Category: Bailout

Burning Bond Holders

The dominant view on this site seems to be that the new government should play hardball with regard to senior bondholders.   While I sympathise with the fury over the inequity of bailing out private creditors, I have reluctantly come to a different conclusion.    In the interests of debate, I give below a stripped-down overview of my reasoning.    I’m sure people will tell me where I’m wrong.

Cutting to the essentials, the State is now effectively on the hook for: (i) bank losses beyond their capital; (ii) any losses on capital the State itself has injected; and (iii) and the eventual losses on NAMA.    The ECB/CBI will provide the necessary liquidity/funding to meet all ongoing obligations to creditors.   In return, they require a shrinking of bank liabilities (to reduce their exposure) and an eschewal of loss imposition on senior bondholders given concerns over balance sheet contagion and eurozone precedents.   (Arthur Beesley reports on eye-opening estimates by Seamus Coffey on the ownership of the Irish bank bonds.)

There is a growing chorus that Ireland should insist on imposing losses on (at least) unguaranteed seniors.   This comes down to gambling the ECB won’t significantly pull the liquidity/funding support, and indeed that we should take the further risk that the fiscal components of the bailout deal will not be withdrawn.

I think most of us agree that the original blanket guarantee was a shocking mistake, and also that in ordinary circumstances losses should be imposed – Danish style – on unguaranteed bank creditors.

I think the difference in views comes down to how we see the obligations of the ECB.   If we think the ECB is simply doing its job with its liquidity/funding support, then demands to protect bondholders do seem indefensible.    (By the way, the dictatorial language used by Commissioner Rehn earlier in the week barring such loss imposition was both undiplomatic and, I thought, extremely unhelpful.)  But  if we see the ECB as going beyond its ordinary lender of last resort obligations to small set of banks within the eurozone, then proportional additional conditions do not seem unwarranted.   I think people should take a close look at what the ECB/CBI are giving, as well as what they are demanding.  From where I sit, the ECB’s willingness to act as long-term lender of last resort does qualify as extraordinary support. 

Fir Tree Capital Opportunity Master Fund LP v. Anglo Irish Bank Corp.

NAMA Wine Lake reports on this case.

Debate Questions

I found last night’s debate a bit depressing. Many people had suspected that the five-way debate would prove to be an unsatisfactory format for useful discussion. In the event, it was worse than I had expected. In particular, the combination of poorly phrased questions from the audience (two of the first three questions were essentially “what are you going to do about emigration?”) and ad hoc and unevenly distributed follow-ups from Pat Kenny, served the audience at home fairly poorly.

There’s two more debates to go, albeit one of them as Gwaelge (as they say in RTE). How about we open a thread for Irish Economy blog participants to suggest questions that could be used in the remaining debates?

Here’s a few starters for ten:

1. Fine Gael are planning to reduce public sector employment by 30,000 and Labour by 18,000. Can this be achieved without breaking the Croke Park agreement ruling out involuntary redundancies or without affecting front-line services? (The core administrative civil service only has about 30,000 employees).

2. The European Commission says that it expects Ireland to be borrowing in the bond market again in the second half of next year. Should Ireland look for a bigger lending package from the EU and IMF to delay this return to the bond market or, if you accept this timeline, how do you plan to raise these funds?

3. It appears that the EU authorities want the Irish banks to repay the almost €100 billion they have borrowed from the ECB and the €50 billion that they have borrowed from the Irish Central Bank and to do this soon. How do you plan to deal with these requests?

Plan A*

Although he had a rough ride in Comments here, Lorenzo Bini Smaghi’s London Business School presentation provides a useful official take on the choice between the Plan A of fiscal adjustment and the Plan B of default. (From a narrowly Irish perspective, his identification of the costs of default probably puts too much emphasis on balance sheet contagion and too little emphasis on the reputational damage to an economy that is one of the world’s most dependent on international trade and investment. Understandably, he also does not dwell on possible costs of default for access to ongoing international assistance, not least from the ECB itself.)

However, I would put the case for Plan A in more dynamic terms – a Plan A* perhaps. The literature on the option value of waiting provides a useful dynamic angle on the default decision. This applies to a decision that is costly and irreversible and must be taken under uncertainty that will lessen with time. An outstanding feature of our present predicament is that there is unusual disagreement about whether we can stabilise the debt to GDP ratio and regain market access. There is a good chance that the range of this uncertainty will narrow substantially over the coming year. Four major sources of (diminishing) uncertainty stand out:

Continue reading “Plan A*”

A Flexible EFSF

In his latest speech, Lorenzo Bini-Smaghi provides some insights into how European financial stability can be improved.  Some key passages:

One objection to a more integrated banking system in Europe is the role of national budgets in crisis resolution. As long as budgets remain national – so goes the argument – crisis resolution has to remain national, and so does supervision. The crisis has shown that bank resolution and restructuring are more complicated for cross-border institutions, given that any fiscal costs have to be distributed across several host sovereigns. As Charles Goodhart has said, “…cross-border banks are international in life, but national in death”. [4]

As I see it, enhanced financial integration in the euro area does not necessarily imply a need for greater fiscal union – if that is understood as a pooling of tax revenues, harmonisation of tax rates or issuance of a common bond. Instead, we must develop the capacity at the area-wide level to address specific financial tensions that threaten to spill over to the area as a whole, minimising disruptions to market integration and supporting the transmission of monetary policy.

The recent crisis – and, in particular, developments in Ireland – have demonstrated that, despite the imperfect integration of the European financial system, very strong cross-border contagion takes place within the financial sector. The instruments available at present to block this contagion are not efficient and have side-effects. In practice, much of the burden to contain contagion has fallen on central banks. This is neither desirable nor appropriate.

In my view, the European authorities need to develop a capacity to conduct a ‘surgical strike’ on problematic financial institutions or market segments in the event of a financial crisis. Through such actions, the area-wide externalities created by specific problems can be contained. In practice, this means ensuring that programmes such as the European Financial Stability Facility (EFSF) or the European Financial Stabilisation Mechanism (EFSM) – and their envisaged permanent successors – are given sufficient financial resources and the required flexibility by the Member States to act as necessary to support financial stability. To do so, these bodies may also need to be able to support the recapitalisation of an ailing banking system, if its weakness threatens the stability of the area as a whole. All this of course comes with strict conditionality in the context of an overall EU/IMF programme.

This has been the case in both the Greek and Irish programmes, in which funds are dedicated to the recapitalisation of the weak banks. A more systematic approach should be pursued, making it easier for countries to implement such a scheme.

and

The recent crisis has demonstrated that the European financial system was insufficiently robust. Further measures to deepen integration and bolster stability are required. Looking forward, we have to identify any remaining weaknesses and seek to address them.

Until now, it has generally been argued that the main responsibility for financial supervision has to remain at national level. The consequences of failures in supervision ultimately fall on the taxpayers of the country where the bank resides. To align incentives and ensure appropriate accountability, nationally defined tax bases imply nationally defined supervisory institutions.

However, the crisis has demonstrated that the implications of supervisory failures extend well beyond national boundaries. First, cross-border contagion has been magnified by externalities and spillovers arising from greater area-wide financial integration. Second, experience has shown that, within a more integrated market, greater specialisation may imply that financial systems in one country outgrow the capacity of national taxpayers to support them.

The implications of this experience are profound. As I have argued, they point to the need for a much greater euro area and EU perspective in the supervisory and regulatory framework. While progress has been made in this domain, much remains to be done.