Putting brakes on default bandwagon

I draw on arguments from some recent blog posts on the default question in a piece for today’s Irish Independent.

70 thoughts on “Putting brakes on default bandwagon”

  1. Thanks for your lucid exposition of the optimistic perspective — and for putting paid to the myth about a ‘bright line’ between guaranteed bank debts and the debts of the State itself.

    My two cents:

    Three possible grounds for non-default:

    1. Don’t default unilaterally because we might be able to recover, given economic growth. (JMC optimistic)
    2. Don’t default unilaterally because the reputational damage will do greater harm in the long run than if we wait for ‘default to come to us’ — e.g. as part of a negotiated multi-country rescue plan. (JMC pessimistic)
    3. Don’t default unilaterally because we are so indebted that incurring extra debt can’t make things worse (i.e. we’ve reached our repayment limits already). (CG ultrapessimistic)

    So I see only one alternative:
    Threaten to default unilaterally in the expectation that the leading Eurozone countries will grant better conditions for fear of the disastrous consequences of such a ‘Kamikaze’ action.

    At any rate those advocating the ‘default now’ option should spell out just how the pain incurred is likely to compare with that resulting from the current austerity programme. As John McHale points out :“We saw on Tuesday what a €6bn one-year adjustment looks like; most of us would not like to see a €19bn version.”

    That really is the crux of the matter.

  2. Good to see the argument against default (and euro exit) put forward. We are not Iceland! (or Argentina or Russia). I think there’s plenty we can do to get our own house in order (public sector reform and wage cuts at higher levels – political reform – partial list system – local government reform – larger local authority areas and much more).

  3. Nice article but I think you miss an important point. It would cause serious immediate problems in the domestic economy if we default on the bank debt unilaterally without our own central bank to provide liquidity to the banking system. (It seems logical that the ECB would discontinue liquidity support if we took unilateral action.) Any unilateral action, without our own currency, is likely to lead to a repeat of Bank of Ireland from last week only this time for real.

    Nonethelss, the EU/IMF terms r.e. burden sharing are unfair and a sovereign default would be even messier. There is no easy solution.

  4. John,

    Nice piece, it’s provides a bit of balance to the arguments we have seen recently advocating a unilateral default. I think maintaining the political consensus (of the main parties anyway) in relation to non-default is of the utmost importance.

  5. @John McHale

    You state

    ‘ The new funding (ELG) was not provided to the banks based on confidence in their balance sheets, but based on a promise by the State to make good on the loans’

    You haven’t stated what the rationale for the state’s 2009 promise was. According to the official statement:

    ‘The ELG Scheme was introduced by the Minister for Finance as a measure to maintain the stability of the financial system in the State’

    The price to be paid was the risking of the financial stability of the state itself, so things had to be arranged in such a way as to give that exercise a gloss of economic respectability. AIB was left to fester, and the size of the hole in the banks’ balance sheets was delibertely unexplored. Hara kiri could not have been contemplated by a sovereign government if the relevant facts had been allowed to emerge.

    The ECB and the local vested interests made common cause, and the imperative has been to postpone recognition of losses at the major EZ banks. That effort will eventually run into the sand, at which point debt restructuring will become a respectable topic. It’s just that our options will be minimal then.

  6. John,

    I politely suggest that perhaps you are being accurate, but you are hitting the wrong target. Its not so much a question of default/no default, but one of our willingness and ablity to repay. This is where the real focus must be. We might be willing, but are we able?

    The ‘modest growth required’. I do not wish to put you or any other commentator on the spot about this, but could you guesstimate an actual value, say +X% pa for the next N years – or whatever. Even a range will do.

    Next you need to take a close look at domestic consumption, not retrospectively, but prospectively. There will surely be some decrease in aggregate domestic consumption. At best it may plateau, but I doubt that. So what would be the level of domestic consumption that we need to reach just to ‘stand still’? 50% of G*P or whatever? That’s a proportion – what’s the real value?

    The residential property market is still on life-support. Property values will keep declining – no matter what sort of financial and political chicanery is put into effect to prevent that decline. My guesstimate for the ‘bottom’ is values that pertained in early 1990s.

    Growth: John, and others, please remember that aggregate economic expansion is joined at the hip to energy costs. Energy costs are slowly, inexorably, silently, increasing. This means growth must slow, and if energy costs escalate sharply, we have un-growth. What will this do for our ability to repay debt – since debt, although real, grows exponentially through the miracles of compound interest and electronic spreadheets.

    The morality, equity or reputational damage of a default. As the man said, “You can’t be serious!”. Seriously. Oh! “The Rules of the Game” – now they would be …? Yes, I was afraid of that! Cheers.

    BpW

  7. @ JMcH

    Sheer common sense – we simply cannot go on a suicidal solo run. I would also like to echo Mark Hutchinson’s point that a unilateral default on bank debt could trigger a meltdown of the domestic economy.

    One quibble. You seem to imply that you agree with the growing (almost lazy) consensus that the original guarantee was a “massive” blunder. Labour in particular have latched onto this as almost gospel. They trumpet that they were the only party to reject the “massive blunder”. SF squirm and say they changed their minds soon after. FG capitulate and say they were duped. The fact is that we have learned from recent events that we would never have been allowed by the EU to default on any seniors. In practical terms no massive blunder was made.

  8. People who possibly take few risks in their lives apart from the usual ones such as choosing a partner, carreer or change of job and buying a house, can propose moves for a country that entail huge risks but they generally avoid considering the downsides and how they would be responded to.

    This includes ‘respected’ international commentators.

    Unilateral exiting from the euro and default are two such issues with huge potential consequences.

    On default, it would be useful to consider the scenarios — rather than this wishy-washy “we may be locked out of lending markets for sometime…”

    It also wouldn’t be possible to choose to go to the IMF for support if we were to tell the ECB where to get off.

  9. @ JMH

    Interesting piece
    But I dont buy the reputational damage claims, as we have already screwed up that.
    We have a reputation for incontinent regulation and an inability to govern in the states long term interests.
    If we were to debate a default, clearly and in a reasoned method expressing this debate both nationally and internationally we may improve our reputation.

    I have one question following on from this.
    Do you think that the EU/ECB has shown us respect from the conduct displayed so far?
    (follow on question might be do we deserve any….)

  10. Next down the tracks is a general rise in interest rates

    http://www.ft.com/cms/s/0/8ad7ce9a-02fa-11e0-bb1e-00144feabdc0.html#ixzz17blAk9zb

    The surge in 10-year Treasury yields above the psychological 3 per cent level this week crowns a miserable period for bond traders and investors who bet on the Federal Reserve’s second round of quantitative easing policy, or QE2, being bullish for the market.

    http://www.ft.com/cms/s/0/86a0bd42-02f9-11e0-bb1e-00144feabdc0.html#axzz17bfqkDTP

    “Eurozone bond markets face a testing run-up to Christmas amid fears the regional crisis could blow up again because of thin trading volumes that may send borrowing costs of the most vulnerable countries to new highs.

    The eurozone is expected to issue €760bn next year, according to JPMorgan, a vast amount compared with previous years. Sovereign debt issuance is also complicated by the need for the eurozone’s bail-out fund, the European financial stability facility, to raise money in the markets to go towards the Irish bail-out.”

    So another ingredient into the default pot . The whole ECB no default assurances sound to me like a fruity Texas 15 year old pledging abstinence.

  11. It might not be advisable for Ireland to go on a solo run but this issue is far bigger than Ireland now. What if Portugal defaulted? How would that change the equation?

  12. @John McHale,

    Many thanks for your efforts at trying to hold the line against these onslaughts – in particular, given the international reputation of many of those shouting ‘fire’ in the theatre. Politically, it’s easy to see how a strong populist case is emerging formed from an unholy alliance of those who, quite legitimately, say that they didn’t benefit significantly from the Tiger so why should they bear the burden and those who benefit from the deadweight costs they are imposing on the economy and wish to protect their comfortable positions. The latter are either those, or the successors of those, who thrived in the reduced circumstances of the ’50s and ’80s when those excluded from economic participation were encouraged to take a hike.

    There will have to be some restructuring of debt across the peripheral EZ – and probably within some of the core. But the timing, nature and extent of this restructuring is out of our hands and, if we were to do something unilateral, we could scupper the slow progress that is being made in this area.

    What we lack is a government with the necessary credibility and popular mandate that can speak to and for the Irish people and, more importantly, to our EU partners and their voters. There is a very simple message:

    “Irish governments and many Irish people have made serious mistakes that have brought us to this situation. We accept a measure of culpability and are prepared, reluctantly, to accept a measure of economic pain to remedy the situation. But we cannot endure the measure of economic pain that is being prescribed for the full duration of its current prescription as it runs the risk of sinking the economy under a mountain of debt and debt service. We need some relief and we would appeal to our EU partners to take the necessary steps to provide, in a co-ordinated and legally sound manner, some necessary relief. We are culpable, but not entirely culpable and there must be some sharing of this culpability – and some sharing of the burden imposed by the remedy.”

    But what chance have we of this with the current battered and inept government clinging grimly to power and still, to a considerable extent, in a state of denial about what it and its predecessors have done.

  13. @Brian

    To the extent it closed off options for proper imposition of the losses, the original guarantee was a blunder. Even if their central estimate was that it was a liquidity crisis. surely with the run up of house prices there was a non-negligible probability attached to the serious solvency problem emerging. Tail risks should be centre stage in considering any guarantee.

    However, you do raise an imporant point (one that I also raised in a paper for Kenmare conference some weeks ago): the guarantee was not a binding constraint given that the Government were unwilling to impose losses on bondholders — and until recently that applied even to junior bondholders — in any case. There are various possible reaons for protecting unguaranteed bondholders given, most of which I find unconvincing. However, one reason is hard to dismiss — that it was a quid pro quo for long-term support from the ECB. While I still doubt that this could have been the case early in the crisis, recent events have shown us the the ECB takes this source of contagion risk very seriously and is willing to play hardball. So maybe that has been the real reason for the Goverment’s puzzling stance all along.

  14. @Brian 

    To the extent it closed off options for proper imposition of the losses, the original guarantee was a blunder.   Even if their central estimate was that it was a liquidity crisis. surely with the run up of house prices there was a non-negligible probability attached to the serious solvency problem emerging.  Tail risks should be centre stage in considering any guarantee. 

    However, you do raise an important point (one that I also raised in a paper for the Kenmare conference some weeks ago): the guarantee may not have been a binding constraint given that the Government were unwilling to impose losses on bondholders — and until recently that applied even to junior bondholders — in any case.  There are various possible reasons for protecting unguaranteed bondholders given, most of which I find unconvincing.   However, one reason is hard to dismiss — that it was a quid pro quo for long-term support from the ECB.   While I still doubt that this could have been the case early in the crisis, recent events have shown us the ECB takes this source of contagion risk very seriously and is willing to play hardball.  So maybe that has been the real reason for the Government’s puzzling stance all along.

  15. @John

    “Populist”, “bandwagon”, “siren calls”, “pessimists” – tendentious at all?

    “For a country so dependent on international trade and investment, losing a reputation for dependable rules of the game could seriously under- mine Ireland’s attractiveness as a place to do business. ”

    What about a country that has gotten into such a fix that it had to call in the IMF? American venture capital giant (and former Burger King backers) TPG has withdrawn from the €120m purchase of a prime property portfolio here because of the IMF bailout (link below). You could argue that a default would be much worse, though you also argue that you might as well be hung for a sheep as a lamb.

    As one of the populist pessimists hanging on to the back of the bandwagon (or mainstream realist!), I simply feel that agreeing to a programme that will guarantee us 100%+ debt:gdp without any nice Euro regional development grants in prospect like at the end of the 1980s and with productivity already at a plateau and competitive advantages *eg corp tax rate) at risk, that the burden will be so great as to undermine society to an unacceptable extent.

    And to those who challenge you about the alternative – remember we were funded to the middle of next year, we had €15bn unallocated in the NPRF and a nice portfolio of State assets to dispose of which would have brought us to 2013 at which point we would have had a 5% deficit:gdp. In fact if our competition quangos got their acts together we might be able to perform a faster adjustment – if food, energy, communication etc fall by 25-50% then society might be able to accept a faster adjustment.

    That would still leave the banks but if we can’t carve an adequate banking system with €50bn of pre-IMF committed funding and default then frankly we deserve to conduct our transactions with barter.

    http://www.irishtimes.com/newspaper/commercialproperty/2010/1208/1224285016010.html

  16. I think you mistaken in saying those who are commenting that default is inevitable want a pre emptive default.

    I think the country needs to get its house in order first bring the deficit down to nothing, reform public sector and the tax system.

    However, after that I fail to see how the state will be able to function properly with a interest bill of €10+ and capital repayments on promissory notes of circa €4bn. Even if tax is €40bn what level of cuts will be needed to run the state on a net €25bn

  17. *FITCH DOWNGRADES IRELAND TO ‘BBB+; OUTLOOK STABLE
    *IRELAND PROFILE INCONSISTENT WITH HIGH INVESTMENT GRADE: FITCH
    *IRELAND S-T FC IDR CUT TO F2 FROM F1 BY FITCH :1167Z US

  18. Exactly DE.

    The numbers just do not add up!

    John Mchale may claim that a default will put is on the rocks but no default will send us to the ocean floor.

    All of you who say that the consiquenses of default are many and varied are missing an important point. Do the numbers.
    It is as simple as DE has outlined above. We cant take in 14 billion more than we spend and manage to run the country.

    To paraphrase Colm McCarthy

    The government hasnt run out of sympathy for senior bond holders. Its run out of money.

    The consiquenses of and of not negotiating an organised defauilt now is having an unstructured one later.

  19. @Jagdip

    I did not set out to be tendentious. But seeing those words lined up I take your point. Apologies.

    We would have burned through our financial assets fairly quickly, which by itself would have reduced creditworthiness. And there is the issue of funding the banking system. I don’t see the alternative as being that promising.

  20. @Jagdip,

    “…remember we were funded to the middle of next year, we had €15bn unallocated in the NPRF and a nice portfolio of State assets to dispose of which would have brought us to 2013 at which point we would have had a 5% deficit:gdp. In fact if our competition quangos got their acts together we might be able to perform a faster adjustment – if food, energy, communication etc fall by 25-50% then society might be able to accept a faster adjustment.”

    You are right, of course, and you could have thrown in additional swathes of the public, semi-state and private sheltered sectors. I have been banging on about this for ages – much to the annoyance of many on this board. But, politically, this was never on. Not for this government or for any conceivable government that contains a populist catch-all element or a left-of-centre element – or, even worse, both.

    It simply demonstrates how bankrupt and dysfunctional the process of political governance is when, confronted by a reputation and credibility destroying loss of sovereignty, the Government fails to deploy the resources at its disposal and to commit to removing the deadweight costs that are sapping the resilience and recovery potential of the economy. It doesn’t augur well when those who wish to protect the sectors enjoying the benefits of the deadweight costs they are imposing are making the politcial running by calling for unilateral actions in relation to bank debt default and leaving the Euro. And, hypocritically, advancing these as being in the interests of the Irish people.

    And it makes it worse when academics and commentators of some international renown are playing the role of ‘useful idiots’.

  21. Thank you for this and other reasoned contributions. Your posts are a welcome corrective to the folly and self-indulgence that currently dominate our public discourse.

  22. Is there any merit to considering buying back state debt on the secondary market? If a bond with a nominal yield of 4% is being sold to give an effective yield of 9% then isn’t that a substantial discount in the price of the bond?

    Also, if the ECB has bought bonds at a substantial discount, then could it negotiate with the relevant issuing state to sell the bonds to that state for the amount the ECB paid for it?

  23. @Zhou,

    I would be surprised if options along these lines are not being considered here and in the power centres of the EU. It seems we can only speculate. But I expect that the apparent willingness of Irish politicians and voters to tolerate, though not, understandably, entirely uncomplainingly, the harsh medicine being applied is not being unnoticed in the EU’s capitals. But it may be that more thorough-going reform of the non-traded sectors will have to be initiated (including semi-state privatisations) before core EU politicians will feel able to tell their voters that Ireland is doing everything in its power to resolve the current problems, but that it needs some help from them – or else it will face economic ruin which would not be in their interests.

    @Eoin,

    Market toe-dabbling by the NTMA postponed a bit?

  24. @ Zhou

    but where does the liquidity come from?

    If the ECB would promise to keep the liquidity tap running, this is EXACTLY what the Irish banks (or even the NTMA itself) should be doing. Buy an Irish 2016 at 7.15%, repo it at 1%, and pick up the 6% carry. You could do a good bit of the bank recapping via this route alone.

    But we now know that the ECB is not happy with this sort of idea.

    Interestingly, the Tremonti/Juncker piece in the FT on Eurobonds suggested that Eurobonds could be swapped for existing national debt at current market price, ie exchange at discount, crystalising the loss for the original holder. Question remains over who gets the ‘profit’ though.

  25. @Jagdip Singh
    If we were to take the money recently loaned and then to default on some portion of the previously loaned or guaranteed money, what’s to stop us ending up in a situation like Argentina?

    10 years on they’re getting sued in NY Courts.

    http://online.wsj.com/article/BT-CO-20100923-713465.html

    I can imagine a judge in a similar Irish case saying that the guarantee could not be overturned because (and now I paraphrase the NY Judge);

    “the guarantee achieved its intended goal of providing Ireland with access to capital despite impediments presented by its troubled financial sector and investors’ wariness of purchasing its debt.”

  26. @ Bond. Eoin Bond

    “*FITCH DOWNGRADES IRELAND TO ‘BBB+; OUTLOOK STABLE”

    That will be STABLE , DOOR, HORSE, BOLTED

  27. @Paul Hunt:

    …you could have thrown in additional swathes of the public, semi-state and private sheltered sectors. I have been banging on about this for ages …

    Keep banging, Paul — I don’t think the point can be made often enough.

  28. @John

    “I don’t see the alternative as being that promising.”

    Fair enough though setting out a proper alternative would require more than a comment! And presumably it goes without saying that any alternative is going to involve pain and in the end it will be about choosing the lesser of two (or more) evils.

    But what I would say isn’t subjective is that neither you nor I has sufficient information to adopt firm positions. We don’t have the BoI restructuring plan approved by EU on 15th July still not published or the secret IMF/EU side letter. Whilst we might have the Regulator arguing that further bank losses will be modest, I make the observation that there still hasn’t been a granular examination of non-NAMA loans and the recent history of predictions of losses from Messrs Elderfield and Honohan has’t been great (Patrick’s estimate of funding required for INBS doubled from mid August in Beijing to the end of September 2010). We also don’t know the identity and positions of the lenders to our banks.

    So you may be right and the present course is the best of a bad lot. I instinctively disagree and think there is a better path. But surely we can both agree that by being deprived of information (yes acknowledging alarm and market sensitivities comes into it), it is impossible to own the solution.

  29. @Hugh Sheehy

    @If we were to take the money recently loaned and then to default on some portion of the previously loaned or guaranteed money, what’s to stop us ending up in a situation like Argentina?

    Nice. My only tentative defence for Ireland’s continuing to borrow is that the country is already in an Argentina-like situation, and that perhaps we might as well be hanged for a sheep as for a lamb.

    Incidentally, I reckon the mantra “Ireland isn’t Argentina” is likely to become quite a hit in the coming months (remember: Ireland isn’t Greece, etc.). So it might be worth while actually examining the similiarities between the two countries that do exist.

    The Argentine public sector:

    Furthermore, contributing to the fiscal deficit and lack of export competitiveness were rigidities in the Argentine labor market. During the late 1990s, public sector employment accounted for 12.5% of the labor force. Both the existence of these jobs and the level of wages were guaranteed by strong organized labor unions and political cronyism. As the economy fell into recession, unemployment rose as labor was released from the private sector, but federal jobs were maintained with wages nearly 45% higher than the private sector. Not only did the federal payroll prove to be a burden on the economy, but wage rigidity prevented prices from falling, maintaining the real exchange rate at high levels and reducing export competitiveness.

    http://www.scribd.com/doc/17188880/Argentine-Debt-Crisis-and-Devaluation

    Think the Croke Park deal.

  30. @Jagdip 

    I agree with what you are saying, and absolutely acknowledge the uncertainties involved.  I suppose I am reacting to what I see as inadequately justified momentum towards very negative conclusions.   Based on the information we have, I sense the pessimism is being overdone on growth, the bank losses (though I acknowledge your important empirical contribution here), and our political capacity to produce the necessary adjustment.   Maybe it is that I instinctively believe in mean reversion — things are rarely as good as they seem when they are going well; or as bad as they seem when the recent trend is adverse.

  31. A Carolus

    Indeed. And think this, courtesy of CSO

    The long-term unemployment rate now stands at 6.5% compared with 3.2% in the third quarter of 2009 and 1.7% in the third quarter of 2008.

    As of Q3 2010, long-term unemployment accounted for almost 47.0% of total unemployment compared with 25.5% a year earlier. Long-term unemployment constitutes a larger proportion of total unemployment among males than females (52.5% compared with 35.6%).

    It’s BBBloody worrying to say the least.

  32. Good try at explaining some of the issues. I’m not sure however, if the ordinary punter, reading this article, gets a flavour of the real choices ahead of the next government. Reprofiling of debt is not a black and white issue, and it is not always clear in this article what kind of debt is being talking about (non gteed bank debt barely get a look-in here), although you go to some trouble to explain, correctly, that ELG debt sinks or swims with government debt. The bottom line for me has always been, and remains, that any measures that alleviate the prospective burden of debt on the taxpayer from banking sector liabilities (non gteed ones) would be very much supported by holders of government debt in time.

  33. @John McHale.

    Well argued. However:

    IMHO we need to fully explore the possibility (and itś consequences) of either defaulting or exiting the Euro. As a political scientist I fully agree that “we are all economists now” but as a nation we also have to live in the world of “RealPolitik”.

    One possibility would be a policy decision committing the state to a referendum on Euro Zone membership in June 2014 coinciding with EP and local elections. By which time the fate of the Euro will be very clear anyway and the controversial Croke Park agreement will no longer exist thus enabling further public spending cuts or devaluation if necessary.

    By committing to a referendum it will enable the state to use the political clout of being able to (in the words of the first commentator) “threaten” to default or exit the Euro. We may be one of the most vulnerable economies right now but we are also the longest continuous democracy in the EZ with a record of holding referendums on European issues.

  34. @Ciaran O’Hagan

    The counter-argument being made to your point (“that any measures that alleviate the prospective burden of debt on the taxpayer from banking sector liabilities (non gteed ones) would be very much supported by holders of government debt in time ) is that any moves to restructure unguaranteed senior debt may cause contagion and that this could be fatal to the Eurozone, and therefore to Ireland, in the contaxt of circa €8 trillion outstanding senior bank debts combined with sovereign debt of peripherals.

    This point is made by Dan O’Brien:
    http://www.irishtimes.com/newspaper/opinion/2010/1203/1224284678673.html

    What do you make of the argument that we shouldn’t non-gteed senior bank creditors while they are holding an €8 trillion baby/bomb in their arms?

  35. @Eoin

    There is no liquidity without ECB support. At the same time, discounted buy-backs seem to be a legally straight-forward and market-friendly measure.

  36. @Ciaran O’Hagan,

    “The bottom line for me has always been, and remains, that any measures that alleviate the prospective burden of debt on the taxpayer from banking sector liabilities (non gteed ones) would be very much supported by holders of government debt in time.”

    I expect you must be getting weary of stating the obvious, but it seems brain surgery is required to get this into the heads of some people. The converse, of course, is equally true, if the quantum of bank sector liabilities on the taxpayer is uncertain, sovereign bond investors will not advance any more money to the sovereign. We are now getting closer to identifying what the prospective burden of bank debt on the tax[ayer will be – and the Troika deal should provide sufficient firepower to deal with what emerges. The next step is a general recognition in the other EZ capitals that imposing the full bank-related burden on Irish taxpayers in addition to the necessary fiscal adjustment will either bury the Irish economy or, if it barely survives, prevent it from re-entering the sovereign bond market for a very long time.

    The final step is convincing core EZ voters that they may need to provide some fiscal support to some of their dodgy banks to write down their holding of Irish bank debt in an orderly manner.

  37. @John McHale,

    You’re right to highlight that a sovereign default is dangerous. At this point reneging on sovereign guarantees is of limited value. (Though the threat of reneging may have been of some value in negotiating with our EU partners on the bail-out. Having the same people that introduced the guarantee represent us in these talks was a mistake.)

    However, I think you unfairly present the view of those calling for default. I don’t believe these commentators are looking for an easy option. It’s more likely that they’ve looked at the numbers and decided Ireland will not be able to pay its debts. If this is so, then all they are saying is to default sooner is the preferable option.

    Ireland’s biggest problem is the aggregate public and private sector debt is too high. As it will continue to grow under the EU/IMF package, it’s still going in the wrong direction. I’m quite worried that Ireland will be forced to take even larger debts than necessary. This relates to the ‘contingent capital’ and the ECB’s desire to reduce it’s exposure to Irish bank debt. If Irish banks are forced to sell loans at steep discounts to foreign investors, the ‘contingent capital won’t last long. Alternatively, if the ECB is happy to retain Irish debt as long as there’s a large loss buffer; it will be less (/but still) expensive.

    I’m not sure if there is much value in the Delay and Pray strategy. The projected level of austerity will still leave us with a significant budget deficit in 2014. To me, that isn’t a solution. There are more downside than upside risks over the next three years. I don’t see the point in heading off down a road to nowhere.

  38. The government has announced that it will ask the Dáil to approve the MoU on Wednesday, so there will be more heat and perhaps some light emanating from this debate in the coming days.

  39. @Joe
    At last -democracy.

    @Brian Woods

    ‘The fact is that we have learned from recent events that we would never have been allowed by the EU to default on any seniors.’

    The report today on the conference call with investors and EU officials makes it clear that any incoming government will not be allowed default on senior bank debt. It follows that we will not be allowed default on sovereign debt.
    So we have no options until the EU organises a mechanism for restructering.
    Interestingly, a BBC report has it that Gordon Brown expects a major Euro event early in the new year.

    We are simply not going to be allowed unilaterally solve our problems.

  40. @JMcH

    “On the banking losses, the pessimists have recently been in the ascendancy, with seemingly ever-escalating estimates of the likely losses. Time will tell whether the resilience view of Elderfield/Honohan or the mass impairment view of their critics is correct.”

    One problem with the Elderfield/Honohan view is that, given the dire situation, it is kinda their job to paint a rosy picture, or at least to stress the potential upsides.

    With respect to analysts, (perhaps from places like GS), who predict levels of default that are manageable, a concern might be that although these people appear plausible they got it so so wrong during the early stage of the crisis in relation to Irish bank losses that it is difficult to put much faith in what they say now. Some analysts (and evidently Sean Quinn, our leading businessman) predicted that Anglo’s equity was worth something. The Equity!. Sure losses at the bank destroyed the equity four times over! It was one of the most insolvent banks ever!

    I would be concerned that they are using some sort of model to predict losses and that that model is using or is based on historical data that doesn’t really tell us anything useful about the current situation.

    Now people are being asked to believe GS et al and Honohan/Elderfield et al just like last time they were asked to believe GS et al and Lenihan/Neary et al.

    Until we have it explained to us, in some detail, why they were so so wrong the last time, it is difficult to be any way sure that they are not making the same mistakes again

  41. @Christy
    ‘I would be concerned that they are using some sort of model to predict losses and that that model is using or is based on historical data that doesn’t really tell us anything useful about the current situation.’

    from the article in Spiegel posted by Peter above-

    ‘The size of the EU/IMF bailout was calculated on the basis that the banks could bear a default of up to 10 percent on all mortgages. This super-stress scenario would cost around €15 billion, according to the Irish financial regulators. The rescue package would suffice for that.

    However, the high interest rates mean that Ireland has no prospect of paying back the loan. There remains only the hope that the government won’t have to avail of all the funds. But no expert believes that this will be possible — after all, the Irish banks have repeatedly sought fresh capital over recent months. ‘

    No prospect says it all.

  42. @Ahura Mazda

    ” However,I think you unfairly present the view of those calling for default. I don´t believe these commentators are looking for an easy option.”

    I have definitely noticed in recent weeks that such “calls” have become less populist and more sobering. My instinct is telling me that Ireland will be renegotiating these loan (IMHO”bail-out” is a misnomer) facilities over the coming years and 5.8% will just be a curious historical footnote.

    If not “Nemu” (Northern European monetary union) may become part of our vocabulary.

    The offer of bi-lateral loans from Denmark, Sweden and UK did not appear just by chance and were most certainly not altruistic.but (IMHO) reflect fear of a potential pan-European socio/economic scenario in which Irish democracy appears comparatively mature and stable.

    This is the toughest challenge faced by Ireland since WW2. However , contrary to tabloid-like assertions, Ireland is not the “laughing stock” of Europe and this time around the “great unwashed” are a lot more educated, sophisticated and engaged.

    Now if you will excuse me I want to go and check behind the sofa to see if I have any old pennies or maybe even a punt.

  43. @Livonian

    Ireland is not the “laughing stock” of Europe and this time around the “great unwashed” are a lot more educated, sophisticated and engaged.

    Shure, we’re so much more educated and so sophisticated today that we can demand one of the highest minimum wages in Europe even if one of the unintended consequences of this policy is a doubling of long-term unemployment in the course of a year:

    http://www.independent.ie/national-news/budget/news/number-of-longterm-unemployed-doubles-2455101.html

  44. @Carolus

    Ahaa!

    So the global economic downturn is just a figment of our imagination and has no bearing on unemployment in a small open economy.

    Shure it must be my lack of edumikation that was konfusin me! Tis grate that we have edumikated sofitikated people as yer gud self te kayp the rest of us from gettin bould .

    Best…L

  45. It would be interesting to have a thread about the minimum wage. I am very curious about what kind of jobs would be created by a lower minimum wage?

    Cleaning, manufacturing sneakers, manufacturing Ipods?

  46. @ Livonian

    So the global economic downturn is just a figment of our imagination and has no bearing on unemployment in a small open economy.

    Now, now – of course I don’t impute all our woes to the minimum wage, but it is certainly the cause of some of them. Would you propose raising it?

    No, you wouldn’t, you’ve put on your thinking cap.

    @ Jesper

    I am very curious about what kind of jobs would be created by a lower minimum wage?

    .. bus drivers, meat cutters, dishwashers, gravediggers, street artists, jobs for Media Studies graduates.

    I can think of a lot more.

  47. @Carolus,

    are you serious with those examples?

    Bus-drivers earn a lot more than minimum wage, street-artists are rarely employees. Economic development by employing more meat-cutters, dishwashers & gravediggers?

    I think I’d like the more that you can think of, if you please?

  48. @ Zhou, Paul, The easiest course of action is to do nothing and paper over the cracks. We’ve had some years of that now, not just in Ireland,, but in Europe and indeed in Japan for a while longer. A move towards a meaningful resolution will involve considerable pain, and more pain for some interests that others. So yes. The consequences of not taking any action, whether for Ireland or the European economy, makes me far more fearful than not acting at all.
    Like in Japan, Europe has seen almost no receiverships. The US has seen Lehman and Bear Stearns, among hundreds of other financial institutions, undergo shock therapy. The economy is on the whole stronger for that, and the long term interests of taxpayers are protected. Certainly, walking down 5th Avenue yesterday, it’d be hard to see any vestiges of the crisis. But the road ahead is still long.
    Fear of certain pain is not an excuse for avoiding treatment.

  49. Pardon the nostalgia but I remember the ’80s. Debt/GDP was well over 100%. Interest rates were double digit. Interest payments were 35% of tax revenue. Marginal tax rates (on modest incomes like my own) were 73%. Ah! The good old days. And yet I never recall any talk of even the remotest possibility of default.

    Of course what makes today’s situation somewhat different is the unknown of the banking black hole. If in fact our economy is a complete illusion and very few of the banks’ assets are worth anything, ala Morgan & Constantin, then we will just have to default, we won’t have the money, we won’t have the economy.

    But what is poisonous is the current debate about the calculus of a deliberate default strategy rather than accepting that default is a last resort when we simply cannot pay. The fact that strategic default as opposed to “can’t help it default” is an option openly promoted not only by opportunistic opp politicians but prompted by a coterie of academic headline grabbers has done us no favours at all and goes a long way to explaining why we are pushed into the tender mercies of the IMF.

  50. @Jesper
    are you serious with those examples?

    No not really. But (taking my tongue out of my cheek) there is an almost endless and growing potential demand for unskilled and semi-skilled hospital and nursing home staff.

    Economic development by employing more meat-cutters, dishwashers & gravediggers?

    What guarantee is there that economic development is an option? Skyrocketing energy prices (for example) might well create a demand for more brawn power rather than more brain power.

    Who spread the self-congratulary yarn that we are a nation of near-geniuses anyhow? Perhaps one of Ireland’s problems is that many of our young people are overeducated and have totally unrealistic career expectations that are out of sync with their intellectual capacities and market demand. But that’s another story. Would be a good idea for a thread, though.

  51. @ BW II

    Another difference with the eighties, as far as the ordinary irish citizen is concerned, is that none of the sovereign debt back then was from incompetent private banks racking up billions in losses. It’s only natural now that people would be shouting default given such a portion of our debt is not really ours.
    Having said that i think having a default debate now, post IMF/ECB bailout, is extremely odd. We cant now, it’s completely out of our hands, maybe everyone should just be honest about that reality and move on. It’s sort of like a child trying to decide if his parents should default on their mortgage. Not really his call to make!

  52. @ Brian Woods II

    But what is poisonous is the current debate about the calculus of a deliberate default strategy rather than accepting that default is a last resort when we simply cannot pay.

    + 1000

    Though I think your optimism is totally astray, you have written something quotable here. No doubt some of your critics will retort that you are whacking a straw man. But the irresponsibility of the pro-defaulters is plain enough to see.

    I think they realise in their collective heart of hearts that no real-life decision maker will ever put their proposals to the test. Not even (Heaven forfend) a nightmarish Labour-Sinn Fein coalition. They are safe-haven second-guessers. I wonder if they even take themselves seriously.

  53. @Brian Woods

    “Ah! The good old days.”

    My father who survived the 30ś, 40ś , 50ś and 80ś is fond of saying the following : ” The good old days! What was good about them?” (Mind you I have not heard him say it too much lately)

    @Jesper

    Yes I agree it would be a good idea to have a thread about the minimum wage. (Not forgetting, of course, John McHaleś excellent article which we are all posting/commenting on at the moment) I enjoyed your recent post about “double Irish” and how the Swedish public is perceiving the whole Irish “bail-out” saga.

    @Carolus

    No I would not propose “raising it” (or lowering it in the devisive way it was done) but as you can gather I am a little impatient with the “self flagellation” we Irish are prone to indulge in as if we are somehow embarassing ourselves in front of our European brethren. In my experience Ireland does not have a monopoly on “fiscal madness” within Europe.

    Best…..L

  54. @ carolus

    Actually I am not very optimistic. The defaulters are the optimists – those who see a silver bullet. There is no silver bullet. We must plod on and do the right thing and do what the EU tells us (that is not a an anti EU swipe, it is right they should call the shots).

    Someday this might mean saying sorry, we just can’t pay. The optimists are those who urge “we’re not paying, sod off, we don’t need you, we don’t need your euro, we don’t need your bail outs, just you watch soon you will be back panting to lend to us”. Now that’s optimism.

  55. BW2: Pardon the nostalgia but I remember the ’80s. […] And yet I never recall any talk of even the remotest possibility of default.

    Either you have a remarkably poor memory or you never attended an economics seminar back then. Given that you remarked in an earlier thread that you hadn’t heard of Ricardian equivalence (and all credit to you for your frankness), I’m going with the latter. That freshwater stuff was all the rage. It seems rather quaint now. You had to be there, man.

    Of course what makes today’s situation somewhat different is the unknown of the banking black hole.

    That and the fact that in the 1980s we had (a) a currency of our own, which meant we could shrink the real value of debt denominated in Irish pounds at will, which we did repeatedly; and (b) controls on capital movements. My memories of the 1980s include the Form E4 which had to be submitted to the Central Bank whenever we needed to pay a supplier in foreign currency. Admittedly the controls were full of holes, but as a Central Bank official remarked, when you need to put out a fire a leaky bucket is better than nothing. (Asked if he could be quoted on that, he replied: “Yes, as long as you don’t mention the fire.”)

    But what is poisonous is the current debate about the calculus of a deliberate default strategy rather than accepting that default is a last resort when we simply cannot pay.

    So what’s it going to take to convince you that we can’t pay? A mass exodus such as East Germany experienced when the wall came down? Taxpayers are not sheep to be shorn just so that you can take pride in your green jersey. The damage was done when we allowed our bankers to run amok and then gave them a state guarantee for their liabilities. All that remains to be decided is who pays for those enormous losses. In principle I accept that we should live with the consequences of decisions made by our elected representatives. But there are limits. Personally, I draw the line at the point where we enter a downward spiral with austerity causing emigration, which shrinks the tax base and forces a further round of austerity. Some very intelligent people think that’s where we’re headed and I take what they say quite seriously. I don’t relish the thought that my hard-earned savings may be depleted by a default of one kind or another, but worse things can happen.

  56. @ KD

    You embarrass me on my lack of knowledge of Ricardian Equivalence, I bet I know more than you on the history of the Cheltenham Gold Cup.

    We can’t pay when we can’t pay. Not very Ricardian I know. As it happens we can pay and the IMF/EU bail out ensures that we will be able to pay for the foreseeable future.

  57. I agree with BWII about the optimists being defaulters.

    The optimists assume that things cannot become worse than they already are. Therefore we are free to take any risks we please since there will be no downside. I believe, on the other hand, that things can get far, far worse.

    We still have a functioning banking system and economy. In fact the export sector is booming. So we have an awful lot to lose. Despite all the understandable complaining, we are still a wealthy country.

    On Tuesday of this week Bank of Ireland had a computer problem, which meant that I could not make electronic payments, including payroll. Fortunately, the problem was sorted out within 24 hours.

    Imagine if the system was gummed up for a week or even a month (say next April) while a new government played strip poker with the IMF/EU (I don’t believe that will happen, incidentally, Labour and Fine Gael will do as they are told for all their bluster).

    Regarding the 1980s I don’t remember any economist or politician calling for default then. The only person I remember who was advocating such a policy was a young Hot Press journalist by the name of John Waters, who was given a platform on the Late Late Show. I wonder what ever happened to him! His basic argument, as far as I remember, was that we were really a third world country, which just happened to be located in Europe and that we should do what third world or Latin American countries do and plead inability to pay.

    That is the biggest difference between then and now: it is now considered perfectly respectable as a proactive policy decision to default. Maybe there is much greater intellectual freedom now, but I can’t help feeling that there is a price to be paid for this.

  58. If we don’t threaten default on bank bondholders now we will probably default on our sovereign debt – that issued unequivocally by the government/agreed with our EU partners/IMF – later. It would be a huge reputational blow, locking us out of the sovereign bond markets indefinitely. People who advocate not defaulting are optimists because they do not believe things can get any worse than they are now. We could end up having to leave the Euro to regain competitiveness and to slash the deficit to nothing overnight.

  59. @John McHale. You can address the response to our banks insolvency as many ways as you want from the point of view of consequences of measures. None of them will get away from the essential unfairness of visiting the money losses from bank failures in Ireland on us the people when all these banks were fully private. Nothing you can say in terms of effects on other institutions, banks or political bodies in Europe or elsewhere or reputation can take away from this essential unfairness.

    No other private business that I am aware of would attract any discussion as to a public bailout at all, apart from the nuclear industry. The nuclear industry is of such importance that the toxic radioactive material must be taken into public responsibility, because it is so dangerous to us, nothing to do with fairness.

    Aspects of the economic crisis are of course part of the collective responsibility but private banks are not part of that. Iceland has effectively adapted old banking structures to support the banking needs of Icelanders, without taking responsibility for their insolvency.

    Who are the parties to whom we are having regard in how are government have been taking their decisions here? Primarily the ECB and EU Commission. What interests are they representing and what true assistance are they offering us to keep safe the senior bondholders? What genuine systemic vulnerability exists in Europe and beyond, that is put on hazard by non payment of some senior debt by even one failed Irish bank. And we are asked in the name of patriotism to stop debating it. Secrets in families get visited from generation to generation just our astonishing debts risk being visited on several generations from here.

    Even if we have to have the discussion privately, as families should also do, not in public, we must subject these crucial questions to scrutiny to establish what is really going on so we can take the decisions in response to these awesome event of bank insolvency from a platform of wisdom. Incoming administrations in the years ahead will need this wisdom from us and hopefully will welcome it.

    And whatever responses are made in the future , how can the Irish people ever be compensated for the horrendous bank insolvency debts that have been added to us, the socialisation of these utterly private debts.

    And thank you for your own contributions to the debate.

  60. Excellent adult debate, proving that people on both sides of this debate are operating in good faith (which is not suprising but sometimes we need reminding of when emotions are raw). I was especially impressed with John, Jagdip, Ciaran, Ahura, Oliver, Neil and Paul H.

    Eichengreen has a new article out, here:
    http://www.project-syndicate.org/commentary/eichengreen25/English

    “So, if internal devaluation is to work, the value of debts, where they already represent a heavy burden, must be reduced. Government debt must be restructured. Bank debts have to be converted into equity and, where banks are insolvent, written off. Mortgage debts, too, must be written down.

    Policymakers are understandably reluctant to go down this road. Contracts are sacrosanct. Governments fear that they will lose credibility with financial markets. Where their obligations are held by foreigners, and by foreign banks in particular, writing them down may only destabilize other countries.

    These are reasonable objections, but they should not be allowed to lead to unreasonable conclusions. The alternatives on offer are internal and external devaluation. European leaders must choose which one it will be. They are united in ruling out external devaluation. But internal devaluation requires debt restructuring. To deny this is both unreasonable and illogical.”

  61. @ Brian Woods

    It seems to me that, behind all the obfuscation, professional economists are really all defaulters now – and th argument is between those like yourself (a) who advocate taking maximum pain in the hope of extracting permission for a default from a merciful from Europe somehwhere down the road and (b) those who say default as soon as possible because the reputational damge is the same no matter when it happens and the sooner it is done the less misery is forced on the people.

    The majority of the populace have have no clue about either uncharted course and have to put their trust in people rather than arguments. And the advocates of course (b) have misled us far less than the advocates of course (a).

    I may be wrong but I see only employees of the financial services “industry” maintaining the delusion that default can be avoided.

  62. From the link above posted by Oliver Vandt

    Senior EU officials have told international investors that even a new Irish government will not be allowed to remove the protection which has been given to senior bondholders in the banks.

    The MoU does not contain any provisions prohibiting senior bondholders being hit. Any such provision written into the agreement would probably be illegal, since forcing a state to assume private debts would likely contravene Treaty provisions. So where is this “protection” documented? In a secret annex? A gentleman’s agreement perhaps in return for ECB funding? Time for SF to step up again and challenge the legal basis under which this “protection” has been put in place and which constrains the future policy choices of a new government. They seem to be the only party willing to challenge in the courts decisions of a highly dubious nature.

    The laws of arithmetic will win out in the end. The markets believe there will be a default/restructuring. So does Germany, since they have insisted that the new ESM will be senior to private debt unlike the EFSF. The €22bn in unguaranteed senior debt should be on the table for a new government as a policy option, either to be restructured or used in negotiations to lower the interest rate for example.

  63. @ John Martin

    As always you articulate these things so much better than I. But the thought of La Burton playing strip poker was not what I needed before breakfast.

  64. @ John Martin

    ‘That is the biggest difference between then and now: it is now considered perfectly respectable as a proactive policy decision to default. Maybe there is much greater intellectual freedom now, but I can’t help feeling that there is a price to be paid for this’

    The other difference bewteen then and now is that the global financial services industry has grown to dominate the real economy and the political process. The main participants have demonstrated a breathtaking disregard for the fundamentals of corporate governance and social responsibility. Perhaps there’s a price to be paid for that sort of stupidity and hubris too.

  65. @ Paul
    Yes, the international or Global dimension was important. But, of course, saying this runs the risk of being accused of being an apologist for Fianna Fail.

    Regarding corporate governance we had ICI and AIB back in the 1980s. So it is not as if everything was rosy in the corporate garden back then.

    But your point is well made. With globalisation and the removal of restrictions on capital flows the financial services sector has become larger in relation to the rest of the economy. Therefore a crisis in this sector has had more severe consequences. That is indeed a second difference between now and then.

    I think we should be a little more realistic about what has happened in the last 10 years. We benefitted from globalisation. There were 25,000 people employed in the financial services centre. Businessmen had access to capital which they never had before which enabled them to grow their businesses. Of course a lot of it was wasted, but a lot of good things were done in that period.

    I am both optimistic and pessimistic. I believe that manufacturing in this country has never been more competitive. The prospects for this country are very good. However, we can blow it if we do something very, very stupid.

    A unilateral, proactive default on our debts by a country which depends on trade with the rest of the world to work our way out of the economic crisis will cause irreparable damage.

  66. @ John M

    I accept that that many good things happened during the boom, and that many are still happening. I am simply recommending that we cast a cold eye on what lies behind the oh so solemn visages of central bankers. We know the Church now, so we have leaned something about power.

    Manufacturing here may be competitive, but I am not sure how much of it is ‘ours’. The Double Irish is pretty central, and changes in tax regime or regulatory environment could have unforeseen impacts.

    It would be also unwise to do make positive assumptions about long term economic prospects on the basis of fluid, contingent realities. I think the ‘default’ camp sense this weakness very strongly, but the necessary thinking outside the box has not yet been done.

    Either way, there’s no going back. Both default and default avoidance processes will change Ireland deeply, and collective intergenerational wisdom was never more necessary. Luckily the excellent commentariat here are really helping to sharpen and develop the political choices.

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