Jim Stewart: Much comment argues that the increasing cost of Irish Government borrowing (the second/third highest in the eurozone and over twice the cost of German Government borrowing) is a direct consequence of Government economic policies in relation to the banking system. Other policies are also likely to be a factor, such as the emphasis on fiscal austerity in the belief that this will restore confidence and lead to economic success - what Paul Krugman has called the ‘confidence fairy’.
Removing the blanket guarantee on all bank liabilities, rather than extending it, is very likely to reduce the cost of Government borrowing (on August 19th, the Minister was quoted in the Irish Times as saying that "Elements of the guarantee will not be continued from September”).
However, amending the guarantee also gives an opportunity for a much more radical intervention.
In his Beal na mBlath speech, the Minister recently restated the Government’s policy of supporting the existing debt of Anglo Irish.
“...we must stand behind our banks in order to ensure that a sustainable financial system is established and, in the case of Anglo, to ensure that the resolution of its debts does not damage Ireland’s international credit-worthiness and end up costing us even more than we must now pay”.
It is false analysis to present the options in relation to Anglo Irish Bank as allowing it to fail (liquidation) or continuing to support it. Those who advocate continued support may justify this position by calling for a type of Special Resolution regime in Ireland for failing banks, to reduce the risk of bank failures in the future. As has been pointed out by others – most recently the Bank for International Settlements, p.3 – a Special Resolution regime within one country is unlikely to work for a large institution whose operations straddle a number of different countries. Assets in other countries cannot be seized unilaterally. Legal systems have differing requirements for creditor protection in the event of a firm being forced into liquidation, further complicating the efforts of any single regulator.
A third and less costly option is to negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.
There are some implications: Anglo Irish must not be allowed redeem any existing bonds, as it has done in the past, and then declare the difference as profit.
Such a solution is consistent with proposals for reform in the consultative document recently published by the BIS, which addresses the issue of banks which received public sector funds but most of whose long term capital did not suffer any losses.
What are the costs?
It is important to note that it is normal commercial practice to renegotiate with debt holders in the event of a corporate financial crisis. A well known example is Eurotunnel.
It has been argued that the costs in terms of reputational damage to the State would be large, the credit rating on existing Government debt would fall, and government debt yields would rise. The fact that Anglo Irish is State-owned gives some credence to these views. However, continuing with current policy to undertake to redeem most long-term debt at face value will ensure continued risk and uncertainty in relation to State finances.
These costs are likely to be exaggerated. Those firms who advise bond holders, and who may have a financial interest in maintaining the value of bank debt, are likely to complain the loudest.
Issues might arise in relation to increased risk to depositors and deposit withdrawals. The largest single source of deposits in the most recent accounts consisted of bank deposits (€33 billion), of which the largest single component is likely to be Irish Central Bank/ECB, whose deposits are automatically guaranteed. However, a risk of deposit withdrawal could be met with an extension of the guarantee to all depositors in Anglo Irish alone. The risk of not being able to issue new debt would be covered by specific guarantees.
There are fundamental changes taking place in the structure of Irish banking (the closure of Bank of Scotland, Halifax, Post Bank; the re-emergence of a banking system dominated by two banks). Government policy in recent years has been far too quick to allow – and even encourage – abandonment of the mutual form of ownership/control. This policy is continuing in the case of the EBS (see Irish Times 4/8/10 and Financial Times 4/8/2010).
Mutuals and credit unions play a key role in the financial architecture of all EU states (and for very good reasons). The largest and best-known is Rabo Bank in the Netherlands. With appropriate policies, these benefits could also accrue to Ireland (See here).
The costs associated with, and the excessive focus on, Anglo-Irish means that there has been little analysis of, or comment on, the important changes taking place in the structure of Irish banking and the implications for the sector’s likely future conduct and performance. Coupled with the absence of specific policies to provide finance to indigenous firms (a loan guarantee scheme as in the UK and other countries; a State Development Bank) these changes are unlikely to be conducive to economic success.
The rising cost of supporting Anglo Irish bank has at least clarified one issue – nationalizing this bank did not reduce the cost to the tax payer.