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.


Seamus Coffey said...

Hi Tom,

It is disheartening that we are forced to have this debate with such a shortage of concrete information.

I do think that the current structure of our government debt makes it difficult to generate the savings to make such a default worthwhile. However, as NWL has helpfully pointed out there are substantial savings to be made by defaulting on the bank debt.

This is the key calculation. Would the savings that could be generated by not paying this debt be offset by the costs of undertaking this action? While we can all see the benefits of reneging on this debt we are left to "the wink-and-elbow language" of the ECB to guess the costs, such that they even exist.

You are absolutely right that this debate has to happen - and fast. The benefits and costs should be laid out and the process should be transparent. It may that the current policy is 'best' but with so much hidden it is impossible to take this as given. There is too much at stake.

Tom McDonnell said...

Hi Seamus,

I agree it is disheartening.

Today's announced French initiative is an interesting development and one worth keeping an eye on. It is reported in the Irish Times here:

Your point about the uncertainty surrounding the costs of undertaking action x or action y is an important one. The accounting exercise of measuring the benefits is one thing but we simply do not even know what the ECB (or for that matter the ratings agencies) will do. This complicates the analysis.

And what they 'say' they will do is a very different thing from what they will 'actually' do.

Of course not all the costs are measurable. There are political costs as well.

According to Markit swaps on Greece have climbed again (to 2,143 basis points). This means the markets are estimating an 84 per cent probability of default within five years.

Damian T said...


Not sure that it is quite true that this is not costing the ECB a penny. Funding the loan book of a dysfunctional banking system does carry a cost - same funds cannot be used elsewhere to fund other more productive loan books.

I would imagine the ECBs economists already made a cost/benefit analysis on that point around 2008 and decided that a bailout, which would ultimately reduce our banks' dependence on external funding, was the most cost-efficient option - unfortunately it appears it growth assumptions were flawed – as was the extent to which the banking system could finance this growth.

For the Irish govt the cost/benefit analysis might not necessarily be on default but on the likely contribution liquidity constrained banks can make to future investment.