Strenthening the Ring-Fence (Warning: Wonkish)

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.

57 thoughts on “Strenthening the Ring-Fence (Warning: Wonkish)”

  1. @John,

    What do consider to have been the reasons for the EU changing its position on Greece, which in June 2011 was that its debt at present levels was sustainable as long as Greece followed the IMF/EU programme, to a position on 21st July when it was considered Greece’s debt was not sustainable unless there is some default. There was a U-turn.

    After all, the Troika had been saying for some time that Greece’s debt was sustainable. There are helpful graphs at the back of their staff reports which demonstrate why the debt is sustainable.

    Why the change, do you think, and do you consider it might be relevant to our own circumstances?

  2. There seems to be strange misunderstanding about the banking system in Europe – the banks are a utility of the economy , the economy is not a utility of the banks.
    I am not a fan of MMT but that is how the worlds monetory system works albeit with some strange hybridisation of ideologies & functioning withen the ECB but they are not even faithful to these ideologies in my opinion.
    There is simply to much debt relative to cash withen the Eurozone preventing effiencent production & transactions withen the Euro area.
    Production is falling to service debt – this is a strange Alice in Wonderland economy we have got here.
    The ECB refused to default on shadow bank debt destroying sovergin debts credibility and now refuses to produce money so that we can service the debt.
    The weakest are just falling first but if they continue with this irrational or possibly vindictive policey it will be find its way to Germany.
    http://www.youtube.com/watch?v=VYkFuziLaBU

    And now a possibly more rational solution from a Chartalist – OH MY GOD A CHARTALIST is rational – sit down in your comfy seats gentlemen.

    http://www.youtube.com/watch?v=riz-1pUqPXs

  3. 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.

    This was whole point of the Greek bailout operation. The markets had to be calmed with an almighty sugar fix before they threw their next tantrum and upped Italy’s borrowing rate. This fix came in the form of an effective get out of jail free card for Greece’s debtors; the EU/Greek Taxpayer will cover 90% of their losses. The 10% PSI was little more than a political token.

    The message of the Greek bailout was simple. Bankers and financiers will have ALL their losses covered by the European taxpayer, come what may. Not matter how risky the bet, you can make it and are guaranteed by the EFSF that you’ll get your money back.

    And lo, the markets were calmed!

    You would be too if you were told you could go to the bookies and never lose anything. Banks, lose money? Not on the EUs watch. Moral Hazard be damned!

    Of course, ultimately the money will have to come from somewhere and that somewhere is the general European Taxpayer; starting in Greece, Ireland and Portugal, but eventually extending to even the humble German saver. These people are the links in the chain that holds the ring fence together. It will be on their sacrifices and contributions that “debt sustainability” will be preserved.

    Until of course, the financial arsonists decide to burn the fence down for fun and profit.

  4. @John McHale

    “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.”

    You are absolutely correct. Not having enough PSI contribution has weakened the deal to the point of it being almost useless.

    1. The first reason is that the debt crisis is not over for Greece. The whole tortuous procees will have to be gone through again, with all the political, economic and financial uncertainies and issues still alive and still kicking on the table.
    2. The second and less obvious reason will be loss of a democratic mandate for the governments that signed the deal, principally because it was so biased against PSI involvement. This will turn out to be the fatal weakness in the deal. The EU footsoldiers, who pay for the EU, will simply stop fighting for the elitist EU that is now emerging.
    3. Finally, the ring fence is therefore not only weakened in terms of the fence itself, but more importantly by the demoralization of the troops behind the fence. Why fight for an EZ or and EU that is going to be a Transfer Union. Not a Transfer Union from rich country to poor country, but a Transfer Union, which transfers wealth to an elitist financial sector througout Europe.

  5. @OMF et al.
    “The 10% PSI was little more than a political token.”
    It was also the most that could be done without admitting that the other high-debt countries (including those planned to be high-debt like Ireland) were carrying unsustainable debt.

    IIRC, Greek debt-GDP was 140% at the end of 2010. So 10% off that (which is a gross simplification of what is happening) still leaves Greece more indebted that the other sick men. If there had been, say, a 20% cut in outstanding debt, where would that leave those newly with a debt-GDP above Greece?

    I think the interest rates and the ability of the EFSF to buy existing debt are more significant. As long as the EFSF can repo the bonds it buys at the ECB, it has unlimited money to support redemptions and to manage the secondary price.

  6. I am rather surprised that the question is even posed given that the answer is already so evident. For example, The Economist has this to say:

    “Their latest salvo in defence of Greece on July 21st produced some favourable initial reports, but the bang has faded. In a strange inversion of the crisis to date, the new bail-out plan seems to have helped the weaker peripherals and hurt the stronger ones”.

    http://www.economist.com/node/21524868

    (The point is also being debated on the thread “Europe’s 200 billion reverse wealth tax explained”).

    As The Economist points out, further ammunition will be needed and the likely candidate has to be E-bonds.

    The alternative is that identified in the attached contribution to Martin Wolf’s blog.

    “For instance, the International Monetary Fund derives its resource base from the quotas paid by its members, but it may, if necessary, swiftly activate a contingent credit line – the New Arrangements to Borrow – which it did last April”.

    http://blogs.ft.com/economistsforum/2011/07/squaring-ecb-independence-with-fiscal-decentralisation/#axzz1TUPpG3U0

    Nothing will resolve the crisis other than an unequivocal commitment by the two major players – Germany and France – and the other AAA members of the EZ to put their money where their mouth is. The rest is mere detail. On balance, the introduction of E-bonds would be the better option as it would serve to camouflage politically that this was being done.

  7. @Jagdip

    My intention with the post is not to pick on Greece. But the IMF projections always looked heroic: moving from a primary deficit of 4.9 percent of GDP in 2010 to a primary surplus of 7.7 percent of GDP in 2015, and then effectively sustaining a primary surplus of 6.4 percent of GDP thereafter.

    As to why the change, I think it is a combination of it being necessary to have some PSI to make a second package politically feasible in Germany, the Netherlands, etc, and the creeping risk premium in Italy and Spain brought home the need for a ring fence (sorry to keep using that ugly term). A ring fence with Greece inside it is just not credible. A priority for us is to leave no doubt but that we are on inside.

  8. @DOCM
    France & Germany can only provide more debt – this crisis has very little to do with executives.
    Its the CB network in Europe – if they cannot produce more money and not debt this experiment is over.
    The debt is internalised withen the EU – whats the big problem ?- the money will remain in Europe – if our wealth is represented by 10 chips and the CBs expand the money supply to 100 chips where does the wealth go ?
    In the event of the “authorties” staring through the looking glass much longer we will probably run towards Sterling now given the poltical problems seem half solved up North ( except for the loyalist working class) – maybe a devaluation of Sterling and a return of shipbuilding may solve that problem.

  9. @Hoganmahew

    In making comparisons between countries in terms of debt sustainability you also need to look at the political capacity to achieve improvements in the primary balance, the underlying growth rate and the size of the domestic bond market. I think there is scope for bringing the Greek ratio below that of other countries while leaving them inside the ring fence. It is also worth noting that under the IMF projections, the Greek ratio was to top out at 172 percent of GDP in 2012.

    See page 73 of this document, which I believe is the one Japdip is referring to: http://www.imf.org/external/pubs/ft/scr/2011/cr11175.pdf

  10. It seems that the PSI involvement in Greece is anything but clear.

    “As for the participation of the private sector in the restructuring of the Greek debt, there are more and more estimates that the cost for non-state bondholders will above 21 percent. Rabobank International claimed that the so-called haircut would amount to no less that 40 to 50 percent, while JP Morgan puts it at up to 34 percent.

    On the other hand, by calculating the average loss from both bailouts packages, Barclays estimates that the haircut may not reach 21 percent, leading to a cut of just 10 percent instead.”

    With the experts calculating haircuts from 10% to 50% the uncertainty can only increase.
    Another problem looming is that Italy may not participate in the next payot to Greece payable in SEptember.

    http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_29/07/2011_400440

  11. @JohnMcHale
    Given the assets available for sale and widespread poor collection of tax, never mind excessive military spending and sclerotic governance, I believe Greece has much larger scope than other countries to achieve targets set for it. Think Ireland in the 1990s. Like Ireland in the 1980s, political will to reform seems absent, but again, look at what happened in Ireland, in particular with regard to tax evasion.

    I sit with Reinhart and Rogoff on it not really mattering what the other factors are. High debt is its own problem, regardless of perceived ability to deal with it. I suppose this is the essential divide between quick and slow deficit reducers. Perception is ephemeral and subject to small political mis-steps.

    As there is no currency risk, there is nothing to keep conservative domestic purchasers buying, so I think the domestic bond market size is a bit of a non-sequitor. It didn’t help Greece to have large domestic purchasers. Indeed, one could argue that it made the situation more dangerous since a fiscal crisis becomes a de facto banking crisis.

  12. “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”

    Not sure what you are getting at here. The real international political economy game being played is about Italy (as a bullseye for Euro break-up) and also Spain.

    You seem to be suggesting that zero PSI for Greece might stop people thinking those two countries could end up requiring PSI. Is that right?

    As it is, we know that, particularly Italy is too big to bail – although the dynamics might be a bit more slow-burn than the others. Either it, or Spain will or will not get to that point, but if PSI had been avoided – say by fiscal transfers from the core, would that really have been viewed as a credible strategy in the case of Italy?

    Just above that you say: “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. ”

    If by ring fence you mean a method of separating expectations about the bailout three and the others, then I haven’t viewed it as functioning in that way.

    Leave finance behind for a mo. In Chemistry there is the concept of a chemical reaction being likely to occur if the size of the initial energy barrier to cause the reaction is small enough and the subsequent liberation of energy is large enough.

    The interest rat reductions and term extensions serve to make bailoutland a more logical destination than before.

    The market was reluctant to really concentrate on Italy previously. Not any more.

  13. The notion of a ring fence has little credibility. Notice that while Irish and Portuguese bond yields have dropped quite a bit, without coming anywhere near levels consistent with market re-entry, Spain and Italy are pretty much where they were before the Greek deal.

  14. @grumpy

    You seem to be suggesting that zero PSI for Greece might stop people thinking those two countries could end up requiring PSI. Is that right?

    I clearly didn’t explain myself very well. I am actually arguing the opposite: that there needed to be decisive action on Greece in a way that it didn’t that left doubts that enough was done, and so leaving the PSI regime as an expandable work in progress.

    In terms of the moves that improve debt sustainability, I was thinking of Ireland and Portugal here. I take your point that these moves could increase the chances of Italy and Spain getting sucked into the black hole. How’s that for mixing metaphors?

  15. @JMcH,
    I think they were trying to send several not altogether consistent messages. The most important of these was that German, Dutch and Finnish taxpayers will eat the lion’s share of losses from sovereign defaults in the Eurozone for as long as this can be sustained politically, so contagion will not spread through Ireland and Portugal.

    Regarding the level of debt that can be sustained, I think our EU friends (and possibly yourself) are placing too much emphasis on what is technically feasible, and what can be sustained politically in the short run. My reading of the evidence is that very high debt levels place a severe drag on growth that is hard to shift because high debt levels are themselves hard to shift.

    This creates a dilemma for governments that succeed in stabilising foreign denominated debt at a high level, which historically has usually been resolved by a debt crisis and the imposition of sense by the IMF.

    The EU is doing its best to prevent this resolution taking place for any members of the Eurozone, which for me raises a question as to what else can or should trigger it if the usual trigger has been disabled. In the case of Greece, I strongly suspect that when they reach a positive primary balance in the relatively near future, with a long way still to go to reach fiscal sustainability, the political calculus within the country will shift in favour of a really big unilateral default.

    In the case of Ireland, I think we will be able to keep postponing the default for as long as the political will exists, but that a time will come when we will recognise that the long term economic malaise caused by high public debt levels is more damaging than a managed default down to debt equivalent to 80% of GDP, and that we would really like to put some of those interest payments into lower taxes and better public services.

  16. @ Hoganmayhew

    “I think the interest rates and the ability of the EFSF to buy existing debt are more significant. As long as the EFSF can repo the bonds it buys at the ECB, it has unlimited money to support redemptions and to manage the secondary price”.

    Although I cannot lay claim to any particular expertise in the matter, I think that this comment by you is correct. In fact, the comment helps explain for me the involvement of the ECB in the decision-making.

    The difficulty is the slowness with which the EFSF moves as Domenico Lombardi points out (in the link to Martin Wolf’s blog I give above) “the EFSF will still have to rely on and wait for bond issuances to fund its operations, which is plainly inconsistent with its emergency rescue role. Its current governance arrangements foresee it under a tight inter-governmental grip, rather than as a pan-eurozone decision-making mechanism”.

    Even in its revised format, it is not fit for purpose. Events in the coming weeks are likely to prove that this is the case.

    As to Ireland’s situation, the changes in bond speread would suggest that Ireland may be decoupling from Greece and Portugal. This is as it should be as the country’s circumstances are entirely different.

    QUOTE Wilbur Ross CNBC

    Wilbur Ross, chairman and CEO of WL Ross told CNBC the investment amounted to a “re-privatization of the bank.”

    “I think the Irish government deserves it. They really bit the bullet. They cut the total cost of civil service 13 percent… they also refused to put up the corporate tax rate,” he added.

    “They really are fixing the economy, unlike what I call the Club Med countries, who are not reforming anything,” Ross said.

  17. John, I might be being a bit dim, but I don’t understand – is this fence supposed to separate the bailout three from the rest, or Greece from the other two?

    If the former, then wouldn’t even lots of PSI for Greece have just led to the conclusion that PSI will end up being applied where debts are deemed unsustainable – even if they were deemed sustainable the previous week?

    If the latter, it seems to me the fence mainly consists of talk that Greece is unique. Talk is cheap, and maybe it is unique, maybe not; but its not much of a fence.

  18. Slightly off topic but I was wondering what is the “correct” 10 year yield for a euro sovereign bond? Let’s say they went the whole hog and announced a fiscal union. The theory is that in a fiscal and monetary union physical default is not on the cards, the printing presses would crank in before that, leading to depreciation of the currency.

    Consider the two extremes:

    1) Countries should stand on their own. In this scenario default would be the main fear and driver of yields.

    2) The ECB guarantees all sovereign debt in a fiscal union. Clearly then the 10 year yield on euro bonds would be the same for all countries just as it is the same for all US sovereign debt. But what would that yield be? Probably around 5%.

    The powers that be are attempting to steer an optimal course somewhere in between but we should not rush to say it isn’t working just because Spanish/Italian yields are 6%; 5% might be the very best that could be achieved given the level of indebtedness, even if default was firmly off the table (and was replaced by inflationary fears).

  19. @DOCM
    Reform means a transfer of the remaining surplus from wage earners to capital holders – it does not solve the problem.
    The problem is the west – its incapable of wealth generation.
    All financial activities involve wealth transfer.
    I’m not big into Financial masturbation – it miraculously produces evolutionary dead ends.
    http://www.youtube.com/watch?v=SgUYUOGvVZM

  20. @grumpy

    The fence is meant to be between Greece and the four +, though there are of course important differences between the two already in programmes and the others.

    Think of if this way: If a perfectly credible LOLR (with no PSI requirement) were to appear in the morning, our problems would melt away and we could back in the markets in the morning at our guarantor’s yields. (Credible here meaning a LOLR with both the will and the financial capacity to back it up.) The ring-fence, as I understand it, is an attempt to move in this direction. Given the likely losses on Greece, there isn’t a willingness to give it this sort of protection without creditors taking some losses, but there is more of a willingess to provide it to others. Now granted, the fence is quite ragged given understandable concerns about large contingent transfers and debtor/creditor moral harzard. DOCM is right that eurobonds would make a fine fence, but the stronger countries are not willing to go there (at least yet) and who can blame them. Can you imagine our indignation if we happened to be the stronger group? My point in the post is simply that by leaving it likely that the PSI issue with Greece will be revisited again, we leave the fence that bit more ragged.

  21. Too little PSI is being applied?

    Oh come on. What did we seriously expect. My guess is a good chunk of the people on this blog work in some kind of banking/financial services and we all know how they operate. Who do you seriously think pulls all the strings behind the scenes and manipulates the politicos and ECB – Santa?

    However, bankers aren’t noted for longer term strategic thinking (rarely see past what they need to achieve for this and next years bonus) and something like transfer of debt to taxpayers will have some kind of feedback loop that will invariably come back and bite them on the bottom a little way down the road. For example, the 122,000 credit card accounts that have been closed in Ireland in the recent past (year I think?) – this is their most profitable business directly with the individual taxpayer-types. Similarly, the lack of demand for loans. This is all going to hit them down the road (perhaps where their road meets the can) and is a direct result of hitting the taxpayer for it.

  22. @BW2: Slightly off topic but I was wondering what is the “correct” 10 year yield for a euro sovereign bond?

    Presumably lower than the US 10-year, given that the ECB is much more hawkish about inflation than the Fed, which has a dual mandate; also US legislators are quite willing to flirt with default for partisan reasons, which is not the case in any major EU country.

  23. @John McHale,

    Is there any reason to suppose this ring fence is anything more than a skirmish line? It seems to me that the really important line for the ECB is the one that contains the big banks. Really, what evidence is there that they regard the peripherals as particularly important? Of course they don’t want to lose skirmishers if they can help it. But if push comes to shove, Ireland and Portugal are expendable – or so it seems to me. I’d love to be wrong and would welcome any evidence you may have that we really are beloved of the captains and the kings.

  24. @Kevin Donoghue
    Sticking to that theme – is the second Greek bailout simply to protect the Greek banks and through them the rest of the eurozone banking system?

    Ireland may be expendable; it’s banks weren’t, but soon will be?

  25. If there is a credible guarantor then there is no need for a LOLR – then you’d have market access. Nobody with means want to guarantee the debt of Greece at current levels. Default appears to be acceptable, the question now is who will pay for it.

    The talks about PSI are excellent examples of newspeak. Contagion will be ensured by creating a link from the ones who won’t/can’t pay to the ones who can pay for themselves but can’t also pay for others. The Irish bank-guarantee might turn out to be such an example.

  26. #Joseph
    (Reuters) – German Finance Minister Wolfgang Schaeuble denied on Saturday that this month’s Greek bailout deal paves the way for a future ‘transfer union’ in which euro zone countries are liable for each others’ debts.

    Schaueble’s remarks in a newspaper interview to be published on Sunday follow his attempt earlier this week to reassure conservative political colleagues that a new euro zone rescue fund would not have ‘carte blanche’ to buy bonds of states in difficulty.”

  27. The bond market has had six trading days to chew over the outcome of the Brussels summit. The verdict thus far is in two parts:

    1. For the three (Greece, Ireland, Portugal) with double-digit ten-year yields, the estimates of potential haircuts have been trimmed a little. (Cyprus has just joined this club). Default at some level of haircut is implied to be virtually certain.

    2. For Italy and Spain, expectations are essentially unchanged. Default at some level of haircut probable but not certain.

    In John McHale’s terminology, the three ‘programme’ countries remain on the wrong side of the fence, with Italy and Spain close by.

    All else is chatter, until the next market surprise and the next summit.

  28. @John McHale

    (Credible here meaning a LOLR with both the will and the financial capacity to back it up.) The ring-fence, as I understand it, is an attempt to move in this direction. Given the likely losses on Greece, there isn’t a willingness to give it this sort of protection without creditors taking some losses, but there is more of a willingess to provide it to others.

    but there is more of a willingess to provide it to others??

    My understanding is that the EFSF would loan money to sovereigns to bail out banks. The bank losses would still remain firmly with the citizens of the relevant country. In terms of any banks that will fail therefore, there is virtually a guaranteed no PSI involvement, except the PSI involvement of general taxpayers.
    In simple english, banks must pass their losses to State citizens under the new EFSF arrangements and State citizens must accept those losses? In fact my read of article 8&9 of the Greek ‘deal’, is that the EFSF will be able to intervene to save the failed bank, and pass the bill to the State in question.

    The ring fence is therefore in part a ring of steel around the banks throughout Europe to be paid in full by the citizens of the home country of the failed bank.

    @ Ceteris
    Schauble may be aleady be trying to back away from the idea of a transfer union, as that is understood in Germany.
    But we already have a transfer union of a different kind.
    A Transfer Union, that transfers wealth from citizens to failed lenders.
    And a Transfer Union that forces deleveraging at firesale prices, thereby further impoverishing State’s citizens at large to the benefit of the wealthier classes.

  29. @JMcH,
    I think you are wrong in thinking that a perfectly credible LOLR would necessarily resolve our problems. If lenders felt there was an underlying solvency problem, and I think most do feel this, then they would logically be concerned that they might be left holding the baby when, whatever the trigger, the solvency problem became a crisis.

  30. @John Mch

    OK, we should read “strengthened or weakened the “ring-fence” beyond Greece” as “strengthened or weakened the “ring-fence” around Greece”

    “From the point of view of the ring-fence [around] 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.”

    It would have in as much as the EZ would have been in a position to move the conversation on from PSI for Greece, so PSI could be sold as a unique thing for a unique situation – and they could have a less cluttered stage for holding the line against PSI of any kind, for any institution for Ireland and Portugal.

    However proper PSI for Greece would have upped the stakes, thereby making PSI a perhaps less frequent, but perhaps more important goal/policy tool (choose description and spin according to prejudice 😉 ) on which to focus.

    “If a perfectly credible LOLR (with no PSI requirement) were to appear in the morning, our problems would melt away and we could back in the markets in the morning at our guarantor’s yields. (Credible here meaning a LOLR with both the will and the financial capacity to back it up.)

    I’m not so sure. A LOLR might extend the debate, but at some point the reality of debt sustainability or not would emerge. Then PSI anyone? If you go further and say, OK, then a LOLR at however low the interest rate has to be – zero even – then the political realities at that point become prohibitive – fiscal and essentially political union and German style wages, costs etc.

    @Colm Mc

    “2. For Italy and Spain, expectations are essentially unchanged. Default at some level of haircut probable but not certain.”

    My take is that the EU will consider the slight narrowing followed by significant widening for Italy in particular, to be a real slap in the face. OK, it is dodgy to read too much into a few days moves in a volatile market which has one eye on the circus in Washington, but Italy getting fingered was what panicked them into doing something and from that perspective it doesn’t seem to have worked.

  31. @grumpy:

    “My take is that the EU will consider the slight narrowing followed by significant widening for Italy in particular, to be a real slap in the face. OK, it is dodgy to read too much into a few days moves in a volatile market which has one eye on the circus in Washington, but Italy getting fingered was what panicked them into doing something and from that perspective it doesn’t seem to have worked.”

    Bingo! And the BTP auctions this week weren’t particularly encouraging either. We will have another rescue summit before the end of September.

  32. Some horrible truths:
    The market is human. It has a mind. It is intelligent. It is co-ordinated. It moves with the focus of greed.
    Colm McCarthy and his ilk have been a little irritating in stating that if we get a few mathematical parameters right we will sate the markets. The markets want the German taxpayer and will not stop until they get it. Irish commentators are depressingly naive. They are mammy’s boys commenting on the outcome of a street fight. This is going to be messy.

    A greed motivated market will find a way through a shoddily constucted ring-fence. And that is what will happen.

    But..the market is also dumb. It has unleashed forces that it cannot dare to control. The instinct of poor people is not to left-centred pink semisocialist discontent. The instinct of the threatened societies is to the right – and to the extreme right at that (witness the tea-party movement in the US)

    As for us – the facts are the facts. We got to reduce our deficit but……we have to start up our domestic economy again. I don’t think we can rely as much on MNC’s any more. The FDI is under a double threat – the Consolidated Corporation Tax and an administration in Washington that might me under more pressure to bring taxes back home. Maybe it’s time to really start thinking.

  33. @Grumpy

    Real news. No wonder Italian yields went up.
    Ackerman of Deutsche was the man entrusted with coming up with the Greek bail-out idea, was he not.

    The people of Europe have no idea what kind of a monster they are up against.
    There goes the Italian section of the fence. I am not too sure what it says about Deutsche Bank’s ability to absorb some risk.

  34. Apologies for posting several times but the Telegraph quoting a Deutsche Bank analyst really takes the biscuit.

    http://www.telegraph.co.uk/finance/financialcrisis/8667986/Eurozone-crisis-fears-continue-as-Italy-forced-to-pay-higher-rates-to-borrow.html

    “”George Saravelos, a strategist at Deutsche Bank, added: “We are seeing a sell-off in Italian bonds post-auction which is putting pressure on the euro.”””

    His employer, Deutsche Bank, headed up by Mr Ackerman, was doing the selling.

  35. There is an established pattern, the core member states come to the rescue a little late and contribute enough to keep the sick country from defaulting but not enough to allow it to stimulate growth. The rest of the world sees a failing economy incurring more debt with no prospect of enough growth to pay the debt. Some people take the position that this pattern of behaviour will continue til after the German and French elections. This is not seen as high risk behaviour by investors or prospective investors in PIGS bonds/debt. The risk is expected to ramp up if Merkel and Sarkozy are punished at the polls for bailing out foreign and domestic banks. If that happens their successors will have campaigned on a no reward for profligacy platform and although governing a country has a sobering effect they will lean toward imposing stricter conditions on debt holders and debtor countries.
    We will look back on the last few years as being quite benign.

    The technocrats and the bureaucrats have behaved, as expected, in a rational manner. Politicians have to cater to the masses and have a limited window to see whether the measures taken by the technocrats and bureaucrats are successful. If after spending hundreds of billions, it becomes evident that none of the debt ridden countries is close to balancing their budgets they will be perceived as a lost cause. The core will then focus on saving itself since the first and foremost responsibility of national government is to remain solvent.

    As we all know Germany and France are vulnerable to the winds of change blowing out of the USA and China in addition to the internal problems of the EU and the Euro Zone.

    The ring fencing effort was far too weak to be effective. It did stave off serious problems and gave each of the PIGS an opportunity to deal with their problems. We should be duly grateful.

  36. Eureka Says:
    July 30th, 2011 at 10:33 pm

    The markets want the German taxpayer and will not stop until they get it.

    This is the definitive statement on the entire Eurozone crisis.

  37. I think it would help greatly to use an analogy at this point. The banks and the rentiers are tanks and the Ring-Fence is the Maginot Line. Get the picture?

  38. @Joseph Ryan

    “His employer, Deutsche Bank, headed up by Mr Ackerman, was doing the selling.”

    DB have been systematically disposing of their exposure to peripherals/southern European bonds. They (and all the other leading banks) have politicians all over the world in their pockets and always have the inside track on what is happening so that they can get in/get out way ahead of anyone else.

    Does anyone not get that the only ring-fencing that’s going on in the world is around the major banks?

  39. @Eureka

    I don’t think we can rely on as much on MNCs anymore. The FDI is under a double threat – the Consolidated Corportaion Tax and an administration in Washington that might be under pressure to bring taxes back home. Maybe it’s time to really start thinking.”

    Brings me back (wistfully) to my first comment to your great site late last year.

    You could have added that MNCs are not contributing significant net employment increases and that MNC exports are shifting proportionately from EZ markets to Asia making a European base less relevant.

    Could Ireland need a radically new “industrial”/enterprise strategy?

  40. I should have mentioned that the ring-fence around the banks also contains a number of very wealthy individuals within it too.

  41. @Mickey Hickey

    The SPD in Germany and the PS in France (likely adversaries of Merkel and Sarkozy) are critisizing le lack of involvment of the right ,not the excessive generosity towards the PIGS.
    Sarkozy wont be lucky enough to have Martine le Pen as an opponent in the second round.
    Nobody is going to be “punished at the polls for bailing out foreign and domestic banks”.
    The campaigns are going to be ugly but they will not be centered on Europe’s problems.
    Right now the main problem for Ireland and Greece in Europe is the German right not its opponent the SPD.

  42. @John Mchale,

    I wonder if you have seen this excellent article by Simon Johnson

    http://www.iie.com/publications/pb/pb11-13.pdf

    Agree that too little PSI has been applied to Greece, there is not enough emphasis on growth, where is the growth coming from?
    For me the most important role in the financial crisis is played by the ECB.
    The president and executive board of the ECB are key players in the financial crisis.
    The executive board and president by a gentlemans agreement must have sitting members from Italy, Germany, France, and Spain. So far we have seen them ‘ring fence’ smaller countries like Ireland, Greece and Portugal.

    The reason for the change in attitude of the ECB, especially towards the ECB buying bonds in the secondary market recently has been because Italy and Spain may be involved in the crisis. Countries like Greece and Ireland really had no say at executive level in the ECB. Countires like Italy and Spain do. Italy will take over presidency of the ECB in October and 5 of the 6 executive members will now be from troubled countries. Albiet still biased towards finance over workers.

    Couple this with the increasing reluctance of German and French taxpayers to bail out bankers and we can hopefully expect more PSI in the months ahead.

  43. Interestingly Dr.Johnson seems to agree with Dr. Kelly on the point of balancing Irelands budget. They are both leading memebers of CEPR. According to Dr.Johnson if Irelands pubic sector wages were returned to mid 2000’s level Ireland would have a balanced budget.

  44. As regards more PSI through restructuring where relevant making things worse or better. Well are you talking short term or long term? Short term worse, yeilds on government bonds go up and there is contagion to other countries. .Medium to Long term better, countires can grow better and get out of their difficulties easier with less debt load.
    Example, Iceland. Example South Koreas recovery from the Asian crisis, which some would say they were dragged into by contagion.

  45. Politicans seem to keep taking the short term kicking the can a few yards down the road option.
    Federal Elections in Germany to take place in Fall 2013. Angela Merkel origionally said we could have PSI on bonds issued after that date.
    French elections April 2012.Sarkosy will be hoping to keep the show on the road until then.
    Elections in Spain bought forward by a few months to this autumn. Does Barroso expect things to worsen by next year?
    Italtian elections early 2013.
    Seems to be plenty of incentive there for the 4 core Eurozone goverments to perform well in the next elections by taking the better solution in the short term.

  46. “The debt dilemmas in Europe .. prove yet again that elected officials will ignore long-run costs to achieve short-run benefits, and will act only when forced, in a doomed effort to circumvent the laws of economics and revoke the laws of arithmetic. And that implies an extended period of episodic economic disruption and political upheaval far beyond .. Europe’s distressed sovereign debtors. These debates represent just one round in an ongoing struggle, with vast political and economic consequences for years to come. – Michael Boskin, currently Professor of Economics at Stanford University, Chairman of President George H. W. Bush’s Council of Economic Advisers, 1989-1993.

  47. It was interesting to see Friday that Moody’sreasons for putting Spain on negative outlook last Friday very clearly was motivated by the risk of a much wider form of PSI in the years to come. First time we see such explicit fears by a rating agency, and on a well rated sovereign to boot.
    .

    The “decisive action on Greece’s debt” that you want, John, unfortunately however would necessitate large “burden sharing”. You do say “granted, the fence is quite ragged given understandable concerns about large contingent transfers and debtor/creditor moral hazard.”
    So even more affirmative action could lessen the pressure off Greece to engage in serious austerity, and to sell some of its (very extensive) assets. The risk of moral hazard thus is ever greater. And your “decisive action” would also set an even worse example to other countries that might be tempted to go down the same road.
    Even mild forms of PSI/default/burden sharing have a deleterious impact on incentives for government to take the pain on the chin of the structural change to living standards and prospects for growth.
    .

    All of this underscores that once we open the Pandora’s box of “burden sharing”, it is very difficult to keep the lid on financial stability. That is of course why the ECB has been so worried about such talk, and now action, by Europe’s governments. And to the pundits that see no problem in the financial sector getting hit, do bear in mind that financial stability is an imperative if we are to see real growth in the years to come (let alone a somewhat healthy financial sector).
    .
    ps I once remember – before we had the euro – that a certain European sovereign had to implement an exceptional levy to find the cash to pay for a certain bond redemption. That was before we had the tooth fairies in Brussels and Frankfurt and Washington etc. that are all too ready to envisage burden sharing and PSI.

  48. @Ciaran

    Just to be clear, I do see the threat of PSI as a major obstacle to Ireland regaining creditworthiness and also increases the chances of the crisis spreading.

    What I am really getting at is the news content in terms of the PSI regime contained in the measures imposed on Greece’s creditors. Surely it cannot have come as a surprise to the rating agencies or anyone else that Greece’s creditors will be forced to take losses. My point is that by leaving Greece still with an apparently unsustainable debt we know that Greek PSI will probably have to be revisited, with the possibility that other countries will then be dragged in. If the goal was to ring-fence other countries from expectations of defaullt–imposed or otherwise–it would have been better to deal decisively with Greece.

  49. @Ciarán O’Hagan

    It’s rather easy to disparage nameless pundits. Serious commentators like Harald Hau, Kevin O’Rourke and Colm McCarthy (to name just a few at random) are not blind to the problems which result from requiring creditors to bear the consequences of their rashness. But requiring taxpayers to bail them out also gives rise to problems and it doesn’t usually foster financial stability. Quite often the rescued banks go on to create yet another mess.

  50. This:
    “Even mild forms of PSI/default/burden sharing have a deleterious impact on incentives for government to take the pain on the chin of the structural change to living standards and prospects for growth.”

    is the direct result of not having the defaulters balance their budgets overnight…. Low interest rates to cover the shortfall isn’t really helping matters much

    What is ‘financial stability’?
    Is it availability of credit for the real economy?
    The real economy can live with increased interest rates for interbank borrowing for a period of time. Some banks might become insolvent & pushed into government hands in that time but that is just a function of the market economy.

  51. @ Kevin Donoghue Yes, point taken. Hitting anyone with losses on government debt is always problematic with deep, indirect, undesired consequences, be that banks, investors or of course the taxpayer. I sometimes wonder how matters might have turned out so differently if, in 2009, the new Greek government had been told firmly, once and for all, that it would have to stand on its own two feet, with support instead being directed towards the consequences abroad of failure to do so. I think the Pasok government would have got by.
    .
    @Joe McHale Halfway houses I think are dissatisfactory for everyone, not least the politicians, but also imposed by the difficulties of the political processes. And when you introduce politics into finance, there is always uncertainty. So Moody’s was not surprised to see PSI in Greece (already Greece is rated at what some might consider an impairment rating). And they are now drawing out what the likely form of PSI means for even governments rated Aa at present.
    .
    Jesper Low interest rates helps of course the debtor sovereigns but is far from a panacea, and an advantage that needs many years to be felt. As for ‘financial stability’, it certainly covers a broad set of conditions and can be in the eye of the beholder. The US has let banks go to the wall. Europe and Japan almost none. Yet it is hard to say that avoiding the tough decisions (like in Europe) is the right way to go, or has contributed to long term stability and security.

  52. @John

    “a priority for us is to leave no doubt but that we are on inside.”

    Any ideas? The projected 118% peak debt:GDP hasn’t worked. The 140% peak debt:GNP which is possibly more relevant to us hasn’t worked. Truth be told, we would have been unlikely to have even gotten EFSF at 3.5% with longer maturities unless Greece was at the brink. It seems that even unfairness has limits in the Eurogroup! As I understand it there has been an offensive at diplomatic, foreign, finance and European affairs levels to “spread the word” about Ireland’s finances. Appeals for fairness have not worked very well so far.

    And we have very limited weapons in our own arsenal – recapitalising the banks during the past week was one and we surrendered that. Unilaterally defaulting on an unguaranteed unsecured bond is another but that is seen as too provocative and nuclear set against an ECB with €120bn of cheap funding in our banks which might be withdrawn in October. What other weapons have we got left?

    And look at this from the point of view of creditor governments, or to be more accurate, governments of countries whose financial institutions have invested in Irish bank bonds. As a creditor, you don’t relent until the pips squeak – as a nation that’s what we want NAMA to do with developers and we don’t even like the thought of our neighbours getting a free ride with debt forgiveness on unsustainable mortgages. And our creditors can rightly point to welfare rates, low tax rates (particularly corporate) and high public sector costs and say the pips aren’t even beginning to squeak. Creditor governments would need to be idiots to voluntarily relent on Ireland’s debt at this juncture. Complete idiots.

    What else can we do? My slightly tongue-in-cheek suggestion is that we could fund financial analysis of the Spanish banking and property sector to throw light on what increasingly looks like a country facing severe funding difficulties. Because unless Spain or Italy gets into difficulty, our issues will continue be relegated off the agenda.

    By the way, Colm McCarthy’s weekly column in the Sunday Independent is now available here – http://www.independent.ie/opinion/analysis/eu-concession-still-long-way-from-facing-reality-2835976.html

  53. @Ciaran,

    thanks for the reply. It appears a lot of money is being handed over to the financial industry on the basis that the concept of ‘financial stability’ has to be maintained. The concept is very vague and I’d agree with you that it seems to be decided arbitrarily (eye of the beholder). At the moment it seems the decisions have always been decided in favour of the finance industry…

    My cynical view is that unless governments take charge then the ‘instability’ will end when no more money can be extracted 😉

    Greece looks like getting:
    Debt writedown
    Low interest rates to fund continued deficit
    Infrastructure funds (roads to nowhere and corruption?)

    What Greece is expected to do:
    Reform

    Their deal looks really, really good. Other countries reform and will not be handed the same advantages they’ll have to be satisfied by ‘virtue is its own reward’.

  54. @ ciaran o’hagan

    ‘And when you introduce politics into finance, there is always uncertainty’

    Hmmm. Politics is always involved in finance. Its’ a question of what kind of politics we want. Karl Polanyi had it right in his 1947 Great Transformation.

    Private property rights were established over centuries of struggle against mediaeval notions of heritance and duty. The credit bubble of the Greenspan era could not have happened without the active political colllusion of the various national treasuries and regulatory agencies. Without wishing to defend the inefficiencies and vested interests in the public sector, we are dealing mainly with a mess created by a plutocratic cabal.

    The markets, we are suppoed to believe, will discilpline the politicians. That;s story look pretty thin now.
    Quis custodiet custodiantes ? That’s the challenge for the 21st century, as for every century before us.

  55. @DOCM
    ‘As to Ireland’s situation, the changes in bond sprfead would suggest that Ireland may be decoupling from Greece and Portugal. This is as it should be as the country’s circumstances are entirely different’

    Ireland real position is obscured by the transfer pricing flows within the FDI enclave. The corpo tax tail is wagging the ratings dog. We scarcely know what our medium to long term circumstances are, as Michael H, and also a number of other posters above have pointed out.

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