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And Now, For The Prime Attraction: Subordination Vs Moral Hazard
We have long been concerned at the implicit and explicit subordination of both financial and sovereign bondholders in Europe by the actions of their overlords political elite in pursuit of short-term liquidity fixes to insolvency issues. As talk of the ESM coming to life in the short-term and a 'Redemption Pact' in the intermediate term - which as Goldman describes involves mutualizing a portion of each country's debt (resulting in a partial upgrade of the existing pool of Eurozone sovereign bonds) in a European Redemption Fund (ERF) and, in the process, extending debt maturities (kicking that can) onto the public sector's balance sheet. As with all these mutualization schemes, the ERF ineluctably raises the twin problems of 'moral hazard' and 'subordination', which need to be mitigated. Goldman discusses these two sides of the same coin as it notes subordination is explicit when the ESM intervenes (and also with the ECB's SMP) but a little less obvious in the ERF (though still as painful) which is, we note, perhaps more appealing to keep the masses unaware.
Goldman Sachs: Trading Off Moral Hazard against Subordination
As all mutualisation schemes, the ERF ineluctably raises the twin problems of ‘moral hazard’ and ‘subordination’, which need to be mitigated. We consider them in turn.
‘Moral Hazard’: A prominent concern for a fiscally strong countries participating in the ERF is the potential for a relaxation of the budgetary efforts of fiscally weak countries once their debt has been mutualised. This risk is amplified by the fact that, according to the blueprint, the ERF would take over the riskiest part of national debt, i.e., the portion above 60% of GDP.
The Redemption Pact would (only) work under a reinforced conditionality, where countries subjugate their fiscal authority to stringent external control, in our view. The ‘fiscal compact’ and ‘debt brake’ rules not only need to be ratified by all participating countries, but may need to be supplemented by enhanced delegation of fiscal authority (for example, last year Germany's CDU had floated the idea of a ‘Sparkommissar’, an EU commissioner for public finances). Moreover, the Redemption Plan would require sovereigns to pledge assets as collateral (gold, fiscal revenues, government stakes in public companies) to the ERF in proportion to the debt the fund takes over. These assets could be seized (even temporarily) in the event of fiscal profligacy. This seems to be more credible than the penalties currently envisaged by the fiscal compact.
In evaluating the proposal, it is important to consider the ‘moral hazard’ risk embedded in alternatives to the ERF. Open market interventions by the ECB, either through the Securities Markets Program or the LTROs, expose the balance sheet of the central bank to credit risk. Potential losses are mutualised among the ECB’s shareholders on a joint-and-several basis. Further, such ‘risk sharing’ comes without a ‘time consistent’ control over public finances of debtor countries, and no collateral. Purchases by an (ECB-levered) ESM may have conditionality attached to them, but involve explicit subordination of existing bondholders, as the fund enjoys preferred creditor status. The recent experience of Spain illustrates how sensitive markets are to shifts in seniority.
'Subordination’: EMU countries have already agreed to structural budgetary restraint, and reducing public debt steadily (the 1/20th ‘rule’). Some, like Italy, are also contemplating selling public assets to reduce outstanding liabilities. Given this backdrop, fiscally weaker countries may acquiesce to tighter constraints on their sovereignty in fiscal matters and agree to pledge collateral. Their concern, however, will be around the issue of subordination of the portion of sovereign debt that will remain national.
Access to stable funding and reduction in borrowing costs on ERF debt should result in an increase in a country’s ability to service the first 60% of debt. But for this result to hold, it is critical that the ERF is explicitly pari passu with existing bondholders, and that collateralization is appropriately calibrated (in our calculations, we use 15-20% of debt). For this reason, ERF bonds need to be jointly and severally guaranteed by all participants. If the ERF issuance is only severally guaranteed, as some commentators have advocated, the fiscally strong countries, like Germany, would be transferring less of their creditworthiness to the Fund. This would entail that larger collateral pools would need to be transferred to the ERF in order to make its bonds palatable. And the greater the collateral, the bigger the subordination of national bonds.
Subordination is explicit when the ESM intervenes, and the issue has also been associated with ECB purchases. This is important to bear in mind when passing judgement on these different solutions to the crisis through the intervention of the public sector.
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Morals are a Hazard Bitchezz!!
Moral dilemma: bankster having to choose between robbing a 80 year old european pensioner or a 80 year old american pensioner.
Is the red (subordinated) stick man from the image blowing the blue one?
So subordination means the bondholders get a haircut, or lose all. Plus everyone knows the soverign will never be able to pay back the EU. So why bother with the moral hazard middle man at all? Just give out the bondholder haircuts as a straight default and problem solved.
Fuck Subordination!
Suck, FUBAR'd nations!
Fuck moral hazard too, the real hazard was giving mortgages to tramps on the street, that goose was cooked and the bankers ran away with the cash. Now we're all fucked and they want to tell us its morally wrong to save ourselves because we might be tempted to save ourselves again some time in the future.
My God, clear the bad debt already, prosecute the fraud, restore the rule of law and let's move on. There is no such thing as "stable funding" in a ZIRP world, especially when capital creation is simply being used to service old, bad debt and not create anything of real fucking value.
You ask too much. The system simple does not have the ability to deal justice because the crooks are in charge.
exactly - none of this is about economic prosperity and only about endless control.. herione and opium for the troublemakers and addiction to debt for the rest (talking about countries more than just people)
This deal is as stupid as all the others put forth.
As I understand it this will come with a new tax as well. How does that help member states dig out of their debt hole? Isn't this the same old alchemy whereby we lump a bunch of bad debt of varying quality into a security in the hopes of making it investment grade?
The biggest problem is that the countries closest to the edge of insolvency don't have much gold. Spain has about 11B Euros, Greece has about 4B Euros and Italy has the biggest amount at around 2400+ tonnes (assuming it is still there, rumor has it that 400 tonnes was lost during the LTCM debacle). However, I think this is still almost half of what they would need (20%) to cover the excess debt above 60% GDP. I think Ireland only has about 250M of gold as well. Are these countries going to retain their gold or is it shipped to Germany? Are there any sovereignty rights subjugated in this deal?
Basically it's a non-starter from the aspect of having gold to cover enough of their outstanding debts. Why wouldn't they use their gold to back their own sovereign debt if they had enough to be a meaningful % of their portfolio instead of joining this circle jerk?
"Why wouldn't they use their gold to back their own sovereign debt if they had enough to be a meaningful % of their portfolio instead of joining this circle jerk?"
When was the gold of these soverign debtors last audited? Just asking...
i agree. but it's not so easy to clear debt and fraud when the entire system is predicated on this. if you clear zirp and remove the illegal fed activities you get a MASSIVE CRASH. that would be a purge in order to reset. but TPTB will not be powers if they allowed this. not even sure who votes for whom anymore at this stage or why they even pretend to have democracy, but hey the spectacle of voting makes it more palatable i guess.
The point you made about the effects of dismantling the fed is'nt made often enough. As much as I despise their practices, I realize if they ceased to exist tommorrow, the resulting crash would be the ugliest any of us have ever seen. Some on ZH may see that as necessary to force a return to honest money. No political will exists to do such a thing. The fed represents a blank check in the hands of politicians. Think they'll kill the cash cow? Unlikely. One related widespread perception is that at some point, "the checks will stop coming, and people will be rioting in the streets, etc.". Obviously, we're at approximately the 16 trillion mark for federal debt. What keeps them from pushing it higher? Especially, if it helps avert national unrest?
Subordination Vs Moral Hazard
but to whom? Pax Americana banksta cabal or Germany uber-alles splinter strategy...
Zat ees ze kestion.
Hint: only one of those two countries has military bases in the other one.
hint back : military bases cost a lot of money; especially if on top of it they serve no purpose...OSt politik could change all that. Gas + military + oil sector+ industrial...Germany is a real industrial power house, has a lot to offer, not a broken market, outsourced importer of Apple toys from Foxconn junk yard. Not saying both are not drowning in debt, but thats a universal disease these days. Tipping point means all sorts of new alliances in the coming wind down.
connecting dots...we've been down this road before.
PROJECT HAMMER RELOADED (2003)
The Ties That Bind – Mapping The Covert Connections
http://www.bibliotecapleyades.net/sociopolitica/projecthammerreload/hamm...
Follow The Yellow Brick Road: Part Two (2002)http://www.scoop.co.nz/stories/HL0204/S00030.htm
You preach to the choir...if only we could find something more useful for all those pesky jobholders in those pentagonal offices to do!
Being an export powerhouse on a broke planet is kind of like first prize in the tallest midget contest, don't you think?
Who will be able to buy turbines, solar arrays, and Beemers in the brave new world?
new paradigm, who will invent it and then apply it, thats the question. think out of the box. That's my best offer in a one eyed leading the blind world.
If I don't start seeing more Snorg T ads I'm gonna go moral hazard!
nothing new
yaawn
.
We have long been concerned at the implicit and explicit subordination of both financial and sovereign bondholders in Europe by the actions of their overlords political elite in pursuit of short-term liquidity fixes to insolvency issues.
And more generally, stay tuned for the explicit subordination of private wealth and individual liberty by the actions of the overlords/political elite in your affected area in pursuit of short-term liquidity fixes to insolvency issues.
Only so many chairs
Music stops
Government doesn't like to lose
Please make a note of it.
Not too worried about that, remember to the overlords and political elite, Debt and Paper are wealth. I carry neither, so nothing to subordinate.
Welcome to the other 1%.
Still want to stay out of the way when the government is jockeying for that seat.
They have a mighty big ass... and they'll be interested in your hard assets too.
A lot of people's jobs (and food) depend on my land and other hard assets. I employ many ex-military, and our representative is a vet. Good luck with that. It is what it is, some parts of the country will fair much better than others. Same as it ever was. What's that old real estate saying again? Location, location, location.
The theft of wealth continues:
http://finance.yahoo.com/news/net-worth-implosion-not-just-095200189.htm...
I agree prosecuting fraud and restoring the rule of law is what's needed to move on. The problem is the government couldn't win a case in a court of law if their salaries depended on it.
The Europeans are dreaming if they think they can get their necks out of the noose. All this talk about subordination and moral hazard is as useless as giving a vaccine to a dead horse.
But... Is the horse dead or has it merely just stopped breathing? Stay tuned as we try to figure that out in the summits and meetings.
Mmmm... Pass the shrimp sushi please...
At least a dead horse has some uses.
Steak anyone ?
Call out the knackers.
The horse is merely stunned.
http://www.youtube.com/watch?v=4vuW6tQ0218
The one who lends last, lends the best!
I have that "subordination" post bookmarked. It was a tough read for a novice, but I have returned to it repeatedly. ZH is too often correct. (Scary correct)I suppose it's simple in principle, but complex in process. It's why we need Tyler.
A poor fool is now buying chump change silver when before he was wasting his precious little wealth away.
I am grateful. I share the word with those who will recieve it.
That ought to get you a lot of hot dates...
Great graphic, but a little incomplete regarding the subject matter. You dont have what the little red guy is holding and what the little blue guy is tickling.
Very strange, all markets seem to have been suspended. 8.56am EST
those cartoon guys on the home page for this article resemble Obama's/Timmy G's favorite position in front of their banker/Wall St overlords
or meredith servicing jamie
How about: If you owe you pay; else go bankrupt and be liquidated.
"Old pirates, yes they rob I...Redemption Songs..."
Cyclial recessionist disciples will stomp moral hazard into the ground every time....proven over and over in USSA and Japan
They could use marmite cheddars as collateral
Moreover, the Redemption Plan would require sovereigns to pledge assets as collateral
Is that rehypothecated collateral?
Saving the banks and declaring "bailout" repeatedly only exacerbates the problems. They are the drags on the economies.
Interest is a thing of the past!
These are still Sovereigns in Europe...witness tha apoplectic response when Poopy-doo tried to have a referendum on Greece staying in the euro-zone (great idea in hind sight no?) anywho Greece still gets to form a Government and still gets to decide what to do with the monies (since this is coming from a public Treasury...an "ECB"...instead of from the Bank of Hatfield and McCoy) and as such still has full discretion over its spending and savings priorities. In other words "the Banksters have not won here." Nor does it appear they will since whatever happens to "Greece" the euro looks to be getting devalued anyways.
http://www.youtube.com/watch?v=gaDq3MWNNa0&feature=related
Surreal embedded in alternatives. Both sides of the pond wrapped in a Enigma.
A bit OT but this link from General Jim is interesting:
http://www.fdic.gov/news/news/financial/2012/fil12027.html
A. Zero Percent Risk-Weighted Items
The following exposures would receive a zero percent risk weight under the proposal:
For more information, please refer to sections 32(a) and 37(b)(3)(iii) of the proposal. For exposures to foreign governments and their central banks, see section L below.
A Government Warning! http://shutupnsing.wordpress.com/2012/06/19/a-government-warning/
In other words...
We're still being subordinated to being on the Paper Banker Road to Serfdom with no Moral Hazard Removed Yellow Brick Road exit here sign in sight yet.