Comparison of EU Bank Bailouts

Michael Taft uses Eurostat data here to compare the 'direct' impacts on General Government Deficits caused by the EU's numerous bank bailouts. In some cases these figures dont even capture the full cost of the bailouts as, for example, in the case of Ireland the €20 billion taken from the National Pension Reserve Fund is not included in the Eurostat figures.

Guest Post by Arthur Doohan: "Federalise the Debt" has become a mantra and a “meme” in recent weeks

There are many people in the world who hope that someone else can, with a few waves and strokes of an implement, make all their troubles go away. The vast majority of these people are children and they grow out of believing in fairy-godmothers and genies by the age of eight.

There is no entity that can make our sovereign debt go away, nor is there one that can assume responsibility for it.

The right to borrow money is granted to those who have demonstrated legal and economic capacity to repay it. People (investors, speculators, call them what you will) buy bonds from entities that have:
1) assets that produce an income;
2) a track record of repaying their debts;
3) are not currently overburdened with debt.

There is NO entity in the EU that matches any one of those criteria, let alone all three.

Now, we could create one but that would imply tax gathering powers granted directly to some arm of the EU, probably, the Commission because tax-gathering is the only way for sovereign or supra-national bodies to raise revenue in a reliable or efficient fashion. Other ways have been tried in the past which usually employed the legions of Rome or the divisions of the Wehrmacht but this was not only inefficient but was exactly what the EU was founded to prevent.

Further, such a debt-management body would not have a track record of repayment and would probably be seen as being overburdened with debt and so would worsen the situation rather than improve it.

The history of this entire crisis from American sub-prime mortgages onwards has been one of the commingling of good debt risks with bad ones to the eventual and ever more rapid deterioration of both. "Gresham's Law - red in tooth and fang."

A further lumping of the good with the bad and the ugly will only make it harder for debt-buyers to distinguish good from bad. It would therefore, most likely, cause bondholders to seek a higher return or abandon the Euro altogether.

So, please, would those advocates of 'debt federalization' be so kind as to complete the circle of their prognostication and tell us what institution they see as being in charge, how much of their taxes they want to send to it, what they see happening to the yield on current debts and, lastly, how would they arrange the disbursement of new debt to the huddled masses of the EU?

A long, long, long way to go

Michael Taft: A good step; but a very small step: the Finance Minister’s announcement that the Government will seek a substantial write-down of the €3.8 billion in senior unguaranteed unsecured debt in Anglo-Irish and Irish Nationwide will be welcomed. Some will legitimately complain that this should have been done after the Anglo nationalisation, when that debt stood at approximately €16 billion. But that was the fault of the previous government. Most of the debt has been paid off and we are left with the bill – a €31 billion promissory note which will cost the Exchequer €43 billion with interest over the next 15 years. So this first step on senior bondholders is the new government’s initiative. But let’s put it in perspective – the impact will be very small and even if successful we will be left with a staggering bill for winding down, what the Minister has called, this ‘warehouse’.

Currently, the Government is committed to paying off a promissory note of €31 billion (€25.3 billion to Anglo, €5.4 billion to INBS and €0.35 billion to the Educational Building Society). This will entail a cost of €3.060 billion borrowed in each year up to 2023, with a further payment of approximately €2.8 billion in 2024 and 2025.

This is an intolerable burden – equalling 2 percent of 2011 GDP; a burden that would not be accepted in any other EU country; and for a bank that isn’t even a bank. So what difference would it make if the Minister gets his way? Some, but not very much.

In putting forward his suggestion for burden sharing, the Minister referred to the current discount. This, therefore, doesn’t suggest a complete liquidation. The Irish Times reports that Anglo’s November 2011 bonds (€750 million) fell to 70 cents following the Minister’s announcement.

The following calculation, therefore, assesses the impact of writing down the €3.8 billion in senior unguaranteed debt by 50 percent. This would mean a write-down of €1.9 debt, or 6 percent of the current promissory note. This would result in the following difference in annual payments:

• Current Annual Payment: €3.060 billion
• New Annual Payment after Write-down: €2.870 billion

While the new annual payment is my own calculation, any revisions would be trivial.

So after a 50 percent write-down of the senior unguaranteed debt, we would see the annual payments fall by €190 million per year. We would still be pay close to €2.9 billion. This is no less an intolerable burden.

However, we may be into a ‘running-to-stand-still’ situation. The Department of Finance’s projections of the overall cost of the promissory note, including interest, is premised on long-term borrowing costs of 4.7 percent – a technical assumption ‘based on the weighted average cost of funds raised by the NTMA in the bond market in 2010’.

That technical assumption no longer holds. With ESFS borrowing rates at 5.8 percent, we should expect the overall cost of the promissory note to increase. So if we apply that new interest rate and apply it to the promissory note minus the 50 percent write-down of senior unguaranteed debt – we will find the level of payments rise again over the lifetime of the note. In other words, there is little if any net gain.

The Minister for Finance should be supported – as a first step, as an opening of the door. But the fiscal impact will be minimal and the state will still be under an unacceptable and irrational burden.

It is now time for a more radical, thorough-going approach to write-down, if not entirely eliminate, the public exposure to the costs of winding down Anglo and INBS. A starting point comes from the TASC document on banking, ‘The Debt and Banking Crisis’:

‘Insolvent banks should not be further supported by public funds and should be allowed to fail. In Ireland this means that, at the very least, Anglo Irish Bank and INBS should be allowed to fail. No further payments for Anglo Irish Bank’s promissory notes should be made.'

That’s a good starting point.

The people have spoken - but what did they say?

Michael Burke: The first clear message of the 2011 election was a rejection of Fianna Fáil, receiving just 17.4% of the first preference vote – also of over 24% of the entire electorate. Given that the unlamented PDs had also been effectively absorbed by FF, and the Greens (who stayed just long enough to help through a draconian budget, but not a weak climate change bill) were also obliterated, there was effectively 30% of the electorate in motion.

Fine Gael was not the main, or even the primary, beneficiary of that dramatic break with FF, receiving just 8.8% of that 30% compared to the 2007 election. The primary beneficiary was Labour, up 9.3%. But the main beneficiary was a generic Left, comprising Labour, Sinn Féin, a majority of the ‘Independents’ and the smaller socialist parties. The combined FF/FG/Green/PD vote in 2007 was 76.3%. That fell to 55.3% in 2011. The combined Labour/Sinn Féin/socialist vote rose from 17.6% to approximately 43% (depending on how many you assign to the Left from among the Independents’ vote).

So, there was a sharp turn towards the Left, but not an outright victory for it. 43% is not 50%.

The key issue was clearly the economy, and the election was held against the backdrop of the recent arrival of the EU/IMF representatives in Ireland, to dictate terms of the bailout of the EU banks. Given that FF was the main architect of the response to the economic crisis and presided over the arrival of the raiding party, then voters were clearly rejecting more of the same. A key aspect of the campaign, and probable determinant of the outcome, was the parties’ attitude towards the terms of that bailout and the further imposition of cuts in public spending to underwrite it. (In another post, the issue of the viability of that programme will be addressed).

In that regard, every single party that stood in the campaign, bar the outgoing coalition partners, argued that that they would at least ‘renegotiate’ the bailout deal. Both FG and Labour spokespeople argued that point repeatedly in the course of the campaign, with Enda Kenny in particular promoting his party’s ties with EU counterparts as the best way to achieve a renegotiation.

Now, it appears from the weekend reports of the EU summit that no such renegotiation is currently possible. Under attack over the 12.5% corporate tax rate, the new Taoiseach and his team seem on the defensive. In any event, the suggested quid-pro-quo of a 1% reduction on the EU portion of the bailout funds would yield a saving of only €450mn per annum. While this is not nothing, it is overwhelmed by the public spending cuts and the bank bailout, the latest installment of €10bn likely to be paid before the month is out.

This payout highlights a clear anomaly in the outcome of the election and the intransigence of the EU leaders, some of whom seem more concerned with their own future tied to the outcome of regional elections or with bombing Libya. Yet, at the election, more than 75% of the population voted for parties or individuals who stood on a platform of renegotiating the deal. The voters of have spoken – but the EU refuses to listen.

Therefore the only reasonable response is to make the same case in a more forceful way. There should be a referendum on the bailout of EU banks by Irish taxpayers, with a rejection obliging a full renegotiation. Then perhaps the EU will listen.

Munchau’s purgatory between bailout and default

Tom McDonnell: Weak measures to report from Part 1 of the big European double header last weekend: see here and here. The unfortunate unwillingness to accept the true scale of the crisis and take the decisive action required is troubling.

The Guardian is taking the line that Ireland is facing a default if a renegotiation of the IMF/EU bailout isn't available.

They point to a Sunday Independent article claiming the stress tests will identify an additional €15 to €25 billion to cover the bank losses.

As Wolfgang Munchau at the Financial Times reports, “muddling through will not work this time – the EU has created a purgatory between bailout and default”. Munchau’s preference is for a bailout not through cross-country transfers, but through a single European bond.

Ireland and Greece – A tale of the good twin and the bad twin and their common fate

Terry McDonough and CJ Polychroniou: The Celtic Tiger was one of the most famous economic success stories of recent times. Ireland was the poster boy of the globalised, low tax, business friendly economy. Foreign direct investment poured in at least in the early years. Recorded exports rose to close to 100 percent of GDP. The economy achieved full employment while at the same time profit shares rose. The government deficit was paid down. Ministers and economic pundits travelled the world dispensing advice on how others could emulate ‘the Irish Model.” On the opposite pole, Greece had one of the worst economic reputations in the EU. The public sector, while not especially large by European standards, was notoriously corrupt and fragmented, catering to the needs and demands of an industrial and financial elite and their political collaborators.

At the same time, a swiss cheese of loopholes and tax evasion meant that tax revenues had no hope of catching up with expenditures. The deficit grew to unsustainable levels. Greek exports could not expand fast enough to cover the rising demand for imports. Employment was stagnant and a proper welfare state was never really achieved despite the deficits.

Now the good boy and bad boy of Europe sit side by side like frogs in a pan of water, closed in by IMF-style stabilization programmes, while their European “allies” turn up the heat with unsustainable interest rates. Both economies entered crisis and collapsed. How could this have happened? What did two such disparate actors have in common?

Both economies emerged from the stagflationary crisis of the 1970s and early 80s trying to successfully navigate in the context of the emerging global neoliberal order. Both countries' politics were governed by populist parties throughout much of this period. In Greece the socialists dominated the political scene, while in Ireland Fianna Fail was known for a conservative variety of populist nationalism. Both countries pursued an international model characterised by globalization, neoliberal policies, the financialisation of the economy and a weakened labour movement. This is the fundamental thing they had in common. Each country implemented this programme in its own way with initially differing results. While Ireland caught the neoliberal tide and Greece wallowed in the global shallows, both countries eventually foundered.

Both nations opened their economies to the international markets. EU membership and the adoption of the Euro were central to this strategy. Ireland attracted investment in information and communications technology, pharmaceuticals, and international services. For Greece, it was tourism, shipping and services. While Ireland often ran a trade surplus, Greece was chronically in deficit. Both Ireland and Greece would come to regret, for different reasons, their involvement in international financial markets. A pro-business globalization strategy led both nations to institute a low tax regime. In Greece income tax rates were low and indirect taxation was relied on. Widespread tax evasion was openly tolerated. The Greek government ran a continual deficit building up an impressive stock of national debt consistently well over 100% of GDP.

By contrast the Irish state often ran surpluses, but it did so by heavily relying on property related taxes. This revenue rose as international financial markets and domestic banks pumped funds into the Irish property market and blew up a bubble of monumental proportions.

A weakening labour movement in both countries failed to translate growth into social progress. Inequality increased in both countries. In Greece this resulted in pressure on an inadequate and fragmented welfare state. Coupled with low tax take, this added stimulus to the national debt. In Ireland, people compensated by going into debt. Irish household debt rose from around 40% of disposable income to 180%.

In both countries developments were justified by the aggressive importation of neoliberal ideology. In Ireland, market fundamentalism justified an over-reliance on foreign direct investment, low taxes, privatisation, labour market flexibility, and light touch financial regulation. The Irish deputy prime minister famously claimed that, spiritually, Ireland was closer to neoliberal Boston than supposedly social-democratic Berlin. In the past ten years or so, Greece has been selectively implementing neoliberal policies, engaging in asset stripping of its most profitable public enterprises and the liberalization of the financial landscape, It has been rolling back labour rights, social programmes and entitlements. It has also sought to entice foreign direct investment and to compete at the low end of the index against nations like Estonia and Bulgaria.

The globalization, the neoliberalism, the international financial markets and the rising inequality so central to the growth strategies of both nations would ultimately also prove to be their undoing. Ireland’s financially driven property bubble stalled in 2007 and the international financial crisis in 2008 accelerated the decline. This collapsed property-related revenues and the much lauded low tax regime triggered the fiscal crisis of the Irish state. The collapse of the construction industry, the drying up of credit, radical reductions in state expenditure and tax increases added to consumers lumbered with debt have decimated Ireland’s domestic economy.

Similarly, the Greek crisis was violently brought to surface when the global crisis reached Europe. Inequality in the private economy had driven a halting and uneven expansion in the public sector. A neoliberal commitment to low taxes and “competitiveness” in the global economy had dictated that revenues would lag behind. A massive national debt built up. The government had no reservations in relying on a bloated and lightly regulated Goldman Sachs in order to quietly borrow billions in order to join the euro in 2001 and later on to mask sovereign debt from public eyes through the use of fake statistics. The revelation of these deceptions hastened the EU/IMF intervention.

It is part of the Celtic Tiger myth to believe that the Irish economy was motoring along just fine until Lehman Brothers collapsed. Both Ireland and Greece collapsed very much in the context of the failure of the global neoliberal model.of which they were local variations. This should not obscure the fact that domestic institutions and local policies, supported enthusiastically by local elites, played important roles in both cases. Thus, the Irish and Greek crises are both international and local.

Now both economies are trying to escape their crises by “doubling down” on the very neoliberal policies that brought them to this pass. In both countries inequality is being pursued through cuts affecting the most vulnerable. The wealthy are being sheltered from the tax increases loaded onto the rest of the population. Greece and Ireland have become an early testing ground for the effort of the ECB (and its collaborators) to save the banks and the euro. In Ireland the banks have swallowed tens of billions of taxpayer money. Both governments surrendered sovereignty with no resistance, as if there were no alternatives, and are now trying to convince their citizens that it their “patriotic” duty to offer support to ruthless anti-labor, anti-popular measures of the kind that the IMF, was imposing in Third World dictatorships in the ‘60s, ’70s and ‘80s, under the threat of guns. Ironically, in this regard, the EU appears more ruthless than the IMF.

Further financial turmoil has demonstrated that even “the markets” know that these “bailouts” will only intensify the problem. For both the good frog and the bad frog the choices are stark. They can poach when the crisis reaches the boiling point. They can take a leap in the dark, gambling on an abandonment of the Euro. Or Europe can turn off the heat. This would first involve allowing the radical restructuring of both bank and sovereign debt. Secondly, the EU as a whole should reflate its economy led by trade surplus nations like Germany. The peripheral countries alone cannot, and ultimately will not, bear the cost of addressing a crisis affecting the whole of the Eurozone.
Terry McDonough is Professor of Economics at the National University of Ireland; CJ Polychroniou has taught in universities in the US and Greece and is an Associate in the Freire International Program for Critical Pedagogy at McGill University.

Time for Plan B?

The euro area’s bail-out strategy is not working. It is time for insolvent countries to restructure their debts. You can read the rest of The Economist's leader here.

The story keeps shifting

Slí Eile: 28 November we are told (1) 'Without this external support, the State would not be able to raise the funds required to pay for key public services for our citizens and to provide a functioning banking system to support economic activity' and (2) 'The Council has today extended the time frame by 1 year to 2015'. Last Wednesday we were told that there was no alternative to 2014 (it had been 2013). The goal posts keep changing as deflationary policy impacts negatively on domestic growth. And 10 days ago we were told that we were fully funded up to mid-2011. What story next? Nobody really believed 2013 (and then 2014). It may be 2020 before the public deficit is down to 3% of GDP and possibly longer if the current deflationary strategy of flogging the half-dead horse is continued.

Cometh the moment of truth

Slí Eile: Some international organs of the media are showing a particular interest in Ireland which extends to the voices crowded out in the national media. See here. And the New York Times is saying: 'That might force Ireland to raise its ultra-low corporation tax rate, a magnet for foreign investment, to help cut its debt. The tax has long been seen as a form of unfair competition by higher-taxed countries.'

What to do about Anglo Irish Bank?

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.

Bank shareholders bailed out, welfare recipients to pay

Michael Burke: There is clearly a degree of dissembling that is taking place regarding the bank nationalisation, smokesceens about leaving the Euro, or how bank debt will impair our credit rating (the government has already done that), and perhaps the biggest of all, that the cost of 'oblterating' Anglo-Irish would be huge and would be incurred by the State.

It is therefore important to establish some of the key points of the bail-out:

* the State will add €33bn in debt in order to bail-out bank shareholders and bondholders. This is true whether the debt is issued in the form of promissory notes, IOUs, or sovereign bonds

* the State has removed €10.6bn from the economy in spending cuts and tax increases
gven that nominal GDP was €163.5bn over the course of 2009 and nominal GNP was €131.4, the bank bailout was 20% of GDP and the fiscal contraction was 6.4% of GDP (not including December’s effort)

* for those who insist on using the GNP denominator, the proportions were 25% bank bailout and 8% fiscal contraction (it would be wholly inconsistent to use two different denominators for government finances and the bank bail-out, since both debts must be met from the same income stream, mainly taxes)

* likewise, it is important to use nominal measures, since, unfortuantely the debts cannot be serviced in CSO-2007 euros, but must be met from the actual incomes received, by corporates, households and the government in 2009 euros and beyond. This inconvenient truth is regularly ignored by advocates of competitive deflation; real debts increase as prices and incomes fall

* the €33bn is a fraud in the strictest sense; ie payment of an extremely large sum of money for something that is worthless. Without the government guarantee all the shares in the banks receiving capital would be revalued at zero, likewise the majority of the bonds. The government has increased taxpayers' stake in nothing

* the €33bn is, and I know many scourges of the public sector are fond of these type of comparisons, equivalent to the 3 largest voted departmental spending areas combined, health & children, social & family and education & science, with room to cover arts, sports & tourism as well as the communication, energy and natural resources budgets for 2009 too,

* if issued as four-year debt (assuming a speedy resolution of the banking crisis) the annual cost would be €925mn, for 4 years, or more realistically, if issued at 10yrs, the annual interest bill based on prevailing interest rates would be €1.475bn, slightly more than the Employment, Trade & Enterprise budget

It is hard to imagine which Irish entitities could absorb all the additional State borrowing, implying that foreign ownership of Irish government (or quasi-goernment) debt will increase. While there was a €29.3bn trade surplus in 2009, net factor income from abroad was -€31.9bn. Increased foreign indebtedness will tend to increase the net capital outflow via debt interest payments, pushing a (virtually non-taxed) export-led recovery even further back on the horizon.

Clearly, the project represents a huge transfer of weatlh from the poor to the rich. In the modern era, this usually takes place in some under-developed economy by a Western power and is little reported. It is rarely done so blatantly within a Western economy; so one for the record books.

So what should progressives argue for as an alternative? The key to the situation, and the reason Mr Lenihan's assertion about 'obliteration' is a falsehood, is the bank guarantee. Without it there would be no possible contagion from the banks to government debt. And wthout it there would be no bank shareholders, either.

Their holding would be valued at their true worth, that is zero. It is probably also true that zero would be the share price without the latest lifeline from taxpayers, since any residual value in the shares was premised on the expectation for further slugs of taxpayer money as required.

Therefore, the shareholders would be wiped out and most of the bondholders too by either a withdrawal of the guarantee, or even charging a realistic price for it, or the repatration of the capital injections. Since the taxpayer is now the largest shareholder, emergency legislaion should be prepared to do both those things and at the same time, protect the deposits of the banks' customers by seizing them.

The new entitities would be owned by the State, as now yet rigorously managed, but could then form the basis of a banking sector which did not jeopardise depositors, engaged in prudent balance sheet management, not casino capitalism, and was directed to invest in the most productive areas of the economy, delivering large returns for the shareholder; the taxpayer, and large economic benefits for all.

Banks: elsewhere on the web ....

Over at Ireland after Nama, Declan Curran asks some pertinent questions. On Irish Economy, Karl Whelan takes a look at The Good, the Bad and the Ugly. Meanwhile, Ronan Lyons points out that the first tranche of loans may not be representative, and that subsequent tranches may show significantly larger discounts.

The 'I'm really getting tired of this nonsense' guide to bond yield trends

Michael Taft: There are others who will discuss intelligently the fall-out from Ireland’s financial Black Hole Day (Sli Eile, Stephen Kinsella and Nat O’Connor on this blog for instance). One thing that struck me during the Finance Minister’s robust, if economically-challenged, interview on Prime Time was his contention that things were, like, totally cool. Why? Since he announced the massive give-away, bond yields hadn’t moved. Wow. He made his announcement at 4:30 pm and by 10:00 pm bond yields hadn’t moved. This proved that not only that the international markets were not ‘concerned’ with our financial black hole, they were positively chill (or they just go to bed early).

One could really get tired of this. There’s an eerie anthropomorphic quality to discussions on bond markets. Apparently, these markets can ‘feel’, ‘be happy’, ‘become angry’, ‘contemplate’, etc. and on and on. The trend of commentary usually goes like this: ‘the markets will be concerned if the Government doesn’t get tough on trade unionists, the poor, public spending and businesses in debt’. And when the Government does do tough guy stuff, the bond markets ‘approve’ and so, are at peace.

All this comes from the sound-bite school of deep, thoughtful analysis. Tracking bond yields can tell us many things – and it’s amazing that what it usually tells us is what we want it to tell us: vide the Finance Minister last night. So in that spirit I have constructed my own way of explaining bond yield trends. I have used the gross redemption yields for 10-year plus bonds on the last day of the month, sourced from ISEQ (one of many ways to track borrowing costs). This is what the ‘markets’ are telling me.

APRIL 2008: We are still innocent. The ESRI has yet to discover the recession and predict 3.1 percent growth for 2009. There is talk of property prices but we are assured it will be a soft, gentle landing. AIB is trading at €13.25. In another country baseball season is starting and little boys will be playing well into the bright summer evenings.

Bond Yield: 4.40

SEPTEMBER 2008: The boys of summer are still playing baseball but the financial dogs in the street are muttering something about Irish banks and insolvencies. The Sunday Independent declares that if anything goes wrong, whatever that might be, it will of course be the fault of trade unions. Bank Guarantee announced at the end of the month. Markets don’t have time to react before month’s end because they go to bed early.

Bond Yield: 4.60

OCTOBER 2008: Bankers say everything is fine and they don’t need equity; the markets get worried. AIB trades at €5.00 but no one is fired. Bringing forward the Budget doesn’t help either – especially this budget.

Bond Yield: 4.84

DECEMBER 2009: Markets get less jittery. All that hysterics about the state being exposed to hundred of billions of bank Euros fade away. ISME calls for the suppression of trade unions. Their competitors, the Small Firms Association, call ISME weak on the issue of trade unions.

Bond Yield: 4.47

JANUARY 2009: Everything goes haywire. Markets up in arms. Is it because Anglo-Irish is nationalised or because the Government, only a few days before, was going to pump billions in it because they believed it was still viable? The markets unsure whether the Government was colluding in a tissue of lies and deceit or are just plain idiots. Live Register experiences biggest jump in two decades.

Bond Yield: 5.54

FEBRUARY 2009: The Government goes macho. They kick the unions out of Government buildings in the early morning (and don’t even call them a cab). The Finance Minister announces a pension levy on public sector workers and cuts in the number of special need teachers. Pumped abs and testosterone everywhere. Commentators note that even the weather has improved. The markets, however . . .

Bond Yield: 5.57

MARCH 2009: The Tánaiste declares the Government has public finances under control. No one, not even the omnipotent markets, knows what to make of this.

Bond Yield: 5.45

APRIL 2009: Just to prove the Tánaiste was right, the Government introduces an emergency budget. The markets don’t understand – consumer spending is collapsing, businesses reliant on domestic sales are collapsing; and the Government takes even more money out of people’s pockets. There’s counter-intuitive and there’s counter-intuitive; and then there’s Fianna Fail.

Bond Yield: 5.28

JUNE 2009: The markets reconsider the Government’s emergency budget and their deflationary strategy of cutting €11 billion out of an already debilitated economy over the next four years.

Bond Yield: 5.84

AUGUST 2009: For months the three major credit rating agencies have been downgrading Irish Government debt and are threatening more. Commentators are horrified and claim we’ll never be able to borrow again ever, the Sunday Independent blames trades unions, employers demand the minimum wage be cut (though no one can figure out how this will get cheaper money). The markets, however, prove they have a sense of humour.

Bond Yield: 4.68

THE AUTUMN RUN-UP TO THE BUDGET - NOVEMBER 2009: Everyone is giddy. If the Government keeps their promise to implement a puppy-crunching, Bruce Lee, in-your-face, take-no-prisoners budget, the markets will smile and investors will actually pay us to borrow from them. The Taoiseach promises blood, sweat and bankruptcies, the Tánaiste claims that what ever makes us redundant only makes us stronger; the Minister for Health (sic) goes one better and threatens IMF tanks in every town square in the country if we don’t take the pain.

Bond Yield: 5.16

DECEMBER 2010: The Government introduces a puppy-crunching, Bruce Lee, in-your-face, take-no-prisoners budget.

Bond Yield: 5.18

[For a few weeks everyone’s attention is on Greece and those irrational Greek workers striking and marching in the streets because they don’t want to be the fall-guys and fall-gals for maintaining a strong Euro, Germany’s current account surplus and finance capital’s hopes for a return to Alpha status.]

MARCH 30th 4:30 – 10: 00 pm: The Minister declares markets are totally cool with him shovelling up to €20 billion in Anglo-Irish (proves what shrewd market players the Cabinet are), that the economy has turned the corner, unemployment is stabilising and we’ll return to growth this year. Recession? What recession? The only recession is in your mind, dude.

Bond Yield: Moved not one cent according to the Minister.

* * *

All that – all that courageous action the Government has taken that has so impressed the markets – and bond yields are worse than when we started on this dismal path. Of course, there will be those who will claim that if the Government didn’t take courageous action, borrowing costs would have been worse. If so, then why is it high bond yields got worse every time they did?

That’s one way of looking at all this. For another perspective have a read of Michael Burke’s take on borrowing costs and the Government’s deflationary policies. You might have your own perspective. If so, go on to the Irish Stock Exchange website and build your own story.

But, please, just don’t make the markets ‘nervous’.

How much are the bank bailouts going to cost us?

Nat O'Connor: There is a lack of clarity about just how much the bank bailout will cost ordinary people. But based on recent news, the estimated costs are huge.

The Irish Independent states that "Every man, woman and child in the State will have to pay an average of €2,000 every year just to service interest payments on borrowings to pay for the bank bailout, estimated to cost €40bn."

In fairness, it's not clear that we have enough information to know that yet. If the banks raise their own capital we won't need to borrow as much. Also, if we part-recapitalise the banks out of the National Pension Reserve Fund (which is what we did before) we will borrow less again. But let's tease out the scale of what borrowing €40 billion would mean.

Unfortunately, not every man, woman and child in Ireland has an income. So will paying the bill fall on the shoulders of Ireland's 1.6 million households, rather than its 4.5 million people? The costs then comes out at roughly €5,600 per year per household. But with state pensioners and other people living on social welfare on incomes of around €12,000, are we talking about halving their incomes and plunging hundreds of thousands of people into destitution?

Alternatively, we could look at the 1.9 million people in employment, who would have to take on an average of €4,600 each (with couples, where both partners are employed, taking on €9,200).

Average earnings for someone in employment in Ireland in 2009 were around €36,300 per year (CSO). So, for example, a single person on this income, already on c. €29,500 after tax, will see their final income fall to around €24,900. (Of course those on lower incomes might pay less, and those on higher incomes might pay more... this is just the average cost applied to the average income).

The cost to those in employment is likely to be lessened by further cuts in public expenditure (social welfare cuts, cuts to pensions, cuts to public capital expenditure, cuts to public services of all kinds, etc). Except that these cuts will also reduce quality of life, health, education, and increase households' costs to fill the gap created by the absence of public services.

And this is just to pay the interest on the loans to bail out the banks.

All the above assumes that NAMA will work and we will only have to pay the interest on the loans for a period of years. If NAMA makes a loss, or further bank bailouts are required, the burden of paying for all this will increase.

If that wasn't bad enough, some people will be further affected by mortgage interest increases. The Belfast Telegraph suggests that AIB "will respond to its latest bailout by raising mortgage rates by a further 1.5% this year." That's on top of this week's 0.5 per cent increase. Assuming the other banks follow suit, that will increase pressure on tens of thousands of households.

Not every household is affected by this double squeeze, but it is hard to see how households will be able to afford to pay another couple of thousand extra per year on their mortgage repayments, alongside bearing the tax increases to pay the interest on the loans to bail out the banks.

It is possible that we could see a major wave of mortgage default and repossession, which would trigger a further crisis in the banks, and a need for further recapitalisation. Those who don't default are likely to be paying way more than they can comfortably afford to keep their homes; all to avoid the nightmare of selling their homes at a low price, while still owing the bank the balance of their original (massive) mortgage loans.

In a year or so, the State could own all or most of the banks, but the citizens who own the State will be paying increased charges to the banks as customers at the same time as paying taxes for the loans to own them. The burden of paying the interest on the loans will all but rule out any productive investment in better infrastructure, better education, etc. Most of our potential for investment will be tied up for years in paying for the mistakes made by past governments.

There is a need for much more accurate information to be made available on exactly how the Government plans on paying for the banks and at what point it would be cheaper to let some of them go bust. We need to know exactly how much households will have to pay and what will be the opportunity cost in cuts to public services and the loss of a generation's ability to invest in a better future. At present we can only speculate. But based on the figures currently in the news, it's a perverse and gloomy situation and we haven't gotten to the bottom of it yet.

Groundhog Day

Stephen Kinsella: Super Tuesday has been and gone. Even those of us who study Irish public policy and the Irish economy on a daily basis were taken aback by the scale of the wealth transfers from state to private banks. What does it all mean? I’m a professional economist folks–don’t try this at home.

As I mentioned on Drivetime this evening, the injection of capital, combined with the government guarantee and NAMA, is supposed to heal banks’ balance sheets enough to get them into a position where they can borrow cheaply from abroad, and so resume lending again.

My opinion is that this increase in lending won’t happen, because canny investors know that residential loan defaults are on the way. We’ll have a groundhog day. This is not the one big moment to sort out our banking sector. This is a stage in a process, and nothing more. We’ll see the outright nationalisation of AIB by the end of 2010.

NAMA is getting going with its big 10 debtors, transferring 16 billion euros worth of loans in the next few weeks, representing perhaps 20% of the overall loans to be transferred by the end of the year. In particular, Anglo transfers €10bn at 50% discount, AIB transfers €3.29bn (43%), BoI transfers €1.93bn (35%), Nationwide transfers €670m (58%), and EBS transfers €140m (37%). Overall, the haircut is 47%. We need to be careful with that 47% discount number (or ‘haircut’) everyone is talking about. As usual, the bigger haircut, the greater the hole to fill in balance sheets to be filled by taxpayer’s money. While it might be the weighted average of the discounts being applied to each bank as the Minister says, we can’t back out the prices NAMA is going to pay for the loans in, say, AIB or Anglo. Update: Karl Whelan has more on this issue.

Notice also the rhetorical shift. We knew after guaranteeing the liabilities of the banks that a bad bank or asset management vehicle like NAMA was necessary, but also a further injection of capital and perhaps even full scale nationalisation. We were told NAMA was the only game in town, and all other options were not to be considered. Those who argued for nationalisation were derided or ignored. Now it looks highly likely that at least AIB, Anglo, INM, and EBS will be nationalised by the end of 2010, with the state taking a large piece of BoI as well.

Finally, notice the precise imprecision: promissory notes are being issued for several billions, but spread out over ‘10 or 15 years’. Surely we can do better? Not to worry though, we’ll have another crack at it, when groundhog day rolls around again.