RTE: Nation to Be Spared From Promissory Note Deal

RTE’s Nine O’Clock news are reporting Enda Kenny as explaining that promissory note negotiations are totally separate from the question of will the Irish people vote for the Fiscal Compact Treaty and that the Irish people will not bribed to vote for the Treaty.

RTE also noted that the latest Council meeting was “dominated by jobs and growth” which sounds like great news. And, best of all, reporter Tony Connelly helpfully explained that it was now felt that asking for a better deal on promissory notes was actually a bad idea because it would send a bad signal to financial markets that we were not able to cope with our debt burden and that there was no way this issue would be dealt with any time before the summer.

Ok, so be it. But I suspect that “the Irish people won’t be bribed” may prove to be the worst referendum slogan in history.

2012 TINA Award Winner: Laura Noonan

One of the most depressing aspects of the Irish banking crisis has been the consistent insistence of most of our financial journalists that any action that ran counter to government policy would result in disaster. There was simply no alternative.

I remember countless reports that nationalising any more banks after Anglo would result in torrents of frogs and locusts in the streets of Ireland. Today we have many economic problems but I doubt if the nationalised status of AIB and ILP would make the top ten.

I remember, time and again, journalistic reports that you couldn’t nationalise a bank because the ECB couldn’t lend to such a bank because of the monetary financing clause. Only this was blatantly false.

Even more common was the insistence that if any senior bank bond was defaulted on, the Irish people would be reduced begging in streets for scraps for a millennium. Of course, Brian Lenihan ended his period as Minister for Finance looking to get haircuts applied to senior bank bonds and Michael Noonan spent most of 2011 arguing that this was the right thing to do.

It’s early days yet, but the status of runaway favourite for the 2012 “TINA Award” must go to the Irish Independent’s Laura Noonan for her appearance on last night’s Vincent Browne show. Despite Michael Noonan’s consistent statement of his hope that the promissory note could be renegotiated, Laura insisted that There Simply Was No Alternative to making the €3.1 billion on March 31.

Among the reasons why we “Had to Make this Payment” were:

  • Eurostat have insisted on it (yes, Eurostat, who knew they were the real powers behind the throne, huh?)
  • Failing to make the €3.1 billion payment would, via some mysterious process, trigger the need to pay the full €28 billion that was outstanding on the notes.
  • Failing to make the €3.1 billion payment would also trigger the need to pay all of Anglo’s outstanding bonds.
  • And all of AIB’s guaranteed bonds.
  • And all of Bank of Ireland’s guaranteed bonds.
  • I think the frogs and locusts appeared again at some point.

Anyway, exciting stuff. All complete nonsense of course. There is nothing preventing the note being restructured in any number of ways, provided the ECB Governing Council are willing to go along with it. And none of Laura’s appalling vistas are remotely relevant.

I guess the more interesting question is whether Laura is passing along what she’s been told by DoF spinners or whether she came up with this exciting stuff all on her own.

Those interested in checking out this Olympic-level TINA performance can check it out here (in particular, after 26 minutes in.)

Update: Laura has written to me to say the following: “A few points of fact: I never said that the Government could not restructure the pro note, in fact I said repeatedly that efforts were under way to restructure the pro note, and that they were progressing well. I said that the pro note repayment for this March would have to be made, with the benefit of more airtime I’d have qualified that it will have to be made unless the pro note is restructured before then. I did not say that there was no alternative to make the pro note payment every year to maturity – the whole point of the restructuring is that the pro note payment schedule would be changed.”

So I’m happy to say that Laura was only saying that the March 31 payment had to be made and that failure to do so would trigger these consequences. I have edited the post to remove any implication that Laura said  the note couldn’t be renegotiated at some point in the future.

Briefing Paper for Oireachtas Finance Committee

I’m appearing at the Oireachtas Finance Committee this afternoon, along with Brian Lucey and Stephen Kinsella, to discuss ELA and promissory notes. Here‘s a copy of a briefing paper I have provided to the committee and here are my opening remarks.

I’m told that the meeting can be watched live online at this link by choosing Committee 4 and also on UPC channel 801.

Interest Rates on Promissory Notes Not the Key Issue

I am now planning to talk at Friday’s conference about promissory notes, ELA and all that. I will post a link to a detailed presentation when it’s finished, so I don’t want to spend a lot of time on this now.

However, I do want make a brief comment on the recent media commentary on the promissory note issue. Most of this commentary has motivated the issue in the same terms as this article in today’s Irish Times by Arthur Beesley:

State support for the bank is being financed with expensive promissory notes which carry a comparatively high interest rate of some 8.6 per cent.

This is considerably in excess of the prevailing rates for stability facility loans, leading the Government to explore whether it is feasible to draw down additional stability fund aid to replace the promissory note scheme.

Arthur is a fine journalist but I’m afraid this is not a good way to think about this issue. The interest on the promissory notes is going from one part of the state (central exchequer funds) to another (the IBRC). Since the interest rate on these notes is higher than the average interest rate on IBRC’s liabilities, the additional margin can be retained inside IBRC and handed back to the state at a later date. 

So the key issue in relation to the burden on the taxpayer of the IBRC is the amount of liabilities that need to be paid out to bondholders and central banks, and the timing of these repayments, not the interest rate on the promissory note.

I’d note that Arthur’s colleague, John McManus, correctly explains this aspect of the promissory note issue in this article (though other parts of the article are not correct, such as the claim that the Central Bank of Ireland had to borrow the ELA funds from the ECB and that the ELA needs to be collateralised by marketable assets.) The true interest cost of the promissory notes is the interest on the €3.1 billion a year being borrowed from the EU and IMF to hand over to the IBRC, not the notional interest rate on the promissory notes.

Promissory Note Campaign: A Quiet Downgrading

From the Irish Times:

THE GOVERNMENT has quietly downgraded its campaign to persuade the European Central Bank to change the terms of the €30 billion of promissory notes it issued to bail out Anglo Irish Bank, according to an authoritative Government source.

The efforts by Minister for Finance Michael Noonan to seek a reduction from the ECB in the 8.2 per cent interest rates being charged on the notes or extend the term of the loan has not really worked, said the source.

I suspect most of us can think of other euphemisms for “quiet downgrading”.

Time for a Deal on ELA

Whatever happens, there’s going to be a lot of Euro summitry in the coming months. It seems clear that Germany is pushing for a swift Treaty change to introduce all sorts of legal limits on debt and deficits as the solution to the debt crisis. (You could argue it’s a bit like a flood defense plan that relies on banning rain.) In return for this, the ECB will agree to provide funds to bail out Italy and others, perhaps via turning EFSF into a bank.

Personally, I still think the economics and politics of the “Debt Treaty” approach are terrible. But it’s probably going to happen.

Given that, what should Ireland’s government do? Most likely, with the EU threatening to pull fiscal and bank funding if they don’t co-operate, our leaders will just agree to sign the dotted line at the relevant EU Council meeting and then see if they can get away with not having a referendum. (Unlikely — an Irish referendum will be one of many banana skins the process could encounter).

So here’s one thing that I think they can do. If the ECB is going to move into uncharted territory, then it’s time to ask for a small favour that will barely register as relevant when compared with a huge sovereign bond purchase scheme: Delaying repayment of the IBRC’s ELA debts. While unimportant in the European scheme of things, it would give Enda Kenny a big political win if he could announce the cancellation of the €3.1 billion March 31 promissory note payment.

If you want to read more about this, here‘s a column I’ve written for Business and Finance.

Burning Ourselves?

On tonight’s edition of The Frontline on RTE, Gavin Blessing, Head of Bond Research at Collins Stewart made some comments about repayments of ELA liabilities by the IBRC (i.e. Anglo-INBS) that I’d like to elaborate on. Gavin pointed out that IBRC’s major liabilities are to the Central Bank of Ireland. Indeed, I estimate that IBRC now owes about €42 billion in ELA to the Central Bank.

Gavin then followed this up by saying that we would be “burning ourselves” if we cancelled these payments to the Central Bank. This is a complicated business and I fully understand Gavin Blessing expressing the situation in this way. However, I would like to emphasise that it is my understanding that there is no offsetting financial gain to the Irish state from the IBRC’s repayment of Emergency Liquidity Assistance to the Central Bank.

The details are below but I can summarise this issue as follows: Channelling taxpayer funds towards repayment of ELA is equivalent to burning public money.

Let me start by describing the information communicated by a central bank balance sheet, such as this one for the Central Bank of Ireland. Central banks could create money by following Milton Friedman’s analogy and dropping it from a helicopter. However, helicopter drops are neither efficient nor fair. So the long-standing tradition has been for central banks to issue money by acquiring assets via open market operations.

Central bank balance sheets thus show you the assets that a central bank has accumulated via its money issuance. At some point in time, somebody decided it was a good idea to place the money that was issued to acquire these assets on the “liability” side of this balance sheet. I’m not sure this was such a great idea as central bank balance sheets can cause a lot of confusion. Suffice to say, however, these liabilities are somewhat theoretical. If someone brings a banknote to the Central Bank, the only thing they can exchange it for is other banknotes that the cost the Bank almost nothing to print.

That over with, the accounting treatment for Central Bank’s issuance of ELA can be described as follows.

1. The Central Bank provided ELA by crediting, for example, Anglo’s reserve account that it holds with the Central Bank. This was just the Central Bank creating electronic money out of nowhere and this new money was counted as a liability on the Bank’s balance sheet.  In particular, this shows up in “Other Liabilities” on the CBI’s balance sheet.

2. On the other side of the balance sheet, the money that Anglo then owed back to the CBI as a result of the ELA is counted as an interest-bearing asset for the CBI.

Now consider the repayment of part of the ELA by the IBRC. For example, consider repayments funded by IBRC’s annual receipt of €3.1 billion in promissory note payments. One could imagine two possibilities for what happens next.

One possibility is that the following happens. A €3.1 billion repayment gets taken in by the CBI who can then, for example, buy German bonds with it and ultimately use the interest payments on these to pay money back the government when they make profits.  In this case, the amount of money created from the original operation doesn’t change and the Central Bank’s ELA asset gradually turns over time into other, more tangible, financial assets. It is likely that this is what Gavin Blessing thinks is happening.

The alternative possibility is less attractive. The Central Bank takes in the €3.1 billion repayment and then deducts this from the value of its ELA asset. On the liability side it reduces “other liabilities”—the idea is that taking in this €3.1 billion is effectively siphoning off part of the money that was created in the original ELA operation.  In this case, no new securities are purchased by the Bank. The €3.1 billion is effectively being burned.

The available evidence indicates that the latter, less attractive, mechanism is what occurs.

Earlier this year, the Irish government deposited a large amount of money in the Irish banks; this money was later converted from a deposit liability into equity when the banks were recapitalised. When the banks obtained these funds, they reduced their ELA debts to the Central Bank of Ireland.

A quick look at the Central Bank’s balance sheet shows that “other assets”  (which we know is mainly ELA) are down by €17 billion since February. Other liabilities are also down by €19 billion. There is no sign of any jump in the Central Bank’s holdings of other securities as a result of the ELA repayments. There is no hidden positive story at the end of the ELA rainbow.

So why repay it at all? Well, if we don’t repay this money, the Central Bank’s ELA operation will have been equivalent to flying a helicopter over the IBRC, dropping €40 billion and not asking for it back. A jolly good wheeze for the bondholders and depositors who got paid back but possibly not a good precedent for the Euro area. If every Euro area country could do that with their troubled banks, there would be no banking problems but there would probably be a decent amount of inflation.

So our European partners would consider failure to repay ELA to be bad form. But that still seems to leave the pace of repayment, and the funding of this repayment, as very much an open question. In the meantime, let’s not kid ourselves about hidden benefits from these payments.

How Would a Greek-Style Haircut Affect Ireland?

Someone asked me today how a Greek-style haircut for private bondholders would impact on the Irish debt situation if applied here. Without any claim that this is a prediction for what could happen to Ireland, or a policy recommendation, here are the calculations.

While the figure grabbing the headlines is the 50%-60% haircut for private holders of Greek sovereign bonds, it appears that the bonds bought by the ECB will not be written down, nor will the IMF loans. FT Alphaville discuss a UBS report that calculates that a 50% haircut for private bondholders actually implies a 22% reduction in total debt.

In Ireland’s case, the latest EU Commission report estimates (page eight) that our year-end general government debt will be €172.5 billion or about 110 percent of GDP. The report also estimates that by the end of this year, we will owe €38.2 billion to the EU and IMF.  (Table 4 on page 23).

We don’t know how much Irish sovereign debt the ECB own but it’s believed to be a large amount. I do remember a report from Barclay’s claiming they owned €18 billion by June 2010. Let’s say ECB owns €22 billion of Irish debt (that’s just a guess, I really don’t know). Combine that with €38 billion from EU-IMF and you have €60 billion in debt that wouldn’t be getting a haircut. Better guesses of ECB holdings of Irish sovereign debt are welcome.

Now apply a 50% haircut to the remaining €92.5 billion of our debt and you reduce the debt by €46.25 billion, or 29 percent of GDP, getting the debt ratio down to 81 percent. (Of course, we’d still be running large deficits, so it would start increasing again.)

So that’s the answer. Perhaps worth noting, however, is that an alternative method of writing down Ireland’s debt by close to 30 percent of GDP without haircutting private bondholders at all would be to have Anglo’s ELA debt to the Central Bank of Ireland written off.

According to its interim report Anglo owed €28.1 billion in ELA at the end of 2010 but this had risen to €38.1 billion by the end of June. This is because Anglo transferred €12.2 billion in NAMA senior bonds to AIB in February to back the deposits that were being moved out of the bank.

On July 1, Anglo was merged with Irish Nationwide Building Society (INBS) to form what is now called the Irish Bank Resolution Corporation (IBRC). As of the end of 2010, INBS had €7.3 billion in loans from the ECB. However, €3.7 billion of this was backed by NAMA bonds and other assets that were transferred to Irish Life and Permanent. INBS has been in receipt of ELA since February to replace this lost funding. While this has been admitted by a Department of Finance official (see this story) the exact figure has not been released. I assume it is about €4 billion.

So my estimate is that the IBRC now owes about €42 billion in Emergency Liquidity Assistance to the Central Bank of Ireland. If the European authorities ever decide they like the idea of haircuts for Irish debt, it would be fair to ask which of a fifty percent haircut or a write-off of ELA would be more likely to damage Ireland’s reputation or cause financial market contagion.

Central Bank 2010 Annual Report

The Central Bank’s annual report for 2010 was released today. Continuing his valiant service, Lorcan has read the report so we don’t have to. For those ELA-philes out there, Lorcan spotted the following lovely sentence:

In addition, the Bank received formal comfort from the Minister for Finance such that any shortfall on the liquidation of collateral is made good.

Anyone care to speculate on the legal value of “formal comfort”? For instance, relative to the guarantees passed in to law under ELG scheme, how does a formal comfort compare?

Central Bank Balance Sheet April 2011

The Central Bank balance sheet for the end of April 2011 has been released. It shows a decline of €12.6 billion in the famous “Other Assets” category which is where the Bank’s ELA operations show up. It also shows a decline of €8 billion in lending under the Eurosystem umbrella. These are large declines for a one month period and it’s not clear how they came about, i.e. whether there was a large increase in deposits at the guaranteed banks, whether any new market funding was sourced (unlikely) or whether there were significant deleveraging deals involving selling off foreign loan books and using them to pay off central banks.

As Namawinelake notes, these questions will be clarified at the end of this month when the balance sheet of the guaranteed banks for April will be released. Certainly, the decline in emergency borrowing from central banks is welcome and is a first concrete sign that the March 31st announcements have had a positive effect on the health of the banking system.

Update: Thanks to Eoin and Lorcan for coming up with the real story. NTMA have deposited €19 billion in cash resources into the banks. Reuters have a story here while Lorcan had already figured it out. NTMA apparently couldn’t be bothered putting out a press release.  So all of the above out positive effects etc. is hereby withdrawn.

Speculation on New ECB Lending Programme

There has been a lot of focus in the past few days on stories based on leaks of Thursday’s stress tests results. Perhaps more important, however, is the question of what the plans are for the €150 billion in central bank funding that the Irish banks are currently receiving.

Two interest stories here and here suggest there is lot to be negotiated on this issue. While less visible than the question of the interest rate on Ireland’s EU loans to the sovereign, the questions of how long the Irish banks will have to pay back these loans, and at what interest rate, are perhaps more important.