Tom McDonnell: As well as being World and European football champions Spain also currently holds the distinction of having the world record for number of sovereign defaults. Spain defaulted six times on its external debts in the period between 1557 and 1647 and a further seven times between 1809 and 1882. Thirteen in all.
Spain will clearly be the key battleground of the debt crisis. Already things do not look good and the bank recapitalisation process is now set to begin in earnest. The Spanish Government nationalised Bankia yesterday. This may well prove the first of a number of nationalisations. Veteran observers of the Irish bank bailout will watch with great trepidation as this story unfolds and the full scale of the losses in the Spanish banking sector become clear.
According to the European Commission Spain is unlikely to meet its deficit targets this year or the next while yields for Spanish 10 year bonds were 6.171% as of this morning, a level that is unsustainable over the long term. Arguably Spain is now insolvent and it could easily totter into a bad equilibrium whereby it is de facto locked out of private markets and requires rescuing by a bailout fund. Over at the FT Nouriel Roubini and Megan Greene are pessimistic. They argue that:
"The only way for there to be a happy ending in Spain is if action is taken swiftly in Brussels, Frankfurt and other European capitals. But that is not likely to happen. The eurozone periphery and Spanish crisis look like a slow-motion train wreck."
The bailout packages (EFSF, ESM) as designed are inherently fragile in nature and certainly not suitable for a country of Spain's size. Worsening figures in Spain and the threat of a fourteenth external default could be the catalyst for the ESM to get a banking licence. That would completely change the dynamic of the debt crisis.
Showing posts with label default. Show all posts
Showing posts with label default. Show all posts
Thursday, 10 May 2012
Monday, 13 February 2012
Guest post by Arthur Doohan: Loose lips sink ships
Arthur Doohan: The "grown-up's" will remember the opening sequence to the 'Mission Impossible' TV series, where the tape self destructs a few seconds after being played.
I have sad news for you. That technology has not been perfected.
So ... There is no way for Draghi, Barroso, Van Rompuy or Merkozy to make your Euro notes or those in the bank's ATMS disappear in a puff of smoke.
As we teeter on the brink of a possible debt crisis, there is a lot of loose talk flying around about the death of the Euro and about Ireland being thrown out of the "Euro". Such talk is ill-informed, ignorant and, at a time of distress and fear, it is scaremongering, if not actually amounting to "shouting 'Fire!' in a crowded cinema".
Money is …..whatever people deem it to be. In the past money has been: cowrie shells, temple vouchers, unopened packs of "fags" and bits of metal. Today, money is mainly electrons, some paper and a few bits of base metal "dressed as lamb". We worked hard, jointly with our European partners, to re-denominate our money into a jointly held and managed currency called the Euro.
And now, there is nothing, NOTHING, that can stop the Euro being our currency.
Firstly, we are an equal partner in the Target2 payments system that the ECB uses as a clearing house for the Central Banks of the Euro-system to make and receive payments. Further, no authority in either the EU or the ECB has said that anyone can or will be kicked out of the Euro. There is no process for so doing and there can not be under the current treaties. Again, with respect to the currency, there is, quite deliberately and by design, no way of telling a Greek from an Irish from a French Euro.
Secondly, when Argentina defaulted on her US dollar debts it did not stop the dollar being a valid currency in Japan or in the US. It did not stop the majority of Argentinian business being conducted in US dollars. It weakened the Argentinian Peso and made the overall debt burden greater. But that can't happen to us because our debts are denominated in our own currency (the Euro). Even if Ireland decided to default on some of her sovereign obligations, it would make no difference to your usage of the currency or to a German person's usage of it or to the French Government's usage.
Finally, the concept of 'leaving the Euro' is often referred to as some form of solution, as if our troubles would be over if we cast off the yoke of Euro-usage. Nothing could be further from reality and the truth.
If we left the Euro we would have to 1) print and distribute a new currency, 2) institute capital controls (in a vain attempt to stop money leaving the State, and which might now be un-Constitutional), 3)attempt to establish and then defend a value in Euro terms for this currency (with all the interest rate volatility that implies and requires), 4) institute import and export controls in order to prop up the capital controls (with all the extra costs and delays for business that implies).
Further, just who would be leaving the Euro? Probably just the State in terms of redefining exactly what 'legal tender' would be for tax and contract purposes. But the State could not seize the Euros in your bank account and force them to be changed to 'NewPunts' or whatever. So we would become like Argentina with a weak official currency for State and tax related transactions and civil service pay and an external currency (Dollars for them, Euros in our case) for 'real stuff'.
And what would we get in exchange for all that trouble? Only the opportunity to say 'We can't pay you back everything we owe you'.
I am not recommending, in this post, any particular course of action. I just want to see an end to the loose talk and the propagation of fear, uncertainty and doubt as a means for ill informed politicians to bludgeon people into agreeing with them. I have in mind particularly suggestions that our ATMs would 'run dry' if there were to be a default.
To suggest that anyone in Europe would attempt or even think of stopping Irish citizens from buying their daily bread in reaction to a problem created by Irish politicians is to display an ignorance of how such systems work, and to the people and the Commission of the EU.
The Euro is not the problem. The Euro works, and works tremendously well as its endurance of the upheavals and stresses of the last few years have shown.
The design of the 'Growth and Stability Pact' is not the problem. Since it was never enforced (and Germany was the worst and longest rule breaker) it cannot be said to have failed and all of the debt problems we now have are the exact things the GSP was designed to prevent.
The problem is the level of debt some countries are carrying. This is an old problem, and the old answer was always a currency devaluation. Since we all have the same currency now we can't do that. But a debt 'haircut' amounts to the same thing.
So, can we please take a haircut now before we all go bald?
Arthur Doohan is a former banker currently promoting a public policy debate on alternative solutions to the debt crisis in Ireland and to bank restructuring
I have sad news for you. That technology has not been perfected.
So ... There is no way for Draghi, Barroso, Van Rompuy or Merkozy to make your Euro notes or those in the bank's ATMS disappear in a puff of smoke.
As we teeter on the brink of a possible debt crisis, there is a lot of loose talk flying around about the death of the Euro and about Ireland being thrown out of the "Euro". Such talk is ill-informed, ignorant and, at a time of distress and fear, it is scaremongering, if not actually amounting to "shouting 'Fire!' in a crowded cinema".
Money is …..whatever people deem it to be. In the past money has been: cowrie shells, temple vouchers, unopened packs of "fags" and bits of metal. Today, money is mainly electrons, some paper and a few bits of base metal "dressed as lamb". We worked hard, jointly with our European partners, to re-denominate our money into a jointly held and managed currency called the Euro.
And now, there is nothing, NOTHING, that can stop the Euro being our currency.
Firstly, we are an equal partner in the Target2 payments system that the ECB uses as a clearing house for the Central Banks of the Euro-system to make and receive payments. Further, no authority in either the EU or the ECB has said that anyone can or will be kicked out of the Euro. There is no process for so doing and there can not be under the current treaties. Again, with respect to the currency, there is, quite deliberately and by design, no way of telling a Greek from an Irish from a French Euro.
Secondly, when Argentina defaulted on her US dollar debts it did not stop the dollar being a valid currency in Japan or in the US. It did not stop the majority of Argentinian business being conducted in US dollars. It weakened the Argentinian Peso and made the overall debt burden greater. But that can't happen to us because our debts are denominated in our own currency (the Euro). Even if Ireland decided to default on some of her sovereign obligations, it would make no difference to your usage of the currency or to a German person's usage of it or to the French Government's usage.
Finally, the concept of 'leaving the Euro' is often referred to as some form of solution, as if our troubles would be over if we cast off the yoke of Euro-usage. Nothing could be further from reality and the truth.
If we left the Euro we would have to 1) print and distribute a new currency, 2) institute capital controls (in a vain attempt to stop money leaving the State, and which might now be un-Constitutional), 3)attempt to establish and then defend a value in Euro terms for this currency (with all the interest rate volatility that implies and requires), 4) institute import and export controls in order to prop up the capital controls (with all the extra costs and delays for business that implies).
Further, just who would be leaving the Euro? Probably just the State in terms of redefining exactly what 'legal tender' would be for tax and contract purposes. But the State could not seize the Euros in your bank account and force them to be changed to 'NewPunts' or whatever. So we would become like Argentina with a weak official currency for State and tax related transactions and civil service pay and an external currency (Dollars for them, Euros in our case) for 'real stuff'.
And what would we get in exchange for all that trouble? Only the opportunity to say 'We can't pay you back everything we owe you'.
I am not recommending, in this post, any particular course of action. I just want to see an end to the loose talk and the propagation of fear, uncertainty and doubt as a means for ill informed politicians to bludgeon people into agreeing with them. I have in mind particularly suggestions that our ATMs would 'run dry' if there were to be a default.
To suggest that anyone in Europe would attempt or even think of stopping Irish citizens from buying their daily bread in reaction to a problem created by Irish politicians is to display an ignorance of how such systems work, and to the people and the Commission of the EU.
The Euro is not the problem. The Euro works, and works tremendously well as its endurance of the upheavals and stresses of the last few years have shown.
The design of the 'Growth and Stability Pact' is not the problem. Since it was never enforced (and Germany was the worst and longest rule breaker) it cannot be said to have failed and all of the debt problems we now have are the exact things the GSP was designed to prevent.
The problem is the level of debt some countries are carrying. This is an old problem, and the old answer was always a currency devaluation. Since we all have the same currency now we can't do that. But a debt 'haircut' amounts to the same thing.
So, can we please take a haircut now before we all go bald?
Arthur Doohan is a former banker currently promoting a public policy debate on alternative solutions to the debt crisis in Ireland and to bank restructuring
Monday, 18 July 2011
Plan A for austerity; Plan D for default and devaluation
Slí Eile: Events are moving fast on the European monetary plains. Suddenly, various 'unthinkables' are being mentioned as real possibilities rather than impossibilities. Whatever the coming days and weeks hold a number of inconvenient truths are emerging:
European political leadership is at an all time low since the foundation of the European Coal and Steel community in the 1950s.
National interests are dominating over any sense of collective European 'esprit de coeur' and to the fore in various national interests are national financial interests.
The institutions of the European Monetary Union are not up to task - we have in some respects a house built on sand (and when the gales blew etc)
In the long-term (and possibly in the coming months) you can have a 'transfer union' and growing federalism or you have an EU without a single currency but you can't have both.
Like marriage single currencies are very attractive and lead to all sorts of mutual gains, lowering of transaction costs and increased market certainty when the partners are 'in it together'. But when communication breaks down so does trust and the current arrangements represent a pact 'til dissolution do us part'. Moreover, when the partners squabble endlessly over what is mine in terms of assets, debts and sharing of these then trouble is on the horizon. Responses at the European level have, to date, focussed on fiscal austerity with the addition of some clumsy attempts to rescue a number of peripheral countries in the Eurozone while all the time denying that there is a larger elephant in the European Euro parlour.
At the end of the day all of this comes down to who gets paid off and who has first claim to the assets of an insolvent corporation. Without wishing to over-simplify the current politico-economic crisis - financial institutions and funds in France, Germany, the UK and the US want to get paid back, the ECB wants to save the Euro and are ready to sacrifice absolutely anything for it, German and French politicians are watching their electoral backs. The IMF is playing good guy but you really would not want to be dependent on the IMF if you can help it. Read up on the last two decades of reform and adjustment in various nations in receipt of its magnificence. As for the domestic political response in the periphery let charity restrain this commentator.
'Plan A' meaning austerity (as Wolfgang Münchau terms it)is not working as it is compounding the problem by embedding debt through automatic fiscal stabilisers. Plan B is a muddle through involving some type of debt relief together with some fiscal transfer and contributions by bondholders. Plan C is Plan B plus a wider EFSF umbrella to save the big ones like Spain and Italy and Plan D is - you have guessed already - default and devaluation to continue with Münchau's terminology.
One way to prepare for the future is to deny it. Another is to assume the worst and prepare for it (secretly or openly). One wonders if policy makers and senior officials in Merrion Street are currently discussing 'what if' scenarios at a more leisurely and studied pace than what happened in September 2008. A good night's sleep would help.
And still more options include hoping for the best and proactively going for it while being prepared for the worst. The Euro is not dead yet. Even it if does not survive in the shape that we know it (in other words some countries exit in a more or less orderly fashion) it may be worth giving it another try. There is a lot to be gained and lost both ways. The protagonists for default and devaluation here in Ireland (the latter meaning the creation of An Punt Nua) need to spell out what that might mean for savings, deposits, capital controls, direct foreign investment, interest rates, mortgages and ultimately - jobs and living standards. They may argue that we are going down the swanny anyway and it is best to exit or threaten to exit before events impose themselves on us. Now they have a point bearing in mind the denial of reality in September 2008 and again in the latter half of 2010. However, the risks involved in wholesale and large-scale sovereign default allied to currency break-up are huge, unknown and without precedent. Ireland, Greece, Portugal, Spain and Italy are not Russia, Mexico or Argentina.
Right now citizens and progressive movements in Europe need to act together and reason out a number of solutions. One modest - very modest - way forward is for a European wide push that henceforth bondholders for insolvent banks should not be paid a cent. It will not - of itself - kick start economic growth and job creation but it points in the right direction and would help countries who desperately need some fiscal elbow room to crowd in investment where economic activity is being crucified by a thousand cuts. The idea of letting these categories of bondholders take the hit is hardly a revolutionary proposal as economist Colm McCarthy argues in the Sunday Independent here that:
Minister Noonan should now be seeking European support for an end to payments to holders of bonds, guaranteed or unguaranteed, in the Irish banks. Every cent paid to them is at the expense of the holders of Ireland’s sovereign debt, who have been treated in quite cavalier fashion at the behest of the European Central Bank and apparently in response to threats from this unique organisation.
Surely progressive economists and commentators can be a tad more radical and courageous than an existing pillar of economic orthodoxy?
Can we hope that at last the cent is beginning to drop on politicians, economists and progressives?
European political leadership is at an all time low since the foundation of the European Coal and Steel community in the 1950s.
National interests are dominating over any sense of collective European 'esprit de coeur' and to the fore in various national interests are national financial interests.
The institutions of the European Monetary Union are not up to task - we have in some respects a house built on sand (and when the gales blew etc)
In the long-term (and possibly in the coming months) you can have a 'transfer union' and growing federalism or you have an EU without a single currency but you can't have both.
Like marriage single currencies are very attractive and lead to all sorts of mutual gains, lowering of transaction costs and increased market certainty when the partners are 'in it together'. But when communication breaks down so does trust and the current arrangements represent a pact 'til dissolution do us part'. Moreover, when the partners squabble endlessly over what is mine in terms of assets, debts and sharing of these then trouble is on the horizon. Responses at the European level have, to date, focussed on fiscal austerity with the addition of some clumsy attempts to rescue a number of peripheral countries in the Eurozone while all the time denying that there is a larger elephant in the European Euro parlour.
At the end of the day all of this comes down to who gets paid off and who has first claim to the assets of an insolvent corporation. Without wishing to over-simplify the current politico-economic crisis - financial institutions and funds in France, Germany, the UK and the US want to get paid back, the ECB wants to save the Euro and are ready to sacrifice absolutely anything for it, German and French politicians are watching their electoral backs. The IMF is playing good guy but you really would not want to be dependent on the IMF if you can help it. Read up on the last two decades of reform and adjustment in various nations in receipt of its magnificence. As for the domestic political response in the periphery let charity restrain this commentator.
'Plan A' meaning austerity (as Wolfgang Münchau terms it)is not working as it is compounding the problem by embedding debt through automatic fiscal stabilisers. Plan B is a muddle through involving some type of debt relief together with some fiscal transfer and contributions by bondholders. Plan C is Plan B plus a wider EFSF umbrella to save the big ones like Spain and Italy and Plan D is - you have guessed already - default and devaluation to continue with Münchau's terminology.
One way to prepare for the future is to deny it. Another is to assume the worst and prepare for it (secretly or openly). One wonders if policy makers and senior officials in Merrion Street are currently discussing 'what if' scenarios at a more leisurely and studied pace than what happened in September 2008. A good night's sleep would help.
And still more options include hoping for the best and proactively going for it while being prepared for the worst. The Euro is not dead yet. Even it if does not survive in the shape that we know it (in other words some countries exit in a more or less orderly fashion) it may be worth giving it another try. There is a lot to be gained and lost both ways. The protagonists for default and devaluation here in Ireland (the latter meaning the creation of An Punt Nua) need to spell out what that might mean for savings, deposits, capital controls, direct foreign investment, interest rates, mortgages and ultimately - jobs and living standards. They may argue that we are going down the swanny anyway and it is best to exit or threaten to exit before events impose themselves on us. Now they have a point bearing in mind the denial of reality in September 2008 and again in the latter half of 2010. However, the risks involved in wholesale and large-scale sovereign default allied to currency break-up are huge, unknown and without precedent. Ireland, Greece, Portugal, Spain and Italy are not Russia, Mexico or Argentina.
Right now citizens and progressive movements in Europe need to act together and reason out a number of solutions. One modest - very modest - way forward is for a European wide push that henceforth bondholders for insolvent banks should not be paid a cent. It will not - of itself - kick start economic growth and job creation but it points in the right direction and would help countries who desperately need some fiscal elbow room to crowd in investment where economic activity is being crucified by a thousand cuts. The idea of letting these categories of bondholders take the hit is hardly a revolutionary proposal as economist Colm McCarthy argues in the Sunday Independent here that:
Minister Noonan should now be seeking European support for an end to payments to holders of bonds, guaranteed or unguaranteed, in the Irish banks. Every cent paid to them is at the expense of the holders of Ireland’s sovereign debt, who have been treated in quite cavalier fashion at the behest of the European Central Bank and apparently in response to threats from this unique organisation.
Surely progressive economists and commentators can be a tad more radical and courageous than an existing pillar of economic orthodoxy?
Can we hope that at last the cent is beginning to drop on politicians, economists and progressives?
Monday, 27 June 2011
Cost/benefit analysis of complying with the ECB’s wishes
Tom McDonnell: Namawinelake has put up part of the transcript from Minister Noonan's interview yesterday on 'The Week' programme. Evidently the ECB doesn't threaten sovereign countries. Except when it does.
On the ECB stonewalling of burning bondholders Namawinelake makes the following reasonable statement:
"The point of this is we have serious economic considerations on the bonds but we also have serious considerations on what the cuts and austerity will do to our society. And it is logical, is it not, that there is some tipping point in the cost/benefit analysis of complying with the ECB’s wishes that we say “that’s not worth it”. If bondholders cost us €1tn then the decision might be black and white. If the cost was €1m, it would also be black-and-white at the other end. I tend to think that the costs are too much and when we consider the sort of society we’ll have with the cuts and taxes, the larger class sizes, the lower healthy life expectancy, the fear and fact of crime.
So let’s have the debate, acknowledge the ECB funding of our banks (which is not costing the ECB a penny though there is risk), consider the savings, consider Plan B and its costs and benefits, set out the likely cuts and taxes and then decide for better or worse to accept this or not.."
Over at Economic Incentives
Seamus Coffey takes a look at default options and concludes:
"it does not seem that default could generate the required savings to make it a viable policy option.."
These are debates whose time has come. Of course events may overtake everything. Reuters (citing Markit) reported on friday that five-year credit default swaps on Greek government debt rose 138bp to 2025bp, implying a more than 80% default probability.
On the ECB stonewalling of burning bondholders Namawinelake makes the following reasonable statement:
"The point of this is we have serious economic considerations on the bonds but we also have serious considerations on what the cuts and austerity will do to our society. And it is logical, is it not, that there is some tipping point in the cost/benefit analysis of complying with the ECB’s wishes that we say “that’s not worth it”. If bondholders cost us €1tn then the decision might be black and white. If the cost was €1m, it would also be black-and-white at the other end. I tend to think that the costs are too much and when we consider the sort of society we’ll have with the cuts and taxes, the larger class sizes, the lower healthy life expectancy, the fear and fact of crime.
So let’s have the debate, acknowledge the ECB funding of our banks (which is not costing the ECB a penny though there is risk), consider the savings, consider Plan B and its costs and benefits, set out the likely cuts and taxes and then decide for better or worse to accept this or not.."
Over at Economic Incentives
Seamus Coffey takes a look at default options and concludes:
"it does not seem that default could generate the required savings to make it a viable policy option.."
These are debates whose time has come. Of course events may overtake everything. Reuters (citing Markit) reported on friday that five-year credit default swaps on Greek government debt rose 138bp to 2025bp, implying a more than 80% default probability.
Thursday, 2 June 2011
Martin Wolf's Intolerable Choices for the Eurozone
Martin Wolf provides a timely analysis of the Eurozone's options. Wolf argues that ultimately the Eurozone faces a choice between default and partial dissolution or open-ended official support.
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
Monday, 14 March 2011
Munchau’s purgatory between bailout and default
Tom McDonnell: Weak measures to report from Part 1 of the big European double header last weekend: see here and here. The unfortunate unwillingness to accept the true scale of the crisis and take the decisive action required is troubling.
The Guardian is taking the line that Ireland is facing a default if a renegotiation of the IMF/EU bailout isn't available.
They point to a Sunday Independent article claiming the stress tests will identify an additional €15 to €25 billion to cover the bank losses.
As Wolfgang Munchau at the Financial Times reports, “muddling through will not work this time – the EU has created a purgatory between bailout and default”. Munchau’s preference is for a bailout not through cross-country transfers, but through a single European bond.
The Guardian is taking the line that Ireland is facing a default if a renegotiation of the IMF/EU bailout isn't available.
They point to a Sunday Independent article claiming the stress tests will identify an additional €15 to €25 billion to cover the bank losses.
As Wolfgang Munchau at the Financial Times reports, “muddling through will not work this time – the EU has created a purgatory between bailout and default”. Munchau’s preference is for a bailout not through cross-country transfers, but through a single European bond.
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