The latest collection of briefing papers for the European Parliament’s Monetary Dialogue with the ECB are available here. One set of papers (including one by me) discuss bank and sovereign debt resolutions (this paper is the source of my comments here on senior bank bonds). The other set discuss the issue of Eurobonds.
Category: Banking Crisis
I’d like to flag an excellent new initiative that our readers are likely to find useful. As many of you know, the Institute for International and European Affairs has played a very important role in recent years in promoting debate on European issues. The Institute has now started a blog focusing on European topics which already has a lot of interesting material. I have agreed to contribute some longer pieces there. They’ve promised to make me some pretty graphs if I ask nicely which might make a nice change sometimes from the no-frills approach we adopt here at the IE blog!
Which brings me back to an issue related to my proposals for a debt-to-equity swap for central bank loans. Some commenters have rightly pointed out that this proposal seems to give up on burden sharing with bondholders. That it does so is just a reflection of the current EU position on this issue. However, this strengthens the case for the EU becoming involved in owning the Irish bank sector: If they want the bondholders paid back so badly, then one can argue that they should contribute some of their own funds to the effort.
But coming back to the European debate on bank debt, I think the EU officials are adopting the wrong approach to dealing with this issue. I also think that the proposals adopted by the European Commission to allow haircuts on bonds that are issued in the future, say after 2013, is unworkable. For a discussion of this and an alternative approach, see this post at the IIEA site.
Here‘s an article I wrote for today’s Irish Times. It argues that a conversion of central bank loans to equity is now the best way to end the banking crisis and avoid a sovereign default.
It was great to see Jon Ihle, one of Ireland’s best financial journalists, writing in the Sunday Business Post yesterday. Missing Jon’s weekly insights was one reason to mourn the Tribune’s demise.
Jon has an informative piece on the coming bank stress tests: see here.
We are clearly being prepared for some additional bad news on the bank losses, and maybe for once we will be surprised on the downside. In interpreting the additional capital needs, however, it will be important to distinguish between estimates of additional losses and the new capital required to meet higher capital ratio targets.
The EU/IMF terms require A baseline capital level of 12 per cent for all banks – far above the normal 8 per cent regulatory level at which Anglo and INBS are being allowed to operate.
But if the stress level is as high as 10.5 per cent – meaning capital could not fall below that point even under dire conditions – bankers expect the baseline level could go as high as 16 per cent, imposing huge recapitalisation costs.
I’ll take my turn linking to Colm McCarthy’s agenda-setting column in the Sunday Independent (available here).
While I don’t find much to disagree with in Colm’s piece, I worry that some readers might come away with the sense that default provides a relatively painless solution to our problems, which I don’t at all think is Colm’s view.
A few thoughts: First, it would of course be wonderful if a Europe-wide solution to the banking problem is pursued, one involving other countries absorbing a large chunk of our banking losses. It is unlikely to happen.
Second, some hold the view that defaulting on State-guaranteed bank debt (ELG) would be less costly than defaulting on State bonds. It would be good to see more discussion of why the reputational and balance sheet contagion costs would be less as a result of defaulting on State guarantees, especially given that available numbers indicate more than half of the bank bonds are held domestically.
Third, we have to recognise that part of the reason that the perceived default risk is so high is the perception that an orderly default will in fact be organised as per Colm’s advice. An orderly creditor “bail-in” – one supported by Europe and the IMF and probably involving additional funding – would indeed be less costly than the disorderly alternative. But making defaults less costly raises the expectation that a default will actually occur and thus raises the risk premium. We can see potentially self-fulfilling expectations of a default equilibrium emerging.
Fourth, we have to recognise that a more organised system of creditor bail-ins that makes it easier to restructure debt will itself make market access harder in the future.
Colm is right that the current bail-out mechanisms are deeply flawed and make exiting our creditworthiness crisis daunting to say the least. It would be a mistake, however, to conclude that there is some painless alternative that is not being taken because of stupidity or even politics. There are no easy solutions. We may end up going the default route. But given the costs of this route, the alternative of an assisted drive to shift expectations to the no-default equilibrium should not be too quickly set aside.