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It is obvious that the banking crises in Ireland and Spain share many similarities.   However, it is also clear that the Spanish banking crisis is quite a bit smaller relative to its GDP (even if it is bigger relative to euro area GDP).

• The credit boom was not quite as strong in Spain as in Ireland.  The credit/GDP ratio in Ireland rose from 104 percent in 2002 to 210 percent in 2008; the increase in Spain was from 100 percent in 2002 to 188 percent in 2008
• A recent DB report calculates that real estate loans peaked at 77 percent of GDP in Ireland but only 29 percent of GDP in Spain, while estimated non-performing loans stand at 52 percent of GDP in Ireland but only 17 percent of GDP in Spain
• Ireland’s Troika funding of 67.5 billion euro is equivalent to 43 percent of Irish GDP, the Spanish funding of 100 billion is equivalent to about 9 percent of Spanish GDP.

The proposal for a Debt Redemption Fund made by the German Council of Economic Experts seems to be gaining a bit more traction (see here).   This working paper from February provides a useful overview.   Given that this is the only “eurobonds” proposal with anything approaching momentum, it is worth debating its merits. 

Some of the basic elements:

·         Countries would be able to finance an amount of debt (as a share of GDP) equal to the difference between current levels and 60 percent of GDP through the fund.   This would occur as new funding needs (deficits/redemptions) arise

·         The fund would have joint and several guarantees

·         Repayments would be a constant share of GDP, equal to the ERF interest rate plus one percent divided by initial GDP.   The repayment schedule is designed to fully repay fund borrowings in 20 to 25 years

·         Countries would have to commit to reduce their total debt to below 60 percent of GDP.   Longer term, it doesn’t appear that there would be additional commitments beyond the revised Stability and Growth Pact and Fiscal Compact.   However, during the “roll-in” phase, countries would have EFSF-style adjustment programmes

·         Would only apply for current programme countries after they had exited their programmes. 

Karl Whelan has a very useful post on options relating to reducing the burden of banking-related debt (see here).   Of particular interest is his comparison of the present discounted cost of the current promissory notes/ELA arrangement and a low-interest (3 percent) long-term (30-year) financing deal with the ESM to immediately payoff the ELA.   This calculation shows that that ESM alternative has a lower NPV by a wide margin.  

We could perhaps quibble with some of the assumptions used in the calculation.   Karl assumes the ECB’s main refinancing rate rises to 4.5 percent by 2016, which would require a strong euro zone recovery (see Table 7 here).   Also, in a world where official financing remains available as an option over the longer term, the assumed discount rate of 7 percent (based on current secondary-market bond yields) could be considered high.   (I am also not sure from the calculations if Karl is allowing for Irish Central Bank profits on outstanding ELA.)  But Karl’s basic conclusion seems robust to reasonable relaxations of these assumptions.    

Karl notes that I am “neutral” with regard to whether the long-term refinancing via the ESM would be a good deal, waiting to see the details.   Based on his numbers, I am happy to agree that a 30-year deal at 3 percent is likely to result in a substantial reduction in the burden of this debt.

Dan O’Brien examines the grievance-based case for debt relief here.

Seamus Coffey has an excellent article on resolving the euro zone banking crisis in today’s Irish Independent (HT DOCM).   For the Irish situation, Seamus puts the proper focus back on the case for extending the maturity of the promissory notes/ELA arrangements as the correct focus of negotiations.   The idea that the ESM would retrospectively cover already crystallised losses in the Irish banking system looks fanciful, and only serves to create confusion about what Ireland needs – and could realistically be provided – in order to further the shared objective of getting Ireland off external assistance.  

In the certainty of attracting vitriol in comments, I think Seamus is being a bit hard on the ECB.    The problem that the ECB faces is a bank creditworthiness crisis across a significant part of the euro zone.    In fairness, they have been willing to meet their proper function of acting aggressively as a lender of last resort to stem deposit flight.   But they can only do this if the banks they are lending to are solvent.   They have insisted that the banks be recapitalised, preferably directly from centralised bailout funds, but failing that by governments, with money borrowed from those funds.  

I think most analysts agree that the future stability of the euro zone will require a form of banking union, with centralised supervision, centralised deposit insurance and a centralised resolution regime that allows for losses to be imposed more broadly on certain classes of bank creditors.   The challenge is how to get from here to there.  In the short term, putting creditors at greater risk of losses reduces bank creditworthiness further, potentially causing the crisis to escalate.   Moreover, given the differences in the solvency of the banks in different euro zone countries, any move towards centralised deposit insurance has potentially large distributional implications across euro zone countries.   If a deposit insurance regime could be agreed behind a “veil of ignorance”, with negotiators not knowing which country they represented, it should be relatively easy to agree to such arrangements.   But alas this “ignorance” is not available.   The messy and fragile two-way process involving greater risk sharing and more credible assurances of mutual discipline will continue.