Tom McDonnell: Reinhart and Rogoff's finding that the growth rate starts to decline once the public debt to GDP ratio exceeds 90% has become embraced as a stylised fact by the commentariat and in particular by the austerians. However, a recent paper by Thomas Herndon, Michael Ash and Robert Pollin has critiqued this finding. As Slate reports here, Herndon et al. find that the Reinhart and Rogoff result is attributable to a coding error, and they also raise other methodological objections. Herndon et al. find that overall the evidence contradicts Reinhart and Rogoff's claim that public debt loads greater than 90% of GDP consistently reduce GDP growth.
It will be interesting to see how Reinhart and Rogoff respond to the Herndon critique.
Showing posts with label debt. Show all posts
Showing posts with label debt. Show all posts
Wednesday, 17 April 2013
Wednesday, 17 October 2012
Jobs and credit crises call for clear policy response
Michael O'Sullivan (author of Ireland and the Global Question) has written a lucid article on what's required for job creation in today's Irish Times.
While Ben Bernanke, head of the Federal Reserve, voiced “grave concern” over high unemployment for “the enormous suffering and waste of human talent it entails”, Michael O'Sullivan argues that we are failing to address the fundamental barriers to job growth here.
While Ben Bernanke, head of the Federal Reserve, voiced “grave concern” over high unemployment for “the enormous suffering and waste of human talent it entails”, Michael O'Sullivan argues that we are failing to address the fundamental barriers to job growth here.
Thursday, 14 June 2012
Guest post by Martin O'Dea: A simple suggestion
Martin O'Dea: Forgetting banking debt and its link to sovereign debt and resolutions required around this issue and just dealing with excessive sovereign debt, if I might. Can blocks of sovereign debt, instead of just being subsumed into Euro Bonds, not be reconstituted so that they create some of what the fiscal treaty was attempting in terms of structural balance? In other words, could sovereign debt above perhaps 80% not be repaid (interest on same etc) until the country is running a current surplus? As the country's surplus increases the amount of repayment correspondingly goes up. The design would need to be long-term and equitable in its nature but should also leverage a short-term mechanism to bring sovereigns back from the brink of default and allow current deficits be addressed without the markets focusing on sovereign default potentials.
Tuesday, 22 May 2012
Guest post by Arthur Doohan (II): Debt realities
Arthur Doohan: In five years we have gone from being the "pinup stars" for EU growth to being the "posterchildren" for austerity and, like a nodding dog in the back of a car, our leaders are as clueless now as they were then about the road taken and final destination.
Some of that 'clueless-ness' can be seen in 'loose talk' going around at present about the relationship between Ireland and the EU and the other EU member countries. An awful lot of this loose talk revolves around how damaged that relationship would be if the Irish people choose not to join in the Fiscal Compact. A further chunk of the 'chit-chat' revolves around the question of where else we would borrow 'the money' from when (much more so than 'if') we need a further dose of 'austerity medicine'.
I will skip over the blatant inconsistency of a Government that insists we are on the correct path with light at the end of the tunnel under a fully funded and committed financial program while at the same time hastening to arrange the paperwork on yet more borrowings. But not without pointing out that the Taoiseach has recently reiterated and reaffirmed that the existing borrowing program supersedes the envisaged ESM facility that may be provided by the Fiscal Compact.
I will also skip over the issue of whether the Fiscal Compact is a smart or pragmatic or sensible or even a 'pro-European' step to take.
I will skip over these things to state some boring, practical banking 'facts of life'.
There is an 'old saw' from the banking world which states that if you owe the bank 400,000 you have a problem, if you owe the bank 4 million you both have a problem and if you owe the bank 40 million the bank has a problem.
By the end of 2012, all financial sectors of the Irish economy, its households, businesses and the State, will be massively in debt. The State particularly will have a debt/GDP ratio about 120%. This is the level at which it becomes a very dicey proposition for both borrower and lender to go any further into debt.
But the most important thing about this debt is that this money is ALL SPENT. It is not sitting on deposit in a Swiss bank account.
You can debate all you like about whether we did the right things with that money. You can argue until you are blue in the face about whether we can repay it and grow our economy at the same time. You cannot deny that the money is gone and that all that remains is our promise to pay it back.
Those who lent it to us have no lien on the State. There is no court they can turn to enforce any security or charge because there is no such court and they have no security. And, once again, the money is not on deposit somewhere where they can go and seize it.
The only choice our lenders have is on what terms to lend us any more money. A refusal by them would put us into default.
So the issue is not where we can borrow. The issue is on what terms we will continue to repay.
Now, that is the hard practical business reality of it. If that is an uncomfortable truth for you, you should be aware that this is the reality that confronts every lender to every State that gets into financial difficulty. It is not some uncharted territory or some nightmare of eternally shattered reputation and financial purgatory. The experience of Iceland proves that. In fact, the experience of Ireland after it's 1993 devaluation proves that. And anyone who suggests that devaluation and default are different things betrays their hopeless ignorance of the mindset and disposition of the investment and bond trading communities.
One of three things will happen in our near term future. The happiest and least likely is that we will resume some solid growth in the economy and will slowly but steadily repay these debts over a fifteen to twenty year span. The unhappy probable outcome will be that we will have weak growth and the economy will move sideways for a decade or two. The unhappy possible third option is that there will be a default which may, or may not be, 'graceful' and 'managed'.
If and when that day comes for Ireland, some people will seek refuge in economic theories, some hope in protection of laws and regulations, some will seek solace in the arms of supra-national entities and a few will still seek help from deities. But the reality is that bankers and accountants will sit down with the politicians and thrash out what can be paid and seek to extract as much as possible for themselves and their clients.
If a country has leaders who care about it and who have some ability and some understanding of how the real world works, when they sit down to negotiate at that post-default table, then a positive and helpful result can be achieved for the people while being fair to the lenders.
Before that day comes it is still possible for leaders to start us down the path of a more sustainable debt burden that will in the end be fairer to both the borrower and the lenders by simply starting to talk realistically about these overarching realities. But they have neither the ability, the expertise, the self-confidence nor the courage to rock the 'European boat' and are content to be errand boys for the apparatchiks and the bankers by continuing on the path to default while asking us to swallow ever greater doses of pointless austerity.
Some of that 'clueless-ness' can be seen in 'loose talk' going around at present about the relationship between Ireland and the EU and the other EU member countries. An awful lot of this loose talk revolves around how damaged that relationship would be if the Irish people choose not to join in the Fiscal Compact. A further chunk of the 'chit-chat' revolves around the question of where else we would borrow 'the money' from when (much more so than 'if') we need a further dose of 'austerity medicine'.
I will skip over the blatant inconsistency of a Government that insists we are on the correct path with light at the end of the tunnel under a fully funded and committed financial program while at the same time hastening to arrange the paperwork on yet more borrowings. But not without pointing out that the Taoiseach has recently reiterated and reaffirmed that the existing borrowing program supersedes the envisaged ESM facility that may be provided by the Fiscal Compact.
I will also skip over the issue of whether the Fiscal Compact is a smart or pragmatic or sensible or even a 'pro-European' step to take.
I will skip over these things to state some boring, practical banking 'facts of life'.
There is an 'old saw' from the banking world which states that if you owe the bank 400,000 you have a problem, if you owe the bank 4 million you both have a problem and if you owe the bank 40 million the bank has a problem.
By the end of 2012, all financial sectors of the Irish economy, its households, businesses and the State, will be massively in debt. The State particularly will have a debt/GDP ratio about 120%. This is the level at which it becomes a very dicey proposition for both borrower and lender to go any further into debt.
But the most important thing about this debt is that this money is ALL SPENT. It is not sitting on deposit in a Swiss bank account.
You can debate all you like about whether we did the right things with that money. You can argue until you are blue in the face about whether we can repay it and grow our economy at the same time. You cannot deny that the money is gone and that all that remains is our promise to pay it back.
Those who lent it to us have no lien on the State. There is no court they can turn to enforce any security or charge because there is no such court and they have no security. And, once again, the money is not on deposit somewhere where they can go and seize it.
The only choice our lenders have is on what terms to lend us any more money. A refusal by them would put us into default.
So the issue is not where we can borrow. The issue is on what terms we will continue to repay.
Now, that is the hard practical business reality of it. If that is an uncomfortable truth for you, you should be aware that this is the reality that confronts every lender to every State that gets into financial difficulty. It is not some uncharted territory or some nightmare of eternally shattered reputation and financial purgatory. The experience of Iceland proves that. In fact, the experience of Ireland after it's 1993 devaluation proves that. And anyone who suggests that devaluation and default are different things betrays their hopeless ignorance of the mindset and disposition of the investment and bond trading communities.
One of three things will happen in our near term future. The happiest and least likely is that we will resume some solid growth in the economy and will slowly but steadily repay these debts over a fifteen to twenty year span. The unhappy probable outcome will be that we will have weak growth and the economy will move sideways for a decade or two. The unhappy possible third option is that there will be a default which may, or may not be, 'graceful' and 'managed'.
If and when that day comes for Ireland, some people will seek refuge in economic theories, some hope in protection of laws and regulations, some will seek solace in the arms of supra-national entities and a few will still seek help from deities. But the reality is that bankers and accountants will sit down with the politicians and thrash out what can be paid and seek to extract as much as possible for themselves and their clients.
If a country has leaders who care about it and who have some ability and some understanding of how the real world works, when they sit down to negotiate at that post-default table, then a positive and helpful result can be achieved for the people while being fair to the lenders.
Before that day comes it is still possible for leaders to start us down the path of a more sustainable debt burden that will in the end be fairer to both the borrower and the lenders by simply starting to talk realistically about these overarching realities. But they have neither the ability, the expertise, the self-confidence nor the courage to rock the 'European boat' and are content to be errand boys for the apparatchiks and the bankers by continuing on the path to default while asking us to swallow ever greater doses of pointless austerity.
Thursday, 17 May 2012
Guest post by Arthur Doohan: It's the economy, stupid
Arthur Doohan: "...most of the people ...were unhappy… Many solutions were suggested for this problem, but most of these were largely concerned with the movements of small green pieces of paper, which is odd because on the whole it wasn't the small green pieces of paper that were unhappy." - Douglas Adams.
Or to put it another way, there is nothing wrong with the Euro as a currency and plenty wrong with how much debt we expect our economies and our households and our taxpayers and our citizens to bear.
As a medium of exchange and a unit of account the Euro has been a complete success. As a store of value it is facing some challenges.
These challenges arise from the fact that we Europeans have misvalued our property assets by a considerable margin and the wealthiest of us are trying to get the poorest to bear an unfair share of the burden of those mistakes.
The property mis-valuation occurred at a time when the German economy was in the doldrums, post re-unification and post the 'DotCom bubble'. German bankers and bondfund managers were getting very little return on their Euros in the German economy. It was perfectly natural for them to seek investment opportunities abroad, especially as the newly minted currency made it easier to measure, price and transact business opportunities.
What was not perfectly natural was for them to forget the rules of prudent investing, to mimic what US and UK banks were doing and to ignore what external advisors were telling them. But as the erstwhile chair of Citigroup, Chuck Prince so neatly expressed "You've got to keep dancing while the music plays!"
That the regulators in the EU and domestic economies also abandoned their responsibilities and let the music play at an ever faster tempo at the same time is perhaps just another case of hubris in the postpartum roseate glow of the newly arrived Euro. But that does not excuse their trying to shift the blame for the coming of Nemesis.
The Euro was and is well designed. It is a fine piece of engineering, built largely by the French and the Germans, who know a thing or two about building. But the Euro is the financial equivalent of a car, not a plane or other anti-gravity device. By refusing to use it in the way it was intended to be used and by refusing to keep national debts and deficits in check by the fines and other mechanisms built into the Euro design the politicians and bureaucrats have made fools of themselves and a mockery of the patient efforts of two generations of statesmen.
What they have done is the equivalent of driving it off a cliff. What they are doing now is the equivalent of trying to ……well, actually I don't know what they are trying to do because they keep changing their minds. First, it was guarantees, then it was bank recapitalisation, then it was austerity, after that it was a 'unique bond transaction with retrospective contract changes' and now it seems we are to have 'austerity with growth'….
If a country has too much debt or is paying its civil servants and other non-exporting workers too much in salaries and benefits then changing currency in order to partially writedown those debts and reduce those costs is the equivalent of shooting yourself in the foot in order to learn to hop.
The point that I wish to get across is that the fault is not with the Euro and is entirely with what burdens our economies are trying to carry. Abandoning the Euro does not solve Greece's problems or anyone else's. It most cases it will make them worse because the dislocation effects of the 'defenestration' and because of the knock-on effects in the wider EU.
The borrowers are being made to suffer because of the mistakes and the greed of both the borrower and the lender. This is business and it turns out to be 'bad business. There is no moral superiority of the lender over the borrower. Both are equal parties to a contract, willingly if stupidly, entered into. Making Greece jump through hoops to save the blushes of greedy bankers and feckless regulators and stubborn politicians will be fun while the 'wheels are still turning'
If Greece abandons or is forced out of the Euro the debts of Greece will still be denominated in Euro's and the only thing that will have been achieved will have been to make it harder for Greece to get Euros to pay us with.
Returning to my car analogy I will close with another Douglas Adams quote about going over a cliff….
"It's not the fall that will kill you, it's the landing…."
Or to put it another way, there is nothing wrong with the Euro as a currency and plenty wrong with how much debt we expect our economies and our households and our taxpayers and our citizens to bear.
As a medium of exchange and a unit of account the Euro has been a complete success. As a store of value it is facing some challenges.
These challenges arise from the fact that we Europeans have misvalued our property assets by a considerable margin and the wealthiest of us are trying to get the poorest to bear an unfair share of the burden of those mistakes.
The property mis-valuation occurred at a time when the German economy was in the doldrums, post re-unification and post the 'DotCom bubble'. German bankers and bondfund managers were getting very little return on their Euros in the German economy. It was perfectly natural for them to seek investment opportunities abroad, especially as the newly minted currency made it easier to measure, price and transact business opportunities.
What was not perfectly natural was for them to forget the rules of prudent investing, to mimic what US and UK banks were doing and to ignore what external advisors were telling them. But as the erstwhile chair of Citigroup, Chuck Prince so neatly expressed "You've got to keep dancing while the music plays!"
That the regulators in the EU and domestic economies also abandoned their responsibilities and let the music play at an ever faster tempo at the same time is perhaps just another case of hubris in the postpartum roseate glow of the newly arrived Euro. But that does not excuse their trying to shift the blame for the coming of Nemesis.
The Euro was and is well designed. It is a fine piece of engineering, built largely by the French and the Germans, who know a thing or two about building. But the Euro is the financial equivalent of a car, not a plane or other anti-gravity device. By refusing to use it in the way it was intended to be used and by refusing to keep national debts and deficits in check by the fines and other mechanisms built into the Euro design the politicians and bureaucrats have made fools of themselves and a mockery of the patient efforts of two generations of statesmen.
What they have done is the equivalent of driving it off a cliff. What they are doing now is the equivalent of trying to ……well, actually I don't know what they are trying to do because they keep changing their minds. First, it was guarantees, then it was bank recapitalisation, then it was austerity, after that it was a 'unique bond transaction with retrospective contract changes' and now it seems we are to have 'austerity with growth'….
If a country has too much debt or is paying its civil servants and other non-exporting workers too much in salaries and benefits then changing currency in order to partially writedown those debts and reduce those costs is the equivalent of shooting yourself in the foot in order to learn to hop.
The point that I wish to get across is that the fault is not with the Euro and is entirely with what burdens our economies are trying to carry. Abandoning the Euro does not solve Greece's problems or anyone else's. It most cases it will make them worse because the dislocation effects of the 'defenestration' and because of the knock-on effects in the wider EU.
The borrowers are being made to suffer because of the mistakes and the greed of both the borrower and the lender. This is business and it turns out to be 'bad business. There is no moral superiority of the lender over the borrower. Both are equal parties to a contract, willingly if stupidly, entered into. Making Greece jump through hoops to save the blushes of greedy bankers and feckless regulators and stubborn politicians will be fun while the 'wheels are still turning'
If Greece abandons or is forced out of the Euro the debts of Greece will still be denominated in Euro's and the only thing that will have been achieved will have been to make it harder for Greece to get Euros to pay us with.
Returning to my car analogy I will close with another Douglas Adams quote about going over a cliff….
"It's not the fall that will kill you, it's the landing…."
Tuesday, 20 March 2012
Nama Wine Lake on the Promissory Notes
Tom McDonnell: Here is a timely recap by Nama Wine Lake of the grotesque farce that is the Anglo promissory note debacle.
Wednesday, 22 February 2012
The EU-IMF Deal Does Not Require Privatisation
Michael Taft: Whatever about the case-by-case merits of the Government’s announcement today regarding the sell-off of state assets, we should be clear: the EU-IMF Memorandum of Understanding does not require privatisation, in whole or in part. In addition, the discussion of the sale of state assets in the Memorandum does not take place in the fiscal section but rather in the section regarding obstacles to competitiveness. In other words, if there is to be a sale of state assets, the objective is not to write down debt but to improve competitiveness. Indeed, it is hardly likely that the Troika would demand that state assets be sold in order to reduce the projected debt of 115 percent in 2015 down to 114 percent (which is what the Government’s announcement today would do).
The quarterly reviews conducted by the Troika make it clear that the provision for selling state assets did not come from them – it came from the Government and its Programme for Government. And it was Fine Gael that was the driver of the privatisation provision in the Programme – Labour campaigned against privatisation in the last general election.
What we have had is an elaborate choreography around the issue of privatisation, shifting blame and inventing targets which have had the effect of obfuscating the issue. Nonetheless, this should not blind us to where the demand for privatisation is coming from. Senator Shane Ross, writing about the meeting between the Troika and the Technical Group of TDs, reported this exchange on the subject:
‘The troika delegates insisted that they had not prescribed any privatisations. They wanted to see certain semi-states "restructured" and competition in the market. Contrary to media perceptions, they were not pressing the Government to raise any specific amount from the sale of State assets. The figures in the public arena of between €2bn and €6bn did not come from them.’
That this is confirmed by Sinn Fein, from their meeting with the Troika, only reinforces this point.
The demand for privatisation – and the paying down of debt – does not come from the Troika. It comes from our own Government.
For a detailed overview of this issue you can read this post I wrote back in October.
The quarterly reviews conducted by the Troika make it clear that the provision for selling state assets did not come from them – it came from the Government and its Programme for Government. And it was Fine Gael that was the driver of the privatisation provision in the Programme – Labour campaigned against privatisation in the last general election.
What we have had is an elaborate choreography around the issue of privatisation, shifting blame and inventing targets which have had the effect of obfuscating the issue. Nonetheless, this should not blind us to where the demand for privatisation is coming from. Senator Shane Ross, writing about the meeting between the Troika and the Technical Group of TDs, reported this exchange on the subject:
‘The troika delegates insisted that they had not prescribed any privatisations. They wanted to see certain semi-states "restructured" and competition in the market. Contrary to media perceptions, they were not pressing the Government to raise any specific amount from the sale of State assets. The figures in the public arena of between €2bn and €6bn did not come from them.’
That this is confirmed by Sinn Fein, from their meeting with the Troika, only reinforces this point.
The demand for privatisation – and the paying down of debt – does not come from the Troika. It comes from our own Government.
For a detailed overview of this issue you can read this post I wrote back in October.
Wednesday, 25 January 2012
Draft heads of Personal Insolvency Bill out today- at long last!
Marie Sherlock: The long awaited heads of the Draft Personal Insolvency Bill was published today and at first glance, there is much to welcome.
For too long Ireland has stood far behind most other advanced industrial countries in not having a non-judicial framework in place to address contemporary problems of over- indebtedness, but Ireland will now move ahead of the curve by including not only unsecured, but also secured, typically mortgage debt in the new debt settlement institution. The problem of addressing the debt overhang problem could only ever be achieved by adopting a holistic approach to all forms of debt currently borne by Irish households, and I’m glad to say that today’s draft is a vital first step in the right direction.
There are three new forms of non-judicial debt resolution proposed (i) debt relief certificates to cater for unsecured debt under €20,000, (ii) debt settlement arrangements to cater for unsecured debts over the value of €20,001 and (iii) personal insolvency arrangements which will cover unsecured and secured debt up to a value of €3m.
Ultimately, it would seem that the success or failure of the non-judicial system to function as a less costly, more effective and more humane system for dealing with the problem of over-indebtedness in this country, will rest on five key measures.
The first is that debtors wishing to enter a non-judicial process will have access to appropriate advice and representation. The draft bill sets out clear guidelines for each of the three debt resolution processes on how the intermediary (for the debt relief certificate) or personal insolvency trustee (for the debt settlement and personal insolvency arrangements) will advise the debtors and mediate in the debt resolution process.
The only concern is that debtors should not be saddled with excessive costs for this service, but the draft bill states that other the initial fee, the debtor will not have to bear the costs of the process. There is some mention that the Insolvency service will “recover costs”, but does not state from whom. I would firmly share the view of the Law Reform Commission which was set out in their 2010 Report on Personal Debt Management in Ireland that the State should not be made bear these costs (for a task that if the Banks were doing correctly, there would be no need for these new processes) and that the creditors should be held liable.
The second key measure will be the success in forcing the banks to the negotiating table. There is some concern that the banks have an effective veto over their participation- the personal insolvency process depends on the agreement of 75% of “secured” creditors- which is typically the mortgage lender. Given what we know about the practises of some lenders in this country and that some 50% of those mortgages in arrears are with banks outside the “covered” institutions, there is a danger that some mortgage lenders will not engage. However it must also be noted that failure to participate in the non judicial process will be factored into consideration in the awarding of costs if a bankruptcy petition goes to the Courts.
The third measure is that a decent minimum level of income must be established for households who enter any of the three non judicial processes and to its credit the draft heads of Bill is very clear on this. But the detail has yet to be ironed out and will be set out by way of ministerial regulation. Imposing a new repayment schedule in a debt settlement/insolvency arrangement should not have the effect of forcing more households into a dependence on social welfare. Already, we have seen that the availability of the mortgage interest supplement has become an implicit subsidy to the Banks, while helping households’ repay some of their mortgage. The Social welfare system and the State must not be made take on any more of the costs of resolving the problems of the banks.
Fourthly, keeping people in their homes, where it is viable to do so will be a key measure of success, so that additional pressure in not loaded on an already over-subscribed social housing waiting list. Remember that as of the end of September 2011, over one in eight mortgages held in this country were either in arrears or had pre-empted arrears by restructuring the mortgage schedule or payment. Personal insolvency will not necessarily result in an individual having to surrender their home and the Bill details how the recommendations of the Keane report on mortgage arrears published last October, must be considered as part of the range of options for the debtor in terms of split mortgages, mortgage to rent and trade down mortgages, even though these proposals are not without their problems in terms of broad assumptions on rising incomes and increasing house values.
In terms of the balance sheet implications for the banks, the draft heads of bill specifies that no write down can be below the current value of the security, so if the bottom up stress testing exercise undertaken by Blackrock was done correctly last Spring, then the corresponding negative impact of a write down on the Bank’s balance sheet should be limited to the rolled up and future interest payments.
On a final note, this legislation has been long overdue but support for its introduction has taken time to gain traction and support, with plenty of doomsayers talking up the risks of moral hazard. Indeed, I remember sometime in late 2008 doing an radio debate against a certain economics professor from NUIG before he took up the role of Special Adviser to the Minister for Finance and was dismissed out of hand when putting forward our (hardly radical) proposals for distressed mortgage holders! But back to the draft heads of Bill, provision has been made for reform of the judicial bankruptcy procedures with the reduction in the discharge period from 12years down to 3years which opens up a significant difference in the discharge period between the judicial and non judicial procedures. Non judicial personal insolvency has a discharge period of 6-7 years. The terms of discharge for a bankrupt appear to be much more onerous, with 50% of all preferential creditors to be paid and a possible extension of the discharge period out to 8 years.
On a superficial level, the lack of a level playing pitch between the discharge periods for these two processes may appear unjust to a public dissatisfied with the pace in which delinquent bankers are being pursued and uneasy about salaries of €200,000 paid to developers co-operating with Nama. The Government will have a significant job to do in communicating its reasons for the distinction.
For too long Ireland has stood far behind most other advanced industrial countries in not having a non-judicial framework in place to address contemporary problems of over- indebtedness, but Ireland will now move ahead of the curve by including not only unsecured, but also secured, typically mortgage debt in the new debt settlement institution. The problem of addressing the debt overhang problem could only ever be achieved by adopting a holistic approach to all forms of debt currently borne by Irish households, and I’m glad to say that today’s draft is a vital first step in the right direction.
There are three new forms of non-judicial debt resolution proposed (i) debt relief certificates to cater for unsecured debt under €20,000, (ii) debt settlement arrangements to cater for unsecured debts over the value of €20,001 and (iii) personal insolvency arrangements which will cover unsecured and secured debt up to a value of €3m.
Ultimately, it would seem that the success or failure of the non-judicial system to function as a less costly, more effective and more humane system for dealing with the problem of over-indebtedness in this country, will rest on five key measures.
The first is that debtors wishing to enter a non-judicial process will have access to appropriate advice and representation. The draft bill sets out clear guidelines for each of the three debt resolution processes on how the intermediary (for the debt relief certificate) or personal insolvency trustee (for the debt settlement and personal insolvency arrangements) will advise the debtors and mediate in the debt resolution process.
The only concern is that debtors should not be saddled with excessive costs for this service, but the draft bill states that other the initial fee, the debtor will not have to bear the costs of the process. There is some mention that the Insolvency service will “recover costs”, but does not state from whom. I would firmly share the view of the Law Reform Commission which was set out in their 2010 Report on Personal Debt Management in Ireland that the State should not be made bear these costs (for a task that if the Banks were doing correctly, there would be no need for these new processes) and that the creditors should be held liable.
The second key measure will be the success in forcing the banks to the negotiating table. There is some concern that the banks have an effective veto over their participation- the personal insolvency process depends on the agreement of 75% of “secured” creditors- which is typically the mortgage lender. Given what we know about the practises of some lenders in this country and that some 50% of those mortgages in arrears are with banks outside the “covered” institutions, there is a danger that some mortgage lenders will not engage. However it must also be noted that failure to participate in the non judicial process will be factored into consideration in the awarding of costs if a bankruptcy petition goes to the Courts.
The third measure is that a decent minimum level of income must be established for households who enter any of the three non judicial processes and to its credit the draft heads of Bill is very clear on this. But the detail has yet to be ironed out and will be set out by way of ministerial regulation. Imposing a new repayment schedule in a debt settlement/insolvency arrangement should not have the effect of forcing more households into a dependence on social welfare. Already, we have seen that the availability of the mortgage interest supplement has become an implicit subsidy to the Banks, while helping households’ repay some of their mortgage. The Social welfare system and the State must not be made take on any more of the costs of resolving the problems of the banks.
Fourthly, keeping people in their homes, where it is viable to do so will be a key measure of success, so that additional pressure in not loaded on an already over-subscribed social housing waiting list. Remember that as of the end of September 2011, over one in eight mortgages held in this country were either in arrears or had pre-empted arrears by restructuring the mortgage schedule or payment. Personal insolvency will not necessarily result in an individual having to surrender their home and the Bill details how the recommendations of the Keane report on mortgage arrears published last October, must be considered as part of the range of options for the debtor in terms of split mortgages, mortgage to rent and trade down mortgages, even though these proposals are not without their problems in terms of broad assumptions on rising incomes and increasing house values.
In terms of the balance sheet implications for the banks, the draft heads of bill specifies that no write down can be below the current value of the security, so if the bottom up stress testing exercise undertaken by Blackrock was done correctly last Spring, then the corresponding negative impact of a write down on the Bank’s balance sheet should be limited to the rolled up and future interest payments.
On a final note, this legislation has been long overdue but support for its introduction has taken time to gain traction and support, with plenty of doomsayers talking up the risks of moral hazard. Indeed, I remember sometime in late 2008 doing an radio debate against a certain economics professor from NUIG before he took up the role of Special Adviser to the Minister for Finance and was dismissed out of hand when putting forward our (hardly radical) proposals for distressed mortgage holders! But back to the draft heads of Bill, provision has been made for reform of the judicial bankruptcy procedures with the reduction in the discharge period from 12years down to 3years which opens up a significant difference in the discharge period between the judicial and non judicial procedures. Non judicial personal insolvency has a discharge period of 6-7 years. The terms of discharge for a bankrupt appear to be much more onerous, with 50% of all preferential creditors to be paid and a possible extension of the discharge period out to 8 years.
On a superficial level, the lack of a level playing pitch between the discharge periods for these two processes may appear unjust to a public dissatisfied with the pace in which delinquent bankers are being pursued and uneasy about salaries of €200,000 paid to developers co-operating with Nama. The Government will have a significant job to do in communicating its reasons for the distinction.
The Promissory Notes
Tom McDonnell: The IBRC promissory notes have attracted a lot of attention in recent days. Karl Whelan, Seamus Coffey, the Nama Wine Lake contributors, the Debt Justice Action Group and many others have all highlighted and explained this issue very well. Here is a brief primer (click on bottom right to view in full screen mode):
Tuesday, 17 January 2012
If we don't talk about it, nothing bad will happen
Michael Taft: It is frustrating that so much debate about the economy is informed by denial (the insanity of the speculative boom was denied for years and then we heard the chants: ‘soft landing, soft landing’). It is further frustrating that Government Ministers and so many commentators refuse to engage in an open and honest dialogue about the problems that lie ahead (we will return to the markets, all is well). This despite the fact that independent forecasters are lining up with depressing projections: low growth, missed targets, high debts – and, yes, the growing prospect of a second bail-out, 'ludicrous’ as that might sound.
Let’s take a tour of what some of these forecasters – NCB, Goodbody and Davy - are estimating, bearing in mind they are only projections based on the current situation.
NCB and Goodbody (not available yet on-line) are a good place to start as they stretch out their projections to 2015 (click graphic to enlarge).
Both the forecasters are projecting growth rates at substantially less than the Government. This will entail lower tax revenue and higher unemployment costs – so much so that they are projecting that the Government will miss the Maastricht target by 2015 – miss it by a substantial amount.
Further, they are projecting debt levels to be higher than the Government’s estimate. Overall debt levels haven’t got as much attention as they should – despite Richard Tol’s warning about a decade of austerity. The debate is obsessed about meeting the EU-IMF programme targets and the Maastricht target of -3 percent. However, higher debt levels undermine debt sustainability and increase interest payment costs – key indicators that international markets examine when considering whether to lend to a government (and at what rate).
Taking our eye of this ball could be costly. For instance, the Government revised growth projections downwards three times since taking office (yes, three times). They ramped up the level austerity over what Fianna Fail had planned. And all with a view to hitting the 2015 Maastricht target. And, yet, they had to revise upwards their projections for overall debt levels – three times. And that’s with the benefit of the €3.6 billion mistake, interest rate cuts from the EU-IMF lending facility, and less bank capitalisation than previously projected.
The difference in debt projections is not just a number on the page. It could amount to substantially increased interest payments – between €300 and €400 million a year by 2015 and growing, using the NCB projections. And even when (when?) the Maastricht target is hit, we will be looking into years of further austerity to reduce these high debt levels.
Davy projects only up to 2013 – but these are no less grim for that. For 2012 and 2013 combined Davy projects:
• GDP growth at 2.0 percent (the Government: 3.7 percent)
• GNP growth at 0.4 percent (the Government: 2.4 percent)
Davy estimates the Government will miss its deficit target – in both 2012 and 2013 as a result of lower growth. This will lead to debt rising to 122 percent of GDP – in line with the other forecasters.
And to make things more unnerving, Davy admits there is a ‘significant risk’ that GDP growth will undershoot even their pessimistic projections – with all the consequences that would have for our debt levels.
Of course, this may not happen. These forecasters may have got it wrong. Maybe the Government has a handle on the situation and has contingency plans for a fall in external demand (though, I suspect, their plan – if they have one – would mean further measures to depress domestic demand further; and down the recessionary rabbit-hole we go).
But to call this scenario ‘ludicrous’ is hardly a response to instil confidence. A better strategy would be to assess whether the current strategy is working, is likely to work. And, if not, start debating an alternative approach – and invite people into an open and honest discussion.
That is the best way to restore confidence in the Irish economy.
Let’s take a tour of what some of these forecasters – NCB, Goodbody and Davy - are estimating, bearing in mind they are only projections based on the current situation.
NCB and Goodbody (not available yet on-line) are a good place to start as they stretch out their projections to 2015 (click graphic to enlarge).
Both the forecasters are projecting growth rates at substantially less than the Government. This will entail lower tax revenue and higher unemployment costs – so much so that they are projecting that the Government will miss the Maastricht target by 2015 – miss it by a substantial amount.
Further, they are projecting debt levels to be higher than the Government’s estimate. Overall debt levels haven’t got as much attention as they should – despite Richard Tol’s warning about a decade of austerity. The debate is obsessed about meeting the EU-IMF programme targets and the Maastricht target of -3 percent. However, higher debt levels undermine debt sustainability and increase interest payment costs – key indicators that international markets examine when considering whether to lend to a government (and at what rate).
Taking our eye of this ball could be costly. For instance, the Government revised growth projections downwards three times since taking office (yes, three times). They ramped up the level austerity over what Fianna Fail had planned. And all with a view to hitting the 2015 Maastricht target. And, yet, they had to revise upwards their projections for overall debt levels – three times. And that’s with the benefit of the €3.6 billion mistake, interest rate cuts from the EU-IMF lending facility, and less bank capitalisation than previously projected.
The difference in debt projections is not just a number on the page. It could amount to substantially increased interest payments – between €300 and €400 million a year by 2015 and growing, using the NCB projections. And even when (when?) the Maastricht target is hit, we will be looking into years of further austerity to reduce these high debt levels.
Davy projects only up to 2013 – but these are no less grim for that. For 2012 and 2013 combined Davy projects:
• GDP growth at 2.0 percent (the Government: 3.7 percent)
• GNP growth at 0.4 percent (the Government: 2.4 percent)
Davy estimates the Government will miss its deficit target – in both 2012 and 2013 as a result of lower growth. This will lead to debt rising to 122 percent of GDP – in line with the other forecasters.
And to make things more unnerving, Davy admits there is a ‘significant risk’ that GDP growth will undershoot even their pessimistic projections – with all the consequences that would have for our debt levels.
Of course, this may not happen. These forecasters may have got it wrong. Maybe the Government has a handle on the situation and has contingency plans for a fall in external demand (though, I suspect, their plan – if they have one – would mean further measures to depress domestic demand further; and down the recessionary rabbit-hole we go).
But to call this scenario ‘ludicrous’ is hardly a response to instil confidence. A better strategy would be to assess whether the current strategy is working, is likely to work. And, if not, start debating an alternative approach – and invite people into an open and honest discussion.
That is the best way to restore confidence in the Irish economy.
Wednesday, 26 October 2011
Martin Wolf's open letter to Mario Draghi
"You must choose between two paths: the orthodox one leads towards failure; the unorthodox one should lead towards success.
The eurozone confronts a set of complex longer-term challenges. But the members will not get the chance to make needed adjustments and implement required reforms if it does not survive. The immediate requirements include putting Greece on a sustainable path; avoiding a meltdown in public debt markets of several large countries; and preventing a collapse of banks. Of these, it is the last two that matter." You can read the rest of Martin Wolf's open letter to Mario Draghi here.
The eurozone confronts a set of complex longer-term challenges. But the members will not get the chance to make needed adjustments and implement required reforms if it does not survive. The immediate requirements include putting Greece on a sustainable path; avoiding a meltdown in public debt markets of several large countries; and preventing a collapse of banks. Of these, it is the last two that matter." You can read the rest of Martin Wolf's open letter to Mario Draghi here.
Wednesday, 5 October 2011
Sailing rudderless into the Anglo storm
Tom McDonnell: The Greek tragedy that is the eurozone debt crisis may soon enter its fourth act. A hard write-down of Greek debt is necessary and there is now a significant probability that Greece will be allowed to default around December. Martin Wolf argues here that:
“the bare minimum the eurozone needs to cope with its crisis is an effective mechanism for writing down the debts of evidently insolvent private and sovereign borrowers, such as Greece; funds large enough to manage the illiquid bond markets of potentially solvent governments; and ways to make the financial system credibly solvent immediately.”
He suggests the sums required will be several times larger than the €440bn of the existing EFSF.
The Dexia crisis is finally forcing the core countries to acknowledge that their banking systems are in serious trouble and this creates an opportunity for Ireland. While the original intent was for the EFSF to be a sovereign bailout fund it is becoming increasingly clear that its future role will likely involve the recapitalisation of failing banks.
If and when Greece is allowed to default the EFSF will be standing by to preserve the solvency of the European banking system through large-scale recapitalization. It is at this point that the Irish Government should request the Anglo/INBS promissory note liabilities be transferred to the EFSF with Ireland then agreeing a negotiated repayment schedule at a low interest rate.
Renegotiating the promissory notes is of huge consequence to Ireland’s future prosperity. Michael Noonan hints here that he has begun the process of renegotiation. We can extrapolate from these new figures that the total cost between 2011 and 2031 will be in the region of €85 billion (assumes a 4.7% interest rate from 2013 onwards). That is €4 billion a year. The infinite spiral of cumulative interest costs is the reason why the figure is larger than the commonly cited €47 billion i.e., we have to pay interest on the €47 billion in borrowings and then pay the interest on the borrowings required for those interest payments and so on and so forth (click on table to enlarge).
Seamus Coffey explains the issues here. Turning the notes into a long-term bullet bond owed to the EFSF may offer one plausible solution. Our institutions were unforgivably unprepared for the 2008 earthquake. It would be feckless to sail in to the current storm without a worked out strategy to deal with the promissory note question.
“the bare minimum the eurozone needs to cope with its crisis is an effective mechanism for writing down the debts of evidently insolvent private and sovereign borrowers, such as Greece; funds large enough to manage the illiquid bond markets of potentially solvent governments; and ways to make the financial system credibly solvent immediately.”
He suggests the sums required will be several times larger than the €440bn of the existing EFSF.
The Dexia crisis is finally forcing the core countries to acknowledge that their banking systems are in serious trouble and this creates an opportunity for Ireland. While the original intent was for the EFSF to be a sovereign bailout fund it is becoming increasingly clear that its future role will likely involve the recapitalisation of failing banks.
If and when Greece is allowed to default the EFSF will be standing by to preserve the solvency of the European banking system through large-scale recapitalization. It is at this point that the Irish Government should request the Anglo/INBS promissory note liabilities be transferred to the EFSF with Ireland then agreeing a negotiated repayment schedule at a low interest rate.
Renegotiating the promissory notes is of huge consequence to Ireland’s future prosperity. Michael Noonan hints here that he has begun the process of renegotiation. We can extrapolate from these new figures that the total cost between 2011 and 2031 will be in the region of €85 billion (assumes a 4.7% interest rate from 2013 onwards). That is €4 billion a year. The infinite spiral of cumulative interest costs is the reason why the figure is larger than the commonly cited €47 billion i.e., we have to pay interest on the €47 billion in borrowings and then pay the interest on the borrowings required for those interest payments and so on and so forth (click on table to enlarge).
Seamus Coffey explains the issues here. Turning the notes into a long-term bullet bond owed to the EFSF may offer one plausible solution. Our institutions were unforgivably unprepared for the 2008 earthquake. It would be feckless to sail in to the current storm without a worked out strategy to deal with the promissory note question.
'Understanding what controls us'
Peter Connell: Writing in last Saturday’s Guardian, Ian Jack, bemoaning the irrelevance of the current party conference season in the UK, argued that the media, rather than providing publicity for stage managed political rallies, would better serve society and its citizens by focusing on the powerful institutions and corporations whose decisions shape our society, our economy and our lives. In his piece Jack laments the fact of high levels of economic and financial illiteracy and argues that ‘we don’t understand what controls us’. How can we address what is essentially a democratic deficit? How do we control what we don’t understand?
Given the high level of complexity of the financial system that is an integral part of modern capitalism it is, perhaps, unreasonable to expect that the average citizen will have a good handle on credit default swaps, contracts for difference and ten year bond yields. But that’s not really the problem. The real issue is how is a citizen in a democracy to assess the efficacy of their government’s economic management without some grasp of the context in which decisions are made? The government, naturally enough, have claimed credit, for renegotiating the terms of the EU/IMF bailout that will see a significant reduction in the country’s debt burden on the back of a 2% cut in the interest rate. It’s fair to say that most reasonably well-informed citizens will assess this claim in the context of the Minister for Finance indicating in early June that a 0.6% rate cut might be the best that could be hoped for. Very often, though, it’s much more difficult to make a judgement call.
A good example is the infamous promissory note which, under current arrangements, will cost the Irish taxpayer €65 billion over the next 14 years. Michael Burke, Tom McDonnell and Michael Taft performed a valuable public service when posting on PE on the promissory note and arguing that it should become a major political issue. The nature of the promissory note, the institutions and entities that are party to it and the implications of defaulting on or restructuring it are complex issues on which even professional economists differ. Prompted by the PE posting, a lot of these issues were teased out on irisheconomy.ie. The debate, though, remains one largely between ‘insiders’ when it deserves and demands the widest public audience. Given that the cost of Anglo-Irish/Irish Nationwide debt over the next few years completely dwarfs the gains that will be accrued from the reduced interest rate on the State’s EU/IMF bailout funds, it is an indictment of our mainstream media that it has largely failed to facilitate an informed public debate on this issue.
In assessing how the government deals with the promissory note in the coming weeks the bar needs to be set high. A complete restructuring of the debt, with a rescheduling of payments over a 30 or 50 year period, seems the least we should expect. And the least we should expect from our media is that is that it addresses the democratic deficit and helps us ‘understand what controls us’.
Given the high level of complexity of the financial system that is an integral part of modern capitalism it is, perhaps, unreasonable to expect that the average citizen will have a good handle on credit default swaps, contracts for difference and ten year bond yields. But that’s not really the problem. The real issue is how is a citizen in a democracy to assess the efficacy of their government’s economic management without some grasp of the context in which decisions are made? The government, naturally enough, have claimed credit, for renegotiating the terms of the EU/IMF bailout that will see a significant reduction in the country’s debt burden on the back of a 2% cut in the interest rate. It’s fair to say that most reasonably well-informed citizens will assess this claim in the context of the Minister for Finance indicating in early June that a 0.6% rate cut might be the best that could be hoped for. Very often, though, it’s much more difficult to make a judgement call.
A good example is the infamous promissory note which, under current arrangements, will cost the Irish taxpayer €65 billion over the next 14 years. Michael Burke, Tom McDonnell and Michael Taft performed a valuable public service when posting on PE on the promissory note and arguing that it should become a major political issue. The nature of the promissory note, the institutions and entities that are party to it and the implications of defaulting on or restructuring it are complex issues on which even professional economists differ. Prompted by the PE posting, a lot of these issues were teased out on irisheconomy.ie. The debate, though, remains one largely between ‘insiders’ when it deserves and demands the widest public audience. Given that the cost of Anglo-Irish/Irish Nationwide debt over the next few years completely dwarfs the gains that will be accrued from the reduced interest rate on the State’s EU/IMF bailout funds, it is an indictment of our mainstream media that it has largely failed to facilitate an informed public debate on this issue.
In assessing how the government deals with the promissory note in the coming weeks the bar needs to be set high. A complete restructuring of the debt, with a rescheduling of payments over a 30 or 50 year period, seems the least we should expect. And the least we should expect from our media is that is that it addresses the democratic deficit and helps us ‘understand what controls us’.
Tuesday, 20 September 2011
Wiping Clean the Anglo/INBS Debt Slate
Tom McDonnell, Michael Burke and Michael Taft: The Anglo Irish and Irish Nationwide debt must become a major political issue. The Anglo/INBS debt-burden is an unjust and unwarranted charge which the Irish people ought have no responsibility for, a charge which will continue to drain the productive economy for years to come. In the following we discuss how we can expunge this debt based on (a) renegotiating the promissory note, (b) renegotiating a new repayment schedule (if any are needed), (c) writing down bondholder debt, and (d) political strategies to strengthen the Government’s negotiating position. The starting point should be a Government announcement this autumn that it does not intend to continue with the current promissory note payment schedule and will enter into renegotiation with the affected parties.
Many people are not aware that the vast majority of the Anglo/INBS debt has yet to be repaid. While the full amount has been placed on our general government debt, this was an accounting exercise. Under the current promissory note of €31 billion, of which Anglo Irish comprises €25 billion, the Department of Finance estimates the total cost to the state to be in the order of €65 billion, including interest on the promissory note, interest on borrowing and the capital payment made to Anglo Irish in 2009 (though this total could vary depending on future interest rates). This averages out to an annual bill of €4.2 billion over the next 14 years.
• In the next four years the cost of Anglo/INBS debt will make up almost a third of all state borrowing.;
• The annual repayments will exceed the entire budget for the nation’s primary school system;
• The average annual repayment for just one year exceeds the entire cost for a next generation broadband network;
• The total cost is equivalent in scale to half of our GNP this year.
The absorption of Anglo/INBS debt has currently added over 15 percent to total Government debt. Were it to be removed or substantially written down, Ireland’s debt levels would fall back towards the Eurozone average which stands at 87 percent of GDP. Even with the recent Anglo Irish interim report and the anticipated reduction in losses, the scale of future borrowing will be substantial.
In dealing with Anglo/INBS debt we have advantages. First, the promissory notes are not part of the EU-IMF Memorandum of Understanding. Therefore, further payments under the IMF-EU bail-out deal are not contingent upon maintaining the current promissory note schedule. Second, Anglo/INBS is for the most part detached from the European financial system; the issue of contagion to other financial institutions is extremely limited.
Bondholder debt makes up only a small part of Anglo/INBS liabilities – less than 10 percent. The major liabilities are made up of loans from central banks (€40.8 billion) of which the promissory note (€23.8 billion) makes up over half.
Renegotiating the Promissory Note
While the Central Bank of Ireland (CBI) is part of the Euro system of central banks (and, therefore, cannot act unilaterally), the promissory note is the CBI’s responsibility. The loans from other central banks look set to be covered by the non-promissory note assets on Anglo’s books (over €30 billion). Therefore, the renegotiation will, in the first instance, commence with our own Central Bank.
In a renegotiation, the Government should be seeking a complete write-down of the promissory note. This would require an innovative response from the CBI. We believe this will be done as the CBI has already accepted its critical role in the Anglo/INBS debacle.
In early January 2009, the Minister for Finance relied on advice from the CBI and the Financial Regulator when nationalising Anglo Irish. This led the Department of Finance at the time to state that Anglo Irish was ‘solvent’ and ‘open for business’. Subsequently, however, the CBI admitted they had been profoundly mistaken, stating that months before nationalisation and the bank guarantee both Anglo Irish and INBS ‘were well on the road towards insolvency’. Shortly after the Anglo Irish nationalisation, the CBI was compelled to notify the Gardaà and the Office of the Director of Corporate Enforcement (ODCE) of ‘certain matters’. These admissions are signals of a potentially positive response from the CBI to rectify some of the damage its mistakes have inflicted on the Irish public.
The crucial issue is the extent to which CBI can unwind its position without risking balance-sheet insolvency (through write-downs and other strategies). Anything short of that risk should be explored and negotiated. A Government announcement that it does not intend to proceed with the current repayment schedule would provide the incentive to parties to explore all the options.
Such a course would of course require sanction or, at least, tolerance from the ECB. However, it is a matter of debate as to what extent the ECB was aware of Anglo/INBS insolvency when negotiating with the Government over the fate of these banks. In this respect, it would be helpful in terms of accountability, transparency and clarification if the Government published all communication between itself, the CBI and the ECB regarding Anglo/INBS since the run-up to the bank guarantee starting in early 2008. Such publicly-released information can help progress the debate by establishing where different responsibilities lie for propping up insolvent banks with Irish taxpayer money and central bank loans.
A New Repayment Schedule
If, at the end of this process, an agreement is negotiated which imposes a debt on the Exchequer, the next issue is the repayment schedule. There are two approaches.
(a) Reschedule with the CBI
The debt could be repaid over a greatly extended period of time (e.g. 30/50 years) via a similar instrument to the existing one. The goal would be to significantly reduce borrowing in the short/medium term with either a repayment holiday for the period that we are reliant upon EU-IMF funding and/or a payment restructuring so as to back-load the annual liability. This also leaves open the possibility of revisiting the issue in the future with a view to further write-downs. This approach may provide the CBI with more flexibility than actually writing down the promissory note itself and could constitute an effective write-down via future inflation.
(b) Reschedule with the EFSF
Alternatively, the Government could seek to transfer the promissory note to the European Financial Stability Facility (EFSF) with whom the Government could then negotiate a greatly extended loan. As the EFSF can now lend to recapitalise banks, this would simply be taking advantage of a new opportunity. Even this option, on the basis of repayment of the Anglo Irish debt, would greatly reduce borrowing in the medium-term.
Restructuring the repayment schedule, even if there is no write-down of the promissory note, would provide the Irish economy with considerable breathing space. A further option would be to substitute a ‘bullet bond’ (similar to a normal Government bond) whereby only interest would be paid annually with the full amount redeemed after a greatly extended period (e.g. a 30-year bond). At the least, we could expect annual costs to fall by a minimum of two-thirds, saving the taxpayer €2 billion a year over the next 14 years and postpone the payment of the principle to a longer-term horizon where it would be easier and cheaper to roll-over the debt.
Bondholder Debt
Bondholder debt, estimated to be approximately €6 billion, would be the subject of separate negotiation/actions. There is a clear argument in equity, as mooted by the Minister for Finance, to unilaterally write-down the unguaranteed debt. The ECB is reported to be opposed to this strategy because of contagion fears. However, the markets have already distinguished between the debts of viable banks and those of the dead banks Anglo and INBS. Financial analysts continue to criticise and express bemusement that the Government is continuing to honour unguaranteed debt: ‘because the two banks are effectively in the process of being liquidated, burden sharing by senior unsecured bondholders does not constitute a threat to financial stability’.
As for the guaranteed bondholders, it would be argued that not honouring this debt would undermine the credibility of similar guarantees underpinning the pillar banks, with implications for their ability to access the market. That is why this debt should be negotiated.
A Political Debate – in Ireland and Europe
The Government has a strong opportunity to strike a new deal on the Anglo/INBS debt. We have outlined a series of approaches which can provide the Government an opportunity to expunge this unjust debt. By opening up renegotiations on the entire amount of Anglo/INBS debt, the Government would give itself (and other parties) more flexibility across a range of issues (the promissory note, restructuring the payment schedule, and bondholder debt). This could allow for more give-and-take than focussing on one issue such as the unguaranteed senior debt.
It is important the Government keep the Irish public abreast of its goal and strategies and that this be done in an open and transparent manner (hence the publication of communications between the Government and the CBI/ECB regarding Anglo/INBS). For this is essentially a political project – to reverse the decision by the previous Government to place the private debt of dead banks on to the public balance sheet. That the new Government had no part in this vast transfer of resources (over €14,000 per person living in the State) gives it clean hands and greater moral capital.
But this is a Eurozone issue as well and it is necessary for the European public to become aware of the immense burden Ireland is carrying for non-existent banks. For instance, how would the German public react if they had to repay an equivalent dead-bank debt of over €700 billion, with annual repayments of around €50 billion for over a decade? Or if the French had to pay over €550 billion with annual repayments of around €40 billion (nearly four times the amount of the recently announced austerity package)? The appropriate Government Ministers could launch a Eurozone-wide information campaign – informing the public, commentators and policy makers of the immense debt burden that is Anglo/INBS. We believe this would elicit considerable sympathy (and not a little bit of shock), thus strengthening the Government’s negotiating position.
There are reasons why the ECB, under a new President, would be open to such a renegotiation. The Anglo/INBS debt is relatively small in comparison to the amount that the viable banks (e.g. AIB, Bank of Ireland) owe the ECB. The elimination or write-down of Anglo/INBS debt would reduce the burden on the economy. A strengthening economy, in itself, will increase the chances that the viable banks can return to private funding and that the ECB will be repaid in full.
This debate must be taken up by all sections of society – by individuals, civil society organisations, political parties; for the Anglo/INBS debt is a key component of the economic and fiscal crisis. While we cannot pre-empt or predict the ultimate outcome, we can call for the Government to suspend the current repayment schedule for the promissory notes (which requires a further €3.1 billion payment in March of next year) and enter into a renegotiation.
And if there are other, better alternatives than the ones outlined here, we welcome that. For we are only concerned here with starting the debate, not writing the last word. But that debate must start now before we spend one more cent on this invidious debt.
Many people are not aware that the vast majority of the Anglo/INBS debt has yet to be repaid. While the full amount has been placed on our general government debt, this was an accounting exercise. Under the current promissory note of €31 billion, of which Anglo Irish comprises €25 billion, the Department of Finance estimates the total cost to the state to be in the order of €65 billion, including interest on the promissory note, interest on borrowing and the capital payment made to Anglo Irish in 2009 (though this total could vary depending on future interest rates). This averages out to an annual bill of €4.2 billion over the next 14 years.
• In the next four years the cost of Anglo/INBS debt will make up almost a third of all state borrowing.;
• The annual repayments will exceed the entire budget for the nation’s primary school system;
• The average annual repayment for just one year exceeds the entire cost for a next generation broadband network;
• The total cost is equivalent in scale to half of our GNP this year.
The absorption of Anglo/INBS debt has currently added over 15 percent to total Government debt. Were it to be removed or substantially written down, Ireland’s debt levels would fall back towards the Eurozone average which stands at 87 percent of GDP. Even with the recent Anglo Irish interim report and the anticipated reduction in losses, the scale of future borrowing will be substantial.
In dealing with Anglo/INBS debt we have advantages. First, the promissory notes are not part of the EU-IMF Memorandum of Understanding. Therefore, further payments under the IMF-EU bail-out deal are not contingent upon maintaining the current promissory note schedule. Second, Anglo/INBS is for the most part detached from the European financial system; the issue of contagion to other financial institutions is extremely limited.
Bondholder debt makes up only a small part of Anglo/INBS liabilities – less than 10 percent. The major liabilities are made up of loans from central banks (€40.8 billion) of which the promissory note (€23.8 billion) makes up over half.
Renegotiating the Promissory Note
While the Central Bank of Ireland (CBI) is part of the Euro system of central banks (and, therefore, cannot act unilaterally), the promissory note is the CBI’s responsibility. The loans from other central banks look set to be covered by the non-promissory note assets on Anglo’s books (over €30 billion). Therefore, the renegotiation will, in the first instance, commence with our own Central Bank.
In a renegotiation, the Government should be seeking a complete write-down of the promissory note. This would require an innovative response from the CBI. We believe this will be done as the CBI has already accepted its critical role in the Anglo/INBS debacle.
In early January 2009, the Minister for Finance relied on advice from the CBI and the Financial Regulator when nationalising Anglo Irish. This led the Department of Finance at the time to state that Anglo Irish was ‘solvent’ and ‘open for business’. Subsequently, however, the CBI admitted they had been profoundly mistaken, stating that months before nationalisation and the bank guarantee both Anglo Irish and INBS ‘were well on the road towards insolvency’. Shortly after the Anglo Irish nationalisation, the CBI was compelled to notify the Gardaà and the Office of the Director of Corporate Enforcement (ODCE) of ‘certain matters’. These admissions are signals of a potentially positive response from the CBI to rectify some of the damage its mistakes have inflicted on the Irish public.
The crucial issue is the extent to which CBI can unwind its position without risking balance-sheet insolvency (through write-downs and other strategies). Anything short of that risk should be explored and negotiated. A Government announcement that it does not intend to proceed with the current repayment schedule would provide the incentive to parties to explore all the options.
Such a course would of course require sanction or, at least, tolerance from the ECB. However, it is a matter of debate as to what extent the ECB was aware of Anglo/INBS insolvency when negotiating with the Government over the fate of these banks. In this respect, it would be helpful in terms of accountability, transparency and clarification if the Government published all communication between itself, the CBI and the ECB regarding Anglo/INBS since the run-up to the bank guarantee starting in early 2008. Such publicly-released information can help progress the debate by establishing where different responsibilities lie for propping up insolvent banks with Irish taxpayer money and central bank loans.
A New Repayment Schedule
If, at the end of this process, an agreement is negotiated which imposes a debt on the Exchequer, the next issue is the repayment schedule. There are two approaches.
(a) Reschedule with the CBI
The debt could be repaid over a greatly extended period of time (e.g. 30/50 years) via a similar instrument to the existing one. The goal would be to significantly reduce borrowing in the short/medium term with either a repayment holiday for the period that we are reliant upon EU-IMF funding and/or a payment restructuring so as to back-load the annual liability. This also leaves open the possibility of revisiting the issue in the future with a view to further write-downs. This approach may provide the CBI with more flexibility than actually writing down the promissory note itself and could constitute an effective write-down via future inflation.
(b) Reschedule with the EFSF
Alternatively, the Government could seek to transfer the promissory note to the European Financial Stability Facility (EFSF) with whom the Government could then negotiate a greatly extended loan. As the EFSF can now lend to recapitalise banks, this would simply be taking advantage of a new opportunity. Even this option, on the basis of repayment of the Anglo Irish debt, would greatly reduce borrowing in the medium-term.
Restructuring the repayment schedule, even if there is no write-down of the promissory note, would provide the Irish economy with considerable breathing space. A further option would be to substitute a ‘bullet bond’ (similar to a normal Government bond) whereby only interest would be paid annually with the full amount redeemed after a greatly extended period (e.g. a 30-year bond). At the least, we could expect annual costs to fall by a minimum of two-thirds, saving the taxpayer €2 billion a year over the next 14 years and postpone the payment of the principle to a longer-term horizon where it would be easier and cheaper to roll-over the debt.
Bondholder Debt
Bondholder debt, estimated to be approximately €6 billion, would be the subject of separate negotiation/actions. There is a clear argument in equity, as mooted by the Minister for Finance, to unilaterally write-down the unguaranteed debt. The ECB is reported to be opposed to this strategy because of contagion fears. However, the markets have already distinguished between the debts of viable banks and those of the dead banks Anglo and INBS. Financial analysts continue to criticise and express bemusement that the Government is continuing to honour unguaranteed debt: ‘because the two banks are effectively in the process of being liquidated, burden sharing by senior unsecured bondholders does not constitute a threat to financial stability’.
As for the guaranteed bondholders, it would be argued that not honouring this debt would undermine the credibility of similar guarantees underpinning the pillar banks, with implications for their ability to access the market. That is why this debt should be negotiated.
A Political Debate – in Ireland and Europe
The Government has a strong opportunity to strike a new deal on the Anglo/INBS debt. We have outlined a series of approaches which can provide the Government an opportunity to expunge this unjust debt. By opening up renegotiations on the entire amount of Anglo/INBS debt, the Government would give itself (and other parties) more flexibility across a range of issues (the promissory note, restructuring the payment schedule, and bondholder debt). This could allow for more give-and-take than focussing on one issue such as the unguaranteed senior debt.
It is important the Government keep the Irish public abreast of its goal and strategies and that this be done in an open and transparent manner (hence the publication of communications between the Government and the CBI/ECB regarding Anglo/INBS). For this is essentially a political project – to reverse the decision by the previous Government to place the private debt of dead banks on to the public balance sheet. That the new Government had no part in this vast transfer of resources (over €14,000 per person living in the State) gives it clean hands and greater moral capital.
But this is a Eurozone issue as well and it is necessary for the European public to become aware of the immense burden Ireland is carrying for non-existent banks. For instance, how would the German public react if they had to repay an equivalent dead-bank debt of over €700 billion, with annual repayments of around €50 billion for over a decade? Or if the French had to pay over €550 billion with annual repayments of around €40 billion (nearly four times the amount of the recently announced austerity package)? The appropriate Government Ministers could launch a Eurozone-wide information campaign – informing the public, commentators and policy makers of the immense debt burden that is Anglo/INBS. We believe this would elicit considerable sympathy (and not a little bit of shock), thus strengthening the Government’s negotiating position.
There are reasons why the ECB, under a new President, would be open to such a renegotiation. The Anglo/INBS debt is relatively small in comparison to the amount that the viable banks (e.g. AIB, Bank of Ireland) owe the ECB. The elimination or write-down of Anglo/INBS debt would reduce the burden on the economy. A strengthening economy, in itself, will increase the chances that the viable banks can return to private funding and that the ECB will be repaid in full.
This debate must be taken up by all sections of society – by individuals, civil society organisations, political parties; for the Anglo/INBS debt is a key component of the economic and fiscal crisis. While we cannot pre-empt or predict the ultimate outcome, we can call for the Government to suspend the current repayment schedule for the promissory notes (which requires a further €3.1 billion payment in March of next year) and enter into a renegotiation.
And if there are other, better alternatives than the ones outlined here, we welcome that. For we are only concerned here with starting the debate, not writing the last word. But that debate must start now before we spend one more cent on this invidious debt.
Tuesday, 6 September 2011
This time, it's different
Michael Burke: The ESRI’s latest research paper, ’Irish Government Debt and Implied Debt Dynamics: 2011-2015’ has received much coverage. Commentary has focused on the projected stabilisation of the overall debt in relation to the economy; the debt/GDP ratio or the debt/GNP ratio. From this, some more excitable commentary has suggested that this is a vindication of the broad-based attack on living standards, increased taxes on working people (but not on corporates) and public spending cuts euphemistically known as ‘austerity’ policies.
However, this last contention, that ‘austerity works’, is not supported by the authors’ findings themselves. To quote their own summary of their paper, ‘[Our projected debt ratios are] much lower than had been projected in official figures earlier in the year, partly because the cost of the bank recapitalisation was much lower than anticipated and also because of the reduction in EU interest rates’.
So, the lower projections are based on the lower level of bank recapitalisation and lower rates for bailout funds for those recapitalisations. According to the authors’ abstract of their own findings, none of the projected improvement is attributable to ‘austerity’ measures.
Quality of Forecasts
But how ‘good’ are these forecasts, in both senses? First, what is the quantum of improvement that is being forecast by the ESRI? Secondly, how likely is it that these forecasts will prove correct? The debt ratios forecast by the ESRI are set out in the table below:
Debt Ratios, % GDP
Source: ESRI, Eurostat, IMF databank, Euro Area Spring Forecasts
The first point to note is that the ESRI is not projecting any reduction in the level of government debt over the period 2010 to 2015. Over that period, debt will rise from 94.9% of GDP to a projected 106.2%. It is in effect projecting a deterioration in the debt level to next year, then stabilisation and then a reduction. Both the IMF and Eurostat forecasts are much worse.
This disparity is a function of two factors. First, the Eurostat and IMF forecasts were made before the reduction in interest rates and before the lower projections for the level of the bank bailout were made. Secondly, the ESRI has stronger real growth projections than either Eurostat or the IMF.
Before dealing with the substantial point of how large the bailout and interest rate savings are, it is worth highlighting the main source of the discrepancy in growth forecasts. In effect, ESRI has a much larger growth forecast of +1.8% real GDP in 2010 than either Eurostat (+0.6%) or the IMF (+0.5%). The difference arises because whereas the IMF and Eurostat both have prices rising by 0.6% in 2010 to reduce real GDP by that degree, the ESRI projects falling prices of 1.1% (implied from the gap between real and nominal GDP (Table 7). Given that deflation both reduces the nominal level of taxation revenues while also increasing the ratio of existing debt to nominal GDP, there can be little argument that this ‘stronger’ growth forecast is responsible for the ESRI’s more optimistic debt/GDP forecasts.
Instead, it is the combination of lower interest rates and a lower projected bank bailout cost which is responsible for the projections of a substantially improved debt outlook. On the former, the consensus appears to be that the annual saving will be in the order of €1bn per annum, perhaps slightly more. Implicitly the ESRI authors assume a saving of €1.125bn per annum, on the basis of a former interest rate of 6% (p.20, point 2.). Compounded, this saving over a 5 year period amounts to €8.5bn or approximately 4.6% of the GDP level projected for 2015.
On the lower bank bailout costs, the international bailout of creditors to Irish banks in November 2010 included €10bn of immediate bank recapitalisation plus another contingency amount of €20bn. To date, of this a total of €17bn has been provided by the State (banks funding €7bn themselves in the financial markets for a total of €24bn). The ESRI authors expect €3bn to be repaid to the State by 2014. This ‘saving’ of €13bn also incurs interest. However, the authors now argue that funding from the Troika will be needed in 2014, even though the terms of the original bailout were that the government would return to the financial markets in 2013. Therefore, there will be no net interest saving, based on the authors’ projections. Instead, there will be an additional cost of approximately €0.5bn (based on the 3.5% interest rate, rather than a projected interest rate of 6% in the financial market borrowings that are also assumed in the ESRI paper). As a result, the projected saving from a less onerous bank bailout is a net €12.5bn.
Taken together the actual interest rate saving of €8.5bn and projected saving on the bank bailout of €12.5bn combine for a total €21bn. This is equivalent to 11.4% of projected 2015 GDP.
Without these actual and projected windfalls, the ESRI forecast would otherwise have been 117.6% of GDP in 2015. This compares to a debt/GDP ratio of 94.9% in 2010.
Debt Dynamics
The idea that there will be no more bank bailouts has firmly taken hold and is largely responsible for the specific rally in Irish government debt in recent weeks. This is despite the fact that the EBA’s stress tests were widely discredited by the failure of two small Spanish banks shortly after publication, with total losses exceeding the EBA’s estimate of EU-wide recapitalisation requirements.
It may be the case that further losses do not require further recapitalisations. But the key exposure of the Irish banks is to the domestic economy, which continues to deteriorate on all forecasts, including those of the ESRI. This has an impact on the banking sector. Currently, this is most evident in the rise in the rate of mortgage defaults.
This highlights a key misconception regarding the relationship between the banking sector, government finances and the real economy. It is assumed that, if the banking sector is stabilised to the extent that it requires no further taxpayer funds, this will restore government finances to health, as long as public spending is reduced towards the level of taxation revenues (sufficient to provide a ‘primary surplus’, that is before interest payments are included). It is argued that, if all three occur, bank stabilisation, no more bailouts, a swing toward a primary surplus, then the crisis ‘will be over in 3 years’.
This is the premise that underlies a section of the ESRI paper dealing with debt dynamics. It is not denied that significant remedial action was required to resolve the crisis in the banking sector, even while many argue that a bailout of all their creditors was one of the least effective means of doing so. But, ever-greater contraction of the domestic economy can only be fatal to any ambitions to remove the banking sector from the life support it has been given by taxpayers. In effect, the ESRI and many others look through the world through the wrong end of the telescope. Neither banks’ balance sheets nor government finances can be restored to health until and unless there is an economic recovery.
The authors argue that, absent any further negative ‘shocks’, the debt/GDP ratio will begin to fall from 2013 onwards. The horizon for an imminent improvement never seems to alter. It is always 18 months hence. But the Irish economy received no external shocks in the way that economists use the term. The recession began here nearly a year before it began in the world economy, the slump in investment also a year earlier (which preceded the recession in both cases).
Three years ago in the Autumn 2008 Quarterly Economic Commentary the ESRI was forecasting a general government debt of 47.5% of GDP in 2009 and was fully supportive of government efforts to cut the deficit, in particular urging cuts in public sector pay. But this contractionary fiscal policy was a shock to the economy and the effect was slower growth, rising unemployment and falling tax revenues.
In the event, the debt/GDP ratio was 65.6% of GDP, not 47.5% in 2009, even while the government implemented ‘austerity’ measures equivalent to 9.1% of GDP. In effect the ESRI was forecasting a near-term deterioration in the debt level followed by stabilisation and then reduction, based on ‘austerity’. In fact a trawl through the QECs since 2008 shows that this debt profile is what the ESRI has been forecasting since 2008.
The authors clearly haven’t asked themselves the key question, so we must: Why will it be different this time?
However, this last contention, that ‘austerity works’, is not supported by the authors’ findings themselves. To quote their own summary of their paper, ‘[Our projected debt ratios are] much lower than had been projected in official figures earlier in the year, partly because the cost of the bank recapitalisation was much lower than anticipated and also because of the reduction in EU interest rates’.
So, the lower projections are based on the lower level of bank recapitalisation and lower rates for bailout funds for those recapitalisations. According to the authors’ abstract of their own findings, none of the projected improvement is attributable to ‘austerity’ measures.
Quality of Forecasts
But how ‘good’ are these forecasts, in both senses? First, what is the quantum of improvement that is being forecast by the ESRI? Secondly, how likely is it that these forecasts will prove correct? The debt ratios forecast by the ESRI are set out in the table below:
Debt Ratios, % GDP
Source: ESRI, Eurostat, IMF databank, Euro Area Spring Forecasts
The first point to note is that the ESRI is not projecting any reduction in the level of government debt over the period 2010 to 2015. Over that period, debt will rise from 94.9% of GDP to a projected 106.2%. It is in effect projecting a deterioration in the debt level to next year, then stabilisation and then a reduction. Both the IMF and Eurostat forecasts are much worse.
This disparity is a function of two factors. First, the Eurostat and IMF forecasts were made before the reduction in interest rates and before the lower projections for the level of the bank bailout were made. Secondly, the ESRI has stronger real growth projections than either Eurostat or the IMF.
Before dealing with the substantial point of how large the bailout and interest rate savings are, it is worth highlighting the main source of the discrepancy in growth forecasts. In effect, ESRI has a much larger growth forecast of +1.8% real GDP in 2010 than either Eurostat (+0.6%) or the IMF (+0.5%). The difference arises because whereas the IMF and Eurostat both have prices rising by 0.6% in 2010 to reduce real GDP by that degree, the ESRI projects falling prices of 1.1% (implied from the gap between real and nominal GDP (Table 7). Given that deflation both reduces the nominal level of taxation revenues while also increasing the ratio of existing debt to nominal GDP, there can be little argument that this ‘stronger’ growth forecast is responsible for the ESRI’s more optimistic debt/GDP forecasts.
Instead, it is the combination of lower interest rates and a lower projected bank bailout cost which is responsible for the projections of a substantially improved debt outlook. On the former, the consensus appears to be that the annual saving will be in the order of €1bn per annum, perhaps slightly more. Implicitly the ESRI authors assume a saving of €1.125bn per annum, on the basis of a former interest rate of 6% (p.20, point 2.). Compounded, this saving over a 5 year period amounts to €8.5bn or approximately 4.6% of the GDP level projected for 2015.
On the lower bank bailout costs, the international bailout of creditors to Irish banks in November 2010 included €10bn of immediate bank recapitalisation plus another contingency amount of €20bn. To date, of this a total of €17bn has been provided by the State (banks funding €7bn themselves in the financial markets for a total of €24bn). The ESRI authors expect €3bn to be repaid to the State by 2014. This ‘saving’ of €13bn also incurs interest. However, the authors now argue that funding from the Troika will be needed in 2014, even though the terms of the original bailout were that the government would return to the financial markets in 2013. Therefore, there will be no net interest saving, based on the authors’ projections. Instead, there will be an additional cost of approximately €0.5bn (based on the 3.5% interest rate, rather than a projected interest rate of 6% in the financial market borrowings that are also assumed in the ESRI paper). As a result, the projected saving from a less onerous bank bailout is a net €12.5bn.
Taken together the actual interest rate saving of €8.5bn and projected saving on the bank bailout of €12.5bn combine for a total €21bn. This is equivalent to 11.4% of projected 2015 GDP.
Without these actual and projected windfalls, the ESRI forecast would otherwise have been 117.6% of GDP in 2015. This compares to a debt/GDP ratio of 94.9% in 2010.
Debt Dynamics
The idea that there will be no more bank bailouts has firmly taken hold and is largely responsible for the specific rally in Irish government debt in recent weeks. This is despite the fact that the EBA’s stress tests were widely discredited by the failure of two small Spanish banks shortly after publication, with total losses exceeding the EBA’s estimate of EU-wide recapitalisation requirements.
It may be the case that further losses do not require further recapitalisations. But the key exposure of the Irish banks is to the domestic economy, which continues to deteriorate on all forecasts, including those of the ESRI. This has an impact on the banking sector. Currently, this is most evident in the rise in the rate of mortgage defaults.
This highlights a key misconception regarding the relationship between the banking sector, government finances and the real economy. It is assumed that, if the banking sector is stabilised to the extent that it requires no further taxpayer funds, this will restore government finances to health, as long as public spending is reduced towards the level of taxation revenues (sufficient to provide a ‘primary surplus’, that is before interest payments are included). It is argued that, if all three occur, bank stabilisation, no more bailouts, a swing toward a primary surplus, then the crisis ‘will be over in 3 years’.
This is the premise that underlies a section of the ESRI paper dealing with debt dynamics. It is not denied that significant remedial action was required to resolve the crisis in the banking sector, even while many argue that a bailout of all their creditors was one of the least effective means of doing so. But, ever-greater contraction of the domestic economy can only be fatal to any ambitions to remove the banking sector from the life support it has been given by taxpayers. In effect, the ESRI and many others look through the world through the wrong end of the telescope. Neither banks’ balance sheets nor government finances can be restored to health until and unless there is an economic recovery.
The authors argue that, absent any further negative ‘shocks’, the debt/GDP ratio will begin to fall from 2013 onwards. The horizon for an imminent improvement never seems to alter. It is always 18 months hence. But the Irish economy received no external shocks in the way that economists use the term. The recession began here nearly a year before it began in the world economy, the slump in investment also a year earlier (which preceded the recession in both cases).
Three years ago in the Autumn 2008 Quarterly Economic Commentary the ESRI was forecasting a general government debt of 47.5% of GDP in 2009 and was fully supportive of government efforts to cut the deficit, in particular urging cuts in public sector pay. But this contractionary fiscal policy was a shock to the economy and the effect was slower growth, rising unemployment and falling tax revenues.
In the event, the debt/GDP ratio was 65.6% of GDP, not 47.5% in 2009, even while the government implemented ‘austerity’ measures equivalent to 9.1% of GDP. In effect the ESRI was forecasting a near-term deterioration in the debt level followed by stabilisation and then reduction, based on ‘austerity’. In fact a trawl through the QECs since 2008 shows that this debt profile is what the ESRI has been forecasting since 2008.
The authors clearly haven’t asked themselves the key question, so we must: Why will it be different this time?
Wednesday, 13 July 2011
Why Irish debt is cut to junk status
Michael Burke: Moody’s is the first of the credit ratings agencies to cut Irish government debt to below investment grade – the sovereign debt is now ‘junk’. It will be recalled that when the ‘austerity’ programme was introduced- in reality a project to drive down wages and the social wage in order to revive profits- a key justification was that the financial markets needed reassurance that Ireland would remain credit-worthy.
Along with junk status, Irish 10yr yields at the time of writing are 13.65% and Irish 2yr yields are at 18.64%. This ‘inversion’ of the yield curve indicates the perceived market risk of the imminence of default. When the price of shorter-maturity debt falls below that of longer maturities it reflects the perceived risk of an immediate default. Currently Greek long and short-term debt are both trading fractionally above 50 cents in the Euro. Irish 2yr debt is just above 60 cents, while 10yr debt is around 55 cents.
This can be summarised as the view in the bonds market is that both are highly likely to default, and that Greece may do so very soon; Ireland might take a little longer.
There is some anger at Moody’s decision. The complaint is that successive Irish governments have done everything asked of them, that the programme agreed with the Troika is on track and that the real failing is the insufficient capital of the European Stability Mechanism.
These are strange complaints. It is true that successive governments have done everything asked of them – and more. In Fianna Fail’s case severe cuts were imposed when no international body was calling for them. But everything is not on track. Final domestic demand (the bit that actually generates jobs and taxes) is contracting at an annual rate of 5.5%. As a result, despite higher taxes and the imposition of the USC, tax revenues are actually below target and the shortfall seems to be growing. The complaint that the ESM is now not large enough to cope with the crisis in Greece, Ireland and Portugal (let alone Italy) is actually an admission that the problems are deepening.
Of course the interconnected European crisis is also a key factor. But this is far from a one-way street. The failed loans of German, British and French banks to the Irish banking sector and to the State are an important factor in the general crisis.
Moody’s offered this reason for the downgrade. “Ireland has shown a strong commitment to fiscal consolidation and has, to date, delivered on its programme objectives, the rating agency nevertheless notes that implementation risks remain significant, particularly in light of the continued weakness in the Irish economy”.
‘Implementation risk’ is a strange term in this context. It is often used, quite spuriously, in relation to Greece- the implication being that the protestors outside the Parliament in Syntagma Square are somehow preventing the implementation of the cuts and privatisations. On the contrary, all necessary legislation has been passed.
But there are no similar protests outside Leinster House. So in this context especially ‘implementation’ is an abuse of the language. All the packages have been implemented. But they have not been successful, the domestic economy continues to contract and tax revenues to decline as a result.
The reason they have not been successful is suggested in the Moody’s statement; “in light of the continued weakness in the Irish economy”. It is the weakness of the economy that is the source of the crisis, and the downgrade to junk status.
Without policies to re-establish growth, the Troika and the government are navigating the economy towards the rocks.
PS: if there is any silver lining from this round of the crisis, it is this: all talk that the widows and orphans of Ireland (or anywhere else) would be hurt by a default can end. Most pension or insurance funds would have exited high-risk sovereign debt markets a long time ago. But they are simply not allowed to invest in sub-investment grade debt, that is the point of the rating. The private holders of Irish debt are now banks, hedge funds, vulture funds and other parasites.
Along with junk status, Irish 10yr yields at the time of writing are 13.65% and Irish 2yr yields are at 18.64%. This ‘inversion’ of the yield curve indicates the perceived market risk of the imminence of default. When the price of shorter-maturity debt falls below that of longer maturities it reflects the perceived risk of an immediate default. Currently Greek long and short-term debt are both trading fractionally above 50 cents in the Euro. Irish 2yr debt is just above 60 cents, while 10yr debt is around 55 cents.
This can be summarised as the view in the bonds market is that both are highly likely to default, and that Greece may do so very soon; Ireland might take a little longer.
There is some anger at Moody’s decision. The complaint is that successive Irish governments have done everything asked of them, that the programme agreed with the Troika is on track and that the real failing is the insufficient capital of the European Stability Mechanism.
These are strange complaints. It is true that successive governments have done everything asked of them – and more. In Fianna Fail’s case severe cuts were imposed when no international body was calling for them. But everything is not on track. Final domestic demand (the bit that actually generates jobs and taxes) is contracting at an annual rate of 5.5%. As a result, despite higher taxes and the imposition of the USC, tax revenues are actually below target and the shortfall seems to be growing. The complaint that the ESM is now not large enough to cope with the crisis in Greece, Ireland and Portugal (let alone Italy) is actually an admission that the problems are deepening.
Of course the interconnected European crisis is also a key factor. But this is far from a one-way street. The failed loans of German, British and French banks to the Irish banking sector and to the State are an important factor in the general crisis.
Moody’s offered this reason for the downgrade. “Ireland has shown a strong commitment to fiscal consolidation and has, to date, delivered on its programme objectives, the rating agency nevertheless notes that implementation risks remain significant, particularly in light of the continued weakness in the Irish economy”.
‘Implementation risk’ is a strange term in this context. It is often used, quite spuriously, in relation to Greece- the implication being that the protestors outside the Parliament in Syntagma Square are somehow preventing the implementation of the cuts and privatisations. On the contrary, all necessary legislation has been passed.
But there are no similar protests outside Leinster House. So in this context especially ‘implementation’ is an abuse of the language. All the packages have been implemented. But they have not been successful, the domestic economy continues to contract and tax revenues to decline as a result.
The reason they have not been successful is suggested in the Moody’s statement; “in light of the continued weakness in the Irish economy”. It is the weakness of the economy that is the source of the crisis, and the downgrade to junk status.
Without policies to re-establish growth, the Troika and the government are navigating the economy towards the rocks.
PS: if there is any silver lining from this round of the crisis, it is this: all talk that the widows and orphans of Ireland (or anywhere else) would be hurt by a default can end. Most pension or insurance funds would have exited high-risk sovereign debt markets a long time ago. But they are simply not allowed to invest in sub-investment grade debt, that is the point of the rating. The private holders of Irish debt are now banks, hedge funds, vulture funds and other parasites.
Tuesday, 24 May 2011
How will it end?
Tom McDonnell: It is too early to tell but there are worrying signs that the Euro zone crisis may spread. Bond spreads for Spanish and Italian 10-year bonds have shot up in recent days. A WestLB Strategist is quoted by Reuters as saying: 'The key point is that the crisis seems to be taking hold even if peripheral countries regarded as solid'
Daniel Gros over at VOXEU has run the numbers and is arguing that it is actually foreign debt rather than public debt that is driving the solvency turmoil in the Euro zone. Meanwhile Paolo Manasse is adding to the chorus pointing out the likeihood of a Greek default.
There are three ways this can end (assuming the monetary union doesn't break up):
The ball is clearly in Germany's court. Eurointelligence provides a useful overview of the current thinking in that country.
Daniel Gros over at VOXEU has run the numbers and is arguing that it is actually foreign debt rather than public debt that is driving the solvency turmoil in the Euro zone. Meanwhile Paolo Manasse is adding to the chorus pointing out the likeihood of a Greek default.
There are three ways this can end (assuming the monetary union doesn't break up):
- Roll over existing debts for the forseeable future (at a more sustainable cost of borrowing)
- Restructure the debts, or
- Introduce Euro bonds
The ball is clearly in Germany's court. Eurointelligence provides a useful overview of the current thinking in that country.
Thursday, 12 May 2011
Options on default
Tom O'Connor: Doomsday scenarios have been painted recently by Prof. Morgan Kelly and others concerning the need to abandon to EU/IMF deal on the one hand or totally repudiate the debt on the other. Kelly has suggested we abandon the bailout and balance the exchequer books immediately. Balancing the books immediately is not an option however.
The newly elected Fine Gael TD Paschal Donohoe has warned against abandoning the bailout, predicting huge cuts in social welfare. The Central Bank Governor, Paddy Honohan is defending the bailout and fighting to save his reputation. There is a huge amount of kneejerk-ism around and people taking sides. I attempt in this post to stand back and examine evidence which might inform the way forward.
Let’s start with the most radical scenario, Argentina: In 2002, it had developed a triple financial crisis in terms of its unmanageable fiscal deficit, banks which were broke and ultimately a government external debt crisis as a result. To a large extent, this is where Ireland is right now. In January 2002, Argentina essentially abruptly defaulted on $81.8 billion of its external debt without consultation with creditors.
This led to a run on the banks. It wiped out the savings of citizens. It dramatically increased the cost of borrowing by the government and deflated the size of the economy by 25% in one year from 2001 to 2002. The collapse of the currency greatly indebted the country also, as much of it was denominated in dollars.
For many years afterwards, Argentinean credit has been more costly in its bond spreads. Bond debt has been more costly there and in Ecuador, far higher than in other countries which had restructured their debt with creditors in advance, such as Ukraine (1998) and Uruguay (2003).
Argentina and Ecuador also imposed large haircuts on the debt on which it defaulted, far higher than that of countries which had negotiated in advance. Ukraine and Uruguay imposed lower haircuts and in the years that followed, their bond spreads were lower. This means that they could subsequently borrow more cheaply as a reflection of the greater level of international trust in these countries.
Nonetheless all four countries did eventually formally agree repayment terms with the IMF, either pre-default or post-default. This happened under the IMF’s Sovereign Debt Restructuring Mechanism (SDRM). According to Professor Nouriel Roublini, at this point the European Union should examine this mechanism as the way forward for debt restructuring, and not be wasting its time looking for new legal mechanisms.
Working on his evidence as well as that contained in work by De Paoli (2006), Gelos (2004) and others, there is strong evidence to suggest that the preferred option is a partial and negotiated restructuring of debt in advance of a default. The term ‘restructuring’ sounds more positive and is more advantageous.
Nonetheless, a negotiated ‘restructuring’ is still a default according to the eminent work of Reinhart and Rogoff (2009). The benefits of lower bond spreads in the years following a ‘restructuring’ or ‘exchange offer’ (Roubini) of a restructured debt are augmented by a significantly less negative impact on growth in the years ahead on the ability raise finance internationally. This negotiated mechanism (as in the SDRM) reduces ‘deadweight costs’ also such as costly legal proceedings. It is infinitely better than allowing a country to stumble towards default to the destruction of its economy. This resembles death by a thousand cuts.
Taking this eminent advice on board, I would suggest that the EU/IMF deal needs to rescinded and replaced with Ireland cutting a deal on external debt, including sovereign debt and the debts of the Irish Banks.
The current bailout offers bad terms for Ireland. The prospect of repaying 70 billion worth of bank debt without any deal on writing down the bonds involved, at a rate of interest of 5.8% cannot be done, particularly as it will have to be paid in conjunction with sovereign exchequer debt. The repayment of 8 billion a year in interest is off the scale.
On the basis of the evidence from international experience, the bailout needs to be replaced by an IMF led Sovereign Debt Restructuring Mechanism (SDRM). Many Irish economists have pointed to the fact that under the current bailout, Ireland will become insolvent by 2014. The country cannot sit back and wait for this to happen. Instead, it needs to offer, along with other euro zone countries in danger of default, what Roubini terms a ‘pre-emptive, pre-default exchange rate offer’.
Without a default, national debt will be 225 billion in 2014 and our GDP according to the Dept of Finance will be only 184, a debt/GDP ratio of 122%. This figure 225 does not include NAMA. This 184 debt would include 70 billion of bank debt if we include the recapitalisations from 2008 till then. At that point, the sustained debt would be over twice the international solvency rule of thumb whereby a country needs to keep its debt below 60% of GDP.
The Roubini Pre-Default Exchange Offer under existing IMF rules should be done in the same was as was done in Pakistan, Uruguay or Ukraine and in many other countries in recent years. The EU/IMF deal should be cast aside.
This would be a partial default. It needs to be planned with creditors. A haircut of at least 50% on the bank debt of 70 billion needs to be agreed right away. Haircuts of this magnitude have been proposed by Rogoff and Roubini.
Exchequer debt needs to be extended well beyond the 7.5 years of average maturity which exists under the EU/IMF deal. A significant cut in the interest rate on sovereign external debt will also be necessary alongside a possible haircut also. The 160 billion owed to the ECB by Irish banks will also need to be restructured. These are some of the areas of ‘offer’ that the Irish government needs to make to its creditors.
Another international model which might inform the default is that of South East Asia in the late 1990s. After receiving IMF funds, they opted out of their quasi-fixed exchange rate with the dollar and devalued significantly. They recovered economically far more quickly than Hong Kong which stuck with the dollar. If Ireland sticks with the euro under a default, its recovery will take longer, as happened in Hong Kong. By contrast, the devaluation of the currencies in Thailand, Indonesia and South Korea greatly added stimulation to their economic recovery.
This scenario would help greatly in avoiding severe cutbacks in wages, social welfare payments and public spending. The scale of future GNP increases is also key to preventing punitive measures been implemented by the Irish government on its population. A significant economic stimulus is needed in this regard.
Despite the warnings of some commentators however, the published evidence does not necessarily support the inevitability that pay rates in the public sector and social welfare payments will automatically be dramatically cut in the event of a default.
If a default is ‘offered’ pre-emptively by a country in negotiation with creditors and particularly under the IMF (SDRM), recovery may happen within three years according to the in-depth research by Reinhart and Rogoff of Harvard. With access to capital markets within months and growth restored quickly, penal cuts to public pay and welfare are not in any way an inevitable and may in fact be prevented.
After a default, countries are not ‘blacked’ for finance for long periods and usually can access market finance within four months in many cases, according to a study by Gelos (2004). An exhaustive World Bank study by Zettelmeyer and Sturzenegger (2007) also echoes the view that default is far from a doomsday scenario. Many countries recovered quickly despite the negative effects on economic growth and the increased cost of borrowing. Argentina and Russia are cases in point.
In addition, it may well be the case that the blanket austerity being demanded by the EU and IMF under the bailout plan would be a lot worse and more punitive on those not responsible for the problem, than would a structured default where Ireland exerts more control on its own affairs.
It is obvious that Greece Will negotiate a default very soon. It seems increasingly likely that the EU cannot hold back the tide of default. The Portuguese bailout may never fully even get off the blocks and it certainly does not look sustainable.
The Irish government needs to stop burying its head in the sand and posturing about a possible lowering of the interest rate in the bailout. This bailout will not work. Modelling from other countries demonstrates that a negotiated default needs to happen as soon as possible. This will give the economy a better chance of bouncing back quickly, a lesson that has been learned from Japan’s stubbornness in this regard heretofore.
A Debt Audit Commission was set up in Ecuador in 2007. Some unions, academics and civil society groups have been calling for one to be set up in Ireland. This will determine the fairest course of action on defaulting. This could inform the way forward.
this piece originally appeared in the Irish Examiner
The newly elected Fine Gael TD Paschal Donohoe has warned against abandoning the bailout, predicting huge cuts in social welfare. The Central Bank Governor, Paddy Honohan is defending the bailout and fighting to save his reputation. There is a huge amount of kneejerk-ism around and people taking sides. I attempt in this post to stand back and examine evidence which might inform the way forward.
Let’s start with the most radical scenario, Argentina: In 2002, it had developed a triple financial crisis in terms of its unmanageable fiscal deficit, banks which were broke and ultimately a government external debt crisis as a result. To a large extent, this is where Ireland is right now. In January 2002, Argentina essentially abruptly defaulted on $81.8 billion of its external debt without consultation with creditors.
This led to a run on the banks. It wiped out the savings of citizens. It dramatically increased the cost of borrowing by the government and deflated the size of the economy by 25% in one year from 2001 to 2002. The collapse of the currency greatly indebted the country also, as much of it was denominated in dollars.
For many years afterwards, Argentinean credit has been more costly in its bond spreads. Bond debt has been more costly there and in Ecuador, far higher than in other countries which had restructured their debt with creditors in advance, such as Ukraine (1998) and Uruguay (2003).
Argentina and Ecuador also imposed large haircuts on the debt on which it defaulted, far higher than that of countries which had negotiated in advance. Ukraine and Uruguay imposed lower haircuts and in the years that followed, their bond spreads were lower. This means that they could subsequently borrow more cheaply as a reflection of the greater level of international trust in these countries.
Nonetheless all four countries did eventually formally agree repayment terms with the IMF, either pre-default or post-default. This happened under the IMF’s Sovereign Debt Restructuring Mechanism (SDRM). According to Professor Nouriel Roublini, at this point the European Union should examine this mechanism as the way forward for debt restructuring, and not be wasting its time looking for new legal mechanisms.
Working on his evidence as well as that contained in work by De Paoli (2006), Gelos (2004) and others, there is strong evidence to suggest that the preferred option is a partial and negotiated restructuring of debt in advance of a default. The term ‘restructuring’ sounds more positive and is more advantageous.
Nonetheless, a negotiated ‘restructuring’ is still a default according to the eminent work of Reinhart and Rogoff (2009). The benefits of lower bond spreads in the years following a ‘restructuring’ or ‘exchange offer’ (Roubini) of a restructured debt are augmented by a significantly less negative impact on growth in the years ahead on the ability raise finance internationally. This negotiated mechanism (as in the SDRM) reduces ‘deadweight costs’ also such as costly legal proceedings. It is infinitely better than allowing a country to stumble towards default to the destruction of its economy. This resembles death by a thousand cuts.
Taking this eminent advice on board, I would suggest that the EU/IMF deal needs to rescinded and replaced with Ireland cutting a deal on external debt, including sovereign debt and the debts of the Irish Banks.
The current bailout offers bad terms for Ireland. The prospect of repaying 70 billion worth of bank debt without any deal on writing down the bonds involved, at a rate of interest of 5.8% cannot be done, particularly as it will have to be paid in conjunction with sovereign exchequer debt. The repayment of 8 billion a year in interest is off the scale.
On the basis of the evidence from international experience, the bailout needs to be replaced by an IMF led Sovereign Debt Restructuring Mechanism (SDRM). Many Irish economists have pointed to the fact that under the current bailout, Ireland will become insolvent by 2014. The country cannot sit back and wait for this to happen. Instead, it needs to offer, along with other euro zone countries in danger of default, what Roubini terms a ‘pre-emptive, pre-default exchange rate offer’.
Without a default, national debt will be 225 billion in 2014 and our GDP according to the Dept of Finance will be only 184, a debt/GDP ratio of 122%. This figure 225 does not include NAMA. This 184 debt would include 70 billion of bank debt if we include the recapitalisations from 2008 till then. At that point, the sustained debt would be over twice the international solvency rule of thumb whereby a country needs to keep its debt below 60% of GDP.
The Roubini Pre-Default Exchange Offer under existing IMF rules should be done in the same was as was done in Pakistan, Uruguay or Ukraine and in many other countries in recent years. The EU/IMF deal should be cast aside.
This would be a partial default. It needs to be planned with creditors. A haircut of at least 50% on the bank debt of 70 billion needs to be agreed right away. Haircuts of this magnitude have been proposed by Rogoff and Roubini.
Exchequer debt needs to be extended well beyond the 7.5 years of average maturity which exists under the EU/IMF deal. A significant cut in the interest rate on sovereign external debt will also be necessary alongside a possible haircut also. The 160 billion owed to the ECB by Irish banks will also need to be restructured. These are some of the areas of ‘offer’ that the Irish government needs to make to its creditors.
Another international model which might inform the default is that of South East Asia in the late 1990s. After receiving IMF funds, they opted out of their quasi-fixed exchange rate with the dollar and devalued significantly. They recovered economically far more quickly than Hong Kong which stuck with the dollar. If Ireland sticks with the euro under a default, its recovery will take longer, as happened in Hong Kong. By contrast, the devaluation of the currencies in Thailand, Indonesia and South Korea greatly added stimulation to their economic recovery.
This scenario would help greatly in avoiding severe cutbacks in wages, social welfare payments and public spending. The scale of future GNP increases is also key to preventing punitive measures been implemented by the Irish government on its population. A significant economic stimulus is needed in this regard.
Despite the warnings of some commentators however, the published evidence does not necessarily support the inevitability that pay rates in the public sector and social welfare payments will automatically be dramatically cut in the event of a default.
If a default is ‘offered’ pre-emptively by a country in negotiation with creditors and particularly under the IMF (SDRM), recovery may happen within three years according to the in-depth research by Reinhart and Rogoff of Harvard. With access to capital markets within months and growth restored quickly, penal cuts to public pay and welfare are not in any way an inevitable and may in fact be prevented.
After a default, countries are not ‘blacked’ for finance for long periods and usually can access market finance within four months in many cases, according to a study by Gelos (2004). An exhaustive World Bank study by Zettelmeyer and Sturzenegger (2007) also echoes the view that default is far from a doomsday scenario. Many countries recovered quickly despite the negative effects on economic growth and the increased cost of borrowing. Argentina and Russia are cases in point.
In addition, it may well be the case that the blanket austerity being demanded by the EU and IMF under the bailout plan would be a lot worse and more punitive on those not responsible for the problem, than would a structured default where Ireland exerts more control on its own affairs.
It is obvious that Greece Will negotiate a default very soon. It seems increasingly likely that the EU cannot hold back the tide of default. The Portuguese bailout may never fully even get off the blocks and it certainly does not look sustainable.
The Irish government needs to stop burying its head in the sand and posturing about a possible lowering of the interest rate in the bailout. This bailout will not work. Modelling from other countries demonstrates that a negotiated default needs to happen as soon as possible. This will give the economy a better chance of bouncing back quickly, a lesson that has been learned from Japan’s stubbornness in this regard heretofore.
A Debt Audit Commission was set up in Ecuador in 2007. Some unions, academics and civil society groups have been calling for one to be set up in Ireland. This will determine the fairest course of action on defaulting. This could inform the way forward.
this piece originally appeared in the Irish Examiner
Friday, 15 April 2011
Troika statement: It's Friday, let's go to the pub
From the statement by the EC, ECB and IMF released today:
‘The teams’ assessment is that the program is on track but challenges remain and steadfast policy implementation will be key.’
Oh. I wonder if they are referring to the National Recovery Plan which the three institutions endorsed and became the basis of the Memorandum of Understanding; or maybe there is some secret, super-encrypted plan which the masses don’t have access to. Let’s go through the headings.
The Macro-economic Outlook
The NRP projected growth up to 2014 to be 2.7 percent annual average. The IMF projects an average of just under 2 percent. According to the ESRI, at 2 percent we risk a deflationary spiral. In addition, the IMF is projecting nominal GDP to be some €10 billion less than the NRP estimates – over 5 percent less. There’s hitting targets and then there’s hitting targets.
The Bank Sector
This doesn’t pose too much of a problem for the cheerleaders of the NRP. If €24 billion in new recapitalisation won’t do the trick, then there’s always another €20 billion waiting to be burned up. And if that doesn’t do it, there’s always the Central Bank’s Hibernian QE. There is no shortage of money to be thrown at the problem – and as we all know, the taxpayers’ pockets are black-hole deep.
The Fiscal Front
The NRP claimed it could get the deficit down to under 3 percent by 2014. The IMF projects that on current trends it will be 2017 or 2018. On that small matter of the debt, the NRP hoped to keep it 100 percent of GDP – the IMF says, no, it will be 25 percent higher.
Structural Reforms
But not to worry, the IMF believes this will do the trick. Cutting workers wages always promotes growth – and cutting low-paid workers’ wages via ‘reform’ of the JLC will no doubt double that growth.
* * *
On just about every metric the NRP, which forms the basis of the bail-out deal, is completely defunct. Yet the Troika says everything is just as it should be.
I know why. It’s Friday. What would you rather do? Admit ‘game over’, sit down and work on something new? Or sign-off on a statement and get to the pub? I mean, the Troika are only human.
And let’s forget the small matter of the debt. The NRP was hoping to keep debt at 100 percent of GDP. The IMF projects it to be 124 percent.
‘The teams’ assessment is that the program is on track but challenges remain and steadfast policy implementation will be key.’
Oh. I wonder if they are referring to the National Recovery Plan which the three institutions endorsed and became the basis of the Memorandum of Understanding; or maybe there is some secret, super-encrypted plan which the masses don’t have access to. Let’s go through the headings.
The Macro-economic Outlook
The NRP projected growth up to 2014 to be 2.7 percent annual average. The IMF projects an average of just under 2 percent. According to the ESRI, at 2 percent we risk a deflationary spiral. In addition, the IMF is projecting nominal GDP to be some €10 billion less than the NRP estimates – over 5 percent less. There’s hitting targets and then there’s hitting targets.
The Bank Sector
This doesn’t pose too much of a problem for the cheerleaders of the NRP. If €24 billion in new recapitalisation won’t do the trick, then there’s always another €20 billion waiting to be burned up. And if that doesn’t do it, there’s always the Central Bank’s Hibernian QE. There is no shortage of money to be thrown at the problem – and as we all know, the taxpayers’ pockets are black-hole deep.
The Fiscal Front
The NRP claimed it could get the deficit down to under 3 percent by 2014. The IMF projects that on current trends it will be 2017 or 2018. On that small matter of the debt, the NRP hoped to keep it 100 percent of GDP – the IMF says, no, it will be 25 percent higher.
Structural Reforms
But not to worry, the IMF believes this will do the trick. Cutting workers wages always promotes growth – and cutting low-paid workers’ wages via ‘reform’ of the JLC will no doubt double that growth.
* * *
On just about every metric the NRP, which forms the basis of the bail-out deal, is completely defunct. Yet the Troika says everything is just as it should be.
I know why. It’s Friday. What would you rather do? Admit ‘game over’, sit down and work on something new? Or sign-off on a statement and get to the pub? I mean, the Troika are only human.
And let’s forget the small matter of the debt. The NRP was hoping to keep debt at 100 percent of GDP. The IMF projects it to be 124 percent.
Monday, 21 March 2011
Debt-equity swap for banks won't work
Michael Burke: The sheer size of the bank debts being assumed by the State has led to a flurry of alternative proposals which might diminish the burden to taxpayers. The latest proposal is from Karl Whelan, who has proposed a debt-for-equity swap to recapitalise the banks. This has received some mixed support.
But it fails on the first count: it doesn’t reduce taxpayers’ burden at all, it increases it. Scandalously, it does so in order to reimburse bondholders for every last cent of their failed investments.
For Irish taxpayers, the form of the bank bailout, debt or equity, is less important than the amounts involved. It was the last government’s determination to bail out the banks which led to the arrival of the EU/IMF. More precisely, it was the government’s position combined with the refusal of the ECB to countenance further liquidity support for the banks without a bailout for EU banks which brought the EU/IMF impositions.
Under the latest proposal €150bn would be required to recapitalise the banks, which would be achieved by the Irish central bank converting its €70bn in short-term loans to the 6 Irish banks guaranteed by the State into equity. There is a hope that the European Financial Stability Fund (EFSF) would also do the same for the €80bn in loans from the ECB.
If, as Karl Whelan suggests, the true picture is that the 6 banks’ underlying value is approximately -€30bn, yes, that’s a minus number, then the immediate loss incurred by both would be 20% with the CBoI losing €14bn and the EFSF’s loss would be €16bn. Quite why the European authorities would agree to this is not explained, even if others have suggested that Irish referendum voters won’t play ball when there are the (inevitable) further Treaty changes. In context, the European authorities have dug their heels over a 1% cut in the punitive interest rate levied on Irish taxpayers, which would only yield a saving of €450mn per annum.
By contrast a unilateral repudiation of the bank portion of the debt requires no agreement, just a determination to carry out what’s fair and reasonable. That determination alone might even be enough to force a more reasonable stance from the EU itself.
The unwillingness of the EU authorities seems a fundamental practical objection to the plan. But there is an obvious objection in principle. Why would taxpayers in either Ireland or the rest of the EU provide massive amounts of new capital for worthless institutions and their bondholders, or shareholders? It is unfortunate that Whelan, an effective scourge of the previous government’s support for the banks, now seems to accept that the bondholders are to be made whole, while taxpayers, and State finances take the enormous strain.
Whatever the unacceptability and immorality of the plan- it simply won’t work. The ECB has no intention of ‘printing money’ to bailout one of lesser members- the EFSF is borrowed capital ultimately financed by taxpayers. Neither is the ECB is unlikely to allow the CboI to do the same. All of the capital to be handed over for failed investments in Irish banks must come from taxpayers.
In the dizzying collapse of the Irish financial sector - and the authorities’ determination both in European and in Ireland that the private sector be protected from the consequences of their own investment decisions - it is easy to forget that November ‘s €35bn bank bailout provided the tipping point- into the tender embrace of the EU & IMF . Suggesting that the crisis can be resolved by a €70bn bailout has no logic. Irish taxpayers potentially picking up the bill of €150bn (and at an annual interest bill of over €4bn) for the most over-capitalised banks in the world would be simply bizarre.
Although the bank bailout sums are getting greater, and may become greater still if the stress tests are at all serious, the same principles hold. Irish taxpayers can’t pay for a bank bailout. Nor should they.
But it fails on the first count: it doesn’t reduce taxpayers’ burden at all, it increases it. Scandalously, it does so in order to reimburse bondholders for every last cent of their failed investments.
For Irish taxpayers, the form of the bank bailout, debt or equity, is less important than the amounts involved. It was the last government’s determination to bail out the banks which led to the arrival of the EU/IMF. More precisely, it was the government’s position combined with the refusal of the ECB to countenance further liquidity support for the banks without a bailout for EU banks which brought the EU/IMF impositions.
Under the latest proposal €150bn would be required to recapitalise the banks, which would be achieved by the Irish central bank converting its €70bn in short-term loans to the 6 Irish banks guaranteed by the State into equity. There is a hope that the European Financial Stability Fund (EFSF) would also do the same for the €80bn in loans from the ECB.
If, as Karl Whelan suggests, the true picture is that the 6 banks’ underlying value is approximately -€30bn, yes, that’s a minus number, then the immediate loss incurred by both would be 20% with the CBoI losing €14bn and the EFSF’s loss would be €16bn. Quite why the European authorities would agree to this is not explained, even if others have suggested that Irish referendum voters won’t play ball when there are the (inevitable) further Treaty changes. In context, the European authorities have dug their heels over a 1% cut in the punitive interest rate levied on Irish taxpayers, which would only yield a saving of €450mn per annum.
By contrast a unilateral repudiation of the bank portion of the debt requires no agreement, just a determination to carry out what’s fair and reasonable. That determination alone might even be enough to force a more reasonable stance from the EU itself.
The unwillingness of the EU authorities seems a fundamental practical objection to the plan. But there is an obvious objection in principle. Why would taxpayers in either Ireland or the rest of the EU provide massive amounts of new capital for worthless institutions and their bondholders, or shareholders? It is unfortunate that Whelan, an effective scourge of the previous government’s support for the banks, now seems to accept that the bondholders are to be made whole, while taxpayers, and State finances take the enormous strain.
Whatever the unacceptability and immorality of the plan- it simply won’t work. The ECB has no intention of ‘printing money’ to bailout one of lesser members- the EFSF is borrowed capital ultimately financed by taxpayers. Neither is the ECB is unlikely to allow the CboI to do the same. All of the capital to be handed over for failed investments in Irish banks must come from taxpayers.
In the dizzying collapse of the Irish financial sector - and the authorities’ determination both in European and in Ireland that the private sector be protected from the consequences of their own investment decisions - it is easy to forget that November ‘s €35bn bank bailout provided the tipping point- into the tender embrace of the EU & IMF . Suggesting that the crisis can be resolved by a €70bn bailout has no logic. Irish taxpayers potentially picking up the bill of €150bn (and at an annual interest bill of over €4bn) for the most over-capitalised banks in the world would be simply bizarre.
Although the bank bailout sums are getting greater, and may become greater still if the stress tests are at all serious, the same principles hold. Irish taxpayers can’t pay for a bank bailout. Nor should they.
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