13 Public Debt
13.1 Public Debt Management
Romerskirchen
Already before the outset of the global pandemic, public debt loomed at historically high levels in all but a few advanced economies. The pandemic-related surge in government financing needs has resulted in OECD governments issuing a record amount of debt. Questions around the sustainability of this growing debt burden have taken centre stage in accounts of public finance. What is largely absent in these debates is the question of how governments actually borrow. The budgetary constraints of debt are not merely a function of debt levels, but are influenced by the ways in which public debt is planned, issued and managed. In the UK, 2019/20 debt interest payments, while benefiting from low interest rates, amounted to £48 billion – more than defence spending. In spite of its economic and political importance, public debt management has received scant attention and continues to be clouded with technocratic obscurity. The arcane nature of public debt management has allowed consequential reforms in debt management agencies to largely fly under public and academic radars. This ESRC-funded study seeks to give a comprehensive account of this overlooked revolution.
Starting in the 1980s, debt management functions in rich economies have been handed over to newly created debt management offices, which now enjoy far-reaching policy independence in managing sovereign debt. Who are these agencies which manage over 50 trillion US-Dollars across OECD countries? How can we explain the transformation of public debt management, both regarding institutional arrangements and new managerial practices? And what are the consequences and challenges of this silent revolution?
This project on the operational arm of debt management seeks to throw light into an overlooked corner of public finances. ToPDeM will theorise and analyse the diffusion of new practices in sovereign debt management. In so doing, this research will combine evidence from statistical analyses of 24 advanced economies with an in-depth comparative case study of 3 countries demonstrating variation in institutional outcome (the UK, Germany, and Denmark).
13.2 Sovereign Debt after Covid
G30 Report
Sovereign Debt and Financing for Recovery after the COVID-19 Shock: Next Steps to Build a Better Architecture
This report acknowledges the world – and lower-income countries – have so far avoided large pandemic-driven debt defaults in part due to positive spillovers from extraordinary monetary and fiscal support in mature markets. However, the authors caution against complacency, warning that as the overall economic outlook brightens, the likelihood of tightening policy may result in outflows as well as further debt distress and ill effects in emerging and frontier market economies. Moreover, continued worries over the course of the pandemic, predominately vaccination rates and global access, must discourage early complacency or congratulatory posturing.
The report makes clear that collective aversion to crisis planning - ostensibly for fear of triggering a self-fulfilling prophesy of debt defaults - is irresponsible when much of the world is one unforeseen shock away from a lost decade. The report underscores that now is the time to rebuild and reform the architecture to improve its long-term resilience and effectiveness. The G30 report makes a series of important recommendations designed to buttress the sovereign debt restructuring process and mechanisms in the following areas: There should be a recycling of SDRs, creditors should reaffirm and elaborate the comparability of treatment principle, the G-20 should establish a standing consultative mechanism in conjunction with the Common Framework, national law in major financial markets should shield payment systems and intermediaries from disruptive debt collection, the G-20 should publicly disavow the use of contract terms that impair debtors or creditors participation in international debt negotiations, and commercial, official, and multilateral lenders should encourage sovereign borrowers to adopt robust domestic debt disclosure requirements as part of their debt authorization.
Slow progress on reforming debt architecture leaves the world unprepared to deal with persistent global public health and macroeconomic vulnerabilities in the coming years.
The ravages of the pandemic are now at the highest point in several important emerging markets, while higher inflation is resulting in policy tightening, endangering the economic recovery.
The possibility of debt servicing difficulties is substantial in the near term.
The mechanisms put in place so far are likely inadequate to the challenges ahead.
Continued failure to take the necessary steps to prepare for future shocks increases the risk that debt problems would not be resolved in an orderly way.
13.3 Treasury Bond Market
Tooze
The system as a whole looks highly unstable. The Treasury market, “is primed so that high-frequency traders and primary dealers pull back when there are problems”, said Yesha Yadav, a professor at Vanderbilt Law School in Nashville who studies Treasury market structure and regulation. “The way this is set up is designed to fail. It is exceptionally fragile,” Yadav said.
Yadav has just put out a Columbia Law Review article on Treasury market structure and its fragilities which I highly recommend. The picture she paints is alarming:
The asymmetric distribution of regulatory burdens between primary dealers on the one hand and high-speed securities firms on the other limits opportunities for private cooperation and mutually reinforces risk-taking behavior by both sets of players. Unwieldy public monitoring, combined with a light-touch rulebook, allows all firms to take risks or trade opportunistically with little chance of detection and discipline. Traders can also cheaply exit the market if something goes wrong, limiting how fully they must internalize the costs of their risky behavior. For the less-regulated, nonprimary dealer firms, the regulatory constraints are even weaker, further increasing their financial incentive to seek risk in Treasury markets. Faced with diminishing profits and a less lucrative franchise, primary dealers are also incentivized to take risks and shirk self-discipline. So, not only is the task of private oversight logistically harder as the number of traders proliferates and diversifies, but it is also problematic when self-policing would result in primary dealers imposing added costs on themselves in a period of fierce competition and lower profits. The consequences of this regulatory neglect in Treasury markets were apparent even prior to the March 2020 COVID-19 crisis, as a number of disruptions over the years pointed to unaddressed fragilities at the heart of this supposedly failure-proof market.
Regulators have discussed making changes to bolster Treasury market liquidity. There have been recommendations also from the G30.
But progress has been slow and the lack of a centralised Treasury market regulator can cause confusion.
Yadev’s first proposal for stabilization would be a binding Memorandum of Understanding between the regulators themselves to create a clearer division of labour between them.
Her second proposal takes up the suggestion from Darrel Duffie for a centralized Treasury clearing house model that would ensure that all major players had skin in the game in ensuring that the market continued to function even at moments of stress.
In the view of Bank of America analysts: “Treasury market size “has outgrown dealer ability to effectively intermediate risk.” This then requires an “official-sector role as dealer of last resort.””