Improving the bailout terms

The Government rightly continues to make the case that there is a common interest in lowering the interest rate on EFSF/EFSM borrowings, among other adjustments to the programme.   Writing in the Sunday Independent today, Peter Mathews – in one of the milder articles in the paper – goes quite a bit further and accuses “EU partners” of “profiteering” (see here).    

Last January, the European Financial Stabilisation Mechanism charged Ireland an interest rate of 5.51 per cent for money that it borrowed at 2.59 per cent. A month later, the European Financial Stabilisation Fund charged Ireland an interest rate of 5.9 per cent for money that it borrowed at 2.89 per cent. On this basis, the EFSF earns a profit margin of 3.01 per cent and the EFSM earns a profit margin of 2.93 per cent.

These margins are draconian. The majority of the interest that Ireland pays is not used to pay for the EU’s borrowing costs. It is excessive profit for the countries that are lending us money. For every €1m that Ireland pays in interest costs, Ireland must pay another €1.08m so that our EU partners make a profit. This, clearly, is not a bailout. It is exploiting our vulnerability. It is financial bullying.

It would appear that Peter believes that the EU is taking on zero risk in lending to Ireland.   (Formally, at least, the EFSF has eschewed IMF-style preferred creditor status.)   I would be interested if readers agree that these official funders can rest assured their loans are riskless. 


The Sunday Business Post provides its usual welcome calm analysis of the options (no web access until Monday).   Understandably frustrated with the pace at which EU governments are responding in terms of providing a mutually-advantageous exit route from the crisis, its lead editorial advocates taking a tougher line, notably with Anglo (and presumably) INBS) senior debt. 

With our government bond interest rate soaring and our banks locked out of the markets, we haven’t got a lot to lose.   We are most unlikely to be able to return to the markets on the schedule set down in the EU/IMF programme late next year, or in early 2013.   It would be much better realise this and arrange some restructuring of the deal now – and there are many ways this could be done.  [Emphasis added]

Just looking at the first sentence, my interpretation of the first clause is that the resulting dependence on external support means, unfortunately, we do have a lot to lose.   With popular pressure for a tougher line ramping up, it seems a worthwhile issue to debate. 

Guest Post from Daniel Gros: How to Make Ireland Solvent

Daniel Gros from CEPS has provided the following guest post based on his recent IIEA talk.

How to Make Ireland Solvent

The Republic of Ireland can no longer raise funds on the capital market and has had to accept a bail-out financed jointly by the IMF and the European Financial Stability Facility or EFSF (the EU’s rescue fund).  Many investors fear that by the time European support ends as planned in 2012, the country will not have market access, and might then be forced into default if anti-bail-out forces are determining policy in Germany at that point. 

But this dependency of Ireland on foreign support is difficult to understand given that the country has not lived continuously above its means in the past.  Ireland has run a current account deficit (which means the country uses more resources than it produces) only for a few years; and if one totals the current account balances over the last 25 years, one arrives at a foreign debt of about €30 billion.  This should not be too difficult to finance given that it represents only about 20% of the country’s GDP of €150 billion. Moreover, Ireland is on track to run a current surplus this year and should thus not have any need for additional foreign funds.

So why does the government need a continuing bail-out?  The reason is that the government has a huge foreign debt whereas the Irish private sector has huge foreign assets.  To make matters worse, the government pays exorbitant interest rates on its large foreign debt whereas the private sector earns very little on its foreign assets (and keeps these meager returns for itself).  If this is allowed to go on, the government could indeed still have to default.

This was the case in Argentina where the private sector had large foreign assets while the government had an even larger amount of foreign liabilities.  The Republic of Argentina went bankrupt with only a moderate net foreign debt because wealthy Argentines had spirited their assets out of the country, and thus out of the reach of the government, while the poor Argentines refused to pay the taxes needed to satisfy the claims of the foreign creditors. 

Ireland is not Argentina and should be able to avoid its fate; but only if the government can mobilize private foreign assets.  This should be possible given that these foreign assets are mostly held by institutions, such as pension funds and life insurance companies. 

The little data published by the associations of Irish pension funds and that of (life) insurance companies suggest that these two groups of financial companies own over €100 billion in foreign assets, of which about €25 billion are in non-Irish government debt and about €72 billion in foreign equities.[1] 

From the point of view of the country, it makes no sense that Irish pension funds invest in Bunds which yield about 2-3%, whereas the government pays close to 6% on fresh money to foreign official institutions (and Irish government bonds promise yields of close to 10%).  A very strong case can thus be made that Irish pension funds and life insurance companies should somehow be ‘induced’ to invest their entire portfolio of gilts in Irish government bonds.  The €25 billion in financing that this would yield for the government is equivalent to the entire contribution of the IMF to the rescue package.

A similar case can be made for the €72 billion in foreign equity investments. If two-thirds of that sum (or €48 billion) were also be invested in Irish government bonds, the total financing available for the government would rise to over €73 billion, more than all the foreign funds made available to Ireland under the rescue package. 

Would this mean robbing retirees of their future?  The opposite seems to be the case: the rate of return achieved by the average Irish pension fund has been only around 1.7% over the last decade (as claimed in a recent report of the public pension fund).  A massive investment in the bonds of their own government, which offer a return of close to 10% (on the secondary market), should actually be in the interest of present and future Irish retirees as well.  Moreover, by doing so, the probability of a state default would actually be much reduced, which in turn will preserve growth prospects for the economy – the most important determinant of future pensions.

The EU might of course protest that any restrictions on the investments of Irish pension funds and life insurance companies smack of capital controls.  But this could be finessed by either a waiver under Article 65 of the EU Treaty, or a clever wording of the ‘directed’ investment.  Moreover, the public pension fund has already been obliged to accept a ‘directed’ investment, without any opposition from the EU.[2]

Given the scale of foreign assets owned by Irish residents there should be no need for the government to depend on the funds of the EFSF and the IMF, which are very expensive in both political and economic terms. There will be practical and political obstacles to mobilizing pension fund assets, but they should be overcome if the future of the entire country hangs in the balance.


Daniel Gros,

Director CEPS,

Brussels, May 2011

[1] Sources available from the author.

[2] A technical note: Pension liabilities are bond-like in nature, so the present heavy weighting in equities represents a substantial mismatch and investment risk in itself.  There may thus be scope within appropriately framed solvency requirements to facilitate/encourage pension funds to more closely match their bond-like liabilities with instruments issued by their own sovereign.

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. 

Corporate Tax Saga, May 11 Edition

The saga over Ireland’s request for a reduction in the interest rate on its EU loans continues, with the French continuing to link this issue with Ireland’s corporate tax, a role they swap every so often with the Germans (media stories from today here and here). As Christine Lagarde’s recent comments show, having made such a big deal of the issue, the French are now motivated to achieve the crucial goal that “Everybody will have to save face.”

It is worth noting, however, that the French signed this document “Conclusions of the Heads of State of Government in the Euro Area” on March 11. It stated:

Pricing of the EFSF should be lowered to better take into account debt sustainability of the recipient countries, while remaining above the funding costs of the facility, with an adequate mark up for risk, and in line with the IMF pricing principles.

Note the absence of any mention of corporation tax or renegotiation of deals.

Despite the constant repetition of the line that Ireland is somehow looking to change the status quo, it seems to me that there is a strong case for the opposite position. Having agreed to change the pricing of EFSF loans on March 11, the EU’s principle political leaders have reneged on this agreement for the moment, most likely because the political kudos that come with appearing tough on Ireland outweigh those associated with honouring agreements made at Heads of State level.

Those who believe that Ireland’s situation will end well because European institutions have our best interests at heart may wish to consider how things have played out over the past few weeks.

Lending between National Central Banks

See the following contribution here from Hans-Werner Sinn.  It is certainly original but frankly alarmist.  It focuses on the fact that National Central Banks within the euro system are lending bilaterally to each other though without changing the monetary base as a whole.  Sinn jumps from there to draw apparently worrying conclusions:  that these are “forced capital exports”; that they are the counterparty to current account deficits and that “the PIGS would have had a hard time finding the money to pay for their net imports”.

There is not a scintilla of evidence that the private non-bank sector in the PIGS has lost access to normal European financial markets.  If the Bundesbank lends to the Central Bank of Ireland, it does not, in any sense, expand the availability of credit to the private non-bank sector in Ireland.  Similarly, German households and firms do not suffer a credit contraction.  This is, of course, because there is free movement of capital within the single currency area.

The second non-sequitur in Sinn’s article is the association of accumulated current account deficits in the PIGS with these bilateral loans.  Ireland has, of course, a current account surplus so the point is completely irrelevant to at least one of the PIGS.  Sinn notes that Italy has not availed of these inter NCB loans, despite its current account deficit, but mistakenly attributes this to virtuous policy on the part of the Italian authorities!  It is of course because Italy so far has not yet suffered from a banking or sovereign debt crisis.  And for no other reason.

My suspicion is that Target 2 credit is ultimately guaranteed by the ECB: that the Bundesbank loans to the Central Bank of Ireland should be considered as contingent items on the ECB balance sheet.  In short, that Target 2 credit is simply a mechanism for implementing ECB policy.  But I remain to be corrected on this.

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. 

Continue reading “Is the grievance against the ECB overdone?”

Dan O’Brien on the Story of the Bailout

Dan O’Brien has an interesting article (and an accompanying news piece) in today’s Irish Times on the “behind-the-scenes” story of Ireland’s bailout. The article is based on interviews for a radio documentary to be aired tomorrow on BBC Radio 4.

I suspect that regular readers of this blog won’t be surprised at the story of how the ECB triggered Ireland’s bailout and then favoured a plan involving a larger upfront fiscal adjustment than the government were comfortable with and a massive and rapid downsizing of the banking sector.

Time will tell whether the ECB’s actions in November helped or hindered the resolution of Ireland’s economic problems.  However, the story of November’s events does raise very serious questions about the role the ECB now plays in European politics. Should the key role in this historic decision have been played by an unelected and essentially unaccountable organisation?

Buchheit and Gulati on Greek Debt

Today’s article by Wolfgang Munchau is a summary of the dinner talk that he gave at last week’s EUI workshop on sovereign default. A very interesting counterpart to Munchau’s article is this paper by veteran sovereign debt lawyer Lee Buchheit (lead negotiator for Iceland! with its creditors) and Mitu Gulati (Duke law professor) which discusses other scenarios for Greek debt. Buchheit and Gulati gave very interesting presentations on this and other relevant topics at the EUI conference (a podcast is due to go up this week and I will pass on the link when it does). It perhaps goes without saying that this paper has a lot of relevance for Ireland.

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. Continue reading “Paul De Grauwe on austerity and implications of the ESM”

Business and Finance Article on EU-IMF Negotiations

Here‘s an article I wrote for Business and Finance on the ongoing negotiations with the EU and the IMF. I wrote the article before last Thursday and have to admit to being a bit less positive now that I was when I wrote it but the general point about the need for a careful approach to ongoing negotiations over the coming year or so still stands.

S&P Rating Downgrade

See here for the reasons behind S&P’s downgrade (registration required).   See here for Irish Times report; here for Bloomberg report. 

This is noteworthy:

The downgrade reflects our view of the concluding statement of the European Council (EC) meeting of March 24-25, 2011, that confirms our previously published expectations that (i) sovereign debt restructuring is a possible pre-condition to borrowing from the European Stability Mechanism (ESM), and (ii) senior unsecured government debt will be subordinated to ESM loans. Both features are, in our view, detrimental to the commercial creditors of EU sovereign ESM borrowers.

Anti-gloom on the stress tests

While having to put another €24 billion into the banks is hard to stomach, I am still surprised by the overwhelming negativity in the reaction to the release of the stress test results.    I think there were three big questions going into yesterday:  

(1)  Would we get the information necessary to reduce the large range of uncertainty about ultimate banks losses that has been weighing so heavily on the creditworthiness of both the banks and the state?  The detailed information on bank balance sheets and projection assumptions used allows anyone interested to reengineer the calculations as necessary, and is a step change from the kind of information analysts were working with before.   The bank balance sheets and loan loss projections are now far less of a black box. 

(2)  Would the banks end up sufficiently well-capitalised to overcome the difficult funding environment?   By my calculations, allowing for the capital buffers, Core Tier 1 is close to 10 percent under the stress scenario and close to 17 percent under the base scenario.   [Note that the stress scenario is binding for all four tested banks this time round; see Table 16]   We will have very well capitalised banks.  Continue reading “Anti-gloom on the stress tests”

April Fools One Year Ago

Given the day that’s in it, I was contemplating whether to do a funny story. But then I remembered the Irish Independent’s entry in the April Fool’s stakes from last year and figured I couldn’t beat it.

Brendan Keenan interviewing Brian Lenihan:

“With the banks playing for time, and the regulatory system discredited, we needed to establish an asset-relief programme like NAMA. That takes time to put into practice. It can’t be done overnight.”

He makes a point that tends to be overlooked in discussions of whether more should have been done sooner. It could not have been done 12 months ago, with the financial markets fretting over the scale of the budget deficit.

The country came close to not being able to borrow the money to keep it running. Attempting to cover the bank losses as well might have made that danger a reality.

At the time, however, I didn’t find it that funny.

Michael Noonan in the FT

Michael Noonan has an article in the FT. There’s no mention of bondholders or new ECB facilities. We do get this, however:

We will, of course, repay our debts but we must ensure that the debt is sustainable and not such a burden that it could cripple the economy for generations.

The EU has helped make Ireland the business-friendly, entrepreneurial country it is today and the solidarity shown recently through liquidity support from the Eurosystem, the ECB and through the Europe Financial Stability Mechanism, the European Financial Stability Facility and bilateral loans is greatly appreciated. It is in everyone’s interest that this support be repaid by the banks and we can ensure that that happens by pursuing policies that foster growth and boost market confidence.

Message: Ireland Europe and don’t worry about all that money we owe ye.

Irish Times Needs Better Sources

Prior to today’s announcements, the Irish Times were flagging the following:

Mr Noonan will make a “watershed” argument for a EU-wide solution around passing bank losses on to bondholders in response to the tests on Bank of Ireland, AIB, Irish Life and Permanent and EBS building society. Government colleagues last night described it as the first radical policy departure from the previous Fianna Fail-led government.

A few months ago, just prior to the announcement of the EU-IMF agreement, the Times had reported:

The source said there was a “common understanding” between delegations from the EU Commission, the European Central Bank and the IMF that senior and junior bondholders should each pay a share of the rescue costs.

Two conclusions to draw from this. First, people shouldn’t pay much attention to the Irish Times reports on these matters. Second, the Times need better sources.

The Grand Bargain

Having been a bit tough on the FT yesterday morning, I would like to echo commenter DOMC in drawing attention to a very good article by David Oakley (see here; related piece here).   While our attention has naturally been on the Ireland-specific aspects of negotiations over the crisis-resolution mechanisms, the Grand Bargain on the ESM is probably far more significant for our creditworthiness.  

David Oakley notes that market conditions are improving for Italy and Spain.   This is consistent with the idea of a self-fulfilling equilibrium: if you look like your will need a bailout no one wants to lend to you (and get caught up in a later “bail-in”), and so you end up losing market access and forced into a bailout.   This is what seems to be happening to Portugal at the moment; Italy and Spain have been able to stay out of the critical region — at least for now.   A problem for Ireland is that improving your fundamentals looks less effective once already in the bailout mechanisms.   Can it make sense to have this “black hole” (potentially) spreading from the periphery?   Hardly a Grand Bargain.

ESM Details

Details of the proposed structure of the new European Stabilisation Mechanism can be found in various parts of the World Wide Web thingy, e.g. here and here.

Two things jump out to me. First, the agreed margin on a 7.5 year fixed rate loan from the EFM would be 260 basis points, about 60 points lower than the current rates on offer from the EFSF. Perhaps someone will insert a clause making the margin dependent on a country’s corporate tax rate but somehow I doubt it.

Second, despite a lot of previous focus on the idea that only bonds issued after 2013 would be eligible for restructuring, the proposal does not contain such a commitment. As expected, there is a commitment that government bonds with a maturity greater than one year issued after the introduction of the ESM will have to have collective action clauses facilitating restructuring. But rather than adopt a position that existing bonds cannot be haircut, the proposal seems to essentially take the opposite strategy. A country that fails a “sustainability analysis”

will be required to to engage in active negotiations in good faith with its creditors to secure their direct involvement in restoring debt sustainability. The granting of the financial assistance will be contingent on the Member State having a credible plan and demonstrating sufficient commitment to ensure adequate and proportionate private sector involvement.

I’m all in favour of this, having argued at various times (e.g. here and here) that a proposal to only haircut bonds issued after the introduction of ESM was unworkable. However, this does help to explain the market jitters of the past few days. The Irish two-year bond yield was up another 40 points or so today and stands at 10.25% as I write, having reached as high as 10.7% earlier today.

The Black Hole Grows

It has been apparent for some time that proposed design of the post-2013 ESM — notably preferred official creditor status and arrangements for creditor bail-ins — is undermining peripheral country creditworthiness. The so-called bailout mechanisms have the rather grotesque feature that they can suck a country in once it begins to show enough vulnerability.  

At the moment, markets do not want to lend to Portugal in large part because markets expect Portugal will enter the bailout mechanisms, increasing the risk they will be caught up as junior creditors in later accelerated bail-ins.  This could end up happening well before 2013; hence the surge in our 2-year yields. These fears are likely to be self-fulfilling, despite the resistance of the Portuguese government (no doubt informed by watching what happened to Ireland).  As we are learning more by the day, once in, it is damn hard to get out.   Peripheral yields have shot up every time the ESM became that bit more certain (latest news on the agreement here).   With the evidence so clear, it is hard to understand how European leaders persist with a solution that could end up destroying the Eurozone.   The interest rate issue appears a sideshow by comparison.

The FT has a couple of good articles that nicely capture that damage being done to our and others’ creditworthiness (see here and here).  A flavour:

Investors warned they could boycott peripheral eurozone bond markets as reform of the region’s bail-out fund sparked fears of a sovereign default in Europe.

Irish three-year bond yields leapt close to a full percentage point at one point on Tuesday, while the cost of borrowing for Portugal and Greece also shot up on worries that one of these countries would have to restructure their bonds.

European finance ministers finally drew up plans to make investors share the burden of potential sovereign defaults beyond the summer of 2013 in a deal hammered out on Monday night. Concerns centre on the preferred creditor status given to European Stability Mechanism, the permanent eurozone rescue fund, which takes up the reins from the temporary fund, in the middle of 2013.

Investors warn that this will mean they will be the last in the queue for the recovery of money in the event of a default. One fund manager said: “We will definitely not buy peripheral bonds now, not with the uncertainty this has created.”

Tamara Burnell, head of sovereign and financials analysis, M&G Investments, said: “This agreement will not do anything further to encourage investors to buy peripheral bonds.

Inversion: Two-Year Bond Rate Moves Above Ten-Year

As I write, the two-year Irish bond yield has risen from 9.3% to above 10% and is now higher than the ten-year bond yield. I suspect this may be a reaction to yesterday’s meeting of Euro area finance ministers and the prospect that Ireland will not get a reduction in its interest rate. But I’d be interested in hearing if people can point to other reasons.

Daniel Thomas: Irish Bail-Out Terms Endanger EU’s Future

Here‘s an article by my UCD colleague Daniel Thomas that makes an important argument. If the Irish authorities are to get anywhere in relation to getting a better deal on issues such as the interest rates on official loans or dealing with our banking problems, they cannot rely on arguments based on narrow self interest.

Dan points to the dangers to the EU political reform process stemming from Ireland getting a bad deal. I think one can also argue that a deeper role for the EU in solving Ireland’s banking crisis can also be justified on the grounds that it can help to maintain financial stability throughout the Eurozone.

Kenny Returns from Brussels

Enda Kenny has returned from Brussels without any agreement yet to reduce Ireland’s interest rate (Irish Times story here and FT story here). Not surprisingly, Mr. Kenny wasn’t too keen to give up Ireland’s 12.5% corporate tax rate in return for a mere one percent reduction in the interest rate on the EU loans.

To my mind, there is a lot of shadow boxing going on here. The EFSF is an EU institution and it cannot set the terms of its lending on a bilateral basis with individual countries. I’d be surprised if thee tradeoff between these two elements ended up being as explicit as suggested in this weekend’s news stories.

I think the business about interest rates and corporation tax rates has a feel of fiddling while Rome burns. More interesting were Kenny’s comments about the ECB:

“I made the point that for me to conclude a deal here I need to be much clearer in respect of elements related to the ECB,” he said.

“I spoke to president Jean-Claude Trichet and the Minister for Finance will be meeting with him on Monday. He has agreed that I should meet with him before the [next EU summit on March] 24th/25th to discuss a number of issues relating to the ECB and its positions.

“Before the council meets again in two weeks time we hope to be in a much clear position insofar as Ireland’s position is concerned and continue on our progress arising from the mandate that I’ve got about an improvement in the terms of the package for Ireland,” the Taoiseach said.

He continued: “In the next couple of weeks I expect to be in a much clearer position in respect of the state of what we have inherited is in respect of Ireland’s position.

“We’ll have had discussions with the ECB in respect of a number of matters. We’ll have a much clearer picture of what’s emerging from the stress tests and as the principle has now been accepted and implemented of a reduction in the interest rate I . . . would regard that actually as the beginning of a process.”

I reckon they could fill Croke Park if they sold tickets for those discussions with the ECB.

Failure to Catalyse

While the change of government has brought a welcome fresh start, long-term bond yields – and the implied probability of an Irish default they signal – continue to rise.   The 10-year yield is now above levels that forced Ireland to seek the EU-IMF assistance programme in November.  It is of course early days.    But there is no getting away from the message the bond market is sending.  

The hope behind the programme is that it would catalyse private funding.    With this in mind, it is interesting to look at the literature on the catalytic effect of official funding, much of it originating from the IMF itself (see here for an example).   The basic idea is that official funding can be a complement to private funding.    Continue reading “Failure to Catalyse”