Tag Archives: Default

“Sovereign Bond Prices, Haircuts and Maturity,” JIE, 2023

With Tamon Asonuma and Romain Ranciere. Journal of International Economics 140, 103689, January 2023. PDF.

We document that creditor losses (”haircuts”) during sovereign debt restructurings vary across debt maturity. In our novel dataset on instrument-specific haircuts suffered by private creditors in 1999-‒2020 we find larger losses on short- than long-term debt, independently of the specific haircut measure we use. A standard asset pricing model rationalizes our findings under two assumptions, both of which are satisfied in the data: increasing short-run restructuring risk in the run-up to a restructuring, and high exit yields. We relate our findings to the policy debate on restructuring procedures.

“Sovereign Bond Prices, Haircuts and Maturity,” UniBe, 2022

With Tamon Asonuma and Romain Ranciere. UniBe Discussion Paper 22-13, November 2022. PDF.

We document that creditor losses (”haircuts”) during sovereign debt restructurings vary across debt maturity. In our novel dataset on instrument-specific haircuts suffered by private creditors in 1999-‒2020 we find larger losses on short- than long-term debt, independently of the specific haircut measure we use. A standard asset pricing model rationalizes our findings under two assumptions, both of which are satisfied in the data: increasing short-run restructuring risk in the run-up to a restructuring, and high exit yields. We relate our findings to the policy debate on restructuring procedures.

“Moderne monetäre Theorie: Ein makroökonomisches Perpetuum mobile (The Macroeconomic Perpetuum Mobile),” NZZ, 2019

NZZ, April 25, 2019. PDF.

  • Modern monetary theory (MMT) is neither a theory, nor modern, nor exclusively monetary.
  • I discuss fallacies related to MMT.
  • Dynamic inefficiency requires permanent, not transitory, r<g.
  • For now, policy makers should rely on common sense rather than MMT.

“Financial Policy,” CEPR, 2018

CEPR Discussion Paper 12755, February 2018. PDF. (Personal copy.)

This paper reviews theoretical results on financial policy. We use basic accounting identities to illustrate relations between gross assets and liabilities, net debt positions and the appropriation of (primary) budget surplus funds. We then discuss Ramsey policies, answering the question how a committed government may use financial instruments to pursue its objectives. Finally, we discuss additional roles for financial policy that arise as a consequence of political frictions, in particular lack of commitment.

“Sovereign Bond Prices, Haircuts, and Maturity,” NBER, 2017

NBER Working Paper 23864, September 2017, with Tamon Asonuma and Romain Ranciere. PDF. (Local copy.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Sovereign Bond Prices, Haircuts, and Maturity,” CEPR, 2017

CEPR Discussion Paper 12252, August 2017, with Tamon Asonuma and Romain Ranciere. PDF. (ungated IMF WP.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Sovereign Bond Prices, Haircuts, and Maturity,” IMF, 2017

IMF Working Paper 17/119, May 2017, with Tamon Asonuma and Romain Ranciere. PDF.

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

Puerto Rico’s Debt Restructuring

On Econofact, Daniel Bergstresser provides background information on Puerto Rico’s debt crisis. From his text:

  • Unlike U.S. municipalities, a U.S. territory cannot resort to Chapter 9 of the Bankruptcy act.
  • The island’s economy benefited from corporate tax exemptions (until 2006) and from tax exemptions on interest paid by municipal bonds issued by Puerto Rico and its agencies (“triple tax exemption”).
  • Total bond indebtedness (face value) amounts to over $70 billion, about 70 percent of the island’s GDP. The island owes an additional $50 billion in unfunded pension obligations to its state employees and retirees. Different government-sponsored entities issued the debt, apparently representing different claims on the Commonwealth’s revenue streams.
  • Puerto Rican issuers were downgraded from investment grade status in 2014. In March 2015, governor Padilla announced that the island’s debt was unpayable.
  • Resolution has been delayed by disagreement about the borrowers’ capacity to repay.
  • Puerto Rico defaulted on its general obligation debt in June of 2016 and President Obama signed the “Puerto Rico Oversight, Management, and Economic Stability Act” (PROMESA) law. This created an oversight board with the authority to oversee the island’s budget and facilitate restructuring talks. The law also created a bankruptcy-like “Title III” mechanism. The oversight board placed a moratorium on debt collection by the island’s creditors until May 1, 2017. On May 3 the island entered the debt restructuring process. Chief Justice John Roberts has assigned the case to U.S. District Judge Laura Taylor Swain, and the first hearing in that case is scheduled to occur on May 17.

Zimbabwe’s Monetary Policy

On his blog, JP Koning provides an account of recent monetary policy in Zimbabwe:

  • The country dollarized in 2008.
  • The central bank offered USD deposit accounts for banks, specifically for inter bank payments. But these accounts were not fully backed by USDs, or the central bank rationed access to USDs for other reasons (early 2016).
  • Banks got squeezed, bank customers started a run, and the government imposed withdrawal limits. Retailers started to charge higher prices for “plastic money” (USD denominated bank deposits) than for USD cash.
  • In November 2016, the central bank introduced another parallel currency, “bond notes.” The government promised that bond notes would be fully backed and redeemable in USD cash (via the African Export Import Bank) but it defaulted on that promise too. Redeeming bond notes now is as difficult as cashing in deposits.
  • Bond notes and deposits trade at a discount vis-a-vis USD cash. But the government forbids retailers to charge different prices.
  • Gresham’s law works its way.

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.

Currency Denomination Risk in the Euro Area

In the FT (Alphaville), Marcello Minnena explains what type of currency denominations of Euro area sovereign debt constitute credit events; and how markets assess the risk of such denominations.

After the Greek default in 2012

new ISDA standards entered into force: contracts made since 2014 protect against euro area countries redenominating their debt into new national currencies [unless the debt is redenominated] into a reserve currency: the US dollar, the Canadian dollar, the British pound, the Japanese yen, or the Swiss franc. In all other cases, the only way to avoid the triggering of a credit event is if the switch to the new currency does not result in a loss for the investor: “no reduction in the rate or amount of interest, principal or premium payable”.

Since 2014 two types of sovereign CDS therefore coexist: the old (ISDA 2003) and the new (ISDA 2014). The latter has always traded at spreads wider than the CDS-2003, but the difference (the ISDA basis) has generally been small: 15-20 bps for Italy, 8-12 bps for Spain, 2-4 bps for France, and 1-2 bps for Germany.

Since January 2017, the spread difference for Italy and France has increased by roughly 20 basis points.

Re-denomination Constitutes Default

In a letter to the editor of The Economist, Moritz Kraemer, sovereign chief ratings officer of S&P Global Ratings, clarifies what it would mean for France to re-denominate French debt:

Buttonwood wondered whether Marine Le Pen’s plan to re-denominate French government euro bonds into new francs might constitute a sovereign default (January 14th). There is no ambiguity here: it would. If an issuer does not adhere to the contractual obligations to its creditors, including payment in the currency stipulated, S&P Global Ratings would declare a default. Our current AA rating on France suggests, however, that such a turn of events is highly unlikely.

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.”

“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.

On the Benefits of Higher Inflation in Japan

In his blog, John Cochrane critically reviews arguments in favor of higher inflation in Japan.

He approves of the view that a conventional stimulus argument does not make much sense—given that Japanese growth is around potential and unemployment is low.

He does not approve of the view that inflation would be helpful by lowering (public and private) debt burdens. He doubts that an inflation induced default on outstanding debt would significantly lower taxes (rather than lead to more government spending) and that even if it did, such a default would increase the optimism of young households.

He also questions whether inflation could significantly reduce the real value of Japanese public debt (because debt maturity is short) and whether the debt burden is actually large (given near zero interest rates).

Credit Default Swaps

In a set of slides from Deutsche Bank Research (from 2011), Kevin Körner discusses credit default swaps and the sovereign default probabilities implied by these swaps.

The CDS spread amounts to the insurance premium a protection buyer pays to the protection seller; it is quoted in basis points per year of the underlying security’s notional amount; and it is paid quarterly. In the event of a default on the underlying security, the protection seller effectively must pay one minus the recovery rate on the security (the protection seller pays the notional amount and receives the security).

Example: A CDS spread of 339 bp for five-year Italian debt means that default insurance for a notional amount of EUR 1 m costs EUR 33,900 per annum; this premium is paid quarterly (i.e. EUR 8,475 per quarter).

“In equilibrium,” the present discounted value of premium payments (up to the maturity of the underlying security) corresponds with the present discounted compensation payments by the protection seller (up to maturity).

Current data.

Populist Dishonesty?

Marc Champion comments in Ekathimerini that the planned referendum question in Greece disguises the relevant trade-offs.

Not once in his address on the referendum did Tsipras mention the common currency. When the Associated Press asked Syriza cabinet minister Panagiotis Lafazanis whether the nirvana of reconstruction and progress he described as following from a “no” vote to the bailout would involve leaving the euro, he said: “It is you [the media] who pose this dilemma.”

A Plan for Greece

In the FT, Willem Buiter proposes a 5 point plan for a way out of the Greek debt crisis:

  • Greece effectively regains sovereignty and can do whatever it pleases, with some exceptions, see below.
  • Greek debt held by the ECB is bought by the ESM: The ESM extends long-term, low-interest financing to Greece which Greece uses to repay the ECB debt. “Since most of Greece’s other sovereign liabilities have long maturities and deferred interest payments, payments to creditors would fall sharply.”
  • No further financing by the IMF, the ESM or other official sources is extended to Greece.
  • The ECB does no longer accept any Greek government debt paper as collateral or for purchase.
  • Commercial banks in Greece are recapitalized or restructured using funds from the Hellenic Financial Stability Fund and other sources. The ECB bars Greek banks from accepting any Greek government debt paper.

The plan would require additional European taxpayer money for the ECB-ESM debt swap and the bank recapitalization. It would isolate the Greek banks from the mayhem triggered by government default.

Update: 7 July 2015

A related proposal by Willem Buiter and Ebrahim Rahbari.

The IMF on Greece vs. the Creditors

An iMFdirect blog post by Olivier Blanchard outlines the IMF’s perspective on the standoff between Greece and her official creditors. According to Blanchard, last week’s offer extended to Greece is realistic. On the part of the Greek government, it requires

truly credible measures to reach the lower target budget surplus … [and] … commitment to the more limited set of reforms.

On the part of the creditors, it requires

significant additional financing, and … debt relief sufficient to maintain debt sustainability. … debt relief can be achieved through a long rescheduling of debt payments at low interest rates. Any further decrease in the primary surplus target, now or later, would probably require, however, haircuts.

Blanchard also explains why the IMF deems pension cuts unavoidable:

Pensions and wages account for about 75% of primary spending; the other 25% have already been cut to the bone.  Pension expenditures account for over 16% of GDP, and transfers from the budget to the pension system are close to 10% of GDP.  We believe a reduction of pension expenditures of 1% of GDP (out of 16%) is needed, and that it can be done while protecting the poorest pensioners.

Blanchard recalls the 2012 agreement between Greece and her creditors:

Greece was to generate enough of a primary surplus to limit its indebtedness. It also agreed to a number of reforms which should lead to higher growth. In consideration, and subject to Greek implementation of the program, European creditors were to provide the needed financing, and provide debt relief if debt exceeded 120% by the end of the decade.

How will European governments, parliaments and taxpayers interpret the proviso “In consideration, and subject to Greek implementation of the program”?

Greece Benefited from Troika Support

In a Vox column, Jeremy Bulow and Ken Rogoff argue that perceptions of Greek net debt repayments over the last years are wrong.

[C]ontrary to widespread popular opinion, the net flow of funds (new loans and subsidies minus repayments) went from the Troika to Greece from 2010 to mid-2014, with a modest flow in the other direction after Greece stalled on its structural reforms.

They also make some other points:

  • Cash withdrawals, non-performing loans and capital losses in the wake of the 2012 Greek government debt default hurt the Greek banking system.
  • Mistrust of the Greek government by European partners and Greek citizens slowed down the recovery.
  • Greece has incentives to avoid a default on its official loans since default might trigger lower EU subsidies; the loss of other benefits of EU membership; less ELA funding and other forms of financing at below market rates. (Harris Dellas and I have argued the same in our paper Credibility for Sale.)
  • As Greece approached the point of being a net payer its bargaining stance hardened.

Greece Delays Payment of First IMF Tranche

Kerin Hope and Peter Spiegel report in the FT that Greece will delay payment of the first tranche of June payments it owes to the IMF:

Following a rarely used procedure permitted under IMF rules, the Greek government intends to bundle all the payments it owes in June totalling €1.5bn and transfer it at the end of the month.