What's going on here? Obviously, Greece was going to need decades to pay off loans, in the sense of running primary surpluses to actually work down debt. Why lend Greece money for a short amount of time, then institute regular "crises" about rolling over the debt?
This is part of a larger question. In "A new structure for U. S. Federal debt" I thought about the same question for the U.S. Why does the U.S. continually issue new debt to pay off the old debt? Why not just issue perpetual debt, which automatically rolls over? For the U.S., I couldn't come up with a decent reason.
For Greece, there is a good reason. Yes, in the end, the IMF will most likely lend Greece the money to pay back the IMF. Or maybe the ECB will lend Greece the money to pay back the IMF. But both sides will renegotiate the terms.
The IMF and Europe lent money to Greece with conditions that are politically painful, but that are be beneficial for Greece and for the chance of the money being paid back eventually, at least in the IMF and Europe's eyes. (I don't agree with all the conditions, especially tax increases, but the point here is the negotiation not the wisdom of the terms.) By lending for a year and then renegotiating, they can enforce that Greece actually follows through on the conditions.
If you are going to lend money to a spendthrift relative you might want to do the same thing. Limit the time of help, and in a year we'll see if you're really cleaning up your act.
But this is a two-sided renegotiation. They can only impose conditions if the costs to them of allowing a default are not too large. And Greece will only take the conditions if the costs of default to them are large. So it is to Greece's interest to make its default as painful to the rest of Europe as possible.
Also by calling it a roll over, though, Greece had an interesting option -- if it didn't like "austerity," it could try other means of reviving their finances and paying off the debt. It's too late for that one.
Doug Diamond and Raghu Rajan in a series of papers have been arguing that short-term debt allows lenders to monitor and discipline the borrowers. "Short" here can mean years, any debt that has to be rolled over a few times before being eventually paid off. This situation seems like a good instance of their theory.
Back to the U.S., though, this does not strike me as a good argument that the U.S. should voluntarily issue debt that needs to be rolled over. So I'm still in favor of perpetuitites for the U.S.
The Wall Street Journal's Greek Debt Timeline is an interesting perspective on this issue. I excerpted the full set of payments, and the payments due in 2015 and 2016 below. Of course, as debt is rolled over, new payments take the place of old ones.
Except "treasury bill holders," the debt until 2020 is almost all due to governments. A small slice of "private investors" starts showing up after that. So for the next 5 years, this really is about IMF and ECB lending money (presuming nobody else wants to) to pay back loans to the IMF and ECB.
The 2015 and 2016 graphs make it even clearer. All the loans are to IMF, ECB or EIB.
But..What about these Treasury bill holders? There is this huge slice of debt that needs to be rolled over this summer. Who is going to do that? Who is holding this debt?
One problem with the US issuing perpetual debt is that we then do not ever have the option of paying it off without the holders' consent. Also, lenders might be more interest-rate risk adverse than the US, meaning that they would charge more for a perpetuity than we would end up paying if we rolled it over periodically.
ReplyDelete-dk
Just make it callable. There's still Napoleonic debt from the UK floating around out there. They just rarely call it because the interest is so low.
DeleteJohn,
ReplyDelete"Why does the U.S. continually issue new debt to pay off the old debt? Why not just issue perpetual debt, which automatically rolls over?"
The first question you must ask is why does the U. S. government bother to issue debt at all? And the reason is quite simple - insurance. The U. S. government sells default risk free debt to banks, insurance companies, and other financial institutions so that they can mix and match it with private debt to reduce overall credit risk.
Your question - why doesn't the federal government issue perpetual debt is quite simple as well - ACTUAL perpetual debt is what it sounds like. It is never redeemed. Once sold, the federal government is legally precluded from buying it back or canceling it.
Perpetual debt has some policy implications:
1. The federal government would not have an outlet for tax revenues in excess of expenditures. With fixed term debt, the federal government can use revenues in excess of expenditures to reduce outstanding debt. With perpetual debt, it cannot.
1a. Liquidity. In the presence of government surpluses, perpetual debt causes the federal government to withdraw liquidity from an economic system. Government becomes a mattress stuffer.
2. When you insure something, you try to match the duration of assets and liabilities. Perpetual debt short circuits that process since there are no perpetual private debts to insure against. This has the potential to create zombie financial institutions.
3. There are also political implications. Elected representatives should serve at the will of the people. And so, if the will of the people is for the federal government to reduce it's debt, that will should be accommodated. Perpetual securities can violate this will.
@Frank Restly - re your #1 - that's not true. Even with perpetual debt the USA could set up a fund to offset the perpetual debt, and fund this fund when and if revenues are in excess of expenditures. The US could set up this fund that legally cannot be used except to offset or pay off a portion of the perpetual debt.
DeleteThis comment has been removed by the author.
DeleteRay,
DeleteSee:
http://www.merriam-webster.com/dictionary/perpetual
a : continuing forever : everlasting as in perpetual motion
b (1) : valid for all time as in a perpetual right
(2) : holding (as an office) for life or for an unlimited time
2: occurring continually : indefinitely long-continued as in perpetual problems
I don't think the term "perpetual" is ambiguous here.
Frank,
DeleteYes, you can issue "perpetual" debt, then buy it back and cancel it. Or, if you want to be utterly pedantic, you can issue Consols, which are debt instruments that have no specific redemption date and are valid indefinitely unless and until redeemed at the option of the issuer (other redemption rules may be applied).
Anonymous,
DeleteWas that so hard? See:
http://johnhcochrane.blogspot.com/2015/05/on-writing-well.html
Okay, so you want Consols where the option to redeem is left totally to the issuing agent (the federal government as borrower).
So how do Consols function as an insurance instrument when both the rate of return and the date of redemption are totally at the discretion of the federal government?
As a potential buyer of Consols, I can't duration match it with other private debt and I can't insure against interest rate risk on private debt. In short, as a bank / insurance company / or other financial institution, I would have no use for them?
Who is the would be buyer for perpetual debt sold by the federal government? The simplest question to ask yourself is if you want the federal government to sell something, are you willing to buy it? Are you?
From what I understand those treasury bill holders are mostly local Greek banks, owned indirectly by the Greek state, which now buy the treasuries with ECB's ELA. That is also why some are calling what's going on is a disguised form of monetary financing.
ReplyDeleteYes, and this is why it is being closely monitored by the troika with a strictly enforced ceiling being placed over such financing.
DeleteGeorge J. Georganas
Absolutely true, it's mainly Greek banks trying to keep the Greek state afloat, then posting the very same bills as collateral to the Greek central bank who provides Greek banks with liquidity (within the limits decided by the ECB).
DeleteThere might be also a few other investors with high risk-appetite lured by the high yields (a rarity nowadays) and by the fact that t-bills tend to be safer than bonds, even for the same maturities. Usually t-bills are not involved in restructurings/defaults as they are an important source of short term liquidity; indeed markets differentiate the yields of bills and bonds in time of stress, as described for example in the following article:
http://blogs.wsj.com/eurocrisis/2013/02/18/mediobanca-finds-worry-in-new-italy-yield-gap/
However in the case of Greece now there's not much money left to pay even the t-bills...
Aha! Thanks. Yes, these debt schedules ignore ELA financing by ECB. So the ECB limiting ELA could trigger a failure to roll the Bills?
DeleteYes.
DeleteIndeed, the schedules in the original post do not take into account the financing by the ECB of Greek banks, since, stricly speaking, ECB is not financing the Greek state (directly, anyway).
DeleteOne can get a clear view of the size of ECB financing by graphing the data on liabilities of Greek banks to the Bank of Greece (in effect to the European System of Central Banks, essentially the ECB).
http://www.bankofgreece.gr/BogDocumentEn/Aggregated_balance_sheet_MFIs.xls
As of April 2015 this financing had not yet reached the records it had established in the period between November 2011 and December 2012, but its rate of increase, starting in November 2014, has been itself a record.
A "failure to roll the Bills" can come about through the refusal of the ECB to keep extending credit to the Greek banks that bleed deposits every day, thus forcing them to demand payment of the Bills, instead of rolling them over. Since banks are effectively controlled by the state, one would expect this to happen only after all other means of conserving cash have been exhausted. Thus, one would expect limits on cash withdrawals from bank accounts, thus enabling the government to meet its payroll for a short time yet, rather than a failure to roll the Bills. After all, the government needs to be able to pay the wages of police and army that will likely be called to guard the banks, as well as of the judiciary who will be called upon to try the many troublemakers. Who knows, the government might also need to pay for search parties to slit open cash-stuffed matresses ...
A failure to roll the Bills will not be a triggering event but, rather, the end result of other adverse developments.
George J. Georganas
One problem with issuing perpetual debt is that the Government only wishes to do it when interest rates are low - but then private buyers are reluctant to buy. The British government issued perpetual debt to finance wars in the 18th and 19th century, but then found that they were faced with an unnecessarily high interest bill when nominal interest rates fell during the long 19th century peace. In (I think) 1888 they managed to convert outstanding perpetual debt to a lower interest rate (I don't know the legal background which explains how they were able to do this). Similarly they financed the First World War by issuing perpetual debt, but cleverly inserted a get-out clause which allowed them the option of redemption or conversion to a lower rate after 15 years. Without get-out clauses of this type perpetual debt can end up being expensive to finance.
ReplyDeleteCall options are not free. And they can be issued separately from bonds.
DeleteJohn,
DeleteWhat is the point of having the federal government sell perpetual debt and then turn around and sell 30 year call options on the same debt? Why not just sell 30 year debt?
Japan is disappearing its debt tbrough QE.
ReplyDeleteThe US could do the same.
Maybe it will have to.
No, Japan is turning its debt from long maturity to zero maturity. Central bank reserves are just very short term government debt.
DeleteJohn,
ReplyDeleteI've seen the suggestion that the government should issue "trills", which are perpetual instruments that pay, say, one trillionth of US GDP per year. Thus, today a trill would pay about $16.80/year, equivalent to the interest on a perpetual bond of about $700. Conceivably, even government expenditures could be set by allocating trills (thus, entitlement programs could be allocated trills); and the value of a trill would provide market-based input on the expected effect of government initiatives. Any thoughts on that idea?
I'm not a huge fan. If the point is to force countercyclical stimulus, you don't really need a new kind of debt to do that. If the point is to create state-contingent debt, GDP is a poor indicator of when to cut payments. Companies don't pay dividends mechanically linked to sales. So I'm sympathetic to the general idea but I think there are better ways to do it than link to GDP.
DeleteMore thoughts on p. 35 here
http://faculty.chicagobooth.edu/john.cochrane/research/papers/Cochrane_US_Federal_Debt.pdf
John,
ReplyDeleteThanks for the link. On the adjustable-coupon debt idea, and your belief that governments would lower coupons only rarely and in extremis, I honestly laughed aloud!
I understand what you're saying, but I think any such instrument would need more safeguards than "trust us not to inflate". We already know how that turns out.
Really? What inflation? Now trending downwards despite our central banks best efforts? Yes, the US had bouts of inflation in the late 40s and mid 70s. But since 1980, the facts are a broad decline in inflation. We should not let well founded cynicism get ahead of the facts. Our governments have, for quite a long time, avoided the equal temptations of inflation and default. Yes, so far, but we do not live with chronic hyperinflation.
DeleteWe've become so accustomed to inflation that we think nothing of the fact that dollar-denominated assets have lost 17% of their value in the past decade, and 35% since 1995. And that's what we consider "practically nothing", because it's often been much faster than that. I would expect that coupon-lowering would quickly proceed to an annual target rate...
DeleteInflation aside, the historical record on Consuls shows that governments are prone to lower interest payments (quite frequently sometimes) and never raise them back.
DeleteThat lends itself to the theory that government will respond to a crisis by lowering the interest rate and once that crisis is over government will find a new one to justify an even lower interest rate.
What episodes do you have in mind? The UK re-funded its cosols in the 1870s, but it had sold them with an explicit right to recall them at par, so this was not a default. And having sold the new lower interest consols, there was no need or expectation of raising rates. Yes, there were many defaults early on, and Greece and Argentina default today. And everyone basically defaulted in leaving the gold standard. But what example is there in the last 250 years of an advanced economy lowering interest on consols and not raising them again?
DeleteJohn,
Deletehttp://en.wikipedia.org/wiki/Consol_(bond)
When did the UK raise the rate back to the original 3 1/2% or even raise the rate at all?
1751 Consols first issued
1752 Consolidated 3.5% Annuities
1752 Reduced 3% Annuities
1757 Consolidated 3% Annuities
1855 New 3% Annuities
1888 National Debt (Conversion) Act 1888 (Goschen's Conversion)
1888 2¾% Consolidated Stock
1903 2½% Consolidated Stock
1923 to present 2½% Consolidated Stock
The ones I know, such as Goschen's, are not arbitrary reductions in coupons. The consols included a call option. When interest rates fell, the government exercised its call option. This is just like refinancing a fixed rate mortgage at a lower rate. When rates fall from 6 to 3 percent there is nothing nefarious about refinancing.
DeleteThe right analogy is dividends or preferrred stock, where a corporation has the right to lower payments and then to raise them. Miraculously, companies seem to pay dividends.
The ones I know, such as Goschen's, are not arbitrary reductions in coupons. The consols included a call option. When interest rates fell, the government exercised its call option. This is just like refinancing a fixed rate mortgage at a lower rate. When rates fall from 6 to 3 percent there is nothing nefarious about refinancing.
DeleteThe right analogy is dividends or preferrred stock, where a corporation has the right to lower payments and then to raise them. Miraculously, companies seem to pay dividends.
That isn't miraculous at all. We know that the shareholders own the profits. The dilemma is between distributing those earnings today, or retaining them now and paying them out at a later date. This is a poor analogy to government debt, because citizens own the residual assets of government, but coupon payments are being made to a different group - which might be outside the country altogether. The case of Greece makes the conflict between these two claimants very clear - two groups fighting over the same pile of resources.
DeleteMost call options that I am familiar with offer redemption on the call date. Meaning that if you don't like the new terms ("refinance rate") you can walk away.
DeleteThat was not my impression of Consols (but I could be wrong). It was my impression that Consols were not redeemed once sold. Once bought, you were stuck with whatever interest rate was chosen by the UK government.
So the question becomes - do you want the federal government to sell Consol like securities where the government upon changing the interest rate must redeem and then roll over the entire federal debt?
"The right analogy is dividends or preferrred stock, where a corporation has the right to lower payments and then to raise them. Miraculously, companies seem to pay dividends."
There is nothing miraculous about it and that is the wrong analogy because with dividends / preferred stock, the voting stake in the company is controlled by the owners of that stock. That is not the case with sovereign debt of any kind.
The voting stake in a sovereign is not allocated to the biggest owner of the debt of that sovereign.
I guess the reason why the U.S. Government keep the debt high is that they want to protect the value of USD by connecting USD with other money. Since those money are connected, a drop in value of one kind of money will cause the other connected money drop too, so if they want to keep their money in high value, they have to keep the money of other connected country in high value too. therefore, each other in the connection will help to protect money value of each other.
ReplyDelete