Standard and Poor’s view on Ireland via Seamus Coffey: see here. Irish Times report here.
Author: John McHale
In case you haven’t seen it yet, the “Europe on the Brink” article by Peter Boone and Simon Johnson is a must-read for anyone grappling to understand the Eurozone crisis (see here). Oversimplifying their argument a bit, they contend the feasible exit routes from the crisis involve either the extremes of decisive debt restructuring or a committed lender of last resort (something that they refer to more explosively as a “moral hazard regime”). Paul de Grauwe’s Irish Times piece from today makes the argument for a committed LOLR, but he cautions it is only conceivable with much greater central control over fiscal policy. I think Willem Buiter’s FT piece from earlier in the week can be read as saying the intermediate route combining a more modest LOLR function with private sector involvement is still most likely – and may succeed. Readers might also be interested in this more recent Citi Economics paper by Buiter and others urging more decisive LOLR action from the ECB.
In his Sunday Independent column today, Colm McCarthy again makes the argument the Government is protecting – or being forced to protect – senior bondholders in order to protect European banks.
It is entirely fair for our European partners to observe that we have brought this on ourselves but it is equally fair to note that in picking up the tab, the Irish are ‘taking one for the team’, in the phrase of Sharon Bowles, the British MEP who chairs the Economic and Monetary Affairs Committee. The team, in the form of the EU Commission, the European Central Bank and the Franco-German political leadership, persist in the pretence that the protection of creditors of the bust Irish banks, at the expense of the Irish Exchequer, represents some form of generosity to Irish citizens and taxpayers.
Fortunately, the existing deal with our European partners is impractical as well as unfair. It has not worked, it will not work and there will be further rounds of modifications as Europe gropes towards a resolution of the banking and sovereign debt crises. It will not be enough, in regaining solvency, for the Irish Government to avoid further pay-offs to bondholders in Anglo and Irish Nationwide. The Irish Exchequer’s contributions to bank rescue have already destroyed the sovereign’s capacity to borrow. There is still an opportunity to avoid default on the sovereign debt of the state, but the ability to avoid this outcome is being undermined by the obligations undertaken to investors in bonds issued by insolvent banks.
The restoration of that ability requires, in addition to vigorous reductions in the budget deficit, that the remaining costs of rescuing the Irish banks be shared with their creditors and with the European institutions whose defence of bank bondholders has helped to create the current untenable situation.
Putting aside the relative costs to Ireland’s creditworthiness of defaulting on sovereign bonds compared to sovereign guarantees, oversimplified claims that senior bondholders are being protected to protect foreign banks are undermining support for necessary fiscal adjustments.
The concerns of the ECB about balance sheet/precedent-related contagion does explain the absence of loss sharing for the roughly €3.5 billion of unguarnateed seniors in the defunct and depositor-less Anglo and INBS. The constraints on loss sharing in the pillar banks are quite different.
There is an effective instrument to impose losses on pillar-bank bondholders – bankruptcy. Although we know the credit system is already impaired, making the pillar banks bankrupt would impair the credit (and payments) system to a significantly greater degree. Also, it is conveniently ignored that depositors rank equally with senior bondholders under current law. It might have been possible for the State to make depositors whole when the State was creditworthy. That ship has sailed.
Now I do think more should have been done early on to put in place a resolution regime to increase loss-sharing options. However, the legal avenues appear to be quite proscribed. While I am not saying this is the end of the argument, given the damage done to public support for tough fiscal measures, anyone who pushes the line that losses should be imposed on broader bondholders has an obligation to explain how the legal obstacles could be overcome while protecting the credit system and protecting depositors. It is emotionally satisfying to heap blame on a requirement to protect foreign banks. The reality is more complex.
Now that we’ve had a bit more time to digest the implications of the EU summit, I would be interested to hear more views on how the measures have strengthened or weakened the “ring-fence” beyond Greece, especially as it applies to Ireland. The idea of a ring-fence is that measures to improve debt sustainability and the reliability of a lender of last resort attenuate potentially self-fulfilling expectations of default; that is, expectations of default that lead to higher interest rates, thereby increasing the probability of default (in part because countries get pulled into European crisis resolution mechanisms that threaten debt restructuring as part of subsequent financing packages and also because of worsening debt dynamics).
I think it is fair to say there is general agreement that the interest rate reductions / maturity extensions strengthen the ring-fence given that they improve the chances of debt sustainability. However, there also seems to be a view that the private-sector involvement (PSI) that is being applied to Greece weakens the ring-fence, as it increases the threat of that PSI being applied to other countries at a later stage. The latter does not seem right to me. It is widely recognised that Greece’s debt to GDP ratio makes debt restructuring inevitable. From the point of view of the ring-fence beyond Greece, it would have been best to have decisive action on Greece’s debt, so that it is unlikely that the necessary PSI would have to be revisited in their case. As it is, it is likely that further restructuring of Greece’s debt will have to take place, creating ongoing uncertainty about what the PSI element of the Eurozone crisis-resolution mechanisms is going to look like down the road, increasing the uncertainty facing other countries. In other words, the problem (from the perspective of the ring-fence) is that too little PSI is being applied to Greece, not too much.
If the objective is restored market access, the limits of exisitng crisis resolution arrangements were further exposed by Moody’s four-notch downgrade of Portugal. The FT has the story here. This bit is particularly important:
Moody’s cited the tortuous negotiations over Greece in its note, warning that although the likelihood of a restructuring in Portugal was lower than in Greece, the European Union’s “evolving” approach to providing further support “implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well.”
The full Moody’s statement is available via ft.com/alphaville.