Author: John McHale

Funding Versus Capital

The debate about the banks has gone off the boil.   But, as John Ihle argues in yesterday’s Sunday Tribune, the next six months will be a very active period in the restructuring of the Irish banking system (article here).    

Fixing the credit system and minimising the cost of the rescue to the State have been the focus of the debate.    The first has strangely faded from view.   The second has acquired an ominous twist: tension between the ECB (which bears increasing risk as funder of last resort of the banking system) and the State (which is effectively on the hook for bank losses given limits on creditor loss imposition).  The ECB wants to shrink the balance sheets of Irish banks to minimise its exposure, even at the cost of “fire sales”; the State wants to minimise bank losses to give it a fighting chance of regaining its creditworthiness.    Like the ECB, the Central Bank of Ireland is increasingly on the hook for funding the banks through its Emergency Liquidity Assistance, although things are complicated by the fact that first on hook for losses on this assistance will be the State itself.  

This basic funding versus capital tension is most likely behind the conflict pointed to by John Ihle between the Central Bank/Financial Regulator on one side and the NTMA/Department of Finance on the other.   How this conflict plays out will have a significant impact on how the restructuring unfolds. 

Paying Attention to European Crisis Resolution Developments

Even as we are distracted by political upheavals at home, the debate on how best to reorient the euro zone’s bailout mechanisms continues.   The proposal gaining most traction, with at least a degree of German support, is to allow countries in difficulty to use EFSF funds to buyback their own debt on the secondary market.   The initial focus is on Greece, but any new mechanism should be available in time to Ireland.   (Wolfgang Munchau provides a critical analysis here.)

The attraction of buybacks is that they allow a country to reduce the face value of outstanding debt without a formal default.   A disadvantage is that they can be gamed by bondholders: it makes sense for bondholders to hold out for a higher price if a buyback is really expected to improve creditworthiness.   One partial solution that I mentioned previously is for countries to buy back the debt accumulated by the ECB through its Securities Markets Programme (see here).  

Writing on Friday before the latest developments, Arthur Beesley reminds us of the stakes:

[T]he debate merits serious attention across the political spectrum in Dublin. Political activity for the next . . . weeks will centre on the election, but neither the Government nor the Opposition can afford to lie low on this front.

The debate on Greek debt takes place amid an intensive negotiation of key reforms to the European Financial Stability Facility (EFSF) rescue fund, including lower interest rates. Any inattention here would hamper Ireland’s argument for a rate cut, which is already difficult. But the Irish dimension does not end there, far from it.

.  .  .

[S]etting the election date brings clarity as to when a new government is likely to take office. From the perspective of European talks, the timing is tricky enough. Polling day is March 11th. EU leaders are working to make final decisions on EFSF reforms and a new permanent bailout fund at a summit only 13 days later.

There will be time – just about – to install a new taoiseach. By then, however, the really tough talking may well be done.

Emigration

The ESRI’s new emigration forecasts are sobering (see here for QEC Press Release).    For the year to April 2011, net emigration is forecast to be 60,000, falling to 40,000 for the year to April 2012.  The gross emigration forecasts are 75,000 for 2011 and 60,000 for 2012.   The numbers are consistent with anecdotal evidence of a resurgence of interest in the emigration option.   It is also worrying that significant outflows are forecast in the context of a relatively depressed UK labour market, and despite quite restrictive and skill-biased immigration policies in the destinations of choice: Australia, Canada and the US. 

The numbers are a reflection of how limited opportunities are at home for young people, though it would be even worse for those who leave if outside opportunities were not available.   The unemployment rate for those aged 20-24 is 25.5 percent.   And this is despite a fall in the participation rate from roughly two-thirds in 2008Q3 to half in 2010Q3.  

We must also worry about the implications of large-scale emigration for economic recovery.    In a thought-provoking post back in November, Kevin O’Rourke drew attention to the danger of an adverse fiscal feedback loop given the large fixed cost of the national debt.   We get a form of fiscal increasing returns: the more people leave the greater the tax burden (and indeed the poorer provision of State services) for those who stay, further increasing the incentive to leave. 

Continue reading “Emigration”

Michael Noonan in the Sunday Independent

Michael Noonan puts forward some ideas for amending the bailout deal in an opinion piece for the Sunday Independent.   His focus is on ways to reduce the expected cost/risk to the State of cleaning up the banking mess.  

He suggests four main options: (i) have the EFSF put capital directly into systemically important European banks; (ii) have the EU provide insurance against bank losses beyond some specified level (an idea already suggested by Patrick Honohan); (iii) the fast-tracking of an EU-wide of a bank resolution regime (that presumably would not be limited to future bank creditors); and (iv) an ECB-funded special purpose vehicle for bank assets to avoid the alternative of firesales with losses rebounding on the State.

Bond Purchases as the Tool of Choice for Tackling the Debt Crisis?

The FT is reporting that the Christine Lagarde is the latest high-level official to offer tentative support for bond purchases by the EFSF as a central element in the reform of liquidity support measures.

Christine Lagarde, French finance minister, said France was ready to discuss allowing the eurozone’s €440bn ($588bn) bail-out fund to start buying bonds of struggling European economies amid signs of consensus that it would become the primary new tool for tackling Europe’s ongoing debt crisis.

How significant a development would this be? The first thing to note is that ECB bond purchases have failed to bring market yields to affordable levels. While probably helping to a degree, the ECB’s secondary-market purchases have lacked commitment and provide no real certainty to investors on how high yields could rise.  Secondary market purchases by the EFSF are unlikely to be much more effective unless operated at a very different scale.

In principle, however, official primary-market bond purchases could provide guaranteed funding at some maximum interest rate. This maximum rate could be set high enough to create strong incentives to rely on market funding. I would presume that the total amount of funding would be capped and the programme would have a time limit. But because they involve purchases of ordinary bonds, concern about the seniority of official creditors should be lessened. Overall, the existence of such an official buyer of last resort should give market investors reasonable confidence that governments would be able to roll over their borrowing as bonds mature over a significant time period. The proposal has the potential to provide support to a country facing difficult market conditions without crowding out longer-term private investors from the market; such crowding out appears to be a major shortcoming of current support measures.

Of course, the devil is in the detail, and there is little concrete yet about how such bond purchases would actually operate. It is also unclear whether these new facilities would be available to countries already in support programmes. But it is an interesting development.