Putting Monetary Bandaids On Fiscal Bullet Wounds

As QE winds down, and the Eurozone winds up, what is a central banker to do? … issue more debt!

by James Parascandola, NewOak

NewOak is an independent financial services advisory firm built providing a broad range of services across multiple asset classes, complex securities and structured products for banks, insurers, asset managers, law firms and regulators, including financial advisory and dispute resolution, valuation, credit and compliance, risk management, stress testing, model validation and financial technology solutions. Reprinted with permission. Visit NewOak.com

There is one parallel to draw between Greece and developed nations around the globe: namely, the issuance of massive amounts of debt to address economic woes and fiscal deficiencies.

No doubt Greece has unique and complex problems, not to mention an unemployment rate hovering around 25%, but no amount of debt, new or refinanced, will solve the country’s fiscal and economic woes.

The $500 billion in reported outflows from Greek financial institutions Monday underscores just how fragile the situation has become. And Greek bailouts of yesterday have morphed into Greek bailouts of today. Is the U.S., Japan or the Eurozone headed down the same path? Granted these economic behemoths are in a different league compared to Greece, but so are their debt woes.

Outstanding sovereign debt is accumulating at a pace that GDP simply can’t keep up with—no doubt a function of central banks depressing interest rates. In the U.S., for instance, central bank leverage breached 83:1 six-plus years into the Federal Open Market Committee’s (FOMC) asset purchase program while the country’s most recent quarterly GDP contracted.

Greece, Italy, Spain, Portugal and Ireland—along with the U.S. and U.K. —have been able to service exploding debt loads by depressing borrowing costs to historic lows. But as we’re finding with Greece and elsewhere, this approach has significant costs, risks and uncertainty associated with it.

A Precarious Global Recovery

In the past two weeks, the International Monetary Fund and the World Bank cautioned the FOMC to delay its much anticipated 25 basis point rate increase until 2016 as economic growth in the Eurozone simply hasn’t materialized as anticipated, exacerbating fears at the policy-setting level that any increase in base rates will only hurt an already weak global recovery.

The not-so-subtle concern is they may be just as fearful of the ramifications of a euro at parity with the U.S. dollar. So, as the U.S. winds down quantitative easing and the Eurozone ramps up, what’s a central banker to do? The answer is—and has been—issue more sovereign debt.

In 2010, it was the credit derivative market’s fault for the spike in costs to insure principal losses stemming from credit deterioration/default of one of the PIIGS (Portugal, Italy, Ireland, Greece and Spain). Today, the OTC markets are in disarray, bond market liquidity has been reduced by 70% due to regulatory reform, the same fiscal problems that plagued countries in 2010 persist, and transferring/hedging risk requires the skills of a magician.

Overall liquidity is about as normal as a 30-year mortgage rate of 3.5%, and central bankers continue to purchase assets and issue debt, treating symptoms instead of the sickness. In the U.S. alone, outstanding debt has increased almost 100% from $9.2 trillion to $18.1 trillion in just seven years; nearly as much as Japan, China, German and Italy combined.

Greek bailouts of yesterday have morphed into Greek bailouts of today

Across the world, outstanding public debt of the 10 largest issuers as a percentage of GDP is approximately 100%. On June 17, we’ll hear the FOMC essentially state (in 10,000 words or less) the following: Q1 U.S. economic weakness was transitory and signs point to a significantly better 2nd half.

There remains slack in the labor market, and inflation remains below the Fed’s 2% target. Any future changes to the direction of monetary policy and interest rates remain data dependent and there will be continued monitoring of currency markets in light of the market’s evolving perception of changes in monetary policy. See, I summed it up in only 66 words. The next treasury auction isn’t until next week, so the FOMC can afford to offer you a Dodd-Frank dose of verbose transparency.

Also Considered:

Indenture trusts and trustees: Do they impy fiduciary duty?

by P. Peter Shahram, NewOak


An ongoing trend in residential mortgage-backed securities (RMBS) litigation is plaintiffs seeking to recover from an indenture trust.

In light of this trend, coupled with the New York State Court of Appeals’ recent decision in the ACE Securities Corp. v. DB Structured Products, Inc. case[1]—holding that under New York law, the statute of limitations for breaches of representations and warranties in an RMBS deal runs for six years from the time the warranties are made (i.e., the closing)—it is prudent to have an understanding of what is meant by “trust indenture” and “indenture trustee.”

A “trust indenture” or “indenture agreement” is the governing agreement in a bond contract made between a bond issuer and a trustee that represents the bondholders’ interests by highlighting rules and responsibilities of the parties.

An indenture trustee is appointed to act as a type of agent on behalf of the bondholders collectively. The role of an indenture trustee, however, is not subject to an ordinary trustee’s duty of undivided loyalty. Unlike an ordinary trustee, who has common-law duties imposed beyond those in the trust agreement, an indenture trustee is more like a stakeholder whose duties and obligations are exclusively defined by the terms of the indenture agreement.[2]

Courts have consistently rejected the imposition of additional duties on the indenture trustee in light of the special relationship that the indenture trustee already has with both the issuer and the debenture holders[3] under the indenture.[4]

As long as the indenture trustee fulfills its obligations under the express terms of the indenture, prior to a contractually defined “event of default,” an indenture trustee’s duty is governed solely by the terms of the indenture, with two exceptions:

  1. Avoid conflicts of interest
  2. Perform all basic, non-discretionary, ministerial tasks with due care.

These two pre-default obligations are not construed as fiduciary duties, but as requirements that may subject the indenture trustee to tort liability if breached.

Following an event of default, the indenture trustee’s obligations “come more closely to resemble those of an ordinary fiduciary, regardless of any limitations or exculpatory provisions contained in the indenture.”[5]



[1] ACE Securities Corp. v. DB Structured Products, Inc., 2015 NY Slip Op 04873 (NY Ct. of App. June 11,2015)
[2] Hazzard v. Chase National Bank, 282 N.Y. 652 (1940).
[3] A debenture is type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are documented in an indenture.
[4] Meckel v. Continental Resources Co., 758 F.2d 811 (2d Cir. 1985).
[5] Beck v. Manufacturers Hanover Trust Co., 632 N.Y.S. 2d 520 (1st Dep’t 1995).