Thursday, 2 December 2010

The €67.5 (not €85) billion bailout

Jim Stewart: Whatever the Taoiseach thought he was doing at the press conference last Sunday) in announcing the EU/IMF net loans to Ireland of €67.5 billion, he was not as he claimed, addressing ‘the Irish People’. At least the Secretary General of the Department of Finance adopted the right tone by wearing a black tie. Nevertheless in the rather rambling responses there are some nuggets of information.

The Official Announcements

There are a number of very disappointing features in the Government statement about the receipt of EU/IMF Funds for Ireland. The most is the failure to ensure that the debt of all bank bondholders is written down. This follows the poorly thought-out “National Recovery Plan 2011 - 2014”. One feature of this plan is, in places, its simple reflection of narrow sectional interest. For example (p. 94), the view is expressed, as argued by the pensions industry, that tax deferred on accumulated funds for pension provision is not a cost as it is in effect ‘deferred income tax’, and the open invitation to the pensions industry to lobby for ‘alternatives’.

There are some surprises :- Why is the contribution from the UK €3.4 billion rather than the much-publicised €8 billion? Could it be related to the proposed interest rate on UK borrowing? (A direct question on this subject was asked but not answered at the press conference announcing the rescue fund). Or was it reduced to ensure that State discretionary funds were reduced?

There are some perfectly reasonable proposals: we will no longer have to contribute to the Greek rescue fund, although the two documents together repeat the same mistakes that started with the September 2008 guarantee (see endnote)

The Bond Holders

Yetm in dismissing the write-down of the value of bonds to senior debt holders, one argument has been dropped, and that is that Senior Debt cannot be restructured (writen down in value, extending maturity etc.) because it ranks ‘parri passu’ with depositors, meaning senior debt and depositors have the same rights. Other legal issues have been hinted at.

In answer to a question regarding whether the ECB ‘vetoed’ debt write downs by banks, the Taoiseach stated that there was no ‘agreement from the EU for such a policy and, to a second question on the same issue he answered that there was no political or institutional ‘support’ for such a move. Ajai Chopra, the leader of the IMF mission, again in answer to a question refused to categorically say that bond holder write downs might not be an option in a future period (Morning Ireland 28/11/2010). The reported lack of support at EU level for such a policy is surprising, given recently enacted German banking laws which the Financial Times state will ensure that “creditors take losses rather than the State” (Jennifer Hughes and James Wilson, Financial Times November 11).

The Financial Times (November 30) quotes the Central Bank governor as stating that ‘Dublin’ had refrained from taking action against [bond] investors in return for a “liberal attitude” by the ECB – in another article this is explained in terms of funding of Irish banks. This funding is likely to have increased from the reported figure of €130 billion (Irish banks borrowing from the ECB is likely to be less than this) on 29th October, because of liquidity strains on Irish Banks due to large deposit outflows. Similar outflows are likely to be taking place in other countries where government bond prices have fallen such as Portugal, Spain and more recently Italy. In providing such liquidity, the ECB is acting as a normal Central Bank. The ECB has been reported as opposing senior debt restructuring by insolvent banks. As a result, it is in effect imposing private sector liabilities on a sovereign State in the case of those bonds not subject to a government guarantee. There cannot be any legal basis for such a position. There is certainly no economic basis.

It is likely that, in the event of liquidation or wind down in the case of Anglo Irish bank and the Irish Nationwide, any competent insolvency practitioner could reorganise assets so that depositors and bond holders were in separate legal entities. The one with depositors' funds could be rescued. The other not. This is unlikely to require any legislative changes or the introduction of a Special Resolution Regime, as it could be performed under existing law. Bonds with a government guarantee could be written down at the expiration of the guarantee.

As in the case of junior bond holders, no legislation is required to ensure bond holders suffer losses through falling market values. Policy should be to drive down the value of this debt and then negotiate with senior bond holders. The Anglo Irish subordinated debt write down did not require legislation. Nevertheless various statements that legislation to require restructuring is in preparation pose a threat, even though it is currently proposed that this should relate to subordinated bondholders. This action coupled with refusals to categorically rule out such a policy will help achieve the desired objective. More is needed. Some bond traders have been reported as already anticipating such a policy. Many bond holders may have covered potential losses via credit default swaps, passing the ultimate liability to counterparties.

Writing down senior unsecured debt issued by Anglo alone, and not covered by a guarantee, by 80% would reduce required State funds by €3.2 billion. Writing down senior unsecured debt covered by the guarantee would reduce State funding by €2.1 billion (See Parliamentary Answers to Joan Burton, 27 October, 2010). Current actions to write down subordinated debt by 80% will reduce required State funding by €1.88 billion

Some argue a debt for equity swap could be instituted. This is only likely in one case. The Bank of Ireland is in the best-placed bank to raise additional capital and may be able to do so in conjunction with a debt for equity swap. Bond holders would convert debt into equity and subscribe for new shares. A debt for equity swap where bank capital requirements and access to capital from markets are uncertain, would introduce additional complications and cost to bank financing. As in the case of debt write downs, debt for equity swaps are unlikely to result in sufficient additional capital. Any shortfall is most likely to come from the State.

The Austerity Programme: What Options Remain?

One effect of the ‘austerity package’ in the National Recovery Plan and the EU/IMF “Programme of Financial Support for Ireland” ( (not entitled Memorandum of Understanding as in the case of Greece) is to lock any incoming administration into existing policies, by extensive prescription of budget balances and monitoring, but especially by removing options relating to the use of National Pension Reserve Fund, Options still remain - not all the fund will be used. There are possibilities for utilising the exceptionally high savings rate to partially fund the exchequer borrowing, as noted in the National Recovery Plan, but this could be extended to fund skill enhancing programmes such as placement schemes, work experience and employment creation. The government has control over aspects of tax policy and social welfare policy; initiatives can be introduced to create and sustain jobs; further efficiencies can be derived from the public sector; our state owned enterprises could be used to rebuild our economy, as their assets and liabilities are not subject to EU/IMF approval. This could be particularly important as the EU/IMF document, in contrast to the National Recovery Plan, specifically states that “any additional unplanned revenues must be allocated to debt reduction” (p. 13). This assumes that State-owned companies are not privatised - an option discussed in the National Recovery Plan but not in the EU/IMF programme.

An incoming administration will have many problems. One that receives little or no attention in the National Recovery Plan or the EU/IMF Programme is how change may be achieved in the attitudes and outlook of ‘official Ireland’. One symptom of this is the failure to recognise how far out of line pay and conditions of senior personnel in the public sector (academics, hospital consultants, judges, politicians, regulators, senior civil servants, etc) are in comparison with other countries in absolute levels, and as a multiple of average earnings. At at the same time the minimum wage will be reduced and the scope of the “inability to pay clause” widened (EU/IMF Programme pp. 10-11). There are even greater pay disparities in the private sector between those at the top of organisations and those on average earnings. These disparities have been an essential ingredient in creating our economic problems.

An incoming administration will have to work with the existing civil service, the IDA, etc. Some of these have contributed directly to the problems we face, some have a strong economic ideology, disguised as ‘economic science’, but there are many who would welcome change, and would also welcome debate about the policies that have led to the collapse of modern Ireland.

Endnote: some Issues with current Policy

(1) The belief in the austerity fairy’, that is cutting expenditure and raising taxes will lead to an economic recovery, without any other policies; and that recapitalising the banks will lead to economic recovery;
(2) The absence of proposals to create and sustain jobs, or proposals to develop and sustain indigenous firms such as a Loan Guarantee Scheme. Labour market reforms (much loved by the IMF, OECD and other institutions), such as cutting the minimum wage will have little impact on job creation. Wage costs have fallen considerably as acknowledged by IBEC (See Irish Times, 27/11/2010). This is partly due to the growing prevalence of short week contracts (particularly in retailing).
(3) The State is now a major owner of property (hotels, office blocks, houses) yet there is no statement as to how economic value might be obtained from these assets. Where are the plans to vastly expand the tourism sector and visitor numbers?


paul sweeney said...

Of course the bondholders must pay. Why should we pay for the debts run up by Anglo, AIB BOI, Nationwide etc lent by these banks to FF builders and developers?

The bondholders/lenders knew full well what they were doing in lending to these banks. These German British Danish and Swedish banks did expect that they will share the pain. Our stunningly incompetent Government and its advisers insist that Sean and Mary Citizen will pay every red cent of debt plus all the interest for decades. The truth is that default is no longer an option. We simply cannot pay all of this money.

Look what the FT editorial said today:

“This nervousness (of ECB in continuing to lend to the banks – since changed per Tricet this afternoon) shaped the Irish rescue package, meant to somehow staunch a hemorrhage from sovereign bonds by sending Dublin deeper into debt for the sake of wobbly banks’ creditors. This only pushed sovereign yields higher and further undermined the stability of Europe’s banking system.

Patrick Honohan, Ireland’s central bank governor, has described a “quid pro quo” in which Dublin renounced a belated interest in haircuts for bank creditors in order for the ECB’s “liberal attitude” to funding Irish banks to last a little longer. That is intolerable."
It is ironical that the conservative FT and the New York Times have both been far to the left of the Irish media on Ireland’s debt crisis. Both have, as commentators here said been closed to most views on PE.

The mainstream Irish media has not served us well in its defence of the 3 Year Plan then a 4 Year Plan and Now, for a while, the 5 Year Plan; bailing out the banks, the bondholders, 4 deflationary Budgets etc. It has too slavishly backed the government on many of its harebrained economic decisions.

Bad economics – tax cuts, de-regulation and tax subsidies for the speculators in the boom - got us into this mess and bad economics is digging deeper.

What about "Brady Bonds" for Ireland and the bondholders, Jim? An better option than what the Govt is proposing at least?

Well, the deep snow here in Dublin reflects the economic crisis.

Anonymous said...

Stewart has provided a most insightful and constructive piece.

He is of course right to highlight the appalling failure of Government and its various officials to ensure that the debt of all bank bondholders is written down. That failure is all the more astonishing given that it is such a no brainer.

How dumb is the self serving approach of the henchmen of the IMF and the ECB not to realize that they cannot get blood out of a stone. While “official Ireland” have raised the white flag to these henchmen we must be resolute in not accepting this death sentence for Ireland and continue to insist that those who so recklessly provided the wherewithal to the “Seanies” of this world to wreck our banking system and our economy must pay the price for their foolish behaviour. The banks’ bondholders must take their losses.

Stewart also raises another excellent point in relation to changing the attitudes of official “Ireland”. The most astonishing aspect of the coverage of our crisis is the fact that those most responsible i.e. Ireland’s professional classes (economists, lawyers, accountants and auditors, academics, journalists and civil servants) have by and large escaped any scrutiny as far as their responsibility for the crisis is concerned.

It is a scandal that as the minimum wage is being reduced that the Irish sheltered professional classes are not asked to carry some of the pain. We have a completely inadequate health service and yet like some tin pot dictatorship system, medical consultants are paid several multiples that of their peers in the rest of Europe. If resources are that abundant for our health system that we can pay medical consultants several multiples that of their European peers then those resources should instead be used to improve our wholly inadequate system rather than paying such outrageous amounts to our sheltered professional classes. Likewise our Universities are supposed to be lacking resources yet Professors are paid vastly in excess of their European counterparts.

It is time that the pampered professional classes in Ireland were paid in line with European norms. It is very odd at the least that if there is, as it is claimed, concern about the generally excessive level of many Irish pay rates by comparison with those in neighbouring countries that only the minimum wage has been targeted. It can hardly be that the concern only extends to the low paid and not to the powerful pampered sheltered professional classes that hold so much of the responsibility for the mess that Ireland and its institutions find themselves in today.

Jim Stewart said...

Paul Sweeney and anonymous have made some excellent points.

Anonymous expresses in such a clear way, the view of the many, that those who in one way or another have made the largest contribution to our problems, and have caused the greatest amount of damage, have suffered the smallest losses.

In relation to the question from Paul on Brady Bonds, there is no doubt that in the event of a default by Ireland, Greece, or some other Eurozone country,the concept underlying Brady Bonds would be very useful. This is because it would prevent further destabilisation, in reducing the impact of losses on banks and others, holding bonds that were reduced in value.

Brady bonds involved converting sovereign debt from one country into new bonds (Brady Bonds) issued by the US Treasury with certain guarantees. The conversion involved a discount ("haircut") in one form or another. This meant that banks holding Brady Bonds did not have to recognise capital losses and the new bonds were tradeable, adding to liquidity. If 'Brady' type bonds were to be issued in the erozone, a central problem is who would issue and underwrite them? The most suitable candidate is the ECB, but a fairly limited Government bond purchase programme is opposed by some, such as Axel Weber, President of the Bundesbank.

This issue is important because of the fall in bond prices in countries such as Ireland and Greece. As a result some banks have large undisclosed losses. For example,the German bank, Hypo Real Estate has €80 billion of government debt of countries such as Greece, Spain, etc. which has fallen considerably in value.

Default on sovereign debt by any member of the eurozone would not be easy. The process would create great considerable uncertainty. A better option is to reduce the amount of debt Ireland needs to borrow by reducing the amount of capital that banks need. This involves the write down of bank bonds and bank resdtructuring.

mikehall said...

I would like to flag up something here which I hope & urge that 'progressive' economists of Ireland will follow up.

I believe that there is a rapidly rising popular demand for radical political reform in Ireland now. One that may well succeed in a fundamental shift from politics serving the interests of a wealthy elite to representation that serves the majority of citizens. If that change is truly radical it must also be accompanied by economics policies that are appropriate & can work. Even if political reform is less than radical, Ireland's precarious situation needs the best economics policy decisions it can muster. And I think we can agree, that's not the ones being foisted on us now.

I posted up the link to this paper previously:
"No One Saw This Coming": Understanding Financial Crisis Through Accounting Models

The author filters out the 'lucky guessers' (including some prominent international figures) & studies the work of 12 economists, all of whom used similar non-orthodox methodolgies, & who, in fact, +did+ predict the global crisis with a high degree of accuracy in extent & timing.

I'm sure economists here (I hope) will know of Michael Hudson, a professor at University of Missouri - one of the 12.

I've been looking at another of the 12 - Steve Keen of University of Western Sydney, Australia. I have looked at his online lecture materials & am currently reading his book 'Debunking Economics' - written for (somewhat) 'lay' audience, but referenced throughout to in depth analysis on his website. Not only is he a superb academic, in his thinking & writing on economics, but also a talented mathematician. Above all, his rigour in applying proper Academic method to his work is as impressive as I've seen anywhere, in any discipline. (My own background is Science/Engineering & some MBA studies.)

The Groningen University paper above points to massive flaws in the macroeconomics modelling methods common to & in universal use by the US, IMF, EU, ECB & pretty much every major institution worldwide to inform policy makers.

If that wasn't bad enough, Steve Keen's body of work, backed by rigourous argument & mathematics, also concludes that virtually the entire basis - basic assumptions & theories - of 'orthodox' economics are false. Moreover he asserts that these bogus foundations have completely dominated mainstream practice & nearly all teaching faculties for the last several decades. He isn't entirely alone. There are other academics who support his approach. And there are surely many practising economists who are uncomfortable with the many failures of economic policy, not just the most recent near global meltdown, that 'orthodox' economists didn't spot, inches from the cliff edge.

The point I'm making here is that Ireland (& elsewhere too) needs the best economic policy advise it can get. And in my opinion, & I'd be sure that of Steve Keen & others, that that excludes all are present decision-making incumbents. Finance, Treasury, Central Bank, ECB, EU, IMF & all the other institutions proffering the same flawed thinking. The more so if our political reform is to succeed. Because, if it doesn't, guess where the blame will be placed by the worlds ideoligical dominants & pliant media? It won't be the teflon dons of the current economics 'establishment'.

Besides the 'light touch' regulation, corruption & downright fraud in the relevant companies & institutions, there also lies an intellectual bankruptcy. One that the ideologues supporting the interests of wealthy elites find highly convenient. They are doing fine.

Reform in politics is vital, but reform in economics thinking & policy advice equally so.

paul sweeney said...

Thanks Jim for the comment on the Brady Bonds. I favour a default on all bank bondholders (had wanted to negotiate originally) and now think it will be inevitable and not a choice, but a Brady or Axel Bond (sounds better, more mobile than a Weber Bond) might be a better option than the current course of action of enslaving two or three generations of Irish men and women to the German French and British bank bondholders.

In the meantime, sadly, is it now possible to believe that the Euro might collapse? If it took us 5 years to prepare for its arrival, how long to prepare for its demise, never mind our exit? Mayhem may yet rule Europe and afar. And it is worse than mad, unregulated markets!

Mike Hall, I did see your reference and indeed had read the paper when it came out, some time ago. It is excellent.

Robert Sweeney said...

uestion. How would Ireland 'defaulting' on the bonds covered under the guarantee threaten the stability of the euro as is often asserted? Presumably holders of Portuguese, Spanish and other troubled countries' debt would start selling in fear that they won't get their money back. This supply of euros in international markets presumably would drive down the value of the euro (as well as increase their bond's interest rates) vis a vis other currencies. It would also I'm sure severely damage the German, British and other banks that are heavily exposed to Irish banks. However, I don't see how this would threaten the euro. Am I missing something?

paul sweeney said...

Robert, I was commenting separately on the difficulties of the Euro. The difficulties of the Euro are much bigger and I leave that complex area to the better informed.
Ireland simply cannot afford to pay off all the bank bondholders.Its worth remembering that deep though our fiscal problems are, the "rescue" is for the banks and their bondholders. We, citizens, are told that it is we who must pay. Crazy economics!