The Irish Economy

In his Sunday Independent column today, Colm McCarthy again makes the argument the Government is protecting – or being forced to protect – senior bondholders in order to protect European banks. 

It is entirely fair for our European partners to observe that we have brought this on ourselves but it is equally fair to note that in picking up the tab, the Irish are ‘taking one for the team’, in the phrase of Sharon Bowles, the British MEP who chairs the Economic and Monetary Affairs Committee. The team, in the form of the EU Commission, the European Central Bank and the Franco-German political leadership, persist in the pretence that the protection of creditors of the bust Irish banks, at the expense of the Irish Exchequer, represents some form of generosity to Irish citizens and taxpayers.

Fortunately, the existing deal with our European partners is impractical as well as unfair. It has not worked, it will not work and there will be further rounds of modifications as Europe gropes towards a resolution of the banking and sovereign debt crises. It will not be enough, in regaining solvency, for the Irish Government to avoid further pay-offs to bondholders in Anglo and Irish Nationwide. The Irish Exchequer’s contributions to bank rescue have already destroyed the sovereign’s capacity to borrow. There is still an opportunity to avoid default on the sovereign debt of the state, but the ability to avoid this outcome is being undermined by the obligations undertaken to investors in bonds issued by insolvent banks.

The restoration of that ability requires, in addition to vigorous reductions in the budget deficit, that the remaining costs of rescuing the Irish banks be shared with their creditors and with the European institutions whose defence of bank bondholders has helped to create the current untenable situation.

Putting aside the relative costs to Ireland’s creditworthiness of defaulting on sovereign bonds compared to sovereign guarantees, oversimplified claims that senior bondholders are being protected to protect foreign banks are undermining support for necessary fiscal adjustments.  

The concerns of the ECB about balance sheet/precedent-related contagion does explain the absence of loss sharing for the roughly €3.5 billion of unguarnateed seniors in the defunct and depositor-less Anglo and INBS.   The constraints on loss sharing in the pillar banks are quite different. 

There is an effective instrument to impose losses on pillar-bank bondholders – bankruptcy.    Although we know the credit system is already impaired, making the pillar banks bankrupt would impair the credit (and payments) system to a significantly greater degree.   Also, it is conveniently ignored that depositors rank equally with senior bondholders under current law.    It might have been possible for the State to make depositors whole when the State was creditworthy.   That ship has sailed. 

Now I do think more should have been done early on to put in place a resolution regime to increase loss-sharing options.  However,  the legal avenues appear to be quite proscribed.    While I am not saying this is the end of the argument, given the damage done to public support for tough fiscal measures, anyone who pushes the line that losses should be imposed on broader bondholders has an obligation to explain how the legal obstacles could be overcome while protecting the credit system and protecting depositors.    It is emotionally satisfying to heap blame on a requirement to protect foreign banks.  The reality is more complex.

Now that we’ve had a bit more time to digest the implications of the EU summit, I would be interested to hear more views on how the measures have strengthened or weakened the “ring-fence” beyond Greece, especially as it applies to Ireland.    The idea of a ring-fence is that measures to improve debt sustainability and the reliability of a lender of last resort attenuate potentially self-fulfilling expectations of default; that is, expectations of default that lead to higher interest rates, thereby increasing the probability of default (in part because countries get pulled into European crisis resolution mechanisms that threaten debt restructuring as part of subsequent financing packages and also because of worsening debt dynamics). 

I think it is fair to say there is general agreement that the interest rate reductions / maturity extensions strengthen the ring-fence given that they improve the chances of debt sustainability.   However, there also seems to be a view that the private-sector involvement (PSI) that is being applied to Greece weakens the ring-fence, as it increases the threat of that PSI being applied to other countries at a later stage.   The latter does not seem right to me.   It is widely recognised that Greece’s debt to GDP ratio makes debt restructuring inevitable.    From the point of view of the ring-fence beyond Greece, it would have been best to have decisive action on Greece’s debt, so that it is unlikely that the necessary PSI would have to be revisited in their case.   As it is, it is likely that further restructuring of Greece’s debt will have to take place, creating ongoing uncertainty about what the PSI element of the Eurozone crisis-resolution mechanisms is going to look like down the road, increasing the uncertainty facing other countries.   In other words, the problem (from the perspective of the ring-fence) is that too little PSI is being applied to Greece, not too much.

The updated programme is here.

To take our minds off the heavier economic / financial topics for a while I thought I would share some thoughts provoked by the Annual Summary of Vital Statistics for 2010 published at the end of June. Taken in conjunction with the preliminary results of the 2011 Census, it reveals some surprisingly positive trends for a country in the throes of a very deep recession.

Our birth rate is holding up despite the surge in unemployment and the resumption of net emigration (even if at a more modest rate than previously feared).

Over 75,000 births were registered in 2008 – almost 60% more than in 1994 and the highest number recorded in modern times. However, this was probably the peak, as the annual total for 2010 was 2% lower than that for 2008, while the 2010Q4 figure was 4% lower than the corresponding figure for 2008.

The surge in births will have far-reaching implications for the economy’s medium-term prospects.  Most immediately it is placing pressure on the educational system, but over the longer run it could be argued that our relatively youthful population will bestow a competitve advantage relative to the rest of Europe, where the ageing of populations is becoming an acute problem.

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Roberto Perotti and Luigi Zingales provide an additional perspective on last week’s deal in this Bloomberg article.

Harald Hau is an excellent German academic financial economist  (living in France) - his take on last week’s deal is available here.

The NESC Secretariat have released a paper on this topic: available here.

The European Commission has released details of the PSI element of the Greek deal: you can find the note here.

My talk at the MacGill Summer School yesterday was based on this paper.  Core point: I argue that last week’s European deal calls for an acceleration in the pace of Irish fiscal adjustment.

Update: The webcast for this session (also featuring David Begg, Brigid Laffan and Colm McCarthy) is available here.

Update:  The Irish Times carries a shorter, edited version of my talk in this article.

The most recent Financial Stability Report from the Bank of England warns about the danger to U.K. economic stability from excessive debt forbearance by U.K. domestic banks. The governor of the Bank of England, Mervyn King, put stress on this risk in his speech introducing the report (although he also noted that this does not mean that forbearance is always a bad thing). In the report, only the potential UK fallout from the Euro crisis ranks more highly than excessive debt forbearance on the list of risks to the UK banking system. This should ring alarm bells in Ireland, since the level of debt forbearance in Ireland at present is much higher than in the U.K.  Encouraging debt forbearance is a deliberate Irish government policy, and the extreme level of forbearance by domestic Irish institutions is storing up potential problems for the future.

There is a considerable overhang of unwanted or distressed (in some cases unfinished) property assets in Ireland (see Ronan Lyons and Namawinelake for discussion). The smart-money players (foreign-owned banks with Irish property assets) might front-run the slower-footed players (domestic, taxpayer-owned banks and Nama) by selling relatively quickly, leaving the Irish taxpayer to fund any eventual shortfall. (I am including the IBRC, the vestiges of Anglo Irish and Irish Nationwide, in my definition of domestic banks.) So loan forbearance and front-running in Irish property markets could interact to the detriment of taxpayers.   

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