Without an interest rate and a credible quantity pledged, the agreement is grossly deficient.

The way Greece obtains funding is by offering ever higher rates until there is a taker.

So let’s say they offer securities at 5%, then 6, then 7, then 10, then 15, then 20 with no takers. How high do they go before they tell the EU group they have failed to obtain funding?
And then what rate does the EU charge them if they agree?

The process makes no sense.

The way to do it is for the EU group to offer funding at some rate, giving Greece some amount of time to try to find a better rate.

Euro finance ministers to agree on Greek aid: source

By Jan Strupczewski

March 13 (Reuters) — Euro zone finance ministers are likely to agree on Monday on a mechanism for aiding Greece financially, if it is required, but will leave out any sums until Athens asks for them, an EU source said on Saturday.

Policymakers have been debating possible financial support for the heavily-indebted European Union member state for more than a month, but have provided only words of support. Germany, key to any deal, has resisted appeals to promise aid.

British newspaper The Guardian on Saturday quoted sources as saying Monday’s meeting of the currency zone’s 16 finance ministers would agree to make aid of up to 25 billion euros available.

But a senior EU source with knowledge of preparations for Monday’s meeting told Reuters no numbers were likely at this stage.

“I think we should be able to agree on principles of a euro area facility for coordinated assistance. The European Commission and the Eurogroup task force would have the mandate to finalize the work,” the source said.

“It would be the principles and parameters of a facility or mechanism, which then could be activated if needed and requested.

He said no figure had been agreed.

“You would have a framework mechanism and you would have blank spaces for the numbers because there has been no request (from Greece) yet,” the source said.

Greece has announced steps to reduce its budget deficit this year to 8.7 percent of GDP from 12.7 percent in 2009, triggering street protests and strikes but also reducing market concern over whether the country would be able to service its debt.

That helped Athens sell its bonds with ease on debt markets earlier this month, but policymakers are still searching for ways of making its cost of borrowing — still far above that of other Europeans — more sustainable.

They are also concerned that the problems in Greece could undermine confidence in the euro and spread to other heavily indebted eurozone countries such as Portugal or Spain.


The EU source said that among the instruments considered to help Greece were both bilateral loans and loan guarantees.

“The preparations have been done under the Eurogroup by member states and the Commission. The Commission has done much of the technical work,” the source said.

“The aim of the exercise so far has been to do the technical preparations, so that the political decision could be possible on Monday. Germany holds the key at the moment.”

Polls show that public opinion in Europe’s biggest economy Germany is strongly opposed to bailing out Greece, which has for years provided unreliable statistics about the true size of its deficit and debt, breaking EU budget rules.

In a move that is likely to alleviate German concerns about spending money on Greece, the Commission has said it would soon make a proposal for stronger economic cooperation between euro zone countries and tighter surveillance of their performance.

French Economy Minister Christine Lagarde told the Wall Street Journal she believed Greece’s austerity moves were behind the improvement in its situation on markets and negated the need for a bailout.

“”There is no such thing as a bailout plan which would have been approved, agreed or otherwise, because there is no need for such a thing,” she said.

But she added that “technical experts” at the EU have been working on a contingency plan, so that if the need arose “all we would have to do is press the button.”

The Guardian quoted a senior official at the European, the EU executive, official as saying the euro zone members had agreed on “coordinated bilateral contributions” in the form of loans or loan guarantees if Athens was unable to refinance its debts and called on the EU for help.

The agreement has been tailored to avoid breaking the rules governing the operation of the euro currency which bar a bailout for a country on the brink of bankruptcy, and to avoid a challenge by Germany’s supreme court, the official said.

A German ministry spokesman said he could not believe the newspaper’s report on the bailout plan was correct.

“We are not aware that this is being planned,” he said, adding that Greece had not requested any aid. “Greece is implementing its (savings) program and we expect that it will manage it alone.”

(Additional reporting by Tim Pearce in London, Pete Harrison in Brussels and Volker Warkentin in Berlin, Writing by Sarah Marsh and Jan Strupczewski; Editing by Patrick Graham)

24 Responses

  1. when the fed buys tsy secs it is merely exchanging financial assets at what markets deem indifference levels.

    when the tsy buys other goods and services it is adding new dollar balances to the economy

    when it taxes it removes dollar balances.

    printing money refers to fixed fx regimes

  2. I was trying to figure out the way in which ADDITIONAL monetary base gets into the Euro economy.

    Warren says “when the tsy buys other goods and services it is adding new dollar balances to the economy….when it taxes it removes dollar balances.” That is true where income from taxes equals Treasury spending. But when it comes to NEW or ADDITIONAL monetary base the Treasury is not allowed to create this out of thin air.

    The procedure for creating it (I think) is: Treasury borrows in the open market and spends the money borrowed and gives bonds to those it has borrowed from. Central bank then buys the bonds (Treasuries in the US) with money created out of thin air, i.e. “printed”. Alternatively the Treasury borrows “thin air” money direct from central bank and gives bonds to central bank. ( I believe this latter ploy is forbidden in Europe).

    If that is right, how does the ECB get extra monetary base into the Euro economy? Presumably ECB buys bonds that individual countries have issued in exchange for funds borrowed from the markets. Presumably this is done in some sort of “fair” way, e.g. in proportion to the population or GDP of each country.

  3. First, why do you care about ‘monetary base?’ Does have something do with spending somehow?

    Since monetary base includes ‘clearing balances’ at the CB, called ‘reserves’ in the US, and monetary base does not include treasury securities, all the Fed or ECB has to do is buy securities and they’ve increased the monetary base. But nothing is altered for the economy as a consequence, apart from interest earned going down some when the securities purchased earn more than the clearing balances created.

    Hence quantitative easing does nothing through the ‘quantity’ channel.

  4. “But nothing is altered for the economy as a consequence, apart from interest earned going down”

    That is not altered either. Each time a coupon payment is made, the price of the security declines by an equivalent amount, and the portfolio value of the holder is unchanged. Nothing is altered at all, and the private sector is never “drained” of coupon income, anymore than the private sector receives a benefit from the coupon payment.

    In both cases, only if the stream of coupons are bought/sold at above or below market value is there a benefit.

    1. “Each time a coupon payment is made, the price of the security declines by an equivalent amount…”

      A bond paying 10% coupon would, according to this, have negative value starting in year 11. 🙂

      1. Yes, clearly nothing can yield 10% for more than 10 years because (.9)^10 =0. Brilliant math skills 😛

      2. 1) Bond yield is calculated from market value. I.e. a zero coupon bond can have a positive yield.

        2) Over time, the market value of the bond increases by the discount rate of the bond, but not in NPV terms.

        3) On the “ex-coupon” date, the amount of the coupon is subtracted from the market value of the bond

        4) You cannot make money by buying a bond the day before a coupon is paid, and selling the bond the day after the coupon is paid. The bond will sell for the previous price net of the coupon paid.

        5) Therefore the portfolio of the bondholder does not increase or decrease in value when the coupon is paid. It increases or decreases in value based on the overall discount rate for the economy, which represents the opportunity cost of investing in the universe not containing the bond — i.e. the next best investment. So the return of MBS is determined by everything OTHER than MBS, and the return of government securities is set by the return of non-government securities. The price of any asset is set by the cost of replicating that return in the universe not containing the asset.

        6) Therefore if the government buys the bond from a willing seller at market prices, you can assume that the seller believes that he has a “next best” investment that will give the same return. If he did not believe this, he would not sell the bond, or would demand more money for the bond.

        Putting all of those things together, the payment or not payment of coupons does not cause the portfolio of the investor to increase in value — it is the overall opportunity cost as measured by the discount rate that causes the portfolio to increase in value, and this rate is unchanged even if all the bonds are purchased by the CB in an OMO.

      3. “On the “ex-coupon” date, the amount of the coupon is subtracted from the market value of the bond”

        So, according to this, if I spend $100 on a $100 face value bond with a 10% coupon, after 1 year, I will get $10 in interest and the market value of the bond will drop to $90, after year 2, I will get another $10 interest and the market value of the bond will drop to $80, etc…

        In year 11, the market value of the bond will be negative.

    2. RSJ,
      Cash at bank has credit risk, treasuries do not.

      Smaller supply of treasuries pushes yields down which is relevant for new issues and most of issuance is short term. Old issues are rather indifferent to yield changes since one can treat the whole market as HTM.

      1. Government debt is in the 5-6 year maturity range. Non-financial corporate debt has a similar maturity. And of course private corporate equity + traded equities is larger than the non-fixed income markets, although the fixed income markets are larger than each.

        Short term bills are primarily used as a substitute for deposits in the non-financial sector, and for balance sheet expansion purposes in the financial sector. No one is relying on these for coupon payments.

        Generally you need to distinguish between financial sector balance sheet expansion and actual interest payments delivered to households. If a bank levers up 30:1, it is not delivering the gross interest payments to anyone — only the net is being delivered to the household sector. But that net comes at the expense of the non-financial sector, so it washes out.

        In this process, if the government raises bill prices, then this is an attempt to *increase* net incomes of banks, as longer term yields are expected to move by a lower amount. And that is the point, an increase in one person’s yield is a decrease in another’s. Households, which hold claims on both the financial and non-financial sector, do not see any increase or decrease in returns on capital as a result of these changes, except to the degree that the interest rate movements promote debt growth in the overall economy.

      2. MBS were redistributing assets within private sector from mortgage borrowers to investors. Now this money flow disappears in Fed.

        Overall the stated purpose of QE is to bring long-term yields down which for all new issues means lower coupon payment to the private sector be it financial or household.

        So while QE does not mean that loss of private sector income is matched $4$ by coupons overall private sector clearly has lost certain income.

  5. Sergei, this is just a simple question of accounting:

    “Now this money flow disappears in Fed.”

    No, it does. The Fed buys an MBS at a fair market price from an investor who rolls the proceeds over to some other asset. The return MBS return is replaced with some other return. No money flow dissapears anywhere, UNLESS, the investor mispriced the asset and sold it for less than it was worth. On average, these errors will cancel out.

    It all boils down to:

    change in financial liabilities = change in financial assets.

    The only way that any government action can cause the change in financial assets to increase is if it causes an increase in liabilities. This can be via government fiscal policy, in which case government liability issuance increases, or it can be via encouraging liability issuance in the domestic sector. But that is the only channel.

    If interest income declines, then dividend income will increase. If short term debt income declines, then long term debt income will increase. If MBS income declines, then non-MBS income will increase. If the sum of corporate profits of all forms (dividends, interest income) declines, then returns from profits from non-corporate business increase. But the return on capital will not shift as a result of these games, regardless of what the “stated goal” was. The real goal was always to increase the incomes of banks, at the expense of non-banks.


    1. what you say is valid for financial (banking) sector which has accounting possibilities to approach financial assets from NPV perspective.

      However, and it is important, non-financial sector does not have to treat government bonds on NPV basis. You might have an exception here and there but households never ever approach bonds on NPV basis, i.e. they are typically hold to maturity investors. Moreover a significant part of financial sector like pension funds and insurance companies also approach these assets purely from hold to maturity perspective. Even banks try to keep maturity mismatch in their collateral book as low as possible and are therefore also HtM investors.

      So what you say about valuation is true from trading perspective but not every agent in the private sector is approaching this problem from the trading perspective. And when private sector rolls over maturing bonds at lower yields they clearly lose income as the result of QE

  6. The only way you can value cash-flows is by NPV.

    This is not subjective.

    If a household buys a zero coupon $100 bond that matures in 1 year for $95, they pay $95 because they do not think that they can get a better return. And they do not pay $99, because they *do* think that they can get a better return.

    That means that they are valuing $100 1 year from now at a discount rate of 5.3%, even if they don’t know what a discount rate is, and they are valuing the asset on an NPV basis. Anytime you invest money today in order to make more in the future, you are conducting a NPV calculation. You buy an orange based on how tasty it is, but you only invest on an NPV basis.

    And for the household, in their IRA or brokerage account, the bond does not show up as being worth $100, but $95, because that is how much the household paid for the bond. In their tax statements and net-worth calculations, the bond is worth $95, not $100.

    Next year, it will be worth $100, but next year, ALL their investments will be worth 5.3% more, according to their estimation. That is what a discount rate means.

    If, over the long term, the buyers tend to be wrong as much as they are right, then their financial net worth will be unchanged as a result of selling their financial claims to the government, or buying those claims from the government. No one has any more or less financial assets, and as a result, no one is receiving any more or less cash-flows. They are merely shifting their portfolio from corporate bonds to MBS to equities to REITs, and back to bonds again. But in the opinion of the household, these assets will grow at a risk-adjusted rate of 5.3%, and they are indifferent as to which asset they hold.

    1. RSJ, households do not calculate discount rate. If they can buy something at 95 then they buy it regardless of whether it pays 5.3% or 5.4%. Households do not do IRR calculation on their savings. They are price takers as long as they want to save. And prices for all bonds increased across the whole term structure because:

      a. fed rate decreased
      b. market supply decreased while demand increased

      and b is the point which you and I try to argue about.

      So when the previous term deposit contract of households expires they enter into a new one at much lower rate and they accept it as it is. Do they lose income due to (b)? Yes, they definitely do because they have to pay higher prices or lock in lower coupons

      Market efficiency or fed purchases’ efficiency is not the issue here

      1. Sergei,

        Deposits do not compete with bonds as an asset class.

        Deposits are for immediate transactional needs as well as a fall-back buffer stock — much like inventory management in the business world. You have some inventory in the store, and more in the warehouse — this is called “working” capital. No one expects working capital to earn a return, and working capital does not compete with long term assets. There is no trade-off between the two.

        In the same way, you should be careful when valuing “walking around” cash, checking accounts, and savings accounts as financial assets. The benefit of holding deposits is utility, not return. The choice is not money in your checking account vs. buying an MBS. The choice is between consumption and investment, and then you set the deposit account levels based on your transactional needs.

        As a result, you only buy a bond if you first sell some other investment. It does not come out of a reduction in your walking around money. And neither does a bond sale result in an increase in your walking around money.

        You may decide to invest less or more overall, but those are separate decisions from the instrument used. The instrument trades at the level of indifference, and no purchase or sale benefits anyone in a predictable way, or cause anyone’s deposit account levels to increase or decrease.

      2. RSJ, you consistently keep on jumping from one topic to another. This time I talked about savings and term deposits. You ignored that and jumped on current (checking) account logic. Yes, I know what current account does, how much money it can earn and what logic _I_ apply to my balances there. But it was not the topic of my comment

  7. Warren asks in “5” above why I “care about the monetary base”. Reason is that increasing it increases the private sector’s stock of cash: something that needs doing in a recession. And the extra cash needs to go to Main Street, not Wall Street.

    When the Treasury borrows in the markets, offers tsys in return and spends the cash it has borrowed, this increases private sector net financial assets and in the form of an expanded holding of tsys. But the latter are not liquid from the point of view of the private sector as a whole. Also, to the extent that this operation is stymied by crowding out, there is no increase in aggregate demand.

    Then when the Fed prints more monetary base and buys the tsys, those illiquid tsys become liquid. I don’t how much extra AD one gets from the process in the above para (and I suspect few other people are sure). But when the process is completed by the Fed buying the tsys, the private sector’s stock of cash rises and an increase in AD is much more likely.

    1. Ralph:

      Increasing monetary base increases private sector stock of cash, but as you say, this is going to banks and not households.

      Increasing bank’s holding of monetary base has no impact on AD.

    2. The private sector has as much cash as it needs. There is no general shortage of currency.

      The private sector wants more financial assets, and bond sales or purchases do not do this. When the government buys a bond from a willing seller, that seller plans to roll the proceeds of the sale over into some other investment.

      Alternately, a household may decide to draw down their stock of financial assets and spend more, or spend less and increase their stock of financial assets. But neither of these decisions is affected in any meaningful way by government OMO.

  8. Other things equal, a fixed income security accrues incremental value equal to one coupon payment over each period between coupon payment dates. Such value accrues between coupon payments, and when the coupon is paid, the value of the security drops by the amount of the coupon, but the security holder’s cash position increases by the amount of the coupon payment.

    (“Other things equal” means the yield curve progresses over time such that the value of the security reverts to par immediately following each coupon payment. That just means that market yields follow the original implied forward yield curve of a bond originally priced at par.)

    The cycle repeats over each period between coupon payments. When the bond matures, the holder has his original principal plus the accumulated portfolio from cash coupons, however that has been invested.

    During the life of the bond, the marked to market effect of other yield curve changes is additional valuation noise that is overlaid on the basic interest accrual, payment pattern, and portfolio result of owning a bond. If the bond is held to maturity, that noise ends up being of no significance to the final value of the portfolio, other than its effect on the reinvestment of coupons.

    (I recommend the classic “Inside the Yield Book” by Homer and Leibowitz.)


Leave a Reply