Bailout
Bank recapitalisation
Bond and bondholder
Bridge loan
Collective Action Clause
Concessional loan
Debt relief/restructure/cancellation/haircut/swap/write-down/work-out
Debt haircut
Debt relief
Debt restructuring
Debt service
Debt swap
Debt stock
Debt workout
Debt write-down
Default and repudiation
Deficit
Deflation
European Central Bank (ECB)
Federal Reserve
Holdout
Inflation
International Finance Corporation (IFC)
International Centre for Settlement of Investment Disputes (ICSID)
International Monetary Fund (IMF)
Liquidity
Maturity
Multilateral Investment Guarantee Agency (MIGA)
Pari-passu
Primary surplus
Quantitative easing
Speculate
Structural/economic reforms
Vulture fund
World Bank
Yield
Definitions and explanations:
Bailout
A bailout is any use of public money to protect private financial institutions suffering from the negative consequences of their speculation, even if only in part.
Direct bailouts in recent years have included by the British and Irish governments of British and Irish banks. For example, during the 2008 financial crisis, it became apparent that British banks including RBS and Lloyds had lent large amounts of money that they were not going to be repaid (mainly through buying complex derivatives). Officially they were therefore bankrupt – owing more money than they owed. The UK government gave them a bailout, and in return got part of the ownership of the banks through being issued their shares.
Indirectly, banks and other financial institutions are often bailed out when governments are no longer able to pay their debts. Other public institutions, such as the IMF, World Bank and EU, lend more money to enable these debts to be paid. This is effectively bailing out whoever the debt was owed to originally, as otherwise they would have received nothing, or had to accept cancellation of some of the debt.
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Bank recapitalisation
Banks both owe people money and are owed money. Banks owe money to people who deposit money with them (who have effectively lent it) and also borrow in other ways (such as issuing bonds). Banks are owed money by the people they lend to.
In addition, banks have ‘capital’ or ‘equity’ which is money they hold which does not come from borrowing. They are supposed to hold a significant proportion of such money, which is used so that banks are able to pay the people they owe money to (including depositors) if those who owe the bank money don’t repay. The main way banks get such ‘capital’ or ‘equity’ is by issuing shares – giving ownership of a proportion of the bank (and its profits) to someone in return for money.
However, throughout recent history, many banks have had so many loans not being repaid to them that this has wiped out all their ‘capital’ or ‘equity’ in order to repay the loans they owe. Such banks are effectively bankrupt. Bank recapitalisation is giving more ‘capital’ or ‘equity’ to such banks so that they do not go bankrupt. This money cannot be given as loans because this would not improve the bankruptcy situation of the bank. Instead, it is given as equity, which means whoever is giving the money, usually a government, gets some of the ownership of the bank instead. What financial media refer to as bank recapitalisation is otherwise known as a direct bank bailout.
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Bond and bondholder
A ‘bond’ is a kind of way that governments and companies borrow. To take the example of a government, it borrows money in return for issuing a contract saying it will repay the money in full in a certain number of years (eg, 10) and interest every year until then (eg, 3%). This contract is known as a ‘bond’. The bond is then tradable. Whoever initial lent the money usually sells the bond on. Such bonds are being bought and sold in their millions every day on financial markets. The current owner of a bond is called a ‘bondholder’.
Bonds attract the most attention by the media because they are the most public debts as they are traded on financial markets (though it can be very difficult to know who owns bonds at a particular time). However, they are only part of the debt of most governments. For developing country governments, bonds make-up 40% of the total foreign debt they owe. Other forms of debt include debts owed directly to banks, to multilateral institutions such as the World Bank and directly to other governments. For low income countries – the most impoverished developing countries – they owe just 2% of their debt as bonds.
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Bridge loan
A bridge loan is a short term loan to enable a debt payment to be made, which in turn allows more loans to be given which enable the bridge loan to be repaid.
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Collective Action Clause
Collective Action Clauses were clauses in government bonds which began to be introduced in the early 2000s. They stated that if a certain percentage of owners of those bonds (eg, 75%) agreed to reduce the amount owed through a debt restructuring, every bondholder would have to accept this reduction. However, they only applied across bonds issued at the same time. Most governments have tens if not hundreds of such different ‘bond issuances’. Therefore, when Greece was known not to be able to pay its debts, vulture funds bought up enough to block bonds to block restructuring for a particular bond issuance, and so in 2012, avoided the debt restructuring, and made a huge profit out of the Greek people on what they had paid for the debt.
Following this, the IMF in 2014 suggested that when governments issue bonds they should include collective action clauses which are properly collective across all issuances. Even if governments do start doing this, it will only become effective at preventing holdouts / vulture funds on bonds once all the government bonds without such clauses have been repaid (which will be several decades). Moreover, vulture funds could still buy debts which are not in the form of bonds, such as other forms of private sector debts, or debts which original come from loans from governments.
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Concessional loan
A concessional loan is a loan with ‘lower’ interest rates, though this is not defined in a particular way. Sometimes it means the interest rate is lower than the lender would normally lend at. Sometimes it means the interest rate is lower than the borrower would normally borrow at (which could still mean the interest rate is high enough for the lender to make a large profit).
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Debt-
Debt relief/restructure/cancellation/haircut/swap/write-down/work-out
If creditors are forced to accept that they need to reduce the amount of debt owed – usually because the debtor has defaulted or threatens to – there are three main things they could agree to do:
1) Lengthen the ‘maturity’ of the debt, so it does not need to be paid now, but the debtor is still agreeing to pay it in the future
2) Change the interest rate of the debt, usually through reducing it, though this can also include changing the terms so that future interest payments are linked to something such as economic growth, as Argentina did in 2005
3) Reduce the actual amount of debt owed
A haircut is the term used by financial markets when a debt restructuring involves an actual reduction in the size of the debt. Similarly, debt cancellation would imply that the total amount of debt has been reduced, though might not mean all the debt has been cancelled.
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Debt relief is a term with no clear definition. Financial markets would tend to use it interchangeably with debt restructuring, meaning any change in the terms of the debt. Campaigners would tend to assume a more sizeable change had been made, such as a large reduction in interest payments or some kind of reduction of the actual size of the debt.
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Debt restructuring is any combination of these things. It means any changes to the terms of the debt, which could include just changing when it is paid over, but can also include reducing the amount of debt owed.
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Debt service is the amount being spent on paying a debt and the interest at a particular point in time, usually one year.
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Debt swap is when a debt is cancelled, usually in full, in return for the debtor committing to spend the equivalent amount of money on something agreed with the creditor. Some governments agree debt swaps on money they are owed, such as agreeing to cancel a debt in return for the debtor government spending the same amount of money on an environmental project in the country.
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Debt stock is the total amount of debt owed, not including any interest payments. It is effectively the amount a debtor would need to pay now to get rid of the debt. Another word for stock is debt principal.
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Debt workout is the process by which all these above changes to debt are made. At the moment, this is a negotiation between the debtor and creditor, though there are calls for the creation of a ‘debt workout process’ which would create rules for how these changes to debt contracts happen, independent assessments of the debt, and powers to force creditors to accept any agreed changes to the debt.
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Debt write-down implies there has been some debt cancellation, but it is used loosely, and could just mean any of the forms of debt restructuring listed above.
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Default and repudiation>
Default is missing a debt payment when it is due. Often contracts allow for a ‘grace period’ after a payment is missed before a default is officially declared – often around one month. A default can be a full default – on all payments coming due – or a partial default – on just some of the debts, usually depending on who the creditor is.
Repudiation is both defaulting on the debt and the debtor saying it has no intention ever paying the debt. Repudiation is much rarer than default but it does happen. For example, after the Iranian revolution of 1979, the new government both defaulted on some of the debts inherited from the Shah dictatorship, and said they would never pay them (in the case of debts the UK government claims it is owed, this repudiation continues to this day).
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Deficit
The deficit is the difference between the amount a stated entity receives in income, with how much it spends. For instance, if a government spends more than it receives, it has a deficit (the opposite is that it has a surplus). If a government has a deficit this normally means it has to borrow to fund the difference.
A government deficit is not the only kind of deficit. A much more important deficit in most countries is the current account deficit. This is how much more a whole country (public and private sectors) is spending on things from the rest of the world than it is receiving in income from the rest of the world. Where a current account deficit exists, the gap is made up by borrowing (again either by public or private companies) or selling off assets to overseas owners (eg, selling shares in local companies). Again, if a country is earning more from the rest of the world than it is spending, it has a current account surplus.
Most debt crises are caused by debts being owed between countries, whether it concerns the public or private sector. Therefore, large current account deficits and surpluses are the main causes of debt crisis. For one country to have a deficit requires another to have a surplus, so both are responsible for causing debt crises.
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Deflation
See Inflation
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European Central Bank (ECB)
The European Central Bank is the Central Bank for the Eurozone. It is owned by the 28 Central Banks of the EU member states, though in practise those which have not joined the Euro have only made nominal contributions to it, and all decisions are taken by representatives of the 19 Central Banks from the Eurozone. Within this, the three most powerful are Germany, France and Italy.
The European Central Bank sets the interest rates at which European private banks can borrow from it, the main way new cash and electronic money needed for payments within the Eurozone is created. Since 2011, the European Central Bank has been creating more of such money and putting it into the financial system in various ways, primarily through buying government bonds of Eurozone members. This policy of Quantitative Easing was adopted much later than in the US and UK. A new sizeable round of European Central Bank Quantitative Easing began in early 2015.
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Federal Reserve
The Federal Reserve is the US’s Central Bank. Like the European Central Bank and UK’s Bank of England, it sets monetary policy. The Federal Reserve does so through a variety of measures which are intended to influence the interest rate at which US banks lend to each other.
Since November 2008 the Federal Reserve has embarked on three rounds of Quantitative Easing under which it has created new money with which to buy $4.5 trillion of assets by October 2014, when the policy was halted. These assets were both US government bonds and forms of private sector debt. As of late 2013, just over 60% of the Federal Reserve’s Quantitative Easing money has been used to buy US government debt, with 40% other forms of debt. This means that around $2.7 trillion of US government debt is owed to the US government via the Federal Reserve, around 20% of its total debt.
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Holdout
A holdout is a creditor who refuses to take part in a debt restructuring agreed with other creditors. A vulture fund is a holdout, who also bought the debt for less than the face value amount, and is therefore seeking (a usually very large) profit by refusing to take part in the debt restructuring.
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Inflation
Inflation is an increase in prices paid for exactly the same product. Deflation is the opposite, a fall in prices for the same product. Inflation/deflation estimates for the whole economy are usually calculated by taking the same set of goods and services, and comparing how they change over time.
Assuming that wages increase in line with inflation (which is often not fully the case), inflation is good for debtors as it reduces the size of a debt compared to what price goods and services are bought and sold at. Inflation is bad for creditors for the same reason. Many instances of large reductions of government debt, such as the UK after the Second World War, have been caused by a combination of high inflation and high growth (rather than spending cuts or tax increases). Of course, if inflation gets too high it gets out of hand, people stop trusting the currency, economic activity falls and economies can enter major recessions.
Deflation is also likely to cause recessions, because falling prices mean it becomes beneficial to wait for the price of a good to fall further, and so delay spending. This again reduces economic activity, and causes recessions. Whether or not this happens may depend on which prices are falling – prices of goods and services which are bought on a recurring basis (which is less likely to cause this deflationary spiral) or more one-off purchases. If deflation does take place, this also increases the relative size of a debt, as explained above, thereby being bad for debtors, increasing debt burdens and further undermining confidence in the economy.
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International Finance Corporation (IFC)
The International Finance Corporation lends or gives equity to private companies. In recent years that has included giving money to private equity companies which then choose which companies they then speculate on.
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International Centre for Settlement of Investment Disputes (ICSID)
The International Centre for Settlement of Investment Disputes is a World Bank court which allows private companies to sue governments. Thousands of Bilateral Investment and Trade Treaties exist which specify that if a private company feels it is harmed by the actions of a government, it can bring a claim against that government at ICSID. If ICSID rules against the said government, it issues a fine which the government is expected to pay to the private company. There is no corresponding court for governments to sue companies.
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International Monetary Fund (IMF)
The International Monetary Fund was created by the US and UK towards the end of the Second World War. It was initially created to give loans to countries suffering from a short term economic crisis, on the expectation that the country would quickly recover, and the loans would be able to be repaid.
Overtime, and particularly since the Third World Debt Crisis began in the 1980s, the IMF has shifted to giving loans to countries that have a longer term economic crisis and are unable to pay their debts. These IMF loans repay the original lenders, whilst the debt remains with the country. In return for such loans, the IMF usually insists on a set of austerity measures, such as cuts in government spending, increases in regressive taxes such as VAT, privatisation and removal of regulations on businesses.
The IMF is run by its member governments according to a voting formula designed to ensure the US and Europe would control the institution. The US has 17% of votes at the IMF, therefore having an effective veto on major changes, as these require an 85% majority. European countries have 32% of the votes. The head of the IMF has always been a European in a deal agreed between the US and Europe; the head of the World Bank has always been American.
The IMF’s money for lending comes from contributions from each of its member governments. The IMF’s income to pay for its staff and running costs comes from the interest it charges on the loans it gives. Back to List of terms
Liquidity
Liquidity is the extent to which something can be bought or sold without the price being affected. In terms of a debtor, they may be ‘solvent’ – are owed more money than they are owed – but still not able to pay their debts because the money they are owed is due to be paid to them in the future, whilst the money they owe is to be paid now. This would also be described as the debtor not having ‘liquidity’.
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Maturity
Maturity is a term which describes the length of time a debt is owed over. Its exact meaning can depend on the context. For example, $1,000 is borrowed through a contract which says it will be repaid in 10 year’s time, its maturity is 10 years. Five years later, its maturity is five years. When the 10 years is up and the $1,000 is due to be repaid, the debt is said to ‘mature’.
Governments will usually owe debts over a whole range of different time scales. The average ‘maturity’ of the debt can be worked out by analysing when each of the individual debts mature. Often both governments and companies assume they will be able to repay debts when they mature by borrowing the money to do so. If for some reason people are no longer willing to lend, this is when a debt crisis is often triggered. Therefore, a lot of debt ‘maturing’ at the same time can be very risky.
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Multilateral Investment Guarantee Agency (MIGA)
This insures lending or equity speculation by private companies. It therefore does a similar job to the IFC, but debts only come to be owed to it directly if the deal goes financially wrong.
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Pari-passu
Pari-passu is a clause in bonds which is meant to ensure bondholders are treated equally. Bizarrely, since 2013 a US Judge has interpreted pari-passu in Argentine bonds as meaning that Argentina has to pay vulture funds in full before it is allowed to pay the creditors who accepted a debt restructuring. This is despite the fact the vulture funds were treated exactly equally to those who accepted the debt restructuring in 2005, being offered exactly the same terms, but refusing them. In effect, the US judge has interpreted pari-passu to mean ‘treat vulture funds far better than everyone else’.
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Primary surplus
A government’s primary surplus is how much more it is earning than it is spending, not taking into account spending on debt interest payments. Many debtor governments such as Greece and Jamaica have large primary surpluses, showing that they are earning more than they spend, often contrary to popular belief. However, their debt often still does not fall because the interest payments are high and/or, the economy is declining – itself often a consequence of having a large primary surplus (because the actions of the government are effectively to reduce economic activity).
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Quantitative easing
Quantitative easing is a policy used in recent years by Japan, the US, UK and the Eurozone to try to stimulate the economy. Central Banks create electronic money with which they buy bonds, usually bonds of governments. The effect of this is that the demand for government bonds increases, increasing the price paid to buy or sell one, and reducing the ‘yield’. What this means in practise is that people who already owned government bonds (usually relatively wealthy people and companies) earn money by being able to sell bonds at a higher price. Also, the interest rate at which governments can borrow new money at falls.
Central Bank argued this would stimulate the economy as the fall in the interest rate for the government would in turn reduce interest rates across the economy, and so enable more lending, borrowing and economic activity. And the sellers of the bonds, usually banks and pension funds, would use the windfall they had gained to lend and invest in the economy. However, there was no necessity that this is what the money would be used for – it could also be used to lend and speculate elsewhere in the world (in the absence of capital controls), increase cash reserves of banks, hedge funds and pension funds, or just be taken as profit. Similarly, where the fall in government interest rates was also matched by large cuts in government investment, as happened in the UK, this offset any stimulus. The government failed to take advantage of the fall in interest rate it was being charged.
Regardless of the limited extent of stimulus provided by quantitative easing, its distributional effective is to benefit those who own assets – primarily the wealthy.
A further consequence of quantitative easing is that a large amount of government debt comes to be owed to the Central Bank, ie, to the government. As of 2015, one-quarter of UK government debt is owed to the UK government via the Bank of England. When payments are made on this debt, the money is effectively deleted. Advocates of Quantitative Easing argue these debt payments need to be deleted to ensure inflation does not increase, but there are many determinants of inflation, and there is not a clear relationship between the amount of money in the economy and inflation (though at some point large amounts of money creation will lead to higher inflation).
During the financial crisis economist Steve Keen argued that a fairer and more effective policy would be to create money which was distributed to everyone in a country equally, but require anyone with debts to use the money to pay off those debts. This would have provided a longer-term solution to the UK’s main economic problem at the time – its private sector had too much debt, but any attempt to pay off the debt reduced economic activity and thereby caused recession. It would also have been far fairer than benefitting the wealth through quantitative easing, as each individual would benefit by exactly the same amount.
The UK’s Bank of England has created £375 billion through Quantitative Easing, virtually all of which was used to buy British government bonds. If it had distributed the same amount to every adult and child in the UK, this would have been just under £6,000 each (though a smaller amount would have been needed to provide the same stimulus under this policy, and to prevent runaway inflation). In reality that £6,000 each has gone to a far smaller number of people and companies who already owned UK government bonds.
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Speculate
Speculation is buying an asset which already exists, with the aim of making money out of it increasing in price by the time you want to sell it, earning income from it, or both. Speculation can be contrasted with investment, which is creating an asset, from which money is expected to be paid. The media usually refer to any buying of assets as ‘investment’, but globally this is mostly just buying assets which already exist, and therefore purely speculation.
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Structural/economic reforms
There is no more empty phrase used in media reporting on economics than ‘structural reforms’. The phrase could mean any change in economic policy. What it usually means is people arguing for or imposing the removal of regulations on business, removal of labour laws and privatisations, without the people doing so wanting to admit specifically what they are doing or calling for.
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Vulture fund
See Holdout
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World Bank
The World Bank was initially setup by the US and UK at the end of World War Two, but it has subsequently become five separate institutions. The International Bank for Reconstruction and Development (IBRD) lends to Middle Income country governments, supposedly for investment projects, but since the mid-1980s this has included bail out loans similar to the IMF. The International Development Association (IDA) does the same as the IBRD, but to low income country governments. It charges a lower interest rate, and to low income governments that are thought to be at high risk of not being able to pay their debts, it gives grants instead.
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Yield
The interest rate on a bond is usually fixed at a particular amount, though it can also be linked to a particular measure of inflation, or a standard interest rate such as the London Inter-Bank Offer Rate (LIBOR). However, the price bonds are bought and sold at changes based on a whole variety of factors, including how likely it is thought a government will stop paying the debt, what inflation is expected to be in that currency and whether other people are selling or buying other assets, so want to buy or sell bonds in order to do so.
When bonds are bought and sold, this does not change the interest rate, that remains whatever was agreed in the initial contract. However, financial markets calculate a ‘yield’ based on the price the bond is bought and sold at. Changes in this ‘yield’ do not affect the amount paid by the debtor. The best way to think of it is the interest rate financial markets have decided they would want to charge the debtor in order to lend to them now.
For example, if Greece owes debt through a bond with a 5% interest rate, when the media report that the yield has increased to 20%, Greece will continue to pay 5% interest. What is happening is owners of the bond have sold them for less than the face value of the debt, because they think Greece will stop paying at some point before the bond is due to be repaid. The 20% indicates that this is what interest rates lenders would charge Greece now. Which of course only matters if and when Greece wants to borrow from those lenders.
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