Blog Post

Subordination is not the main issue in Spain

Many commentators have recently argued that sub-ordination of Spanish debt to the official assistance is the main driver of Spanish bond yield increases. Default on Spanish debt supposedly is becoming more likely because the new debt coming from the ESM is senior to the old debt. In this column, I argue that this is not […]

By: Date: June 18, 2012 Topic: Macroeconomic policy

Many commentators have recently argued that sub-ordination of Spanish debt to the official assistance is the main driver of Spanish bond yield increases. Default on Spanish debt supposedly is becoming more likely because the new debt coming from the ESM is senior to the old debt. In this column, I argue that this is not the case. The main driver of the yield increase is the increase in the absolute debt level due to the assumption of private sector debt by the government.

The new programme is Spain has two outstanding features for the question at hand. First, it increases Spanish debt by around 10% of GDP. Second, this 10% of debt is treated senior to the 70% of exisiting Spanish debt. To illustrate what is driving the increase in yields, let’s do some simple arithmetics. Suppose that Spanish debt has a face value of 100 but a market value of 70. This means, markets expect that only 70 of the 100 will be repaid. The ability to pay of the Spanish government thus amounts to 70.

With the new programme, debt is increased by around 14%. If the ability to repay stays constant and the programme is providing finance without subordination, then the value of the outstanding debt should fall from 70 cents on the euro to 61 cents on the euro. If the 14 units of additional debt are given a senior status and we assume that the Spanish government will repay them in full, the capacity to service the old outstanding debt will be reduced by 14 and will amount to 56. This implies that market price of debt will fall to 56. The table illustrates the simple numbers.

Before programme

After programme without subordination

After programme with subordination

Face value of debt

100

114

114

Ability to repay debt

70

70

70-14

Ratio market over face value

0,7

 

0,61

0,56

Subordination thus indeed lowers the market price of outstanding debt. However, this effect amounts to around 1/3 of the problem while the fact that new debt is put on top of old debt drives 2/3s of the yield increase. The seniority effect is thus of second order compared to the actual increase in debt.

The key for Spanish solvency is thus not that assistance is given seniority or not. The key question is whether banking sector assistance as such will mean an increase in Spanish net debt. To the extent that private creditors of banks shoulder the largest part of the burden, the equity injections into the Spanish banking system should not negatively affect Spanish government solvency. In fact, becoming a shareholder of banks that have been restructured at the expense of old creditors of banks should not imply a net financial liability. On top of this, a significantly lower interest rate on the programme debt will contribute to debt sustainability. Moreover, sorting out banking sector problems should increase the ability to repay debt as credit provisioning to the dynamic export sector gets improved. On the downside, imposing losses on private creditors of banks may dampen consumption as well as investment depending on who are the main creditors to banks. It is therefore of central importance that the public authorities investigate carefully who are the creditors of banks and how losses would affect their behaviour. Overall, imposing losses on private creditors of banks will be a possible way of improving solvency of the Spanish government.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Opinion

European governance

Can the EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Grégory Claeys and Wolfgang Lemke Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More by this author
 

Podcast

Podcast

A green fiscal pact

How can the European Union increase green public investment while consolidating budget deficits?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: September 29, 2021
Read article More on this topic More by this author
 

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Read article More on this topic More by this author
 

Opinion

The pandemic’s uncertain impact on productivity

The pandemic has certainly permanently affected our way of working. Whether this is for the better remains to be seen.

By: Maria Demertzis Topic: Macroeconomic policy Date: September 28, 2021
Read about event More on this topic
 

Past Event

Past Event

How to strike the right balance between the three pillars of the pension system?

In this event panelists will discuss the future of European pension schemes.

Speakers: Elsa Fornero, Svend E. Hougaard Jensen and Suvi-Anne Siimes Topic: Macroeconomic policy Date: September 23, 2021
Load more posts