Public debt management as weight management

Recently I decided to start exercising more and eating healthier to help bring my weight down to a more socially agreeable level because, let’s face it, “dad bods” are sadly nowhere near the hot trend of the summer proclaimed by gossip magazines. As a public debt management expert consultant, I then quickly realized how many debt management lessons can be learned from weight management techniques and dynamics. The analogy is almost complete. Read on.

 Public debt accumulation: Calorific surplus (or simply, when your daily calorie intake from food is higher than your calorie burn) leads to weight accumulation just like chronic budget deficits lead to debt accumulation. Additionally, the pace of debt accumulation is a direct factor of the size and frequency of budget deficits and the level of economic growth: persistent and sizeable budget deficits, coupled with sluggish real growth rates, lead directly to a rapid rate of debt accumulation (assuming that the financial gap is financed from net borrowing, and not from drawing down of asset reserves). It is common knowledge that a healthy diet and exercise help maintain a healthy weight. In public finance, dieting is the equivalent of fiscal discipline, and exercise is the equivalent of pro-growth reforms and investments.

Public debt composition:  Public debt management focus has been for the longest time focused solely on the level of public debt (often expressed as a percent of GDP), and its long term sustainability. Rules of thumb (40 percent) were floated indicating the maximum levels of debt to GDP below which debt is considered sustainable. For the past decade or so, a new thinking on public debt management is now highlighting the importance of the composition of public debt: how you borrow is apparently as important as how much, and public debt portfolio cost and risk dynamics are important dimensions to manage through a well-designed and implemented medium-term debt strategy. In parallel, we also know that what we eat (sugar, fat, carbs) is as important as how much we eat (total calories): that pint of heavy cream can conceivably be substituted with a same amount of much healthier low-fat Greek yogurt. Even fat has good fat and bad fat types. Diet choices are thus crucial for a healthy living, and choices abound.

The cost of public debt: The cost of public debt is often approximated and captured by a statistical measure like the average interest rate paid on the debt portfolio, but this relatively simple measure often ignores the hidden and sometimes non-financial costs of debt accumulation like social costs (see modern day Greece), the eviction effect of buying domestic government securities, the hidden cost of tied aid from certain bilateral creditors, and others. Similarly, unhealthy weight management practices and diet choices often lead to bigger health problems down the road like heart disease and diabetes: That 5 dollar McDonald combo may look cheap and tasty, but its ultimate cost on your health may prove down the road to be higher than you could bare.

Portfolio risks: The overall risk profile of the debt portfolio is determined by the levels of risk factors like refinancing risk and/or exchange rate and interest rate risk. For example, high refinancing risk exposes the portfolio to short-term frequent rollover of (generally cheaper) debt, but at possibly different terms and most likely higher volumes each time. Similarly, a diet high in (cheap artificial) sweeteners for example exposes the body to frequent intra-day snacking due to a large fluctuations of sugar-derived energy levels during the day. This often leads to on average eating more to counter the effect of energy crash.

Debt relief: When weight becomes unmanageable, gastric bypass surgery is often used as a drastic measure to return to normal weight. In public debt management parlance, this is the equivalent of irrevocable debt relief from creditors. But just as weight will likely re-accumulate if nothing is done about one’s eating and exercise habits, debt is likely to re-accumulate (and often at faster pace than before) if nothing is done about the structural factors behind debt accumulation, like sluggish growth and poor fiscal discipline. That’s why creditors often insist on wide-ranging structural reforms as a condition for debt relief (albeit my decade-long experience as public debt consultant tells me that monitoring and follow-up by multilateral creditors is often weak and spotty).

Growth: Body metabolism is the process by which food is transformed to energy. People with high metabolic rates burn fat faster and more effectively than people whose metabolic rate is slower. Slow metabolic rate is often a result of a combination of age and daily practices. Healthy eating habits and regular exercise helps keep metabolic rates at reasonable levels. Economies with slow metabolic rates (sluggish growth, structural inefficiencies, and poor governance) would have a harder time “absorbing” debt into productive, investment-driven economic activities that would ultimately improve economic growth, and hence help raise the metabolic rate of economies.

DMO independence: Debt managers often complain about undue interference from the political class in debt management decisions and lack of independence of the debt management office (DMO). In a social setting, this is called peer pressure (“what do you mean you can’t come out with us tonight for a few beers??”). Fiscal discipline is not very popular for politicians in an election year, and let’s face it, the gym is boring, but go ahead, go out, be social, don’t be a party-pooper, but count your beers wisely and be ready to hit the gym the following morning.

Ultimately, if we were to distill some practical lessons for public debt managers from weight management and healthy living practices, we find the following sensible recommendations:

  •  Debt composition matters: Watch what you eat as well as how much you eat or you could be liable for health trouble down the road. This is the essence of the medium term debt strategy (MTDS) vs the debt sustainability analysis (DSA) argument.
  • There are no magic solutions to public debt: Burn more calories than your daily calorie intake and maintain healthy metabolic rate through regular exercise and diet choices. Lean and credible budgets are a pre-requisite, and fiscal discipline is hard to achieve and maintain overnight. A harsh, prolonged, and unrealistic diet will ultimately kill your body and lead to over-eating relapse, just like overly-harsh fiscal austerity measures are likely to choke off your economy and lead to a public spending binge in efforts to revive growth.
  • Debt relief only buys you time if countries don’t upgrade their debt management capacity and practices in the meantime. Statistics show that gastric bypass surgery is only successful in keeping the weight off for only a small fraction of patients.
  • Debt is not bad by itself if you’re borrowing sensibly to finance needed investments for the economies that will ultimately accelerate growth. Eat what you want (within sensible limits) but make sure you find effective ways to burn it.
  • Each body is different and unique in its ability to burn calories (environmental, genetic, chronic diseases), just like each economy is different and unique in its structure and growth engines. Debt managers should avoid the temptation of comparing with and imitating other jurisdictions when it comes to public debt management practices. Similarly, countries with specific economic features like a narrow economic base and high natural vulnerabilities to external shocks are left with little maneuver space when it comes to borrowing and debt.
  • DMOs should set reasonable debt management objectives and diligently pursue them: you simply can’t stabilize your debt in the short to medium term if you keep running successive budget deficits in a sluggish growth environment, just like you can’t possibly expect to lose some weight if you eat junk food 5 times a week and have your idea of an active life as walking to the nearest burger joint.
  • You can still borrow to finance that mega infrastructure project with an equally-mega loan from EXIM bank [insert latest emerging bilateral creditor] “for the good of the country” (says the Minister of Finance), but make sure you negotiate the terms of the loan according to your preferred debt portfolio risk profile if you are presented with choices of loan terms and creditors.

High debt levels is a burden on the economy, but a couple of pounds around the waist enhances love handles, and I’ve heard from the same aforementioned gossip magazines that love handles are in vogue again!

Debt reporting on steroids using TABLEAU 8.2

I’ve been recently working on an idea/project after being on so many public debt management missions observing so many debt management offices struggle with low headcounts/capacity (among other things) and the ability to produce analytical debt output.

The idea is simple: using the data visualization software Tableau, debt management offices (DMOs) greatly streamline and enhance their debt reporting function, allowing them to produce web-based debt statistical bulletins and reports with minimal effort and maximum impact.

The selling points:

  • The production process of the debt report/bulletin is highly automated and streamlined, requiring no more than 30 minutes time for each update (once a month/quarter/year, depending on frequency of debt report), thus freeing up the DMOs time to do other analytical functions. That’s benefit #1 in my mind.
  • The data is sourced from a very simple and streamlined Excel file, which is then linked to the Tableau web interface. Making changes in the Excel file automatically and instantaneously reflects on the web output. No additional coding skills required once the web report template is designed.
  • The web output is fully customizable in layout and content, and integrates easily into any existing DMO/MoF webpages.
  • It is visually stunning, sleek, and modern, but most importantly, it’s “live”! Hover the mouse over different chart components to reveal additional underlying data. Click on individual components to highlight/shade/sort/filter them for easy viewing (try it using the link below). How many DMOs you know out there have “live”, interactive debt bulletins?
  • The web output can be exported into PDF bulletins with just one click, for easy archiving and distribution/printing outside the web environment.

Click on link below for a demo I’ve designed. I used fictitious data from a fictitious country. Page 1 is more descriptive of the debt portfolio (structure and evolution), page 2 is more analytical (cost and risk).

See a Prezi presentation on the Dashboard here


Slew of Research grants for Saab Laboratory @ Brown/RI Hospital

photo 2-17

The Saab laboratory at Brown University and Rhode Island Hospital was recently awarded several research grants related to basic pain research:


The Association for Migraine Disorders Apr 2014- Apr 2015

“Neurovascular mechanisms of migraine”

Validating a new transgenic mouse model and optogenetic testing of the neurovascular hypothesis of migraine


Norman Prince Neuroscience Institute & University of Rhode Island Jul  2014- Jul 2015

“RGS9 modulates dopamine 2 receptor signaling and Parkinsonian behavior”

Developing a new transgenic mouse model and studying the role of RGS9 in modulating the dopamine 2 receptor pathway and Parkinson tremor


Boston Scientific Jul 2014- Jul 2015

“EEG pain biomarker”

Pre-clinical dentification of an EEG correlate of nociceptive behavior using an electrode ‘grid’array


Dean’s Award, Brown University, Aug 2014- Aug 2015

“Biomimetic Nerve Conduit to Promote Peripheral Nerve Generation”

Pre-clinical in vivo validation of peripheral nerve regeneration and prevention of painful neuroma using biomimetic nerve conduit

For Barbados, Staring into the Abyss can be Scary, but Somehow Reassuring

A steady stream of rumors and speculations has been sweeping the public and not so public forums in Barbados lately about the state and fate of the economy. The intensity of the speculation has been ratcheted up significantly following the release last week of the much anticipated Central Bank’s 6-month economic review, whose bleak assessment of the current situation (and most troubling, the future outlook) helped feed the growing suspicion and fear that things may have come unhinged once and for all. Talk of an IMF financial rescue program, complete with harsh conditionality and possibly a voluntary devaluation of the local currency, now sounds as imminent and inevitable as Kadooment after Cropover. While there is plenty of reason for concern, policy makers in Barbados should not succumb to the panic and should instead let their heads cool down in the gentle Caribbean breeze, and prevail with poise and wisdom, for the time for reckoning is finally upon them.

In his latest review, Governor Worrell didn’t mince words, and instead painted a bleak picture of anemic growth, dwindling foreign reserves, widening fiscal deficit, growing (domestic) debt, weakening external sector, and a drop in tourism receipts. While the news itself did not come as a big surprise to most as some of trends highlighted have been progressively observed and predicted for a while now, I was rather surprised with the more direct (read honest) tone of the language, and especially with the realization and communication, for the first time in such reviews, of the need for a major adjustment, and a quantification of that adjustment (around $ 450 million according to the Governor). To illustrate this point, I prepared below 2 word cloud visualizations for the transcripts of the latest 2 quarterly economic reviews, to examine, via side-by-side comparison, if this change in tone and urgency can be visually observed. If you’re not familiar with word clouds, the bigger the size of the word, the more frequently it appears in the transcript. Click on picture for enlarged view.

barbados word cloud

Sure enough, while the March 2013 review focused more on issues of debt, taxes, and spending, the June review saw words like reserves and growth take further prominence. The most interesting finding I observed was the creeping up of the word “major” in the June review in much higher frequency, like a sort of a subliminal message to the readers alerting them of the fact that the situation is on the verge of something dramatic, both in realization and in the scope of the solution needed. This marks a departure in tone and style of communication that tended previously to downplay major risks and offer a reassuring tone to readers, almost to the point of false security. To be fair, the job of Governor Worrell as gatekeeper of macro stability and bearer of the message (no matter how bad the message) is not an easy one: One has to balance between an accurate transmission of a message in a way not to cause undue worry or panic. In this case, I was glad to see a deliberate shift towards more honesty and transparency, as required by the rapidly deteriorating situation.

I was most particularly troubled by three deteriorating indicators: negative GDP growth, a widening fiscal deficit, and a rapid loss in foreign exchange reserves.


With a high public debt burden of over 100% of GDP, Barbados simply has to “grow out” of debt and start deleveraging by stimulating growth and reducing its fiscal deficits, and hence its future funding needs. The fact that Barbados has been running increasing budget deficits and not able to grow will act as an accelerator for debt accumulation, which will knock the debt trajectory further outside its sustainability zone. As for foreign reserves, they constitute Barbados’ last line of defense for the much prized fixed exchange rate regime against the USD.
I’m worried about these two trends because, with further deterioration, they both lead to the same outcome (financial insolvency), albeit via different paths: as I said above, spiraling fiscal deficits, coupled with low or no growth, will increase the future borrowing needs of Barbados, which will force the country to seek financing outside its domestic market (due to its saturation). This external financing will become increasingly more costly both relative to domestic financing and to previous external financing, as the perception of loose fiscal discipline get cemented in the mind of international (non-multilateral) investors, who would then require a higher premium on their lending to compensate for the increased credit risk. This would ultimately start a downward spiral of rising borrowing rates and rising borrowing needs, similar to what Greece and Portugal experienced, leading to financial bailout to starve off bankruptcy. Similarly, a rapid loss in foreign reserves will force the government to do one of two things: seek financial assistance or abandon the currency peg, both unsavory solutions.

But let’s take a quick diversion and talk about currency devaluation, something that pundits both within and outside Barbados have been identifying as a possible (or inevitable) solution. Devaluating the local currency can be achieved either by adjusting the rate at which the currency is pegged to the foreign currency of choice, or abandoning the fixed exchange rate regime altogether and allowing the exchange rate of the local currency to float and be determined by supply and demand. For Barbados, both cases will likely result in a significant loss of purchasing power of the Barbados dollar, since it will be worth less in foreign currency terms. Would this be a good or a bad thing for Barbados? First, in a country that relies on importing the majority of its basic necessities, the price of these imports will be higher in local currency terms. By contrast, Barbadian exports will be worth more, but we all know Barbados does not produce and export many goods besides rum and pepper sauce. However, Barbados does “export” a valuable service to the world in the form of tourism: a weaker Barbados dollar will make the tourism industry more competitive and could attract more tourists, especially from the US. The hope is with a more revitalized tourism sector, more employment can result and growth can be spurred again. The question then becomes, will the effects of an improved tourism sector outweigh the higher import costs associated with a weaker currency? The answer to this question would determine if Barbados comes out a net winner or loser from devaluation. One thing is sure though: the immediate effects of devaluation include higher short-term, uncertainty-induced inflation, which could cause large economic distortions before things settle down again.

All is not lost for Barbados however, and every problem has a solution out there. I don’t doubt for a second that policymakers in Barbados are able to pinpoint the problems and devise solutions. The problem, as is often the case in public policy, is the social cost of implementation and political leadership. So what would a reasonable roadmap for the immediate and longer-term future look like? Concerning fiscal management, and just like when one needs to tackle high credit card balances, one needs to work extra hard at work in hope of a promotion, or even get a second job to supplement income, while reducing discretionary spending and limiting the use of the credit card to bare essentials. Savings generated will allow for faster repayment of debt. The situation is analogous in the case of governments: restoring fiscal discipline requires measures both on the revenue and expenditure side, and there is room for both in Barbados. Here, the usual culprits spring to mind: on the revenue side, there is a clear need to stem the revenue leakage emanating from VAT and tax discretionary waivers and loopholes, which by some conservative estimates account for about 25% of total tax revenues, and in a country where tax revenue represent 95% of total revenues, the stakes become significant. In essence, it’s the whole tax framework that needs reviewing (and this does not necessarily translate into higher tax and VAT rates as most people think). The bigger battle resides in the expenditure side, with much room to reduce spending on stalwart silos of financial waste as the transportation board, public pensions, the public wage bill, and the tertiary education sector. Like it or not, these spending areas are generous by any standard, and would need to be adjusted in one form or another. Again, the common misconception is that this would translate into loss of jobs in the public sector, which is not necessarily true. For example, the size of the public workforce can be allowed to shrink by natural attrition without replacing retiring public servants with new ones, and pension benefits can be harmonized and re-allocated in a more efficient manner.

A quick look at the government’s recent Growth and Development Strategy 2013-2020 confirms that, indeed, these and other beginnings of solution are currently being investigated and programmed. The Government is not as blind or irresponsive as one would like to think, as one would seem to think that this time, the adjustment effort is radical and for real. In fact, the government is proposing a fiscal effort that would effectively half the current fiscal deficit from over 9% to 4.4% in 2013/14, which would seem on the face of it like a herculean effort. Can it be done in one year? Surprisingly, it has been done the same way not once, but twice in the past 7 years (see graph on fiscal balance above): immediately before the 2008 crisis and again in 2011/12. The effort was however inconsistent and short-lived. A major prerequisite for the success of this roadmap is thus a high level of consistency and discipline, coupled with higher than usual political leadership to enhance political ownership of the roadmap, and help “sell” what amounts to a tough medicine pill to swallow to a weary and skeptical audience. Additionally, a rather high level of frontloading of fiscal adjustments and broad-based reforms is needed to provide the system with a sizeable positive jolt.

What do you do when the day of reckoning is upon you? Well, you reckon. Staring into an abyss can lead you to do two things: panic and jump, or pause and assess your options knowing that what’s coming can be infinitely more devastating and painful. Staring into the abyss can be somewhat reassuring if you somehow believe you can fly, but you have to be honest: in a world of lies and liars, the most dangerous lie is the one you tell yourself.

Rethinking the State’s Role in Finance

A new and interesting paper on Rethinking the State’s Role in Finance, by our very own advisor Martin Cihák and Asli Demirgüç-Kunt (World Bank Policy Research Working Paper 6400, April 2013).


The global financial crisis has given greater credence to the idea that active state involvement in the financial sector can be helpful for stability and development. There is now evidence that, for example, lending by state-owned banks has helped in mitigating the impact of the crisis on aggregate credit. But evidence also points to negative longer-term effects of direct interventions on resource allocation and quality of intermediation. This suggests a need to rebalance the state’s roles from direct to less direct involvement, as the crisis subsides. The state does have very important roles, especially in providing well-defined regulations and enforcing them, ensuring healthy competition, and strengthening financial infrastructure. One of the crisis lessons is the importance of getting the basics right first: countries with complex but poorly enforced regulations suffered more during the global crisis. Evidence also suggests that instead of restricting competition, the state needs to encourage contestability through healthy entry of well-capitalized institutions and timely exit of insolvent ones. There is also new evidence that supports the state’s key role in promoting transparency of information and reducing counterparty risk. The challenge of financial sector policies is to better align private incentives with public interest, without taxing or subsidizing private risk-taking.


The Cyprus debacle seems to have taken a course towards a resolution of some sort, with the announcement last week of a bailout plan that includes, among other measures, a one-time tax levy on wealthy (supposedly Russian) depositors in Cyprus banks, even when reports are now surfacing that the Cyprus banking system has been experiencing steady capital flight for several months now, with savvy Russian depositors being tipped-off by money managers way in advance of things reaching their dramatic climax over last week. The bailout deal sets a significant precedent, and fires a warning shot towards European jurisdictions who have allowed their banking systems to become offshore parking lots for hot money, to the tune of multiples of national GDPs.

I distill 4 fundamental lessons from this episode:

1) Capital controls are back, clearly embedded in the bailout terms: Capital controls are an extraordinary breach of basic EU rules, which allow freedom of labor and capital movement. Indeed, article 63 of Europe’s internal market rules explicitly states that “all restrictions on the movement of capital between member states and between member states and third countries shall be prohibited” unless there is an issue of “public security”. But there are few signs of the EU enforcing article 63 when it comes to Cyprus, even when the capital controls proposed are currently treated as temporary measures.

2) All deposit accounts are at risk, and some euros are more equal than others: the latest plan, which will see accounts with less than €100,000 protected, has established a new template for future bank bailouts: that depositors’ cash above the “insured” amount can and will be raided.

3) “Too big to fail” still holds: Some will argue that as big savers in the Bank of Cyprus and Laiki, the island’s two biggest banks, are taking such a haircut, the “too big to fail” mantra no longer works. But in truth the banks were minnows within the euro zone. Their near-collapse tells you that the ECB will do all it can to protect banks it regards as “systemic”, but will let the others go hang.

4) EU stress tests are worthless: The European Banking Authority’s annual health check on euro zone banks at the height of the euro crisis in July 2011 revealed significant concerns about just eight banks – five Spanish, one Greek and two Austrian. The Cypriot banks – Bank of Cyprus, Laiki, and Hellenic – passed what was supposedly a grueling assessment. Bank of Cyprus chief executive officer Andreas Eliades said at the time: “The stress test results justify the group’s strategic choices and actions, and illustrate its very strong capital base even under the most extreme, difficult and adverse scenarios.” Make of that what you will.

So who’s next to follow Cyprus’ path in the euro zone? Speculations have been swirling as of late, identifying Slovenia, Malta, Slovakia, or even Luxembourg as potential next domino piece to fall. In essence, Cyprus fell into its mess due to four fundamental factors that converged at a particular point in time, namely: weak fiscal situation, large debt overhang, banking sector size too big (and too weak), and too much reliant on foreign funding. I figured if I plot those 4 dimensions based on latest data observations (2012) for a host of euro zone countries, maybe one can discern possible next targets? Below is my attempt at a visualization in Tableau software. The x and y axis are self explanatory, depicting the debt and fiscal situation respectively, the relative size of the bubbles represents the size of the banking sector relative to national GDP, and finally he bubble color represents the extent of which that banking sector is reliant on foreign deposits (the more red, the “hotter” the funding). The data was sourced from the latest IMF World Economic Outlook edition, and the ECB’s Eurostat. Voila!

Basically, we’re looking for big, red bubbles that are closer to the upper right quadrant of the chart. Cyprus is right there, along with Portugal, France, Spain, Malta, Ireland, Belgium, Slovenia, Slovakia, Austria and Hungary, to name a few culprits. Malta looks particularly worrying, but consider this: Despite the size of Malta’s banking sector, assets held by the more important banks are slightly more than twice the country’s GDP. This is half the EU average. More importantly though is that the vast majority of deposits and loans administered by these banks are domestically derived: Maltese banks have very little exposure to foreign government bonds, have more than enough cash reserves to cover their loan portfolio and adopted over the years a very conservative low-risk approach to investment.

Slovenia has had its share of rumors lately, and the chart above shows it to be on the edge of the danger zone. These fears could be well founded: Slovenian GDP is set for a deeper-than-expected 1.9pc contraction this year, compared with an earlier estimate of 1.4pc, according to official forecasts released on Friday. The revised forecast brings government predictions in line with the IMF’s gloomier verdict that that the economy will shrink 2pc this year, the most in the European Union after Greece and Cyprus. As such, Slovenia’s cost of borrowing soared to a record high on Wednesday, with yields on two-year debt tripling over the past week, jumping from 1.2pc to 4.26pc before falling back slightly on Thursday. Ten-year yields have reached a post-EMU high of 6.25pc. Add to it the Russian connection, and you’ve got yourself a self-fulfilling prophecy.

Personally, I would be nervous about Belgium, particularly after the IMF’s latest assessment, which states: “The economy has entered a second year of near zero growth amid persistent vulnerabilities. While an improvement in external conditions, even if gradual, should support the recovery, the economy’s capacity to rebound and create jobs is constrained by structural rigidities and a loss of competitiveness. The financial sector has been transformed and downsized in the aftermath of the financial crisis, but vulnerabilities remain. Combined with the fragile situation of public finances, these vulnerabilities could, in an adverse environment, undermine macroeconomic stability.” Hum, zero growth, large and weak banks, lousy fiscal, large debt overhang, and an IMF warning to boot? That’s hard numbers. Does the market agree? Belgium bond yields went lower, so maybe the market knows something I don’t, or maybe it’s just a prelude.

By the way, the Tableau visualization above is interactive and dynamic (and Hungary is hiding behind Austria, conveniently), so feel free to click on data points and bubbles and explore around, then write to me or in the comments section below and tell me which euro zone country would be next to fall to the all-new, all-improved punishing bailout treatment.


A colleague of mine, who goes by “19th & H”, had the following reactions to yesterday’s Euro banking deal. I thought they were worth posting as a guest blog post ( ;


Last night, the euro area agreed on yet another deal, and this is one seems significant for Spanish and perhaps Irish banks, although questions remain. It seems that Germany, after losing the semi-final against Italy yesterday, has realized that it winning streak may be over……

The first reaction of global markets (equities, oil, bonds) was positive, but we will have to see how long it will last (the half-life of euphoria after European deals had fallen to about 3 hours)….

This has reduced the risk in the short term of a euro area break-up although bond markets are now realizing that Italy will officially become a recipient of (limited) European funds.

Direct injection

The deal allows the EFSF and ESM financing vehicles to directly inject capital into banks. This is good news for Spain and its banks. You may remember that the original announcement two weeks ago of a ■100 billion bank loan to Spain’s bank bail-out fund FROB had about a 3-hour positive effect, until investors started to realize that this would increase sovereign debt, and that Spain would carry the risk of losses.

Under the new deal, the capital injection bypasses the FROB and the Spanish sovereign, so it will not add to public debt. Given Spain relatively low sovereign debt, the main concern has always been the contingent liability of bank recapitalizations, so it is hoped that the vicious circle of weakening banks and sovereign in Spain has broken. Spain is still suffering from a deep recession and unemployment, so there will still be a lot of tension on its public finances though.


The second concern was that the uncertainty whether the original loan to the FROB of two weeks ago would have seniority status over all other Spanish bond holders. For EFSF loan this apparently decided case by case, while for the ESM this was automatic. This means that any intervention in any bond market would automatically move all other creditors down the ladder and increase risk of default for everyone else. Once market realized this, Spain’s bond yields went even higher than before the deal of two weeks ago.

The new deal removes this seniority status, so EFSF and ESM loans will not receive any preferential treatment. This is good news for the remaining private-sector bond holders.

These are major concessions from Germany, as it had always insisted on loans through the sovereign to retain influence to push through reforms.

Single banks supervisor

The ECB will host a single banks supervisor for the entire euro area. This seems to include not just cross-border banks but also regional banks. As it was the regional cajas savings banks that were making the largest losses in Spain, this seems to make sense. It is a major concession from Germany, as it wanted to exclude its own Landesbanken from European supervision (those banks made major bets on the US subprime market, and some had to be bailed out). Apparently, the euro-area supervisor will also be able to force recapitalizations and wind down failing banks, which would reduce political influence to keep national champions artificially alive.

Although this seems to be a concession of Germany, it will also have more influence on other euro area banks, and the seat will be in Frankfurt at the ECB. Meanwhile, the UK will be happy that its own banks are not included by this supervisor.

Direct bond buying but less direct monitoring

The new deal will also allow the two funds to directly buy bonds on the primary and secondary market. I thought that this had already been agreed earlier, but maybe there were some obstacles. This will make the ECB and Draghi happy, as they have stopped buying bonds since end-2011.

It was also agreed that new bail-out would not necessarily have the same IMF-EU-ECB monitoring as was the case in Greece, Ireland and Portugal, which carried a big stigma (comparable to the stigma attached to the IMF’s own programs). As the IMF introduced Flexible and Precautionary Credit Lines for good performers, the euro area will do something similar. Given that bond market have largely forced austerity and structural reforms in Italy and Spain, they can now ask for ESFS/ESM help without being subject to humiliating missions.

Italy pushed hard for this deal, so Italy will probably be the next recipient of funds, which completes the PIIGS acronym that had been buzzing around since 2010 (we would almost forget that Cyprus has also requested bail-out this week due mostly to banking sector exposure to Greece).

It is hinted that the Ireland deal may be revised to have fewer conditions and monitoring, as it was a case similar to Spain (the banking sector collapse dragged down the sovereign), which could be good news for Ireland.

Questions remain

Although this could take pressure off Spain’s banks and sovereign and Ireland, while also benefiting Italy through bond buying, many questions remain.

The big question remains how much firepower the EFSF and ESM have. The ■500 billion EFSF has already been partly used for the Greek, Portugal and Ireland bail-outs, and will inject up to ■100 billion into Spanish banks, so how much influence can it have on Italy’s trillion euro bond market? Similar question for the ESM, which will become active soon, but has a similar size.

The implicit assumption must be that both funds will soon obtain European banking licenses, and would be able to borrow on the market. In order to make an impact on Italian yields, it will need to borrow a lot on the market. Would investors lend to an EFSF/ESM which will on-lend to Italy at a lower rate than lending to Italy directly? If that is the case, investors must assume that either EFSF/ESM’s economists are much smarter than those working in Italy, or they must believe that the funds will still be entirely underwritten by the strong European sovereigns.

Creating a new banking supervisor from scratch will take a while, and many details need to be fleshed out. There is no agreement on a common deposit insurance, which could still expose some sovereigns to the risk of a bank run that exceeds their own national deposit insurance funds.

All in all, this deal has the potential to divert bond market attention away from Spain, but now they will have to deal with Italy.


We’ve had an intense fascination with blowing bubbles since the day we’re born. Whether it’s soap bubbles, balloons, bubble gum, we’re forever blowing them, the more the better, the bigger the better. We watch in awe and anticipation as the bubble gets bigger and bigger, and we snap back in excitement (and a little surprise) as the bubble bursts, often in a messy and dramatic fashion. Did we not expect it to blow up? Then we blow another one. and another.

It’s quite the similar story with adults in the financial world: we create, often through breakthrough financial engineering advances, investment opportunities that look too good to pass up, we fuel the bubble with a toxic mix of greed, cheap credit, intense lobbying, and minimal regulation, we market the opportunity as a low risk/high return affair (as if this concept actually ever existed in real life), and we feed it to the people who can least afford it, sometimes forcefully, sometimes fraudulently. And finally, when the bubble bursts, we borrow the government’s bailout mop to clean up the mess left behind. History is riddled with financial boom-bust-bailout episodes, and one does only need to look in the recent past for some of the more striking examples of leveraging and excess gone wild. It has even been shown in a rather comprehensive and thorough way by Reinhart and Rogoff in their excellent seminal treatise on the history of financial crises that this boom-bust cycle has been getting shorter and shorter, with more devastating consequences and spilovers on the global economy (you can download the entire excellent dataset of the book for free here).

So you wake up every morning and you wonder “What is the next financial bubble, how big is it, and who’s blowing it?”. Or maybe you don’t, but you should, since we’ve already experienced in very stark detail (and still do) how someone else’s big messy pile can quickly turn into your own sour bill to pay. And like with every other question I have, I turned to Google search to get started on an answer. I typed “next financial bubble” in the search box and got the following random candidates for the US economy, in no particular order: derivatives, student loans, credit card debt, the stock market (and more recently social media stocks), and healthcare. There are many more bubbles outside the US market, like commodities, China, emerging markets, and other lurking risks, but we can examine those in a different post.

The the $1.2 quadrillion (one thousand trillions) derivatives market has been dubbed “one of the biggest risks to the world’s financial health”. It’s complex, it’s unregulated, and it ought to be of concern that its notional value is 20 times the size of the world economy (note though that we’re talking here about notionalvalues, not net values). U.S. commercial banks currently hold a notional value of $244 trillion in derivatives, with Net Current Credit Exposure of commercial banks to derivatives of $353 billion (due to bilateral netting), and that’s the number we’ll use for the US market. See the latest OCC report for further details. College tuition costs are soaring and forcing the young to bear obscenely high levels of student loan debt, while a ballooning $1 trillion student loan bubble shares a strikingly scary resemblance to the toxic subprime mortgages of six years earlier (and are just as likely to be repaid). Credit card debt is as american as apple pie, and rising healthcare costs prompted ObamaCare, while stock market bubbles are a recurring and familiar scene. While the U.S. Higher Education, credit cards, and healthcare bubbles aren’t an asset bubble like stock or real estate bubbles, it is a bubble-like phenomenon with very similar risks and implications as asset bubbles.

I couldn’t quite seperate media hype from real risk, so to test the claim that a particular phenomenon is a bubble or not, and to compare the claims side-by-side, I resorted to a simple visualization technique called (what else?) the bubble chart, whereby I plot the bubble phenomena on a three-dimensional graph according to 1. overall growth since 2001 (in multiplier form), 2. latest yearly growth rate vs average yearly growth rate (also in multiplier form), and 3. with the size of the chart bubble indicating it’s relative size to US GDP in real life. These dimensions basically illustrate the total amount of growth in the past 10 years (vertical), the most recent rate of growth relative to the 10-year average growth rate (horizontal), and the size of the “problem” relative to GDP (size and color of bubble). The crude and preliminary results look something like this:

Three basic observations: the fastest growing recent trend can be observed in college debt, the biggest increase in the past 10 years has been in the derivatives market, and the biggest exposure to the overall size of the economy can be found in the stock market, albeit at a much slowing pace (due mostly to the great correction of 2008).

The current price to earnings ratio of the overall U.S stock market stands near its long-term historical average of 15, so it seems that overall valuation is where it should be. I’ll go on a limb and say that credit card debt seems to be under control, owing to a recent 3 year episode of consumer credit deleveraging following the shock of 2008. The derivatives market looks like a runaway train on the chart above, but it relatively small in net terms, and considering that the derivatives market is in its infancy pretty much, and hence starting from a low base, such great rates of growth are expected. Which leaves us with skyrocketing healthcare and education costs, among other things, to get alarmed about.

The cost of healthcare, like college education, has exploded in recent years, far outpacing wage growth and the overall rate of inflation:

Healthcare spending as a share of the US economy reached an all-time high of 18.2 percent in 2011, an incredible threefold increase since 1960. The sad fact is that Americans spend twice as much on healthcare compared to other developed countries, but get lower quality care and less efficiency. Like any other industry, the healthcare industry is tied to the health of the overall economy and when their services become even more unaffordable for vast portions of the population, such as in the next recession, the industry will experience some form of a collapse. The popping of the healthcare bubble will cause all levels of the U.S. healthcare industry to downsize in the form of layoffs, salary cuts, hospital and medical office closures. As with housing, healthcare will always be needed, but the US healthcare industry’s current levels of largesse and parasitic profits cannot be sustained.

On student loans and the alarming, crisis-like levels it reached, I point you to this succint piece in the Pulse, and this cartoon:

Bubbles this big simply have to be closely monitored and kept in check. The government should seek sharpening of monetary policy and macro-prudential tools to deal with these, due to their implications for the economy and the strength and stability of the financial system, as well as the overall well-being of the society.



Here’s my latest on Syria below as appeared in Foreign Policy when it asked five “smart observers” to offer their solutions for the quagmire in Damascus.

– Bilal


In an attempt to find a solution to the Syrian crisis, the United States and Russia appear to be discussing a diplomatic option, modeled on the U.S.-led political transition in Yemen, that ensures the departure of Syrian President Bashar al-Assad, his family, and perhaps a few of his close associates but keeps his regime intact. Let us save Washington and Moscow the trouble of having to think through this latest proposal, known in diplomatic circles as “the Yemenskii Variant”: It is a very bad idea that will make things worse.

First, while this proposal, albeit with major modifications and conditions that guarantee a democratic future for Syria, could have been entertained during the first weeks of the uprising, 14 months and more than 13,000 deaths later is simply too late. The bloodshed is too extreme, and Assad must be held accountable. And any theory of him not being in charge or not having ordered this brutal crackdown is utter nonsense. Assad is the head of the Syrian government and — as far as we know — all major decisions, including management of the uprising, are made by him and members of his family.

Second, the Syrian people should be consulted first and foremost. It is one thing to try to stop the carnage and save lives in Syria, but quite another to do it without respecting the long-term aspirations of the Syrian people. Who said that the Syrian people would be on board with keeping a murderous regime that has massacred them on a daily basis? Of course, it is a challenge to know precisely how the Syrian people wish to achieve their goals of freedom, security, and prosperity. Those who speak for the people — the Syrian opposition — are hardly coherent or united. There may not be consensus or unanimity among Syrians on how to move forward. Nevertheless, there is something terribly wrong about the notion of foreign powers planning the future of a people they wish to rescue without their endorsement.

Third, the plan is highly immoral. Diplomacy should seek to end the violence in Syria, but certainly not at the expense of justice. History shows that diplomacy is most effective when it is just and rooted in morality. The Syrian people, like their Egyptian counterparts, deserve to see their tyrannical ruler stand before them and face punishment for his crimes. Without justice, there is no reconciliation, and thus any post-Assad political order that preserves the outgoing president’s regime is a recipe for continued conflict. For Syrian society to be given a chance to heal, all sects and communal groups must come together and collectively build a better future.

Preserving an oppressive and minority-led regime means that the Alawites will retain their political dominance over others, a condition that is guaranteed to cause more sectarian violence and further alienate the Sunnis, who represent the majority of Syrian society. While former Yemeni President Ali Abdullah Saleh personified the state in his country, Assad is not the only problem in Syria. It is the fascist and security-oriented regime that the Baathists built in 1963 and Hafez al-Assad — Bashar’s father — remodeled in 1970. Syria needs new leaders, but it also needs a new system and a new identity and role in international society.

Fourth, has anybody called Bashar and asked him if he is willing to play ball? Given the alliance between Damascus and Moscow, one would assume that Russian President Vladimir Putin has phoned his Syrian counterpart and asked him how he would feel about packing his and his family’s bags in return for his life. Even if he did, there is reason to believe that Assad will reject this offer for one simple reason: He thinks he is winning. His regime has yet to face a significant security or political threat and the balance of power, despite the rebels’ receipt of more modern weapons recently from neighboring countries, still tilts heavily in the government’s favor.

One can understand why Russia would favor the Yemeni model for Syria. Moscow does not really need Assad to preserve its strategic interests in Syria and the Middle East. All it wants is a Syrian government that allows it to use the port of Tartous for access to the Mediterranean Sea, that purchases Russian arms, and that maintains trade relations. Assad is expendable as long as his successors stay the course on relations with Russia.

How could the United States even be thinking about this exit strategy, which does nothing to address the roots of the uprising or hold anyone accountable for the crackdown? The stakes in Syria are too high to resort to solutions on the cheap, especially when such solutions are more likely to make things worse and lead to the same unintended consequences that top U.S. officials have been warning about: a full-blown civil war that engulfs parts of the Middle East, further Islamist radicalization of Syrian society that could open new doors for al Qaeda, and a generally chaotic and violent environment in which chemical weapons — suspected to be held in large quantities by the regime — are either lost, used or both.

Kofi Annan’s U.N.-backed plan has served its goal of exposing the Syrian regime before the world. But that was all anyone could realistically hope of Annan’s mission. Now, the United States should pursue tough talks and bargain with Russia to find a solution that respects the hopes and interests of the Syrian people — not a short-term solution that betrays the Syrian people and undermines U.S. strategic interests in the Middle East.

It’s time for real and serious negotiations with Russia over not just Syria but a range of Middle Eastern issues of concern to both countries. But the Yemenskii Variant is not it.