I’d like to flag an excellent new initiative that our readers are likely to find useful. As many of you know, the Institute for International and European Affairs has played a very important role in recent years in promoting debate on European issues. The Institute has now started a blog focusing on European topics which already has a lot of interesting material. I have agreed to contribute some longer pieces there. They’ve promised to make me some pretty graphs if I ask nicely which might make a nice change sometimes from the no-frills approach we adopt here at the IE blog!
Which brings me back to an issue related to my proposals for a debt-to-equity swap for central bank loans. Some commenters have rightly pointed out that this proposal seems to give up on burden sharing with bondholders. That it does so is just a reflection of the current EU position on this issue. However, this strengthens the case for the EU becoming involved in owning the Irish bank sector: If they want the bondholders paid back so badly, then one can argue that they should contribute some of their own funds to the effort.
But coming back to the European debate on bank debt, I think the EU officials are adopting the wrong approach to dealing with this issue. I also think that the proposals adopted by the European Commission to allow haircuts on bonds that are issued in the future, say after 2013, is unworkable. For a discussion of this and an alternative approach, see this post at the IIEA site.
26 replies on “New IIEA Blog\Post on Bank Debt”
Isn’t this the organisation that published, prior to one of the recent referenda, some commissioned work saying that our corporation tax rate was not threatened by EU?
Perhaps IIEA is revisiting this, as part of an Irish reconsideration of the whole European project, which appears to be underway in other major EU states, as suggested here http://www.irisheconomy.ie/index.php/2011/03/10/northern-exposure/
These blogs and twitter (used correctly) are the internet at its best imho. I think it should be acknowledged that it is legitimate for academics to dedicate working time to these endeavours. They contribute greatly to the public discourse imho. They also re-inforce concepts and topics through the constant flow. A documentary might explain concepts but you need repetition and linking of topics for it to sink in. Again, I wish there were a similar blog of Legal Academics.
“Some commenters have rightly pointed out that this proposal seems to give up on burden sharing with bondholders. That it does so is just a reflection of the current EU position on this issue. However, this strengthens the case for the EU becoming involved in owning the Irish bank sector: If they want the bondholders paid back so badly, then one can argue that they should contribute some of their own funds to the effort.”
So are you saying your proposal is a bluff to try and get the EU and ECB to allow us to burden share with the Bondholders?
re “These blogs and twitter (used correctly) are the internet at its best imho.”
As a web developer I have to advise you the particular no-frills of this blog is fairly bottom of the barrel, its awkward to track posts, to follow conversations and threads, to edit posts, to track different conversations, to reply to an individual post, there is plenty of standard free software eg http://www.phpbb.com I and others use and have set up elsewhere.
Above of course in contrast to the high quality posts makes this an even more urGent todo for someone hintHint
“So are you saying your proposal is a bluff to try and get the EU and ECB to allow us to burden share with the Bondholders?”
No. I’m not saying that.
If it is accepted that the EU can reject out-of-hand even the most timid approaches on burden-sharing, then it is unclear what mechanism is now proposed that will oblige them to participate in a debt-for-equity swap to achieve the same end.
Surely, one feature of the current impasse is precisely the timidity of the approach. The EU insists that no retructuring/default is possible as the heavens will fall in on the EU banks. Yet this is a classic case of the ‘bank has the problem’ arising from the size of the debt, not just the debtor.
At the recent election 75% or more of votes were cast in favour of parties that were in favour of renegotiating the terms of the bailout or of altering them unilaterally. The voters spoke, but the EU isn’t listening. Maybe it believes the approach is too cooperative to warrant adjusting its position.
A referendum on the bailout, with 75% or more of voters against, might persuade the EU to negotiate in a more reasonable manner.
>>If they want the bondholders paid back so badly, then one can argue that they should contribute some of their own funds to the effort<<
We should nothing! And as long as Ireland doesn’t move on their taxpiracy any softening on the terms is out of the question at all!!!
The general continental opinion is that Ireland can’t and shouldn’t be helped with their debtproblem, it’s yours not ours! Any blackmail on Eurozone and /or membership should be rewarded by kicking them out. We will survive that!
Given the challenges you have identified that are posed by efforts to establish a regime post 2013 that would impose haircuts on senior bondholders, do you not reckon that the EU/ECB has a justifiable case for not seeking to impose such haircuts retrospectively (and in the absence of any legally-binding and judicially-tested resolution regime) before then?
@ Paul H.
Funnily enough, my argument is quite the opposite. The challenges I’ve discussed are sufficient to convince me that a transition to a new post-2013 regime probably won’t work. It may be messier but we should be accepting that some existing bank debt should be written down.
Given your US experience I expect you’re more familiar than I am with the the US abhorrence of ‘taking without due process’. Europe has always been a bit more cavalier with legislative discretion governing the enforcement and enjoyment of property rights. The US has a long tradition of judicial testing and enforcement of property rights both in addition to and quite separate from legislative provisions.
So, in essence, you are arguing for a political solution (from which the necessary legislative provisions will flow) in the classic European tradition. We are then into the usual horse-trading and, given that Ireland’s desire to haircut these senior bondholders is probably more urgent than anyone else’s, and while the ECB continues to resist such a course, what can we offer our EU partners – particularly in the northern and central core – to over-ride this resistance?
As I’ve noted elsewhere they will not be unaware that many bubble era excesses, inefficiencies, deadweight costs and profit-gouging still exist. In this context, why should they seek the consent of their voters (who, in general, consider themselves well-governed, lean and economically fit) to take actions that might threaten the financiability of their banks (some of whom are under stress, but which should be mangeable) so as to rescue the Irish from the implications of thier misgovernance?
We have been over this before. The last time you and I discussed this, you agreed with me that the Irish government should not make whole unguaranteed (emphasis, unguaranteed) senior debt owed to the Irish banks. That debt is your problem – or your banks’ problem, should your governments not be craven enough to bail them out – not ours.
Given that you accept this, it is utterly brazen for you to demand a quid pro quo of concessions on corporate tax in exchange for losses on unguaranteed bank bonds. If I steal my neighbour’s lawnmower, I am not entitled to demand that he tidy up his lawn, stop playing loud music at night, etc. in exchange for giving it back to him.
@ Paul H.
On the idea that I’m not giving regard to due process, I don’t agree. What I wrote on this topic was the following
“This approach would, of course, be more complex to implement because it requires making decisions about how to deal with depositors when the existing bonds contain pari passu clauses. However, this is not an insurmountable problem. For example, one approach to protecting depositors would be to apply haircuts to both deposits and senior bonds (thus respecting pari passu), use resolution powers to immediately transfer the written-down deposits to new institutions and then use public funds from deposit guarantee schemes to fully compensate depositors.”
The impediments to haircutting senior bank bonds are not to do with legal due process. Rather they are due to European concerns about financial stability.
On the question of “convincing our EU partners” on this issue, I’ve already conceded that, as of now, we don’t seem to have much chance of doing this. However, note that I’m not arguing the case for hair-cutting senior bonds (in the right circumstances) from an Irish perspective. I’m arguing that this is the correct approach from a European perspective.
Just because the ECB think something doesn’t mean they are adopting the best position for Europe as a whole. They have there own particular set of interests and, also, you know, sometimes organisations just get stuff wrong.
@ Paul Hunt
I find myself attempting to playing keepy-uppy with your thought process and fall behind. Help!
“We are then into the usual horse-trading and, given that Ireland’s desire to haircut these senior bondholders is probably more urgent than anyone else’s, and while the ECB continues to resist such a course, what can we offer our EU partners – particularly in the northern and central core – to over-ride this resistance?”
(1) In Senior Bondholders, do you mean guanranteed and/or unguaranteed?
(2) Assuming unguaranteed. What real power, implicit or explicit, does the ECB have to stop Ireland restructuring the debts whether it likes it or not? I do not mean, is this a good or bad idea.
(3) Are you suggesting that there must be a political quid pro quo for the state doing same? Where does the horse-trading come in?
Thank you, Karl, for this repsonse I noted, but didn’t refer to, your treatment of the infamous ‘pari passu’ issue. I think your point about financial stability is key. I suspect the ‘hard core’ (Germany, Austria, Finland and the Netherlands – with possibly the smaller new entrants) and a slightly softer core (France, Belgium, Luxembourg and Italy) believe they can manage their dodgy banks without haircutting senior bondholders. They don’t want to go down that road anywhere else for fear of the general repercussions.
If they can keep Spain out of the line of fire, it may be that they reckon they can manage the smaller peripherals as ‘wards of state’. However, unlike Greece and Portugal, we can do a huge amount that is in our own interests to fend off the possibility of default. But do we want to?
I think the continuation of my exchange with Karl may offer some clarification. There is, apparently, a side-letter to the EU-IMF deal which declares any burning of senior bondholders verboten. It isn’t pretty, but it’s what happens when you get so far off-side.
In our case, the ‘horse-trading’ involves being able to demonstrate to the ‘hard core’ that we’ve done everything we possible can, it won’t work and they’ll have to cut us some slack – even though they won’t want to.
@ Karl Whelan
As the issues are entangled, I am posting a link which answers the question that I posed about the capacity of the ECB to act in the manner that you suggest in your article in the Irish Times.
You will note in particular the comment:
“The ECB can only provide liquidity against collateral to keep the money market functioning. It has no powers to resolve a solvency crisis”.
I am afraid that you are closing the stable door long after the horse has bolted.
I don’t think you’ve actually read my article. It does not propose the ECB loans be directly converted to equity. It states the following:
“The European Financial Stability Facility could issue €80 billion in bonds, loaning these funds to the Irish banks, who would then pay off the ECB, allowing it walk away unscathed.”
maybe i missed some topics on this blog….anyway, when you affirm that “the impediments to haircutting senior bank bonds are not to do with legal due process”, you’re talking about “Anglo Irish” and “Irish Nationwide” i suppose, which are in a winding-down process…i don’t understand how you can impose an haircut on e.g. Bank of Ireland senior unguaranted bond, without causing a technical default. tks.
@ Karl Whelan
Thank you for your reply. I did read your article and with great attention. While I am no expert in the matter, my immediate reaction was that the idea was politically, and probably legally, impractical because the members of the EU, both inside and outside the euro, have already demonstrated unequivocally that they are not prepared to accept burden-sharing in the manner that you suggest (or as suggested by Daniel Gros at the start of the crisis).
Recent developments only serve to confirm this. The ECB is left high and dry with its much disputed 75 billion of government bond purchases and, while I do not understand the technicalities, it seems that Weber in his annual (and final) report on the Bundesbank, according to a newspaper report that I was reading, made some necessary financial provision for Germany’s share of the now inevitable ECB loss on them.
Furthermore, the recent “grand bargain” agreement specifically excludes a solution to even this problem via the EFSF, or its replacement, as any bond purchases are to be limited in the extreme and subject to strict conditions.
The debate on this issue reminds one of that on the supposed responsibility of the ECB to supervise the Irish financial system. It did not have the power, it does not have the power and it will not be given the power because, as far as Germany and the other paymaster states are concerned, its job is to administer a currency union rather than a single currency. What has been negotiated to reflect this reality is a rather weak Systemic Risk Board, chaired by the ECB, and a series of supervisory authorities, the efficacy of which remains to be proven.
Ireland has to face up to the fact that it is a nation state negotiating with other nation states and, while these states – within the association of the EU – were willing to assist Ireland through policies of economic and social cohesion, they are not prepared to absolve us financially from the consequences of our own mistakes. The only leeway we have is that of any debtor, the flexibility that may flow from the desire of his/her creditors to increase their chances of getting their money back. This, it seems to me, is where the focus of expert attention should be.
@ Karl Whelan
Quite coincidentally, there are two articles in today’s Irish Independent which illustrate the quintessential nature of the problem.
Emmet Oliver’s piece contains within it, one of the explanations he seeks.
“Many argue this is as it should be — the principle of senior debt remaining free from government imposed write-downs is central to the whole funding system for banks worldwide”.
There can be no argument about this. It is a fact. And the system includes the CDS market the justification for the existence of which is beyond the understanding of ordinary mortals.
The other indisputable fact is that states, and the international institutions who represent them, do not do either examinations of conscience (or nice).
The sooner all concerned come to terms with these facts, the better.
I think converting the ECB & CB debt into equity sounds like a very good idea.
Would it be possible and /or advisable to limit this action to AIB and BOI?
““Many argue this is as it should be — the principle of senior debt remaining free from government imposed write-downs is central to the whole funding system for banks worldwide”.
There can be no argument about this. It is a fact.”
I know the ‘blanket’ guarantee covered a range of situations. However, with regard to senior debt, do you mean that guaranteeing senior debt is a tautology? Did guaranteeing it then throw a spanner in the works by creating a class of ‘unguaranteed senior debt’, which I take from your post you consider to be meaningless.
If you have a moment, can you expand on whether this key ‘principle’ is an unwritten understanding, has some written underpinning or other?
“I think converting the ECB & CB debt into equity sounds like a very good idea.
Would it be possible and /or advisable to limit this action to AIB and BOI?”
Ideally, I would like to produce something more detailed that goes through the amounts of ELA and ECB funding provided to each of the banks and describes, on a case by case basis, how the debt-for-equity conversions would work.
Certainly they would work wonders for AIB and BoI. On Anglo, one could argue that we could re-write the terms of the promissory note to put in less money (though perhaps at a faster pace) than originally agreed. I know the full amount of the Anglo notes have already been added to the national debt but in practice not a cent has actually been paid out on yet.
“I know the full amount of the Anglo notes have already been added to the national debt but in practice not a cent has actually been paid out on yet.”
If they are repoed to the central bank, would that really be true?
@ Gavin Kostick
I am afraid that you will have to enquire of someone more expert than I for an answer. I was simply referring to the fact that the principle in question, as far as I can establish, is a matter of fact not argument. One way to illustrate the point would be to refer to the recent letter to the FT by Klaus Regling denying that the EFSF was a CDO.
The entire financial system seems to be built on ratings from a small group of private (mainly American) agencies. Why this should be so is a question that has to be addressed to politicians who appeared to accept it without question. Until Lehmans, that is, when they discovered that banking (and the associated economic theories) were not a black box which ordimary citizens did not need to trouble themselves with.
How wrong both were!
As far as I can see from the second Independent article, the CDS market is an entirely private operation deciding when and when not a “credit event” has occurred. To me, this seems to be comparable to talking about the Turf Club and Cheltenham except that the rulings of the Turf Club, as far as I know, are not usually for legal dispute.
With the transfer of deposits of Anglo and Irish Nationwide, I understand that the equivalence between depositers and their senior bondholders may now no longer have the same legal signficance. Maybe this is an avenue that is opening up, as the most recent posts above suggest, but this would be market forces taking their course.
P.S. I wonder if somone could work out the actual,a s opposed to nominal, rate of interest on Ireland’s EFSF loan?
Thanks for the post.
Late in the day, but Karl, by implication looked at the case of the EFSF loan here: