In recent days the heads have AIB and Anglo have called for an extension of the bank guarantees. (Colm Doherty’s conference call transcript here; Mike Aynsley’s interview with RTE here.) This has caused understandable dismay given the almost unimaginable costs the original blanket guarantee placed on Irish citizens. But we should not allow the mistake of guaranteeing already locked–in funds for a period long enough to allow most of them to escape to colour the case against guarantees on new borrowing. (It should be said that with the government’s effective “no–creditor–left-behind” policy, it is not obvious that losses would have been imposed on long-term creditors with or without the original guarantee.)
In looking at the case for continuing with prospective guarantees it is important to consider how the credit system would evolve without them. Without guarantees the cost of new funds would increase, leading to increased pressure to raise rates on new business and household lending. Moreover, without guarantees there would be greater market pressure to increase capital ratios, which in the current environment is likely to be met by greater deleveraging. The credit squeeze would worsen.
I have thought since the outset of the crisis that balance-sheet constraints on credit supply have received disproportionate blame for the credit collapse relative to credit demand and borrower creditworthiness considerations. But one factor I didn’t fully appreciate is how uncertainly about future credit supply can affect current demand. Businesses will want to limit their debt exposure when there is a risk that their legs will be cut from under them when they try to refinance. This may go some way to explaining Colm Doherty’s revelation that 40 percent of overdraft facilities are not being taken up. (Simon Johnson makes a similar point in recent testimony before the U.S. Senate Budget Committee; this wide-ranging testimony is well worth a look more generally.)
The sustained deleveraging by banks, businesses and households risks a Japanese–style “lost decade” for the Irish economy. The recent soft numbers, which have come in despite the stronger performance of broader European economy, could be an early warning. Restoring confidence in the stability of credit supply is an important part of the policy challenge. Unfortunately, guarantees on new bank liabilities will probably have to remain a while longer.
136 replies on “Extending the Guarantees”
It’s Colm not Craig!
As a punter there is no way I am ever again going to have an unguaranteed deposit. I don’t believe their balance sheets and I don’t believe their ratios. Anyway 8% doesn’t sound like a great cushion to me, seems any lending type asset can fall by a multiple of that with just an economic sneeze.
Having said that, I think we have seen that there is always a de facto guarantee at least for the systemic banks, so its formal removal would be a bit of an illusion.
Homer, thanks for the correction. Now fixed.
“The sustained deleveraging by banks, businesses and households risks a Japanese-style “lost decade” for the Irish economy.”
Sadly, we have been in the position for a while that a japanese style lost decade would be a positive outcome for the Irish economy. To understand this, you might want to look at the changes in employment in Japan (in 1991 the unemployment rate was 2.1%, in 2002 it reached 5.5%) and GDP grew by 26% in real terms (while I think that nominal GDP is the figure to watch in a deflationary economy, deflation in Japan was slight peaking at 0.9% and amounting to 6% over the period). In addition, Japanese working age population decreased by 4% in the period, while at the same time it increased by 23% in the US and 11% in the EU15. So GDP per working age adult increased at basically the same rate as elsewhere.
In short, ‘growth’ at Japanese rates per working age adult would be marvellous. Stimulus targeted at getting people to do stuff would be most welcome. A work for welfare scheme would soak up excess labour and could provide real benefits at the end of it (for example if some of the work for welfare was in the form of educational credits, or in labour intensive tourist facility related programs).
@hoganmahew – I put that 2003 property report up on irishmortgagebrokers website. Sorry about delay but its summer !
Leonard Schapiro, writing on Stalin’s approach to propaganda, observed ‘the true object of propganda is neither to convince nor even to persuade, but to produce a uniform pattern of public utterance in which the first trace of unorthodox thought reveals itself as a jarring disonance’.
From the two Brian’s to our own dear Tull McAdoo, we observe neither conviction nor persuasion but a simple piece of propaganda: there is no alternative to the current startegy. We, nor anybody else apart from Eoin and, with one or two wobbles, Zhou, appear to be persuaded or convinced. But the propaganda has worked (in a Stalinist way): we carp, moan and observe the data; occasionally flirt with gloomy forecasts. But we have thrown in the towel and no longer posit coherent alternative strategies. Even the dear old Irish Times has twigged that something is amiss down at Bank Centre and while her ladyship seems to think that nationalisation is inevitable, there is still a good fight were fighting betwen now and then. Shades of the two Brians fighting the good Anglo fight prior to its nationalisation.
Similarly, with the extension of the bank guarantee. To what end? To fight the good fight, again? The really sinister subliminal note creeping into some of the comments here is that the game is up and the fight has almost ended: the sovereign is bust. It’s all over bar some more bad data and an inevitable EU/IMF-sponsored restructuring.
Is that it?
“But one factor I didn’t fully appreciate is how uncertainly about future credit supply can affect current demand.”
The extension of the guarantee may be a benefit but it would be foolish to expect that the swift move from a feast to a famine, will change anytime soon.
There will be both risk aversion by bankers and business/individuals for many years.
Given the rapidity of the change from irrational exuberance, rational and sometimes irrational prudence will be the rule.
It would be a surprise if it was anything else.
The news isn’t all bad; Germany will report its best quarterly growth in 20 years, next week; Germany is Italy’s biggest export customer and Rome has already reported better growth than expected.
In my opinion, one of the biggest problems is that political leaders are addicted to spoof and people inevitably ignore what they say or find solace in the sky is falling scenario.
For example last week, the revised capital budget has Enterprise Ireland saying that it can create 63,000 direct new jobs in Irish firms across the country which will lead to an additional 44,000 indirect jobs in the wider economy.
IDA analysis shows that over the period to 2015, the new investment will create 98,000 direct new jobs.
Why would they spoil the story by also giving net jobs data?
For example in IDA supported companies, there were no net jobs added in 1998-2009.
Enterprise Ireland’s investment in over 800 start-up companies over a 20 year period (1989 – 2009) has yielded only 14,000 jobs.
EI supported 140 spin-outs from third level research in the past 10 years and 1,000 jobs have been created. The ‘smart economy’ target for the next ten years is 120,000 jobs.
So it’s a choice between fact and fiction.
Refudiate that as Sarah Palin would say!
Two sections of that report by Simon Johnson really jump out at me, nothing new in them but they crystalize two big problems for out future.
‘A series of efforts are underway to change the behavior of major global banks and to prevent them from loading up on risks during the next cycle. These are unlikely to succeed. As Jamie Dimon, CEO of JP Morgan Chase remarked in January 2010, “[a financial crisis is] the type of
thing that happens every five, ten, seven, years” – and another crisis within that time frame should not surprise us.’
-> i.e. The longer we limb along in this state the higher the probability our ‘small open economy’ will receive a mortal blow beyond her control.
‘Long-term unemployment results in skill losses and lower productivity in the future. This undermines future growth prospects and it may shift up the “natural” rate of unemployment. So called hysteresis in unemployment – meaning that it goes up fast but comes down slowly and not fully – has very much been a feature in the experience of other industrialized countries during recent decades. This is potentially now a major issue for the United States.’
…. take out potentially and add in Ireland for United States.
Germany will grow along with France and some other central European countries because the savings of productive Germany and Frugal France will be directed to their domestic economies.
You are right the IDA model is inefficient but it will soon become a historical artifact as there will be no capital available.
We will be starved of savings capital for decades and face a era of de post industrialisation if you can imagine that (a Ireland of neither the industry of the 70s-90s period or the consumption of the 90s – 00s)
We will have to default either selectively or in entirety as the debts are absurd and growth will be effectivily stopped because of the centralisation of industrialisation that is a neccecssity in a world of high oil prices and money that still can get a return in such a hostile environment.
In essence I am uber bearish on Ireland as it neither has the skills of the past that can get us through hard times or the capital necessary to bridge the energy crisis.
Default default default default.
and maybe we can supply central europe with cheap goods previously made in the east.
We need to get real because that is the best we can hope for – the apartments have been built – we just need to fill the empty factories with low cost manufacturing and the most efficient mechanism to get us there in a hurry is to go back to a massively devalued punt.
I’m not sure which bit you want refudiated. Yes, the news isn’t all bad but were you indulging in a bit of irony when all of the good news you mentioned had nothing to do with Ireland? Yes, I know about being an open economy and the assumed links to booming world trade but we don’t exactly seem to riding the crest of that particular wave?
I suppose one niggle I have with some commenters on this site is when challenged to present an alternative they retreat into sullen ‘I wouldn’t start from here’. I find it genuinely puzzling that this far into the crisis, with all of the very obvious doubts around the current policy stance, there is no well articulated, coherent, visible alternative strategy, around which us soft-centered ‘liberals’ can coalesce.
I am glad you admit that you “no longer posit coherent alternative strategies”. The opposition to the current govt strategy consists of emoting because there is sadly no alternative other tha default and exit from the euro (if it were even possible). This is not because the current set of policies is either right, moral or optimal but genuinely because it is the only policy that can be pursued given the constraints within which we operate.
We or FF have taken on our behalf-becaue we elected them- the following policy decisions
*to join a currency union so ruling out the option of an independent monetary policy
*to sign up to the SGP which removes what litle fiscal autonomy that we had left
*to adopt a policy of light touch regulation with gusto..such that what a certain bank wanted it got. This and low rates contributed to the biggest property boom in the east densly populated country in the EU.
*to hand out the resultant bubble tax receipts in a series of permanent entitlements
*to prioritise public servants over public service in the Croke Park deal.
In addition memebership of the EU and EMU means signing up to the EUs policy of “no bank left behind” and it implicit policy of no defaults on senior debt. Memebership of EMU alse means we adopt the monetary polciy of the union which at the moment is closer to Berlin than Boston.
As long as we stick to this paradigm we have go to do what we have to do
*cut public services and impose taxes on the productive sector of the economy
*encourage a policy of reduction in real wages in the economy
*socialise the losses of the banking system-we cannot impose them on other liability holders. Trichet has allegedly instructed Dublin to get its banks in order.
*provide capital out of the public coffers or ring fence the toxic stuff and hand over to foreign banks
*hope that there is a global upturn in nominal GDP so that we can ride the tide.
Of course, the current govt will not telly ou that this is the policy to which there is no alternative. The alternative Taoiseach Gilmore will also not tell you this becaues all he feels is our pain. I suspect the only real alternative is actually the policy advocate by Kevin Cunneen but that is perhaps like telling a swimmer struggling against the tide to stop swimming. It has risk associated with it. As Biffo sez “we are where we are”.
What about Morgan Kelly’s debt for equity swap? I haven’t heard anyone explain why this isn’t a viable alternative.
I hope you are sitting down when I say this, but I think you are right. Well, sort of. We are where we are: we have a strategy based exclusively on hope. Hope that there is a rising tide somewhere out there that, eventually, lifts us. That such a non-policy should elicit emoting politicians and an angry blogosphere should not come as a surprise. Particularly, as you rightly say, because all prior choices have propelled us down this path that has led to a fork in the road: follow the road marked hope or the one marked default. That’s it, no other choice. Perhaps no chopice at all if the hope proves illusory.
Lester Thurow, cack in the 1990s, was asked his opinion of Ireland under EMU. He said he thought that Ireland would end up looking like his home State, Montana. Pretty, but empty of economic activity.
There is another way – but it would require a dramatic change in monetary policey on behalf of the ECB.
If Trichet were to bid up the price of Gold equivalent to the M1 money supply then the Big Gold holders such as Germany and France would be able to equalise the inevitable losses at the periphery with there much higher priced reserves while Italys fiscal debt postion would be assured.
Also local central banks within each Euro Zone country could increase their own gold reserves by purchasing gold at the M1 price from private local gold holders – also a uniform capital gain tax could refill the coffers of each countries exchequer and they can start afresh.
This policey of course would mean a direct confrontation between the ECB and the FED and given the incestuous relations between bankers may be a unlikely prospect.
Never the less if the ECB does not do what a real central bank should have done a long time ago and not solely represent the interests of its client banks then the best thing that Ireland and other indebted countries should do is pull out of the EMU and possibly EU structures via a dramatic default.
Hope is not a strategy.
I am swayed by the arguments that we can no longer burn bank bondholders, like we can no longer sever the gangrenous limb that is Anglo. The time for that has passed. However, once the recapitalisation of AIB, EBS and BoI is complete, I see no reason for them to have a continuing guarantee.
Anglo and INBS as nationalised entities will always be considered to have a defacto guarantee. Selling what can be sold from the remains of them is still, I believe, the best maximisation of value. I do not see this as new Anglo going forward, rather a sale of what there is to whoever will pay for it. The dead ducks must be buried, once we’ve eaten whatever meagre meat there is.
NAMA should be limited to being a bad bank. Where a developer, borrower, whatever, is up to date on all their loans, I see no reason why they should be transferred. That it stuffs the NAMA business case is neither here nor there. A new and realistic business case is required which will, again, sell off anything that can be sold in an open and transparent manner. I am sure that if ghost estates in Roscommon were put up for sale on ebay with a small reserve (to cover the local authority charges and NAMA costs) they would sell. It would then be somebody else’s problem. No valuers required… So I don’t really see that there is much that cannot find a price.
@John McHale: credit is essentially reaching into the future to utilize today, in a down economy the demand naturally drops in line with reduced future expectations, not as a function of reaction but as a function of the structure of a recession. Businesses requiring credit now would need to see cause for the requirement, in a deflationary environment that is (in general) not the case, and the ones who were using credit have likely found the debt burden a drain on cashflow and are therefore unlikely to lever up further. A demand slump in credit is natural, the issue with those who may want it are likely to do with credit profile.
Creditworthiness is likely the biggest factor, a bank can create any debt it wants and lodge it into central banks, interbank, repo as collateral, they have to retain the capital amount relevant to the loan but credit expansion is not happening because of the ability to repay the debt and little else, that goes across the lines of SME/mortgages etc.
I don’t disagree with you at all about the importance of credit demand/creditworthiness. That is why I have tended to be more concerned than others about the cost of austerity measures, which have a double effect: first directly on demand, and second by tightening the credit constraint.
But if I understand you correctly, you seem to be disregarding the supply side entirely. If that were the case, then the hugely costly policies being pursued to repair the balance sheets of the banks would be shocking waste of resources (sounds like you would have some support on this from the commenters above). While big mistakes have been made, I can’t follow you in dismissing the importance of fixing the banks so that they can play their critical role in the economy. Yest the ECB has played an insufficiently heralded role in preventing an economic meltdown, it is too simplistic to say that all necesarry funding can be obrtained through their liquidity support mechanisms.
Why? There is still plenty of private debt that we can choose not to support with public money. I can understand why the government and the DoF doesn’t want to to walk away from the sunk costs of its policy. But why is this true for others who never supported those policies? I’m tempted to mutter about Stockholm syndrome.
Because having once guaranteed the debt, including the non-systemic stuff, the state has drawn an ugly line in the sand. It has turned bondholders into untouchables (and not the Indian type). I don’t see how it can credibly step back from that without there being a period of stand alone stability in the banking system and in each individual bank.
Basically, the government has once again boxed itself into a corner. The conditions that pertained when the guarantee was introduced are still extant, therefore the guarantee of senior debt must continue. This must be the most stupid government we’ve ever had. From one expensive gaffe to another.
PS that’s not to say that a different government couldn’t approach the issue with a new broom…
A more nuanced version of what you are saying is that we must have an internal devaluation and a fiscal correction so that we can hope to catch the tide of global recovery. We can also hope that the ECB gives up its insane policy of targeting zero inflation and decides that the only way out absent default is to inflate our way out of the crisis. Kevin advocates buying gold, I think. An easier policy would be to deflate currency versus gold, would it?
what new policy.
“what new policy.”
Is that a questions? What are you referring to? 😕
If it’s my PS to anonym, it’s related to the previous post – the government has no exit strategy from state-backing of the banks; until the banks can stand on their own, the state is on the hook. A change of government with a strong enough mandate *might* change perceptions, but that new government would want to be making noises already. I don’t see that happening.
sorry forgot the question mark. For a new policy to emerge, Taoiseach in waiting Gilmore would have to take a ploicy position would he not. He is likely to wait until his chice of partners becomes clear cut.
Solid thinking on this thread if I may say so.
Seems to me that the issue is going to be the credibility (rather than the bona fides) of the guarantee. We are looking at intertwined state solvency and bank solvency problems in a peripheral deflating economy.
‘I am sure that if ghost estates in Roscommon were put up for sale on ebay with a small reserve (to cover the local authority charges and NAMA costs) they would sell. It would then be somebody else’s problem. No valuers required… So I don’t really see that there is much that cannot find a price’
Is NAMA a ‘business’ in any meaningful sense ? It is designed to protect our constitutional and social order, making whatever x bn loss needs to be made. The ultimate bankrupt semi-state. The risks of property price discovery have got even worse, so anticipate a lot more ‘ businesslike’ denial and prevarication.
Your analysis seems correct, but my core diagnosis is looting by a cabal of local and international vested interests (property, banks, professions and more). The trade unions have been drawn in, but the malfeasance started at the top, and the self-governing professions have torn the ass out of it.
‘all prior choices have propelled us down this path that has led to a fork in the road: follow the road marked hope or the one marked default. That’s it, no other choice. Perhaps no choice at all if the hope proves illusory’
There are two sorts of hope:
* unrealistic: that the Irish economy can recover and we pay our debts in due course. ‘A few tough years, but we’ll get through it’
* realistic: that the EC will be in a position to instal a soverign resolution regime to prevent us going the road of Yugoslavia. Given the openness of the border, it seems that inevitable, and ironic, that Britain will also be drawn in to our state crisis.
That’s the question: how credible is the bank guarantee? Not very, if it’s only the Irsh Sovereign standing behind it. That’s why it is going to be so important to get the Brussels stamp of approval.
One strategy that has yet to be tried: speed. Why is Anglo talking about NAMA transfers taking until well into 2011? If AIB nationalisation is so inevitable why not just do it? Why are devlopers still able to get planning permission for trophy sites? Why are they still in business? As you say, just find the market clearing price for property – it’s easy to do.
Instead, everything is long fingered. It’s that hope again. Hope that something turns up.
We can almost take it for granted that, for various bad but understandable reasons, the current government won’t change tack. But that’s not to say that the government shouldn’t change tack, or that we would be wrong to demand it do so. I reject the idea that the State, even without a change of government, now has an open-ended moral obligation to see the banks’ creditors right for some undetermined distance into the future. The bank guarantee comes with a (relatively…) clear expiration date. If any bank creditor thinks that the bank guarantee gives the State an obligation to guarantee his loans beyond, er, the end of the bank guarantee, well then I would like to see the receipt. There’s a significant difference between undertaking an obligation to someone and giving them the impression that you’re an easy mark.
(Conversely, if we did have such a moral obligation it’s not clear that even a change of government would release us from it. For example, a change of government won’t be enough to release us from the moral obligation to pay up on the already-issued NAMA bonds.)
If anything the unchanged conditions reinforce our moral authority not to extend the bank guarantee, as well as the pragmatic case not to do so. Tried that; didn’t work; time to do something different.
“What about Morgan Kelly’s debt for equity swap? I haven’t heard anyone explain why this isn’t a viable alternative.”
We have to either (a) be willing (otherwise what leverage do we have?) to liquidate a bank to do this (we are quite clearly unwilling to do this for a variety of sensible reason)s or (b) have in place some sort of resolution regime that could enact d-for-e swaps without liquidating the bank – there are a lot of legal and regulatory issues here which are not nearly as simple as some people make out. In theory d-for-e swaps make sense, but with a complicated financial institution balance sheet they are very difficult to enact, hence the reason they happen so rarely.
How serious do things have to get before ‘legal reasons’ and ‘complicated balance sheets’ stop being road blocks? Dan White in today’s Sindo not only rehearses the case for AIB nationalisation but drops braod hints that it may, post that event, may end up going down a very Anglo like path. Is this serious enough?
“For a new policy to emerge, Taoiseach in waiting Gilmore would have to take a ploicy position would he not. He is likely to wait until his chice of partners becomes clear cut.”
Absolutely – when I said I don’t see it happening it is not that I see it as impossible or unlikely, just that I don’t see any evidence of clear [insert colour here] water between the government plans for the banks and the oppositions’. I think we can agree that such a policy change would need to be flagged well in advance, even if only in terms of “we will look at the possibility”?
“As a punter there is no way I am ever again going to have an unguaranteed deposit”.
Recent media reports on the original guarantee seem to suggest that the extension to December include modifications to the original blanket nature of the guarantee. One report seems to suggest that debt (deposits ?) less than 90 days will not be covered. This ambiguity will make depositors nervous and could see a flight of capital come September 30.The ELG scheme only serves to make matters unclear. So I believe de facto guarantees useless.At least with de jure you can rely on the courts.
I agree with you,but the problem is the craven idiots have already applied for an extension (to December) and hinted that a further extension might be in order. The structure of the guarantee made it pretty much impossible that this wouldn’t be the case – a pile up of debt maturing in September. This was obvious from the moment the structure of the guarantee was published and was widely predicted at the time (not by the usual suspects and their cheer-leaders of course).
The moral argument has been sold down the road for an easy life now and, as everyone, everywhere is now saying “where is the resolution regime”? When AIB management are exposed as the fiasco they are, we will be able to point to the fact that “everyone” saw the need for a resolution regime.
In fact it should be possible to put an upper and lower figure on this. How many billions blown on bank recapitalisation are a) clearly preferable to the hassle and risk of a resolution process and b) clearly not preferable to the hassle and risk of a resolution process?
We would be far better off if the EU repudiates the guarantee.
For in a monetary union there is only two ways for the value of loans taken out in the heat of speculation. One, that the entire union inflates, or two the banks are allowed to hit the wall. Where the loans books are then sold for 25 cent an the euro to the government. Then there could be a realistic renegotiation at say 50 cent. This would inject value into the system. And be much better that what is going on at the moment where it really could be 15 years before debts are sufficiently cleared.
Why else are the banks Limited. Nor will allowing the banks to hit the wall matter over much to the Market for they know that both the banks and the Bank Guarantee are valueless anyway.
The answer to your question is a lot more serious before a bank resolution regime which allows for the cram down of assets and liabilities is allowed.
a more intersting question is will the current situation get any better while the ECB is pursuing a monetary policy that is too tight for the peripherals especially Ireland. It seems that this and the oversupply from ther property bubble puts us on a debt deflation path.
To be honest I thought we had agreed the answer to your second question is a big no. The path you describe lies not in our future but is in the here and now. And with it comes the potential failure (aka nationalisation) of another systemic bank. I dunno, but that sounds pretty serious to me.
AIB will sell assets and raise the required capital to meet the stress test. The capital is likely to come from the NPRF from the converson of Prefs. Govt ownership will be above 50% at least. A new board of worthies will be reappointed and AIB will become an instrument of state policy.
We will be reassured by our leaders that AIB is sufficiently well capitalised & fit for purpose. After tht we wait to see if anything tumbles out of the closet. As Brian Lenihan’s father was wont to say “no problem”.
If we are reassured that there is no futher problem at AIB, like we are being reassured that BoI is now fine, then surely there is no requirement to extend the guarantee for either of them.
The state now owns a bank and two building societies. Surely this is enough to provide systemic coverage? (tongue in cheek…).
‘a more intersting question is will the current situation get any better while the ECB is pursuing a monetary policy that is too tight for the peripherals especially Ireland’
An even more interesting question is how will the ECB respond when the debt deflation of the peripherals impacts French and German banks’ balance sheets.
for clarity, ALL retail deposits will be covered by the extended guarantee, regardless of maturity tenor (though only covered for a max of 5 yrs). “Corporate” deposits (by which i assume any ‘business’) will only be covered if they are longer than 3 months in duration.
“legal reasons” are a roadblock? Are we a society of laws or are we not?
We are a society of laws for little people only. And as Brendan Keenan noted today, we are a society rapidly fragmenting. Unless we recognise the gravity of the situation we face we risk our civil society. The point of the law, I think, is to hold society together.
Thanks for clarification.
I am still somewhat confused – if a retail deposit matures on 1st Jan next will the guarantee cover another, say, six month deposit or will the contract have to be of fixed duration (out to 5 years). I see one columnist expressing the view that large mobile deposits may exit come September. I think the powers that be better set things straight quickly as contracts maturing in August may not be renewed if large depositors read the papers.
“we are a society rapidly fragmenting.” Have you morphed into Fr. Sean. Perhaps the next thing you will do is to join the Erich Hoenneker branch of the Labour Party.
Also, I note that you have name checked two articles in the Sindo today. I am concerned.
I don’t dismiss the importance of banks, I’m of the opinion that functional banks are as important to civilization as are things like property rights, law, judiciary, freedome etc. They are a fundamental pillar of any economy.
But when you say ‘credit constraint’ are you talking about ‘capital constraints’ relative to the sanction of a line of credit or the ability to create loan paper which is then turned into money? With ECB support (although best example is BoE who will now take actual loans as collateral) you could potentially increase credit to any extent, credit supply side has no upper limit other than to the extent that it is bound by policy.
There is a clearing mechanism for credit, but there is no clearing mechanism for bad credit – thus I would be comfortable in saying that it is creditworthiness over and above the supply side of credit which is the larger factor. Guarantees are likely required to keep funds in place (bonds/deposits/interbank confidence) therefore offering the market the capacity for credit rather than being the creator of credit, I’m in agreement with you but for different reasons!
@ Mr. Bond
I interpreted simpleton as saying that the benefits of passing a resolution law now outweigh the burden of passing one, not that we should institute revolutionary justice and do without one. How many billions more in recapitalisation is a) clearly not worth the agony of a resolution law and b) clearly worth that agony? (I do note that we seem to have been able and willing to get through the agony of NAMA legislation during the time when we could have been passing a resolution law.)
Why? I don’t see how a resolution law would be a much larger encroachment on property rights than, for example, our current examinership law or NAMA. I also note that the UK passed a resolution law in 2009 (the Banking Act 2009) and I don’t think they’re in a situation which is much more serious than ours.
Sorry; the second quotation is @ tull mcadoo of course.
as i have previously noted on repeated occasions, the situation is far more complicated than just “passing a resolution regime”. I’m all for that, i’m just somewhat skeptical as to how far reaching such a law could be to existing financial institutions and securities, particularly in relation to European law. I seriously doubt we can just enact legislation which hugely undermines the position of some bondholders, for instance, at the expense of other bank creditors, overnight. To this end, i have suggested that Karl et al invite some of their legal scholarly friends up in Roebuck to do a joint post about what IS possible, what would be required, what options/problems could occur, how much could be extracted from the various bank debtholders etc etc. At no stage has anyone with actual knowledge of the legal and regulatory aspects to this been able to explain these issues, along the lines of “here’s how it’d work, here’s what it’d save us”.
if it matures on 1st Jan, as things stand, it will no longer be covered beyond that date, as the ELG expires on 31st Dec. It would at that point only be covered by the deposit protection scheme (100k max). If the scheme is extended in its current format, retail deposits, regardless of tenor, will be covered until the expiry of the ELG extension, or they can put on a fixed term maturity of say 5yrs and it will be covered for that entire period.
The big issue for corporates going forward will be that they have to put the deposits on for a minimum of 3mths to access the guarantee (retail do not have to specify the period), which simply isn’t going to suit some of their cashflow requirements (although this is the way the new Basle rules are going anyway, so not necessarily a bad thing that corporates here are having to think about this now anyway!)
what does the UK Act provide for in terms of bank resolution? What has happened in the case of Northern Rock to the seniors?
Is the discussion on this thread not predicated on an unspoken assumption that Ireland retains some ability to exercise sovereignty unilaterally in these matters? Imo the last exercise of sovereignty was the blanket guarantee, which was required in the absence of a bank resolution process – not to mind a bank system resolution process – and following serious misgovernment and regulatory failures. Everything that has happened since is part of an attempt to get the Irish financial system down safely from the orbit into which the blanket guarantee projected it – under the close suprevision of the European Commission and the ECB.
I sense we are moving inexorably towards a denoument that will comprise provisions for fiscal governance, a bank resolution process and a procedure for limited sovereign and bank debt restructuring that will be applied throughout the EU, but with specific, initial focus on the PIGS.
In the meantime the PIGS (with Greece under tighter rein than the others) will retain some sovereignty not over the level, but over the composition of the net fiscal contraction and over how they might de-leverage the state balance sheet and reform protected sectors.
The budget target has been agreed; some consideration is being given to the state balance sheet; and reform of the sheltered sectors remains.
Nothing happened to Northern Rock Seniors. Here is an easy enough paper to read on the resolution scheme in an international context.
senior debt of Northern Rock Asset Mgt (the bad bank) actually has an explicit government guarantee at the moment. The sub debt is not g’teed however. Not massively dissimilar to Anglo, right? Bizarrely the ‘bad’ bank made a profit in H1 and the ‘good’ bank continued to run up losses. Go figure.
Very true. And they are also doing sub-debt buybacks….
Maybe now that it is becoming more apparent that AIB is the ticking bomb, the end of this farcical process approaches, nearly two years and counting. Extend guarantee for another 12 months, why not? Given the volume and extent of AIB’s loan book and AIB’s recent history it may take to September 2011 until the real numbers emerge.
Sell the good parts (Poland/US) at behest of EU/others as we are no longer capable of managing oursleves let alone overseas investments. Then we are truly left with a fine rump of crap (Anlgo, ILP, BOI, AIB etc).
Anyone got Jonny Gormelys number so we could speed up build on new incinerator, NAMA could realocate for itself to shiny new office on the glass bottle site. From there it would be a quick and simple process to transfer the “waste” to the Poolbeg incinerator. Potentially a great synergy there. Tick tock tick tock…….
Can I ask another basic question?
The original banking guarantee is gone in Sept, correct? This one differed from the ELG in that is guaranteed debt not taken out under the timeframe of the guarantee.
So is it fair to say that the updated / extended ELG actually incorporates many features of the previous (blanket) guarantee? Kind of an almalgamation?
the “blanket” guarantee covered all outstanding liabilities of the banks (with a few exceptions, ie covered bonds i think) at that point, and then covered all deposits (retail, corporate and wholesale) taken on by the banks going forward as well, up to 30th Sept 2010 (ie if it was a 10yr fixed deposit it would no longer be covered after 30th Sept).
The ELG only covered new liabilities ‘created’ in a window period between early 2009 and Sept 30 2010 (since extended to Dec 31). It did not cover corporate and wholesale deposits less than 3mths in duration, but would cover these liabilities up to a max period of 5 years, or maturity, whichever was lesser. Further, it would not cover subordinated debt.
So there are some similarities between the old g’tee and the ELG, but there are some important qualitative differences too.
I guess the crux of my question is this:
If a bank has issued 10-year debt in 2007 (before the blanket guarantee) and it is due in 2017 then is such debt still covered after September 31st as it was “exisiting debt”?
Is exisitng debt (issued pre 2008 guarantee) still guaranteed by the Gov or only until Sept 31st?
The 10 year debt issued in 2007 won’t be covered. Only debt issued under the ELG scheme will be guaranteed after September.
Has anyone done any work on how much the guarantee will cost the State under various scenarios assuming it is extended for say 1, 2 or 5 years ? It’s very hard to see where any sustainable growth is going to come from so presumably the guarantee will be required for some time yet.
@Eoin and Gavin
First note that the guarantee has cost us nuffin’ so far despite the doomsayers. The guarantee will only cost if it is called on, so questions as to what it wil cost over 1,2, or 5 years can only be answered speculatively. The balance of probability is that it would continue to cost nuffin’.
Your question is understandable given all the furore about the “blanket guarantee”. There was nothing blanket about it. It runs out in September and only defaults in the last two years, of which there have been none, are covered. All existing and pre existing debts are unguaranteed when the guarantee expires.
On the contrary the Guarantee has cost us our solvency – it is just a matter of time before its official.
Our last vestiges of freedom are behind us now – welcome to serfdom baby.
Your only hope for success now in this economy is to become a agent for a absentee landlord.
the guarantee is actually a money earner due to the premiums paid by the banks. Obviously if it is ever called-in it’ll cost a fortune, so i dont want people claiming im describing it as a “money earner”, but at the moment it has generated direct profits (although there is a very real argument about what it may have cost is in lost wiggle room in terms of bank restructuring, as well as increased interest costs on our national debt).
It hasn’t cost us our solvency. The only thing that will cost us our solvency is if we don’t get our public finances in order. People obsessing about bank guarantee schemes are forgetting the real problem. We are still spending €20 billion a year more to run this country than we are bringing in. That’s what investors talk about. Not whether the bank guarantee scheme will be extended. And I say that having just come back from a conference…Not one person I talked to was interested in the guarantee. They were interested in the budget.
@ BWII / Eoin
Is the premium rate paid available? if so it would be interesting to back out the implied probability of a call.
@Gavin S +1
Last week we were told that unemployment was at a 16 year high. My first thought was “I thought it was worse”. I decided to look back at 1994. Our debt to GDP ratio was over 90%, worse than it is now. So this Anglo thing should be seen as a one off giving back some of the (illusory) advances made in reducing our ratio to 30% by 2004.
But there was a big difference in 1994. We were running a budget surplus. I checked and found that OAP rates have increased by 60% in real terms since then and I guess public service pay has grown even more. The standard rate of tax has fallen from 27% to 20%.
The real elephant in the room is the fiscal deficit.
“On the contrary the Guarantee has cost us our solvency – it is just a matter of time before its official.”
Nonsense. The guarantee is an insurance scheme. By your reckoning every insurance company is insolvent because it couldn’t possibly honour its guarantees if everybody made a claim. Alternatively every bank is insolvent because all of its assets might fail.
We must get our public finances in order – whose we exactly.
Are you asking me to heroically sacrifice myself and my family for the well being of bankers and other inside men – no thanks.
As I said previously the fiscal debt situation is a sideshow – the guarantee to foreign holders of private bank paper is the primary mechanism for the deflation in this economy.
The 20 Billion debt hole is there because the money supply/credit creation has collapsed while we still pay interest on the vehicles that provided the fuel for this Ponzi so therefore we get massive econimic contraction.
Our solvency is now toast because the sovereign for want of a better term is seen willing to sacrifice the productive economy for the FIRE economy.
Its over – our credibility is shot along with our national self esteem.
The only thing keeping us apparently afloat now is the money centres who reward us with passivity while punishing Greece which has a lower overall debt level – this is done to extract the maximum amount of money before collapse.
This is a monetary fiasco masked by fiscal madness – the budget is a merely a mechanism for a hopefully failed attempt at wealth transfer.
Its a sad farce of epic proportions.
I do not believe in fractional reserve banking so therefore you have my mark.
Credit creation is a millstone around the neck of humanity.
Thanks Eoin. I think I am clear on it now.
It looks like certain large deposits are bound to depart if they cannot roll over deposits for a shorter period. Corporates are unlikely to lock in for lengthy periods if the scheme is extended in its present form.
Sure, the options and risks should be examined in detail. The less uncertainty the better. However it is misplacing the burden of proof to assume that in the absence of (more) certainty about what to expect from a Morgan-Kelly-ish resolution approach, we should play it safe and stick with guarantees and recapitalisations instead. We’ve seen what’s in the prospectus for “playing it safe” – billions more public debt a certainty, ruinous public debt, harsh external intervention and outright sovereign default all serious possibilities. It will take some pretty firm evidence of deep flaws in the Kelly approach to overturn the reasonable starting assumption that it’s less reckless than playing it safe in the present manner.
That’s actually something we wouldn’t have to do, if I understand correctly. A “burn all existing creditors; reassure prospective creditors by leaving behind an unquestionably sound bank” resolution shouldn’t require it; it’s only the mixed-model “burn some existing creditors; leave behind a questionably solvent bank; try to reassure some prospective creditors by not burning some existing ones and by continuing government guarantees and recapitalisations” approach which does. Yes, the first approach might mean burning Europe’s biggest dodgy bank.
As to Northern Rock, I believe that it was nationalised under the emergency Banking (Special Provisions) Act 2008, not the Banking Act 2009 which replaced it. The 2009 Act apparently protects senior bondholders from reordering, among other things, but I’m pretty certain that it doesn’t contain anything close to a general requirement to guarantee senior debt. (IANAL.) It may well permit the government to dig out senior debtholders in various ways; it seems to leave the government a lot of discretion in general.
It seems likely that even if we bring in a Special resolution scheme it would not so radical to allow losses to be applied to senior unsecured bond holders. This is if the UK act is a model or looking at custom and practise in the eurozone where senirs have been protected.
Therefore if a bank in this jurisdiction looks like failing what would happen. It would be given a finite time to raise capital either from existing shareholders or by sale of assets. If this did not work, I presume it would then be nationalised. At that time the state faces the choice of i) recapping the institution and presumably returning it to the market ASAP or ii) enter into a transaction with a 3rd party who would have the resources to recap it. This latter would probably require that the state ring-fence some part of the loan book in a(nother) bad bank.
In reality, not only will “no creditor left behind” have to be rethought, but “no bank left behind” will also have to be reconsidered. We currently have 6 banks and all are moving in lockstep. There is no competition and no benefit to the citizen of having 6 banks. All the economy would need to sustain itself would be a recapitalised BoI, possible with a state guarantee and a fully nationalised AIB.
A bit radical, maybe, but in the long run cheaper than continuing to prop up 5 and a half zombie banks.
The foregoing debate, sparked by John McHale’s article Extending the Guarantees, leads one to question the whole approach the Government prescribed and insisted was the only approach to stabilising the banking Sector viz. NAMA. The Government told us, on the back of massive propaganda, that the NAMA Project would expeditiously clean up the Banks’ balance sheets, introduce liquidity and credit for businesses and households while also stabilising and strengthening the Banking Sector etc. Clearly the Government’s NAMA Project isn’t working according to its (false) expectations. It is now increasingly obvious that the situation is deteriorating quite rapidly.
Of course there is an alternative approach. I inviteall everyone to consider a sounder alternative that can be commisioned without delay to stop the continuing slide into a worsening national financial and economic mess.
This sounder alternative approach was discussed in outline in the Irish Examiner, ANALYSIS page 13, on Friday 6th August 2010 under article headline RIGHTING THE NAMA WRONGS.
The web-link to the article is:- http://petermathews.files.wordpress.com/2010/08/examiner-aug-7-2010-page-13-analysis.pdf
Every good wishes.
“First note that the guarantee has cost us nuffin’ so far despite the doomsayers. The guarantee will only cost if it is called on, so questions as to what it wil cost over 1,2, or 5 years can only be answered speculatively. The balance of probability is that it would continue to cost nuffin’”
What about running a couple of thousand stochastic simulations ? Sure wasn’t the chance of anything other than a soft landing miniscule 3 years ago too ?
@ Peter Mathews
Thanks for the link to your article
‘Overall, this is the correct strategy. It’s also pivotal for accelerating
downward corrections in asset prices and rental levels to revive market
This is Ireland. I don’t believe that our commitment to market economics was ever wholehearted. A revival of market actiivity would involves the crystalisation of losses for well-placed individuals and corporate entities. Paralysis is regarded as the least bad option, so we are stuck with it until it becomes truly unbearable. Time will tell all.
@ Keith Cummeen
Your sentiments are sound but your analysis, with respect, is less so. Read Karl Polanyi.
@Peter Mathews: if you nationalise the banks it undoes much of the reputational gain Ireland has garnered internationally. The main difference, other than the implicit failure implications (ppl in NY & Newport CA think we are doing a good job) would be that you can wipe equity holders, including those who took up the rights issue in the case of BOI.
The bond holders in a nationalised bank still won’t get cut, there is a big difference between a ‘going concern’ and a ‘gone concern’ and only by shutting a bank down can you obtain the latter. Operationally it probably would be fairly simple, but are you sure that by doing this that everybody gets a better deal?
Reaching the bottom is vital, kevin o’rourke/benetrix/eichengreen paper on this topic ties in with that, on one hand that’s an advantage, on another, nationalised banks have issues in collection – arnotts being a prime example. I just don’t see how a reversal at this point is a cure?
Furthermore: nationalised banks distort the market, look at the liability side – who are paying the best deposit rates? EBS/INBS/Anglo all state owned or controlled.
What are the downsides of the plan you have mentioned?
I can see that Mr Mathews is upset that a different Peter got 350k for suggesting NAMA. However, I fail to understand his silver bullet. The only net difference seems to be that he will toast senior bondholders. The practicality of this has been well aired and the NAMA project is somewhat irrelevant to such a toasting.
My beliefs are not classical Austrian in nature although I think the anti – gold/ free floating exchange friedmanites are a sham.
I am a believer in a strong but limited state rather then the weak but increasingly unlimited state structures of today as a typical Austrians worldview fails to encapsulate power dynamics within his worldview.
I also believe the state should control strategic utilities but unfortunetly the banks propogandists portray this as a form of socialism which I believe it is not – it is the state being a equal amongest great non state actors.
Think Charlie Gaulle and you have it – banks will not merely surrender to a intellectual argument.
With brutal regret …I have to agree with Keith on virtually everything he has written. I am no economist, however I think I understand economic fundamentals. As I see it the reality is Ireland has lost billions propping up Anglo, Irish Nationwide, et al. This is cash that is gone with no return, financed through leveraging the country to an unsustainable degree.
To break this spiral there has to be wrenching change.
As I see it the big problems are 1. currency (the strong euro), 3. lack of competitiveness, and 3. the magnitude of the debt.
If Ireland could tackle at least two of these, any two it might begin to be the basis for recovery. However the change will need to be again significant and wrenching, probably beyond what the IMF would do, otherwise Ireland could conceivably loose 30 years to this problem and the economy might drip shrink to half its current size ….with consequent implications for Irish lifestyle and Irish sovereignty.
Hitting the problem head on will be awful but its a winnable battle.
1. The currency …there is no scope here..Ireland cannot leave the Euro, however Ireland might be kicked out if she continues on the current tragectory.
2. Lack of competitiveness, this is an area where Ireland has some control. Wages and spending need to fall by about 50%. if this happens Ireland will again be competitive on an international basis, organic exports will increase, foreign investment will increase, and imports will fall. Ireland will again be the country of ‘bangers’ for a couple of years.
3. The debt needs to be reduced. Ireland needs to sell anything it can to reduce its debt. Therefore the ESB, the airports, forests, anything that makes a dollar or euro needs to be sold. The revenues generated going to debt reduction.
This shock treatment as part of a national program might put Ireland back on its feet in a matter of three or four years. Think Chile and New Zealand both are doing fine now …but there economies were in a bad place too some years back…and they changed although not quite as dramatically I think as I am advocating although there problems were not as dramatic as Ireland’s.
Ireland need to put itself on an emergency footing with a national government with the will to do this, the Irish people need leadership and direction now and a goal, twiddling the knobs is not going to work.
Thanks for agreeing with me but the solutions you post I would have serious problems with.
I would not sell any utilities such as the ESB in this current environment not only because the money extracted from such a foolish mistake would do little to solve our debt problems but more importantly in the current monetary environment all private owners of utilities have thought it more profitable to run down the capital of utilities and express this as profit.
The current neo-liberal consensus pushed the Bord Gas / ESB “competition” to new levels of absurdity.
The goal to reduce wages is imperative but doomed to failure if the debts remain static or increase.
The ECBs attempt to protect all its client banks is deeply damaging to Ireland and if this continues it would be best for Ireland to leave the Euro and also perhaps other EU structures.
We maybe able to form a trade alliance with Iceland whereby we can engage in a trading relationship based on the export of Irish Beef for Icelandic women – and slowly take back the treasure they stole from us 1000years ago.
I don’t understand why you think yours is a better solution. You nationalise the banks and force senior bondholders to take a hit. Fine. Now tell me who is going to fund the bank’s after that? Do you really expect to be able to burn bondholders and then go back to them and say ‘hey guys, fancy lending us a few billion euro’? The banks would be left with a huge liquidity hole that the Government would have to fill. If you think that as a State, we are borrowing a lot now, wait till you see the funding bill of a nationalised banking system.
I don’t understand why people are still going on about this like there is a simple solution. Sell deposit books, burn bondholders, nationalise banks etc etc are not credible solutions.
The state is borrowing to a extraordinary degree because the banks are still paying interest to foreign holders of bank paper.
The fiscal mess is there chiefly because the credit money supply has collapsed but mortgage holders and domestic deposit holders still subsidise holders of risk paper – this deflation in our economy is reflected in government figures which have to spend to fill peoples bellies and engage in activities which enable normal civilisation to continue.
The concentration on fiscal numbers and not monetary numbers is a sham.
This blog is full of economists who seem to get into a hissy fit with regard to fiscal deficits but I find it hard to obtain the figures regarding the amount of money paid on interest to risk bank paper.
I would greatly appreciate yearly figures to quantify such movements.
The state is borrowing to a extraordinary degree because the banks are still paying interest to foreign holders of bank paper.
That doesn’t make any sense whatsoever. Why do you think the Government is paying the interest on bank’s bonds?
Its obvious – demand is down dramatically because mortgage holders have to pay interest dramatically above the base rate to pay foreign holders of bank paper (the drop in domestic deposit rates is proof that the banks seem to value senior bonds over deposits so therefore bonds are gaining extra interest despite the fact that they now share equal risk).
Future demand is also effected as deposit holders will have less wealth to spend in the future
So therefore now that credit creation has stopped which increased demand and therefore tax revenue – money is now being extracted via interest income and now that money base must contract.
Fiscal debt spending must fill that hole or else you get total collapse.
The goverment is dependent on the banks for money creation it cannot create money itself – it must tax or seek debt money.
Of course we do. If the bank that emerges from a bondholder haircut is obviously sound and profitable, then it is in the self-interest of investors to buy bonds in it. The bank is effectively a new bank replacing a failed, liquidated one. This point can be underlined by changing the bank’s name, and of course by wiping out the old board and senior management.
To assert otherwise is to say that no-one will lend to a bank without the expectation that public money will be spent to rescue their investment if necessary. This is to say that the only reason to lend to a bank is moral hazard. This would be Bad Thing if true. It would be an almost-conclusive case for nationalising all banks and never permitting private-sector banking again.
“Credit creation is a millstone around the neck of humanity.” It’s a doctrine which you certainly have endorsed with gusto. When you argue that the Fiscal Deficit is mainly to do with banks paying foreigners interest, I wonder why I bother answering such delusion. Paying foreigners interest did not cause the government to increase social welfare and public pay to twice that of our neighbour, the UK.
So tell me this. If the Government said deposit holders would lose 25% of the value of their deposits and then the next week turned around and said ‘Forget about that old bank. We have a new name and a great new management team. Sorry for the 25% loss you suffered but we would love if you gave us your money. We promise it’s safe and we won’t do it again’. Would you give it to them?
Irish senior bank bonds would be reduced to junk by the ratings agencies if there was a writedown. Investors would take the losses and move elsewhere. The banks would not get funding in the capital markets. If the Government can force bondholders to take a writedown once, why not again? Who would invest knowing that?
@Brian Woods II
I couldn’t follow the argument about paying interest to foreigners so I thought I would leave it to better qualified people than me to respond!
“So tell me this. If the Government said deposit holders would lose 25% of the value of their deposits and then the next week turned around and said ‘Forget about that old bank. We have a new name and a great new management team. Sorry for the 25% loss you suffered but we would love if you gave us your money. We promise it’s safe and we won’t do it again’. Would you give it to them?
Irish senior bank bonds would be reduced to junk by the ratings agencies if there was a writedown. Investors would take the losses and move elsewhere. The banks would not get funding in the capital markets. If the Government can force bondholders to take a writedown once, why not again? Who would invest knowing that?”
There is a big difference to how investors in senior bonds would react and how depositors would react to having to take a haircut on their money.
And anonym is correct, if after the senior bondholder haircut the banks well capitalized with a srtong balance sheet they would find lenders.
In normal times banks (and therefore their customers esp mortgagees) enjoy very cheap funding. Depositors get a pittance. Seniors get a few bp over sovereign.
This is mainly because banks are perceived to be bullet proof. This is a perception nurtured by the State which strictly controls the very use of the word “deposit”. Some even argue that because the State nurtures this perception it is morally, if not legally, bound to back it up when the wheels come off. The key protection to the State is of course regulation and supervision, which has alas been sadly missing.
I agree with you that this makes a good case for nationalisation but it has been thought up to now that a well regulated private banking sector, even with an implicit State backing of last resort, was most optimal. If the regulation is strong enough that is probably still the case.
@ Gavin S.
However, if the asset side of the balance sheet was crammed down we would not need wholesale funding as the loan-depo ratio could be reset to 100%. The senior debt holders would now own 100% of the equity in a shiny new bank. I guess they would have a problem explaining to their policy holders where half the money went too
Then free of the shackles of our debt we could borrow again. This would be funded from ….let me see…I think this needs more work.
I presume then that the exchequer if freed from the burden of bank bail outs would then not have to do any of that nasty stuff. Life would be so much better.
In a debt based monetary system that has no symbolic representation for capital it does not matter whether you reward workers with wages , dependents with welfare or stock holders with profit.
All revenue is used to service debt so therefore capital cannot be created – the global credit bubble of the last 100 years is based on the continued increased extraction of resourse capital and is reaching its endgame.
To argue that fiscal games are not a part of the global debt/banking engine is to not understand the nature of money as we use it today.
With regard to Ireland Fiscal debt money it is a very small part of our money supply – people are defaulting or paying their debts due partially from pressure to pay foreign private holders of bank debt.
This drop in money supply has to create a recession / depression – it is a econimic fundamental not unlike gravity in physics.
The fact that you declared I live in a delusion rather then attack my argument is telling.
There isn’t really a big difference in how they would react. Investors can be as p*ssed off as depositors.
They wouldn’t invest. The bonds would be downgraded to junk so chances are that most fund managers would be unable to invest. Other real money investors would simply say why bother if the Government can just unilaterally decide to inflict writedowns. Even if investors decided to invest, anyone care to hazard a guess at what the new funding costs for banks would be?
That does sound nice. Maybe then we could writedown peoples mortgages as well to nicely balance it off. You know 25% off the liabilities so lets knock 25% off the assets. After all the banks knew the risk they taking when they lent the money.
I didn’t follow any of that. No more can I understand Einstein’s explanation for gravity, to which you alluded. Apologies for straying out of my depth.
i’ve always loved that argument, that after inflicting losses on bondholders, they’ll come back even more eager to give us new funds, and at lovely rates too. Is this known as the “Battered Wife Investment Syndrome”?
@Brian Woods II
I was not referring to any theory that explains why gravity does what it does but to the simple observation of its effects which is just the precursor to scientific observation.
Getting back to the observed increase of risk capital that fueled our bubble in the last 10 years we have to ask why this happened.
I believe the reason is simple – the ECBs fiscal deficit rule prevented surplus countries such as France and Germany from saving in their domestic economies – this forced conservative investors into riskier investments that would not increase their countries debt.
these were monetary vehicles that would expand the ECBs client banks profits at the expense of member states.
The Paris Executives history of scraps with the ECBs high priests is compelling record of the fight for the surplus created in Europe at that time.
@Gavin S & Eoin
If they are professional investors they should come back to invest in a bank if it is a solid investment proposition.
Any trader who won’t make an investment even though the numbers looked good because they held a grudge where I worked would be fired on the spot.
It is not the battered wife syndrome it is the good investor syndrome!
Your posts sound very weighty but I honestly don’t understand them. I will persevere though. Meanwhile I will take the following quote and make a layman’s observation: “Its obvious – demand is down dramatically because mortgage holders have to pay interest dramatically above the base rate to pay foreign holders of bank paper”. I know people who have big mortgages and the one bright spot in an otherwise unceratin environment is that their mortgage repayments are a fraction of what they were pre crisis. Current mortgage interest rates are a definitive stimulus to demand compared to what they were a few years ago.
sorry, i see where you’re coming from now – you’re still a firm believer in rational investment theory. I would have thought that the current crisis showed us how error-ridden that was? Behavioural economics would far more easily teach us that people do not return for a second dose of pain as easily as they lined up for the first one. Simple human nature, which, like it or not, is very much in existence on both trading desks and credit committee meetings. If you want to argue that people are inherently stupid, greedy and prone to repeat their mistakes, i’d find that far more believable, albeit less likely than simply standing aside and playing it safe.
But how is it a good investment? They have just taken a loss on senior debt because the Government have nationalised banks and decided that they should take some of the losses even though other unsecured creditors who rank pari passu with them such as depositors have been spared. You have just changed the assumptions behind a) the probability of default and b) the loss given default that underpins senior debt.
Even if the banks had a strong balance sheet after that, once there is principal loss on senior debt, the rating agencies will move them to junk even if they are owned by the Government. Many investors such as fund managers, pension schemes, insurance companies operate off a mandate that doesn’t allow them to invest in junk bonds so even if they thought it was a good investment, they would be unable to invest.
I know there is no real way to prove it either way unless we go down that road so I think we will probably just have to agree to disagree on this. All I know is that this topic came up recently with regard to Greece and likely debt restructuring. Nobody ever mentioned that Greece will be a better investment when they restructure. All that was talked about was minimising losses and getting out of dodge!
As Eoin says, traders and credit committee’s are made up of people with rational and irrational ideas. There is a reason that many investors are shunning all securitisations just because they may have got burnt on some US housing paper.
“the Government have decided that they (seniors) should take some of the losses even though other unsecured creditors who rank pari passu with them such as depositors have been spared”
Isn’t this the key point? Senior debt is usually cheap for banks precisely because it ranks pari passu with depositors. Of course governments could change the law retrospectively to make them rank below depositors. Never again would banks get cheap access to senior debt (hey, maybe that’s a good thing!). Furthermore the credibility of Ireland inc. would be shot to pieces by such retrospection.
To maintain credibility one would need to let Anglo actually go bust after the expiration of the guarantee period and let the liquidation process follow its legal course. Then afterwards the government would make good the depositors (everyone seems to accept that these must be protected in all circumstances). But this would cost the taxpayer bigtime and the liquidation of even a corpse like Anglo would have unpredictable impacts on asset prices and the rest of the banking system.
I know Mathews argument is not to actually let Anglo go bust but make it known that this is a serious option and thus force seniors into parler. But seniors know they are in a much stronger position than this and that the threat of either retrospection or liquidation would be a bluff. A silly bluff at that as even to bluff these threats would hugely damage credibility. The government has stated that no banks will be allowed fail. It has started on this course and it must not blink, it can’t even hint that an alternative is an option.
Why are we still debating this? Even Richard Bruton gave up on torching seniors a long time ago.
I disagree – the ratio difference between the base rate and what mortgage holders pay is important – also deposit rates have collapsed here since last year which is a implicit subsidy to foreign holders of debt.
Remember this is not like the Japanese economy where at least the fiscal debt is owned by locals who recycle the interest income(although it is a very low interest rate)
Anybody who believes in the debt system of money and advocates doing nothing but allowing mortgage holders , savers and tax payers recapitlising broken banks without a debt for equity swap for so called risk capital is as far removed from capitalism as it is possible to imagine.
The global central banks have shown their true hands – not as guardians of capitalism but of guardians of favoured capital.
“…is as far removed from capitalism as it is possible to imagine…” At last something we can agree on. If the credit crunch/Irish bank disaster/cost of borrowing/money creation etc. had been left to unfettered capitalism we would have been blasted back to the Stone Age.
The global crisis that we have the pleasure or misfortune to be living through is almost entirely due to the central banks mispricing capital through their centralised churches.
Central banks without Gold/silver as a check on unsustainable capital extraction are more communist and socialistic then the USSR ever was.
Although I would not advocate pure unfettered capitalism – capitalism of some sort is what the system needs if it is to recover.
@ Keith Cunneen
‘Anybody who believes in the debt system of money and advocates doing nothing but allowing mortgage holders , savers and tax payers recapitlising broken banks without a debt for equity swap for so called risk capital is as far removed from capitalism as it is possible to imagine
Are your views broadly derived from Murray Rothbard and the von Mises Institute ?
I believe the Austrians are correct regarding the use of specie at least in some form to correct the madness of Government but I believe they are naive in the extreme when it comes to the logical conclusion of a extreme Libertarian agenda which I believe would only create a power vacuum that would be filled by powerful non state actors.
As I said previously there is a role for a powerful but limited government to preform a King Solomon like role in affairs.
No matter what form of government or econimic system power will collect in dark pools and without a vibrant citizenry it will eat its own tail.
Also both Friedmanites and Austrians seem incapable of imagining a Government willing to take collective action for anything.
Under their philosophy the great achievements such as the Apollo program or the French nuclear power renaissance would have been impossible.
A historical document now – but a must read from the days of the London gold pool.
This mother is a much bigger beast then the subsequent inflationary period of the 70s
mises.org/books/monetarysin.pdf – United States
No, I don’t believe that the market is completely rational, far from it, but you seem to have gone to the other extreme and believe that all market practitioners are completely irrational!
I simply do not accept that is the reality.
So while, yes, some traders/investors would no longer hold Irish bank debt due to having losses in the past, better and more professional investors would be able to judge the future investment on its own merits. They would access in the future risks and if the yields were worthwhile they would buy. And at the end of the day it is the rational who will survive and make the most money.
I am not suggesting we change parri passu for any investor!
The depositors and senior bondholders are entitled to the proceeds of the assets of the banks after wind up, that is it.
However, it is and always has been at the whim of the government to give additional protection to any or no investor as they choose or don’t choose.
I don’t think the government is obliged to provide additional protection to bondholders just because it has decided to give it to depositors.
The point you mention about investors being unable to hold junk debt is easily got around with a bit of imagination.
Split assets into good and bad. Leave old senior bonds in bad and setup new good bank. Sell new bank and have government guarantee on future debt issuance. Plenty of other solutions would have a similar effect.
Richard Bruton may have given up on torching the bondholders, but I fail to see why that makes any difference. Either something is right or it is wrong. And senior bondholders suffering 0 losses is simply wrong IMO.
The politics of the situation is completely irrelevant to me but that seems to be one of the major problems. Most of the decisions are being made for political reason rather than economic.
You are probably right the government has made its mind that bondholders will be left untouched but that isn’t going to stop be making the point that it is, in my opinion, the wrong decision for the wrong reasons and based on nothing but half truths and bluster.
Its the debt stupid.
If the ECB does not act fast – I would advocate buying Gold up to the M1 money supply.
or if the ECB fail to do this – Ireland should pull out of the Euro and to say to hell with there unplayable debts – there will be a crisis and I believe it will be a hyperinflationary crisis.
Remember hyperinflation is not a monetary event – it is sparked by a dramatic increase in velocity due to a lack of confidence by the people in their government and central bankers.
With dramatic changes in policey this can still be done but if they wait and wait for something to happen then people will take matters in their own hands and destroy the currency by spending as quickly as possible.
Given the fact that Ireland lacks any moral conviction now it is up to the ECB to do the decent thing and act and act decisively.
If they do not do something soon Europe will spiral out of control as there is a tipping point for everything.
Hold on a minute. Big picture please. We cannot afford to pay everybody back! Let’s just negotiate an orderly default.
Uruguay did it and is ok.
That is the answer – end of!
You are right we , the Iberians , the Greeks have to default but a mechanism must be put in place to cushion the centre from certain economic collapse when we do default – Germany France and Italy at least declare serious gold reserves
If the ECB bids up the price in multiples they can survive if we default.
My only worry is that they do not have the gold they say they have – if so a fair nationalisation of private gold via a similar mechanism would be desirable.
@ dreaded estate. I agree with much of what you say but The key line of your post is that they would invest if the yields were right. The banks would be paying a fortune for any new debt. Should also point that I wasn’t really talking about bondholders not suffering losses in the event of a liquidation.( even though i dont think banks should be liquidated). I was responding to Peter Matthews article where he suggests that all the banks should be nationalised and bondholders forced to take a haircut to help recapitalise the banks. Whatever forgiving losing money if your investment defaults, no investor would forgive that course of action. Anyone who thinks it is as easy as nationalising banks and defaulting on debt is crazy.
I should add that at this stage, I wish I could bulldoze Anglo to the ground and i wouldnt care who lost money or what damage it did but probably too late for that.
@ Keith Cunneen
You are right about Libertariansim. It is is obviously ideological, in that it is historically uniformed and fails to take account of real world phenomena.
‘As I said previously there is a role for a powerful but limited government to preform a King Solomon like role in affairs’
It seems you are also distancing yourself from the ‘self-regulating market’ camp, and that you are concerned about the quality of government. More Berlin than Boston. Fair enough. Trouble is, Ireland is so tiny that we count for little in the grand schemes of either one.
Your ref ‘ mises.org/books/monetarysin.pdf – United States’
Notwithstanding Jacques Rueff’s role in French and European history, his earlier position on German WW1 reparations led to the brutalities of the fascist era. Economic logic was blind to political consequences.
See Pt 2 of Trade Develpment and Foreign Debt by Michael Hudson.
“better and more professional investors would be able to judge the future investment on its own merits…it is the rational who will survive”
I think this is where we inherently disagree – like i said, you still think that all investment decisions should be, and generally are, completely rational in nature. In good times this is often the case, but in bad times rationality gets thrown out the window.
The outlook for both the world and the Irish economy (and regulatory/fiscal/monetary policy) will be far from clear for some years to come. Irrationality has always been a feature of the markets, despite many protestations otherwise, but it will be ‘overweight’ for some years to come while we have such an uncertain future on so many aspects of the economic outlook, especially for debt investors given the huge overhang we’re going to have for the next decade. Throw in the fact that Ireland is peripheral and a miniscule part of any portfolio, and therefore easily avoided by any investor even if they are trying to measure themselves against a benchmark. The only reason we’ve managed to keep most of them involved is the massive reassurance we’ve given them on our debts.
You reckon “some” investors would shun Ireland, i reckon “an awful lot/most” would.
I agree. Traders might want to deal with the ‘New’ Banks because of huge yields but credit departments don’t forget losses as quickly. Credit Lines would be chopped.
The Austrians are right in so far that money is a force – for every action there is a equal and opposite reaction – the keynesians and monetarists can put on their anti gravity belt and float around for a while but unless they develop real technology that can overcome their misadventures they will be incinerated in a great supernova.
I believe Minsky advocated massive spending on technology when his moment arrived.
Ireland may be tiny in population but the debt under our jurisdiction but not under our control could set off a chain of events that could sink Europe.
As for Reuff we all make mistakes but he was dead right about the utility of gold 40 – 50 years ago.
The west is now on the cusp of a massive decline after injecting themselves with fiat heroin for 40 years.
Even Hudson recognizes the value of Gold as a yardstick for human transactions.
I’ve had some doubts about the existence of meritocracy and some of the comments here seem to indicate that on some levels it is non-existent.
The merit or demerit for some in taking part of investment decisions seem to be seen as a good when it is a merit and an unforeseeable event when it is bad and a demerit. The people who made bad decisions seem to be protected from the Darwinism of natural selection despite beeing proven to be significantly less skilled than they portray themselves to be.
Judging by the comments here, not only will their bad decisions not affect their careers but we’re also expected to accept them making future bad decisions based on their feelings of antipathy.
Jobs & bonuses for the boys…..
look at the reaction in the Irish lending market in the last few months – the foreign lenders have completely backed out, regardless of margins to be made, which are now becoming amongst the highest in Europe (especially for the better funded foreigners). They simply dont want to participate in new lending except on an exceptional basis. Does this strike you as rational? They are reacting no differently to how a bond trader would, they are simply not in the mood to potentially have to explain at a later date to their shareholders how they may have suffered even more losses on their exposure to a small peripheral island in the North Atlantic. Its a case of cutting their losses and looking elsewhere, at least for the moment.
my assumptions about why they moved out is that they simply did not have the money to lend out in sufficient volumes to be profitable and instead focused on lending in bigger (home) markets were bigger volumes could be had. In that sense they acted very rationally.
Some might even have hoped for a nationalisation followed by split into good/bank banks and thought that a purchase of the good bank would be a great business opportunity.
Personally I wouldn’t lend to any of the Irish banks without a government guarantee as I don’t believe all of the losses have been recognised yet. & for longer term lending I’d be very careful.
They might very rationally have worked out that Irish bank risk now equals Irish sovereign risk. Essentially, it’s just one very big bucket of risk. And, with Anglo etc haircuts just getting bigger and bigger, with another large financial instituition heading for nationalisation, the bucket is in danger of overflowing.
Now that I have time to think about it I retract a previous statement about relying on the ECB to change monetary policey – they won’t without pressure from the governmental executives.
The ECBs policey is crazy – it wants to increase or at least maintain the debts in the periphery while reducing wages.
If this policey is somehow successful – Iberia , Ireland Greece etc will deindustrialise and even re wild.
Meanwhile France and Germany will still require consumer goods but these goods will be shipped from Asia – madness squared or even cubed.
The obvious implications of a hard debt monetary policey such as Volcker’s high interest dollar regime and now the hard euro is massive deindustrialisation of the host country and even more wealth to the bankers.
The only thing that could put a stop to this monetary malice is the growing price of oil which is a signal that this wage arbitrage model is dying due to unsustainability.
The executives in the various goverments need to once again act like princes and stand up to the papacy in Frankfurt and take down these high priests a notch or two.
Europe needs nothing less then a second reformation.
(To be clear, I’m talking about the same kind of resolution process as D_E here, ie. not one in which depositors are advantaged over other creditors after the fact by legislative fiat.)
Is it the case that, in general, companies which have just emerged from a full restructuring with an unquestionably sound balance sheet frequently cannot raise enough capital to stay open?
i couldnt say (im not a corporate finance/restructuring expert), though i suspect its not the case quite often (ie they can raise capital).
However, if you had a subsidiary and a parent company (which is the kinda relationship some would describe of a country and its banking sector at a time of systematic crisis), would people suffering losses on the restructure of the subsidiary be more or less likely to keep investing in both the subsidiary and the parent afterwards? I’d suggest they stop investing in both of these ventures. Consider further that the type of entities or funds that invest in senior bank debt and sovereigns are generally low risk, low yielding, and very unfamiliar with taking capital losses, and im guessing that they can find simpler and more palatable ways of investing their remaining funds without raising the ire of their stakeholders further.
A better question would focus on those countrie who have defualted/restructured in the past who subsequently gain access to credit markets. Never a pleasant experience and time is always an issue, but there are loads of examples throughout history. Greece has been in default for 50% of its (modern) existence and still, rather obviously, was able to borrow up until recently. Look at Reinhardt & Rogoff. Don’t ask large existing bond holders. They have, er, a vested interest.
Lots of hypotheticals in this discussion but I’m wondering if there any data points/proof-of-concepts that could be used to bolster arguments one way or the other.
Let’s assume country X has a legal regime where depositors and bond holders are equivalent/pari passu. Now let’s assume Bank Y in that country becomes insolvent. Has there ever been an historical case, e.g. in Russia, Argentina, Brazil, New Zealand, Finland, Sweden, Thailand, Indonesia, S. Korea etc. where
a) depositors and bond holders in bank Y were forced to take a haircut (e.g. 25%). If so what happened next?
b) depositors and bond holders in bank Y were forced to take a haircut (e.g. 25%). The government of country X then made the depositors good again by paying them the 25%, such that only the bondholders suffered a loss when all was said and done. If so what happened next?
If there were precedents it would give useful pointers as to the likely behaviour of the markets to newly issued bonds and of depositor sentiment afterwards. If there have been no such precedents then I’m afraid I just can’t see that such a course of action by Ireland would have worked out well – I don’t view financial innovation as a core national competence.
@ Keith Cunneen
Your intuitions are interesting. Perhaps we are back where we used to be.
‘Haute finance, an institution sui generis, peculiar to the last third of the nineteenth and the first third of the twentieth century, functioned as the main link between the political and economic organisation of the world’
Karl Polanyi The Great Transformation (1947) p 10.
Polanyi also makes the point that the rise of the market economy had the same kind of energising effect as the great religious movements. It’s about faith.
You seem to be anti-globalisation, on the grounds that it is a conspiracy of creditor interests. Hudson would concur. I think Stiglitz, who wrote an intro to the above, would probably concur also, as information assymetry problems are very obvious in high-tech production, patenting and accounting. Not to mention speculation, on which see Niederhoffer and also Alex Preda for lively material.
There’s an important environmental streak in your thinking too, but your style is a bit Nostradamus. If, as you say, the west is on the cusp of a massive decline, we have to improve our mutual understanding. Like it or not, most folk start from orthodox economics.
As you say Greece has been in default for 50% of the time post its independence from the Ottoman Empire but it did pay the highest yields in the eurozone prior to the crisis. Indeed, if I recall correctly, Greece was not even an investment grade sovereign just prior to the Euro. While it does not prove the point definiteively, it does suggest that an entity which defaults faces higher funding costs post default.
Of course existing bond holders have a vested interest. But the idea that prospective investors would just flock to the defaulter waving their cheque books is pure fantasy.
I don’t think anybody is saying that default is a desirable option. It is fast becoming clear that orderly default is probably the least bad option though.
Agreed debt cripples and as a result the next decade will involve more cash flow going to pay down debt rather than consumption or investment.
As for the term orderly default is that one of those oxymorons like military intelligence.
Credit money has been destroying more capital then is created for some time now as capital invested in technology has been gutted.
Companies efficiency is in fact capital destruction in disguise with profit coming out the back end of this friedmanite nightmare.
Our own Ryan air is a model company in this regard – people seem to believe that Ryanair is the reason we have low cost air travel – what complete and utter tosh.
We have cheap air travel due to massive technology investment during both world wars and the cold war.
Ryanair is a company that merely extracts this capital.
The revenue it gets is from passengers who pay via credit money created in the banks.
They just pay enough to the manufacturer to make a plane but Airbus or Boeing has no extra capital to invest in new technology as they have become a super efficient company that has no surplus to invest in new technology.
Even Though the progressively higher oil prices over the years should have forced airlines/ airplane manufacturers to fall to high speed rail or develop new aeronautical technology – the increased efficiency within airlines via lower wages and more efficient work practises disguised the capital destruction over time.
Other companies have adopted this approach to the point that they also engage in management practises similar to Ryanair until the mass of the traveling public will not afford to travel.
Ryanair and others can survive or even thrive as they cannibalize other companies but their capital extraction is exponential and eventually it no longer has the numbers to expand and it begins to contract.
Mick o leary is essentially a Irish peasant farmer who is the most efficient spud farmer in his parish – he can produce double the amount of spuds as his nearest neighbour but his effeciencey is at the cost of redundancy and if his crop fails he will starve.
Of course he will blame this as a act of God and not his insane levels of efficiency.
You didn’t get that from Jacques Rueff but interesting nonethless. Who are these anti-libertarian, anti-friedmanite, anti-globalisation, strong-statist, pro-business, capital preservationist, environmentally conscious economists ?
References please mate before someone nips this thread.
They come from various sourses that I have synthesised over the years in my model framework of how capitalism should work.
But at its core is the belief that capitalism should be about creating capital not unlike how it really started when some surplus was saved rather then all expended on consumption via profit or wages after the reformation.
I suppose the Quaker families of the past were close to this belief system.
Ps. I am not a econimist
Nothing wrong with Quakers. The Owenites were interesting too. Suggest you write up that model to article length and stick it up on the web sometime.
PS Neither am I but I like some of their tunes..
@ Mr. Bond
It sounds reasonable to speculate that conservative-minded investors would be irrationally unwilling to invest in a newly-restructured AIB. But it also seems reasonable to speculate that to a large extent AIB has alienated this section of the market already. What does AIB’s Euribor spread over average look like these days?
In any case, let’s assume for the moment that restructuring AIB does lead private investors to overprice its debt, and underprice its equity, so wildly that the newly-restructured bank is put at risk of failure. Well, here is a golden opportunity for the government to correct the market failure and make a nice profit by giving the obviously-fundamentally-solvent restructured AIB loans which we actually will get back with interest. If we can’t afford to do that, then it obviously stands to reason that we can’t afford to plough similar or greater amounts of money into recapitalising an unrestructured AIB, a distinctly less safe and profitable investment. And of course there’s the ECB.
There seems to have been a lot of apparently reasonable (though as it happens apparently incorrect) speculation that Eircom was going to be put through restructuring. As far as I know it was not expected that this would destroy the AAA credit rating of Eircom’s new(ish) majority owner, let alone that of the Republic of Singapore. Apparently limited liability does what it says on the tin here.
And beyond keeping any specific binding commitments it has made, and upholding the law generally, the government has no extra, unwritten, responsibility to bondholders in insolvent private-sector banks. None. Even the lender-of-last-resort role has been centralised to the Eurosystem.