Angela Merkel has just given us a compelling reason to be grateful for central bank independence.
Update: Wolfgang Münchau is pessimistic about future ECB independence here.
Category: Fiscal Policy
There is a widespread consensus among opposition politicians, unions and business lobby groups such as ISME that the government needs to launch a “jobs plan” to reduce unemployment. One such proposal is Fine Gael’s plan to give those firms hiring unemployed workers either a €6000 subsidy over two years or a waiver on employer PRSI. (Labour have a more restrictive version which only applies to recruiting people unemployed more than six months.) Another proposal is ISME’s call for “an employment subvention fund to protect existing jobs.”
At a time of rapidly rising unemployment, I’m sure these seem like tremendous proposals to the public and the government is being widely criticised for its failure to adopt “innovative” proposals like these. To my mind, however, it would be a mistake to adopt proposals of this type. Let me explain why.
Once we have banks that have been re-capitalised and apparently stable once more, where does our financial system go? In negative terms, how can we be assured that the financial system will not generate crises on the kind of scale that we are currently living through? In positive terms, how can we increase the chances that finance flows toward productive rather than speculative uses?
These critical questions are largely sidelined in the current debates on nationalization, which have focused largely on the (urgent and very important) questions of how to restore the stability of the banking system and who will end up stuck with the bill. But, even if this is achieved at the least possible cost to the taxpayer (and therefore with the least possible constraint on public investment into the future), this still leaves the questions of stability and productive investment. There is little reason to suppose that an unreconstructed banking system will deliver this on its own – the banking system provided neither stability nor productive investment before this crisis. Reform of banks themselves will be essential, although this has largely disappeared off the agenda in recent months.
There are five areas through which we can influence how banking practices are shaped by the wider system of financial governance (some of these are usefully reviewed in Stiglitz and Uy’s account of the ‘East Asian Miracle’). In each area, the system has left a great deal to be desired and requires reform.
Anglo Irish Bank has announced losses that bring its measured shareholders’ funds down to about 0.1 per cent of total assets — effectively zero. It has also announced a further €3.4 billion in expected loan losses, little of which would be offset by operating income over the next year or so.
From a strict contractual point of view, the next in line for absorbing these losses are the subordinated debt holders. There has already been some discussion on this site of the issues involved here.
Now we are at a crunch point because a recapitalization of Anglo cannot be long-delayed. Indeed, to continue trading, the bank presumably needed the assurance that was provided by the Government today that needed capital would be forthcoming.
There is €2.8 billion of unguaranteed sub-debt on Anglo’s books. I am assuming that part of the Strategic Plan promised by the bank this morning will have to involve risk-sharing by sub-debt holders. This could take the form of of a deeply-discounted buy-back (as indeed is already suggested in the Government’s statement). It could also take the form of a debt-equity swap. (This would parallel current discussions in the US around debt-equity swaps to recapitalize some of the larger US banks following their stress-tests).
Obviously none of this is easy, and these bondholders may want to play chicken. In a liquidation they would be wiped out, but — absent modern bank insolvency legislation here — a messy liquidation could also inflict severe taxpayer and economic costs.
I admit that I am not sure of the most effective way of accomplishing it. There are some obvious options. Perhaps readers will have some further ideas. I am sure that officials are pondering these issues.
But difficult does not mean impossible. The stakes here are evidently high.
Urgent work to modernize bank insolvency procedures (as recently enacted in the UK post Northern Rock) could strengthen the Government’s hand.
It might be argued that losses incurred even by sub-debt holders of a bank could damage the credit of the Irish government. I disagree.
First, it is really immaterial that the bank is Government-owned: eveyone knows that situation has only arisen as a result of the disastrous performance of the bank. No new subordinated debt has been issued since the nationalization. Besides, in his statement in the Dail on January 20, during the debate on the nationalization bill, the Minister removed any doubt about whether nationalization entailed an expansion of the guarantee.
More generally, even though there might be an immediate knee-jerk reaction in market prices of debt, mature reflection by the financial markets would recognize that a country honouring its debts and guarantees to the letter–and not beyond–was more creditworthy than one which handed over money lightly to unguaranteed risk investors.
The WSJ devotes front-page space to Chile’s success in saving for a rainy day during the boom times: you can read it here.