I agree with Ryan Avent when he says that “the current situation reinforces the idea that strong, well-anchored automatic countercyclical stabilisers—fiscal and monetary—are the best hope for avoiding prolonged economic crises”.
Unfortunately, these days in the eurozone you are more likely to read stories like this one.
Dublin is the location this week for the 58th World Statistics Congress of the International Statistical Institute (the CSO is the local host): the programme shows the wide range of topics covered by this large-scale event, including many relevant for understanding economics and finance.
John Murray Brown reviews the fiscal debate in this FT article.
While perhaps it is just an August effect, the broad quality of the analysis of European crisis-resolution efforts has been disappointingly poor, with a message the often does not go much beyond self-satisfying statements about the stupidity of European policy makers.
To make sense of more recent developments, I think it is critical to go back to the previous Franco-German summit at Deauville in October. The Deauville accord put in place plans for the permanent bailout mechanism to replace the EFSF in 2013. Understandably, debt restructuring was envisioned for countries needing new programmes under the ESM to limit both contingent liabilities and moral hazard. Unfortunately, however, this attempted strengthening of market discipline proved devastating for the creditworthiness of countries where any doubts existed about their ability to stabilise debt levels. Ireland can be seen as the first casualty, first getting sucked in and then actually seeing its bond yields rise steadily as the extent of default risk under the new arrangements became more evident. The ambivalence about default among key Irish opinion makers did not help. We then saw Portugal get sucked in as doubts emerged that it too might get sucked into the “black hole” of an EU/IMF programme given the limited nature of the exit options. The realisation that the structures that had been put in place were effectively a machine for self-fulfilling debt crises really came home as the creditworthiness of Italy and Spain began to ebb away.
The July 21 summit was a welcome attempt to move away from this “market discipline” regime. Although you would hardly know it from the commentary, and recognising there is a long way to go, the summit has been highly successful from an Irish perspective. The combination of the interest rate reduction, lengthened maturities and a more open-ended commitment to countries without imposing debt restructuring has led to a dramatic fall in Irish bond yields. 10-year yields have fallen from over 14 percent to under 9.5 percent. Even more dramatically, 2-year yields have fallen from 23 percent to under 9 percent. Clearly, the measures taken at the summit were not enough to stem the doubts about the creditworthiness of Italy and Spain, and their yields continued to drift upwards in the days following. Subsequent intervention by the ECB – really the only entity with the firepower to make a credible commitment to a sufficient backstop – has been quite successful in shifting from a bad equilibrium where expectations of default change the fundamentals and risk becoming self-fulfilling.
None of this is to say we are anywhere near out of the woods. More bad luck has come with increasing signs of a significant global slowdown, which jeopardises debt sustainability for many countries. There are also lingering doubts that the ECB and other major central banks have the stomach and political support to do what is necessary to act as backstop for financial systems, though I believe these doubts will prove unfounded.
Having this strengthened backstop is effectively to move decisively towards what Peter Boone and Simon Johnson label a “moral hazard regime.” It is no surprise that the governments of countries taking on more risk to backstop the system want strengthened fiscal discipline to replace market discipline as far as possible, not least because of the constraints of domestic politics. This is what the Paris summit was all about, although the efforts may have been a bit clumsy and there is a long way to go to workable institutions. Commentators here might ask themselves how they would react if Ireland was in the stronger group and taking on a large contingent liability relating to weaker countries. European crisis-resolution mechanisms are moving in the right direction as the nature of the trade-offs is better understood. We could have a more constructive and informative debate if we spent less time harping on about the stupidity of others.
I’d written the comments below before seeing Stephen’s post on this, so I’m not trying to correct anything in it, just adding my own two cents.
I didn’t attend Morgan Kelly’s talk at ISNE yesterday so all I know about it is what I’ve read in today’s newspapers (e.g. this piece in the Irish Times) in which Morgan is quoted as saying “We are talking sums in the region of €5 billion to €6 billion which would be necessary to spend on mortgage forgiveness”. This evening, I heard a piece on RTE’s Drivetime in which Brendan Burgess of askaboutmoney.com was questioning various figures that were attributed to Morgan and arguing that Morgan was unnecessarily scaring people about the scale of mortgage defaults.
I’d like to make two (hopefully) clarifying points on this issue. First, the sizes of the owner-occupied and buy-to-let mortgage books for Irish properties of the four guaranteed Irish banks are not something that there needs to be any disagreement about, as the balances as of December 31 last year were published in the Financial Measures Programme (FMP) report of March 31 (page 19).
Second, rather than being a scary figure, Morgan’s estimate of between €5 billion and €6 billion for a substantial mortgage relief programme is, if anything, a bit low relative to what the Central Bank’s figures in the FMP report indicate is necessary.
On the size of mortgage books, here are the facts. As of December 31 last year, BoI, AIB, EBS and INBS had a combined €97.7 billion in Irish residential mortgages with €74.4 billion being owner-occupied and €23.3 being buy-to-let (Table 7, page 19 of FMP report).
On estimates of losses on the owner-occupied portion of Irish residential mortgages, the FMP estimates total lifetime losses on the €74.4 billion portfolio at €5.7 billion in their base case and €10.2 billion in the stress scenario. The amount of these losses to be realised over the next three years is estimated to be €3.5 billion in the base scenario and €5.7 billion in the stress scenario (see Table 9 on page 23).
This shows that Morgan’s estimate of between €5 billion and €6 billion corresponds to either the lifetime losses assumed by the Central Bank in the base case or the three-year losses associated with the stress case.
As I said above, I don’t know how Morgan came about his figures but the five to six billion figure for mortgage writedowns seems to me to be in line with the Central Bank’s official policy.
Furthermore, my reading of statements by Jonathan McMahon, head of banking supervision at the Central Bank (e.g. here and here) is that he is keen to see the banks get on with implementing debt writedowns that are in line with the Bank’s assumptions about mortgage losses. The banks have been recapitalised under the assumption that the losses in the FMP base case are going to occur, so it is surely time to start dealing with this problem.
Perhaps rather than have an unnecessary debate about figures that are actually published and can’t really be disputed, Morgan’s talk can serve as a useful starting point for a debate about exactly how mortgage debt write-downs should be implemented.