Karl Whelan on the Burden of Bank Debt

Karl Whelan has a very useful post on options relating to reducing the burden of banking-related debt (see here).   Of particular interest is his comparison of the present discounted cost of the current promissory notes/ELA arrangement and a low-interest (3 percent) long-term (30-year) financing deal with the ESM to immediately payoff the ELA.   This calculation shows that that ESM alternative has a lower NPV by a wide margin.  

We could perhaps quibble with some of the assumptions used in the calculation.   Karl assumes the ECB’s main refinancing rate rises to 4.5 percent by 2016, which would require a strong euro zone recovery (see Table 7 here).   Also, in a world where official financing remains available as an option over the longer term, the assumed discount rate of 7 percent (based on current secondary-market bond yields) could be considered high.   (I am also not sure from the calculations if Karl is allowing for Irish Central Bank profits on outstanding ELA.)  But Karl’s basic conclusion seems robust to reasonable relaxations of these assumptions.    

Karl notes that I am “neutral” with regard to whether the long-term refinancing via the ESM would be a good deal, waiting to see the details.   Based on his numbers, I am happy to agree that a 30-year deal at 3 percent is likely to result in a substantial reduction in the burden of this debt.

29 thoughts on “Karl Whelan on the Burden of Bank Debt”

  1. In addition to the €62.8bn injected into the banks via cash and promissory notes, Ireland has through NAMA gifted €4.86bn to the banks in state-aid according to the Comptroller and Auditor General’s special report a fortnight ago.

    NAMA hides this state-aid through some pretty shameful accounting – “shameful” in the sense that it assumes a recovery in prices, though it should be said NAMA’s accounting complies with IFRS.

    Obtaining funding to pay off the Promissory Note payments at 3% (or 1.2% which is Germany’s long term borrowing rate) would certainly lower the NPV. And that is probably the only negotiation worth pushing. Though if you were any of the other 16 EZ countries capitalising your banks at 5%-plus, wouldn’t you want a sweet deal with the EFSF/ESM as well?

  2. “Those who advocated voting No to facilitate a “deal on bank debt” were advocating cutting off access to ESM. I’m still in the dark as to how those who adopted this position believed Ireland was going to renegotiate a bank debt deal after voting No.”

    Let me enlighten you there Karl! If we had voted “No” we would have been able to bring forward talks on default, and for many in this country – including some economists – 120% debt:GDP within a fixed currency union and little “low hanging fruit” available to be picked for competitiveness gains, we will end in default of some description. A “No” vote would have meant we had those talks in June 2012 when we still have controversial bank debt in play, like the two INBS bonds that are payable on 26th June and which total €635m.

    No rational country would pay such bonds if in a shortish period of time – 18 months in our case – we faced a sovereign default which is what the “Yes” side argued if we voted “No” and had no access to the ESM in 2014.

  3. Why not seek a deal on the lot…64billion and not just the PNs. As it appears that we are stuck with all the bank debt, why not phase it over 30 years at a reasonable fixed rate…or perhaps at the German 30 yr bond rate.

  4. re- Jagdip; ‘Ireland has through NAMA gifted €4.86bn to the banks in state-aid according to the Comptroller and Auditor General’s special report a fortnight ago.’

    There’s also cause to query the purchase of many finished & unfinished housing projects that were under NAMA’s ambit.

    And the current ‘solution’ for distressed mortgages – the resident moves out, rents, and rents out the property – needs a bit of scrutiny.
    Housing benefit has been twisted into social welfare for the banks & NAMA.

  5. “I am happy to agree that a 30-year deal at 3 percent is likely to result in a substantial reduction in the burden of this debt.”

    Big deal! Thanks for stating the bleeding obvious. It would have helped Ireland’s case for this treatment if the economics community had got behind a No vote, in the same way that the AGs torpedoed the Dail Enquiry referendum, instead of doing surveys amongst themselves and blogging and commenting on the importance of a Yes vote. It was also bleeding obvious that Yes voters would kick themselves for voting Yes: http://www.planware.org/briansblog/2012/06/yes-voters-will-kick-themselves-for-voting-yes.html

  6. Clearly the solution is a new National Equity Management Agency (NEMA) which will take over the state’s negative equity investments in the non-IBRC financial institutions. This NEMA will be able to “wash its face” with ESM financing while realizing the losses on the existing equity stakes, manage them until they can be sold into a rising market, and in general get credit flowing again.

    I am willing to write all this up in a consultant’s report for a small 6 figure sum payable into an account in Deutsche Bank in Frankfurt.

  7. What if we simply didnt pay the notes. What if we go on a solo run and just issue a statement saying we wont be paying them.

    The ECB would be pissed as hell and it would be considered a default event, but what would happen. Would they hold the ‘comfort letter’ up at a press conference. Would other EU countries be obliged to pay?

  8. @Jagdip

    “…would certainly lower the NPV. And that is probably the only negotiation worth pushing. Though if you were any of the other 16 EZ countries capitalising your banks at 5%-plus, wouldn’t you want a sweet deal with the EFSF/ESM as well?

    There is pressure from German Banks for funds from these sources to be used to prop up the Greek banks, at least to some extent, in the event of a Greek currency being introduced.

    If you combine that with EFSF or ESM lending to the FROB for banking recaps not general state expenditure, why isn’t it possible to argue that Eurobonds may be already emerging as a reality – but only for the banking system?

  9. re- John Foody,

    Perhaps itemise the debt, bill the relevant amount ot the ECB, continue repayments on whatever amount was justified.
    Would the move be accepted by ratings agencies, and potential lenders ?

  10. @Mark, J Foody

    I would regard that as a sovereign default and would be interested in the explanation of any ECB decision to then accept Irish Gilts for repo. Any ratings agency inaction would also be rather curious.

  11. “The Prime Minister said he was not pressured into requesting aid, saying he was the one who had pressed for this line of credit, insisting it was different than bailouts taken by Greece, Ireland and Portugal because their lifelines include strict outside control over public finances – and Spain’s does not.”

    Thats it…we should ask for a line of credit of 64 billion.

    Btw, the ST say that the funds will come from EFSF.

  12. re- PR Guy

    – Unless it’s the govt. upping themselves by comparison ? Probably not; these are, after all, much of the same personnel, unchanged & unscathed by the last several years.

    It goes to show that we are drastically in need of laws that recognise financial subversion, of the individual, society & the State.

    Article 39, for instance, is rather antiquated in not recognising how Might can rule without force of arms:
    ‘Treason shall consist only in levying war against the State, or assisting any State or person or inciting or conspiring with any person to levy war against the State, or attempting by force of arms or other violent means to overthrow the organs of government established by this Constitution, or taking part or being concerned in or inciting or conspiring with any person to make or to take part or be concerned in any such attempt.’

    With a treasonous government, is sedition a crime ?

  13. With regard to PRGuy’s link, isn’t it funny that in the perception of the banks, mortgage borrowers are fair game for maximum unpleasant consequences of financial shortcomings and in Ireland it is almost trendy to talk about defaulting on Ireland’s sovereign commitments, but nobody campaigns for a default on contracted ammounts for rescued bankers’ pay, bonuses or pensions or payments to former ministers. Why is that OK? Why are TDs’ and senior public sector employees so protected despite 1.28 meaning Croke Park offers them no protection.

    What is it about Ireland that makes all that OK?

  14. re-Grumpy;
    every undeserved benefit has an obverse of an undeserved loss.

    When the minimum wage was lowered, I know several people who – already in employment – were told that they would be fired if they didn’t accept the reduction. I know of one fairly large & well-known company that put workers on a 4-day week with a pay cut, and then had the staff work five days for four days pay when it was thought necessary. I know of one company that introduced compulsoary alternate-saturday attendance for no extra pay. I know of one large revenue services company that hired a raft of new staff on 17k p/a, moved all existing staff (on c. 25k) to a new section (restructured), and then closed down that new section within a year.
    Employment law has been continually flouted, since before 2007.
    r own question.
    The answer to why this is so is intimately coupled with the answers to you

  15. You can juggle around with borrowing over here at one rate to pay off this at another, etc. etc. but what Ireland really needs is some debt forgiveness. Soon.

  16. @Jagdip

    +1

    Karl and others seem to already assume that the promissory notes are bone fide sovereign debt when in fact it is odious debt.

    All discussions should start from what is necessary to make the state viable. As you point out 120% debt in a currency union is unsustainable as the experience of Italy in the last 12 months has shown (and Italy has comparatively low private debt). So default/restructuring/write-down will have to come from somewhere.

    The most painless option would be a write-down in the value of the prom note. If that is unavailable then the next painless option is a unilateral default on the prom notes. The most painful outcome would be the conversion of the prom notes into sovereign debt followed by a full sovereign default.

    The use of a 7% discount rate to calculate the NPV of promissory notes converted to sovereign debt is spurious. Use of such discount factors is only applicable if you are an investor in such debt, which we clearly would not be.

    From our point of view, we MUST repay this debt, so as issuers, the debt is considered risk free and the only discount rate that applies is the coupon rate (or, even worse, the risk-free rate). By Karl’s logic, the more risky, the more irrational and the more bananas the sovereign becomes the less the value of its debt to the itself, which is clearly wrong.

    Of course, the value of the debt remains constant to the issuer. It is only the market value of the debt to the investor that changes.

    We already have an interest rate on the prom notes of 3%, so to claim the appropriate discount factor of the new debt is the equivalent bond market rate is nonsense.

    This is a very disappointing post. I would have expected better.

  17. Doesn’t the PNs arrangement offer a clean and clear distinction in our favour. They were created solely to pay the creditors of rogue banks. Aren’t they also backed up by dubious capital and pinky promise letters of comfort.

    If we replace it for ESM debt, thats it, its ours and it becomes senior to everything else and likely to be mixed up with future state borrowings. If the mess we’re in, is or becomes unsustainable we’ll have to default on European partners as opposed to the ECB.

  18. Let me start with rare agreement with Karl. Absolutely agree with his No vote comment. Amazed how this site tends to be dominated by what Alan Shatter would term street anarchists!

    On the compound interest, well of course a discount rate of 7% will hugely favour a long term deal at 3%. But 7% is not the correct discount rate. The correct one is the official lending rate not the market yields. Having said that 3% over 30 years is a good deal and that’s why we won’t get it.

    Karl says there were some who thought we should just write off the ELA/PNs. He forgot to mention that he was their chief cheerleader.

    Finally, we should by now have become completely skeptical of book values esp of banks. Market values are not much better. AIB’s market value this morning is over €30Bn! Now that is just as silly as its book value. However, long term AIB is capable of generating €2bn a year profits from the domestic economy. As I understand it, Karl is recommending a fire sale of this core taxpayer asset.

  19. “…AIB is capable of….”

    We’ve seen what AIB is capable of; these are the wonderful people who brought us the exciting stories of Insurance Corporation of Ireland, John Rusnak, Faldor Limited and more; this was all before their shares fell off the big board. Sell all the assets to China. Let the ECB hassle Beijing the next time that crock needs recapitalisation.

  20. @ John Foody.

    +1

    Currently the prom notes are not bone fide sovereign debt. If we replace them with ESM money then they will become senior to outstanding government bonds and any bonds to be issued in the future. How is that conducive to regaining access to the bond market?

  21. @Brian Woods

    Amazed how this site tends to be dominated by what Alan Shatter would term street anarchists!

    What exactly do you mean by anarchists Brian? (I will ignore Alan Shatter, everyone else does.)

    The reason I ask is that traditionally anarchism is thought of as being about organizing to smash the state, and the various political cohorts of the anti-bondholder bailout seem only to be unified only in their desire not to sacrifice the Irish state for European financial capitalism, EU “credibility” or German neoliberal fanaticism.

    I am never quite sure whether the bank bailout classes are using Newspeak or Humpty Dumpty-ish.

  22. @ shay

    It is easy to recognise anarchists. They tend to use expressions such as “financial capitalism” and “German neoliberal fanaticism”

  23. @Brian Woods II

    It is easy to recognise anarchists. They tend to use expressions such as “financial capitalism” and “German neoliberal fanaticism”

    Humpty Dumpty it is.

  24. @Brian woods.

    “It is easy to recognise anarchists. They tend to use expressions such as “financial capitalism” and “German neoliberal fanaticism”

    Its easy to see how this generation of economists brought thi country to it’s knees.

  25. Why stop at 30?

    There’s a lot of talk of kicking the can down the road. None of the solutions so far tried amount to that. A large crisis requires a large kick… (plus the usual underpants and pencils).

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