Note: I had not seen Karl’s post before writing this one, so it is not meant as a response. Since the two posts cover somewhat different ground I hope they are complementary.
The argument is increasingly heard that if Greece is allowed a write-down on its debts then Ireland should be allowed a similar treatment. Unfortunately, a number of different things seem to get jumbled together in the discussion: the costs and benefits of default on State debt; the costs and benefits of default on senior bonds in the former Anglo and INBS; and the costs and benefits of restructuring the promissory notes. I don’t pretend to have all the answers, but it seems worthwhile to try to disentangle the different elements.
(1) Implications of a Greek write-down for the possibilities of an Irish write-down
There is almost universal agreement that Greece’s debt is unsustainable. Largely against the will of the Greek government, the EU/IMF funders are demanding burden sharing with private sovereign bondholders. This is unlikely to ease the austerity burden being imposed on Greece. The immediate benefits will go the official funders in the form of reduced loans that they have to make to Greece.
So could Ireland follow the same path? While we are certainly not out of the woods in terms of debt sustainability, the situation here is quite different. The debt to GDP ratio is projected to peak at about 118 percent of GDP in 2013. Irish bond 9-year bond yields have fallen from a peak of around 14 percent to about 8 percent now – still far too high to return to the markets but reflecting increasing confidence that Ireland will avoid default despite the chaos in the European crisis-resolution effort. Whether or not you believe that Ireland’s debt is sustainable, a move by Ireland to default on its sovereign debt is likely to be badly received by the official funders. There is no guarantee that official support would continue to be forthcoming. Loss of that funding would require the deficit to be closed cold turkey, with the austerity having devastating effects on living standards and the economy. Even it official funding continued, it is highly unlikely that the required austerity measures would be lessened. My conclusion is that it is hard to see a short- to medium-term gain from defaulting, with huge downside risks.
Longer-term, a default would obviously enough lower the amount of money we have to pay back. Against this would have to be weighed the cost of the loss of the asset of creditworthiness/reputation. Defaults can sometimes be viewed as “forgivable” if undertaken (or forced) as a last resort. The reason is that they don’t reveal that much about the country’s underlying willingness to honour its debts. A default by a country that can pay is quite different, and would involve a huge reputational loss for a country that begins with a strong reputation. Creditworthiness for a country with a large debt, a volatile economy and a large dependence on inward private investment is extremely valuable. I find it hard to see how a cost-benefit analysis would support trying to voluntarily follow a Greek default precedent.
(2) Implications of a Greek write-down for defaulting on Anglo/INBS senior bonds
The first thing to be said is that defaulting on unguaranteed senior bonds would not be a State default. I doubt if there is an economist anywhere that doesn’t find it stomach churning for citizens to have to absorb the losses of private bond investors in what was a privately-owned bank when they made their investments. But there are pragmatic considerations that simply can’t be ignored. For good reasons, the ECB does not want to set a precedent of default on senior bonds within the euro zone. This would make an already fragile bank funding situation more difficult. In normal circumstances I would say — too bad. But the ECB/CBI has been providing roughly €150 billion in funding to Irish banks, taking significant risks of losses in the process. The quid pro quo is that losses are not imposed by the Government on seniors bondholders. Even if you don’t accept the give-and-take argument and say that the Government should call the ECB’s bluff, this would be extremely risky. My guess, for what it’s worth, is that the ECB would not cut off funding to Irish banks because of fears of broader contagion. But we should remember that until quite recently Ireland was suffering a slow motion bank run, digging us deeper and deeper into the hole of foreign dependency. The reason the run has stopped is because of confidence in the ECB/CBI to act as lender of last resort. Doubts would build again if we looked inclined to play chicken. The reasonable stabilisation of the bank funding situation has been a major success in Ireland’s stabilisation effort. Jeopardising this stability again does not seem to me to pass a cost-benefit test.
(3) Implications of a Greek default for restructuring the promissory notes
The technicalities of the Anglo/INBS promissory notes make it especially fraught. Simplifying drastically, the State made a grant of assets to these effectively bankrupt banks, essentially promising to make cash transfers of €3.1 billion for a decade. The full cost of grant was added to Ireland’s debt and General Government Deficit. Also putting aside the interest holiday in 2011/12, interest is paid on the full amount of promissory notes outstanding from the beginning. The promissory notes have been used as collateral with the ECB/CBI to access funding, and this funding has been used to pay off bank creditors, most of whom have been paid already. There is roughly €3.5 billion of senior debt left in the successor bank to Anglo/INBS.
One complaint is that the interest rate is excessive – over 11 percent on one tranche – but this is effectively a transfer from one arm of the State to another, given that Anglo/INBS is 100 percent owned by the State. The interest payments substitute for capital in terms of the total amount that needs to be transferred.
As far as I can see the issue with restructuring the promissory notes has absolutely nothing to do with defaulting on anything. As it stands, the State has to raise €3.1 billion a year to fund the promised transfers. This could create severe funding pressures post-2013 when it is hoped we will have exited the EU/IMF programme, and indeed such funding needs will make market investors more wary, making it harder to return to the markets at all. The alternative of securing the funding from the EFSF is very attractive from a funding/liquidity point of view. The idea that the ESFS will step in to actually cover the losses of these horrendously bankrupt seems to me to be fantasy. If I understand it correctly, the proposed restructuring has nothing to do with loss imposition on senior bondholders; it is an attempted exercise in good debt management.
I have covered a fair bit of ground and have certainly oversimplified many issues. I welcome corrections and alternative interpretations. But hopefully we can have a sensible debate about the implications of a Greek default.