Ireland’s Experience in the Bond Markets Post author By Philip Lane Post date October 27, 2010 Oliver Whelan of the NTMA gave a presentation on this topic to the IIEA last week. His slides are available here. Categories In Fiscal Policy Tags Irish bonds 35 Comments on Ireland’s Experience in the Bond Markets ← What sort of four-year plan? → Address by Governor Patrick Honohan to Institute of Certified Public Accountants in Ireland 35 replies on “Ireland’s Experience in the Bond Markets” The last slide is interesting. In 1998 Irish institutions held 80% of government debt. Today that is around 20%. And what did massive overseas exposure do for Irish unit-linked life and pensions business ? One of the most interesting consequences of the financial crisis is that there does not appear to be any basis for a belief in currency diversification. Most investment classes appear to be strongly correlated. John Authers had a very good article on this in the FT recently. Interesting historical perspective. Apart from Japan most of the other big economies and Ireland had bond yields > 6% well into the 90’s. Yet this did not indicate financial crises requiring IMF intervention. Whats different now? Were those bond yields caused by inflation expectations rather than debt levels. If so does it really matter, inflation is bad, debt is bad, but inflation trumps debt (makes it go away) so it’s all the same in the end, whats the big deal. Why are we so worried now when we, and the rest of the industrialised world survived the early and mid 90’s? The opposite question also holds true, with US and UK debt rising you would expect them to inflate their way out, yet current yields are in the 3 – 4 % range, about 1/3 of where they were in the early / mid 90’s. Why is the US not paying 6% of it’s debt, historically that would not be outlandish. The ECB hawkish statements seem to be exacerbating EMU problems. The FT account of the last days before the Stability Fund was announced recount Sarkozy demanding that the ECB purchase bonds and Trichet reacting against any suggestion that the ECB might be open to political influence. One worries that the ECB might be letting its [slightly egotistical] fear, that its independence may be questioned, influence its machinations so as to blow it off the optimum course which a truly independent and impervious ECB might take. It is interesting that the NTMA is confident in shifting its efforts to marketing to a whole new class of investors. The implication is that we need these investors while yields are hgh but that the traditional investors will be back in the game when the crisis passes. The corollary is that we do actually need these investors now which suggests that yields will remain high as internal investment rules have eliminated many low-risk-seeking investors from our target market. It suggests that there is a structural division (in terms of bond yields and ratings) in the market which we have traversed to our detriment. It appears that it is harder to return to lower yields once one has crossed this division as the target market changes. Some interesting figures, however “Evidence of continued demand for our bonds as certain real money investors take the view that Ireland will successfully deal with its problems and Irish bonds will rally.” Are certain individuals not also betting that the ECB will not let us default? “Evidence of continued demand for our bonds as certain real money investors take the view that Ireland will successfully deal with its problems and Irish bonds will rally.” Or perhaps more accurately: At current prices buyers of Irish Government bonds believe the probability of default at some point in the next 10 years is less than 40%. It doesn’t have the same ring of confidence though does it? @Justin Collery It was inflation that mainly set the yields. In the US it is currently inflation/deflation plus a savings glut that sets the yields. What is different now wrt Irl is that it doesn’t have a central bank that can print instead of default, so default it may do. Our experience today, albeit as part of generalised piigs wekness, has been very unpleasant. An interesting presentation. I wonder why there were no explanatory notes relating fiscal events to the widening of bond spreads; Budgets, emergency measures, collapse in taxation revenues, etc. While there can be no doubt that the extraordinary bank bailout will have negatively impacted Irish government debt, offering it as the sole explanatory variable is not tenable. Across the EU, there is no correlation between bank bailouts and bond spreads- Greece had no banking crisis, and no bailout to speak of. Belgium had the next bigget bailout after Ireland- and no bond blowout. Is it not more likely that the cause of the bond market crisis is the deterioration of the fiscal position? As Garrett Fitzgerald says, a one-off bill for €30bn is not as bad as accumulating annual debts of €20bn (even if the estimates prove to be awry). The presentation comes across as more of a sales pitch rather than an explanation of what went wrong. The author seems to be a salesman selling bonds without giving much decent information in the way of context. The sales people where I work are no different. I find it very hard to get insight from salespeople. @ Brian Lucey some rumours going around that you’ve been having a mini deposit-selling moment on your twitter page recently, about some mysterious Anglo Irish Bank “buybacks” at the end of Sept?? Please say its so…. @M Burke What planet are you living on. You are given evidence by the NTMA that the increase in yields happened when the bank guarantee was given and the Anglo problems developed. Also Belgium didn’t guarantee the bondholders. They also probably have a finance minister who isn’t a cambridge golden boy lawyer who believes he can do no wrong and stubbornly refuses to listens to economists and direct evidence that he is on the wrong course. We have an obvious fiscal problem granted caused by the irresponisible government but this is an remains a much more minor problems in the bond market than Mr give it all away to bankers Lenihan. The figure by the way is 50 bn and that does not include the coming NAMA and mortgage problems that we have to deal. Also the bank issue is now feeding directly into the fiscal problem. We have an army of NAMA bureaucrats to pay on and ongoing basis (100 million a year), 5 % NAMA bond (2.5 bn a year) and increased borrowing costs (currently only 0.5 bn a year but growing as we role over bonds). 3 bn of the fiscal is caused by the bank crisis. Maybe Garet the good called this one wrong. If a Goldfish could be asked the question – what is the most common object they see around them, the fish would never respond with the obvious – water. http://www.youtube.com/watch?v=DxnpujfanUM Eoin, I believe it is Dr G twitter and you can observe it on politics.ie. We have closer to €10bn maturing in H1 2011 when you include the treasury bills @ Tull its Dr G, its Prof L, its a few others. Embarassing stuff. I figured out what happened 10 secs after reading the story. Another one for the scrapbook… @Michael Burke “Is it not more likely that the cause of the bond market crisis is the deterioration of the fiscal position?” We agree! @jules I think the point is not the price, but the crisis. Undoubtedly the financial crisis has added to cost. The guarantee was foolhardy in the extreme, the lack of resolution of the banks in the two years available suicidal, NAMA either an inept folly or a massive stroke to benefit the rich (neither of them attractive prospects), the extension of the guarantee cowardice, and the continuing inability to close the issue close to treasonous. If, however, it was just that extra cost on the national debt and the interest bill and there was no other deficit, there wouldn’t be such a problem. Even allowing my own figure as the cost, 50 bn, it would be ‘manageable’. However, that would be an interest cost of 2.5 bn per year (at 5%). The problem is that in two years of trying, the deficit has not been reduced. Income has declined faster than spending (which is not saying much, as spending has declined by only 2% since peak (from 73 billion to 71.5 billion)). @Eoin Well, the further rumour is that all the expiring CIFS debt was repaid, none was rolled over. So basically all available collateral (and more 6.5% promises?) have been used up. Which leaves not much room for maneuver and less for lending. You do remember lending, don’t you? That’s the reason we’re supposed to be saving the banks. Oh, and where do they get money for lending from? Well, one place used to be the bond market… so tell me again why we bothered to save these useless banks? @ Hogan we’re not discussing policy here, we’re talking about a basic understanding of the facts. The Trinity boys thought there was some huge underhanded deal going on, when quite clearly it was a pretty basic bond redemption. You didn’t need to be a Professor (or Doctor) of economics to see what was going on, but the boys just love their gossiping… Hogan, why did we save the banks? Cos we were told to. Why are we removing another 15bn over 4 years? See previous answer. Why no debt restructuring? Come back when you have cut spending & raised taxes. I wd have thought people have figured out that the country is no longer run from Merrion st. @Eoin Yeah well, they can stick to their gossip and you both to your snide remarks. I’m a little tired of it. I’ll carry on wondering about the country. And you can take that one to the bank… oh, never mind, it’d probably want to rip off your head and feast on the goo inside. And if you think Mr. Lenihan pulling another 23 December 2009 trick of issuing promissory notes, going to the EU to look for retrospective permission, and getting around to telling Parliament three months later is not underhand, I despair. @Tull “Cos we were told to.” Yeah. But we weren’t told to cut off an arm and a leg to do it. The peculiar characteristics of the Irish bailout are just that, peculiar to the brand of crony capitalism and gombeenism we have here. We don’t need debt restructuring. We need a pair of brass balls, a thick-ankled girl with a downy lip, a small aubergine, and half a packet of cigarettes. We would do better with a monkey and a iPad and implement immediately whatever button it presses. At least there would be some action. Hogan, I disagree with you on your first point. The word went out to honour senior debt on that day. Permission was sought from Brussels. The commission did not demur. I have yet to figure out how one made seniors whole without guaranteeing it. After that, there is still the ongoing order to close the day to day gap to Brussels liking. @Tull I don’t doubt that new seniors needed to be protected in the guarantee. And not just because the commission said so. Existing seniors just didn’t matter. What mattered was that no banks were let collapse “you must save your banks”. So, what do you do? Guarantee deposits, guarantee new issues. Introduce a resolution scheme and start to talk to existing bondholders… meanwhile nationalise any that are bust. Bring in a SLS for their non-repoable stuff. Split each of them into good/bad banks. Actually do what the Swedish did, not just pretend you are. What did our bozos do? Guarantee everything and then go on a shopping spree with NAMA… Why? That’s the question. If you were going to design a bank bailout scheme to follow a textbook bad bubble and you wanted the perfect bad bailout scheme that would also make the textbooks, you couldn’t have picked a better one. The Century Bank scandal in Indonesia was heading for number 1 position, but the Irish 5-bank (or 80% of the banking system) crony coverage scheme will surely be long remembered. Hogan, The other move that history may comment on is how NAMA turned from a vehicle to kick the can down the road into a vehicle to up-front most of the bank bail out costs. We actually have come cleaner than most in confronting what lies beneath the floorboards. NAMA is already knocking out some trophy properties at a profit after about 6 months. Why was this stuff marked down to create a hole for the taxpayer to fill. Look at that estimable Spanish bank BBVA. It reported today that its NPL in Spain were flat at 5% in a housing market where prices are down 50%. Obviously the Caja’s were doing all the bad lending. Yeah, the alternative seems to be zombie banks or dead banks. We have dead banks… H, Zombies can still walk, I guess. @Tull, ““Cos we were told to.” BS! You can read too much into things, but thinking about this last night this stood out for me: “while certain investors will have a reduced interest in our bonds new classes of investors will become engaged in the market” Think of bonds as widgets that you are trying to sell. As an SME let me translate that for you “our customer base has disappeared, we’ve dropped our price and we are desperately looking for a new customer base” Couple of implications – we are told we’re saving the banks and cannot renegotiate our debts as there are a small number of people who lend to us and we will alienate them if we blink. Well, actually, from this presentation they have distanced themselves from us already. Maybe we just can’t say it out loud, but perhaps the solution includes debt restructuring. – this is catch 22. New bond holders charge a higher price. This makes the cost of servicing higher, making it less likely for our traditional bond holders to return. – as said above, this is a sales job. Finding this “new class of investor” adds complexity and risk to the operation. The war will be over the christmas (or at least we will know the outcome)! I see on Bloomberg that that bond yields are up touching 7%. Is this the end ? Has the market decided that the cost of the treatment required to cure the patient will in fact intensify the cancer? Or are they putting pressure on the EU to act as the responsible parent and take the keys off the teenager? Question: Are bond markets agnostic about actual policy viz. raising taxes vs. expenditure cuts? Belief that future productivity is essential suggests not. If we are taxing private sector productivity on grounds of ‘fairness’ whilst supporting the Croke Park deal on grounds of ‘realism’ then surely this suggests that we are not serious about future productivity of the country and hence, unlike the UK which seems to be sort of serious about cuts, the bond markets will not be impressed. All this Keynsian stuff about ‘taking money from the economy’ will depress confidence is, in my view, an academic parlour game. I know they don’t teach this (any more) in economics but if you’ve got tens of thousands of people whose pay and pensions represent a politically driven misallocation of capital and if (worse) you are funding this on the Exchequer credit card then you are going to harm productivity and impair your very chances of repaying money. @PaulMac I’m sure the savvier bondwallahs are aware that the union position on Croke Park has more than a slight link to the fact that thousands of PS workers are lumbered with massive mortgages that were contracted over 40 years on close to 100% terms that any more cuts in pay will drive these mortgages underwater. The damage that the property boom has done to the country hasn’t stopped yet. Justo’s crazy idea for the day. Lets issue dollar bonds. With the US going for QE2, the Germans going in the opposite direction, and the presentation saying that US investors are becoming more important. Lets borrow in dollars, convert to euros today and repay in dollars which will be worth less in the future. I’ll get my coat. @seafoid That seems plausible. But the net effect of tax increases must surely be the same in the short-term (less money to repay mortgages) and worse in the long-run (damaged PS productivity). I guess any strategy I’d support would initially drive the economy deeper into recession but would be better in the long-run as it would allow resources to be reallocated (Question: Do all Keynsians just want to play Santa Claus?).m But what we’re doing now is just delaying the inevitable whilst hampering the chances of recovery. The young private sector workers are not only the canaries in the mine they’re also the miners. All future growth will come from the private sector. Ireland – as a province of the world Economy – will become a public sector dominated outpost living on EU welfare. We’ll be on EU aid very soon and our trades unions will be experts on poverty. By the way I was at an ICTU event (Don’t ask) recently and when I criticised Social Partnership, Jack O’Connor replied that the great benefit of social partnership is that it can ‘correct a wrong election result’ (SIC). Jules commentary isn’t evidence. The average bank bailout in Italy, Greece, Portugal and Spain was 9.3% of GDP, compared to Ireland’s 230% of GDP. All European bond markets are spread markets, traded in relation to German bunds. The spreads on all these blew out even though there was no bank bailout to speak of. The ‘core group’ had much higher bailouts, Belgium 92%, Netherlands 52%. Does Ireland’s unique guarantee to every Tom, Dick and Roman add to upward pressure on yields? No doubt. But, absent a generalised correlation between bailouts and yields, offering it as the sole or even main explanatory variable is not tenable. Hogan Indeed. A perfect timepiece and a broken clock will agree twice a day. We ca both content ourselves on who is which. @PaulMac I agree on the taxes. Whatever is chosen in terms of the 15bn is going to hit those people who went long on their 100% mortgages and then the banks and then the government . I remember seeing the first 100% mortgage product reported in the IT . And there was rejoicing that it somehow made houses more affordable… One of the tragedies of the boom was that not enough people were told that they could not afford to buy a house. A 40 year mortgage is a cop out from a bank. Those people should have been refused mortgages. @Michael “A perfect timepiece and a broken clock will agree twice a day. We ca both content ourselves on who is which.” Ah, but I have the correct time written on a piece of paper here in my pocket. 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