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How much do bailouts really cost creditor countries? The question is particularly pertinent in light of the recent German Constitutional Court hearings regarding the scope of the European Central Bank’s new sovereign bond buying programme, called Outright Monetary Transactions, and the renewed concern that Greece may need further financial assistance.
Just as banking crises tend to entail transfers of risk from the private to public sector, sovereign debt crises involve supranational bodies such as the International Monetary Fund or the ECB assuming some of those risks. Attention, though, tends to focus on the headline numbers involved – the money at risk – much more than on the likely, or indeed ultimate, net cost to the provider of financial support.
It is instructive to reflect on those net fiscal costs, distinguishing between governmental interventions such as guarantees, equity stakes or nationalisation of institutions on the one hand, and activity – such as liquidity support, loans or asset purchases – that constitutes part of a central bank’s role as lender of last resort.
Evidence for government guarantees and equity ownership is somewhat mixed, though the costs generally prove less onerous than originally feared.
As part of its troubled asset relief programme in the wake of the global financial crisis, the US Treasury made a number of equity investments. On the positive side of the ledger, its stake in AIG yielded a $5bn gain and its investments in Citigroup and Bank of America a further $4.5bn. However, a positive cash return on the US Treasury’s automotive investments seems unlikely.
In the UK, the government’s investment in Lloyds Banking Group is now tantalisingly close to break-even, though its stake in Royal Bank of Scotland remains below water. Note, though, that the government made £5bn on RBS’s participation in and LBG’s exit from the Asset Protection Scheme.
The jury remains out on the nationalisation of Northern Rock and subsequently Bradford & Bingley: the sale of the restructured Northern Rock resulted in a paper loss, but the government’s interest-bearing loan is expected to be repaid in full with the slow winding down of the remaining book of assets.
By contrast, the record of central bank lender of last resort activities is better, with bailouts typically ending up profitable for those taking on the risk.
In its response to the Asian financial crisis, the Hong Kong Monetary Authority bought HK$118bn of assets during a market operation in 1998, culminating in an equity portfolio that included a 10 per cent stake in HSBC. It eventually recovered HK$208bn, representing a gain of HK$90bn.
The US Federal Reserve’s purchase of nearly $30bn of Bear Stearns assets in spring 2008 generated a positive result of $6.6bn, representing a more than 20 per cent return. In the case of the Fed’s loans to and asset purchases from AIG, it was able to add $17.7bn to the Treasury’s gain.
The Bank of England’s Special Liquidity Scheme, whereby financial institutions were allowed to swap illiquid assets for UK Treasury bills for up to three years, generated a profit of £2.3bn by the time it was wound up in January 2012.
Likewise, the Bank’s Asset Purchase Facility, which started life in January 2009 in order to buy private sector assets and is now the vehicle for its quantitative easing programme, has so far accumulated more than £31bn, which is now being distributed to the UK Treasury at regular intervals.
It is clear that at some point these payment streams will reverse, but under the scenarios outlined by the BoE, all but one of its published scenarios point to a net gain.
Through its covered bond and securities market programmes, the ECB acquired €276bn in assets between 2009 and 2012, when it was superseded by OMTs. This includes substantial peripheral sovereign debt – more than 50 per cent of outstanding Greek debt and a quarter of Portuguese debt – as well as commercial paper. As these assets will typically be held to maturity, coupon is the main source of gains rather than capital appreciation. Assuming no further defaults, these programmes should generate a net gain of around €70bn-€80bn, including €9bn on the Greek debt.
Viewed in this light, the lender of last resort plays a critical yet ultimately profitable role in the face of banking or sovereign debt crises. Should the situation arise that Greece requires further financial assistance involving public participation for the first time, then at least some of the cost would be made good by the proceeds of the ECB’s other earlier programmes. If this was better understood, perhaps the popular opposition to bailouts would be tempered.
Andreas Utermann is co-head and global chief investment officer at Allianz Global Investors
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