Here is a short article on crisis resolution strategies that I wrote for Eolas magazine. It was written before the debate over Morgan Kelly’s new resolution proposals. The piece contrasts a Plan A — involving a phased fiscal and banking adjustment, offiical assistance to cover funding shortfalls, and absorption of significant banking losses — with a Plan B that has an earlier focus on debt reduction. Morgan’s proposals — a Plan C? — combine immediate elimination of the borrowing requirement with eschewal of both official assistance and responsibility for bank losses.
101 replies on “Article for Eolas Magazine”
I expect you’re steeled for the usual assaults on your subscription to the so-called official (both Irish and EU) group-think. The principal problem, as I think you identify, is that our main creditors are either instituional, a presumably over-collaterised ECB, and official, the IMF, EFSF and EFSM which have positioned themselves at the top of the creditor pile. Even if the next round of EZ bank stress tests are ‘for real’, there is a possibility that Greece and Portugal might get some relief, via EZ bank write-downs of sovereign bonds, before us. ECB liquidity support has allowed EZ banks holding Irish bank bonds to flit our shores. There ain’t a lot left to write-down – and we’re holding the can.
One of the central planks is to recapitalize the “pillars” and make them self financing. To my mind this is doomed to failure as it is extremely unlikely that international banks will lend money to these banks. bondholder burning at AIB, even though they are subordinated, will only further damage whatever is left of their reputation. Any transactions involving counter party risk will be scrutinized to death. Therefore plan A is unlikely to work.
What about plan C?
Your phrase “With some reasonable luck ” is one I have heard you use on radio as well. And you wonder why the markets are skeptical?
This is the “strategy” that allowed the previous government to live in denial for 2 years hoping something would show up. Well it did – the IMF.
I prefer Plan B to Plan C because it does not rely on “luck”. Public spending can be cut back to 2003 levels without anyone starving though there would need to be severe cutbacks. Why is cutting costs only acceptable for restaurants, tourism, construction and traded sectors?
Is it not obscene that a restaurant owner who employs staff, buys from suppliers, pays VAT, rates and PRSI counts themselves lucky to bring in 600/week when an unfireable college lecturer with no managerial responsibilities who works part-time for 6 months per year takes home 2-3 times that?
The sooner we accept where we are, the sooner we start pulling ourselves out with our dignity intact and control of our own affairs.
I noted today that M. Noonan used the word “hope” three times in the one sentence.
Let’s hope he is relying on something more credible.
One of the things that has surprised me most about the crisis is how Ireland and the other “peripherals” came to be treated more like emerging markets than developed countries in terms of being able to sustain market access.
I suppose this was apparent early on but I did not fully appreciate the extent to which it was true. Looking back I am struck that my first contribution to the debate here began (Irish Times, Jan 26, 2009):
I was still struggling later that year to understand why creditworthiness appeared so vulnerable (and this is when bond spreads were roughly half what they are now) when I posted here, asking “Is Ireland that Different?”
What I think now I underestimated is the added vulnerability a country faces within a monetary union, where there isn’t a national central bank in control of the currency to act as an effectively unconstrained lender of last resort. Paul de Grauwe’s recent work has been linked to on the site a number of times, but I think it provides some critical pieces of the puzzle (see here). Unfortunately, the design of the ESM, including the preferred creditor issue you mention, provides a poor substitute for a proper LOLR. I would have gone into this in more depth in the article if I had more space.
What about a plan D, all the way from Finland?
The first link is, incidentally, from the Danish government EU website which demonstrates the interest the Scandinavian countries have generally in the successful work of the EBRD. It certainly leaves the EU and the IMF in the shade.
The great value of this latest contribution by John McHale is that it looks forward, not back. There is no point in debating who caused the fire while the house is still ablaze.
While not being an expert in the matter, it seems to me, however, incorrect to lump liquidity funding to the Irish banking system by the ECB with the level of sovereign debt. The first is required because investors have no confidence in the new Irish banking structure, the second is deadweight in respect of past expenditures or new ones to keep the economy going.
There are multiple balancing acts to be considered, the most important being where the balance lies between the carrot and the stick in the matter of the loans made available to Ireland. It is clear that Greece does not believe in the stick and, until the clear statement of the official position by the MOF and the MOS for European Affairs today, neither did Ireland.
The French position on the reduction in the interest rate for Ireland is, at a guess, an aspect of the decision-making in Paris described by Sarkozy’s former minister for defence in a recent book as that of a “capricious little boy” who, however, happens to be president of France.
However, the Heads of State and Government have made commitments at their March meeting to which I drew attention on another thread and repeat here.
Paragraph 17 of the conclusions of the European Council of 24/25 March.
“The preparation of the ESM treaty and the amendments to the EFSF agreement, to ensure its EUR 440 billion effective lending capacity, will be finalized so as to allow signature of both agreements at the same time before the end of June 2011″.
As to which professor is right in the Irish domestic academic debate, who cares?
“Why then are the bond markets so pessimistic about the chances of an Irish default? ”
a) anticipation of further property market declines
b) the assumption that the “what we have we hold” tendency mentioned in the same publication here:
sees the prospect of default as not their problem, not their fault and no reason to change that philosophy
c) seniority stuffing by the official funders
d) the possibility of a roll-over in global gdp.
e) the strange behaviour of paying out in full on bank bonds at the expense of government bonds and willfully failing to try bank resolution when it should have been done
f) The new guarantee issued in Sept 2010 – linked to e) above. (in addition to the one you mention in the article).
g) the fact that government policy seems to be to hang about, do what they are forced to, but basically wait for an EZ led rescheduling.
The perception is, holders of gilts are on their own. No party is, has been, or will protect their interests. They’ve been had.
We discussed Plan C a bit on the earlier thread. Just looking at the elimination of the borrowing requirement element (which requires a large enough budget surplus to meet redemptions of maturing debt), this would provide an almost unimaginable hit to the economy. As you pointed out, the funding requirement for this year (including the last month of 2010) is €55 billion, with about €12.5 billion assumed to come from reserves. The borrowing requirement is €43 billion.
I understand why you recoil at the invocation of luck, and I do see that it is awkwardly put. But what I am trying to recognise is the very high level of uncertainty we face.
Just a sample of the open questions: How will the contractionary force of impaired balance sheets weigh against the expansionary force of the export-led recovery? How much will the austerity slow the economy? What will be the additional bank losses due to impairment of residential mortgages as interest rates rise? What sort of political backlash against bailouts can we expect in Europe? Grumpy’s list above amplifies the point.
Policy thus has to be made under huge uncertainty. But this is why we need a strategy that is reasonably robust. As things stand, Plan A looks to me to be the most robust on offer, though I do think it requires moving more quickly with the fiscal adjustment. Although no one likes to call for cutting their own pay, I do agree with you that the size of the needed adjustment is such that it is wrong for better paid public-sector workers not to take additional cuts. As Karl Whelan has pointed out, however, net pay at higher grades has fallen by about 30 percent. That is not to say it is enough, but it is only fair to note that significant cuts have taken place.
Getting my plans mixed up.
The interesting proposal coming out tday is the “reprofiling” of existing with the commission’s Amadeu Altafaj saying that reprofiling would not be a default event. It would certainly help with our current debt pile. However, I not Bin Smaghi say it would not address debt sustainability (in the case of Greece?)
Is this a worth consideration?
The EFSF has re-entered the fray.
Merkel rules out restructuring of any debt but admits possibility of voluntary participation of private sector for Greece.
Press Release: IMF Completes First and Second Reviews Under Extended Arrangement with Ireland and Approves €1.58 Billion Disbursement
‘Supporting these efforts with a more comprehensive European plan would help overcome market doubts, regain market access, reduce the threat of spillovers, and bring about a recovery of the Irish economy.”
They must’a read Kelly – give the bleed1n banks to the ECB!
Nouriel Roubini has a post on Project Syndicate on this subject today
I got a tshirt from a crowd in the States today. They also sell bumper stickers. One of them was very good and reminded me of the peripherals.
Organised together, we bargain. Divided, we beg.
@ John Mchale
‘One of the things that has surprised me most about the crisis is how Ireland and the other “peripherals” came to be treated more like emerging markets than developed countries in terms of being able to sustain market access.’
Ireland was, and still is, in many respects an LDC. The high-tech FDI sector is an enclave. The structural imbalances in the domestic economy have been spectacular. The rigidities in the state and state-dependent sectors have been a barrier to adjustment. As John Mauldin might put it, ‘this was a bug looking for a windscreen’.
‘In domestic US markets, debt and equity analysts are extremely sensitive to’……unstable capital structures and will severly penalise a company whose balance sheet incorporates too much market risk…’
‘Less developed countries usuallly unwittingly design capital structures that amplify volatility. Good times, which tend to be reinforced by the typically inverted capital structure of most LDCs, seem more robust and permanent that they actually are, but when a country is affected by some external shock, the result can be devastating’
‘Towards a theory of sovereign capital stucture management ‘ in Michael Pettis ‘The Volatility Machine’ OUP 2001
@Paul Q, John McH
Its the fact that Ireland is so small compared to the core that the Euro is effectively a foreign currency. The Irish central bank is not much more than an observer and the core has no interest in devaluing, nor was there a dampening appreciation during the boom.
As a public sector employee I say this with reluctance, but the immediate obstacle facing us is Croke park.
Everything else will land where it will, but this is something immediately within our power.
Govt should be presenting a case that it is better to relook at Croke park now, rather than an end of term greater adjustment in 2014.
It will be easier for Govt to let the IMF do the heavy lifting, but this won’t be the Irish governing the Irish, more like the political cucoldery we are used too.
With respect plan A may seem like the most responsible but it is morally reprehensible and it won’t work. As far as I can see the key aspects of the plan are to a) absorb losses for banks that were managed to a level of irresponsibility that is profoundly disturbing but in doing that b) minimize the losses that these banks may suffer. That effectively means enforcing mortgage contracts for individual residential borrowers while forcing the losses on commercial mortgages (the insiders) onto those very residential borrowers.
As far as I know there are two precedents for the program. Mexico in the mid 1990’s and Chile in the early 1980’s. In both cases, the banks walked away free but the countries suffered horribly..no investment in social infrastructure, no investment in physical infrastructure, underpaid law enforcement and teachers and an abandoned underclass of destitute. Chile’s system could only be enforced with a dictatorship and Mexico effectively ceded control of it’s border to nasty drug lords.
This plan won’t work either. It is fundamentally immoral and unfair and it can only work if you can steal the fruit of labor from the next generations to rep the banks. Irelands population is mobile and they enjoy free access to a huge labor market across Europe and even the US (if you don’t worry too much about the green card thingy).. So when you insiders are finished setting up the mark (the ordinary guy) to pay your professors, economists politicians and their banker/developer cronies, you’ll find that you don’t have the population you though you did.
That’s only the beginning, you insiders are also giving away sovereignty to other that are NOT our friends. Frances demands that we lower the CGT are serious and when the time comes for us to default, they will be brutal in blaming everything on us. Do not expect any golf club “ah well you gave it a good try” type reaction. It’ll be horrible and it’ll be the fault of the banks, politicians and their lackeys.
Shame on all of you
Excellent analysis, I lived through the Mexican FOAPROA (Google it if you are really interested in what Ireland will see). I am still living in Mexico over 15 years later. It’s just one happy picnic. My ancestors left Ireland over 100 years ago and I have been back numerous times. I find the Irish and other periphery of the EU fascinating case studies. In the coming years there will be massive migration from Ireland. It is the only real answer to a very old problem.
If you think your European brothers are going to bail you out, you may wish to read a little history. Humane nature has not change one iota.
Strongly put. But if you are going to argue so strongly against Plan A, then it would be good to see the positive case for the alternative given the situation we face now. It sounds like you support some version of Plan B, with an emphasis on imposing losses on bank creditors.
Starting with the easiest one, would you impose losses on unguaranteed seniors in Anglo/INBS.? What is your reading of the likely impact ECB/EU support? Is the roughly €4 billion worth the risk at this stage?
Moving on to senior debt in the main banks, around €12 billion. Depositors currently have an equal legal ranking. Would you also impose losses on depositors? Through what legal mechanism might you use to impose losses on seniors while sparing depositors?
Then we move to the State guaranteed bonds, around €16 billion. It would be good to see your cost-benefit calculation in regard to reneging on the guarantee, with due regard to the uncertainties that we face.
It is too easy to throw stones.
@grumpy & Paul Quigley
The smallness of Ireland does indeed seem to be a problem. Given that we are part of the euro zone, earlier in the crisis it wasn’t obvious to me that this would be so. We could borrow from a large market in our own currency with no exchange rate risk — not the situation that faces the typical emerging market. Our smallness meant we were always a tiny part of any portfolio, and I would have thought this would have led to fairly flat demand curves for our bonds over the relevant range. Except maybe for the very biggest countries, grumpy’s point about our central bank being an observer when it comes to setting monetary policy is not limited to the very small. It would be good to hear more thoughts about why a small country is especially vulnerable within a large monetary union.
This is emerging as one of the more thoughtful and enlightening threads on these issues. I can understand why passion is aroused on occasion, but it won’t inform rational decisions. Grumpy highlights a number of salient factors. They could probably be grouped into three categories – government decisions taken in response to a perception, but not knowledge, of the requirements of external forces, government decisions (or failures to make decisions) in response to clear external instructions and reflexive, instinctive decisions made by various segments of Irish society. But we are now at a point where all the key decisions will be made externally. The risk is that popular opinion will turn against adjustments and reforms being demanded by the Troika, not because they are not in the broad public interest, but becasue they are being imposed ecternally. It will prove impossible demonstrate the extent to which these reforms are very much in our own interest – and not in the interests of the external parties. And deeply entrenched vested interests will be able to play on the loss of sovereignty and contend that the refroms are really in the interests of external parties.
Media reports suggest that the non-EU members of G20 are putting pressure on the political and institutional EU to sort out this mess. It is fundamentally a political decision. The smaller new members (Slovenia, Slovakia, Estonia) have demonstrated a willingness to do what it takes to stay in the EZ. The real core (Germany, France, the Netherlands, Luxembourg, Austria and Finland – with Sweden and Denmark as very closely aligned non-EZ members) has to decide how much political capital and treasure they are prepared to expend to cut the smaller peripherals some slack to ensure their continued membership. And this decision will also need to take account of the fact that Belgium, Italy and Spain will have to be indulged.
Voters in the core perceive themselves as being well-governed (France is always a lwa unto itself). And as they cast their gaze towards the periphery to see expanding cricles of increasing misgovernance (despite the fact that the extremely deficient governance and regulation of many of their own banks is being hidden from them). It is truly a dog-eat-dog world and, rather than aligning in solidarity with Portugal and Greece (and potentially Spain), we should be doing everything to differentiate ourselves from them in the eyes of voters in the core. And we are different, not only because we have a potentially viable sovereign bolted onto a huge malfunctioning banking system, but because we are now significantly better governed.
And we need to do much, much more in terms of structural reforms and reforms of political governance. The day may come when the core will be forced to choose amog the smaller peripherals. We want to be on the right side of that call.
On a seperate issue. fitch have upgraded Iceland to Stable from a lowly negative. They burned the bondholders and refused to repay debts of the banks to Holland and the UK. Yet you and many others advocate debt slavery for decades.
Iceland has been placed on stable, at junk level. And it’s likely to stay there for at least 2 years, per Fitch. And that was even after the ability to annihalate their currency and enforce capital controls, whilst not being members of either the EU or Eurozone, and then will still likely agree to repay $4bn to the UK and Netherlands, a per capita amount that would equal about $55bn for Ireland.
So yeah, they were faced with the same constraints as us and did so much better….eh, no, actually thats not the case….
As @Eoin says, it is not so much an upgrade, as the lack of an imminent downgrade. Or are you a rate of decline in the second derivative improving man?
Lucinda Creighton today said that Colm McCarthy has spoken in favour of accelerating the adjustment.
That is Morgan Kelly, Colm McCarthy and the ESRI singing off similar hymn-sheets. Might we have a new anthem for FG?
There does not seem to be any specific analysis on the effect of these accelerated cuts. Brian Lenihan previously said he was very reluctant to increase austerity from €4.5bn to €6bn. There now seems to be a growing consensus that the cuts should be accelerated further.
The size of Ireland (and Greece and Portugal) is actually a huge advantage .Their indebtedness ,frightening in relation to their own size, is actually small compared to the EZ GNP. It is therefore possible ,economically as well as politically for the large countries to do something meaningful in their favor .If Spain needed the same kind of help ,that would be the end of the EZ, with cascading defaults that would destroy the world financial system .That eventuality seems to be less and less probable ,but it did not look that way a year ago.
Why then are the bond markets so pessimistic about the chances of an Irish default?
I suggest that you need to consider the political context for an answer to all this. Economic analysis (even excellent economic analysis, such as you demonstrate again in this article) should not be considered in isolation, but has a political context. The pessimism is based, not on study of the nitty-gritty detail of how the Irish economy is performing, but on the belief that those advocating default will eventually triumph politically in Ireland.
Based on economics alone, there are no grounds for being pessimistic about the chances of an Irish default. Ireland’s deficit is about the same as the UK and US deficit. But, unlike them, Ireland has a balance-of-payments surplus. The debt burden is about half what it was in the 1990s, when there was no default and not even a suggestion of default. And, as even the IMF say today, competitiveness is rapidly improving, exports are growing, and the agreed program is on target. In fact, the IMF go further and say the agreed program is off to ‘a strong start’ (link below). Actually, so far in 2011, the December 2010 budget targets are being more than met, with tax revenues up to April 1 per cent ahead of target and public expenditure 2 per cent below target. In addition, and in marked contrast to many EU countries, and not just the Mediterraenean ones, the cuts implemented so far in Ireland have been accepted by the public with a minimum of fuss. Much to the chagrin of most posters on here, there have been no strikes, no disruption, no street protests, no riots, nothing (at least since May 2010 when Fintan O’Foole led a Mussolini-style march on the Dail, which attracted a crowd of at least a dozen people).
However, all this is not what investors abroad read about Ireland. The Irish media and the international media reporting on Ireland has been handed over lock, stock and barrel to crazies advocating extreme courses of action. Why shouldn’t investors abroad be pessimistic about the chances of an Irish default, when all their ‘information’ on Ireland comes from the likes of McWilliams, Kelly, Gurgdiev? There are sane and intelligent economists in Ireland, such as John McHale himself, Seamus Coffey, Jow Dowling, Antoin Murphy. But, with all due respect, how many appearances on Bloomberg or interviews in the Wall Street Journal have they clocked up, in comparison with the crazies? It is reminding me more and more of Belfast in the 1970s, when the crazies were the only people the media were interested in, and the sensible voices were drowned out. This media dominance is leading investors abroad to believe that the crazies are much stronger in Ireland than they actually are and that, eventually, the Irish government will be forced to bow to their demands, regardless of the economic merits of doing so.
There has always been a strong body of opinion advocating more rapid adjustment so as to move to the recovery phase more quickly. The Government still retains considerable sovereignty in this area, but I would still argue that the initial focus should be on reducing the cost of living (where public sector and semi-state charges, fees and payments have a huge impact). Increasing real, disposable incomes across the board will allow for a more equitable imposition of the required, accelerated fiscal adjustments. Going head first for fiscal adjustment without doing this will rip the economic, political and social fabric of society.
“It is therefore possible ,economically as well as politically for the large countries to do something meaningful in their favor.”
Indeed. But what do you think they would wish to get in exchange? I think the structural reforms followed, and accompanied, by the fiscal adjustments I suggest above might work, but do you have a view?
I think you’re overplaying the influence of the ‘crazies’ as you label them. We still have a huge malfunctioning banking system with a viable sovereign bolted on that together are in hock to official and institutional lenders for an amount that could come to €225 bn. Yes, €140 bn of this is probably over-collateralised, but can’t be realised immediately and €85 bn requires deep and rapid fiscal adjustments being implemented so that it isn’t fully used and non-official lenders will feel comfortable advancing funds at a reasonable cost. This a tall order irrespective of how much one might highlight the preformance of the well-functioning parts of the economy.
Thanks for all the excellent comments. I am sorry that I have only time to respond to a few, and none in the depth required.
Just to pick up on one of your points. You write: “The risk is that popular opinion will turn against adjustments and reforms being demanded by the Troika, not because they are not in the broad public interest, but because they are being imposed externally. It will prove impossible demonstrate the extent to which these reforms are very much in our own interest – and not in the interests of the external parties. And deeply entrenched vested interests will be able to play on the loss of sovereignty and contend that the reforms are really in the interests of external parties.”
I’m afraid I agree it will harder and harder to sustain political support for what can presented as an imposed solution. This is one of the reasons I keep banging on about our loss of creditworthiness. The real loss of decision making room has resulted from being stranded with a massive deficit and no access to international credit markets. The availability of official credit has saved a massive fall in living standards. I know some people believe that it is only the public sector and those reliant on public transfers/services that would bear the cost of fiscal cold turkey, but this is nonsense given the recession that would follow, not to mention the inevitable tax increases. Although it is much more fun to rail against our new “overlords,” responsible real-world policy makers have no choice but to keep one eye on retaining official support. Arthur Beesley has a nice piece today on German bailout politics: http://www.irishtimes.com/newspaper/world/2011/0517/1224297117482.html
I don’t think it is right to lump what Morgan Kelly is proposing in with what Colm McCarthy and the ESRI are proposing. Cutting the borrowing requirement (including bond redemptions) to zero is so far off the charts — €43 billion this year even after allowing for the use of State cash — that it is really quite a different animal.
Given that the programme is not succeeding in bringing down yields, I do see an advantage in sending a strong signal on adjustment capacity. The main negative event since the programme has been the developments in Greece, including doubts about their capacity to meet commitments and their need for another bailout. As Paul Hunt says, we should be doing what we can to differentiate ourselves. Being able to go beyond what we have agreed to would be a valuable signal at this stage.
Thank you for the kind words. I am surprised you are so patient with me given that I always seem to be pushing back. Thankfully, I think you exaggerate the role of negative commentary here, even if it sometimes seems to reflect broader national beliefs about default. With real money on the line, market participants make up there own minds. If Irish paper offered such obvious bargains they would be picked up. We have to go a bit deeper to understand why we lack creditworthiness, which I believe results from interactions between doubts about debt sustainability and the nature of the (evolving) crisis resolution mechanisms that are being put in place at the European level.
@ Paul Hunt
I would agree wholeheartedly with your contributions above, notably the following.
“It is truly a dog-eat-dog world and, rather than aligning in solidarity with Portugal and Greece (and potentially Spain), we should be doing everything to differentiate ourselves from them in the eyes of voters in the core. And we are different, not only because we have a potentially viable sovereign bolted onto a huge malfunctioning banking system, but because we are now significantly better governed.
And we need to do much, much more in terms of structural reforms and reforms of political governance. The day may come when the core will be forced to choose among the smaller peripherals. We want to be on the right side of that call”.
This comment goes to the very heart of the matter. My only quibble would be with the idea that we are better governed. There is better governance in the regulatory area, of that there can be no doubt, but there has been little perceptible improvement in the performance of the political system.
The IMF appraisal is helpful but the comments about how the “jobs initiative” is to be funded are surely ones that will have raised eyebrows as it suggests a blindness – and technical incompetence – in relation to the wider implications for the perception of the future creditworthiness of the country.
As I remarked on another thread some time ago, all the trains are meeting in the station at the June European Council (Friday 24 June) and someone had better be in charge of the signalling. Unfortunately, there is little evidence of this with the chief person responsible, Angela Merkel, indulging, in what has now become a pattern of behaviour, various iconoclastic interventions to show that she is still the boss in Berlin when all the evidence is that nobody is actually in charge.
However, the EU is at its best when confronted by unavoidable choices. (A recent example is the manner in which the EFSF resurfaced in the aid package for Portugal, a step which eased the position of Cameron with regard to his own domestic constituency).
The two most egregious errors made by Merkel were summed up by Wolfgang Munchau in the following terms.
“Two big policy errors have aggravated the situation, both at the behest of Angela Merkel. The first was the German chancellor’s promise that there would be no default on existing bonds until 2013, the second was the decision to rule out secondary market purchases by the ESM and, by extension, the current rescue umbrella as well. The combination of those two pledges logically implies that the EU has only a single policy tool at its disposal until 2013: continued bail-out linked to continued austerity”.
It seems to me that there has to be some reversal of position by Merkel in relation to the first under the pressure of events from Greece and it remains to be seen what will emerge in the formal treaty language establishing the ESM with regard to the second.
There remains the question of what can Ireland bring to the party?
As reported by Arthur Beesley in today’s IT; “Without naming France or Germany, Mr Noonan said “some individual countries” were looking for further conditionality from Ireland in return for a rate cut”. In another comment piece, he says; “Certain Germans still profess astonishment that Taoiseach Enda Kenny offered “nothing” in return for a bailout interest rate cut on the night he went to battle to Merkel and Nicolas Sarkozy over corporate tax. Months later, the matter remains unresolved”.
There can be no doubt in my mind that this time round, there has to be a clear indication, of some kind, of acceptance of the reality of the Irish situation as you have outlined it for the unavoidable reason that this is how it is perceived by “in the eyes of voters in the core”, to take your phrase, who see themselves with full justification as our creditors and who are also taxpayers.
Thank you for your response and thanks for the IT link. Arthur Beesley has provided an excellent service in his reporting on the institutional and political EU. I’m sure it’s a major source of angst for many Irish that our future well-being and prosperity hangs on political manoeuvrings in and around the corridors of power in Paris, Berlin, Frankfurt and Brussels, but the entire EU has been developed on the basis of political haggling and horse-trading.
What I found interesting was the reported German surprise at An Taoiseach’s failure to put anything on the table that could be used to justify an easing of the terms of the EU/IMF support package.
I keep banging on that Ireland needs to move away from this ‘low tax/high ‘point-of-use’ charge’ model. (For example, we have excessively high ‘point-of use’ charges for electricity and gas because successive governments, in pursuit of a low tax policy, failed to invest directly in these businesses as the demand for investment increased enormously. The burden was placed on final consumers to finance the government’s share of the investment up-front and then to pay for the return on, and full recovery of, all the investment. There is no end of other examples where governments imposed excessively high costs and charges on consumers to avoid financing these activities more efficiently. The cruel irony is, that by starving these businesses of direct shareholder equity, the outcome was gloriously inefficient and imposed deadweight costs on consumers and the economy.)
The Government could and should make specific commitments on changes to this model. Not only would it be massively in our interests to do so in terms of reducing the cost base of the economy, it would also help to deflect the French fetish on the CT rate and present a ‘tax/direct charging’ model that is more compatible with the EU consensus.
The utlimate irony is that this would not be a concession – it would be massively in our own interests – but it could be presented as such. It wouldn’t be guaranteed to evoke the required concessions, but it would be far better than signalling a desire to die in the last ditch to protect the current CT rate.
But imagine the furore the various entrenched vested interests would make.
I do not disagree with what you say, but what you say doesn’t wholly answer John McHale’s question: “Why then are the bond markets so pessimistic about the chances of an Irish default?”
In honour of Her Noble and Gracious Majesty’s visit to Ireland, let me do a comparison between Ireland and the UK. All the things you say could equally well apply to the UK, where I believe you live (and where the numerous partitionists on this site will say I live). Yet, the bond markets are not at all pessimistic about the chances of a UK default. And interest rates on UK bonds are a fraction of those on Irish bonds. If this differential was based on economic factors, there would be no grounds for complaint, and the only solution would be to proceed as fast as possible with the reforms you suggest. This should still be done, of course, as I have never been opposed to your suggestions for reform, but I still insist that the pessimism that John McHale refers to is based on more than economic factors. Coming from north of the border, one quickly learns to never ignore the political context, regardless of the subject being discussed. Based on economic factors alone, interest rates on UK bonds should be higher than those on Irish bonds – because:
(a) Ireland’s (harmonised) inflation rate is much lower – 1.5% in Ireland in April versus 4.5% in UK in April (the UK April figure was published just a couple of hours ago and showed an increase from 4.0% in March to 4.5% in April). And, in addition, this much lower inflation rate in Ireland has now lasted 4 years and seems likely to last many more. The Bank of England are forecasting UK (harmonised) inflation to hit 5% in coming months.
(b) Ireland is in balance-of-payments surplus, the UK in deficit.
(c) Ireland’s budget deficit is about the same as the UK’s and projected to fall at about the same rate.
(d) Even after throwing in absolutely eveything, Ireland’s debt to GDP ratio is very similar to the UK’s.
(e) Ireland’s GDP growth rate has been higher than that in the UK in 41 of the last 52 years, and most of the years when it wasn’t were in the 1980s when North Sea Oil was coming on stream. North Sea Oil is now running out.
(f) Political and street resistance to cuts in spending is much higher in the UK. As I said above, there has been virtually no street or workplace resistance to cuts in Ireland. In Q4 2010, the number of days lost to strikes in Ireland was 27 (link below). Not 27 hundred, not 27 thousand, not 27 million, but 27 – less than the number of posts on this thread. In contrast, in the UK, there have been numerous strikes and riots. I myself, as an innocent bystander on a night out, narrowly avoided being decapitated when the rioting mobs, protesting against the cuts there, reached Leicester Square back in April. There has been nothing like that in Ireland.
Based on objective economic analysis, the most likely scenario is that much higher UK inflation will result in continued devaluation of the £Sterlling v The Euro, for which UK bond purchasers should be getting higher interest rates as compensation, not lower ones that add to their inflation-driven sterling-devaluing losses. The other factors I mentioned above strengthen this argument even more. Yet there are no shortage of mugs in Ireland, willing to but UK bonds at 2%, when inflation there is 5%, while turning their noses up at Irish bonds yielding 10%, when inflation here is 1.5%. Don’t tell me that the media hysteria being orchestrated by the likes of McWiliams, Kelly and Gurgdiev is not a factor in such perverse decisions.
As I have posted many times, I prefer my own advice in these matters, and have gone in the opposite direction. As a result, my savings (in Irish bonds) are raking in a fantastic real interest and growing at an exponential rate, while all those who moved their savings from Ireland to the UK are getting a derisory interest rate, and based on today’s UK inflation figure, almost certainly a continuing currency depreciation loss on top. While I grow rich, they are growing poor. The only thing that can reverse this is if the McWilliams/Kelly/Gurgdiev alliance triumphs politically.
If Her Noble and Gracious Majesty has any sense, while on her visit to Ireland, she should divest herself of all UK bonds, currently yielding 2% against an inflation rate approaching 5%, and buy Irish bonds, currently yielding 10% against an inflation rate of 1.5%. If she does that, she will me mega-rich in a few years time, the future of The Monarchy will be assured, and JTO will be knighted for having suggested it to her.
An interesting link in the present context, especially the reference to Ireland weighing on CDS spreads for Danske Bank, which would tend to bear out the thesis of JTO. But the culprits are not just the celebrity economists. The new government has still considerable ground to make up after an inauspicious start in Europe. It is not yet clear that this message has sunk home.
John McHale: “It would be good to hear more thoughts about why a small country is especially vulnerable within a large monetary union.”
One ingredient is the success of the doctrine (which you evidently adhere to) that a state is liable for the debts of its main banks, even if there isn’t a formal guarantee in place. That idea isn’t especially damaging to the credit ratings of countries such as Australia and Canada, which have currencies of their own and banks of reasonable size. For a small country, with big banks, in a monetary union, it’s a lethal notion.
Why should enda have bothered to offer anything. He had a “mandate” to renegotiate and nothing at all to back it up. Even he must have realised he was just going through the motions for the audience in Ireland. Not offering anything was probably code for ” look, we all know this is a charade so can we try to keep a straight face and get on with it”.
If they thought he meant it, arriving with neither carrot nor stick they would have probably laughed.
The Merkel no default thing really has quite a bit to do with the anti “locusts” PR campaign of a couple of years ago, plus, I repeat, Hugh Hendry just winding up the “champagne socialists” as he call them, a bit too much – and too publicly. I really do think it is as small and petty as that.
I have only one word to use in response – sovereignty. The UK retains sufficient sovereignty to go to its own hell its its own handbasket. Ireland as a small open regional entity within a huge currency union abused the little it had and now has even less. The extent of institutional bank liquidity and official fiscal support is enormous, is at the whim of political forces in the EZ core (which are finding great difficulty deciding how much political and treasure they should expend) and is frightening away non-official lenders.
Whatever about relative inflation rates, household cost of living is 20% higher than the EZ average. As one German economist observed to me recently: “Your cost of living is very high and pay is high to cover this. You can’t expect us to finance this.”
When looking at the Irish politics it can seem like strange things are going on:
-the details of the EU/IMF rescue package became an election issue. I’m not quite sure how that could happen, I’d have expected that to have broad political support over party-lines before aid was being asked for. If it didn’t have broad political support across party-lines then it should not have been asked for before an election, if it did have broad political support across party-lines then it should not have been an election issue. I have to admit I don’t understand this.
-the CT. Again I’m surprised about the politics. Trying to gain political points at home and the price paid is losing political points abroad. Increasing the CT or closing down the ‘double Irish’ would both generate revenue and gain goodwill with creditors. Doing neither puts an adjustment somewhere else and by making an issue of it, it also generates bad will.
Still, I’d say Ireland is doing many things to improve the situation. It will take time before the current situation is resolved. Would it be possible to get to see an updated ‘An Bord Snip’ report where the status of recommendations are written?
It would be interesting to see for each recommendation either:
-being implemented, the timeframe for implementation is….
-not being implemented because….
“One ingredient is the success of the doctrine (which you evidently adhere to) that a state is liable for the debts of its main banks, even if there isn’t a formal guarantee in place.”
This is false, as I am fairly sure you know.
I agrgued strongly for a proper resolution regime to be in place to allow loss imposition after the original blanket guarantee expired.
But one thing I do try to do is to recognise realities: significant bond debt is guaranteed under the ELG; we still do not have a SRR to protect depositors; and we face de facto condtionality in regards the senior debt. Please do not attribute views to me that I do not hold and have gone to considerable pains to argue against before that particular bandwagon began to roll.
Jake watts and John McHale,
I don’t know what letter I would put on a plan, but I find it objectionable that you argue that a there are very few bondholders to burn anyway and b depositors stand equal to bondholders, it’s the law…well guess what nobody worried about the law when all of this rubbish was foisted on us. There is a difference between bondholders and depositors, we have a deposit insurance scheme for depositors we don’t have one for bondholders isn’t that different?
We need to a) draw a line under the bank liabilities we will absorb and that may mean backing off some of the promises we made, but better that the breaking our promise that we would pay our debts b) get out from the IMF EU package by finding alternative sources of financing. It is shocking to me that the government not only haven’t bothered to try to find other sources of finance, but they gave away the only source of liquidity they own ( the 17bn pension assets) that would have given us time to find alternative methods of funding.
Ireland is a small country and that is both advantage and disadvantage. We are bullied by the larger ones (France and Germany) to bee the fall guys for the whole system, that is a clear disadvantage. BUT our 100bn or so in finance needs are small compared to the trillions in derivatives that are out there.thing to stop Ireland buying a CDS on it’s own debt or on Greece’s debt (it’s immoral but it is allowed and when EU politicians say that its allowed, why shouldn’t we take advantage of that? Ireland’s diaspora is another source of funding, there are only 4m in the country, but there are millions more abroad. We need to tap them for funding. the point is we need to find a way to a) limit the egregious liability and b) set up alternative sources of funding. When we have those things we will have the ability to set our own agenda.
Why not force pensions assets into Irish bonds now? That’s what chile did in the 1989’s and that is what Hungary etc are doing now…you are all being too passive and when anyone criticizes your plan Ayou try to draw them into detailed discussions of “which sacred law would you break to let this happen” when you plans have broken so many laws and they have given away Ireland’s sovereignty already.
I think there was, and is, a German political willingness to offer some concessions, but they need some solid evidence of Irish reforms that would make us more EU-compatible and that they could wave before their voters.
And you may be going down the Sir JtO road by attributing more importance or influence to comments from a player or commentator than they deserve. I think there is enough in the public domain to suggest that senior German politicians and officials are pretty angry about the damage rampant Anglo-Saxon financial capitalism was done to their Rhineland capitalism model – and they are determined to enforce remedies eventually.
@John McHale I argued strongly for a proper resolution regime….
My apologies, I had forgotten that.
“It would be good to hear more thoughts about why a small country is especially vulnerable within a large monetary union.”
The short answer is: it isn’t.
Small countries are vulnerable in general, not in the specifics of a large monetary union. They are always in a de-facto monetary union when it comes to external borrowing and have too small a domestic base to fully fund themselves in time of need (there is too small a pool of sheep to provide funding, there is likely herding resulting in everyone going bust at the same time – in short, when funding is required, nobody has any money).
So small countries are exposed to business cycles far more extremely than larger countries – they will do better and worse in turns. They must pick an international reserve currency to function in – it makes sense that this is the currency of their largest markets. They are effectively pegged to that currency and usually there is an advantage to being so.
The serial experience of small countries is to go bust in a downturn as they try to implement big country policies of sustaining aggregate demand with no money (reserve currency) to do so…
Seems to me that the Germanic model created a banking system with chronically low profitability for a very long time and those very banks went out into the world lending up a storm to the riskiest borrowers in an attempt to raise those pathetic returns.
German politicians may decry the Anglo Saxon model, but the motives of their executives are clearly aimed at minimizing the bad debt consequences of their own banks’ horrible capital decisions. This is a zero sum game, the more we absorb, the less they will have ..this is a dog fight and make no mistake about it
I agree. The core EZ banking system needed a real shaking up, but not the one it got. And I also agree about the dog fight. The only thing we can appeal to is what ever limited amount of political desire remains within the core EZ members to shore up the EZ and retain its current membership. I believe this remains quite strong, but it requires strengthening via binding commitments and actions by the peripherals.
One can only hope it’s being developed along the lines of..”We need this from you in order to able to sell these concessions to our voters.” and not “Mr. Kenny, it’s been some time and we haven’t received any further proposals from you on what you are going to do about your CT rate.”
And we only avoid that second one if we show some cajones and stand up for ourselves. We are doing a very very poor job of that so far
I don’t think you’ll find many on here that has argued against any form of bank resolution regime. While the mechanisms may be debated, the actuality of a regime is almost universally desired.
That it still hasn’t been delivered makes one wonder – if it did exist, it would probably have to be used. That doesn’t suit the meme of retaining Oirish banks in Oirish international share ownership.
@ John McHale
‘It would be good to hear more thoughts about why a small country is especially vulnerable within a large monetary union’
The issues around the design of the EZ, Optimal Currency Area, lack of fiscal transfers and domestic politics of the core states have been threshed out at length on this board. Meanwhile three sovereign players have been stretchered off. The casualties have some common vulnerabilities, but are dissimilar in other ways.
With all due respect to your expertise, history matters. One of the great sustaining myths of the US is Henry Ford’s ‘history is bunk’, but the Chinese are playing a longer game Reading someone like Fernand Braudel on the Meditrerranean economy gives a terrific feel for the way in which the wealth of metropolitan centres is accumulated, and dissipated, over centuries. ‘The Wealth of Regions’ Mario Polese’ (U Chicago Press 2009) is an enlightening overview of regional economics, including some of the dynamics of wealth accumulation and wealth attraction.
We all learned in primary school long ago that Ireland had no coal or minerals and was a food basket for Britain. Joe Lee examined the question of our relative performance compared to other small European states, in ‘Ireland 1912-85’. It seems we went into some cul de sacs that the Danes, for example, took care to avoid. But my impression is that they had yeoman farmers, strong local markets and supportive banks. Many native Irish their eggs to the gombeen man, while our banks sent our savings to London to be invested elsewhere.
History will record that the strategy of attracting FDI yielded far less profound results than was imagined at the time. We cannot go beyond the limits set by the past, without first understanding what they were. Otherwise we will surely suffer the fate set out by bklyn_rntr above.
That’s fighting talk.
Actually, wasn’t thinking about Ireland specifically there – more the partial explanation of the 2013 date and the question “so why not now?”
Note the EU decision of CDS last week, my word that was kept quiet.
Stir in a bit of ‘Hugh the Subtle’ on Newsnight openly taking the mickey out of the EZ politician who characterised the original bailout fund as an “anti-speculator mechanism”: this is a short clip;
The French economy is addicted to public spending ,the German economy is addicted to export surpluses, the Irish economy is a victim of several addictions .One of them is private indebtedness (fueled by the low EZ interest rates) which had disastrous consequences (overpriced housing, oversize banks with under brained bankers ,corrupt politicians etc.).Another addiction is the dependence on multinationals enticed by the low corporate taxes .Long term, it is a disaster because this dependence discouraged everybody to do what was needed to create large and medium firms with Irish shareholders, Irish center of decisions and a sustainable income repartition .One of the effects being that the rest of the EZ is mad at you because it destroys their own tax base. Like any addiction it is very difficult to cure because export surpluses are the only bright spot in your economy and those exports are completely dependent on those multinationals .This your partners can understand and can probably accept to delay any return to normalcy for several years if your government asks for it. But this is not what it is asking for. It has boxed himself in a position where any change to the status quo will appear to be a major set-back even though this status quo is clearly detrimental to the long-term prospects of Ireland.
@hoganmahew I don’t think you’ll find many on here that has argued against any form of bank resolution regime.
My earlier comment wasn’t related to bank resolution regimes, as such. The question posed by John McHale and my suggestion as to part of the answer is repeated below, with my offending parenthetical remark deleted:
J McH: It would be good to hear more thoughts about why a small country is especially vulnerable within a large monetary union.
Me: One ingredient is the success of the doctrine that a state is liable for the debts of its main banks, even if there isn’t a formal guarantee in place. That idea isn’t especially damaging to the credit ratings of countries such as Australia and Canada, which have currencies of their own and banks of reasonable size. For a small country, with big banks, in a monetary union, it’s a lethal notion.
@ Overseas commentator
We discussed your point of view on the matter of the Irish corporation tax rate on another thread some time ago and I do not intend to repeat the various arguments. I do, however, wish to draw attention to the curiously paradoxical situation which has now arisen.
A short summary: neither side is willing to budge for purely political reasons but with the weight of both the economic and legal arguments being clearly on the side of the Irish position. As the EU has made no agreement binding on its member states with regard to direct taxation – other than the application of the general rules of the treaties in relation to non-discrimination etc. – no member state can be obliged to do anything in this area. And linking the issue to areas where such agreements do exist, indeed to the deepest area of integration, that of the creation of a single currency, is totally unacceptable and foreign to the EU method of doing business.
Whether it is wise to put so much faith in FDI is another matter but that is a matter for decision by Ireland.
Now to the paradox! The anomalous treatment of Ireland is becoming more evident with every additional change to the Greek – and Portuguese -bailout packages. The core creditor countries are not making these changes because they are fonder of the Greeks and the Portuguese than the Irish but because they think they have no choice in the matter given the weakness of the Greek and Portuguese economies.
They do not have that fear about Ireland. They are, in practice, pushing Ireland in the direction that the political establishment should be taking the country in the first place. In short, they think we can get ourselves out of the fix that we are in and are inviting us to get on with it.
Please help me out with the maths behind your comment that Ireland has less of a debt burden now than in the 1990s. You say:
“Based on economics alone, there are no grounds for being pessimistic about the chances of an Irish default. Ireland’s deficit is about the same as the UK and US deficit. But, unlike them, Ireland has a balance-of-payments surplus. The debt burden is about half what it was in the 1990s, when there was no default and not even a suggestion of default.”
According to the NTMA, Irish government debt/GDP topped out at 96% in 1991 as compared to 94% in 2010 ( http://www.ntma.ie/NationalDebt/debtGDP.php ). So in the coming years it is clear that we will see some debt/GDP figure, the eventual size of which is debatable, but will be in excess of 100%.
Given that taxpayers need to pay off their own debts as well as the government’s, we also have to include the household debt burden, which has increased dramatically since the 1990s. Residential mortgage debt alone has increased from €3,315 per capita in 1995 to €33,105 in 2009 according to the ESRI ( http://www.rte.ie/news/2011/0308/esri.pdf pg 77 ) – if Wikipedia’s GDP per capita figure for Ireland of $37.7k is correct, this increase in mortgage debt represents an additional debt burden of more than 110% of GDP [(33.1k-3.3k)/(37.7k / 1.42)] that the country didn’t face in the 1990s… so on my maths the debt burden is Ireland is at least more than double what is was in the 1980s (before you account for corporate debt, credit cards etc).
Oops – last line should read “double what is was in the 1990s”, was overly nostalgic by a decade.
@Overseas Commenator (& Jesper),
Your observations from the outside are perceptive, but, perhaps, not too many here are willing to heed them. The government is formed of two factions representing two broad sets of interest groups that frequently compete, contest and conflict. The last functioning version of this combination in the mid 1980s totally failed to get to grips with the (then much less severe) economic challenges it was confornting. Nobody wants a repeat.
They are still politically prodding and probing each other. They have the potential to develop a very effective sado-masochistic politicial coupling. “You can have a swipe at one of my sacred cows and then you’ll have to allow me to have a swipe at one of yours.” But we’re still only at the foreplay stage.
Timing and reciprocity will be everything, but they fail to recognise it isn’t enough to get it off before a domestic audience. They now have a very discerning audience of senior politicians and officials in the core EZ economies. The moans and whimpers won’t do anything for them; they want to see some real physical action.
@ John McHale
‘It would be good to hear more thoughts about why a small country is especially vulnerable within a large monetary union’
I don’t know but I bet the Greeks do. I see though that they have found a friend in Mr Junckers.
There is a comment for you stuck in moderation.
Personally I find your last post disturbingly summoning up images of Joan Burton and Richard Bruton in fervered negotiation is the candidate for moderation.
Thank you joseph
“”Restructuring, rescheduling – off the table,” French economy minister Christine Lagarde said late yesterday after Mr Juncker had hinted at a “reprofiling” of Greek debt, a way of extending the maturities on its loans without going through a more fundamental restructuring process.
“A restructuring or a rescheduling, which would constitute a default situation, what we would call a credit event, are off the table for me,” she said.”…………………
…..”If a “reprofiling” or “soft restructuring” is done in coordination with bondholders, rather than forced upon them, it would not trigger what is called a “credit event” and would therefore avoid the prospect of insurance contracts on debt having to pay out, analysts say.”
They are obsessed with large gross notional figures for the CDS market, when the net is fairly small and as they admitted last week, largely used for hedging. Their determination to undermine what they see as locust speculators has warped and twisted their whole approach to the debt crisis.
There’s a great quote in “down to the wire” about the challenges of resolving crises such as the one Ireland is in.
“The future will be be something like a quadratic equation that requires similtaneously solving a series of problems correctly in order to arrive at the overall right answer. Our situation does not have to end in catastrophe but it certainly will unless we act soon to recalibrate economies, political systems and personal expectations..”
I agree that they may be excessively focused on the ‘locust speculators’, but there must also be some genuine fear about the potentially unknown implications of triggering a ‘credit event’.
In any event, there will be nothing for Ireland in whatever might transpire for Greece (or Portugal). So far as the EU’s Grand Panjandrums are concerned, and as DOCM has pointed out, Ireland has sufficient official fiscal support and lashings of instituional bank liquidity (effectively funding) support, so it’s time to crack on. And something meaningful will have to be put on the table to secure any reduction in the cost of the official fiscal support.
Those who think that any softening of the official terms and conditions for Greece might lead to Ireland being looked upon more favourably are fooling themselves.
We should actually be pleased that we are seen to have the resilience and governance to work our way through this.
“They are obsessed with large gross notional figures for the CDS market, when the net is fairly small and as they admitted last week, largely used for hedging.”
It would almost make you think that there are large asynchronous nettings somewhere, wouldn’t it? Someone has gone long Greek and short the euro or some such. This shouldn’t be surprising – what we know about the CDS market in other areas is full of such un-netted hedges – Mr. Buffet, for example, has gone very long the S&P. No?
Apparently, according to The Economist:
the Greeks will have to sell almost everything before any relief will be granted.
If you want to stir up anti-speculator sentiment you work out the gross. The net for each contract – say what would happen at an auction is a small fraction of that. The net off first.
I think Buffet occasionally sells very long dated OTC puts on the S&P. He has sold volatility too, er, in 2007.
Nice summary of Greece here:
re-scheduling / re-profiling, or whatever new description has been invented by the time this comment is posted, is a default viz ratings but not for CDS contracts.
Additionally, in case you haven’t spotted it, the “held to maturity” part of banks books will not have to be marked as a result – unless it was shifted originally fron the “available for sale” book.
@ Paul Hunt
An interesting article in Alphaville regarding Greece’s options and probabilities – are we facing same?
@ Paul Hunt
Beware the authors. 🙂
Thank you. Health warning noted. Ireland has nothing approaching this total value to sell. Indeed, in the revision of the EU/IMF MOU privatisation is being pushed out. As for the Greeks, I suspect the core EZ players remain unconvinced they’re playing ball. Tax receipts remain well below any measure of what they should be.
We are actually well ahead of the Greeks and Portuguese in a number of areas. In reality what our ‘overlords’ want is for Ireland to replicate the apparent efficiency of its tradable sectors in the sheltered sectors.
Actually, I think the key point is that a reprofiling isn’t going to be enough, so who would be mad enough to voluntarily go for it. If there is a binding element, it will be an event of default, albeit a small bang. If a small bang, it is not clear that CDS will pay out anyway – http://ftalphaville.ft.com/blog/2011/05/03/557356/
The other key point is that the suspicion will be that it is a precursor to a full restructuring later – reprofiling stops the cash flow issues with debt rollover without addressing the debt load in any way whatsoever. While I said the other day that cash flow will bust in the short-term, longer term, big debt will too.
That was a well reasoned article and it does emphasise the significant uncertainties. I may not agree with the overall conclusion but nevertheless, well argued!
Can somebody help me with the source of the law that says senior unsecured bondholders rank equally with depositors in the determination of a payout on liquidation?
Further as secured creditors can generally claim the benefit of their security in ordinary company law and therefore rank above unsecured creditors, does this mean that the ECB/ICB €140 billion ranks above the ordinary Irish bank deposit holders.
There is no hidden agenda in asking this question. At this point I find it necessary to question everything I hear and read particularly when it seeks to protect vested interests.
I would like to get to the root of this law. And as we all know saying as mush as hello to a lawyer in Ireland is likely to cost a person in excess of a years salary.
“Actually, I think the key point is that a reprofiling isn’t going to be enough, so who would be mad enough to voluntarily go for it.”
Depending on what the reprofiling is the NPV might not be affected too much depending on the bond. Banks with the bonds in the HTM book who keep telling themselves there is no point in selling at these prices, before watching them get cheaper, would be my guess as to who might go for it.
@ Paul H
comment @1.52 now apparently decontaminated.
@ joesph Ryan
Deposits are unsecured debt liabilities
The standard terms used in a senior bond prospectus says the bond is unsecured and ranks pari passu with all non subordinated and unsecured indebtedness of the bank. Hence senior debt is pari passu with deposits
the 150bn owed to the ecb is a secured liability in the sense that the bank pledges collateral to the ecb. this liability effectively ranks senior to both deposits and senior debt as it is secured against assets owned by the bank.
The Irish banking system has gone from one were a large amount of the balance sheet was funded thru unsecured senior bonds and deposits (2008) to one were it is was funded thru a small amount of senior unsecured bonds, a smaller but still very large amount of deposits, and a huge amount of secured lending from the ecb (2011).
@ Paul Hunt
P2. I think you are right in that. I have said before I believe, in a broad vista ireland is a 1% experiment in the European context.
I would also say why shouldn’t the ‘sheltered’ sector be exposed to effeciency? It is the nature of the world we live in – not perfect but ……
Emotionally I agree that this situation is immoral, I make my bets and take my losses as well as my gains (and pay taxes without resentment in principle – no problems there) – why can’t the bankers and bondholders?
But I live in the deliverable – get the least worst option onto the table and in delivering, don’t forget the mistakes made and understand that a man giving you money is not necessarily your friend. 🙂
Last year there was confusion over this point and even just before the election Labour’s finance spokesperson was asking for Lenihan to make public what this law was.
He had misrepresented the facts by stating things like “under Irish law senior bond holders are the same as depositors” and “under Irish law senior bonds and deposits are the same”
Interestingly immediately after having presumably been briefed by the MoF, J Bruton used the same sort of words after the election.
It spins the situation against the fact that they are as tomc says simply of equal rank in a winding up into the suggestion it is not possible for one to loose money without the other doing so. There is nothing (apart from the fact that at this point the CBoI might have to print it) that stops the state compensating depositors after a wind up.
The ECB would get to keep its collateral. Remember it has applied a variable haircut to each bond etc.
The Empire Strikes Back?
first off on the “parri passu” issue: there is no specific law which “states they rank equal”, but there doesn’t need to be – the banks themselves have entered into contracts which state this. Absent a law which states the opposite, the banks own contracts give deposits and senior debt the same legal status in a wind up. You would basically need a specific law that places depositors ABOVE senior debt to get around this, and we do not have such a law (nor does any European country i believe, but the US do). I don’t mean this in a bad way, but i don’t understand why people can’t understand this?
Secondly, while Grumpy is right that people could in theory be compensated by the government AFTER the windup/liquidation of a bank, essentially the losses would first have to be “shared” by both sets of creditors. Imagine, for simplicity’s sake, a bank along these lines:
Nominal Assets 100bn
Senior debt 50bn
On liquidation, assets generate 70bn. Therefore, there is a 30bn capital loss. Senior debt gets 35bn of the proceeds and depositors get 35bn. The govt makes whole depositors to the tune of 15bn. So instead of the govt having to contribute 30bn to save the bank and keep it running, in liquidation they have to contribute 15bn to make depositors whole.
Imagine now the following banking set up, far closer to the current situation:
Nominal Assets 100bn
Secured Bonds 20bn
Senior unsecured 20bn
Assets in liquidation get 70bn. Secured bonds get 20bn (they’re overcollateralised with the better stuff), so 50bn leftover for distribution. Senior debt gets 25% (ie 20bn/80bn) of this (12.5bn), and deposits 37.5bn. It costs the govt 22.5bn to make depositors whole in liquidation, instead of 30bn for to keep the whole bank going instead. Yeah, they’re saving money in liquidation, but the amounts in reality really start getting a lot smaller – 7.5bn vs 30bn.
grumpy: There is nothing (apart from the fact that at this point the CBoI might have to print it) that stops the state compensating depositors after a wind up.
Actually as the law stands the state is obliged to compensate retail depositors. This obligation pre-dates the blanket guarantee. BEB’s otherwise helpful comment gives the impression that this is merely a theoretical possibility, whereas in fact it’s a statutory obligation.
The state is indeed obliged, but you still have to ask where the money would come from, particularly given we would have not met the de facto conditions of official support by attempting to impose losses on seniors. Grumpy’s “apart from the fact that at this point the CBoI might have to print it” is telling.
@ Eoin Bond, John McHale, etc.
Here’s Morgan Kelly from his recent IT article.
“Ireland’s Last Stand began less shambolically than you might expect. The IMF, which believes that lenders should pay for their stupidity before it has to reach into its pocket, presented the Irish with a plan to haircut €30 billion of unguaranteed bonds by two-thirds on average. Lenihan was overjoyed, according to a source who was there, telling the IMF team: “You are Ireland’s salvation.”
The deal was torpedoed from an unexpected direction. At a conference call with the G7 finance ministers, the haircut was vetoed by US treasury secretary Timothy Geithner who, as his payment of $13 billion from government-owned AIG to Goldman Sachs showed, believes that bankers take priority over taxpayers. The only one to speak up for the Irish was UK chancellor George Osborne, but Geithner, as always, got his way.”
So according to this version the IMF were all-go to haircut unguaranteed bank debt, and backed in this by the UK’s G. Osborne.
I have noted a few times over the last couple of years how US agencies and organisations seemed to have not quite realised that the Irish system is different – it came up in the Vanity Fair article, and in Quinn’s share dealings with Anglo.
It would be nice to be able to unpack this brief paragraph a bit. Does it mean:
(a) The IMF didn’t know about the Pari Passu business.
Against: They’re international and B. Lenihan was always banging on about it.
(b) They, knew but had a plan to get round it.
Maybe as expressed by Eoin Bond above, do and make depositers whole.
(c) They didn’t care about it (the ‘see you in court’ option).
(d) Their plan involved ‘voluntary’ losses, maybe case by case.
Presumably they expected the combined weight of all bailout parties would be able to make them an offer they couldn’t refuse.
Apologies if the above is fairly speculative. I wonder how one would go about finding out more? Phone B. Lenihan? The IMF?
True of course. But that cuts both ways — you have to ask where the money comes from to pay seniors also.
@Eoin: I don’t understand why people can’t understand this?
Partly it’s a problem of people talking past each other. Saying that depositors rank pari passu with bondholders means very little when we are considering what a bankrupt government might do. Since it’s a given that the law is going to change in such a crisis, there’s really not much point in treating existing law as a binding constraint. The real constraints are those imposed by (1) the fact that the state is only semi-sovereign (great powers can always tell lesser powers what to do if they care to) and (2) the willingness of the population to comply with whatever new laws are passed.
I’m certain the IMF knows all there is to know about bond propectuses and what they say about rankings, pari passu or otherwise. But it matters about as much to them as an Iraqi policeman slapping a parking-ticket on an American tank.
When it comes to debt negotiations, a dialogue of the following form is quite common (for various values of X):
Debtor nation: Our law forbids X.
IMF: A condition of our support is that you do X.
Debtor nation: Consider it done, sir.
Very well put – that, indeed, is what I suspect myself.
“Depending on what the reprofiling is the NPV might not be affected too much depending on the bond. Banks with the bonds in the HTM book who keep telling themselves there is no point in selling at these prices, before watching them get cheaper, would be my guess as to who might go for it.”
😳 Oh yeah, I forgot about the “not selling it for less than it is ‘worth'” merchants!
Apologies for intruding on discussion of pari passu and re-profiling, but there is a deeper and more troubling context.
The current economic and financial crisis is feeding broad, poorly-defined discontents about immigration, Islamic culture and terrorism, globalisation and economic insecurity in the core EU countries.
And these discontents are being exploited and channeled by right-wing, populist, nationalistic xenophobic parties throughout the EU to secure power and influence. Gert Wilders’s faction of this ilk is supporting a minority centre-right government in the Netherlands from the outside. Similar arrangments (either within or outside government) may be found in Denmark and Finland. The Swedish Democrats prevented the outgoing centre-right government in Sweden secuirng a majority. The split in the corresponding Austrian faction disguises its popular support. Belgium is coming up to a year without a government for this and other reasons. The disgrace of DSK in New York is adding a futher boost to the National Front in France. Italy always struggles to keep a lid on ugly political forces – and a secessionist tendency by the North. The buffoonery of its PM is counter-balanced by a reasonably competent, technocratic ‘permanent government’. Germany alone, for a variety of reasons, has been able to prevent the rise of these factions. But there can be no doubt the discontents are bubbling below the surface.
This is the politcial landscape that much of the core EU is confronting – and it’s not a pretty sight. Nor does it offer much hope to the hard-pressed peripherals. It is the inevitable outcome of the exercise and abuse of excessive executive dominance and decision-making by elites that fails to engage and secure democratic consent.
For some time centre-right governments have been in power throughout the core EU and voters, understandably, would like to give them a kicking. But the centre-left, as the traditional alternative, is in terminal decline. Any attempt by the centre-right and the centre-left to coalesce to keep out the ‘hard right’ will fuel even more popular anger and discontent.
The core EU is stting on a powder keg. The only question is when and in what way it will explode. The can-kicking on the peripherals is the only approach on which the political and institutional EU can secure some form of consensus. Disbelief may be suspended for only so long. Ireland was able to suspend it on the banks and property markets for nearly 7 years. But then it goes – and tends to go with a bang.
The debate about senior bondholders and their status vis-a-vis depositors is informative but one wonders how relevant it is given the fact that the idea of forced burden-sharing has been taken off the table definitively by the government.
On the results of the ECOFIN meeting yesterday, I was wondering why none of the journalists posing questions to the MOF had the wit to ask if any of the other governments had invited him not to take their money but to go and borrow it at over 10% on the markets instead. But that is by the way. A fuller and more balanced picture was given by the MOS for European Affairs on RTE this morning.
The attached Bloomberg interview with Schroeder is of great interest as it invites Merkel to take decisive action and reflects the current thinking of the SPD.
It is noteworthy also for the fact that he mentions the ECB among the parties to take a hit.
Martin Wolf in the FT goes over all the ground again. However, he puts the fulcrum of the debate, as usual, in the wrong place, giving the impression that the situation is finely balanced when it is, in fact, at the 8% (GDP Gr/P/IRL) versus 92% (rest of EZ) of the scale. He is right, however, about the total lack of weight of Sarkozy, political or otherwise.
@ Ordinary man
The Empire will have all its ducks in a row by the end of June, of that I am quite certain. But whether it will be willing to strike is another matter. I think that there is insufficient time. It will muddle through with another loan for Greece.
If default is ruled out, the only logical alternative is a voluntary restructuring, reprofiling, call it what you will, between debtors and creditors. To do this, they have to meet in the same room free of political grand-standing and out of the glare of publicity. Not alone the heads of state and government but the ministers for finance of Europe have repeatedly demonstrated their incapacity in this regard. A version of the Vienna Initiative or the Paris Club is needed.
It is worth recalling that Schroeder – with Chirac – is one of the architects of the present mess for driving a coach and four through the SGP. It will also have been noted that the Portuguese are invited to increase VAT and reduce charges for their exporters. This is a policy which makes sense for Portugal as it has a major balance of payments problem. It was idiotic when applied by Merkel to Germany when she increased VAT from 16% to 19% and reduced charged for German exporters in 2007 using the spurious argument – still advanced – that “Europe” (for which, read Germany) had to be able to compete with the outside world when the bulk of German exports are within Europe. This is the point so eloquently made by Damien Kiberd in the Sunday Times.
@ K D,
** J McH: It would be good to hear more thoughts about why a small country is especially vulnerable within a large monetary union. **
* Me: One ingredient is the success of the doctrine that a state is liable for the debts of its main banks, even if there isn’t a formal guarantee in place. That idea isn’t especially damaging to the credit ratings of countries such as Australia and Canada, which have currencies of their own and banks of reasonable size. For a small country, with big banks, in a monetary union, it’s a lethal notion. *
I think this is only so if the small country has little sense of social responsibility.
If it knew it was on its own it would be more responsible with its currency – via monetary and fiscal policy, knowing that it would have to bear any nasty consequences. If it does get into trouble, it would know that it was on its own in trying to get out of the trouble and therefore would put in more effort to doing so.
If it shares a common currency, it is more likely to get into trouble, knowing that it will probably share any pain resulting from, shall we say, “stroke standards”. When it is in trouble and gets help from the group, it will be less likely to get serious about doing so, knowing that the others might follow precedent and again render assistance.
So, even the group risks getting into a vicious circle if it goes softly with such a country rather than giving it a kick …
However, a small country has a real advantage within a union, in that it can influence higher context modelling, if it has wits to have something logical to propose, thereby perhaps improving the model for both itself and the union.
Such wits could currently be very useful, as I think the G7 leader does not have any, and may be beyond saving, in so many ways.
(It might be a good idea to invite Russia into the EU. A currency also needs a good military behind or friendly to it, especially in a possible time of world economic turmoil. (The UK has one or two unhelpful policies in common with the USA – a tradition and perhaps need for trade liberalisation and perhaps a not too wholesome monetary policy)).
I was trying to explain the reason why loads of people including Joan Burton THOUGHT there was a specific law to this effect in Ireland – that this was due to spinning.
I am aware the equal rank in windng up comes from the bond docs.
“It spins the situation against the fact that they are as tomc says simply of equal rank in a winding up into the suggestion it is not possible for one to loose money without the other doing so. There is nothing (apart from the fact that at this point the CBoI might have to print it) that stops the state compensating depositors after a wind up.”
What do you think I have misunderstood?
@ Ordinary man
One duck that will not be in the row, and which is pertinent to the discussion on the parity between depositors and senior bondholders, is the proposed directive on deposit gurantee schemes which is running into predictable difficulties. The ECB opinion on it gives a canter over the main points for those technically interested.
@ Paul Hunt
The role you foresee in Germany for a party of th extreme right is rapidly being filled by the FDP, previously the most pro-Europe of all the political parties. The explanation is fairly simple. The FDP represents the entrepreneurial class in Germany which has benefited most from economic developments in Europe over the past decade and is now unwilling to pay the price of seeing its excesses corrected.
@ Peter Kinane
“When it is in trouble and gets help from the group, it will be less likely to get serious about doing so, knowing that the others might follow precedent and again render assistance.
So, even the group risks getting into a vicious circle if it goes softly with such a country rather than giving it a kick …”
That’s it in a nutshell and applies especially to Ireland’s case.
Without a stick and no support won’t happen, but…..
The fact is the seniors being protected is not part of the bailout agreement. It seems there is not even a side letter.
As regards the ECB providing repo facilities, that expression “de facto” is telling.
Can you imagine the international outcry if the ECB put the rate up significantly in response to a recognition of reality?
Can you really imagine them wanting to look so petulant as to ask the Irish to take back the collateral and give them money that they knew wasn’t there?
Do you think they would stridently “forbid” ELG by the central bank?
…..all for stopping the false market in Irish bank bonds?
Can you imagine the press conference?
I’m not quite sure what reduced charges you’re referring to. VAT is a tax on consumption so what goods or services are reduced for exporters? Energy or? What is not consumed is recovered in their VAT filing with local revenue.
Irish exporters can (at least could a couple of years ago) also avoid paying VAT by getting a special VAT status with Irish revenue. If memory serves it was a form 12D which when presented to a supplier made it possible to invoice the exporter without VAT. Could this be the same?
@ Paul Hunt
Fair enough, but I though the True Finns were your new best mates. Are you backing off from that?
All commercial exports within the EU are zero-rated for VAT. This means that traders have to be registered for VAT with their respective taxation authorities and all kinds of complicated exchanges ensue which there is no need to go into here. The real point is the effect of the VAT increase of 3% in Germany was to suppress consumer demand, reduce imports and add to Germany’s commercial surplus when the very opposite policy would have been appropriate.
As to the concessions made to exporters, I would need some time to look these up, as they are quite extensive and complicated (the most recent being – I think – an increase in tobacco excise to pay for some other concession).
Germany, with 88 million people, has the biggest trade surplus after China in absolute terms. While a lot of this surplus is attributable to the excellence of German products, a much larger proportion is attributable to (i) deliberate capping of labour costs (ii) administrative measures e.g. the VAT increase, which effectively favours the export sector over other areas of the economy.
This would not matter if German exports were more widely distributed globally but they are not. The surpluses largely match the deficits in the other European economies. This has a major destabilising impact on the European economy as a whole. It makes the entrepreneurial class rich in Germany but has seen levels of poverty actually increase in Germany in the past decade.
With the boom in the Germany economy, the imbalances are beginning to right themelves. But for this continue, structural reform in Germany is as necessary as in any other country. The Euro Plus Pact gingerly addresses some of the issues but goes nowhere near far enough.
Martin Wolf has dealt with this issue extensively and his columns in the FT are a good source of information.
The True Finns speak some truths that much of Europe does not wish to hear, but they are naive in many respects. I would much prefer that established politicians engage with the concerns and discontents that generate support for them.
yep, I am quite familiar with the EU directive regarding cross-border intra-community VAT issues 🙂
VAT is a local matter. If it was raised when Germany’s deficit was high then it seems it was the correct thing to do as it raised more revenue.
You’re making an argument about something being reduced charged to benefit exporters, I still do not know what this something you’re referring to is?
As Basil said…Reprofilling is off.
Our favourite ECB man Bini has said no hard or soft restructuring yet Olli and Junker are in favour. Is this going to be the mother of all battles?
The more I see of this, the more furtive the bank financing is becoming.
The oft repeated mantra that the ECB is “giving unprecedented support to the Irish banking system ” isn’t true. Not true at all.
The depositors would have had much more security if the banks was put into received ship one or two or three years ago.
Now that security is a winddown/ liquidation is gone. Depositors have been trumped by the ECB/ICB. Every billion put in by the ECB is a billion less for depositors when the sh*t really hits the fan.
Well I’ll be damned.
The introduction of a system of VAT is an essential prerequisite for membership of the EU. It is not a local issue. It has tended to be viewed as such as all decisions are subject to unanimity and member states have been unable to agree to do anything very much in the matter of harmonisation..
To give but one example of what I have in mind, herewith a link to a newspaper article entitled “Smoking for Germany” which deals with the political deal struck between the FDP and the CDA to raise taxes, ostensibly to pay for health care but in reality to lower the costs of energy in the steel industry.
An example of the imaginative use of VAT would be the arrangement under which German farmers do not reimburse the full amount of the VAT they receive in respect of the sale of their products. They do not have to pay social security in respect of seasonal workers where the rate is 6.50 euros an hour as against 11 euros an hour in France. There is no minimum wage in Germany. (Source Le Monde 19 february 2011). Germany has surpassed France as an agricultural exporter.
Correction. The title is “Smoking for Germany and her industry”.
kind of like introducing a tax on private pension funds to ‘generate jobs’?
Special tax-rules for farmers? As if Ireland does not have such…..
Btw, you’re ok with Portugal being invited to change their VAT but it is a problem if Ireland is invited to change their CT? Both are the kind of taxes that outsiders are normally not to interfere with.
I’m not sure why you’re bringing up harmonisation of VAT? It will not happen as long as national governments control taxation -> Probably will never happen.
State subsidies are usually frowned upon by the EU, what are the charges that Portugal is invited to reduce for their exporters (somehow excluding domestic)?
Not a pretty analysis below. I would agree with most of it. However I would have to think a bit more about the centre-left being in terminal decline. I hope not.
One small point also on the can-kicking, a smart ass remark in a way.
‘Can-kicking is ok a policy, provided that you are not the can being kicked’
You might find this publication of interest:
The essay by Andres Velasco, former MoF in Chile, who visited Dublin recently, is particularly bracing. The essay by Colin Crouch probably comes closest to defining my stance.