Jim Stewart: Much comment argues that the increasing cost of Irish Government borrowing (the second/third highest in the eurozone and over twice the cost of German Government borrowing) is a direct consequence of Government economic policies in relation to the banking system. Other policies are also likely to be a factor, such as the emphasis on fiscal austerity in the belief that this will restore confidence and lead to economic success - what Paul Krugman has called the ‘confidence fairy’.
Removing the blanket guarantee on all bank liabilities, rather than extending it, is very likely to reduce the cost of Government borrowing (on August 19th, the Minister was quoted in the Irish Times as saying that "Elements of the guarantee will not be continued from September”).
However, amending the guarantee also gives an opportunity for a much more radical intervention.
In his Beal na mBlath speech, the Minister recently restated the Government’s policy of supporting the existing debt of Anglo Irish.
“...we must stand behind our banks in order to ensure that a sustainable financial system is established and, in the case of Anglo, to ensure that the resolution of its debts does not damage Ireland’s international credit-worthiness and end up costing us even more than we must now pay”.
It is false analysis to present the options in relation to Anglo Irish Bank as allowing it to fail (liquidation) or continuing to support it. Those who advocate continued support may justify this position by calling for a type of Special Resolution regime in Ireland for failing banks, to reduce the risk of bank failures in the future. As has been pointed out by others – most recently the Bank for International Settlements, p.3 – a Special Resolution regime within one country is unlikely to work for a large institution whose operations straddle a number of different countries. Assets in other countries cannot be seized unilaterally. Legal systems have differing requirements for creditor protection in the event of a firm being forced into liquidation, further complicating the efforts of any single regulator.
A third and less costly option is to negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.
There are some implications: Anglo Irish must not be allowed redeem any existing bonds, as it has done in the past, and then declare the difference as profit.
Such a solution is consistent with proposals for reform in the consultative document recently published by the BIS, which addresses the issue of banks which received public sector funds but most of whose long term capital did not suffer any losses.
What are the costs?
It is important to note that it is normal commercial practice to renegotiate with debt holders in the event of a corporate financial crisis. A well known example is Eurotunnel.
It has been argued that the costs in terms of reputational damage to the State would be large, the credit rating on existing Government debt would fall, and government debt yields would rise. The fact that Anglo Irish is State-owned gives some credence to these views. However, continuing with current policy to undertake to redeem most long-term debt at face value will ensure continued risk and uncertainty in relation to State finances.
These costs are likely to be exaggerated. Those firms who advise bond holders, and who may have a financial interest in maintaining the value of bank debt, are likely to complain the loudest.
Issues might arise in relation to increased risk to depositors and deposit withdrawals. The largest single source of deposits in the most recent accounts consisted of bank deposits (€33 billion), of which the largest single component is likely to be Irish Central Bank/ECB, whose deposits are automatically guaranteed. However, a risk of deposit withdrawal could be met with an extension of the guarantee to all depositors in Anglo Irish alone. The risk of not being able to issue new debt would be covered by specific guarantees.
There are fundamental changes taking place in the structure of Irish banking (the closure of Bank of Scotland, Halifax, Post Bank; the re-emergence of a banking system dominated by two banks). Government policy in recent years has been far too quick to allow – and even encourage – abandonment of the mutual form of ownership/control. This policy is continuing in the case of the EBS (see Irish Times 4/8/10 and Financial Times 4/8/2010).
Mutuals and credit unions play a key role in the financial architecture of all EU states (and for very good reasons). The largest and best-known is Rabo Bank in the Netherlands. With appropriate policies, these benefits could also accrue to Ireland (See here).
The costs associated with, and the excessive focus on, Anglo-Irish means that there has been little analysis of, or comment on, the important changes taking place in the structure of Irish banking and the implications for the sector’s likely future conduct and performance. Coupled with the absence of specific policies to provide finance to indigenous firms (a loan guarantee scheme as in the UK and other countries; a State Development Bank) these changes are unlikely to be conducive to economic success.
The rising cost of supporting Anglo Irish bank has at least clarified one issue – nationalizing this bank did not reduce the cost to the tax payer.
7 comments:
This piece is to be commended for offering some constructive proposals on how to deal with the banking sector. It is refreshing that instead of the endlessly tiresome navel gazing that we are accustomed to getting from Irish commentators, this piece draws on established international practice to make some very useful recommendations.
Specifically the government should take Stewart's advice and immediately instruct Anglo to throw down the gauntlet to its debt holders - renegotiate or else. In such a situation, the debt holders will negotiate rather than walk away empty handed and the effect (notwithstanding the self serving judgments of some) will be highly positive for the country, taxpayers and in time international confidence.
Unlike other suggestions that we have heard in the past for dealing with the banking sector such as its nationalisation based on spurious claims that it would save the taxpayer money (as Stewart highlights, Anglo has proven the folly of such unfounded claims), the suggestions in this piece are eminently sensible and are in accordance with established international practice. As such they should be acted on at once by Government.
Great piece! It was understandable that the Government, Central Bank and others should defend the action taken by them originally in bailing out Anglo, UNTIL it became obvious that it was a) not working, b) was costing vast sums, c) will cost even more, d) is the key reason for Ireland's high cost of Sovereign debt, and f) will continue to keep this debt high.
But that was when it was hoped that the strategy would work. It is not working at all.
As citizens we can only hope and pray that today the officials in Dept of Finance, the Minister and Governor are now working out a stratgy which is both viable and will bring to a close this economic disaster. We hope that they are quietly re-negotiating now with debt holders as suggested by Jim and Anon.
Is there a Santa? Yes for Anglo Bondholders and it is Sean and Sile Citizen!
An uncharacteristically balanced principal post - for this site!
The crucial deficiency is that it is predicated on an assumption that Ireland retains some sovereignty to deal unilalterally with Anglo; it does not. The decision on Anglo will be issued next month by the European Commission (presumably in collaboration with the ECB). And it may only be a holding decision while the Van Rumpuy Task force continues its deliberations on EU fiscal governance, a debt restructuring mechanism and financial governance and regulation.
Ireland went into orbit with the blanket guarantee and all the effort since has been focused on trying to get it back down safely - but in the context of a much larger EZ fiscal and banking crisis. The key political issue is how much economic pain voters in the core EZ countries, in particular, German voters, are prepared to endure to rescue the PIGS - of which Ireland is just one (and a small one at that).
Paul Hunt is incorrect on a number of points. The Government has considerable autonomy in relation to policies in relation to Anglo-Irish.
The main concern of the Commission in relation to Government proposals for Anglo-Irish is that these proposals comply with EU competition rules, and rules for state aid. This has been one of the major problems with EU policy in relation to the banking and financial crisis - a very narrow and often misguided focus on effects of State intervention on competition. The Commission were not asked nor indeed would it be of any concern to them if Anglo-Irish bond holders faced a large write down in the value of their debt. Greece has already imposed cuts on the face value of Greek State Hospital debt of at least 19% (John Dizard ,Financial Times, 4th July).
The main concerns of the ECB are (1) financial stability; (2) security of ECB funding to banks. In relation to point (2) as noted in my blog Irish Central Bank/ECB deposits with Anglo-Irish are automatically covered by the Irish State. In relation to the first point the ECB would support policies to ensure stability in the market for Irish Government debt and policies to reduce the cost of Irish Government debt. This is why the ECB has intervened in the bond market in particular as reported by the Financial Times purchasing Irish Government debt.
It is very likely that the BIS proposals or a variant of them referred to in my blog will become future policy amongst EU institutions in dealing with distressed financial firms.
The financial and economic crisis will result in a New Political Economy of the EU, and in particular the eurozone. The outcome of this process is uncertain. The task force chaired by Van Rupuy is but one and not the most important aspect. But whatever the outcome, individual EU States will continue to have considerable discretion in economic and social policies, but in a very different framework.
Completely concur with Stewart’s most recent comment.
Contrary to what Hunt claims above, the key political issue is not how much economic pain voters in the core EZ countries, in particular, German voters, are prepared to endure but how prepared politicians across the EZ are to require debt holders to bear some of the pain and how unforgiving voters will be if politicians fail to ensure that the pain is roundly shared.
I agree that Anglo has ended up in DG COMP's in-tray, but I find it hard to believe that DG ECFIN or the ECB has no interest in the outcome.
Greece is effectively under EC/ECB/IMF administation; any bond write-downs there must be assessed in that context.
Yes, bondholders will have to bear some pain. That will be part of the end-game. But there seems to be this idea that bond investors are evil aliens with pots of money who deserve to be taken to the cleaners. Most of the big bond buyers invest some of the pension and insurance funds of millions of workers. Most voters do not look kindly on self-immolation.
And, yes, there will be a new EZ political economy whose shape is uncertain at the moment. As monetary union has diminished sovereignty in this area, I expect there will be a diminuition in fiscal sovereignty - and a harmonisation of financial regulation and bank resolution procedures. I am not suggesting that sovereignty over purely domestic social and economic policy will be stripped, but I expect a continuing process of pooling and harmonisation.
@ Jim Very interesting piece. Jim, do I understand correctly that you would endorse an orderly winding up of Anglo with re-scheduling of debt and hiving off of some assets and liabilities to a new investment vehicle possibly?
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