Debt_13

Source : Le Nouvel Observateur
Donald Hébert, The Debt Crisis in 13 questions.


The downward spiral of the Stock Exchange comes on the heels of investor worries about the size of the public debt of many countries, who in order to shore up the banks financed themselves on the bond market.

What is a bond?

A bond is a contract which specifies the modalities of reimbursements (interest rate and timing of paiements) for a loan. This entitement is given to the lender who is then free to re-sell it on the bond market. It is a form of investment alledgedly less risky than a share.

Why is a sovereign debt rated?

The sovereign debt is the whole of the loans put out by a State : bank credits, loans from other States, emissions from the Public Treasury.

The latter can be exchanged on the bond market.Their value is thus determined by supply and demand, the majority of buyers and sellers taking their lead. to determine a fair price, by the capacity of the State to reimburse. This information is given by the rating on the debt of the State in question.

Which States are most indebted?

Among the most indebted States of the world we find Japan (229% of Gross Domestic Product), Greece (152%), Jamaïca (137%), Ireland (114%), Iceland (103%), and the United States (100%).

France’s debt represents 88% of its GIP. But, according to Standard and Poor, France is currently extremely stable. It s not necessarily the most indebted who are the most worrisome.

Financial actors fllow the lead of the three large rating institutions : Standard & Poor, Moody’s and Fitch.

France enjoys the best rating from all three agencies (AAA), which is not the case for the United State, whose debt rating from Standard and Poor has just been downgraded
from (AAA to AA+).

Those countries which, like France, enjoy the highest rating from all three agencies are :
Germany, Austria, Canada, Danemark, Finland, Luxemburg, Norway, Holland, Great-Britain, Singapoor, Sweden and Switzerland.

Australia has AA+ from Fitch, and the best mark from the other two.

Japan, Ireland and Spain have lost their triple-A from all agencies. Greece has the worst rating, with CC from Standard and Poor, behind Jamaïca, Grenanda, Belize, Equator ad Pakistan (B-).

Why is there a crisis?

In order to save the banks during the financial crisis of 2008, States loaned them large quatities of money. They had to borrow massively, thus putting a great number of bonds on the market.

As a function of the economic context, not very bright, the debt bonds of certain countries(Greece, Portugal, Ireland, Spain, Italy) found themselves to be too numerous and not attractive, which made their value go down.

In effect, the interest rate of the bond goes up as the value goes down. Those countries whose bonds were less attractive , those whose ratings are less good, thus saw the rates at which they could borrow go up.

Borrowing costs more, while these are the very countries in greatest need of liquidity to stimulate the growth of their economies, finance social programs, and control their deficits to, in the long run, reduce their debt.

Where a country is on the verge of defaulting, it is sometimes desirable to restructure their debt, so they can pay back a portion of it rather than none at all. The country then buys back the debt using a new loan with better conditions : a re-imbursement deadline - one thus speaks of a new calendar - with lower interest rates.

What is a loan default?

When a country does not honor one or many loans, one then concludes there is a payment default. If it is a question of restructuring the debt, as with Greece, then we have a partial default.

How does the European Central Bank try to help those countries whose sovereign debt is problematic?

The ECB has gone back to a program of buying up debt obligations which it had activated for Greece, Portugal and Ireland in 2010. It had then bought 70 billion euros’ worth of obligations. This time it is the debts of Italy and Spain that are caught in the machinery of the markets.

By buying these bonds on the markets, it hopes to make their prices go up and thus lower the interest rates for Italian and Spanish loans. This course of action is aimed at a psychological effect on investors for, taking into account the volumes concerned, the ECB does not have the political mandate to inject the sums necessary to result in a mechanical rise in prices, the Italian and Spanish debts being much larger than the Greek and Portuguese ever were.

According to economist Anton Brender, States intervene too little, too late. The ECB is like a firefighter. Its intervention is held back by countries such as Germany, Holland or Finland, whose public finances were fine-tuned at the price of a great deal of rigour, and who refuse to pay for their too easy-going neighbors.These countries demand the putting in place of austerity measures in the countries concerned.Yet it is in their interest to help because the latter are their commercial partners.

ECB intervention opens yet again the question of the political future of Europe. Debt risk could be mutualized through the use of European bonds «eurobonds». But in order to proceed one would need a convergence of European budgetary policies, only possible with economic government on a European scale.

What are the criteria used by rating agencies?

The ratings of Moody’s, Standard and Poor and Fitch evaluate the pay-back capacity of businesses - but also of regions, cities, administrations - and of States. To evaluate the debt of a country, they use economic fundamentals.

They also look to political elements. Thus Standard and Poor, which downgraded the United States for the first time, issued a reprimand to the incapacity of the American governent to take necessary measures to redress its public finances. Barack Obama asserts that the U.S. still deserves an A rating, but with expenses too large with respect to income, the deficit gets worse every year, making the debt burden heavier, which grows more quickly than GDP. Given these conditions, the risk that the U.S. might not reimburse is less low than before.

The agencies also use contextual elements, such as the attitudes of markets toward a certain country. Thus was integrated the difficulties which Greece faced in finding financing on the markets, as it is penalized by higher interest rates.

Why are the agencies often accused of being pyromaniacal firemen?

The downgrading of a country’s rating automatically makes it more expensive for that country to borrow on financial markets. The higher the rates, the more expensive re-payment is.. and the more putting it at risk of being downgraded.

Thus, when a country is in difficulty, the ratings act as a negative spiral and «self-fulfilling prophesy». One can then accuse the rating agencies of being «pyromaniacal firemen».

Wen things are going well for the economy of a country, the revere effect comes into play. The positive rating makes interst rates go down, which permits those countries to finance themselves at lesser cost. One has also acused the agencies of over-rating certain countries, such as the U.S. which, notwithstabding the importance of its debt, long enjoyed excellent marks.

The independence of Moody’s, Standard and Poor and Fitch is often doubted with respect to ratings given to the private sector, because they get the most of their income from banks which they rate.

Many economists, who feel that economic actors put too much weight on the ratings given to countries, often argue that these are only one more bit of information. This is the argument the agencies themselves put forward to protest their innocence after the 2007 crisis, after they had largely overvalued the subprimes, whose depreciation took down the world economy.

Yet there is currently no alternative to the work of these agencies, who try to give a real-time picture of the situation for a country or an enterprise.

With respect to the rating of sovereign debts, the creation of a public European agency is currently under study in Brussells. The crucial question is that of its independence with respect tot the administrations to be evaluated.

It is the problem one might raise with respect to the Chinese Dagong agency, which rates certain sovereign debts since 2010, and which rates less well European countries and the U.S. than the West but gives higher marks to China.

To avoid the independence question turning up in the public sector,certain elected representatives, such as the Green euromember Pascal Cantin, has proposed a public bidding process for private agencies, which would permit breaking the link between the agencies and the rated institutions, as well as avoiding administrative pressure on such agencies.