The Irish Economy

The Eurozone banking system is not working properly due to fragmentation between core and peripheral banking systems. In a recent speech, the president of the ECB, Mario Draghi, has acknowledged this, but argues that fixing this problem is someone else’s responsibility. The ECB has the tools to address this crucial flaw in the Eurozone system, and over the medium term horizon there is no other Eurozone institution that can. The ECB should use the tools available to fix this market fragmentation, in particular, the ECB should engage in aggressive, long-term asset refinancing on sufficiently generous terms to encourage bank participation. (more…)

This interview with Athanasios Orphanides will ring a few bells in Dublin. I remember in the autumn of 2010, when the ECB in a similar fashion threatened to pull the plug on the Irish banking system, thinking that this was not a credible threat, since such action would de facto mean expelling Ireland from the Eurozone. Would an unelected bunch of central bankers really be willing to do something so political?

I can understand why Irish policymakers were not willing to test this logic at the time, even though I was very angry with them for giving in to ECB pressure not to burn the Irish banking system’s creditors, and still think they shouldn’t have done so.

One thing seems certain however. The ECB cannot have it both ways. It cannot simultaneously threaten to expel a member state from the Eurozone, and also expect us to believe that it will do “whatever it takes” to save the euro.

What investors (and, to be honest, I) have forgotten is that Draghi qualified his pledge: the ECB would do whatever it takes “within its mandate”. It isn’t clear that investors will continue to believe that “it will be enough”.

This piece by Nicolas Véron is well worth a read, even though it was posted yesterday and the situation is fast-moving.

I can’t quite believe that the EC has said this, but they apparently have. Unbelievable. Its obvious implication is that bank runs in troubled countries, if they ever happen, now risk being nation-wide, rather than limited to failing banks. Hat tip Eurointelligence, who call the statement hugely damaging, and Gavin Kostick in the comments.

I thought I would hoist this comment by Gary O’Callaghan onto the front page:

Karl observes in his article that Ireland’s citizens must be feeling foolish today: “After being reassured time and again that all depositors and senior bond creditors of … Anglo Irish Bank must be saved in the name of European financial stability, they find out that Europe’s leaders now believe hair-cutting depositors is fine and fair and doesn’t cause contagion.”

In a related dynamic, there appears to have been a subtle turn by many commentators (including on this site) from the “serves them right” school of economics. That School, most righteously established by LBS, argued that Irish taxpayers should carry the can for bank losses because they “should have” sought better supervision on banks. Many from the same School now appear to argue that depositors (creditors) “should have” been more careful in the Cypriot case and deserve to suffer for their stupidity. Serves ‘em right!

Of course, there is a practical limit on the burden that Cypriot taxpayers can bear in this case but such considerations never bothered the LBS School before. Do they now grant that Irish taxpayers were not fully “to blame” (and that burden-sharing from bondholders was warranted)?

Would they now agree with Karl that “the moral grounds for a retrospective compensation deal for Ireland have increased substantially with this new development?”

The problem with theorizing from morals, of course, is that the ground can shift (and come back to meet you).

I am tempted to add that if we ask “cui bono”, there may be less inconsistency here than at first glance meets the eye.

You leave the computer switched off during the holiday weekend, and look what the Eurozone does while you’re away! I guess we don’t know yet what the final outcome is going to be in Cyprus, and I fully share Sharon Bowles’ hopes that we haven’t seen the final word yet.

But if small depositors are going to take a hit, then, as a reminder of what we will have lost, here is a handy set of links to various EU documents and regulations regarding banking deposits. This citizen’s summary which reflects the media reports of the time helps explain why people have persisted in leaving their money in peripheral European banks for so long. It seems mad to tear this guarantee up on the grounds that Cyprus is sui generis, since as Tolstoy (almost) said…

Update: Tuesday morning, and we still don’t know what is going to happen; maybe the guarantee for savings of less than €100,000 will be honoured. But I fear that Karl and the many other commentators weighing in on the issue this morning are right, and that the long run reputation of the EU’s claim to guarantee such deposits will suffer a big hit as a result of this debacle, no matter what ultimately happens.

Today the Irish government and Central Bank together announced a new set of plans to tackle the mortgage arrears crisis. The new plan reverses two policy decisions from the recent past that are now acknowledged to be flawed: the 2009 Land Conveyancing Act, and the Financial Regulator’s 2011 Code of Conduct on Mortgage Arrears. The plan also imposes ambitious targets on all Irish domestic banks, first, to offer each mortgage holder in arrears a specific proposal for resolving their arrears problem, and second (during 2014) to ensure that a majority of these individual plans are implemented or suitably modified.

The targets seem fairly aggressive, with over 55,000 individual arrears resolution plans to be offered by December of this year. It is not clear when the new process can begin since the legislative changes to the 2009 Land Conveyancing Act may not be ready for several months (today they were promised to be completed by the summer recess of the Dail).

Key documents:

Irish Central Bank press announcement:

Mortgage arrears resolution targets:

Consultation on changes to the Code of Conduct on Mortgage Arrears:

Wolfgang Munchau (crediting Karl Whelan) here.

Donal Donovan here.

John McManus here.

The current issue of Intereconomics has a series of stories about the politics of adjustment in Greece, Ireland, Spain, Italy, and Portugal. Niamh Hardiman and Aidan Regan discuss the Irish case. It’s well worth reading all of the cases for those of us engaged in the current debate, to see similarities and differences in the approaches. It’ll help those of us (read: me) engaged in teaching this stuff as well.

Niamh will also be speaking on this theme at tomorrow’s Irish Economy conference.

The FT has a sobering report here.

Namawinelake has a link to the new Fitch report on global property markets, including Ireland which gets considerable attention in the report. The Irish picture is mixed with some positive signals (affordability ratios have become more normal) and other negative signals (continued bank distress limits future mortgage lending).

Fitch also highlights the unusual behaviour of Irish arrears, and connects this to the Irish policy framework.

“Irish Borrowers on Strike: Despite economic stabilisation, Irish arrears continue to trend upwards. Fitch believes this to be partially driven by policy framework changes. Lenders are constrained from large-scale repossessions, dis-incentivising borrowers from paying their mortgages. In addition, borrowers in arrears are also likely to benefit from significant debt write-offs when personal insolvency legislation becomes effective.”

Brian O’Kelly and I have a new policy paper on Eurozone bank resolution; it is in the Special Papers series produced by the Financial Markets Group at LSE.

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The Director of Credit Institutions and Insurance Supervision at the Irish Central Bank, Fiona Muldoon, has been widely praised for her speech to the Irish Banking Federation, calling for faster action by the banks in dealing with the mortgage arrears crisis.  The speech makes clear that the damaging nexus of the former Fianna Fail government, linking the politically connected property development industry to the banking industry and an overly compliant bank regulator, is no longer in place. The Irish Central Bank is now able and willing to stand up to the industry that it regulates in order to protect the public interest, and it is supported in this stance by the ruling coalition. This is an important positive outcome.

The speech was a step forward, but it was not an unusually brave speech, despite the impression one gets from the wide praise it received in media coverage. A truly brave speech would not be widely praised, since it would need to unsettle people rather than confirm their existing beliefs. The speech ignores a big part of the reason for the mortgage arrears crisis – the deep-seated Irish political aversion to house repossessions. Without facing up to this big part of the mortgage arrears crisis, there will be no solution.  Here is an extra paragraph, offered with proper humility, which might have changed Fiona Muldoon’s partly brave speech into a truly brave speech. I have kept the “teenagers” motif, which was a clever oratorical device in the original speech.

“I cannot come here and give a speech about mortgage resolution without once mentioning repossessions; that would be cowering. The notion that 167,000 mortgages-in-arrears can be resolved without a substantial proportion of repossessions is delusional. We on the senior Central Bank staff could give speeches ignoring this reality, thereby pandering to political sentiment, but we will not do so. Meanwhile, the government’s most recent attempt at reforming Ireland’s repossession laws was a shambles, and virtually the entire law was declared invalid by the Justice Dunne ruling in July 2011. This has left Ireland, and it’s banking system, with virtually no repossession system at all since that date. Rather than fix this urgent legislative cock-up of its own creation, the government has chosen to ignore it and pretend that it will go away. The ruling coalition is acting like a bunch of teenagers; blaming everyone else in the household for their problems while neglecting to do their own homework.”

Landon Thomas outlines some of the reform ideas doing the rounds in policy circles and profiles some of the key participants in this NYT article.  He includes the ESBies idea proposed by our euro-nomics group and a member of our group Markus Brunnermeier, as well as Daniel Gros and Graham Bishop.

I am not entirely sure if it belongs in a post with this title heading but Hans-Werner Sinn makes his own proposal in this FT op-ed.

In a piece in yesterday’s Sunday Business Post my colleague Dr Niamh Hardiman  makes a plea for better understanding of the roots of our current crisis in weaknesses in governance institutions. Such an understanding is a precondition for effective reform. She addresses weaknesses in parliamentary scrutiny, the capacity of the civil service for appropriate engagement over policy making, and the effectiveness of the public service itself. She highlights institutional explanations for tendencies for public policy to favour sectional interests, but argues that understanding the institutional weaknesses is the key to addressing them. The article is behind a paywall, but a fuller, multi-author examination of the issues is available in a book arising from a UCD project on governance, Irish Governance in Crisis, edited by Niamh Hardiman (Manchester University Press, 2012).

Paul Krugman and Richard Layard put forward a case for a coherent and evidence based approach to the crisis. Essentially they argue that a strategy of focusing on the reduction of public debt levels exclusively in order to regain market confidence makes no sense, and has been falsified empirically. They also argue that structural imbalances shouldn’t prevent the use of discretionary fiscal policy for stabilization purposes when it is available.

This chart of the drop in domestic demand from the recent Nevin Institute quarterly report (page 4) is particularly striking as a motivating factor in discussing Krugman and Layard’s piece.

Krugman and Layard have a manifesto you can sign up to (I did).

There are lots of things in this piece I agree with, but two big ones are:

1. Placing the blame for the crisis at governments’ feet makes no sense. The crisis didn’t start in the public finances, it began in the private sector(s).
2. The confidence argument and its attendant strategy is completely wrong headed at this juncture, Ireland in particular shouldn’t be held up by anyone as the role model for austerity, either in the 1980s or today.

There are also aspects I don’t see as pertinent to the Irish case.

Krugman and Layard write:

A second argument against expanding demand is that output is in fact constrained on the supply side - by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations.

But in Ireland, in the IT sector for example, and especially in really high end tech jobs like online video gaming and such, they can’t get people. (Obviously in other sectors like services and construction their argument holds.) There are other examples but I think in a small open economy like Ireland this argument isn’t that important.

The key question from an Irish point of view is: to what extent is the Krugman-Layard prescription possible in a country with so little fiscal room for maneuver? Translating the argument down a bit, if Ireland is somewhere between Greece and Spain in terms of it’s problems, even if Enda Kenny et al bought the Krugman/Layard prescription lock stock and two smoking barrels, given where we are right now, are our options severely limited in any event? I’d welcome your thoughts on this.

Call for Papers

Bank Resolution Mechanisms

A joint academic-practitioner conference with the theme Bank Resolution Mechanisms wil be held in Dublin, Ireland on Thursday May 23rd, 2013, organized by the Financial Mathematics and Computation Cluster (FMCC) at University College, Dublin and the Department of Economics, Finance & Accounting at National University of Ireland Maynooth. (more…)

There seems to be almost unanimous agreement within the Irish media that had the IFSC-based Depfa Bank not been bought by another German bank just before its collapse at the beginning of the financial crisis, the bill would have landed on the Irish taxpayer. Dan O’Brien repeats this view in an article in the Irish Times on Saturday.

I am not sure that the issue is as clearcut as is supposed. Willem Buiter (pages 9-11) suggests that we are in uncharted territory in these matters.

In early 2009, the Irish domestic banks had three critical problems: insolvency, distress, and a liquidity crisis.  Only one of these problems, the liquidity crisis, was solved successfully at an acceptable cost, via ECB liquidity provision.  This massive liquidity provision was one key motivation for the Financial Measures Programme (FMP), which lays out a plan the banks must follow to become liquidity self-financing.  Now, through no fault of the Irish banks but because of the continuing financial crisis, the liquidity target plan in the FMP is looking much too optimistic and needs some adjustment. 

• 1. The loan-to-deposits target date should be changed from 2013 to (end-of) 2015.
• 2. The ECB should make clear that their liquidity assistance to Irish banks is for a longer period than originally envisioned.

Without these adjustments, the Irish domestic banks will be incentivised to continue to starve the domestic economy of credit over the next few years.

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Everyone agrees on the need for big changes to bank resolution mechanisms both in Europe and in the USA. The problems with bank resolution differ in Europe and the USA, and the appropriate solutions differ too. Coco bonds make great sense for the Eurozone but are less appropriate for the USA. European regulators need to think for themselves on cocos, not just ape the muted response of US regulators. Contingent convertible (coco) bank bonds have a trigger point (such as a minimum equity/asset ratio) which when reached immediately forces a conversion of the liability from a debt to an equity claim. So when the bank gets into trouble, junior-grade debt liabilities immediately disappear and are replaced by diluted equity. Coco bank bonds are a very partial solution (at best) to the TBTF bank resolution problem in the USA. For all but the very biggest banks, the harsh and effective resolution system in the USA can close and re-open troubled banks very quickly. This type of super-fast bank resolution will never happen in the fragmented multi-national banking system of the Eurozone. Also, the technical competence of bank oversight in the USA will never be matched across all seventeen countries of the Eurozone, some of whom have long histories of weak and ineffective bank regulation. Cocos can partly substitute for weak regulatory oversight by encouraging greater market discipline emanating from bank bondholders.  Cocos would fit well into the design of a politically-feasible banking union for the Eurozone. 

If the euro survives, some type of contingent convertibility for bank debts in the Eurozone is likely to be part of the new banking system.  Ireland as a small economy in the Eurozone would particularly benefit from a coco feature imposed on bank bonds, and should encourage this regulatory policy innovation.

Spain’s banks are getting a series of loans. Hooray. The rather vague Eurogroup statement on Spain is here. It’s being reported that Spain will require up to 100 billion euro for its banks, which will be added to its national debt. The money will come in tranches, first from the EFSF, and then later from the ESM. There aren’t specific austerity measures attached to this series of loans. People in Ireland are sure to lose their minds over the fact that there won’t be specific conditionality attached to these loans, and the IMF will be ‘observers’ rather than actually part of a Troika of funders. The talk generally is likely to be something like ‘why couldn’t we get such a deal’, and apparently Minister Noonan will be bringing this up with his colleagues at a later date.

It should be noted however that Spain is already enduring a fair bit of austerity, has already signed up to the Fiscal Treaty, and so will have to produce a `programme’ of sorts under its own steam. Spain’s economy is also in pretty rough shape. I made the chart below from FRED to show household debt as a percentage of GDP (left hand axis) and unemployment in Spain (right hand axis), two variables we should be interested in. Clearly with an unemployment rate heading for 25%, a very indebted household sector, and a set of bunched bank balance sheets, the Spaniards have their work cut out for them even without a further programme of adjustment.

A few things to consider:

1. Will treating Spanish banks separately (in some sense) to the sovereign prevent its bond yields from spiking?

2. What will the effect on the EFSF and ESM balance sheets from a large scale Spanish ‘withdrawal’?

3. Will everyone now immediately target Italy (or Belgium) as the next domino to fall?

Vincent O’Sullivan and I write on this topic, applied to the case of the Capital Requirements Directive IV, on the Harvard Law School Forum on Corporate Governance and Financial Regulation here. A related talk I gave at the IIEA is here.

Six months ago on this blog I made a quasi-prediction that the number of new residential mortgages in Ireland might shrink to zero-plus-noise. Arguably this has now happened. I claim no great insight and concede that it might have been dumb luck. My quasi-prediction was based on some informal liquidity-risk analysis of the Irish banks. The banks are in a corner solution with respect to long-term illiquid assets. There is little good reason for an Irish-domiciled bank to issue a new residential mortgage, rather, they might be keen to sell any of their existing long-term illiquid assets at a loss. This has only second-order policy importance relative to Greece, etc., but is worth documenting.

The 2011 Annual Report for the Irish Bank Resolution Corporation has been released.  The Consolidated Income Statement and Consolidated Financial Position are reproduced below the fold though I would recommend looking at the relevant Note in the full report to get more insight on any particular figure.

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Colm writes another dinger of a piece for the Sunday Independent, it’s required reading. From the piece:

No other eurozone member has incurred bank-related debt under ECB duress. There are no provisions in the Maastricht Treaty, in the Stability and Growth Pact or in any other pact or international treaty which grant this power to the ECB, nor was any eurozone member state ever asked to accede to such an arrangement. Commissioner Rehn’s Latin phrase (”pacta sunt servanda”) has no pact to refer to, insofar as these imposed debts are concerned. Ireland never signed a pact or treaty which empowered the ECB to behave in this fashion.

One can only speculate as to the ECB’s motives, since it does not deign to explain. European banks have come to rely heavily on unsecured bond financing and the ECB may have felt that no bank bondholder should suffer losses, in order to encourage the survival of this market in bank debt. If this was the motive, the policy is being paid for, not by the ECB, but by Irish taxpayers and sovereign bondholders and financed by European taxpayers and the IMF. There is no pact which confers powers of taxation on the ECB.

All of the Greek debt relieved, to the tune of €100bn in recent weeks, was contracted, without duress, by the lawfully elected Greek government. The write-down was welcomed by Commissioner Rehn, who described himself as “very satisfied by the large positive turnout of the voluntary debt exchange in Greece”. The same “exchange” was described by one of the bankers enduring a 74 per cent haircut as “about as voluntary as the Spanish Inquisition”. The bondholders agreed only after punitive retrospective clauses had been inserted into bond contracts, with the agreement of the European Commission. Some of them are initiating court actions, presumably in jurisdictions cognisant of the “long European legal and historical tradition” to which Commissioner Rehn refers so approvingly.

The Financial Times, in a leader last Thursday, argued that Ireland should be afforded debt relief in order to ensure debt sustainability. “Pacta sunt mutanda” it intoned, which means treaties should be altered. The portion of the Irish debt in dispute here does not derive from any pact or treaty but was arbitrarily imposed by the ECB. There is no need to alter any treaties and the FT, uncharacteristically, has misunderstood the Irish case.

This whole sorry saga has raised once more the enduring policy dilemma of ensuring that central banks are both independent and accountable.

The Governor of the Central Bank, Professor Patrick Honohan, delivered a speech to the Limerick Law Society in the University of Limerick this evening.  Both the speech and some accompanying slides are available.

Fabian Bornhorst and Ireland-expert Ashoka Mody have a good piece here.

Financial Regulator, Matthew Elderfield made a speech yesterday to the Harvard Business School Alumni Club of Ireland.  The speech dealt with several aspects of the ongoing mortgage crisis and can be read here (pdf here).

Two extracts worth considering are below the fold but there are lots of interesting elements to the speech. 

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Here’s a link to an interesting report by Karl Deeter and Frank Quinn on the current state of the Irish residential property market, using data from MyHome.ie and the Allsop\Space auctions.