Maarten van Eden: Applying same analysis to all Ireland’s debt makes no sense

Maarten van Eden, outgoing CFO at Anglo, has an interesting article in today’s Irish Times (see here).    One useful feature of the second half of the article in particular is that he focuses on what is needed to allow the banks to play their normal lending function in the economy.  

In order for lending to the private sector to resume, the good banks need to be delevered [through debt-funded buybacks of NAMA bonds and promissory notes, with the cash used to pay back the ECB], recapitalised and their funding put on a firm footing.

I am not convinced by his specific solution, but this focus is important given that the debate sometimes seems to have lost sight of the ultimate objective of fixing the banking system.   

As an aside, one of the best papers produced on the Irish crisis is Gregory Connor’s “The Irish Risky Lending Gap”, written back in 2009 (see here).   Greg focuses on the lending decisions of a risk-averse bank holding a distressed asset portfolio with a value that is correlated with the value of potential new lending opportunities.   He shows how the level of lending can be socially sub-optimal, and how various balance-sheet restructuring policies can change the size of the lending gap.  It might be useful to re-read along with the van Eden piece.

Regaining Creditworthiness

Much of the pessimism about Ireland’s predicament has centred on the challenge of stabilising the debt to income ratio.   Undoubtedly this will be challenging, with good outcomes on nominal GDP growth and fiscal adjustment capacity required.    Of course, it has been made much more difficult by the massive bank losses the State has had to absorb.   But I think a focus on the stabilisation challenge misses a critical issue, which is regaining market access at a high if stable debt to GDP ratio (probably somewhere in the region of 120 percent of GDP).   

Martin Wolf’s column from last week provides a useful starting point for a diagnosis of the problem – an article that garnered all of one comment on the blog (from DOCM).   It draws on Paul de Grauwe’s insightful work on the susceptibility of countries in a monetary union to a debt crisis (see here), where a country without its own currency and central bank to act as lender of last resort is vulnerable to self fulfilling expectations that it will not be able to roll over its debts.   The EFSF/ESFM/ESM were put in place to help fill this LOLR gap, but have so far proven to be a poor substitute.   It is understandable that Germany and other likely net funders want to eventually reinstate market discipline, and so demand losses are borne by private creditors as part of any new bailout.   It is also understandable that they want to protect themselves from losses under the permanent bailout mechanism (the ESM) by demanding preferred creditor status.   But it is becoming increasingly evident that crisis-hit countries will find it extremely hard to regain market access with a half-hearted LOLR facility in place given any doubts that they will not be able to pass a debt sustainability test under the ESM. 

The official funders have to be willing to take on some additional risk if a mutually damaging combination of default and ongoing dependency is to be avoided.   One element is to clarify the way the debt sustainability test will be applied.   A current problem is that austerity measures weaken growth, thus making it harder to pass the test.   A useful amendment would be to assess growth in the debt sustainability calculation assuming a neutral fiscal stance.   Another useful amendment would be to set a ceiling on the size of any haircut, thereby limiting the uncertainty faced by potential new investors.   

As a quid pro quo for these amendments the government could offer to speed up the fiscal adjustment (along the lines recommended by the ESRI in its Spring QEC).   Of course, more fiscal adjustment is the last thing the economy needs as it struggles to pull out of recession.   Yet a quasi-permanent loss of creditworthiness and dependency on unreliable official support looks to be the bigger threat, as it saps confidence and undermines the perception of the economy’s stability.   Those resisting fiscal discipline must realise that the situation changed profoundly when Ireland’s creditworthiness disappeared in the second half of last year.   Some observers are putting forward the same fiscal policy prescriptions as they did when bond yields were around 5 percent.   They must see that the ground has fundamentally shifted.  

It is hard to see how further public sector pay cuts could not be part of any balanced additional adjustment.   A credible new regime for long-run fiscal discipline is also essential.  

The government should take the offensive in pointing out the incoherence of the current international support approach, while avoiding playing a self-defeating grievance card.   What is needed is a hard-headed look for a mutually advantageous set of policies that allow Ireland to shed its dependency.    The first step is a proper diagnosis of creditworthiness challenge. 

Is the grievance against the ECB overdone?

Colm McCarthy and Kevin O’Rourke rightly point today to the damage that a sense of grievance towards the ECB does to political support for necessary domestic adjustment efforts (see Kevin’s post below).   While few would disagree that the ECB has been remiss on the public relations front, I think the all-things-considered case against it has been overdone. 

Two main charges have dominated the recent discussion: that the ECB “bounced” Ireland unnecessarily into a bailout; and that it has unfairly insisted that Irish taxpayers bear the burden bank losses that are rightly the responsibility of senior bondholders. 

John Bruton: Time to turn our attention to the things we can change

John Bruton writes today on the downside of grievance and the upside of a positive surprise on the deficit-reduction effort: Irish Times article here.

Paul De Grauwe on austerity and implications of the ESM

The Sunday Business Post carries an interesting opinion piece by Paul De Grauwe in today’s paper.   Although articles are not available on the paper’s website until the Monday after publication, Cliff Taylor has kindly given us early access to article. 

The European Stability Mechanism will not not lead to more stability

After much hesitation and a lot of pressure exerted by financial markets, European leaders finally decided at the end of March to set up a permanent financial support mechanism which was given the name of European Stability Mechanism (ESM). From 2013 on, Eurozone countries will pool financial resources to be disbursed to member-countries in times of crisis. This historic decision illustrates the painful and slow way the Eurozone moves in the direction of more political integration in Europe.

Will the establishment of the ESM shield the Eurozone from future crises? My answer is unambiguous. It will not. In fact it is worse than that. Some of the features that have been introduced in the functioning of the ESM will make it more difficult for a number of countries, in particular Ireland, to attract funds in private markets.  These features will have the effect of increasing rather than reducing volatility in the financial markets.