Taking Stock

It is a day for taking stock after an extraordinary week.   On Wednesday, the Government unveiled its four-year plan for stabilising the debt ratio with about as much political acceptance as could be expected.   Yet by the end of the week the expected probability of default on sovereign debt implied by bond yields had increased, and that was despite the imminent announcement of the details of an international rescue package.    It was also a week in which those advocating sovereign default—on State guaranteed bank debt and State bonds—were advancing, while those arguing that creditworthiness could still be restored were in retreat.   I think it is worthwhile to reflect on the two broad views. 

The “restorationist” view is that there is a path through the crisis that avoids default.   This has to restore the creditworthiness of both the banks and the State.  

The banks provide the most immediate challenge given the slow motion run on wholesale deposits.   Their creditworthiness was based on a three-legged stool: adequate capital as a buffer against additional bank losses; a credible ELG guarantee on new bank borrowing; and a credible commitment by the ECB to act as lender of last resort.   The bank run continued as each leg wobbled.   The restoration strategy requires that each leg is shored up.   Banks must be “overcapitalised” relative to current regulatory requirements (i.e. adequately capitalised relative market requirements).   The State must itself regain creditworthiness to restore the credibility of the ELG.  And on the condition the Government is undertaking to do what is necessary to pursue the first two with international support, the ECB must be willing to do its job as lender of last resort. 

I have long argued that losses should be imposed on the unguaranteed creditors of insolvent or critically under-capitalised banks in the context of well-designed bank resolution legislation.   One of the main failures of policy is that a special resolution regime (SRR) is still not in place.  

Press reports suggest that the international negotiators are intent on imposing losses on senior bond holders, presumably those without an ELG guarantee.   But this will not be easy to do.  The normal series of events would be to first have the SRR in place to determine the rules, then stress test the banks to identify critical undercapitalisation, and finally to impose losses in reverse order of seniority.   Of course, losses are first imposed on equity holders.  This creates a timing problem.   If capital is injected first, then the SRR is less likely to be triggered.    And if it is subsequently triggered, the State’s capital will be wiped out.  It will be interesting to see how the EU-IMF-ECB will square this circle.  (One possibility is that capital adequacy is judged before any State injections took place, but creditors who provided funding the bank on the presumption that the capital buffer was real are protected – essentially the same creditors who provided funding based on the ELG.)   However they go about imposing burden sharing, it is important that the measures do not further undermine investor faith in stable “rules of the game”. 

For the restoration of State creditworthiness, the strategy is to demonstrate that we have the political capacity to achieve a primary budget surplus that stabilises the debt ratio, and that the strategy is economically feasible in the sense that the assumed growth rate is feasible given the austerity measures.  The four-year plan has the debt to GDP ratio stabilising at 108 percent of GDP in 2013 (counting the run down of cash balances as equivalent to an increase in debt).    While I do not think the growth projections are unreasonable, it is not hard to imagine a significantly worse outcome given the unpredictability of events.  However, even with nominal growth averaging just 2 percent – less than half of what is assumed in the plan, the debt ratio would stabilise peak at 113 percent of GDP in 2013 with an additional one percent of GDP improvement in primary surplus in 2014 (2.9 percent instead of 1.9 percent).   Moreover, if we raise the starting ratio by 10 percent of GDP to allow for larger State-financed bank losses, the debt ratio peaks at 124 percent of GDP in 2013.   While one came imagine worse outcomes easily enough, my takeaway is that that strategy is robust to some quite bad news.  

Of course, none of this will be easy, and despite our best efforts it might not be enough.  But the “defaultists” need to make the case that a near-term default on guaranteed bank debt and/or State bonds provides a better path through the crisis.   A revealed propensity to renege on obligations when the going gets tough would have a long-lasting impact on creditworthiness and on Ireland’s broader international business reputation.   I would expect that it will also make it harder to get the support of our international partners, not least the willingness of the ECB to act as lender of last resort to the banking system.   The presumption is that with sufficient defaults on senior bonds the banking system will be well capitalised.   This might be enough to get deposits flowing back into the system without an ELG guarantee and with shaky lender of last resort support; I doubt it.   Moreover, as a still-rich country despite the crisis, we shouldn’t expect international support to cover our budget deficit if we are unwilling to make reasonable sacrifices to pay our bills.   The result would be an even larger forced adjustment that envisioned under the four-year plan.    Those advocating default need to spell out more clearly how their strategy is supposed to work. 

74 thoughts on “Taking Stock”

  1. @John McHale

    ‘Those advocating default need to spell out more clearly how their strategy is supposed to work.’

    Yes. And this surely demands discussion with Iberians, Romans, and Greeks … like NOW. & pragmatism from EZ centre …

    And a mapping of the Web of Forces, and how they might react. IF default [open option], then better structured early rather than havoc later on. Citizenry is not Banking System, and latter destroying former.

  2. @John

    “the Government unveiled its four-year plan for stabilising the debt ratio” – wasn’t the plan to get the deficit ratio to 3% (the Stability and Growth Pact target) but to hell with the SGP 60% target for debt:GDP. I am still confused by our Finnish friend’s concentration on the deficit % whilst 100% ignoring the debt % and if he were serious about the latter, wouldn’t he be assisting in a restructuring/default? Why is Olli silent on this matter?

    ” A revealed propensity to renege on obligations when the going gets tough would have a long-lasting impact on creditworthiness and on Ireland’s broader international business reputation. ”

    Quite correct but wouldn’t it be the lesser of two evils to accept that the losses in the banks which in good faith we tried to cover as a nation, are so great that we have no practical choice other than to default on what was originally private sector debt anyway. Why not default now in an organised way which generates respect in our actions rather than later on when we mightn’t have the luxury of being organised?

  3. Good piece John.

    I wouldn’t argue for an early default now. We need to sort out the deficit by 2014 and get our house in order. However I think it is inevitable that we will default in 2013/14. Sometime around the time originally envisaged by Merkel.

    Firstly, I think expressing any Irish budgetary numbers in relation to GDP rather than GNP should come with a severe health warning. While it doesn’t change the time that the debt stabilizes it gives a better indication of how feasible it is for the country to service the debt.

    The debt will stabilize at somewhere around 150% of GNP. The interest on public debt alone will use up 25% of tax revenue and 7% of GNP.
    Will nominal GNP grow by more than 7% pa?

    That is under the optimistic scenario and doesn’t allow for much extra on the banking side.

    Nor does it include the amount of interest that will have to be repaid on private borrowings, from mortgages etc.
    Including this the total interest payments will be 10%+ and to me that is unsustainable.

    Default isn’t inevitable but I don’t think there is any example of a country that managed to service this level of debt while in a fixed exchange regime.
    Investors are going to have to get used to the idea that if states can no longer reduce the real amount repaid through inflation then default is the only other option.

  4. @Jagdip 

    I think the first order task that they are pursuing is to avoid a default.   The 3 percent of GDP deficit target (and associated two percent of GDP primary surplus target) is instrumental to stabilising the debt to GDP ratio, which is a necessary condition for avoiding default.  

    The original blanket guarantee was an indefensible decision, even based on information available at the time.   At best, it was a reckless rolling of the dice that the banks only faced a liquidity problem, despite the growing awareness that the house price explosion was a bubble.  The original guarantee has now expired, and any debt still locked in is fair game in my view.   Not so for the borrowing we have guaranteed under the ELG.   We have made big sacrifices so far, but to say that we can’t afford to meet our obligations will not fly.   Keeping the Croke Park agreement in place is indefensible for one.   The government should not be intimidated by groups with the capacity to organise. 

  5. Fractures are appearing everywhere, including the economics profession. There is no leadership anywhere. ‘Consensus’ is now a joke.
    “The crisis consists precisely in the fact that the old is dying and the new cannot be born; in this interregnum a great variety of morbid symptoms appear.”-Antonio Gramsci

  6. One problem is that the interest rate projections in the 4 year plan also look too optimistic given the rate on the new IMF/EU facility. Note that even the lower bound being quoted on the new loan (around 5.5 percent) is above anything assumed in the 4 year plan. So it’s really the 3 bad shocks at the same time — higher interest rates, lower growth, and (without some kind of restructuring) the upper end of bank “recapitalization” costs.

    I agree that some kind of restructuring or burden sharing does not look good given our income level (and indeed sits awkwardly with the associated “world class” guff that circulated for most of the last decade). But if, as the Minister is now repeatedly claiming “Europe asked us” to do all this stuff, a high interest rate 9 year loan from them ain’t gonna help. So we arrive at the worst option after exhausting the others.

  7. @Dreaded_Estate 

    I take your point about GNP, and recognise that you and others have made it before.   My only excuse is that I have been following the convention.   As soon as I get a chance I will run the numbers using GNP.   However, the other part of the convention is to focus on gross debt, which also is misleading in Ireland’s case given our cash reserves and the NPRF.   They amount to some 28 percent of GDP–of course more than that in terms of GNP :)–between them.

    @Frank

    You make a very important point about the interest rate. The weighted average interest rate on outstanding debt in 2014 is projected to be 4.7 percent in the plan. We will soon see if our international partners are serious about us getting through this without default. Anything much above 5 percent will seriously erode the chances of achieving a primary surplus that could stabilise the debt ratio. For now I am assuming that they are smart enough–and have come into this effort with enough goodwill–to recognise this. We will know soon enough.

  8. @DE
    ‘That is under the optimistic scenario and doesn’t allow for much extra on the banking side. ‘

    This is the bit that concerns me. As Sporthog pointed out on another thread just when you think it cannot get worse it does.

    Another factor alluded to by Simon Johnson a few days ago is the 20% of GDP accounted for by multinationals with practically no economic activity in Ireland (brass plates). What if these pull out. You can be sure they are currently examining alternatives given all the focus on corporation tax.

  9. @ Prof McHale
    I heard you say on Newstalk that taking a 99.9% government stake, as opposed to a 100% stake, made sense ‘because it keeps the government at arms length from AIB’.
    I apologise if I misheard you. But if you meant this, how seriously should I take other things that you say?

  10. “Moreover, as a still-rich country despite the crisis, we shouldn’t expect international support to cover our budget deficit if we are unwilling to make reasonable sacrifices to pay our bills. ”

    Why after all this discussion – ad nauseam – do some people still refer to bank debts as “our bills”?

    These debts are only ours becsuase of a misguided, irrational unjust and quite likely unconstitutional guarantee. Please stop referring to other peoples bills as mine. I and the rest of the citizenty did not incur them and it is time to stop implying that we did.

    The guarantee must be challenged and overturned in the courts – and only a just outcome of that challenge accepted.

  11. @J McHale
    Good point on the cash reserves and NPRF.

    However by my cals the cash reserves will be down to €14bn by year end and about €5bn by the end of March.

    The NPRF had about €25bn at end of September but with the committed money for the banks that is really €15bn. A little more for the banks and that could be quickly used up. (Not with standing there could be some double counting on future bank from the IMF/EFSF deal)

    Using the government’s base projection this is how they see the GGD/GNP ratio developing.

    2011 2012 2013 2014
    GGD % of GNP 126% 128% 130% 128%
    Interest Payments 4.3% 4.9% 5.6% 6.0%

    This is before any additional bank recaps and the rumoured higher interest rate on the IMF/EFSF funds.

  12. @AMcGrath
    On what grounds would the guarantee be unconstitutional? I can’t immediately think of an article that would apply.

  13. @simpleton 

    Do you not see any difference between the governance structures of a listed company and a 100 percent state-owned company?   I see substantial risk of politicisation at 99.9 percent ownership, or indeed any majority ownership.   But anything that would help to make it more difficult to direct the banks lending, interest rate setting, etc. is to be welcomed.  Avoiding 100 percent ownership should also make it easier to re-privatise.  

    I admit that I am assuming that the bank would be able to retain its listing at this ownership level, which I am open to correction on.   Maybe that is your point and explains the unnecessary edge in your comment.

  14. John, with the guarantee in place, the govt does not need to own a single share to control the banks. It is the perfect situation, power without responsibility

  15. 99.9% state ownership would mean the other investors hold shares worth less than €40m.

    I think the price discovery value of this listing would be very limited as the you would be taking about an extremely illiquid stock.

    Also at this level their would be very little difference between a stock placing on the market vs an IPO in terms of cost or complexity when we want to sell the stake.

  16. Prof McHale,
    Apologies for any unintended edge but those currently inside the banks can attest that they have not been able to buy a toilet roll over the last year without first asking the government’s permission who, in turn, have to refer, to officially appointed EU ‘monitors’.
    De Jure, the residual listing might speak to some degree of independence, de facto, that’s not the way it works on the front line.
    Again, theoretically it might be a bit easier to reprivatise but, in practice, it will be like an IPO. In any event, post default, there cannot be any Irish banks to privatise. In practice, nobody will lend to them – ever. let alone buy them.

  17. @John McHale

    And when NAMA gets into trouble with losses, what then? The property market has not bottomed out. The UK market took a turn for the worse in the past two months. It seemed odd that the NRP made no mention of NAMA disposing of assets. From the very start of the bubble implosion, firesales of assets were the only realistic way forward. They could have been staggered but instead they were postponed. A slew of vested interests are in total and complete denial about this and I suspect it is because there was a degree of ‘misguided thinking’ in official circles about the likelihood of these assets coming back into the hands of their original purchasers – give them time, and they’ll buy them back. Now the ‘them’ is broke and disposals are still stalled. With foreign ownership of what will be left of the banks (the government can force through any deal required to satisfy the EU and IMF) inevitable, perhaps NAMA should follow suit with its property portfolio.

  18. #Simpleton
    ‘In any event, post default, there cannot be any Irish banks to privatise. In practice, nobody will lend to them – ever. let alone buy them.’
    So what is your prediction on the announcement tomorrow?

  19. @Hogan
    ‘That depends on how much new money is put in (i.e. how many new shares are bought). No?’

    Who in their right mind would buy new bank shares after the debacle of BOI.
    25c for shares that cost 55c a few months ago. Getting wiped out once is careless but twice in the space of a few years is…..

  20. I was listening to Karl Whelan and other guest speakers taking stock and injecting a healthy dose of reality into the Labour party pre-budget forum this morning. The interesting thing is that the people attending were listening and understanding. I don’t know if Karl and the others are planning to put up their slides here but if not, they should be on the Labour party website over the next day or so. Worth having a look, especially those related to tax.

  21. @hoganmahew
    “That depends on how much new money is put in (i.e. how many new shares are bought). No?”

    I was working off the 99.9% however I think it will probably be much lower as we will do something a little odd to keep the state’s holding lower.

  22. @cet par
    What SHOULD happen is a break-up on the lines of the FDIC, who have taken over circa 200 banks so far this year. Deposits are given to a good bank, everyone else gets wiped. Oh, we don’t have a good bank. Step forward BNP. Oh, we don’t have the necessary legal framework to this (although we have been crying out for it). Emergency sitting of the Dail tomorrow to pass Resolution legislation? I don’t think so.
    So, the 50p worth of unguaranteed subbies will get burned. And the Irish taxpayer will be on the hook for the rest.
    As John McHale & others have pointed out many times, the algebra of debt dynamics mean that we could pull this off if a lot of things go right – growth in particular. But it is a knife-edge solution path (or should that be saddle point?).
    In any event, markets were not buying it as of Friday. Which won’t matter, I guess, until we return to them in 2 or 3 years time.

  23. @Simpleton
    I thought you had something more radical in mind given you post default comment.
    ‘But it is a knife-edge solution path (or should that be saddle point?)’

    We have being trying solutions that don’t work. Funny bond, promissory notes and the likes and as you point out the markets are not buying.
    So the final solution looms tomorrow?

  24. @ceteris
    Eh, the taxpayer?

    @D_E
    Well looking at AIB, suppose the state puts in 6.6 bn @ 50c a share = 13.2 bn shares
    Existing market cap is about 400 million @ 34c a share = 1.176 bn shares

    So at the end of the recap there will be 14.376 shares in issue.

    If the price stays at 34c a share (and the markets are forward looking, dontcha know 😆 ), then the 14.376 bn shares will be worth 4.888 bn. The state will make a loss of 2.1 bn, the existing shareholders will hold 8% of the company, but their stake will still be worth 400 mn.

    Until the share prices drops further, anyway.

    I don’t buy the 99.9% as a realistic state ownership. That would require the issue of 1.176 trillion shares. Even at the current market price rather than the 50c the state has already announced, that would be 399.6 bn euro… bad and all as AIB is, I’m not sure it is that bad.

    So either they recapitalise by buying shares and increase their percentage ownership or they nationalise it. I don’t see another legal mechanism, but I’m willing to be corrected!

  25. @D_E

    Just a small point on burning through the cash reserves; using the cash to fund the deficit/roll overs means that amount less gross debt is accumulating.

  26. @Cet par
    Sitting behind a Bloomberg terminal on Friday afternoon it certainly looked like lots of people thought something very radical was imminent. Because that’s what should happen – if it is to be a ‘final solution’. If it ain’t radical it certainly is not gonna be final.
    I’m just trying to clear about what should happen as opposed to what will happen.
    @David O’Donnell: it doesn’t matter who signs it, the document is the one constant in all our lives going forward. If isn’t signed, stock up on cigs, tinned goods and barbed wire.

  27. As I understand the guarantee, it effectively only protects bonds which expire next year. What proportion of total outstanding bank debt is covered by this. I cannot see any case for protecting debt not covered by guarantee. Assuming the banks are kept in existence there seems no case for protecting bonds expiring after the guarantee does. That would amount to yet another extension of a policy which was foolish in the first place.

  28. @David Blake
    No, the ELG is an up to five year guarantee from time of issue. The extensions increase the length of time in which you can issue guaranteed debt/take on guaranteed deposits.

    I’ve no idea of the durational breakdown of existing debt and deposits, but IIRC, no longer term stuff has been issued since the earlier part of this year?

  29. @Simpleton.
    Thanks.
    That is what worries me. If its not radical then it won’t be final as you say and on past performance they don’t do radical in the DoF.

  30. John’s final sentence gets to the nub of it. It’s all very well people citing the Uruguayan or even Argentinian default, but the sums involved were small and these countries were for niche investors. The sums that we need to borrow are much larger and can only be lent by mainstream institutional portfolios. These guys are ultimately accountable to trustees , and have all sorts of other issues such as career risk, reputational risk etc. They’ll want a few years after a default before they’ll want to go into a meeting having to justify buying our bonds.
    There’s only one way to get back to market and that means not only not defaulting, but getting those rates down p.d.q.
    The trouble is, there’s too much focus on the projected debt dynamics. What we need to do is to get the starting point down. We can do this by selling assets. There’s no point the family silver sitting on the sideboard when there’s no bread on the table. Sell the electricity, sell the gas, sell the bloody lot! At 9% funding, there’s no economic reason for the State to keep these holdings. Sell the 15bn foreign equities in the NPRF and use it – recapitalise the banks, whatever.
    We also need to get domestic buyers for our debt. Get these insurance companies to smell the coffee – sell their bunds and buy our bonds! If we all go down, they’re in trouble too. According to the 4yr Plan, they have “expressed interest”. Well, why wait? If it was up to me, I’d be biting their arm off – as many billions of 30-yr index-linked as they want (got to get the debt term longer by the way).
    It’s all do-able, but where’s the sense of emergency at the NTMA?

  31. @Hugh Sheehy
    Article 43 on Private property – a bit tenuous but nothing a good barrister couldn’t argue I’m sure.
    The point is that it is against natural justice to transfer debt onto the shoulders of those who didn’t incur it . ISomething so obvious should probably not need to be enshrined in the constitution.

  32. Michael Pettis, now best known as a China expert, but also author of a fantastic 2001 book on the history and theory debt crises in emerging markets* has a new post on the European debt crises. I normally wouldn’t paste a long excerpt but Pettis has actually been working in (as a trader through the 1980s and 1990s Latin American crises), studying and thinking about exactly these kinds of situations for a long time, unlike most people here, and so his views are worth quoting in full:
    http://mpettis.com/2010/11/chinese-inflation-and-european-defaults/

    “The truth is we didn’t need the denials to know what was going to happen. Everything we are seeing in Europe has a great deal of historical precedence and events are unfolding very much according to the standard script. I think it is pretty safe to make the following predictions:

    1. Greece will be forced to default and restructure its debt, and the restructuring will come with a significant amount of debt forgiveness. The idea that it can grow its way out of the current debt burden is a fantasy. Remember that when countries are in conditions of financial distress, they face systematic disinvestment and capital flight, and as a consequence are never able to grow at anywhere close to the necessary rates – especially since any growth they do manage to achieve generally comes from additional fiscal spending, which simply runs up debt further.
    2. Greece will not be the only defaulter. Spain, Portugal, Ireland, Italy, Belgium and much of Eastern Europe will also face severe financial distress and possible default. History suggests that when a country is experiencing a solvency crisis, growth comes only after debt forgiveness, and many or most of those countries will also be forced into debt forgiveness.
    3. Political radicalism in these countries will rise inexorably as a consequence of rising class conflict. As Keynes pointed out as far back as 1922, the process of adjusting the currency and debt will primarily be one of assigning the costs to different economic groups, and this is never an easy or conflict-free exercise. Of course the less stable a government becomes as a consequence of this adjustment, the more likely it is to prefer very short-term solutions.* This Sunday, by the way, Catalans are likely to vote in an election in which the “current Socialist-led coalition government in Spain’s northeastern region will fall, a slap in the face for Spain’s prime minister, José Luis Rodríguez Zapatero,”, according to an article in Wednesday’s New York Times. There will be a lot more of this sort of thing in the next few years.
    4. So why not bite the bullet and just get it over with? Because the European banking system would not survive even the best-case restructuring scenario. As a consequence we are fated to witness several years of difficult economic adjustment while everyone pretends that these countries, under the right policies, can work their way through their debt burdens. What will really be happening is that European banks will aggressively rebuild their capital bases, with the unwilling help of the poor household sector, until they are sufficiently well capitalized to begin taking the write-offs. Only then will we recognize that some countries cannot repay their debts.
    5. As an aside the European junk-bond market might take off. With banks crippled in their lending activities, Europe’s financial markets will probably go through a process much like that which the US experienced in the 1980s. American banks at that time were unable to fulfill their traditional lending function as they struggled to clean up their LDC and energy loan portfolios, leaving the way open for the likes of Drexel Burnham to create a massive junk bond market. This process will be helped to the extent that European policymakers try to avoid paying for the adjustment by liberalizing bank-lending practices.
    6. Several countries, most notably Spain, will be forced to choose between giving up sovereignty to Germany, suffering extremely high rates of unemployment for several years, or giving up the euro. They will almost certainly choose the third option. There are still a lot of people who say giving up the euro is “unimaginable”, but that just shows a weak imagination. I especially remember in 2000 Domingo Cavallo dismissing the stupidity of foreign investors who imagined Argentina might be forced to suspend payments and devalue the peso – which it did in late 2001. More recently, on April 30, Cavallo warned Greece: “Don’t even think of abandoning the euro, whether temporarily or definitively, because that will provoke a financial catastrophe in Greece and various other countries in Europe.” Now there’s some useful advice, especially when you consider the huge surge in growth and the fall in unemployment Argentina experienced after it devalued.

    This has been said before, but in a way this crisis is the European equivalence of the American Civil War. Once the dust finally settles Europe will either be a unified country with fiscal sovereignty firmly established in Berlin or Brussels, or it will be fragmented with little chance of reunion.”

    *http://www.amazon.com/Volatility-Machine-Economics-Financial-ebook/dp/B000SAYU2G/ref=kinw_dp_ke?ie=UTF8&m=AG56TWVU5XWC2

  33. @simpleton

    …. I hope for, but don’t see, radical. I hope for, but don’t see, radical at the EU level. IMF might have a propensity to radical, as pragmatic realists on interest rates and write offs/downs,; but EZ policy re Ireland appears to be to ‘quieten it quickly’, protect core bank bond holders, so that they can figure out what to do with Spain; and a slap on the wrist of the feckless celts on the interest rate gains political capital on the German conservative centre and far right. and Portugal.

    there is a distinction between ‘bail-out/loan’ and ‘rescue’ – the Irish Banking System needs either ‘rescue by others’ [as we do not appear to have the capacity, let alone inclination, to take on such obligations], or we bring it down/default before it ravages the place over the next decade. Better to rebuild with some sense of direction …

    We are a mere pawn in the maelstrom of global capitalism. Yet, a pawn can checkmate a king.

  34. @Mick Costigan
    Thanks for that, excellent piece by Mr. Pettis.

    I do believe that Spain and Ireland are in different groups. The risk in both is the banks. In the case of Spain, they have a stronger position as they have not, as far as I can see, guarantee their banking system. While some of the cajas may be world-famous in Spain, perhaps the mistake of bailout out only locally systemic banks will be avoided?

    On the government debt side, my understanding is that Spanish local governments are in a far worse debt position. Is this guaranteed by the sovereign?

    Irish sovereign debt levels are not at critical levels… so far. The slow adjustment of the deficit risks changing this, never mind taking on additional debt for the banks.

    @igsy01
    Does it make more sense, in a green hair-shirt way, for the insurance companies to buy the utilities rather than sovereign bonds? Would they be able to push through the changes to make those companies profitable at current, or lower, electricity prices?

  35. Prediction – tomorrow nights announcements will be less controversial than people expect in terms of senior debt. Watching Cheryl on Xfactor will be more rewarding.

  36. “Mr O’Connor said that it was about rescuing people at the top of the banks in France and Germany.” I have never agreed with anything Jack o Connor said before but he is right on this. We have been forced to guarantee our banks to save European banks and the humble citizen will have to shoulder this for generations. The Euro will almost certainly collapse, we will inevitably default so lets avoid three years of pain and get on with it. The Great Experiment is over – it never worked on paper in my view and now its been proven not to work in the real world

  37. “Mr O’Connor said that it was about rescuing people at the top of the banks in France and Germany.” I have never agreed with anything Jack o Connor said before but he is right on this. We have been forced to guarantee our banks to save European banks and the humble citizen will have to shoulder this for generations. The Euro will almost certainly collapse, we will inevitably default so lets avoid three years of pain and get on with it. The Great Experiment is over – it never worked on paper in my view and now its been proven not to work in the real world

  38. @Author
    re You comments above about the ” restorationist” view.
    “Their creditworthiness was based on a three-legged stool: adequate capital as a buffer against additional bank losses; a credible ELG guarantee on new bank borrowing; and a credible commitment by the ECB to act as lender of last resort.
    The restoration strategy requires that each leg is shored up. ”

    Shoring up two of the legs in the stool involves the Irish State once again committing Irish citizens (tax exiles exempted) to more non State (bank) debts.
    It would be insanity to incur more non-State debts right now. Particularly so as the third leg of the stool is now holding the other two legs (the State) to ransom. The ECB is doing this in two ways. Firstly by its threat to cease providing liquidity funding which at a stroke will wipe out any extra funds provided by the State as the banks will immediately fail. Secondly by the threat of a punitive bailout interest rate.

    The Irish State should now go it alone.
    1. Withdraw from the euro.
    2. Set new currency at 30% devaluation
    3. Full 100% default of all bank bonds. I would not be in the least concerned about nice legal matters here.
    4. Committment to pay all originating State debts in full.
    How dare a group of financiers or administrators attempt to enslave the children of the nation by foisting further non-State debts on them.

    They cannot be paid
    They should not be paid.
    They will not be paid.

  39. I am still unclear on who we would be defaulting if we haircut bank debt. While bank debt is both eligible for repo and has a small haircut and small risk weighting for capital purposes, the lists of bondholders that have been published so far all seem to be investment funds.

    Mr. Lenihan has repeatedly told us that we would be defaulting on widows, orphans, invalids (and presumably the Church, given its fondness for bank investment). Now worthy and all as these investors are, they are hardly going to collapse the European financial system if they take losses.

    On the other hand, we know that the Green shirt was pulled on for ELG bonds. Did this start earlier than the current crisis? Could the unsecured bondholders be systemic because a large chunk of them is the other Irish banks? Did they balloon their repo’able assets (and artificially reduce their funding costs) and artificially increase their lending capability by selling cheap bonds to each other?

    It shouldn’t surprise us if that was the case. After all, that’s what the Japanese banks did…

  40. Is anyone talking to the Euro bank for reconstruction and development about some money for a stimulus package that might help the growth situation after 10 consecutive quarters of contraction , noting that the 14.9 bn already adjusted hasn’t brought any growth and the next 15bn probably won’t either.

    It is hard not to conclude that as much of the economic growth in the 5 years pre 2007 was illusory so too are the values on the asset side of most Euro banks.

  41. hogan,

    One of the largest German insurers has 40bn in shareholders equity. It owns 32bn or so in (senior & sub) bank debt allegedly. Some of it might be longer dated. Some of that is Irish but more of it is Spanish. I would say it is quite concerned this week end about possible contagion form Ireland.

    simpleton,

    last week HSBC was supposed to be the white knight bet it demurred. I cannot see BNP stepping forward. BTW, you do not need bank resolution to accomplish what you suggest. The Belgian govt called in BNP to carry out its own stress test of Fortis. It gave the Belgian govt a figure that it was prepared to pay.
    I cannot see any buyers of Irish banks emerge given the regulatory uncertainty. Would you put any money on the table if you thought the regulator was as capricious as he seems to be. Capital requrements are being made up on the hoof, bond holders are to be burned/not burned.

  42. When the Irish gov’t made the announcement (Fall 2008) that it was backstopping Irish banks half of Europe was speechless from laughing and the other half was speechless because their teeth were chattering in fear. Ireland far from being forced to backstop Irish banks went ahead and made the stupidest unilateral financial move ever made by a Sovereign gov’t. Every central bank in Europe was now forced to make a similar declaration when a run on their bank was rumoured. The tail wagging the dog made a lot of EU decision makers angry. Now that it is evident that the Irish Gov’t did not exercise due diligence, just blindly sleep walked off the cliff the EU decision makers are livid.
    We will hear a lot of the EU, IMF, Sarkozy and Merkel made us do this that and the other thing. Just remember that our gov’t made the rope, put it around their neck, supplied the ladder, climbed up and jumped off of their own volition.

  43. @tull
    And so it should be. Are insurers the dumbest guys in the room?

    Still, even assuming all their bank debt is burned by 30%, they still have loads…

    If the Irish banks were sold to foreign chappies, they’d be regulated by the foreign chappie’s regulator, n’est-ce-pas? If we no longer had a banking sector, we would no longer have capital requirements for anything… nor moratoriums…

  44. I’m not sure what leaving the euro is going to gain us, when every mortgage coined since late 2001 is denominated in euro. If we devalue/float our own currency/etc etc, those mortgages will still have to be paid, and paid in euro, making debt even worse for house-holders. Are we proposing to forgive that debt? On what grounds could we retroactively recast those contracts _not_ to refer to euros? (I don’t think we can.)

    Massive capital flight will also result, making what has already been lost in the recent travails look like a gentle jog.

  45. @Mickey Hickey
    re Just remember that our gov’t made the rope, put it around their neck, supplied the ladder, climbed up and jumped off of their own volition.

    Our neck. Not their neck.

  46. @Niall
    The gov’t simply declares that The Euro is now valued at choosing, any number that is likely to reassure the public e.g. 3 Punt = 1 Euro. Voila all your bank deposits chqg, saving are now multiplied by 3 and preceded by P. Similarly for mortgages and other forms of debt. Banks close for 72 hours to give them time to stock notes and make computer changes. The Gardai and the army will be evident at every bank branch. The Punt will trade with other foreign currencies either over or under the counter and will probably go to 5P= 1 Euro within a few months. Eireann go Bragh thanks to our clever gov’t becomes competitive in a few months. Import prices will soar trips to Algarve, Canary Islands will be expensive, Ballybunion here we come. Keep an eye on the politicians, are they flying to Basel, Cayman Islands or other tax shelters.

  47. @Mickey Hickey
    All the government has to do is issue its salaries and all welfare payments in the new currency. Everything else can still continue with the euro. We’ll be dual currency. The new currency will soon find its new level…

  48. @Mickey Hickey

    I’m sorry, but I can’t see this as being practical. The second the government announces they’re going to do this, I’d move all my euro deposits elsewhere, and I wouldn’t be the only one. The resulting massive deposit flight will kill the banks more surely than any bond market rate. Such an action would also effectively triple to quintuple mortgage householder’s debts at a time when, to put it mildly, the overall financial situation will not be strong.

    You also say “Similarly for mortgages and other forms of debt”. My information is that you actually cannot do this. The contract is specified in euro. It is not possible to retroactively change that. So either the householders must default on the euro mortgage and sign a new one (incredibly problematic), or they will deprive the bank of the very cashflow it needs to recover.

    @hoganmahew

    That will represent, as per the guesstimates above, an effective 66 to 80% pay-cut for govt employees, while allowing private sector employees paid in euros to retain their current compensation level. Leaving aside the important question of actively creating a two-tier society, how are the govt employees going to afford to eat? Or pay their euro-denominated mortgages?

    Be sensible, folks. This can’t fly, as you’ve currently proposed it.

  49. We can’t get a rate lower than Greece, I would have thought. Therefore we are in for many years of pain and a probable sovereign default or a rescue. The government have been utterly dishonest throughout this crisis and the country has allowed them to get away with it, right up to the end.

  50. @Mick Costigan

    I don’t yet understand M Pettis’ point no. 5:

    “5. As an aside the European junk-bond market might take off. With banks crippled in their lending activities, Europe’s financial markets will probably go through a process much like that which the US experienced in the 1980s. American banks at that time were unable to fulfill their traditional lending function as they struggled to clean up their LDC and energy loan portfolios, leaving the way open for the likes of Drexel Burnham to create a massive junk bond market. This process will be helped to the extent that European policymakers try to avoid paying for the adjustment by liberalizing bank-lending practices.”

    Massive junk bond market of sovereign bonds? bank bonds? both?
    Who would benefit from an active European junk bond market?
    What would the impact be here, do you think?

    Can you help translate “This process will be helped to the extent that European policymakers try to avoid paying for the adjustment by liberalizing bank-lending practices.” (can’t figure out if “helping the process” is a good idea or not, from his point of view)

  51. @Niall

    There will be no prior notice. The day before they do it six cabinet ministers will deny vehemently that the currency will be depreciated. An announcement will be made at midnight that all banks will be closed immediately for 72 hours along with the details of the changes. To lend credibility to a currency it is necessary for the Gov’t and all its agencies to accept the currency in payment for taxes, goods or services. Legal tender would be the new Irish Punt not the Euro, US$ or British Pound. I have seen these things first hand complete with mobs in the street and the money in my pocket now worth 20% of what it was worth the day before. The probability that Ireland will abandon the Euro is quite low. If you see mobs in the streets, police and army guarding banks and gov’t buildings along with politicians coming and going from work in helicopters then the chances of it happening increase enormously. Ireland is a “sovereign” state and its gov’t can get away with murder in the same way as the US, Britain or any banana republic.

  52. According to a Moody’s report, past defaulters had high foreign currency exposure, an average of 76% of total debt was in foreign currency in the year prior to default, and high debt servicing costs.

    The 20 sovereign defaults since 1997 were Mongolia, Venezuela, Russia, Ukraine, Pakistan, Ecuador (twice), Turkey, Ivory Coast, Argentina, Moldova, Paraguay, Uruguay, Domenica, Cameroon, Grenada, Dominican Republic, Belize, Seychelles and Jamaica.

    http://www.finfacts.ie/irishfinancenews/article_1020921.shtml

    @ Mick Costigan

    Greece will not be the only defaulter. Spain, Portugal, Ireland, Italy, Belgium and much of Eastern Europe will also face severe financial distress and possible default.

    Mick, this is a bit alarmist.

    Countries trade most with their neighbours and Germany’s surging growth is benefiting several Eastern European countries.

    Ditto for Italy — Germany is its biggest export market.

    It should also be kept in mind that while Italy has high public debt, Italians are among Europe’s best savers. The banks are in good shape and personal debt is not a problem.

    The majority of Spanish debt is held domestically and overseas investors hold about about 52% of Italian debt.

    Ireland, Greece and Portugal has funded most of its debt overseas and this makes them particularly vulnerable.

    @ Simon O’Sullivan

    We have been forced to guarantee our banks to save European banks..The Euro will almost certainly collapse, we will inevitably default so lets avoid three years of pain and get on with it.

    We weren’t forced to guarantee European banks.

    Fact: The Eurozone has 16 members and Ireland was the only one to guarantee bank debt, which it did without any consultations with other members. In early Oct 2008, German Chancellor Angela Merkel called on EU countries not to take steps at home that could cause problems for other member states.

    @ Joseph Ryan

    The Irish State should now go it alone.

    So leave the EU as well, as any citizen has the right to appeal to the EU Court of Justice to uphold a contract based on the euro?

    Then turn to the IMF alone to provide a bailout?

    The problem there is that the likes of US, European and Chinese taxpayers would have to fund it.

    There is also the smallish detail that foreign companies are responsible for 91% of irish tardeable exports; as for our leading Irish companies like CRH and Ryanair, they would surely move elsewhere and finally, the majority of deposits in the banks are owned by foreign residents.

  53. Guys – I understand that y’all live on an island but someone needs to keep it real.  There are an enormous number of complexities that complicate your situatuon. But as an international investor who believes in Irelands potential, let me give a few observations that need to be heard: 1) ireland is not Argentina.  Argentina has copper, agriculture as exports.  Ireland has a low tax rate.  If Ireland wants to default like Argentina, we better hope that Pfizer sells a lot of generic drugs. Otherwise Ireland will be out of the debt mkts until our kids are running the desks; 2) Frau Merkel is playing everyone – call a spade a spade.  She wants a competitive exchange rate to boost german exports. She is singularly focused on Germany and has zero perspective of the persons that fund her eurozone adventure.  3) impairing sr bondholders will end in travesty.  US and Asia investors fund your standard of living.  I do believe that individual company defaults are subject to Wall Street lack of institutional memory but everyone I know has spent the last month getting smart on Mexico 1994, Asian tigers and Eastern Europe of 2008. Systematically impairing irish bondholders will lead contagion to Spain.  Spain will lead to Italy which will lead to the UK and France.  Everyone can find their own conclusion.  The reality is that you guys all drunk the kool aid now its time to step up and honor the commitments that you made to the rest of the world

  54. It won’t be 6.7% this is just the normal spin to make the actual figure look better. Phew what a relief etc. I can’t see seniors getting any excessive treatment either. They just have too much power for yokels like our Brian to cope with.

  55. @BEB

    Agree. You only restructure (not default) from a position of (relative) market calm. That’s why the EU want to push things out to 2013

  56. I know I’m coming late to this party, but I agree with Mr. Eoin Bond – and with Danny Haskins; the Troika and the Government will huff and puff and labour – and produce a mouse. The problem is that many ordinary voters – irrespective of whether they voted for these inept, successive governments or against – who (a) believe they have not gained significantly from the bubble, (b) went about their business as decent, law-abiding citizens, (c) observe most of those who contributed to, or were a party to, this debacle retaining their positions of power, profit and prestige and (d) sense to some extent that they have been isolated from the political and economic decision-making process will refuse to accept the fiscal burden that will be imposed by whatever the Government and Troika concoct this evening.

  57. Oh, and they will probably dress it up as an ‘overdraft facility’ that we ‘probably won’t draw down on.’ Hahahahahaha.

    No doubt Lenihan and Cowen will use the word ‘firepower’ quite a lot today.

  58. @Paul Hunt

    Does it matter what the voters want though? It seems most likely that FG and Labour will play to voter anger by complaining loudly about our situation and the harshness of the EFSF package, but won’t actually dare anything to seriously upset the EU or IMF. Of course in the longer term this will just feed the SF monster, but the last few years have reminded us powerfully that like jellyfish, all politicians do is squirm away from the most immediate painful stimulus.

  59. Global financial assets equal around USD 200 trillion. What is the Irish share ? Outsiders are going to be looking at this if there is default of any kind.

    Total domestic bank debt is around E770 bn. How about thinking the unthinkable and asking some of the most cherished and richest citizens to chip in ? U2 apparently are worth E525m. Suds must be worth a couple of tens of millions . A national elite solidarity bond with collection services provided by Sinn Fein. Give a little, lads. It would help a lot.

  60. Give a little, lads. It would help a lot.

    Maybe Bertie can be brought in to organise the “dig-out”?

    Added special bonus: allegedly an expert at doing without a bank account, so we can store the money safely in st. Luke’s (well away from the den of thieves that is our financial sector) without worry.

  61. @Real Us
    re “The reality is that you guys all drunk the kool aid now its time to step up and honor the commitments that you made to the rest of the world.”

    Just like the US honoured Lehmans?
    Ireland should honour State originated debt, nothing else. Politeness prevents me from expressing my opinion in more earthy language.

    @Michael Hennigan.
    re: “So leave the EU as well, as any citizen has the right to appeal to the EU Court of Justice to uphold a contract based on the euro?”

    I did not propose leaving the EU. Show me the contract signed by the State with the senior bondholders. The guarantees given by the State were given based on lies-I think false representation is sufficient grounds to invalidate any contract.
    Does Ireland have to borrow to survive? That is the key question. The alternative to borrowing is massive and immediate cutbacks starting at the top to balance a budget within 12 months. It can be done and is preferable to what is being proposed.
    I now hear that the ECB want to take the NPFR plus semi-states as collateral.
    This is the same ECB that oversaw the Irish banks activities as they went on massive worldwide borrowing binge and increased their loan book by over 100% in a few years. Was their anybody in the ECB that understood banking?
    How about suing the ECB for the whole bank mess on the grounds that they were massively negligent in the job. There are good prima facie grounds for such action.
    And if necessary, yes, leave the EU.

  62. @ NoGuru
    “I don’t yet understand M Pettis’ point no. 5: [about junk bond market potential”

    In the 1980s, as U.S. banks struggled – the larger ones to manage their credit problems in Latin America, and the smaller ones with the effects of recession, inflation and then real estate bubbles and their bursting – the creditors that these banks would normally lend to were denied access to credit. The high-yield or junk bond market emerged to give these borrowers access to bond issuance as a credit-raising mechanism. It was driven to a large extent by Michael Milken and the West Coast financial geniuses at DLJ.

    Pettis thinks that in the next few years as sovereign default challenges existing European financial markets and banks, a new junk bond market could emerge outside the existing system. Or maybe he doesn’t really think this could happen because he points out what will likely happen instead: “This process will be helped to the extent that European policymakers try to avoid paying for the adjustment by liberalizing bank-lending practices.”

    @ Michael Hennigan – Finfacts
    “Mick, this is a bit alarmist.”

    I would ordinarily agree but Pettis has my maximum respect on these issues. I strongly advise reading his book on emerging market crises. He understands contagion. I believe that, like Simon Johnson, his prediction that our sovereign crises will increasingly resemble the dynamics of emerging market crises is insightful and true. Ask yourself how your response would have read if if you had substituted Italy, Germany, Spain, Ireland, Greece and Portugal for South Korea, Singapore, Hong Kong, Indonesia, Thailand and Japan. That’s what happened in 1997/ 98. Read Andrew Sheng’s From Asian to Global Financial Crisis:
    For US: http://www.amazon.com/Asian-Global-Financial-Crisis-International/dp/0521134153/ref=sr_1_1?ie=UTF8&s=books&qid=1243571578&sr=8-1

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