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.
In his FT blog, Larry Summers argues for a “quite radical” change in government debt-management. He proposes several lessons:
“Debt management is too important to leave to Federal debt managers and certainly to leave to the dealer community. … when interest rates are near zero, it has direct implications for monetary and fiscal policy and economic performance … and … financial stability.”
“… it is fairly crazy for the Fed and Treasury, which are supposed to serve the national interest, to pursue diametrically opposed debt-management policies. This is what has happened in recent years, with the Fed seeking to shorten outstanding maturities and the Treasury seeking to term them out.”
“Standard discussions of quantitative easing … are intellectually incoherent. It is the total impact of government activities on the stock of debt that the public must hold that should impact on financial markets.”
In the US, “the quantity of long-term debt that the markets had to absorb in recent years was well above, rather than below, normal. This suggests that if QE was important in reducing rates or raising asset values it was because of signalling effects … not because of the direct effect of Fed purchases.”
“The standard mantra that federal debt-management policies should seek to minimise government borrowing costs is … wrong and incomplete. … it is risk-adjusted expected costs that should be considered. … it is hard to see why the effects of debt policies on levels of demand and on financial stability should be ignored.”
“The tax-smoothing aspect, which is central to academic theories of debt policy, is of trivial significance.”
Rather than providing opportunities for carry trade, “[t]reasury should reverse the trend towards terming out the debt. Issuing shorter term debt would also help meet private demands for liquid short-term instruments without encouraging risky structures such as banks engaged in maturity transformation.”
“Institutional mechanisms should be found to insure that in the future the Fed and Treasury are not pushing debt durations in opposite directions.”