Plan A*

Although he had a rough ride in Comments here, Lorenzo Bini Smaghis London Business School presentation provides a useful official take on the choice between the Plan A of fiscal adjustment and the Plan B of default. (From a narrowly Irish perspective, his identification of the costs of default probably puts too much emphasis on balance sheet contagion and too little emphasis on the reputational damage to an economy that is one of the world’s most dependent on international trade and investment. Understandably, he also does not dwell on possible costs of default for access to ongoing international assistance, not least from the ECB itself.)

However, I would put the case for Plan A in more dynamic terms a Plan A* perhaps. The literature on the option value of waiting provides a useful dynamic angle on the default decision. This applies to a decision that is costly and irreversible and must be taken under uncertainty that will lessen with time. An outstanding feature of our present predicament is that there is unusual disagreement about whether we can stabilise the debt to GDP ratio and regain market access. There is a good chance that the range of this uncertainty will narrow substantially over the coming year. Four major sources of (diminishing) uncertainty stand out:

1. Growth. It is still an open question as to whether we are finally turning the corner or will bounce along the bottom for some time. Even if the austerity measures hold back the rate of nominal growth, observers are looking hard for indications of the underlying potential growth rate once the fiscal adjustment is complete.

2. Bank losses. Huge noise has been added to the debate by attempts to add together things that simply cant be added actual recognised bank losses, capital injections, the gross cost of asset swaps, secured ELA lending by the Central Bank, etc. Even so, there is real lingering uncertainty about the size of the contingent liability to the State of the banking system. The new more rigorous and independent stress tests should go a significant way to reducing this uncertainty, especially if they provide detailed information on bank balance sheets to the markets.

3. Political capacity to produce a primary budget surplus. The four-year plan, the passing of the 2011 budget and the EU-IMF agreement itself have all reduced the uncertainty about the capacity to achieve the required fiscal adjustment. However, the fact that the adjustment will have to be seen through by the likely new centreright/centre-left coalition creates additional uncertainty. The failure to produce the necessary adjustment in the mid-1980s by a similar coalition adds to the doubts. Notwithstanding the inevitable election rhetoric, the major parties do appear to understand the importance of demonstrating the political capacity to see the adjustment through. We should have a reasonably good idea of the prospects for the new coalition shortly after the election.

4. The bailout mechanisms. The design of the bailout mechanisms e.g. high interest rates, de facto official creditor seniority, threats of future burden sharing are obstacles to regaining market access. Fortunately, both the IMF and EU policy makers seem aware of the flaws and seem willing fix at least some of them. This uncertainty about the future of support should also be significantly resolved after the major EU summit at the end of March.

Of course, the option value of waiting perspective can also provide reasons for a pre-emptive default. This weeks very useful analysis from Goodbody made the point that 60 percent of the outstanding unguaranteed, unsecured senior bank bonds will mature over 2011/12. There is a potential cost to delay to the extent the costs of default are lower on this debt than State debt or State guaranteed bank debt.

Needless to say the markets understand the government retains the option of default, which explains the continuing risk premium. Policy and policy debate should be focused on reducing the value of this option and thus the probability it will be exercised. On the banking side, this was the key theme of Patrick Honohans January speech to the IIEA, but the point applies more generally. Uncertaintyincreasing actions such as the postponement of the €7 billion capital injection so soon after the bailout agreement and also exaggerated (populist) rhetoric about renegotiating the agreement come at a cost.

The overwhelming sense in Comments across recent threads is that default is inevitable and we should just get on with it. I think there are good reasons to hang in there.

54 thoughts on “Plan A*”

  1. I found much to disagee with in this post, but I’ll just highlight the sentence which really got under my skin:

    “There is a potential cost to delay to the extent the costs of default are lower on this [unguaranteed] debt than State debt or State guaranteed bank debt.”

    Refusing to use taxpayers money to pay off unguaranteed private-sector debt is not default. I don’t owe those creditors a brass farthing.

  2. @John McHale

    The ‘option value of waiting’ should be of interest to the Labour party – and those who wish to see a real social democratic alternative emerge – only real diff between FG/FF is that the latter has had more opportunity … I remain to be convinced that ‘political capacity’ to handle a crisis exists in extant system ….

    I have no quibbles with the deficit – only questions are how, where, and when – and ‘grabbers’ cutting most fragile in society [pilfering the pockets of the blind springs to mind] while maintaining, and increasing, their own take from the state is nauseating –

    Banking system debt – is impossible to sustain – option value of waiting here is/has been disastrous from both local and EU perspectives – post stress tests will tell …. And if EU does not address Big Black Holes in EU Banking system by April we are done. Hopefully Kantian pragmatists, and democrats, come up with ‘sense’ March 24-25 – I’m not overly optimistic – might need a Grand Coalition in Germany and DSK in power in France to do so. I remain in Default mode – and have been since Patricia the Sovereign_in_Exile left many moons ago – and not only on this blog.

    Human cost of present policy (if one can call it that), and supine deference to ‘immoral hazard’, is far, far, far too high. Acceptance of such slavery causes far more reputational damage than would exercising the nuclear option – latter would not impact on FDI.

    So called ‘bail out’ is a bail-out and kick to touch for the EU financial system as a whole …. IMF more or less signalled its unease …. At the time I was hoping for a €50 billion write off – how naïve of me …….. that said, methinks the Mawrkets agree with me – and at least Flaws in EU financial governance are now ‘openly’ acknowledged – if not yet politically addressed, decisive action agreed, and more importantly – implemented.

    You deserve credit for reasoned argument (you might give Lorenzo a little tutorial), and persevering – unlike certain academic meeja_commentators who ‘spin’ the party line from their cozy sinecures and who have never overly troubled either the printer’s ink or the prevailing in-bred upper-echelon gombeen consensus that has us citizen-serfs where we are (to say nothing [which is what de do] of the silent majority of heads down in groves of Irish academe). Then again, you have seen, and done, a bit of/in the world (-;

  3. May I politely suggest a Plan C?

    If the EU cancels all our sovereign and banking debt we’ll cancel Jedward’s entry in the Eurovision.

    Lets face it, we can do a lot more damage to the EU than they can to us 😀

  4. Well, the option value of waiting is also dependent on timing. Waiting for the stress tests runs the risk of having to either cough up more money or see the banks collapse in disorderly fashion.

    The same point could be made on the other points – growth and the budget deficit. They may be inimical to each other – reducing the budget deficit may (almost certainly will?) limit growth.

    The one that may be worth waiting for, though, is the bailout mechanism. With the bailout in place, the fiscal and banking problems effectively belong to somebody else. It is, in my view, within the right of the next government to say to the EU/IMF “what you told us to do isn’t working, you’re so clever, you tell us what to do next; oh, by the way, we need…”

    I believe the IMF have recognised this risk to some degree, if not institutionally, then the actors who were present for the negotiations. The IMF, much less the EU, cannot afford to let this fail.

    Personally, I see Ireland becoming a net beneficiary of the EU again. What will be taken with one hand will be given back with another. As Mr. Hennigan points out, the last time we had a big debt interest bill, the EU paid it. We much hope we get the same kindness from our strangers this time again.

  5. Interesting presentation. I rather think he dismisses the inflation option rather too quickly, in a couple of slides. He cites the ECB’s terms of reference to ensure price stability. But didn’t we also have a requirement to have deficits below 3%? I foresee that inflation must be part of the solution.

  6. @John McHale

    You have instanced four reasons why we should “hang” in.

    1. Growth. The growth targets are extremely unlikely to be met and because of the distortive influence of the export sector on the growth figures, growth figures do not convey the full picture in Ireland’s case.

    2. Banking. We have had stress tests before. All we know is that they were wrong. Very wrong. And we are expected to pick up the consultants bill for the false diagnosis. The simple fact is that the bank guarantee is being called in daily. We as a people cannot stand behind it. Nor should we.

    The bank guarantee covered about €450 billion in bank liabilities. The bank losses to date and the deposit flight to date amount to at least €200 billion and have been covered by the ECB €150 billion and ICB €50 billion. The remaining bondholders amount to approx €60 billion (FT recent report). They will not be renewed. This brings the total support required to €260 billion without further deposit loss.
    What did Irish citizens do to deserve this burden of private banking debt being heaped on their shoulders. One way or another Irish people are currently paying for this debt burden.

    3. Political capacity to generate a surplus. This is the area where Ireland as a country is culpable. It refuses to take on the developers or to reduce the cosseted top pay and pension levels.
    I concede that it impossible for Europeans to contemplate defaults when the negotiators on behalf of the State and the State officers themselves are paid a multiple of the salaries of the debtor representatives. This will have to corrected.

    4. Bail-out mechanisms and lower interest rates. The effect of lower interest rates is miniscule in comparison to the amount of bank debt take on already and potential bank debt that would have to be taken on.

    Ireland’s debt burden because of the banks has been compared to the reparations imposed on Germany after World War 1.
    In seeking to impose strict reparations on Germany at Versailles, Clemenceau is said to have commented ‘When the goose is on the table, you don’t ask her how she would like to be plucked’ .

    The Irish goose is now on the table and being plucked. Ireland must get off the table while it still has some feathers left.

  7. “I think there are good reasons to hang in there. ”

    This is akin to enouraging people to catch falling knives.

    IMHO, the chance of default within the next few years is 50/50 if:

    # The EU fails to address the Irish situation immediately;
    # Interest rates rise;
    # There is limited international growth;
    # There are further bank shocks or extensive home mortgage defaults;
    # There is any civil unrest;
    # The new Government makes some initial mistakes or delays decisions;
    # The 2012 Budget is as severe as the 2011 one:
    # National growth fails to return (very quickly) the levels expected last November.

    More at http://www.planware.org/briansblog/2011/02/prevent-a-national-default.html

  8. @Hoganmahew.

    Thanks for that. The current European events could have momentous implications. Let us hope the implications will not be as momentous as those that followed from Versailles.

  9. There is a fifth uncertainty which is not specifically addressed above, though I suppose it’s tucked into uncertainty #1, Growth. It is the possibility of a big external economic shock in the next several years. My uneducated guess is that it is likely – perhaps probable – that such a shock will happen, and that it could turn a more-or-less manageable fiscal path for Ireland into a clearly unmanageable one. I think it is time for qualified economists who make predictions and recommend policies for the Irish economy to go on the record with their judgement of uncertainty #5. No-one is demanding a prophecy of the next five years of world economic history (well, certainly I’m not). But what will not wash is to keep mum about the subject now, then turn around in (let’s say) 2013 and talk about how nobody could have foreseen the hard landing in China.

  10. @Joseph Ryan
    Well, I think the chances of our tanks rolling into Poland are low. Unless we build a giant trebuchet and they are septic tanks…

  11. @hoganmahew

    Seconded on the Treaty of Versailles slap down. Germany was then (as it is again) the most populous nation in Europe and at its geographical and cultural heart – the risks of victimizing it and destroying its social fabric were high.

    Ireland has 1% of the EUs population, we are an island at its west most extreme and if we disappeared from the EU tomorrow the effects would be genuinely insignificant.

    So if the rescue by proxy of central Europe’s banks does drive us to become a social, economic and political wasteland the net cost to European investors, wealth and stability is +/- nothing at all.

    It is one of the reasons the conditions of the bailout and our current treatment is so harsh – we do not matter except as a bad example. Bini-Smaghi is naturally infuriated that we do not realize this.

  12. @anonym

    I’ve raised the China uncertainty problem the other day in another thread. Can I have my Brownie points now or do I have to NPV them?

    @ Shay Begorrah

    Agree, the idea that unfair dealing with Ireland might bring about the modern equivalent of WW2 is ludicrous.

  13. @JMcH

    The guarantee of existing bonds in Sept 2008 was ridiculous – as is the idea that the popular media have got that it was excusable in the absence of phoning P Honahan down the road in Trinity – since he was unique in all the world in being able to work out this was nuts. Every vaguely competent bond trader / manager knew it was nuts. Some of us actually thought it might be a practical joke.

    It is just as nuts that there is no resolution mechanism still in place so that you can move the banking business to a new bank, taking the deposits (via compensation probably) and telling the un-guaranteed holders to fuque off. This is the language of the market and the rational behaviour they expect. The state has been a total mug from the start.

    The problem is that FG and Lab don’t seen switched on enough to keep their mouths shut and get on with putting in place what is needed to lean on the appropriate bond holders WITHOUT scaring the depositors away.

  14. All of this has nothing really to do with economic growth or job creation, it is simply about how to get the poor Irish taxpayer to pay for the bloated real estate fiascos of the Irish orligarchy. They have taken their money and are gone, you got the tab. Why is this so difficult to understand? Real estate in Ireland was never remotely worth what it is in London or New York. The income and capital flight are not there to support it. It was one big, very sad joke.

  15. Mr McHale, you are basically making the argument that being indecisive about critical matters is a good thing.

    Now, I’m all for prudence and considered reflection before making decisions, but this country has had three years already, which have largely been spent avoiding decisions. I frankly doubt the capacity of those in government or in the civil service for actually making decisions at all, but I digress.

    You’re arguing that this country should kick the can down the road, procrastinate for another 12 months, based on arguments which I for one find hopelessly, if not desperately, optimistic. To briefly respond to them:

    1) The economy is not going to grow
    2) Stress tests are not going to help with bank losses
    3) There has never been a government in the history of the state which has definitely tackled a deficit, let alone the one we have now.
    4) The EU is most likely to simply dither along in dealing with the banking crisis as it has done thus far; there is no political will in Brussels for major reform.

    You appeal to the same dire oracle we have heard since the guarantee of 2008: that there will be “reputational damage” to the state, banks and nation if we default on our loans. Quite apart from the fact that Ireland’s reputation is already in tatters and our procrastination is doing yet further damage, this notion once again reveals the naive understanding of state financing among the Irish economic establishment.

    If the Irish State defaulted on all bank bonds in the morning, all state bonds in the afternoon, and put all ours banks into liquidation in the evening, by the next morning there would be bond traders willing to buy new Irish bonds at 4%. They would be willing to buy because bond traders are greedy—greedy and reckless. Nothing else explains the behaviour of the markets over the last 10 years.

    Of course, burned bond holders would be furious. The ECB would be apoplectic. But the bond traders—cunning vipers that they are—would see a good deal in a State with no debts and an able population and would buy accordingly. Anyone who cannot understand this does not understand how bond markets or indeed how any markets work.

    Ireland is bankrupt. Admitting this lets us write off debt and move on—go back to the market in fact. Denying such a basic financial reality only draws out a long an tortured process of national stagnation and eventual fiscal collapse.

    Ireland is Bankrupt. Everyone needs to just say so. No more stalling, no more dithering, and no more excuses. Let’s just Default and move on .

  16. Thanks for the comments.

    @grumpy and others

    I fear people have the idea that I think it is a good idea to protect unguaranteed senior bondholders. It might be of interest to see how some of the debate has evolved, before the “burn the bondholders” bandwagon really got rolling. Here is a post on this site in response to Colm McCarthy’s call for an SRR for Irish banks, one of the first as I recall. Colm was advocating an SRR as a way to extricate ourselves from guarantees. I stressed that it would be essential for imposing losses on bondholders once the guarantee expired.

    I also wrote a piece for the Irish Times back last April where I made the case for imposing losses in the context of a proper SRR. A short extract:

    How would the bail-in alternative work? A critical element is that the Government puts in place an American or UK-style special resolution regime (SRR) for failing banks.

    This regime should be ready to go when the existing guarantee expires and would affect unguaranteed bondholders whose bonds have yet to mature.

    The SRR would provide options for a bank to seamlessly continue in operation under new ownership (eg, AIB or Bank of Ireland) or for a gradual winding down (eg, Anglo or Irish Nationwide).

    If a bank cannot meet specified capital adequacy requirements on its own, it should be resolved in a manner that is least costly to the taxpayer, while also ensuring that all creditors do at least as well as under a normal bankruptcy procedure. One option would be for bondholders to become owners of a now well-capitalised bank through a debt-equity swap.

    The regime should also allow for the clear protection for depositors and secured creditors such as the ECB. In a wind-down scenario, unprotected creditors should bear losses before any burden is placed on the taxpayer.

    One of the great mysteries of the government’s policy response to the crisis is why a proper resolution regime was never put in place, with insult being added to injury by the offensive piece of emergency legislation that did emerge in December. Whatever the reasons early on, it is now apparent that the ECB has set themselves against imposing losses on seniors, SRR or no SRR. Their concern is contagion, which I believe is exaggerated.

    The problem is that our banks are massively dependent on ECB/Central Bank of Ireland funding support. This has now gone way beyond normal central bank liquidity support; it is now highly subsidised on-going funding. The ECB’s quid pro quo for this support is that the senior losses are not imposed. I hope that they will change their minds on this “informal” condition — just as I hope that the SRR will finally (under the gun of the bailout agreement) be put in place. It would be nice, however, to see some recognition of the ECB reality in the current crop of “burn the bondholder” calls.

  17. John McHale provides a useful antidote to some of the calamity howling.

    I believe that it’s more likely than not that growth will not be sufficient in coming years to offset the weight of sovereign and bank debt but I also believe that the new government would be stupid to use all its ammunition in its early period in office fighting a war it would not win.

    The prudent focus should be on reducing the interest on the bailout deal and the case should be made to the Eurogrup, ECB and European Council about the burden of the bank debt. However, it is very likely at this point that the reaction would be to await the implementation of the IMF program.

    At that point, the facts will be clearer as today, we simply cannot say that we cannot sustain a public debt of 130% of GDP.

    The opinion of the IMF would of course be very important.

    On growth strategies, I have often said that the starting point should be a realistic assessment of the challenges.

    However, all the parties appear to believe in fairytales.

    A Fine Gael document written by Bruton and Varadkar says the Asia Strategy 1999-2009 was a success. During this period, Irish goods exports to China increased fourteen-fold from €119m in 1999 to €1.6bn in 2009. They propose trebling trade by 2025.

    Exports to China were 2% of total exports in 2009 and it had nothing to do with an Asia Strategy.

    The ‘smart-economy’ is a failed policy and Labour wants to add a few bells and whistles to it.

    Then there are the ongoing challenges for our key FDI sector.

    Innovation: The woes of world’s top R&D spenders – – Nokia and Big Pharma

    http://www.finfacts.ie/irishfinancenews/article_1021620.shtml

  18. @John,
    I think the issue on the unguaranteed senior bank debt has arisen because you lumped it in with sovereign debt in your piece above. The dominant reasons for not defaulting on unguaranteed bank debt are all about keeping the peace with the ECB and our EU partners, where the dominant reasons for not defaulting on sovereign debt are reputational, with a bit of keeping the peace thrown in.

    I don’t know what the reputational impact of burning the unguaranteed senior bondholders would be, but I suspect that if it was handled well holders of Irish sovereign debt might see it in a very positive light.

  19. @Hogan/Shay Begorrah.

    I wasn’t proposing to don a corporals cap and lead a tank squadron across the Shannon let alone across the Rhine.
    But these are serious moments for Europe.
    Several European States cannot pay their debts, the European banking system is tottering on the brink for the past three years, the future of the Euro is in doubt and perhaps the EU itself will struggle to survive.
    All that is needed is a trigger to precipitate a series of events that may prove impossible to contain or reverse.
    At that point, Beni Smaghi’s “we will do what is necessary”, will be too late and irrelevant.
    Notwithstanding all that, I hope to gain a few insights from Keynes’ reflections on Versailles.

  20. @ Michael H

    ‘The prudent focus should be on reducing the interest on the bailout deal and the case should be made to the Eurogrup, ECB and European Council about the burden of the bank debt. However, it is very likely at this point that the reaction would be to await the implementation of the IMF program’

    We have hit the iceberg. Reading back on the 2010 threads mentioned by @ John McH, it’s shocking how fast we are going down now. The bank guarantee and the NAMA promissory note wheeze have been revealed as fantasies. Irish solutions to Irish problems. We are famed for our fiction writing, and rightly so.

    In any case, we signed a deal with the EU and IMF in the real world. Them’s the terms, as you say, and perhaps they are not too fussed if the plan cripples our domestic economy. Get used to it, is the message, sure the exports are terrific.

    The incoming regime may fiddle around with the interest rate as you suggest, but they won’t think of questioning the fundamental logic of the EU and ECB. That might start a row about corporation tax.

  21. @ paul quigley

    Paul,

    Yes, it’s shocking and depressing.

    I’m not advocation that we hoist a white flag but the bailout deal was agreed on Nov 28th and I think that it’s too early to make a credible case fro serious change.

    The time will come and the terrible scenario is the still known unknowns.

    The Wall Street Journal said on Saturday that “the (EU-IMF) plan provides just half of the €133.9 billion Ireland would need through 2013 to recapitalize banks, pay its bills and pay back its borrowings, including short-term debt, according to estimates released this past week by the European Commission.

    Of the balance, €17.5 billion will be pulled from Ireland’s own reserves, including the national pension fund, but that means €48.9 billion will need to be raised from capital markets and individual investors.”

  22. @Joseph
    That’s fair enough and I think that problems in a larger, systemic economy will bring matters to a head to our benefit (compared to our current view of the future). The current bailout is not a real bailout. A larger economy may require a proper bailout and the principles of equality that saw the Greek deal revised as a result of the Irish one will hopefully see both the Greek and Irish and Portugese deals revised as a result of the Spanish/Italian/Belgian bailout.

  23. Brendan Keenan put the issue of unity on foreigners coming up with a saving deal while the grab-what-you-can mentality continues to prevail at home, well last Thursday:

    “That philosophy can best be summed up as holding that there is an easy way out of everything and it will somehow be all right on the night.
    The siren call of the easy way out is everywhere to be heard. The bulk of the population need have no fear of income tax rises. There will be a property tax only on places where you don’t live.

    Pensioners will be protected, including those with six-figure pensions and tax-relief schemes. And Europe will give us more money to help pay for this, provided that we are nasty enough to them.

    ….The State will not be able to borrow excessively for a long, long time but that will not prevent it continuing to transfer national resources from the productive sector and individuals to the vested interests, both public and private.”

    http://bit.ly/hK4nVD

    This wouldn’t be the first time for me to highlight the contrast between the lack of interest in reform and remedying the causes of the crash with the eagerness to find scapegoats overseas.

    We certainly are pastmasters with the victims’ cross and invoking Versailles is surely testimony to that.

  24. apologies colleagues for the lengthy nature of this post. fully warned you may now read on

    Very good post again John, congratulations.
    A couple of comments which I would make. First, although attractive it must be realised that the actual use in corporations of real option theory as an investment decision-making tool is actually quite limited. While this does not mean we should not use it it does indicate that in the business world it provides at best a supplement to more traditional, less complex approaches to making costly and irreversible decisions.

    Second, you state “Huge noise has been added to the debate by attempts to add together things that simply can’t be added – actual recognised bank losses, capital injections, the gross cost of asset swaps, secured ELA lending by the Central Bank, etc.” let’s stand back a little bit from this. One of the major issues that causes some disagreement is whether or not we should include as part of some form of calculation of national debt the emergency liquidity which the central bank of Ireland/European Central bank is providing. In a strict sense this is not of course either part of the national debt or even part of the capital structure of the banks. It is useful also to recall that, to a first approximation, the guaranteed banks have no capital other than that which the state has either provided or is guaranteeing. One of the things that people learn in corporate finance is the distinction between financing structure and capital structure. If we think of the emergency liquidity provisions as being part of the capital structure that only provides us with a useful analysis if we believe that this Liquidity can at some stage be replaced by market-based provisions. The reality is that absent this liquidity the banks would shut immediately. It is also clear that the European Central bank wants to remove itself from this never-ending emergency. At some stage therefore it’s highly likely that if the deleveraging is not completed the Irish state or the Irish central bank will have to step in further. So let’s think not so much about different kinds of flavours of debt, let’s instead think about flows of money, amounting in a total stock to some hundreds of billions of Euro, which are ultimately required to be injected, either on the (seemingly never-ending) short-term basis or in the form of actual capital injections. Somewhere along the way the taxpayer is on the hook, either in the form of foregone borrowing opportunities, pre-emption of tax revenue, contingent liabilities for when/if the banks actually strike their tents

    third, you state space “One of the great mysteries of the government’s policy response to the crisis is why a proper resolution regime was never put in place”. In my mind there is absolutely no mystery. It was a political decision made by the government not to put in place the bank resolution scheme. Think on what a bank resolution scheme would have entailed: it would have given the government legal cover to burn through the capital structure of the banks, from junior through to senior if necessary. I have made the point on many occasions that we have to ask who benefited from this. We know the taxpayer did not benefit, therefore private individuals must have benefited. I don’t think you have to have a deeply conspiratorial frame of mind to construct scenarios where or vertically or covertly, by omission or buy, should, influences soft or hard or brought to bear upon the government to ensure that the did not bring in place mechanisms which have would have resulted in the burning of well-connected private individuals. This may well be entirely false. I would be delighted if I was 100% wrong. Perhaps the proposed truth commission might get to the bottom of why this delay, and indeed to the vexed question of to whom exactly the Irish banks (and that is remind ourselves once again, for the 900 millionth time that these were private corporations not state bodies) old the money which they had borrowed

    Finally, let me suggest one possible endgame. There is no doubt that if the Irish government were to unilaterally decided to impose haircuts on senior bondholders, and there is quite a lot of senior bond holding money left available (see Constantine writing on this yesterday at his blog http://trueeconomics.blogspot.com/2011/02/12022011-just-how-much-are-bondholders_12.html space) there would be some degree of contagion into the rest of Europe. I’m with you John that I think this contagion fear is somewhat overstated. The unspoken fear is that if we were to do this the ECB would pull the plug on the emergency liquidity, truly shutting down the ATMs. This be quite naked political decision, and would be seen such. It would in fact be enacted economic warfare. At least we would then know exactly where we stood-in a queue waiting for money perhaps-and so too with the rest of the world. It would in fact expose the ECB/EU is being quite an old-fashioned colonial power. I don’t think that that is at all what they are. I don’t think that there is a plan somewhere in Frankfurt to use wire transfers as the modern equivalent of gunboats. But if there is, then this test we found out sooner than later. We spent several hundred years in one Empire and I for one have no great desire to go back to another. It’s really a case of who would blink first. As I pointed out before in our last set of “negotiations” we had polite people from Castleknock negotiating with the areas of Richelieu and Bismarck. Let’s try in the next set of negotiations to up our game

  25. @JMcHale, B Lucey

    “secured ELA lending by the Central Bank”

    Useful discussion on this site last week on this from which it would appear about 60% of the ELA is “secured” on promissory notes. This is circular security since if there was no security the liquidity advanced would be a simple claim on the state via the CBI. The security however is a simple claim on the state – direct.

    I would also observe that Eoin was very helpful on this (assuming he is correct) but it is unsatisfactory that this sort of information is not easily and clearly available from official sources rather than contributors here.

  26. Brian, thanks for the detailed comments. Some quick responses to your four points:

    1. I agree about the limitations of the real options approach. But I believe it really does provide a useful angle on the pre-emptive default choice, recognising the extent of the uncertainty involved and the likelihood that it will diminish significantly over the coming year. As a side point, I am struck by the certainty with which some of our commenters say we are insolvent. Even the well-formed analysts are pulling in different directions: for example Goodbody did come out negatively this week, but I think it is fair to say they see it as a close run thing; NCB and Bruegel are more positive on Ireland’s chances, but again with recognition of the uncertainty. At this point, a useful rule of thumb is to give less weight to the conclusion the more certainty with which it is expressed.

    2. You lost me a bit on your second point. I expect we agree that what ultimately matters is the cost of banking system “rescue” to the State. For now both the first moment and second moment of the subjective distribution of losses matter. For the first moment (expected value) the basic unit of account is a euro of recognised loss. But we then have add the expected loss on the capital stakes, the expected loss on NAMA, etc. The noise comes from those — most of whom should know better — who start adding the likes of the gross cost of NAMA or gross capital injections. These gross costs are relevant in that they increase the variance of the subjective loss distribution, but it is important to keep our moments clear in thinking about the contingent liability.

    3. On the non-enactment of the resolution regime, my mind is probably not conspiratorial enough, and I still find it puzzling. The litany of explanations for protecting unguaranteed creditors has never been convincing: contagion to sovereign debt, “bondholders are really just a form of depositor”, etc. The one reason that held some plausibility is that the ECB had effectively vetoed it from the start. Their more recent veto gives that explanation more plausibility. If this is true then I think the ECB was and is wrong. But I also am struck by the absolute discounting of funding support that is forthcoming. There is a strong sense of entitlement in this country, but we so very quickly see things differently when we happen to be net contributors to anything. (By the way, did you also find today’s Sunday Independent editorial on Germany truly shocking and embarrassing? The call for emphasis on diplomacy would be hilarious if the overall thrust of this official position of the paper was not so repugnant.)

    4. I actually don’t think that the ECB would cut off all support to Irish banks if we impose losses on seniors, if only because of the risk of depositor panic across the eurozone. But the ECB can make our life difficult in various other ways. They are doing so now with the forced deleveraging, which is risks both additional bank losses and also an even more severe credit squeeze, and this could be made much worse. There is no getting away from the fact that we got ourselves into a huge mess because of our dependence on foreign funding, both for the State and the banks. We have to get used to the fact that there will be a certain price for the supports we receive.

  27. @John McHale/Brian Lucey.

    I am surprised that there is disagreement on the cost of the bank bail out to the State or indeed at the mechanism for arriving at a generally agreed figure for this. Such disagreement is not confined to this site as numbers are wildly thrown about in the media.

    1. A simple solution is to regard all money put into banks in the form of cash or promissory notes as lost to the State.
    2. We then have unknown amounts yet to be committed to the banks under the IMF / EU agreements, which most sensible people would again regard as a loss to the State, if such money is paid out.
    3. In addition we have the contingent liability for ECB/ICB liquidity of €200 billion already advanced to the banks. Many would also regard this money as already ‘lost’. Yes there may be a recovery over the long term and indeed a profitable recovery as the monies from the ECB are at 1% and if the junk loans are already stripped out and gone to NAMA, the remaining loans which are funded by this liquidity could return a profit. Could but may not.
    And then there is the hidden mortgage losses that this €200 billion is covering. Indeed the process of deleveraging itself could see a three card trick operation whereby a disproportionate amount of the €200 billion liquidity is left on “Irish” books vis a vis the loan quality left on “Irish” books”. [I have seen some comments that Irish developers attempted to pay down loans to foreign banks at the expense of Irish banks with whatever cash flow was available.]
    4. Then there are the indirect costs such as potential NAMA losses which I think are better left out of the equation.
    5. The cost of State borrowing to fund advances to banks should be taken into account. It would be far more difficult to take in the equally real cost of the loss of the credit worthiness of the State as a result of the bank bail-outs.

    Overall it is unfortunate that there is no agreed template for the State cost of the bank losses. The economic community would do us all a service to come up with an agreed template for this.
    Imagine the new Taoiseach going to the next summit in March when this is being discussed, arguing his case against supporting the cost of the bank bailouts and then being told that Ireland can’t even agree on what the figure is.
    It makes us look disorganised and stupid. There could be a reason for that!

  28. @John McHale
    “At this point, a useful rule of thumb is to give less weight to the conclusion the more certainty with which it is expressed. ”
    I think a more useful rule of thumb is to look at those who did the sums on the banks and called them as insolvent long before it became consensus and see what they say about the state.

    Looking at fat tail risks is more instructive than option theory, I think. Slight as the chance that the state is insolvent might be, the damage it would do should that be the case has its own weight. This weight sits on those who could do something about it (usually to speed its process by cashing out before they get trashed out). The benefits to staying in the game are limited compared to the risks. This process generates its own snowball effect as we saw with the banks…

  29. “I am surprised that there is disagreement on the cost of the bank bail out to the State or indeed at the mechanism for arriving at a generally agreed figure for this. Such disagreement is not confined to this site as numbers are wildly thrown about in the media.”

    It’s unknowable now, because every estimate is sensitive to assumptions about the value of property assets when realised, and what the timing of the realisations will be. There is still quite extreme uncertainty about these matters. It’s not at all clear that matters will be much more certain in a year’s time.

  30. @ John McHale
    Your consistent efforts are well appreciated.

    The points made above by hoganmayhew and BEE Cee Tee are sound, I feel. The situation is an increasingly dynamic one, in which uncertainty may increase, rather than decrease. ‘Things fall part, the centre cannot hold’ comes to mind.
    We all like a joke, but race hatred and stereotyping is the road to nowhere. It’s a measure of the fear and disorientation in Ireland’s MSM that such reactionary views could appear in print.

  31. @John McHale
    The sums that the Irish state is liable for are now reaching the gigantic level. Frankly, as many commenters have said, few even among those who talked about restructuring before this envisioned us going down in such a Hindenburg-like mountain of flames and so quickly. I certainly didn’t.

    All of the most doughty proponents of Ireland’s solvency on the internet forums I read have now conceded or fled. An army of respected commentators, overwhelmingly those without a financial interest (perhaps Breugel are wearing blue tinted glasses), are agreed. But ultimately the decisive verdict is that of the ECB and the bond market. It’s a thumbs down.

    The only question is how we restucture. It should be in a prepared way in consultation with our European partners. It will probably be a long process of negotiation (Garret after the Thatcher “Out Out Out”). If we are lucky it will all be over with quickly.

    On the editorial Godwin’s law applies to newspapers too.
    http://en.wikipedia.org/wiki/Godwin's_law
    WW2 analogies are lazy and inappropriate. References to Nazi ideology are offensive. The Germans are angry about DEPFA and our other banking disasters, not about our national character. We need to appeal to the German sense of justice.

    We won’t be acting unilaterally. People who fear we will and are thus claiming from the best of motives that our solvency is still a matter of debate are misguided. They should argue instead against unilateral action.

  32. @John McHale

    I agree with what you say. I would add some hawkish points though.

    1. There is a substantial difference and risk involved in signing up to bail-out funds on foot of new debt instruments governed by foreign law as opposed to dealing with instruments governed by Irish Law. Options for restructuring are reduced and the amalgamation of private and public debt is complete.

    2. The full amalgamation of private bank debt and public debt may be extremely politically and socially corrosive. Thus there is a risk of exacerbating debt aversion with consequent reputational damage.

    3. Many people think we should avoid default if at all possible. It has been argued that in order to avoid sovereign default we may have to opt to not draw down portion of the bail-out and to slash expenditure to balance the books. This is an option considered by some, like SF, who think sovereign default is inevitable under the current deal.

    4. There is a risk that if other countries contributing to the bail-out are facing some loss then they will need to push us to the brink of default or actual default to be seen to be getting the last penny back for their electorates. This is also an effective mechanism to ensure that the Irish people contributes to minimise the net contribution their tax-payers must make. Therefore, delay may well make default more likely.

  33. @John McHale,

    I have just picked up your reference to the Sindo’s editorial on Germany in your comment of 6:16pm 13th.

    Words fail to describe how reprehensible this is. There can be no doubt that this has been picked up in Germany and France as representative of a strand of opinion in Ireland – even, perhaps, as representative of a dominant strand.

    The ignorance and prejudice conveyed is worse than anything I have seen in the British tabloids at their most vile. As a defender of freedom of expression I would have no problem with the Sindo publishing this as an op-ed piece, but it is beyond the pale as a leader.

    I will write to the Sindo – and use other channels to express my disgust and seek the publication of an apology to the German people and their politicians. And I would encourage others here to do the same.

  34. Thank you Paul. The Sunday Independent was a fixture in my house growing up. I simply could not believe what I was reading yesterday. Silence, while continuing to treat the paper as a serious publication, gives tacit approval.

  35. @John,

    I see you are not happy with the silence that confers tacit approval, but have you any desire to act upon your unhappiness? I am just a ‘voice crying in the wilderness’ and easily ignored.

    I also believe there is an opportunity to extract something of value from rejecting this gross villification and demonisation of citizens of Germany and France (and their politicians) by encouraging some understanding by Irish citizens of the genuine and legitimate concerns of these citizens and the challenges their politicians are confronting. And, in turn, to encourage some understanding by them of our plight.

    The EU is the boat we are in and we were very happy to clamber aboard in 1973 when these citizens (and their predecessors) were quite content to contribute to help lift Ireland out of largely self-imposed economic backwardness and the legacy of social and cultural dictatorship. Just because we took a position in this boat that put us at the eye of the storm gives us no right to abuse those who strapped themselves in more securely and those who are seeking to steer the craft to safety.

    We need to engage as citizens with shared concerns and a shared purpose, to understand and to make ourselves understood – and to forswear ignorant villification and lazy, out-dated stereotypes.

  36. @ Paul Hunt & John McHaler

    RE: the Sindo editorial

    Terrible, shocking, shameful, and depressing. I cannot believe this was printed on an Irish ‘broadsheet’. Agree with Paul – this is up there with the worst of British tabloid trash. Incredible.

  37. That “thing” in the Sindo was dangerous, moronic and close to incitement to hatred. I don’t buy it and I don’t know many people who do.

  38. @Zhou,

    Since the demise of the Irish Press, fo good or ill, the Indo has secured a dominant position in the print media – partcularly on a Sunday. At the risk of giving this ‘thing’ additional currency, I believe it is in Ireland’s interest to seek publication of a retraction, an apology and a commitment to engage constructively with our fellow citizens of the EU.

  39. I think the tit-for-tat German response won’t be – because they are too grown-up – but could be “look, if you don’t want the money, don’t take it, but do try to think it through first.”

    I imagine if that did happen the unions would be giving the finger to Enda and flying over to see Angela themselves before you could say Jack Robinson.

  40. @Paul Hunt

    It would be hard to hold down a job and and at the same time write letters every time something in the Sindo annoyed one. There is no way to influence people who are as consistently appalling as the Sindo.

  41. @Zhou,

    I know I’ll be accused of making a meal of this, but if this were a bit of biased reporting, a columnist sounding off or an editorial declaration on a matter of purely Irish concern, I would fully agree with you. But this is intrinsically different; it is leader in a major print organ pronouncing on Ireland’s relationship with our EU partners at a crucial juncture in this nation’s history and during a general election campaign when citizens are more engaged than is usual with matters politic.

    This leader purports to express what the paper believes, with which it expects its readers to agree and, if not, what they should be thinking.

    As such I believe it should not be left pass without protest.

  42. @All re the Sindo

    It gives prominence to the Neo-Con Mick McDowell – in as abject denial of PD responsibility for flawed polices on regulation and economics as Bowel Bertie – and plotting a far-roight comeback in mid-summer madness

    It provides space to a now -Tank_less William O’Dea (also in denial), who has solutions to all of the world’s ills – but who failed abysmally those of his own who had hope for some regeneration in Limerick while he was in power –

    It prints drivel from a supercilious, sanctimonious, patronising prat who has somehow obtained a Doctorate in Irish history from Oxford … sad, must be dumbing down over there …. “I’m J-P Mac – I’ve a doctorate in irish history from oxford – genuflect you servile serfs …” Blind Biddy, however, is a fan – claims that reading him is good for her ould constitution – iffen u no wat I mean ….

    To its credit, it provides space to Aristotle Eoin_een, who sadly laments the fact that on-one invites him onto TV or radio anymore ….. Ah Gowan Eoin, write another good play – you’ve done the state enough service …

    To its credit, it provides space to Colm McCarthy – who doesn’t need to bother with assholes holding doctorates in irish history from oxford ….

    have I descended to the level of the sindo yet? ‘Nuf of this ….

  43. @ The Germans

    …. that said, most of the editorial has some merit – references to the ‘national socialist’ 1930s and the beer-drinkers were uncalled for, and most unhelpful .. that said, Herr H. Schmidt has said somewhat similar re Dr. Merkel and Herr Weber recently ….

    Note that in the vote re Irish ‘bail-out’ (sic) Social Democrats supported it -only opposition came from Left Party.

    My apologies to all Germans for any offence caused by this publication – all members of the Irish Frankfurt School, and decent Irish citizens, are disgusted with such drivel ….

  44. John McHale.
    Re: Sunday Independent. I just read the editorial through your link.

    A scurrilious piece of racism both in its tone and in its hate filled content. It would not be first time a major news media organization tried to whip up zenophobia when its own economic interests were threatened. This after all is the organization that cheered for and cheerled 13 years of Fianna fail mis-rule with “Its payback time” editorial.

    I heard no demonization of the cutting of blind peoples allowances from that editor. Nor do I expect any.
    Neither can I concur that the piece would be ok, if it came from a columnist. There should be no forum for contrubutions of its kind.

  45. @Paul

    I have been thinking a lot about your exhortation to push back. I wonder, however, if there is a risk of doing more harm than good drawing attention to this particular piece.

    In a small way, I have been trying to argue for an approach that seeks to understand the valid concerns of the likely net-funders of the bailout. I say this not only because it only fair but also because I think it will be ultimately more effective in terms of getting support measures in place that can actually work. I tried to do this in a piece a couple of weeks back for the Business Post. We need diplomacy not threats. It is ironic that the Sunday Independent’s leader was supposedly advocating diplomacy, while being one of the most un-diplomatic things I have read in some time. Diplomacy, it seems, is for others.

    I know this is a weak response and am open to suggestions.

  46. @Paul Hunt/John McHale

    Well done. I encourage you both not to let up on this issue. No newspaper should get away with this.
    Whatever course of action Ireland must take, it should not resort to the racist and inflammatory rubbish of the Sunday Independent editorial.

  47. Oliver Vandt summed it up …. Godwin’s Law ..

    There is a case under International Law re incitement to racism …. I’d simply send a signed multilingual letter (glad to sign) to all BondHolders of the parent company of Irish Independent .. quietly and diplomatically… re actions of this editor.

  48. The Sunday Independent has been a broadsheet rag for many years now and anyone who continued/continues to believe otherwise really has no feel for quality journalism/comment – S.I. not to be taken seriously for many years now – ‘a quare thing indeed to let into your house’ – says the brother.

  49. Staggering. Unlike many commentators I di not hold the Sunday Independent in high esteem, but this is off the wall. Ignorant and dangerous. It does not speak for me.

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