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.

Whelan: Time for a deal with Super Mario

Today’s developments that Minister Noonan hopes to see parts of the Anglo debt reduced are most welcome. From an Irish Times report:

On the Anglo debts, Mr Noonan said troika officials were preparing a joint technical paper, drawing on Irish suggestions, to reduce the overall burden involved in repaying the principal of the €31 billion promissory note.

This loan arrangement predates the EU-IMF programme and was agreed to fund an effectively insolvent Anglo Irish Bank but is seen by the Government as too expensive.

“We think there’s a less expensive way of doing it by financial engineering, and we’re not talking about private-sector involvement or restructuring,” said Mr Noonan in Berlin.

Writing in the latest issue of Business and Finance, Karl makes a similar point. Read the entire piece, especially a precise description of what promissory notes are and how they work, but this quote struck me as important.

It is true that the Irish taxpayer has taken on far too big a burden in ensuring that bondholders at Anglo and INBS were repaid. But quibbling about bondholders misses the elephant in the room. It is the huge burden of repaying ELA, not bondholders, that is going to bleed the taxpayer dry for the next twenty years.

It is time for the Irish government to declare that it has no intention of putting €3.1 billion towards repaying ELA in March and that it has arranged an agreement in principle with the Central Bank of Ireland that the state will repay this debt when it has fully recovered from its current crisis.

If my understanding of the legal situation is correct, then Patrick Honohan would only require the support of seven other members of the ECB Governing Council to proceed with this plan. This could easily be achieved with the support of Mario Draghi. Ireland has borne a heavy burden in the name of European financial stability. It’s time for a quid pro quo from super Mario.

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”.

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.

TASC on Promissory Notes

TASC’s Progressive Economy blog has an interesting post by Tom McDonnell, Michael Burke and Michael Taft on restructuring promissory notes. I think it is important that there be more public discussion of this issue. With payments of €3.1 billion a year stretching into the middle of the next decade, these notes are going to impose a far greater burden on the Irish people than the remaining unsecured Anglo bonds which receive a lot more attention.

Promissory Notes: The Movie

The text below is a secret draft of the opening scene of an upcoming Hollywood movie. The movie opens at some date in the near future with a conversation between a finance minister, let’s call him Baldini, and a European bureaucrat of Scandanavian origin, let’s call him Wally. (Any resemblance between the characters below and real individuals is purely intentional.)

Wally: Greetings Mr. Minister.

Baldini: Ahh, tis yourself Wally.

Wally: Mr. Minister, I bring a proposal from your European partners.

Baldini: Pray tell, Waldo, what’s the deal?

Wally: Well, as you know, our Greek sovereign debt restructuring has gone fantastically. Combined with the sale of Macedonia to the Former Yugoslav Republic of Macedonia, we’ve practically solved all our problems there. So we’re thinking it’s your turn. We’re proposing that you lengthen maturities on your debt and cut back on some of the principal to reduce your debt burden by over €30 billion. And, to be honest, you’re not getting another red cent from us unless you agree.

Baldini: Is that so? Well you know what Waldo, we’ve got a different plan, one that also reduces our debt by €30 billion but doesn’t involve defaulting on our sovereign bonds.

Wally: Really Minister, this isn’t a time for gallows humour.

Baldini: Indeed, there’s nothing funny about it. No, I’ve been talking with the brains trust here at the Ministry and they’ve explained to me that apparently we’re going to be writing a cheque every year for €3.1 billion until two twenty three and then a bit more after that. Now I’ve been trying to get my head around this business, but I’m just a simple fella, and I can’t figure out for the life of me what we’re getting in return for this money. So, I’ve decided to cancel it. I hear your Eurostat boffins have been counting all of these payments as part of our national debt, so we’ll give them a call in the morning to let them know they can forget about that.

Wally: Really Mr. Minister, this isn’t a time for jokes. I’m sure you’re well aware that the, ahem, promissory note payments are the main asset of a certain Anglo Irish Bank and, its terrible twin, the Bank of Fingers. And I’m sure you’re also aware our beloved ECB is owed a fortune by those two institutions. You can’t really expect to endanger the ECB in this fashion.

Baldini: Hold your horses Wally! Sure aren’t the ECB’s loans to these banks fully collateralised, over-collateralised in fact. Sure I’ve met those ECB eggheads many’s the time and there’s no flies on them lads. I’m sure that’s lovely collateral they have, so no need to worry.

Wally: But, Mr. Minister, don’t you know that the promissory notes have been used as collateral for the loans from the Irish Central Bank to Anglo and the Bank of Fingers?

Baldini: Is that so? Ah well, sure that’s Paddy Honohan’s problem.

Wally: Ah now Mr. Minister, come off it. You know well that without the promissory notes, these banks can’t pay back the emergency liquidity loans they got from the Irish Central Bank and your predecessor has guaranteed that state funds would be used to pay these loans back if necessary.

Baldini: Really? Ye think? I’ve wondered about that. Wouldn’t you imagine there was a major debate in the Dail about that guarantee? But you know what, I couldn’t find anything in the records. And we’ve had the lads here in Merrion Street scouring the place for that guarantee and still nothing’s come up. Sure ye can’t find anything anymore since we introduced that new PPARS2 IT system … No, I’m afraid me mind’s made up. No more promissory thingybobs anymore.

Wally: But this will mean that Anglo and INBS’s debts will have been monetised!

Baldini: I dunno Wally, you’re a quare fella. What’s monetised mean?

Wally: I’m going to have to talk to Mr. Drago about this. I suspect he won’t want to keep lending all that money to your other banks.

Baldini: Well sure we’ll see about that won’t we?

[Baldini raises one eyebrow at the camera. Fade to black].

The question is what happens next?

Suggestions for the casting of Baldini and Wally are welcome. Leonardo di Caprio has expressed an interest in playing the minor but crucial role of Lorenzo Beeni Silly.

Promissory Notes: We Need A Powerpoint Presentation!

Okay, here’s a real treat for all our fans of all things promissory-note related. A classic Burton-Lenihan exchange in the Dail today. My favourite bit:

Deputy Joan Burton: We need a PowerPoint presentation on this.

Deputy Brian Lenihan: We do not.

Deputy Jim O’Keeffe: We need lots of money for this.

Full text below the fold.

Continue reading “Promissory Notes: We Need A Powerpoint Presentation!”

Budget Calculation Update: Promissory Note Interest Payments

It was always going to be unlikely that the process of briefings for opposition parties would be kept secret. However, with what appears to be authoritative and pretty detailed information all over today’s Irish Independent, it may just be best if the Department of Finance publicly released the briefing information it provided to the opposition politicians yesterday.

One of the more mysterious aspects of the budgetary finances is the magic promissory notes. By my count, we will have issued about €30 billion of these by the end of the year: About €25 billion to Anglo and about €5 billion to INBS.

In this post earlier today, I pointed out that while the principal payments on these notes didn’t count against the general government deficit (because these will all be registered as part of this year’s deficit) they will still be part of our ongoing financing requirement in the coming years.

I didn’t write earlier about interest payments on these notes (the figures I was writing about were just my guess about the annual principal payments). One reason I didn’t discuss interest payments is that I wasn’t sure there were any: They could just be zero coupon bonds. However, it looks as though they are not. On Prime Time this evening, Joan Burton and government junior minister Billy Kelleher agreed that the annual interest cost of the promissory notes was going to be €1.5 billion. With €30 billion or so in notes issued, it now appears that the notes have an interest rate of 5%.

Now, as far as I know (and I’m happy to be corrected) these promissory note interest payments of €1.5 billion a year will count against the general government deficit.

Here I’ve updated the calculations from my Irish Taxation Institute presentation to incorporate the “if the promissory notes pay 5%” scenario. The bottom line?  If one adjusts last year’s budget projections for (a) New projections from the Central Bank for nominal GDP (b) A projected decline in revenue of €1 billion (c) €1.5 billion in promissory note interest payments, then the starting point for this year’s budget prior to any adjustments would be a deficit of €22.5 billion or 13.9% of GDP.

Note that even if one didn’t factor in negative effects of fiscal adjustments on GDP, then with a Central Bank GDP projection of €162 billion, hitting the original deficit target for 2011 of 10% of GDP would require adjustments of €6.3 billion (162*0.039). Factoring in the contractionary impact of budget cuts on GDP, it would likely take €7 billion in adjustments to get to a 10% target.

As I say, these calculations are based on a 5% interest rate on the promissory notes. My interpretation from Minister Kelleher’s apparent confirmation of Burton’s comments is that this is the correct rate. However, I think it’s time for the government to fully clarify the terms of these notes as soon as possible.

Eurostat: Irish Deficit 36% of GDP in 2010:Q1

I know that the NTMA have already admitted as much but just in case there were any remaining doubts that Eurostat are counting the promissory notes towards this year’s budget deficit, the picture below is a screencap from Eurostat’s publicly available database. Yes, our deficit in the the first quarter of 2010 was 36.51% of GDP. I believe the figure for the year will be about 20%. (Yes it’s my first time using a picture! Perhaps now you can see why.)

The Impact on the Exchequer

Ok, I promise this is the last time I’ll write about promissory notes for a while.

Pat McArdle, still keen to minimise the link between the cost of bank bailouts and our fiscal problems, writes:

That is not to say that large subventions to the banks were not needed – more than €10 billion has gone into Anglo alone. However, the Minister has been quite clever in the way this has been done. He has issued promissory notes which deliver the capital bang upfront but will be drawn down piecemeal over the next 10-15 years. As a result, the exchequer has had to raise only €200 million to capitalise the banks this year.

And also:

Nama, too, has been structured to minimise the impact on the exchequer. Though it is likely to pay over €40 billion for the assets bought from the banks, this will not be in the form of cash and so will not have to be funded in the markets.

I find it funny that the issuing of promissory notes is now regularly described as, like NAMA bonds, a stroke of genius on the part of the Department of Finance: Last year, advocates of NAMA often told us that overpaying for assets was the best way to recapitalise the banks because if we didn’t do it that way we’d have go out and get “real money” by borrowing on the sovereign debt market, i.e. that banks couldn’t be recapitalised with promissory notes. 

It is certainly true that promissory notes and NAMA bonds do not require going to the sovereign bond market to borrow the money. However, this stuff is debt and the people who have been worried about our ability to pay back all our debts (and they seem to getting worried againare well aware that we are accumulating extra debts in the form of promissory notes and NAMA bonds. In this sense, they have the exact same “impact on the exchequer” as regular borrowing.

Note, however, that the promissory note route will put more pressure on the Irish state to come up with money for the banks in the coming years than would a normal debt issuance. €10 billion in ten-year bond issuance requires forking over interest of about €500 million a year over the next ten years before the full amount has to paid off on maturity, hopefully via issuing another ten year bond. An interest-free promissory note for €10 billion would require average payments of €1 billion a year over the same period.

At the end of the day, debt is debt and those who lend to us aren’t easily fooled. I’d prefer to let history judge exactly how clever this debt issuance has been.

Promissory Notes, Real Money and Borrowing

This is hardly the most important issue right now with so much going on but it’s a two cents I’d like to toss out there all the same.

Last year, I regularly heard the following argument on this blog, in the media and in private. “Overpaying for assets via NAMA is actually the best way to recapitalise the banks. This is because we can purchase the property assets with “NAMA bonds” that we can just print off. They’re not real money, just IOUs. But if we paid a low price and had to recapitalise nationalised banks, we couldn’t do this. We’d have to borrow the money expensively on sovereign debt markets and then hand over real money to the banks.”

Continue reading “Promissory Notes, Real Money and Borrowing”