The blue bond/red bond proposal

by on May 28, 2012 at 7:23 am in Economics, Games, Law | Permalink

The model by Mr. Delpla and Mr. von Weizsäcker , for instance, would let countries put some of their debt — equal to no more than 60 percent of gross domestic product — into so-called blue bonds issued by all members. These would presumably carry a very low interest rate.

The rest — the red bonds — would remain the responsibility of individual countries and would probably carry much higher interest rates.

Countries would need approval from a central committee to issue blue bonds, and could do it only if they followed responsible economic and budgetary policies. Germany would effectively have veto power.

“If you behave well, you have access to blue debt,” Mr. Delpla said. “If you start to behave like Berlusconi, you will not have access to blue debt, and the price of red debt will go up.” He was referring to the former Italian prime minister, Silvio Berlusconi, whose policies were blamed for much of Italy’s current economic and debt woes.

Thus Spain and Italy would still feel acute pressure to improve the way their economies function and to get better control of public spending. One big advantage of the proposal, Mr. Delpla said, is that it could be put into action quickly without a major restructuring of the European Union.

That is from Paul Geitner, here is more.  What are the problems with this?:

1. GDP figures will be manipulated, to allow for the issuance of more guaranteed debt.

2. The key is guaranteeing the banks and their deposits, at reasonable cross-border cost.  This doesn’t accomplish that.

3. Presumably a country has to pay back its joint bonds first, otherwise it is too easy to pass the buck on those and just pay back the national bonds.  That makes the purely national bonds subordinated debt and may raise rather than lower their risk.  Real private sector lending is already becoming subordinate to an unworkable degree, given all the “first in line” public lenders involved.

4. Germany still ends up with its finger on the “send you (and me) to doom” trigger, which already isn’t working out in the Greek situation.  If Spain or Italy is approaching insolvency, can the Germans really withdraw credit?  Didn’t the ECB just lend over a trillion euros, starting December 2012?  How well is that going?  Is Germany finding it easy to say “nichts mehr!”, or is the pressure for ever-greater bailouts integration?  Why should the Germans let themselves be led further down that gangplank?  Why not just call the plan “Germany commits to no more bailouts, not ever, ever again” and cross your fingers behind your back?

What else?

Bill May 28, 2012 at 7:36 am

Ask yourself this question:

If you are a creditor country with many of your banks lending to other banks and real estate developers and contractors in other countries, and those debtors are about to default to your banks, which lend to your businesses and hold the assets of your citizen depositors,

Do you

A) Say, “Nichts Mehr”

or

B) Let’s develop a workout plan.

Ever look at the financial condition of the German and French banks? Germany, and others, should be grateful that thus far sovereigns have come in and backstopped local banks.

I am waiting for cross country deposit insurance funded by fees imposed on deposits. Much of what sovereigns are doing is backstopping banks for the purpose of protecting private assets. Private assets should pay for some of the protection.

Bank runs are less expensive to stop than they are to fix. You show the bazooka, and no one challenges.

MikeDC May 28, 2012 at 11:37 am

Yes. The problem was and continues to be that banks from solvent, responsible nations will continue to lend to insolvent, irresponsible nations so long as the governments of the solvent, responsible nations subsidize this behavior, thus lowing the cost to banks and their depositors.

This is still a banking problem much more than a sovereign debt problem. The latter is a symptom of the former.

Bill May 28, 2012 at 12:21 pm

Or, Spanish, Irish and Icelandic banks will lend to real estate developers and construction companies, and take hot money loans that disappear.

Spain, Ireland, and Iceland would have been better off Had they lent to sovereigns (except Greece).

Bill May 28, 2012 at 12:29 pm

To make clear the language: Spanish, Irish and Iceland banks would have been better off had they lent to sovereigns

L. F. File May 28, 2012 at 9:03 am

Assuming Blue debt would always be cheaper than Red debt. Wouldn’t all EZ members then maximize the use of this resource and never let their debt fall below 60% of GDP? Is this a good thing or a bad thing?

lff

Mabuse May 28, 2012 at 9:03 am

Wait, don’t they have this backwards? Shouldn’t it be that individual member-states can issue their own debt and be as spendthrift as they like up to a certain point, but beyond that point they are beholden to the other member-states (and Germany in particular) to get a piece of the jointly-issued bonds. Seems to me that it would be far more effective in enforcing fiscal discipline and structural reform in such an arrangement than in the one proposed here.

Kevin May 28, 2012 at 9:18 am

The German Council of Economic Experts proposed what I think you’re suggesting last November: http://www.sachverstaendigenrat-wirtschaft.de/fileadmin/dateiablage/Sonstiges/chapter_three_2011.pdf.

I’m surprised the New York Times wrote about Delpla and von Weizsäcker’s Red Bond/Blue Bond scheme as if it were a live proposal. Daniel Gros (an influential German economist) demolished it two years ago with the observation that if the Modigliani-Miller theorem held dividing debt in this way would push peripheral states into bankruptcy.

Dismalist May 28, 2012 at 11:38 pm

That argument demolishes the proposal? It supports it, no?

dan1111 May 28, 2012 at 9:26 am

It seems like an interesting theoretical idea, that might have prevented this specific crisis (or caused it to morph into a differently-shaped crisis) had it been implemented years ago. But there are many policies of which that is true. Many of them are more elegant than this one: “don’t create the Euro” and “don’t amass huge quantities of debt” are two that come to mind.

It doesn’t solve the existing debt problem, which is what actually needs to be solved. That is probably insoluble.

Jim In Panama May 28, 2012 at 9:34 am

Took em a while, but Germany has finally taken over Europe. That whole WWII thing was a hell of a cover

dan1111 May 28, 2012 at 9:57 am

Hardy har har. If they were really running Europe, do you think it would be going this poorly?

Willitts May 28, 2012 at 12:51 pm

Invading Greece and shooting the leftists would be easier than their current strategy.

Frank May 28, 2012 at 1:25 pm

Tyler was looking for a hegemon, and didn’t believe Germany was it for historical reasons. Naive, IMO. Productivity and workforce numbers matter.

Dismalist May 28, 2012 at 11:39 pm

Everybody wrong on all counts. Germany pays. The only question is how much.

gleu May 28, 2012 at 10:21 am

I still don’t get the difference with those eurobonds fordidden by german constitutional law

chuck martel May 28, 2012 at 10:29 am

The Germans managed to absorb their eastern brothers’ failed communist effort without an international financial disaster, an accomplishment perhaps unique in history, so they should be expected to refloat the sinking economic ships of Greece, Spain and Italy as well, and not grumble about it, either.

Michael G Heller May 28, 2012 at 11:02 am

That’s crazy reverse logic. Their policy for the 2nd rescue applies the lessons of the 1st rescue.

Ed May 28, 2012 at 10:50 am

On the objections raise in the post:

1. Yes, but this is one area where more European institutions would be a good thing. Turn the measurement of economic statistics such as GDP over to the EU. For example, the unemployment rate in the state of New York isn’t manipulated by the New York State Department of Labor, its manipulated by the federal Department of Labor. This is an improvement.

2. Why is guaranteeing banks and their deposits “the key”?

3. The point about retail private sector lending becoming subordinated debt is a good one. But I still don’t understand the objection. So the purely national debt, that is guaranteed by individual countries like Greece, is subordinated to debt guaranteed by all of Europe. Why is this some sort of monstrosity. It seems like basic finance.

4. I really don’t see this, and I think lots of commentators are leaping to the conclusion or assumption that the German government joins the EU. This has been a feature of English anti-EU propaganda for decades, so it may not be surprising to see it repeated again and again by anglophone commentators. That doesn’t mean there is anything to this trope.

Bender Bending Rodriguez May 28, 2012 at 6:25 pm

Wasn’t there already a case where Greece put out an arrest warrant for a financial analyst because he told the truth about Greece’s economic situation? Or am I
mis-remembering something else?

Yancey Ward May 28, 2012 at 10:57 am

Too bad the Greeks and Europeans can’t spend stupid ideas.

8 May 28, 2012 at 11:44 am

Sounds like the European fear in the early 1980s that the US would issue “blue backs” to foreigners and continue using greenbacks internally.

To May 28, 2012 at 12:06 pm

Isn’t the whole point that states wouldn’t have to issue red bonds at all, provided they manage to reduce their debt burden to less than 60% of GDP before their existing (red) debt matures ? That market would then just be left to die.

Of course, the stronger the incentives to stay under arbitrary limits, the more likely the manipulation of debt and/or GDP numbers. My personal favorite scheme: the “public/private partnership” for building infrastructure, which Germany uses merrily.

Richard May 28, 2012 at 12:38 pm

Agreed. The Greek crisis started due to years of manipulating figures, abetted by Goldman Sachs. What’s to stop this from happening again?

The answer is probably not more regulators or a supranational level of statistics reporting. Do we trust China’s figures because they’re issued by the central government?

Or even in the US: http://www.shadowstats.com/

Bill May 28, 2012 at 12:58 pm

Youl also have to ask: what is the source of the increased debt burden: it’s the banking system which these countries are backstopping (look at Ireland and Spain, for example).

Maybe the solution is EU wide banking that requires greater cushion capital, looks at what percentage of a banks portfolio is in real estate/construction, and requires deposit insurance to protect depositors and serve as a fund to resolve bad banks.

Willitts May 28, 2012 at 12:55 pm

Spain has a spending problem?

Not if you ask Krugman.

Some people still can’t grasp the rather simple concept of revenue volatility.

Frank May 28, 2012 at 3:14 pm

Spain’s problem is it’s south.

Tom May 28, 2012 at 6:54 pm

It’s not a finance problem, it’s a spending problem; gov’ts spending too much of Other People’s Money.
So they need to borrow.
The gov’ts that need to borrow should borrow from those who get that gov’t cash: gov’t workers, gov’t pension receivers, gov’t contractors. They should be paid in 1 yr, 0% bonds, which are not legal tender (other companies don’t need to accept them as payment) BUT the gov’t will accept them as payment for taxes and fines at 100%.

Greece could issue such bonds in a week — and stop borrowing euros from “the market”.
Germany, too, could issue such bonds — and if they did, they could then insist that Greece does the same.
And the banks now lending to the low risk German gov’t, would have to start looking for real companies to lend to, as they should.

There are far fewer problems if Germany leaves the EURO zone, and allows the ECB to inflate the debt away, avoiding the problem of contract enforcement & bankruptcy. But German banks with Greek/Spanish euro loans outstanding would still be paying for it. They will pay, one way or another. Will their payment be in vain?

Bill May 28, 2012 at 9:16 pm

Tom, If you look at Ireland and Spain, what you would see is that their problem is their banking system which got stuck in a housing bubble, and will collapse without state assistance. That assistance is what is sinking the state fiscal system. If the banking system in either country had been stable, we wouldn’t be even talking about them. Greece, on the other hand, is a different problem, but even there, there is a massive tax evasion issue that needs to be addressed, although that will not solve their problem.

Dan Weber May 28, 2012 at 10:31 pm

need approval from a central committee . . . and could do it only if they followed responsible economic and budgetary policies

I’ve seen this before somewhere.

Dismalist May 28, 2012 at 11:41 pm

Sell off Crete!

A.S. May 29, 2012 at 9:06 am

“Presumably a country has to pay back its joint bonds first”

Why couldn’t they be pari passu?

Lou May 29, 2012 at 9:29 am

Can you imagine a situation where a defaulting country wouldn’t hang its shared bonds out to try? At the very least it would be another lever for the periphery to extract more support from core Euro countries.

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