Monetary Dialogue Briefing Papers: November 2010

The latest collection of briefing papers for the European Parliament’s Monetary Dialogue with the ECB are available here (click on 30.11.2010). One set of papers (including one by me) discusses a package of proposals put forward by the European Commission involving changes to the Stability and Growth Pact. The other papers discuss the issue of so-called currency wars.

21 replies on “Monetary Dialogue Briefing Papers: November 2010”

A little off the point…

An interesting statistic was put forward by Dan O’Brien of the IT on Prime Time last night. *If my recollection is correct*, he said that EU (Eurozone?) banks had suffered losses in the order of half a trillion euros since the Lehmans collapse. He further said that debt held by Eurozone banks together with bonds issued by Peripheral Eurozone countries total with trillion euro. Dan O’Brien said that the net effect of this was that talk of default on senior debt or Eurozone banks or talk of sovereign default on Eurozone bonds could be catastrophic.

Does anybody have a view on whether Dan O’Brien’s figures are correct and whether his aggregate figure of €8tr is justifiable?


He further said that debt held by Eurozone banks together with bonds issued by Peripheral Eurozone countries total 8 trillion euros.


Dan O’Brien has a bit more about these numbers in today’s IT:

Since these are backed by claims on assets and future streams of income, the key question is the net exposure. The ECB and the other EU Grand Panjandrums reckon confronting this net exposure now will lead to meltdown. And I suppose its question to the market following yesterday’s repid performance is “Do you really want that?” I suspect the informal lines of communication to all the markets – sovs, corporate debt, money, equity, etc – are conveying the message that a lot of players in these markets will get hurt if there’s a bloodbath.

This gradualist, trading out of difficulty approach won’t offer much immediate respite to Ireland, but it should lead to more sensible and orderly managing down of the net exposure over time. And the EU only ever develops and evolves in the context of what is perceived as an existential crisi.

@Paul Hunt

If there is a likelihood of a bloodbath you get your blows in first to minimise your losses. You don’t rely on some ephemeral group pact not to cause the whole thing is collapse. That is the nature of contagion. The same psychology applies in bank runs. He who takes action first suffers the least losses.

Who holds the sov debt?
Are we that worried about all of them?
If the ECB buys sov debt at a discount, can it write down the amount of such debt to be the equivalent of the price it paid for it?
How much double counting is there between bank debt and sov debt considering banks hold sov debt?
How much restructuring/relending has there been since Lehmans?
Can we draw a temporal line in the sand. i.e. long term debt issued pre Lehman is at risk?

Whereas market stability needs to be retained, some contained restructuring would appear to be key to this effort. Deauville has made this problem immediate. The gradualists (of which I have been one) are in a bit of a pickle now.


And to think that only back at the beginning of October, the reason we weren’t restructuring senior bank debt was pari passu. European debt levels must have absolutely exploded in the past two months!

(Although Eamon Ryan had the decency to tell a certain amount of the truth at the time.)


“The gradualists (of which I have been one) are in a bit of a pickle now.”

Your candour is appreciated. The gap I describe between the EU’s politcial fantasy and the economic reality the markets perceive may be closed only by a combination of reformed institutions and mechanisms at the EU level and a managing down of this net exposure. And the former is a pre-requisite for the latter. The EU is governed by law – irrespective of how much I might decry the similarity of its making to Bismarck’s sausage-making analogy – and the management of any net exposures that remain when the EFSF is placed on a permanant footing will have to be governed by new laws and reformed institutions and mechanisms. The question is: will the markets sustain the necessary forbearance to allow this process to run its course?

I think the markets will, but only if the EU panjandrums display the necessary commitment and cohesion. As for Ireland, I fear we’ll have to sweat this out and hope that the EU moves quickly. We will benefit from a successful outcome at the EU level.


In fairness, the raison d’etre for the guarantee was contagion risk within and without the EU. It was preceded by a meeting of EU leaders which resolved to the market that systemic banks would not be let fail. The MoF told us about the issue and his conversations with Trichet at the time. The parri passu issue was not the only reason given, and indeed was never given by the Minister because otherwise he would have had to explain why he had not corrected the position with a resolution scheme.

It is not a huge extrapolation to suspect that our delays in implementing a resolution scheme were becasue the introduction of such a schemen would have signalled an intention to default on unguaranteed senior bank debt. It is interesting that “the Memo” now requires a bank resolution scheme for subbies and a general bank resolution scheme.

I worry that the ECB, as good democrats and mindful of the German Courts will be mindful to stick within their statutory mandates. Beware the “creature of statute”.

@Paul Hunt

The purpose of the EU is to force political cohesion. Let’s hope it works. It could be its finest hour.

In the meantime, I expect that the EU/ECB/IMF/USA approach to the problem will have to be to take multiple doverse actions. This has been the case to date. Things are getting more intense.

@zhou – “If there is a likelihood of a bloodbath you get your blows in first to minimise your losses.”

Yes, it will be a case of ‘devil take the hindmost.’


You may find that, in the nothern Med littoral, there is an acceptance of increased centralised EU governance, as there is a strong and growing appreciation of its benefits when it is compared to the quality of governance produced locally. Ireland has only ever measured its quality of governance in relation to a reduction in British influence and control. (Which may explain the sense of bereavement felt by many rational and sentient citizens when the Troika arrived.) Ironically, you may find the greatest resistance to increased EU governance in the northern member-states as they see themselves as well-governed already. Chancellor Merkel has, quite properly – if not very adtroitly, secured a measure of consensus on the need for burden-sharing, but she and her fellow (northern) leaders may encounter strong popular and legal opposition to the necessary institutional developments required.

It would be prudent for Ireland to behave itself while it is on the ‘naughty step’ and not do anything to prejudice the outcome of the important internal debates in these member-states.

In addition, the renewed engagement of the US is significant. It seems to be belatedly recognising that it has important national interests to protect. It may not have done enough internally to make up for its previous dereliction of its financial regulatory duty, but it is in its interests to ensure that the export of this dereliction does not come back to bite it.

@Paul Hunt:

It would be prudent for Ireland to behave itself while it is on the ‘naughty step’ and not do anything to prejudice the outcome of the important internal debates in these member-states.

I am still an ‘undecided’ as to the pros and cons of immediate default but you have certainly swung me to the anti-default side [at this writing anyhow].

An excellent case against default (hat tip: Eoin Bond) has been put by Donal Donoval in The Irish Times today at:

One important but under-discussed point DD raises on the ‘whack the bondholders’ issue:

Unfortunately details on the institutional composition of the bondholder category have not been made available publicly, probably because of data problems and confidentiality reasons. However, as pointed out by Antoin Murphy of TCD, there is reason to believe that Irish institutions, such as pension funds, represent a significant component. There is thus a clear risk that with a default operation we could end up partly shooting ourselves in the foot.

Yes, I see it coming.

But just because Brian Lenihan at some stage played the ‘widows and orphans’ card does not necessarily mean that it is false.

I don’t see why the fact that some bondholders are Irish institutions such as pension funds should make a blind bit of difference to whether Ireland defaults or not.

Well done, Donal Donovan!

But Donal’s point about Ireland not having its own currency could be expanded for those who still lean toward unilateral action on bond holders. Russia and Argentina had their own currencies and could fund their budget deficits. But this fact also allowed them to keep their banking systems afloat.

If we take unilateral action now, we risk being cut off from ECB support for the banks and we have nothing to replace this. There was already a (35 billion) run on deposits in September and this could happen again and very quickly.

As of end October, domestic Irish banks owed just 34 billion to foreign bond holders but owed 86 to the ECB and 193 to foreign depositors. Unilateral action on the first of these could jeopardize the other two.

A sense of injustice toward foreign bondholders is understandable but it is really too late to do anything (32 billion were repaid since April) and only feeds a dangerous political narrative that there is an easy way out.

Paper well argued.

But there is a difficulty with consultation and the EC. Even the UN has structures for consultation so that its various bodies and agencies can draw on expertise as needed; you could argue that there is a certain openness to consultation in ECOSOC or the UNDP, or even in the EP. The new EU lobbying guidelines are not sufficient or fit for that particular purpose. As Philip Lowe said at the Céifin conference in 2009, when the crisis broke the EC didn’t have access to relevant expertise to help them get a handle on the situation. (He also went on to say – and this conference took place in early November 2009 – that that had changed and it was all under control again.)

When you are it it up to the nostrils, with lots more being being pumped into the slurry tank, hitting the reset button is awfully attractive. Even if it blows up banks galore.


But what’s the material difference between the government overpaying for public servants and the government making whole Irish pensioners’ (direct or indirect) holdings of Irish senior bank bonds? In both cases it’s free money from the taxpayer for a special interest. Besides, if the government wants to compensate Irish pensioners for their Irish bank losses, wouldn’t it be a whole lot cheaper to do exactly that, rather than trying to make whole every bondholder? (Though we’re only being lent money to do the latter.) Similarly, if you do want to spend public money on protecting Irish pensioners (or on stimulating the economy), wouldn’t it be much better to pay a lump sum to the basic state pension instead of spending the same amount of money compensating accountants, dentists and what have you?


I am referring to late September and early October of this year, when it was announced that Anglo sub debt would be restructured. Unless my memory is deceiving me very badly, the reason given by the government as to why senior bondholders were not also being haircut was pari passu. This included Minister Lenihan in the Dáil on 30 September. If Eurozone contagion was also given as a reason anywhere, other than by Ryan, it must have been pretty sotto voce. Ryan’s admission was unusual enough that I noted it at the time. Similarly, I don’t recall a rush of media commentators to correct the government’s incomplete account of the situation.


We can probably blame Mr. Zhou for taking us off an a tangent and ignoring these papers – and, in particular, yours which goes to the heart of the Deauville accord between Chancellor Merkel and Pres. Sarkozy. The Chancellor had to concede a significant increase in Eurocratic meddling in fiscal matters – so beloved of the French – in order to ensure agreement on taking the institutional and procedural steps necessary to put some flesh on her quite proper desire to enforce some burden-sharing between bondholders and taxpayers – and to render this lawyer (and judge) -proof.

I expect – and hope – that sensible reforms along the lines Chancellor Merkel seems to desire will impose the necessary market discipline and render most of the Eurocratic meddling redundant.

Btw, should not this board be re-christened “Irish Economy – under administration”?

@Paul Hunt

Default inside the Eurozone is entirely legal right now, as far as I can see. It is the EFSF and the ECB’s heroics which violate the Lisbon treaties, and it’s the non-default parts of the ESM which would likewise require a Treaty change to be legal.

I fear that the ESM will likely make our situation worse rather than better should it ever come into force, and by no means just because it will scare bond investors in the meantime.

First, consider the likely attitudes of the member-states and ECB to restructuring in 2013. Angela Merkel probably does want bondholder loss sharing, but not yet, Lord! Not until the present financial instability has gone away somehow. So will the instability have gone away in 2013? Assume for the sake of argument that we have just over 6% nominal growth in every EU member state each year from 2011-2013 inclusive, compounding to 20% nominal growth over that period. As best I understand it, this would mean that the €8tn debt bomb suggested by Dan O’Brien will have shrunk relative to the EU economy into something equivalent to a €6.4tn debt bomb today. Given that the EU is utterly unwilling to consider detonating the €8tn debt bomb, even to attempt to do it in a controlled manner, would it make that much difference if it were only a €6.4tn bomb? Or will we all be much braver and more principled in 2013? More likely, whatever happens over the next while, as long as there’s no explosion then the conclusion which will be drawn is that extend-and-pretend should continue. If the bomb shrinks, the status quo is working! If it stays the same, then let’s wait and see some more. If it grows, then of course letting it off becomes even more unthinkable.

So now: if the EU is still adamantly against debt restructuring in 2013, how will this affect the operation of ESM? If ESM places Eurogroup sovereign debt restructuring under European law and an EU procedure for the first time, this certainly seems to make default more difficult rather than lessespecially if those who are operating the procedure want to prevent restructuring by hook or by crook. The upshot could be that default would be impossible without crashing out of the EU, not just the Euro.


I don’t disagree with your ‘extend-and-pretend’ description. This is how the EU operates until it is forced to be decisive. The problem is the variety of symptoms not only peripherals, but also other member-states such as Belgium and Italy are presenting. Ireland is at one end of the spectrum with a difficult but manageable sovereign debt problem and a devastating bank debt problem. The others have varying combinations along this spectrum. Issues of scale (Greece, Portugal and Ireland might be manageable, but Spain?) and the interests of the big member-states also complicate matters.

We have been placed at the mercy of strangers – and not much is forthcoming. Unfortunately, we have to just get on with things and demonstrate that we deserve the limited mercy on offer.


I did mean to say something about your paper. 🙂 Clearly it’s welcome if the bond market no longer prices in a European bailout when buying EU bonds. But isn’t it likely (at least in the case of Ireland) that the main cause of underpriced peripheral bonds was simply that the bond traders shared the same unwarranted optimism as everyone else? Such irrational exuberance (at least about the PIIGS – say, isn’t Germany pretty exposed to China?) won’t be returning soon, but when it does then it may not be restrained much by the perceived lack of a Eurozone safety net. That’s aside from the problem that the ESM may not actually increase the likelihood of excessive Eurozone sovereign debts being restructured and the bond markets may draw that conclusion in time.

When it comes to the monitoring of non-fiscal imbalances, I can understand that a scorecard based on weighted averages might not be useful. But I can’t see why reference values for certain non-fiscal imbalances – particularly some to do with total/external/private-sector debt/borrowing – shouldn’t be placed on at least an equal footing with the fiscal criteria. Isn’t it now clear that, say, private sector debt to GDP over 150% and rising is a more reliable indicator of certain and serious (if not always imminent) economic crisis than ≥60% sovereign debt to GDP, and yet at the same time it is an indicator that tends to be ignored by both public authorities and the markets?

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