ESM will not have preferred creditor status

News organisations are reporting the European Stability Mechanism will not have IMF-style preferred creditor status for countries already in a bailout after all, which is a significant change from the draft treaty setting out the planned design of the fund.   Some reports here: FT; Irish Times; Reuters.

It has been apparent from the timing of spikes in bond yields, as well as from investor/rating-agency reactions, that features of the ESM’s design are considered impediments to Ireland regaining its creditworthiness.   The annoucement is therefore welcome news, though the limited initial falls in bond yields suggest it is not a panacea (see here).  Greater clarity about future debt-sustainability tests and also the form of future private sector involvement are important additional steps.   Greece-related developments are likely to be the main market movers for the time being.

The ECB Responds

After a turbulent week, RTE’s This Week programme provides a useful stocktaking with Mark Gilbert (Bloomberg), Dan O’Brien and Brian Hayes.   (You can listen here; starts min 5:19).   Part of the background is a Sunday Times front-page story on the ECB’s reaction to Michael Noonan’s Washington statements (no web link).   The paper quotes an unnamed ECB source,

“In the meantime, we may have to come to the conclusion that it doesn’t really make sense for the ECB to keep putting €100 billion into Irish banks.   What we are doing is actually illegal, but we have being doing it because we want to help Ireland.  Maybe we might come to the conclusion that we should stop,” said the ECB source.

Given the vulnerability of the funding situation facing Irish banks, this reaction from the ECB to the Minister’s comments is unhelpful in the extreme, yet quite predictable. 

Lorenzo Bini Smaghi

LBS’s many fans on this Blog will want to read about the controversy surrounding his continued membership of the ECB’s Executive Board. If he does not step down Nicolas Sarkozy is threatening to block Mario Draghi’s accession to the Presidency. The Financial Times account is here.

Silvio Berlusconi has called on him to step down, although no definite decision has been taken to offer him the post as head of Banca d’Italia in succession to Draghi.

According to the Corriere della Sera LBS had ‘no comment’ about the issue on leaving the palazzo Chigi. However, La Repubblica quotes him (on leaving a conference in the Vatican) to the effect that he cannot be removed before the end of his eight-year term. He underlined that ‘personal independence is one of the doctrines on which the independence of the Bank rests.’

Quarterly National Household Survey, 2011:Q1

The QNHS release is here.   Some analysis of the figures from the Irish Times here.  Overall, some modest good news.   I would say Ronnie O’Toole has it about right,

“This does not indicate that unemployment is on a downward path, and only reverses the surprise rise in the fourth quarter,” said National Irish Bank’s chief economist Dr Ronnie O’Toole.

“However, it does indicate that the labour market is very close to stabilising, with half of all industry categories showing year-on-year increases in employment. These increases, however, were not large enough to offset the continued loss of jobs in hospitality and construction.”

He hasn’t gone away you know…..

Hans-Werner Sinn replies to his critics in relation to Target 2 balances here.  Readers of this blog will undoubtedly draw their own conclusions.  At the heart of his fallacy is the conceptual  absurdity of separate regional credit policies in  a monetary union with perfect capital mobility.

The political economy of eurozone membership

Richard Pine makes a point about Greece that I have found myself wondering about in the context of Ireland:

The public service, which will lose 150,000 workers by 2015, and faces another round of pay cuts as part of new austerity measures, clearly does not relish a return to a new, devalued, drachma. Those in the private sector who need a stimulus to manufacturing, agriculture and tourism would welcome the boost in exports and the end of recession.

I think the political economy of eurozone membership is more complicated than this. Anyone in secure employment, be it in the public or the private sector, is presumably happy to be paid in a nice hard currency, while in the Irish case the multinational sector may not have the same interests as Irish-owned SMEs. But the general point that the more secure elements in society (and the wealthy) have a stake in eurozone membership, while those in precarious employment, and the unemployed, may have quite different interests, seems like a potentially valid one.

What do people think?

Quote of the day

“When we were faced with a similar situation after coming into government, we agreed with the ECB and we held back from burden sharing with senior bond holders and we didn’t proceed down that road.”

Michael Noonan, reported here.

It wouldn’t be altogether surprising, I suppose, if the most conservative party in the State agreed with the ECB when it came to the distribution of bank losses as between ordinary taxpayers and financial institutions. But this isn’t the story we have been told to date.

So: does Fine Gael — and Labour — agree with the ECB regarding burden sharing with bondholders?

Update: Michael Noonan has said that Anglo and Irish Nationwide senior bondholders should face losses.

Sony Kapoor: A plan to rescue Greece and save the Euro

The FT carries has an op-ed with an interesting proposal for resolving the eurzone crisis.  (A shorter version of the article appeared following the Roubini piece that Kevin linked to yesterday.)

The essence of the proposal is a selective Greek default, with preferential treatment given to official creditors.   Whatever the merits of such selectivity, the proposal does offer a way for Ireland (and Portugal) to differentiate itself from Greece.   This is done through the use of explicit triggers before invoking restructuring under the ESM. 

[C]ontagion to Ireland and Portugal can be avoided through the introduction of an ESM clause that allows debt restructuring only when the debt/GDP ratio and debt servicing/GDP ratios exceed 110 per cent and 6 per cent respectively, levels that neither Ireland nor Portugal are expected to breach. The markets recognise that Greece is different.

The proposed debt/GDP ratio looks too low based on current projections.   It would probably need to be in the vicinity of 130 per cent to allow for adverse shocks.    But an explicit trigger set at reasonable level would give confidence to markets that a country following its programme would not be forced to impose a restructuring as a condition of any future programme.   (However, the preference given to official creditors would make a restructuring very costly for non-official creditors in the event that the trigger was breeched.)   The threat of restructuring is now making it almost impossible for Ireland to regain market access.   The proposal offers a way of both resolving the Greek crisis and avoiding rolling contagion through policy precedent.

Roubini on the eurozone

Nouriel Roubini’s post is a useful complement to the piece by Wolfgang Münchau that John linked to earlier. In truth, I don’t think anyone really knows what is going to happen to the eurozone, and Wolfgang is admirably frank about the fact that he is just describing one possible scenario. But an increasing number of people are now arguing that eurozone politicians aren’t going to be able to fudge the unfudgeable forever. If that is the case, the Irish people may have some momentous choices to make in the not-too-distant future.

Wolfgang Münchau: Why debt rescues will boost the scenario of a closer union

Wolfgang Münchau concludes his two-part series on the end game for the eurozone crisis: see here.  

Update — A couple of complementary articles from the Irish Times: John McManus argues perceptively that Europe is already well on the way to a transfer union (see here); Dan O’Brien does not pull his punches in an assessment of Greece’s structural problems (see here).

Patrick Honohan on Vincent Browne

Thanks to grumpy for drawing our attention to a fascinating segment with Patrick Honohan on last night’s Tonight with Vincent Browne show.   (The segment runs from minute 17:40 to minute 36:12; you can read grumpy’s comment here.)  Governor Honohan made an unfortunate reference to “the people” in relation to the blocking of attempts to impose losses on senior bondholders, giving fodder for conspiracy theories.   But I don’t think there is much of a mystery about the people in question.    The ECB clearly worried — and continues to worry — about balance-sheet contagion across the European banking system, and (I would suppose even more importantly) the implications of the precedent of withdrawing the implicit guarantee for senior debt for the funding of a system that continues to be fragile.  

On the Irish side, given the existence of the ELG guarantee on post-December 2009 bank funding, the equal ranking of depositors and senior bondholders, and the systemic importance of AIB and Bank of Ireland to Ireland’s credit and payment systems, a pragmatic decision was made that the fiscal savings from feasible loss imposition (most likely the remaining unguaranteed senior debt in Anglo and INBS) would not be worth risking the reliability of large-scale funding from the eurosystem. 

(It is worth noting that a special resolution regime was not in place, and even if it was the U.K. example shows U.S.-style depositor preference is considered incompatible with European law.   In principle it would have been possible for losses to be shared between depositors and senior bondholders, with the State making depositors whole.   But at that stage the State had lost its creditworthiness, making it hard to see how such depositor protection could have been implemented without significant outside support.   Lastly, both Anglo and INBS still had depositors back in November.   The Credit Institutions (Stabilisation) Act later facilitated the movement of depositors out of those banks, but that piece of legislation – which made it possible to impose proper losses on subordinated bond holders – is unlikely to be costless in terms of the longer-term reputation of the stability of Ireland’s investment environment.)

I think reasonable people can disagree about whether more should have been done to force the issue back in November with senior bondholders.    But I find it hard to understand the certitude with which the policy course is criticised given the very real constraints that were faced.   At this stage, I feel the obsession with the “socialisation of bank losses” is becoming a substitute for hard thinking about what we need to do now to get through a crisis that still poses massive downside risk.

Update: Namawinelake provides a transcript of the key segment with Governor Honohan: see here

Gavin Kostick, Paul Krugman, and Jean Claude Trichet

Commenter Gavin Kostick has done impressive work on our behalf following up with Paul Krugman and Jean Claude Trichet on the austerity debate.   The fruits of his efforts are contained on the Paul Krugman: When Austerity Fails thread, but many readers will probably have missed them on this fast moving blog.

The reply from the ECB and links provided by Paul Krugman are reproduced after the break.   Thanks Gavin.  (I also take back my dig from yesterday about the ECB’s poor communications.) Continue reading “Gavin Kostick, Paul Krugman, and Jean Claude Trichet”

Bondholder Challenges

Simon Carswell reports on legal challenges by subordinated bondholders of AIB and Bank of Ireland.   The main contention seems to be the up-ending of usual ranking of equity and junior debt. 

At the core of the case taken by Aurelius is whether a subordinated bondholder – the lowest-ranking creditor in the capital structure of a company – should be wiped out when the bank is only in existence because of €13.3 billion that must be injected by the State on top of a €7.2 billion bailout.

Aurelius claims the Government has subverted the rules of the capital markets where shareholders should be wiped out first and then junior bondholders.

It says that the stakes held by shareholders, including the Government’s preference and ordinary shares, should bear losses first.

. . .

Another subordinated bondholder challenge is also looming. On Wednesday the London law firm White and Case said it had been hired by bondholders in Bank of Ireland holding about €700 million of the €2.6 billion.

They claim that the bank’s proposal to inflict losses on lenders through a debt-for-cash-or-equity deal is “fatally flawed” because it fails to respect the fundamental principle that creditors must be repaid ahead of shareholders.

Although I am open to correction by the experts out there, my understanding is that for junior bondholders in place before the State’s capital injections, solvency is being judged based on pre-State capital injection capital levels.   On this basis, the reversal of the usual ranking should not affect the ability to raise bond financing in the future.  Moreover, Eoin Bond, our expert commenter on these issues, has argued on a few occasions that the subordinated bond is dead as a financing instrument for Irish banks, so we shouldn’t be overly concerned about its treatment. 

Even so, I worry that uncertainty about the future creditor regime – and not just for subordinated bondholders – is making the restoration of the creditworthiness of the new pillar banks more challenging.  There is not much point in pumping large amounts of supposedly loss-absorbing capital into a bank if there are fears that the capital will later be disregarded.    Regime uncertainty is being much debated in regards to sovereign debt, but it applies in the case of bank debt as well.   The temporary and rather draconian nature of the Credit Institutions (Stabilisation) Act has not helped in this regard; and the proposed permanent special resolution regime is not set to be enacted until the end of 2012.    

I would be delighted to hear from commenters that these concerns are misplaced, and that potential creditors draw a sharp line between the treatment of legacy junior debt and any new debt issued by the banks.   But I do think it would help for the government to provide as much clarity as possible as to the nature of the future creditor regime.

Symposium at TCD on June 16th.

Dublin Economics Workshop Symposium


Energy Policy Priorities


Date: June 16th. at 11 am.


Venue: Room M21, Museum Building, Trinity College.




11.00 Kieran O’Brien (Irish Academy of Engineering): Energy Policy and Economic Recovery 2011-2015


11.30 Rory Broderick (Trinity College Dublin): Wind Energy Economics: the Influence of Gas and Carbon Prices


12.00 Dieter Helm (University of Oxford): Energy Policy in Europe, the UK and Ireland


12.30 Panel Discussion.


Admission is free but places are limited. Book a place by emailing

A better friend than we know

The ECB’s position of “no default” has come in for much derision here, and indeed the Schauble letter makes clear that such an uncompromising stance is not credible.    I believe, however, that Ireland gains from a distinct leaning towards a “default-as-last-resort” position, which is why any Greek precedent is so important. 

A useful approach is to view the possibility of default as a valuable option, with an orderly, officially supported “restructuring” at the more valuable end of the spectrum.   However, the very existence of such an option makes it harder to regain market access.   Potential investors will be repelled by the likelihood of getting caught up in a later restructuring. 

We thus have a trade-off in the design of the bail-out/bail-in regime, with the optimal point along the trade-off being quite different for Greece and Ireland.  A good regime for Ireland, in my view, is still one that offers additional funding on reasonable terms to countries meeting their ex ante conditions  without a requirement of restructuring; in other words, a reliable, though certainly not unconditional, lender of last resort (LOLR).  Potential investors need to know that funding will be there even in a bad state of the world.   Under such arrangements, belief in the country’s capacity to meet pre-specified conditions should be sufficient for renewed market access (assuming of course the LOLR is seen as having the financial capacity to meet its commitment).   For all its communication faults, the ECB does push policy in this direction, and I think is more of a friend in the European policy debate than we realise.

The Irish Times’ Cantillon reports the government is increasingly shifting its focus to the design of the ESM.   This is the right focus.   While I hope that an interest-rate cut is not completely off the table, the reliability of the LOLR function is the most critical factor in resolving the Irish creditworthiness crisis.