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Bond Yields and Bailout Guarantees: Regional Debt Markets in Germany

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In July 2012, MOODY’S INVESTORS SERVICE “changed the long-term rating outlooks of six German states to negative from stable, citing the close fiscal ties between the regions and the federal government, whose outlook was downgraded two days ago”. The change in outlook applied to the German states of Baden-Württemberg, Bavaria, (the two most productive states of Germany in terms of GDP/capita) Berlin (at the same time the largest city in Germany), Brandenburg (situated in former Eastern Germany and characterized by one of the least developed economies in Germany), North-Rhine-Westphalia (the largest state in Germany in terms of population and territory), and Saxony-Anhalt (like Brandenburg the state of Saxony-Anhalt is situated in Eastern Germany with relatively low GDP per capita).
MOODY’S change in outlook can be interpreted as decisive rethinking within the framework of German fiscal federalism as it puts the financial health of single regions (Laender) as independent entities on the spot. Prior to 2010 rating agencies such as FITCH had not even issued region-specific ratings due to assumptions that German regions enjoyed (unconditional) bailout guarantees of the federal government. Does MOODY’S action thus reflect changes in assessments of risks within Germany’s system of fiscal federalism, which are going to increase borrowing costs of German regions? Some German politicians seem to think that this may well be the case. In March 2012, OLAF SCHOLZ the social-democrat mayor and head of state of Hamburg, the second largest city-state in Germany in terms of population, proposed the introduction of “Deutschland-Bonds”, i.e. bonds that are commonly issued and guaranteed by German states and the federal government. SCHOLZ’ approach was also promoted by RAINER WIEGARD, then Schleswig-Holstein’s Finance Minister and a member of the CHRISTIAN DEMOCRATIC UNION. Politicians of other regions and the federal government followed suit. The first “Deutschlandbond” will be issued in 2013. As of the writing of this essay, their structure and volume has not been decided.
What will be the impact of “Deutschlandbonds”? Will they lower state-borrowing costs through introducing new federal bailout guarantees? Or will changes be miniscule as investors assume that these guarantees exist anyway? Viewing the financial crisis of 2008 – 2010 as natural experiment that tested investors’ assumptions with respect to the existence of bailout guarantees on state-level debt in Germany, the essay discusses the question, in how far the introduction of “Deutschlandbonds” is likely to have a significant effect on borrowing costs of German regions. If investors perceived of federal and regional bonds already as close substitutes due to common bailout guarantees, then – so the reasoning of this essay – the introduction of “Deutschlandbonds” will be of limited effect to borrowing costs in regional debt markets.
type book chapter (English)
keywords Bondmarkets, Credit Ratings, Deutschlandbonds, Fiscal Federalism, Spreads, Yields
book title Schulden haben und machen - Auswirkungen auf Wirtschaft, Recht und Gesellschaft
date of appearance 2012
publisher Stämpfli Verlag (Bern)
series title Schriften der Assistierenden der Universität St. Gallen (HSG) (7)
volume / edition 1. Auflage
ISBN 978-3-7272-2286-3
page(s) 129-148
profile area SEPS - Economic Policy
citation von Müller, C. (2012). Bond Yields and Bailout Guarantees: Regional Debt Markets in Germany. In Schulden haben und machen - Auswirkungen auf Wirtschaft, Recht und Gesellschaft (pp. 129-148). Bern: Stämpfli Verlag. - ISBN 978-3-7272-2286-3.