Tag Archives: Debt

David Graeber’s “Debt”

Goodreads rating 4.19.

Graeber’s book contains many interesting historical observations but lacks a concise argument to convince a brainwashed neoclassical economist looking for coherent arguments on money and debt. After 60 pages, 340 more seemed too much.

Chapter one:

… the central question of this book: What, precisely, does it man to say that our sense of morality and justice is reduced to the language of a business deal? What does it mean when we reduce moral obligations to debts? … debt, unlike any other form of obligation, can be precisely quantified. … to become simple, cold, and impersonal … transferable.

… money’s capacity to turn morality into a matter of impersonal arithmetic—and by doing so, to justify things that would otherwise seem outrageous or obscene. … the violence and the quantification—are intimately linked. … the threat of violence, turns human relations into mathematics.

…The United States was one of the last countries in the world to adopt a law of bankruptcy: despite the fact that in 1787, the Constitution specifically charged the new government with creating one, all attempts were rejected, or quickly reversed, on “moral grounds” until 1898.

… historically, credit money comes first [before bullion, coins]

… ages of virtual credit money almost invariably involve the creation of institutions designed to prevent everything going haywire—to stop the lenders from teaming up with bureaucrats and politicians to squeeze everybody dry … by the creation of institutions designed to protect debtors. The new age of credit money we are in seems to have started precisely backwards. It began with the creation of global institutions like the IMF designed to protect not debtors, but creditors.

… the book begins by attempting to puncture a series of myths—not only the Myth of Barter … but also rival myths about primordial debts to the gods, or to the state … Historical reality reveals [that the state and the market] have always been intertwined. … all these misconceptions … tend to reduce all human relations to exchange … [but] the very principle of exchange emerged largely as an effect of violence … the real origins of money are to be found in crime and recompense, war and slavery, honor, debt, and redemption. … an actual history of the last five thousand years of debt and credit, with its great alternations between ages of virtual and physical money …

… many of Adam Smith’s most famous arguments appear to have been cribbed from the works of free market theorists from medieval Persia …

Chapter two (“The Myth of Barter”) contains questionable claims about economics as well as interesting historical facts (or claims?):

When economists speak of the origins of money … debt is always something of an afterthought. First comes barter, then money; credit only develops later. …

Barter … was carried out between people who might otherwise be enemies …

… “truck and barter”’ [in many languages] literally meant ”to trick, bamboozle, or rip off.”

What we now call virtual money came first. Coins came much later, … never completely replacing credit systems. Barter, in turn, … has mainly been what people who are used to cash transactions do when for one reason or another they have no access to currency.

Chapter three (“Primordial Debts”) argues the the myth of barter is central to the discourse of economics, which according to Graeber downplays the state as opposed to markets, exchange, and individual choice. He tries to confront this view with Alfred Mitchell-Innes’ credit theory of money, Georg Friedrich Knapp’s state theory of money, the Wizard of Oz (i.e. “ounce”), and John Maynard Keynes (original?) claim that banks create money.

In all Indo-European languages, words for “debt” are synonymous with those for “sin” or “guilt,” illustrating the links between religion, payment and the mediation of the sacred and profane realms by “money.” [money-Geld, sacrifice-Geild, tax-Gild, guilt]

Wikipedia article on the book:

A major argument of the book is that the imprecise, informal, community-building indebtedness of “human economies” is only replaced by mathematically precise, firmly enforced debts through the introduction of violence, usually state-sponsored violence in some form of military or police.

A second major argument of the book is that, contrary to standard accounts of the history of money, debt is probably the oldest means of trade, with cash and barter transactions being later developments.

Debt, the book argues, has typically retained its primacy, with cash and barter usually limited to situations of low trust involving strangers or those not considered credit-worthy. Graeber proposes that the second argument follows from the first; that, in his words, “markets are founded and usually maintained by systematic state violence”, though he goes on to show how “in the absence of such violence, they… can even come to be seen as the very basis of freedom and autonomy”.

Reception of the book was mixed, with praise for Graeber’s sweeping scope from earliest recorded history to the present; but others raised doubts about the accuracy of some statements in Debt, as outlined below in the section on “critical reception”.

 

How China Lends

In a CEPR discussion paper, Anna Gelpern, Sebastian Horn, Scott Morris, Brad Parks, and Christoph Trebesch document “How China Lends: A Rare Look into 100 Debt Contracts with Foreign Governments:”

China is the world’s largest official creditor, but we lack basic facts about the terms and conditions of its lending. … We collect and analyze 100 contracts between Chinese state-owned entities and government borrowers in 24 developing countries … First, the Chinese contracts contain unusual confidentiality clauses that bar borrowers from revealing the terms or even the existence of the debt. Second, Chinese lenders seek advantage over other creditors, using collateral arrangements such as lender-controlled revenue accounts and promises to keep the debt out of collective restructuring (“no Paris Club” clauses). Third, cancellation, acceleration, and stabilization clauses in Chinese contracts potentially allow the lenders to influence debtors’ domestic and foreign policies. Even if these terms were unenforceable in court, the mix of confidentiality, seniority, and policy influence could limit the sovereign debtor’s crisis management options and complicate debt renegotiation. Overall, the contracts use creative design to manage credit risks and overcome enforcement hurdles, presenting China as a muscular and commercially-savvy lender to the developing world.

Chinese commentary on the paper in the Global Times.

“Schuldenbremse — Licht und Schatten (Debt Brake—Merits and Risks),” FuW, 2021

Finanz und Wirtschaft, June 5, 2021. PDF.

  • The debt brake addresses some political economy frictions, but not others.
  • Focusing too narrowly on explicit government debt it provides incentives to accumulate implicit debt, sell assets, or engage in creative accounting.
  • The political pressure to raise SNB profit disbursements is a symptom of these incentives.

On Cheques

On his blog, JP Koning discusses the versatility of cheques:

  • A cheque instructs a bank to transfer deposits.
  • It is a derivative on bank deposits.
  • A post dated cheque serves as debt instrument, e.g., vis-a-vis pay day lenders.
  • An uncashed cheque may serve as money if marked “to bearer” or endorsed by the recipient. Laws grant cheques currency status.
  • A cheque may be used for payments even if other payment mechanisms break down. During the Irish banking strike of 1970, “for six months post-dated cheques circulated as the main form of money.”
  • A cheque can be used by the unbanked.

This combination of negotiability, robustness, openness, and decentralization means that long before bitcoin and the cryptocoin revolution, we already had a decentralized payments system that allowed pretty much everyone to participate and, indeed, fabricate their own personal money instruments! …

… a whole language of cheques has emerged, allowing for significant customization. By putting crossings on cheques, like this the cheque writer is indicating that the only way to redeem it is by depositing it, not cashing it. This means that the final user of the cheque will be easy to trace, since they will be associated with a bank account. Affix the words non-negotiable within the cross on the front of the cheque and it loses its special status as currency. Should it be stolen and passed off to an innocent third-party, the victim can now directly pursue the third-party for restitution. To even further limit the power of subsequent users to use the cheque as money, the writer can indicate the account to which the cheque must be deposited. This language of checks can be used not only by those that have originated the cheque, but also by those that receive it in payment. On the back of any check, any number of endorsements can be written, effectively allowing for the conversion of someone else’s payment instructions into your own unique medium of exchange.

Legal Tender

Dave Birch blogs about the concept of legal tender: a means to discharge debt.

… you cannot force a retailer to accept legal tender or indeed any other form of tender. If, however, you buy something from them and there is no contractual barrier to the use of any form of tender, and you offer legal tender in payment, and they refuse it, then they cannot enforce the debt in court. That’s what legal tender means: it’s about discharging debts. If you incur a debt you can discharge it with legal tender, but you cannot be forced to incur the debt in the first place …

 

Government Debt with State Contingent Coupons

On VoxEU, Myrvin Anthony, Narcissa Balta, Tom Best, Sanaa Nadeem, and Eriko Togo discuss the history of government debt with state contingent coupons and offer some lessons.

  • In the mid-19th century, the Confederate states issued cotton-linked bonds
  • In the late 1970s, Mexico issued oil-linked bonds
  • In the 2000s, Turkey issued revenue-indexed bonds
  • Since 2014, Uruguay issues nominal wage-issued bonds
  • Some other examples (figure taken from the column):
  • Obviously, confidence in data quality and thus, quality of institutions is important for the success of such issues.

State contingent securities also have been used in debt restructurings:

The first use of state contingent bonds in debt restructurings occurred in the Brady deals from 1989-97, which allowed commercial banks’ claims on debtor countries to be exchanged for tradable instruments, allowing the banks to clean up their balance sheets. Many of these instruments included ‘value recovery rights’, which envisaged additional debt payments in circumstances where the debtor country’s economic or terms of trade conditions improved substantially … Oil exporters generally linked the payments to oil prices, while other countries linked either to GDP or measures of the terms of trade. Many of the Brady instruments subsequently made significant ongoing upside payments (e.g. Bosnia and Venezuela), while in some cases sovereigns chose to repurchase the instruments as it became clear that upside payments would be triggered (e.g. Mexico, and Bulgaria in the mid-2000s).

More recently, ‘upside’ GDP-warrants have featured as part of the package of bonds issued to creditors in each of the three major restructurings of the past decade: Argentina (2005 and 2010), Greece (2012), and Ukraine (2015). In the case of Grenada (2015), the restructuring deal included instruments with both upside and downside features (Table 2).

Inflation linked bonds have been successful:

Inflation-linked bonds have a long history, dating back to a 1780 issuance by the State of Massachusetts … More recently, they emerged in Latin America in the 1950s and 1960s, in an environment of very high domestic inflation, and the UK became the first advanced economy to issue inflation-linked bonds in 1981. … the global stock of government inflation-linked bonds had grown to around USD 3 trillion by 2015 … Despite this recent growth, inflation-linked debt still accounts for a relatively small share of sovereign debt portfolios in most countries …

Related VoxEU column on policy implications.

Predictors of Default

On Science of Us, Seth Stephens-Davidowitz reports about predictors of loan repayment choices.

… language that potential borrowers use is a strong predictor of their probability of paying back. And it is an important indicator even if you control for other relevant information lenders were able to obtain about those potential borrowers, including credit ratings and income. …

Here are the phrases used in loan applications by people most likely to pay them back: debt-free, lower interest rate, after-tax, minimum payment, graduate.

And here are the phrases used by those least likely to pay back their loans: God, promise, will pay, thank you, hospital.

Conference in Honor of Bob King at the Study Center Gerzensee

Jointly with the Journal of Monetary Economics and the Swiss National Bank, the Study Center Gerzensee organized a conference in honor of Bob King, long-term supporter of the Study Center.

Program: PDF.

Jaume Ventura’s discussion of a paper on trade and growth by Alvarez and Lucas: PDF.

My discussion of a paper on debt and debt constraints by Bhandari, Evans, Golosov, and Sargent: PDF.

Pawn Shops, Information Insensitivity, and Debt-on-Debt

In a BIS working paper (January 2015), Bengt Holmstrom summarizes some of the implications of the research on information insensitive debt. He cautions against moves to increase transparency in debt markets and defends the shadow banking system. He explains why opacity and information insensitivity are valuable and argues that debt-on-debt arrangements are (privately) optimal.

It all started with pawn shops:

The beauty lies in the fact that collateralised lending obviates the need to discover the exact price of the collateral. …

Today’s repo markets … are close cousins of pawn brokering with similar risks for the parties involved. … the buyer of the asset (the lender) bears the risk that the seller (the borrower) will not have the money to repurchase the asset and just like the pawnbroker, has to sell the asset in the market instead. The seller bears the risk that the buyer of the asset may have rehypothecated (reused) the posted collateral and cannot deliver it back on the termination date. … the risk that a pawnbroker may sell or lose the pawn was a big issue in ancient times and could explain why the Chinese pawnbrokers were Buddhist monks. …

People often assume that liquidity requires transparency, but this is a misunderstanding. What is required for liquidity is symmetric information about the payoff of the security that is being traded so that adverse selection does not impair the market. …

… stock markets are in almost all respects different from money markets …: risk-sharing versus liquidity provision, price discovery versus no price discovery, information-sensitive versus insensitive, transparent versus opaque, large versus small investments in information, anonymous versus bilateral, small unit trades versus large unit trades. … money markets operate under much greater urgency than stock markets. There is generally very little to lose if one stays out of the stock market for a day or longer. This is one reason the volume of trade is very volatile in stock markets. In money markets the volume of trade is very stable, because it could be disastrous if, for instance, overnight debt would not be rolled over each day. …

… debt-on-debt is optimal … . It is optimal to buy debt as collateral to insure against liquidity shocks tomorrow and it is optimal to issue debt against that collateral tomorrow. In fact, repeating the process over time is optimal, too, so debt is in a very robust sense the best possible collateral. This provides a strong reason for using debt as collateral in the shadow banking system. …

Panics always involve debt. Panics happen when information insensitive debt (or banks) turns into information-sensitive debt.

Puerto Rico and its Control Board

In the FT, Eric Platt offers an update on the debt situation in Puerto Rico:

  • The U.S. territory carries a USD 70 billion debt burden.
  • It has defaulted multiple times over the past year, “including on bonds backed with a constitutional guarantee.”
  • It did not have access to a court-backed restructuring process until Congress recently passed and President Obama signed the Puerto Rico Oversight, Management and Economic Stability Act (Promesa).
  • A seven-person control board controls the island’s finances and will oversee negotiations with creditors.
  • Puerto Rico has two weeks to submit a turnaround plan to the board.

New Questions about Greece’s Indebtedness

On the FT’s Alphaville blog, Matthew Klein reports about discrepancies between IMF and Greek (and EU) assessments of Greek net indebtedness. The IMF appears to report lower Greek financial asset holdings than the Greek Central Bank.

Matthew Klein quotes the Greek Central Bank:

We would like to clarify that the Bank of Greece compiles its financial accounts, from which data on the general government’s net debt are derived, according to European standards. The Bank of Greece’s data are compatible with the ECB’s and Eurostat’s rules (ESA 2010) regarding financial accounts and are used as an integral part in the production of the Monetary Union’s Financial Accounts. These data can also be accessed through the ECB’s Statistical Data Warehouse at http://sdw.ecb.europa.eu/reports.do?node=1000002429.

The IMF’s series on the general government’s net debt come from its WEO database and are not necessarily based on official statistics provided by Greek Statistical authorities. We understand that they may be compiled by IMF’s desk economists (and not its Statistics Department) and we cannot vouch for their accuracy, since they are adjusted according to the programming needs of the IMF. At first glance, they appear to be based on outdated information contained in past EDP [excessive deficit procedure] documentation.

Greek Debt: Now and Then

In the FT, Mehreen Khan offers a “Greek debt dilemma cheat sheet.”

  • Face value: EUR 321 billion, thereof EUR 248 billion owed to official creditors.
  • Official creditors: Eurozone countries (Greek loan facility), eurozone rescue funds (EFSF and ESM), IMF, ECB.
  • Maturity profile:
    1
  • IMF proposal for restructuring:
    2

Banks Without Debt

In his blog, John Cochrane points to SoFi, a FinTech company, as proof that banking services can be delivered by institutions without the traditional characteristics of a bank.

SoFi finances loans by selling equity. The loans are securitized and the cash is reinvested in loans. As John points out:

  • A “bank” (in the economic, not legal sense) can finance loans, raising money essentially all from equity and no conventional debt. And it can offer competitive borrowing rates — the supposedly too-high “cost of equity” is illusory.
  • There is no necessary link between the business of taking and servicing deposits and that of making loans. Banks need not (try to) “transform” maturity or risk.
  • To the extent that the bank wants to boost up the risk and return of its equity, it can do so by securitizing loans rather than by borrowing. (Securitized loans are not leverage — there is no promise of your money back when you want it. Investors bear any losses immediately and without recourse.)
  • Equity-financed banking can emerge without new regulations, or a big new Policy Initiative.  It’s enough to have relief from old regulations (“FDIC-free”).
  • Since it makes no fixed-value promises, this structure is essentially run free and can’t cause or contribute to a financial crisis.

Argentina to Resolve Litigation and Return to International Capital Markets

In the FT, Daniel Politi and Pan Kwan Yuk report about an agreement between Argentina and four holdouts, yet to be implemented by Congress.

A few weeks ago, New York judge Griesa had indicated that he would lift the injunction preventing Argentina from servicing its restructured debt. This improved Argentina’s bargaining power. According to The Economist, Griesa had written: “President Macri’s election changed everything. … The Republic has shown a good-faith willingness to negotiate.”

Central Bank Reserves: Debt vs. Equity

In jusletter.ch, Corinne Zellweger-Gutknecht argues that the legal status of central bank reserves is more equity- than debt-like—at least as far as the Swiss National Bank (SNB) is concerned. According to Zellweger-Gutknecht, reserves constitute debt only if the SNB is legally obliged to redeem them in exchange for central bank assets.

If the SNB purchases dollars against Swiss Francs in an open market operation, it creates reserves which are equity-like. But if it acquires dollars against Swiss Francs and is committed to engage in a reverse transaction in the future (a swap), then it (temporarily) creates reserves which are debt-like.

Argentina’s Debt Negotiations

In the FT, Chris Giles, Gillian Tett, Elaine Moore and Benedict Mander report about the negotiations between Argentina and the country’s creditors that are about to start, now that the new government has taken office.

Argentina’s finance minister has announced that the country intends to honor the face value of outstanding debt but wishes to negotiate interest payments.

As a sign of support from the international community, Jack Lew, Treasury secretary, announced that the US had ended its formal opposition to the World Bank and other multilateral development banks’ lending to Argentina.

Observers expect that the IMF will soon be involved to provide technical assistance.

In an FT blog, Charles Blitzer argues that successful negotiations should start with a non-disclosure agreement. He links to the Institute of International Finance‘s Principles for Stable Capital Flows and Fair Debt Restructuring.

Accounting for Leasing

In the FT, Kate Burgess, Harriet Agnew and Scheherazade Daneshkhu report about new accounting rules according to which companies will have to report leasing commitments as debt (and the leased assets as on-balance-sheet assets).

A new financial reporting standard — the culmination of decades of debate over “off-balance sheet” financing — will affect more than one in two public companies globally.

Retail, airline and hotel companies are expected to be affected most strongly.

Quasi-Sovereign Debt

In the FT, Elaine Moore and Jonathan Wheatley report about the increasing importance of sovereign-backed corporate and other debt in emerging markets.

New figures from JPMorgan and Bond Radar show that issuance of quasi-sovereign bonds outpaced that of sovereign bonds in emerging markets last year, raising the stock of such debt from $710bn in 2014 to a record $839bn by the end of 2015. By comparison, the stock of all external emerging market sovereign debt stood at $750bn at the end of last year, according to JPMorgan.

Quasi-sovereign borrowers include firms that are owned in large parts or controlled by the state, as well as local governments. Although the liabilities of these borrowers may be explicitly or implicitly guaranteed by the state, the official public debt statistics typically do not account for them.

 

Banks’ Debt Valuation Adjustments Will End

In the FT, Ben McLannahan reports about a change in US accounting standards concerning the valuation of bank debt.

Under the rules in place since 2007

banks were allowed to use market prices when valuing their own debt, meaning they could book profits when their debt fell in value and losses when it rose.

Particularly during the financial crisis this led to sizable effects of swings in debt prices on bank profits. Under pressure from financial institutions, the Financial Accounting Standards Board “threw in the towel” and follows the International Accounting Standards Board which already backtracked in 2014. Under the new rules the debt valuation adjustments are expected to become more or less irrelevant.

The intention of the 2007 rules was clear:

… if banks were going to book their assets at market value, rather than cost, they should also book their liabilities at market value. Companies should therefore be allowed to recognise gains when the value of their bonds fell below par, the FASB reasoned, on the assumption that they would be able to buy them back at a discount.

But this implied that banks “booked income in bad times and expenses in good times.”

“Sovereign Debt with Heterogeneous Creditors,” JIE, 2016

Journal of International Economics 99(S1), March 2016, with Harris Dellas. PDF.

We develop a sovereign debt model with heterogeneous creditors (private and official) where the probability of default depends on both the level and the composition of debt. Higher exposure to official lenders improves incentives to repay due to more severe sanctions but it is also costly because it lowers the value of the sovereign’s default option. The model can account for the co-existence of private and official lending, the time variation in their shares in total debt as well as the low rates charged on both. It also produces intertwined default and debt-composition choices.

Lack of Trust in the European Commission

In the FT, Henry Foy reports about critical comments by Jeroen Dijsselbloem. The chair of the Eurogroup has argued that the Euro area needs an independent fiscal oversight body to disperse fears of “politicised” European Commission decisions when it comes to evaluating national budgets.

Naturally, lack of trust in the Commission is widespread. But now it seems to have reached the higher echelons of EU institutions themselves.

In the meantime, Tony Barber writes (also in the FT) that “The eurozone’s fiscally lax nations are at it again”.