Plan B begins to emerge

Colm McCarthy writing on these, em, pages, a few days ago explained that Europe’s Plan A–no banks will go under, no states will default on their debts, fiscal consolidation plus recapitalisation will see us through–is being quietly dropped in favour of Plan B. Today at the EU Debt Summit we got a glimpse of what Plan B will look like. (updated to official version).

Briefly, Greece is being allowed to selectively default, but this won’t harm Greek banks (nor their French owners) because the greek bonds will be guaranteed by an enhanced European Financial Stability Facility (EFSF) that can intervene in secondary markets amongst other new powers. Other debt-laden member states, including Ireland, will have access to cheaper funds from the uber-EFSF at longer maturities.

The markets liked it too, with bank shares enjoying a nice bounce. There’s some evidence the bounce we saw on the markets was just short equity positions being cleared out, so I wouldn’t take that too seriously as an indicator of how well this new plan will go down. I don’t think many people were surprised at Greece’s default. As macroeconomic events go, the default was pretty well expected, hence the lack of jitters when it was announced.

It is to be welcomed that the Greek default is somewhat orderly and buttressed by other member states’ guarantees to reduce (or avoid completely) balance sheet contagion. What’s not so welcome are some of the phrases used in the draft document. They are vague enough to allow lots of leeway should policy makers require it, but precise enough to guarantee action of some shape or form. All this does is move debate away from ‘what will they do’ to ‘how are they going to do it’, which is unhelpful given the seriousness of the situation. This is, after all, the tenth time EU leaders have met to sort the problems in Europe out ‘once and for all’.

Paragraph 7 of the draft contains the following rather ominous sentence:

To improve the effectiveness of the EFSF and address contagion, we agree to increase the flexibility of the EFSF, allowing it to:

– intervene on the basis of a precautionary programme, with adequate conditionality

That is really worrying language. Does it mean, for example, that the EFSF can require states to implement austerity measures without negotiation with the sovereign? The language is vague enough to be quite scary.

The composition of the new beefed up EFSF isn’t reported. The only place Italy is mentioned in the draft is to get a pat on the back for its recent fiscal consolidation. Is Italy, in its current fragile state, expected to keep its share of the EFSF up? Look at the table on page 1 of this document from the EFSF showing the contributions of member states. Italy is expected to pony up up to 78 billion euros if required. More information on just where this money is coming from would be most welcome.

Another slight worry is that Ireland has agreed to talk about the common consolidated corporate tax base (ccctb), meaning that perhaps there has been a movement in the government’s position on this issue, though agreeing to talk does not mean that Ireland’s corporation tax rate (a different beast) is under threat just yet.

All in all, a lot to discuss in today’s announcements, but I don’t personally feel the EU has solved its problems to the satisfaction of all, though commenters may of course disagree.

By Stephen Kinsella

Senior Lecturer in Economics at the University of Limerick.

47 replies on “Plan B begins to emerge”

While the euro may stagger on into the medium term, the core problem remains that we are in a bad marraige. Real interest rates were too low in the last decade and too high in this current cycle. We are also trying to regain competitivness & yet our currency seems bid against our trading partners.

The prospect of our GGD reducing over the course of a few weeks and a reported near 1bn saving in interest rate repayments is somewhat blinding me to the valid points Stephen is making above.

Feeling like a bad neighbour now because all I can think about is the potential improvement in our fiscal position as a result of this move rather than continuing structural issues in the EZ.

I remian bemused by the alarm felt by some commentators that those paying to allow us to remain economically alive may insist we live within our means, the inevitable correction done more abruptly will mean less debt than if kicked down the calendar to 2015…..logic defies me

From the Council document, after the bit where it says Greece is unique etc.

‘7. All other euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms. The euro area Heads of State or Government fully support this determination as the credibility of all their sovereign signatures is a decisive element for
ensuring financial stability in the euro area as a whole.’

What categories of debt (and contingent liabilities) are embraced by ‘sovereign signature’?

Another interesting one:

‘9. Where appropriate, a collateral arrangement will be put in place so as to cover the risk arising to euro area Member States from their guarantees to the EFSF.’

‘Where appropriate’ according to who?. By whom is the collateral to be furnished?

Colm,
7. Includes the debt of systemically impotent banks in each country…. No change there.
8. If you don’t pay your reparations on time, we reserve the right to some of your territory…no change there.

“All in all, a lot to discuss in today’s announcements, but I don’t personally feel the EU has solved its problems to the satisfaction of all, though commenters may of course disagree”.

With all due respect, and without wishing to hurt anyone’s feelings, the EU has half a billion citizens and they are not hanging on the views of participants on this blog.

Ireland blundered into the euro and it would add insult to injury to blunder through the consequences of so doing. That is the challenge for the academic community in Ireland.

Another quite interesting feature of the deal for Greece WHICH WILL NEVER EVER BE EXTENDED TO ANYONE ELSE EVER!! if you believe the tough talk in the draft statement is the conversion, by force majeure essentially, of short term debt to long term debt.

If I were a market participant, I’d ask what might happen to the markets for these debt types if, say, Ireland were to avail of such a facility, and, just by induction, Portugal, Spain, and Italy, in 2 years’ time?

There is a small literature on rollover dynamics, Décamps has a cool paper studying it: http://idei.fr/doc/wp/2011/mafi.pdf, but at the firm level. Who knows what this might look like at an EU level?

By Post Author

Docm,
that is certainly correct. Moreover, having found that it is inappropriate, should we not leave? I suspect this is a question also being asked across southern Europe as well.

@DOCM, if President Van Rompuy *isn’t* reading this blog for his talking points, I suggest we close it up.

On a less sarcastic note, I think we could do better to point out the dueling perspectives-Irish and EU–required to think clearly about this problem.

By Post Author

I see this as a game-changer.

And the IMF is all over it.

Note that, last week, when the IMF was asked if it would give more money to Greece, it said that no request had been made. Tonight, we hear that there will indeed be new IMF money.

Translation: The Fund was not willing to increase its exposure to Greece unless there were serious changes. And it got them.

How little can we give up while agreeing to ‘participate constructively in the discussions on CCCTB’ ?

Can we just take the minutes of the meetings on it? or will it be the end of Corporation tax ‘by the back door’?

@ Stephen Kinsella

There is an instruction in the cyber world called “zoom out” to get the bigger picture. That is all that I am saying.

I think that the point about the political power of the EFSF is really interesting.
The paragraph about Ireland mentions us engaging “constructively” in the debate about CCCTB.
If we use our veto are we being “not constructive”?
Nasty piece of work really.

And when will they get that since the introduction of the EFSF bond yields have all gone up? Why? Because there’s always a buyer for the rubbish that should be thrown in the skip. The EFSF isn’t keeping Ireland alive it’s keeping a debt market in woegous sovereign debts alive.

@Gary O’Callaghan, @Colm McCarthy
If the IMF really are in the driving seat, how does that square with point 9 above, essentially putting Germany and France on the hook if larger states like Spain get into choppy waters?

By Post Author

Stephen, my take on point 9 is different – it looks like it was stuck in for Finland, who have been resisting unsecured advances to programme countries.

Looking at the official document provided by Karl, the change in language from point 7 in the draft to point 8 in the final version is really interesting. Here’s point 8 now:

To improve the effectiveness of the EFSF and of the ESM and address contagion, we agree to increase their flexibility linked to appropriate conditionality, allowing them to:
– act on the basis of a precautionary programme;
– finance recapitalisation of financial institutions through loans to governments including in non programme countries ;
– intervene in the secondary markets on the basis of an ECB analysis recognizing the existence of exceptional financial market circumstances and risks to financial stability and on the basis of a decision by mutual agreement of the EFSF/ESM Member States, to avoid contagion.
We will initiate the necessary procedures for the implementation of these decisions as soon as possible.

By Post Author

@ Eureka

What veto? Decisions taken by unanimity do not imply a veto power such as exists at the UN where the members of the Security Council, courtesy of their victory in World War II (leaving aside the complicated issue of China) each exercise a veto power.

Can you imagine Ireland, like the mouse that roared, standing against the rest of Europe if it decided to proceed?

The issue is how likely is this to happen at the level of the 27. The answer is; not very. But in a more concentrated EZ context, the situation could be different.

If the EFSF is empowered to buy back debt in the secondary markets why would any holder of that debt sell now as there seems to be an implicit guarantee in the agreement that all country debt (bar Greece) will be repaid in full?. Why not wait it out and get repaid in full?

Surely this new power to purchase bonds in the secondary markets will be challenged in the German Constitutional court.Is this not a violation of the Maastricht treaty?.

@ DOCM
“The mouse that roared”. Animal farm comes to mind.
Bottom line is that there was no need to make access to the EFSF conditional on “constructively engaging” (i.e. agreeing) with the CCCTB.
I really don’t know enough about the CCCTB to know what difference it would make anyway. It seemed that by weighting in favour of where the sales occur that it would disadvantage Ireland..but I don’t know.
This may very well be nothing alright, but it was disingenuous to put this into the document. It illustrates the loss of sovereignty that the EFSF brings with it

Ok…so Greece is under water: who takes the hit ? If the game is ‘no default’…then no sensible bondholder will want to partake in a ‘selective buyback’ at below par…

@ Colm, Stephen

I agree with Colm on point 9.

As regards point 8 in the final version, note the use of the term “precautionary programme.” This allows the Fund to pre-approve assistance to member countries on the basis of sound policies. It is aimed at Spain and Portugal.

And EFSF money can be used to “intervene in the secondary markets on the basis of an ECB analysis.”

Taken together, these elements mean that the EFSF can intervene in markets in support of Spanish and Italian debt (if they are behaving themselves, as decided by the IMF). This is where the immediate assistance to Spain and Italy is. People have missed it, I think.

This is no long term solution to the fundamental problem. Ever increasing debt & debt service. (Much as described by Richard Koo.) The EFSF fund is ultimately just another pile of debt service heaped on the people of Europe. Debt service to a blood sucking financial sector, gifted free gratis with the privilege of creating money from nothing, from the private sector &, incredibly, governments of a sovereign currency group alike. Much of this debt not only serves no useful capital purpose in the real economy, but when the financial sector’s created asset bubbles burst & gambling goes bad, the damage to the real economy is huge. The imposed ‘austerity’ means this debt service will be made by taking more of labour’s share of income & decimating public services such as health & education. Welcome to the new Landlord class.

This is what perpetuating this system means. It’s not a rescue for Greece, just another go at kicking the can to prevent all the toxic bets being exposed & crashing the system in Europe beyond. The blackmail continues. There won’t be anything of substance to change Irelands debt servitude program. If we continue, inequality in Ireland is going to grow even further. For those who can afford it, access to health, education & social services will continue. For those who can’t, tough.

Those who believe themselves secure now would do well to consider what happens when the next bubble bursts & the poor have nothing more to give to an even more powerful & wealthy elite (with even less shamocracy than we have now). Maybe it’ll be your turn.

Ceterisparibus at 11:29 pm

Private sector involvement is for Greece and Greece alone according to Barosso. So no relief for us.

Framing is important, and as I believe Mr Kostick mentioned before, since the private sector (well, the financial sector really) helped cause the crisis they are already deeply involved; it is just that it is the policy of the ECB that they be protected en masse and German policy that they be at least be sheltered in Germany, with France wanting to both protect all bond holders and not offend Germany.

I wonder can we try and come up with a less Orwellian way of describing PSI, can we say that preferential financial sector protection will be reduced in Greece and Greece alone? Suggestions welcome.

That off my chest it seems that plan B is the least laughable attempt so far to slow down the spread of the European financial crisis, it might well give Ireland time to prepare an emergency escape from EMU, help us plot the downfall of the ECB and perhaps save the EU from Euro idolatry.

The European Union can then try to be something a little more ambitious than a uniquely low inflation, democracy-lite polity with the safest bank bonds in the world and a real commitment to “competitiveness” (or beggar thy coworker).

As I commented here on an older thread Ireland has now agreed that PSI is only for Greece. So PSI is off the table for at least a couple of years and unless and until a debt-deflation spiral really beings to accelerate out of control. By that time most of the bank senior debt will have been paid off, though most of the sovereign debt will still be outstanding since it is of longer duration.

The ECB walk away with €55bn in indemnities, and veto power over EFSF secondary market operations, so I imagine there won’t be too many tears shed in Frankfurt over the lost battle on PSI/selective default.

I agree that the IMF were all over this. They have now got what they really wanted, which is an opened ended commitment by the EU to collectively fund bailout countries and to recap banks. They also argued for some real, as against phony, PSI, for Greece; significant interest rate cuts and maturity extensions, all of which are part of the deal.

@Stephen K

“The markets liked it too, with bank shares enjoying a nice bounce. There’s some evidence the bounce we saw on the markets was just short equity positions being cleared out”

I’m not sure there was much shorting ahead of this, would say more just standard jobbing given the small tail risk disappeared.

@Colm McC

“What categories of debt (and contingent liabilities) are embraced by ’sovereign signature’?”

I reckon they mean gilts and other specific guarantees given by the state. What sovereign signature has been applied to unguaranteed unsecured bank debt one wonders? It appears there is no document whatsoever. The side letter seems to be a myth based on one newspaper story.

The Irish times is reporting that the new deal will resulting in a reduction of €800 million euro on its interest repayments for Ireland annually. I’m hardly impressed.

Is this really the best the EU can do? Another exercise in half hearted can-kicking? We’ll all be back here again within 18 months at the latest.

@Stephen Kinsella

This is a good analysis. I also picked up the ominous language in the press release.

Deep undercurrents there.

I wonder what the market reaction to the deal will be over the next fortnight. The increased influence of the IMF will presumably be viewed positively but the deal is not the fudge to end all fudging.

Rejoice! It looks increasingly like my decision to shift my savings from Belfast to Dublin back in 2007, and ongoing since then, is paying off in a most handsome way. However, I am not deserving of all the praise I have received for my foresight. Shifting one’s savings from a weak-currency high-inflation low-interest-rate economy to a strong-currency low-inflation high-interest-rate economy is actually a bit of a no-brainer. It always pays to bet against the mob, and the mob is well represented on this site. I read in the paper a few days ago that there is a waiting-time of several weeks to open a bank account in Enniskillen. I have no idea if it is true or not. But, if it is, it must be poor dumb suckers from south of the border, anxious to get their savings into sterling as quickly as possible, so as to avail of the 0.5% interest rate they’ll get as compensation for the 5% inflation there and the ongoing decline of Sterling v the Euro. Fools and their money are easily parted.

@ Shay Begorrah

“I wonder can we try and come up with a less Orwellian way of describing PSI, can we say that preferential financial sector protection will be reduced in Greece and Greece alone? Suggestions welcome.”

How about PSD?

Private Sector Disengagement (Disentanglement?). The attempt is to get the private sector out of (or rewrite) certain financial deals they have signed up for, but are no longer viable. Then we could argue what the cost should be to get out of deals that are now being taken over at the expense/risk of the public purse.

@Gavin Kostick

I see your D and raise you a P.

PSP: Private Sector Prioritization was the practice in the late twentieth and early twenty first century of transferring money to private investors to help preserve the political and economic status quo. This policy of “wealth concentration” only ended when the deadly canapé transmitted plague of 2019 wiped out the European financial elite in a tragedy we still celebrate to this day.

@JtO
“so as to avail of the 0.5% interest rate they’ll get as compensation for the 5%”

How does the 5% inflation in the UK matter to those in the Republic that setup an account in the UK?

And what sort of deposit account only pays 0.5%?

Elsewhere, this is being spun as “Eurozone leaders hail the agreement as a leap towards economic and fiscal union”.

Whatever about what Greece has achieved, I hear Brendan Howlin talking about people flying in to run Greece and the substantial conditionality being placed on Greece? Conditionality men with brief cases….MOU?

Personally, I read this “agreement” as Ireland agrees to discuss the inevitably of raising our corporate tax rate. In return, we save a potential €800 Euro and agree to pay back even more money a longer time period.

Anything Ireland “achieved” simply had to be conceded, as part of this shock and awe. Our sovereign debt is still unsustainable, potential savings of €800 while welcome, only scratches at the surface of our problem.

Ireland has made a complete hames of our negotiations we were the good boys in the class too embarrassed by our economy going from tiger to kitten and too afraid to bite the hand that puts the money in our ATM’s. So I’ll be damned much of what was ‘impossible’ default, buying of bonds in secondary markets and lower interest rates is now necessary and being hailed as a part of a great solution.

Over the last 3 years of this crisis Ireland has taken what Ireland has been offered, at no point did we manage to get ahead of the curve, and yesterday was just another day at somebody else’s office, more of the same. Ireland has become a broken down debt servicing machine on the edge of Europe with politicians who are obsessed with trying to do the impossible.

@Dreaded_Estate

Because, as I am sure someone of your intelligence is well aware, if the UK opts to print oodles and oodles of money in an effort to relieve its debt burden, and, as a consequence, UK inflation remains permanently much higher than in the EZ, then the wretched £sterling will continue to fall against the Euro. Of course, it happens in fits and starts, but, given hoe the BofE has its money-printing presses operating at full blast, an ongoing fall in the value of £sterling against the Euro is very very likely, and even more likely after last night.

The 0.5% is Bank of England base rate. I haven’t time to seek out every rate offered by every deposit-taking bank or building society in the UK. Some may be slightly higher than the base rate. But, that is true in the EZ and Ireland too with regard to their base rates.

Bottom line is: inflation is much lower in Ireland and the EZ than in the UK, but nominal interest rates are much higher, meaning real interest rates are much higher still in Ireland and the EZ than in the UK, but especially so in Ireland. All that means it is very likely the £sterling will continue to fall. Unawareness of that inevitability is the missing link in the logic of those moving their savings from south of the border to Enniskillen. On current arithmetic, anyone moving their money from a bank south of the border to one in Enniskillen is getting a terrible deal and is being screwed, although they may be too dumb to know it until they wake up some morning and hear that the £sterling has fallen below 1 Euro, which will almost certainly eventually happen. The only reason why anyone should make such a move is mob-induced panic and fear. I pray you are not one of them. My commiserations if you are.

@JtO
“I pray you are not one of them. My commiserations if you are.”

So it is completely a currency play on the € as a whole vs GBP.

As I have said to you before, I made exactly the same investment decision in relation to sterling as your good self. But didn’t leave my money on deposit with an Irish bank or lend it to the Irish government.

@Dreaded_Estate

I made exactly the same investment decision in relation to sterling as yourself.

JTO again:

Then you are a lot more sensible than the southern-accented morons queueing outside the banks in Enniskillen, Armagh and Newry. However, it would still be interesting to know the exact nature of your investments, just out of curiosity.

Regarding lending to the Irish government, as far as I am aware, none of my savings were used to buy Irish government bonds. I am not 100 per cent certain because, as I have said many times, I leave all the nitty-gritty up to my financial advisors in the Ulster Bank. That’s what they are paid for. But, if that is the case, I am gutted about it now. I will have to speak sternly to them at our next meeting, as to why they didn’t avail of the opportunity to buy Irish government bonds when the mob panic was at its height, interest rates were through the roof, and a once-in-a-lifetime opportunity was there to become rich.

@ JTO & Dreaded Estate

Try this one – excuse the background but necessary (@ JTO specifically).

As I have mentioned previously I began ‘getting out’ 06-07.

I spoke to ‘a person’ around the same time who supplied FMCG to small business owners in RoI. He was advising them to open an account in the north and begin putting 1-5% of their weekly cash takings into it. ‘Put as much as you need to keep the business going cashflow wise if the bank pulls the plug on you overdraft or any loans’ i.e. putting the ball in another court and ‘relieving the ‘banker’ (sic) of any control of your business.’

Maybe those in the que in Enniskillen are a bit late, but maybe John, they are not ‘morons’ just small businessmen and women owners, trying to keep a business going and people in work- despite the efforts of the same scheming *ankers (B or W take your pick) who risked everyone elses money but their own and all but wrecked the place.

I am coming to the conclusion John that maybe you are just too far down the salary ladder to understand what it takes – or maybe I am just too far up my own to know what exactly your point really is.

@Ordinary Man

I am coming to the conclusion John that maybe you are just too far down the salary ladder to understand

JTO again:

My salary has doubled since 2006/07, mainly from promotion and bonuses. It is now about 100k sterling (I get paid in the north). That may well be peanuts to you, and be well below the salary ladder of people on here, putting me below the poverty threshold (60% median) of people on this site. That is why I have to invest my modest savings wisely. I need to lift myself above the poverty level to which my meagre salary has condemned me.

But, the point is not my salary, but the current value of savings deposited in a northern bank in 2006/07 as opposed to depositing them in a southern bank. The fact is: 1000 euros transferred from a southern bank to a northern bank in 2006/07 would now be worth about 800 euros, taking the exchange rate and UK interest rates into account, whereas, if it had been left in the southern bank, it would now be worth approximately (very approximately, as I have no calculator with me) 1,100 euros.

So, the ‘person’ you spoke to was a fool, and his clients should sue him.

@JTO

First congratulations on your promotion and salary.

I personally wouldn’t dream of taking that much money out of a business – but maybe that is why I am what I am and you are what you are.

‘But, the point is not my salary, but the current value of savings deposited in a northern bank in 2006/07 as opposed to depositing them in a southern bank.’

My point John, was simply this ;

‘Maybe those in the que in Enniskillen are a bit late, but maybe John, they are not ‘morons’ just small businessmen and women owners, trying to keep a business going and people in work ……’

Most small business owners are looking for margins of 15% + and critically maintaining cashflow. In straightened times with business survivability the main issue. Currency exchange rates or deposit rates, however unfavourable, will be tolerated so long as cashflow can be maintained.

For you to label people ‘morons’ and others ‘fools’ etc. for possibly trying, by any means, to keep a business’ survivability out of the hands of someone who cares only for his or her 100k salary is my point.

You have no more idea, than I do, as to why those people are opening an account in Enniskillen, Armagh or Newry – I only offer another possible reason for their obvious desperation (ask you Financial Director for a more detailed explaination of maintianing control over cashflow).

Your labeling of people as ‘morons’ etc. give lie to your sometimes evident intelligence and reminds me of the kind of sweeping generalisations and rational that had your beautiful county rip itself apart for over 30 years.

As for the ‘Fool’, if he is a fool you may chat to ‘Rich’ (I believe he is in Pharma.) and see if he can sell you some ‘Stupid’ tablets – he is doing alright.

Have a good week.

@Ordinary Man

I wasn’t trying to boast about my earnings. It was you who raised the matter first, by suggesting that I was too far down the salary ladder to understand the workings of the minds of those moving their money across the border. I don’t own the business. I am a member of the proletariat. I work as a wage slave for evil American capitalists. Therefore, I have no guilt whatever about taking as much as I can out of the business.

How exactly does moving money in 2006/07 from a bank in Monaghan to one in Enniskillen improve cashflow or survivability, given that the money moved would by now have experienced a 25 per cent exchange rate loss and received a negligible rate of interest? The only ‘reason’ for doing so is the belief that, if the money was left in the bank in Monaghan, there would be a risk of losing it as the bank there might go bust, and that it is safer to move it to a bank in Enniskillen. That was never a likely possibility and it gets more unlikely by the day. In other they panicked, and have now lost a great deal of money through panicking.

@ JTO

Sorry but I can’t resist the temptation to engage your first paragraph.

‘I wasn’t trying to boast about my earnings. It was you who raised the matter first, by suggesting that I was too far down the salary ladder to understand the workings of the minds of those moving their money across the border. I don’t own the business.’

My point exactly.

‘I am a member of the proletariat. I work as a wage slave for evil American capitalists. Therefore, I have no guilt whatever about taking as much as I can out of the business.

Are all US Capitalists evil – or just the company you happen to work for? You don’t strike me as the Oskar Schindler type John.

‘How exactly does moving money in 2006/07 from a bank in Monaghan to one in Enniskillen improve cashflow or survivability, given that the money moved would by now have experienced a 25 per cent exchange rate loss and received a negligible rate of interest?’

If a business lost 25% sales revenue it may be able to survive depending on cashflow and available working capital.

http://en.wikipedia.org/wiki/Working_capital

http://en.wikipedia.org/wiki/Cash_flow

If they are depending on the good graces of a southern bank manager then they are a great risk of loosing all cashflow as the bank seeks to reduce any exposure to the company by reducing any overdraft facility and calling in any outstanding loans – to boost the banks capital. Ask any business owner in the South you may know or in the Tyrone for that matter and LISTEN.

This may come as a bit of a shock to you John, but the rest of society does not move it’s money for the same reasons as you.

Check out the links above to see if things are any clearer for you and failing that as I mentioned before – have a word with your Finance Director.

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