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You don't need a fictional alternative universe, you need the real world.

Consider this from the position of a creditor bank in a creditor country where long-term funding costs are 4%.

Debtor country bonds are now selling in the secondary market (and being issued in the primary market) at 10%.

You can fund yourself at 4% and buy the bonds at 10% in the secondary market, pocketing a 6% margin. However, there is a risk of default. If there's a default by the debtor country, you not only don't make 6% but lose your 4%, and the principal.

To avert a default, the creditor government lends money to the debtor country at 7% to pay interest. The creditor country makes 3% margin, and the debtor country can pay its interest. The market is kept in jitters about default risk so the bonds still sell at 10% in the secondary market and the creditor bank can continue to make its 6% margin from buying in the secondary market.

If you allowed the debtor country to buy the bonds in the secondary market 1) the creditor bank loses the ability to buy the bonds at firesale prices to make the nice 6% margin since the debtor country always has an incentive to outbid the creditor bank in the secondary market; 2) if the creditor bank sells the bonds in the secondary market they instanty realise a large loss.

So the game here is:

  1. the creditor country makes seigniorage income;
  2. the creditor bank avoids losses through default or through realised losses in a sale;
So far, so good. The possible scam made possible by forbidding the debtor country from repurchasing their bonds is

  1. the market in debtor country bonds remains illiquid and the bonds cheap for the creditor bank to buy,
  2. the creditor country cannot be outbid by the debtor country for bonds held by third parties;

It is important that the market be kept nervous about the possibility of a default, otherwise the bonds would become expensive again.

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Wed Apr 6th, 2011 at 08:42:21 AM EST
[ Parent ]
Migeru:
the creditor countrybank cannot be outbid by the debtor country for bonds held by third parties
Anyway, I don't think the creditor bank wants to buy bonds in the secondary market. It's better for them to lend to the creditor country to lend to the debtor country to repay the bonds until 2013, when presumably the bonds held by the creditor bank have matured and all that's left is debt owed by the debtor country to the creditor country.

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Wed Apr 6th, 2011 at 08:55:47 AM EST
[ Parent ]
... that to the EPP (and the Quisling wing of the PES) "makes sense" means "makes sense for our buddies in the banks," not "makes sense for our electorates."

I can haz honest politicians?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Apr 6th, 2011 at 01:27:05 PM EST
[ Parent ]
You don't need a fictional alternative universe, you need the real world.

A choice would often be good.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Apr 6th, 2011 at 09:16:50 AM EST
[ Parent ]
We need a fictional alternative universe in which there's no collusion among the economic policy establishment to make the pain fall on the less well politically connected to the financial core of the Eurozone.

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Wed Apr 6th, 2011 at 09:20:17 AM EST
[ Parent ]

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