an apology might be disappointed.    Read more

Claire Jones

Last week Bank of Japan governor Masaaki Shirakawa claimed that Europe’s sovereign crisis and the impasse over the debt ceiling could trigger a rise in government bond yields the world over.

However, Mr Shirakawa skipped over just how events in Europe and the US – which bond markets view very differently – could lead to soaring yields elsewhere.
The New York Federal Reserve to the rescue. In a note published on Monday on its Liberty Street Economics blog, Vivian Yue and Leslie Shen argue an unexpected rise of 1 per cent in long-term US bond yields can lead to a 0.14 per cent to 0.19 per cent rise in bond yields in Germany, Japan and the UK.

How so? Read more

Greek debt affordability is set to worsen considerably, according to the IMF’s Global Financial Stability Report. But in a series of charts comparing 11 countries, the striking thing is how exposed indebted economies are to rising interest rates or falling GDP.

These charts (a full set toward the end of this post) are a great way to depict several moving parts to get to the nub of the issue. The basic idea is: black line inside the green area – good; black line inside redder areas – bad. Dotted line (forecast) – likewise. (The black line, incidentally, is the historical interest rate on government debt.)

The country profiles, relative to each other, are much as you’d expect. Greece, Ireland and Portugal have less favourable interest burdens (in that order). The US, incidentally, is forecast to edge into the yellow. Japan is not. Read more

Falling Portuguese and Irish bond prices of late will have been hurting whoever is holding them. But who?

If the stress test result data is anything to go by, German banks are the most exposed of Europe’s larger banks. Caution is required here, as the stress test sample excluded medium and small banks, plus this is trading book data and positions will have changed. Caveats in mind, nine of the 14 German banks to be stress tested had exposure to Irish and Portuguese sovereign debt, totalling €4.1bn.

WestLB, Espirito Santo, Santander and RBS were easily the most exposed to the sovereign debt of both countries combined; each had more than €1bn in exposure, mostly for Portugal. Caixa Geral, Credit Agricole, HSBC and SocGen each had more than $750m.

These data should be seen in context: Read more

Further jitters at the eurozone periphery today with Irish, Spanish and Greek sovereign yields higher, and news that Spanish banks tapped the ECB for €140bn during July.

Of particular interest, demand for Italian bonds dropped significantly. This matters because European banks are exposed very heavily to Italian sovereign debt – the top 91 banks own €100bn of the stuff in their trading books. This is quadruple the trading holdings of Spanish debt, and 22 times holdings of Irish debt. Indeed, Italian debt is held in the trading books of Europe’s banks more than any other European sovereign – even German-issued debt totals just $70bn.

Italian banks Intesa and Unicredit carry the greatest trading exposure to Italy, as we would expect. After that come Deutsche Bank and Credit Agricole, each with about €10bn. See the data, split by bank, below: Read more

If a sovereign default had been factored into the recent stress tests, which banks would have failed and how severe would the contagion have been?

Not too many and not too bad, says the Peterson Institute. They used the sovereign holdings provided by 84 of the 91 banks to model an additional shock: namely, a Greek default. Researchers find bank collapses to be relatively limited – Greek banks collapse, predictably, as do those in Cyprus, but: Read more

Ratings agency Moody’s has downgraded Portugal’s debt issuer rating from Aa2 to A1; the outlook is now stable. The short-term issuer rating is affirmed at Prime 1 with stable outlook. The action concludes a downgrade review that began on May 5. The level remains above the (temporarily lowered) BBB- required by the ECB to accept a sovereign’s bonds as collateral.

The rationale, straight from Moody’s: Read more

About €35bn. That is a rough estimate of eurozone government bond purchases by European central banks since Monday.

Spreads between peripheral countries’ debt and bunds have been narrowing, as dealers report strong purchases of Portuguese, Irish, Greek and Spanish bonds. Maturities are reported at up to 10 years and lot sizes are €25m – €50m. Read more

The minimum rating on assets accepted as collateral at the Bank of England is Aa3 — but they can accept lower ratings whenever they please. That is the message of a Bank “clarification” issued today.

Conspiracy theorists might spot a pattern here. The ECB reduced its minimum threshold from A- to BBB- during the crisis, and recently extended this temporary measure into 2011. Read more

Robin Harding

The Fed has reinstated dollar swaps with Europe and Canada because European commercial banks are struggling to get hold of dollars. This problem comes up every time strain mounts on the global financial system – the dollar is the world’s reserve currency and only the Fed can provide it. The BOJ is meeting as I write to agree the same.

The policy is necessary to deal with a rise in short-term dollar interbank rates: Read more

Anti-contagion measures being discussed right now by EU finance ministers might be just a smokescreen for unprecedented action by the ECB. So says Erik Nielsen, chief European economist at Goldman Sachs.

Markets reacted negatively to the Greek bail-out, with equities falling, the euro falling and a rising cost of risk. In other words, markets began to price in a greater chance of contagion. EU finance ministers meeting today want to agree anti-contagion measures before markets open tomorrow. A statement issued Friday said all institutions of the euro area agreed “to use the full range of means available to ensure the stability of the euro area”. Read more

Ralph Atkins

Jürgen Stark has warned of a “full-blown sovereign debt crisis” unless governments take ambitious steps to bring public finances under control, saying the UK, US and Japan face even greater challenges than the eurozone.

His comments were sparked by the escalating crisis over Greece’s public debt, but he played down the idea of the ECB offering Greece a lifeline in an extreme scenario by buying its government bonds. This was not an issued being “discussed at present,” he told journalists. Read more

Robin Harding

Dylan Grice of the Societe Generale strategy team put a punchy note out yesterday on the Japan-national-debt-default-or-hyperinflation theme that occurs when one looks at forecasts of 2010 government net and gross debt of 115 per cent and 227 per cent of GDP.

Here’s a taster (the note has also been written up in apocalyptic tones today by Ambrose Evans-Pritchard of the Telegraph).

Japan’s government borrows from Japanese households and has done for decades. But Japanese households are retiring, and traditionally retirees run down their savings. So who will fund Japan’s future deficits, which are already within the range identified by inflation historian Peter Bernholz as hyperinflation ‘red flags’? Twenty years ago, who could predict long-term JGB yields below 1%? Who sees uncontrolled inflation as the primary risk facing Japan today?

Government debt cannot rise indefinitely as a share of GDP, while the greater the stock of debt and the greater the flow in any given year, the greater the chance of a crisis. I don’t agree, however, that (a) Japan is about to run out of domestic savings to fund its deficit or that (b) the most likely nature of the final crisis is hyperinflation.

As Mr Grice argues, Japan’s household savings are in decline as the population ages. Governments that need to borrow from overseas – most seriously those that need to borrow in a currency they cannot print – are in much greater danger of a debt crisis.

Japan is still very far from that position, however. Read more

Clearly they are not, in fact, risk-free (Argentina proved this). But government bonds are nonetheless viewed as the sole risk-free asset, and banks are required to hold certain amounts of them in their portfolios. The risk-free (read: government) rate is also the basis for valuing almost all assets.

Whether this should be the case is a question posed today by Michael Gordon, former CIO of Fidelity. He argues corporate bonds might be a safer bet; some corporate bonds, after all, come with an implicit government guarantee. (Perhaps corporate bonds could be split into regular and TBTF bonds.) If the view caught on, a revolution would lie ahead for markets, involving mass revaluations and financial remodelling.

But his argument assumes all types of bond issuer are equivalent financial actors. I’m not convinced of this. Read more

What connects computer screens, green cars and military power? Rare earth elements, required for the manufacture of many advanced technologies, from hybrid cars to guided missiles. China enjoys 98 per cent of REE production, cornering the market after a single US mine was closed in the mid 1980s. Chinese companies have bought stakes in Australian and Canadian rare earths prospects and have tried unsuccessfully to buy the still idle US facility.

The debt load of Eastern Europe is apparently putting off investors. But there is worse news for rich countries: investors are betting that rich countries will default on their bonds Read more