Comments on "The Default Puzzle: Underwriters and Sovereign Bond Markets, 1815-2007"
Vincent R. Reinhart | National Bureau of Economic Research
June 12, 2009
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I appreciate the opportunity to comment on the paper, "The default puzzle: underwriters and sovereign bond markets." Marc Flandreau, Juan Flores, Norbert Galliard, and Sebastián Nieto-Parra have written a careful and comprehensive study, commendable in the manner in which they examine the mechanics of sovereign debt issuance over the past two centuries. Having documented the government sales of debt, they go on to offer a plausible mechanism to explain changes in patterns over time.

They direct our attention to market mechanisms, specifically the middlemen in transactions or the entities that make the invisible hand work. The events over the past two years have shown such focus to be important, as it is precisely problems at those middlemen that help to explain the contraction in financial trading, the increase in market spreads, and the drying up of new lending recently witnessed. Concern about such middlemen includes understanding their incentives, capital positions, and balance sheets. In that regard, this paper takes to heart limits of arbitrage arguments, which could help explain why financial markets act sometimes at variance to behaviour expected from atomistic agents exploiting all opportunities for trade.

To put it simply, the authors construct underwriting league tables for four periods. They essentially recreate what Bloomberg magazine would have looked like in the 1820s, 1870s, 1930s, and most recently. They show how those league tables evolved in significant ways. They then offer a plausible explanation that explains those changes by the rising role of rating agencies. Before the dominance of rating agencies, investment banks had the responsibility for signaling sovereign creditworthiness by supporting after-issuance market-making in that debt. When rating agencies became the dominant purveyor of this stamp of creditworthiness, investment banks laid-off that responsibility and no longer needed to support the markets for the debt they had underwritten.

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Vincent R. Reinhart is a resident scholar at AEI.

About the Author

 

Vincent R.
Reinhart
  • Vincent Reinhart, a former director of the Federal Reserve Board's Division of Monetary Affairs, joined AEI in 2008 after working on domestic and international aspects of U.S. monetary policy at the Fed for more than two decades. He held a number of senior positions in the Divisions of Monetary Affairs and International Finance and served for the last six years of his Federal Reserve career as secretary and economist of the Federal Open Market Committee. Mr. Reinhart worked on topics as varied as economic bubbles and the conduct of monetary policy, auctions of U.S. Treasury securities, alternative strategies for monetary policy, and the efficient communication of monetary policy decisions. At AEI, he has continued his work on all of the above in addition to research on key economic variables before and after adverse global and country-specific shocks, policy mistakes leading to the 2007-09 financial meltdown, and the implementation and impact of quantitative easing.
  • Email: vincent.reinhart@aei.org

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