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Banking Crisis: Help Us or We Default

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It is almost two months since my last entry. In the interval:

  • We've had a general election in which the Fianna Fail and Green parties were comprehensively rejected by the electorate in favour of a Fine Gael and Labour Coalition.
  • The Moriary Tribunal has reported and concluded that a former Goverment minister had accepted payments from a Irish businessman in return for helping to influence the outcome of a competition to award his company an extremely lucrative mobile phone licence. 
  • After over two years of drip feeding bad news and "kicking the can down the road", we are now approaching the endgame in relation to the banking crisis with the production of further stress test results.

This extended entry reviews the banking crisis and EU/IMF/ECB rescue package under the following headings:

        1. Depth of the Black Hole
        2. Putting the Cost in Context
        3. No Moral Hazard for Golden Circles
        4. Central Bankers were Asleep
        5. Default is Inevitable
        6. Irish Taxpayers Rescuing Foreign Banks
        7. Ourselves Alone or Kind Strangers
        8. Package Deal including CPT.

This entry conclude that in the absence of basic changes to the terms of the rescue package Ireland will be obliged to default. To prevent this outcome, it proposes changes to the package's interest rate, selective restructuring of outstanding bank bonds and temporary concessions on the politically sensitive, Irish corporation profits tax rate.

1. Depth of the Black Hole

Last week the Central Bank of Ireland published the results of a "definitive" stress testing of the main Irish banks. This indicated that €24 billion (yes, billion) will have to be injected into the banks on top of €46 billion already allocated by way of equity and loans. This represents the fifth (and hopefully final) attempt to measure the depth of the black hole in the Irish banks arising from the property boom/bust. This updated cost is well in excess of my own back-of-envelopes estimates - see here and here. While the stress test results should put a floor under the cost of the bank bailout, it transfers the full risk and cost to the State which is already in a deep recession and under severe pressure. 

Also last week, Anglo Irish Bank announced a loss of €17.7 billion for its 2010 financial year and advised that the final cost of its bailout should not exceed previous provisions amounting to €29.3 billion. We'll see.  

2. Putting the Cost in Context

So, €70 billion is being sunk into the Irish-owned banks by the taxpayers of a country with a population of 4.5 million. That works out at €15,600 per head. To put the Irish bailout in context, the equivalent cost to the UK would be £ 840 billion and US$ 6,700 billion for the US at current exchange rates.

The cost of the bailout, according to RTE's Prime Time (link is time-limited) would:

    • Pay for 108 new national childrens hospitals.
    • Finance 23,500 new, 16-classroom primary schools.
    • Abolish income tax for 6 years.
    • Fund unemployment payments for 25 years.
    • Scrap all public transport fares for 101 years.
    • Pay for a new malaria net for everyone at risk of malaria in Africa every year for 14 years.
    • Build 172 Aviva Stadia (that's 6 per county).
    • Start an Irish space programme by sending half a million Irish people into space.

Instead, we are spending over 50% of annual GDP to fix a broken banking system and in the process increasing our debt/GDP ratio to an unsustainable 120% or so.

At €70 billion, the Irish bailout is the world's most costly bank rescue. The die was cast on the day (29th September 2008) when the Government decided, in questionable circumstances, to blanket guarantee the liabilities (€400+ billion) of Irish banks. My view on this guarantee was set out in the lead letter published by the Irish Times on 30th September 2008.

3. No Moral Hazard for Golden Circles

Aside from compiling a few reports on aspects of the crisis, there are still no plans for a full-blown public enquiry to get to its root cause. Nor have any attempts been made to pursue through the courts the developers, bankers, public administrators and politicians who effectively organised (or turned blind eyes) to a property-based ponzi scheme which created crisis. Instead, Nama has been created to effectively offload (and in due course forgive) bad debts amounting to tens of billions incurred by reckless developers and their greedy banking buddies.  

In any civilised society that is not been run by a "golden circle" of cronies, cute hoors and politician camp followers, you would expect that about 50-100 of the most senior business people, bankers, civil servants and politicians involved in creating or regulating a multi-multi-billion euro bubble would be thoroughly investigated and, where appropriate, undertake "prep" walks. But not in Ireland. 

For an insight into Irish golden circles, check out the 2,000+ page report of the Moriarty Tribunal published last month after fourteen years of investigation at a cost of about €200 million.

Where is the "moral hazard"? Surely, there should be sanctions for economic recklessness.

If the EU/IMF/ECB demand the application of "moral hazard" then it should be concentrated on the golden circles that recklessly or incompetently led Ireland into the boom/bust cycle and not on the population at large.

4. Central Bankers were Asleep

It is worth noting that in addition to the €70 billion bailout, the Irish Central Bank and European Central Bank have lent the main Irish banks about €180 billion at a mere 1% interest rate to help address short-term liquidity problems caused by a flight of deposits. This is additional to the hundred billion of bonds which EU banks acquired over the past decade to help fuel the Irish lending boom and which are now being repaid effectively by Irish taxpayers (rather than by the issuing banks).

Why did the ECB and the National Central Banks allow this situation to develop and have they no responsibility for this? It appears that they were all "asleep at the wheel" alongside the Irish Financial Regulator and Central Bank.  

5. Default is Inevitable 

The IMF/EU/ECB agreed last November to provide a €65 billion package to help address the structural problems in the Irish economy linked to its huge public expenditure deficit (arising mainly from the collapse of tax revenues following the property collapse). Contrary to some overseas reports, these are loans (not grants) with substantial interest rates (about 5.8%) and firm repayment schedules.

Unfortunately, all this support is coming at a huge cost that is leading to even higher unemployment, emigration, constraints on development and undermining the State's repayment capacity to such an extent that the latest thinking amongst "so-called" experts is that sovereign default by Ireland is inevitable within the next few years. At the time of writing, the bond market agrees with this view - for updates check the latest price for Irish 10-year bonds and relate it to this assessment of the probabilities of default.  

Having already absorbed a series of very severe budgets, there is little more that Ireland can do to improve its position without precipating a depression or widescale social unrest aside from continuing to tackle (still) extraordinary salaries and pension arrangements in parts of the public sector; curtailing ridiculous high fees and prices in some professions and non-traded sectors; applying further cuts in social welfare; introducing property and water taxes; and adhering to key undertakings in the Memorandum of Understanding agreed with the IMF/EU/ECB last November.

Even after all that pain and medicine, Ireland will still be grossly overgeared and overborrowed and completely dependent on a substantial, sustained upturn in world trade if it is to have any prospect of muddling through its current difficulties and sorting out its banks. The reality is that Ireland cannot by itself simulaneously address its Exchequer deficit and bale out the banks without generous external assistance.

According to the Irish Central Bank (1st April 2011), the Irish-owned banks had €64 billion of senior and subordinated debt outstanding. Of this, AIB and BoI guaranteed and/or secured bonds amount to €27.2 billion leaving €37 billion of bonds which could be candidates for different levels of restructuring to save billions for Irish taxpayers.

6. Irish Taxpayers Rescuing Foreign Banks

My view on the likelihood of sovereign default was presented on 4th February last. Since then, it appears that Ireland's EU partners intend to stand back and watch Ireland's economy and largely blamless society being roasted in its own juices. This is very unsettling as the inevitable consequence will be that Ireland would be forced to involuntarily default and, in the process, damage the entire EU and undermine the euro. 

The fact that we have had a recent election and a new government is of little consequence as Ireland is now effectively being run by hard-line economists and bankers in Washington, Brussels and Frankfurt whose prime interest is to ensure that the ECB and holders of Irish bank bonds are fully repaid (effectively by Irish taxpayers).

7. Ourselves Alone or Kind Strangers

Ireland needs to be rescued not punished. You don't respond to a SOS call with a big invoice - you help first and only consider the cost when the person has recovered.

Overall, it appears that we cannot depend on Morgan Kelly's "kindness of strangers" and maybe we should start looking to sinn féin (lower case s and f) - ourselves alone.

To mangle Patrick Pearse's oration at the grave of O'Donovan Rossa:

They think that they have foreseen everything, think that they have provided against everything; but the EU, the ECB, the IMF! - they have given us our foreign loans, and while Ireland holds these debts, Ireland in recession shall never be solvent.

In truth, the only way that Ireland can be saved is to (a) separate its sovereign and bank debt, (b) default on the latter and (c) secure a rescue package of low/nominal interest loans* from the EU/ECB. If this is done, Ireland should be able to trade out of its difficulties. If not done then Ireland is likely to default on all its debt with much more serious consequences for both Ireland and the EU.

* Based on the ECB rate (currently 1%) applicable to the liquidity support measures for Irish banks rather than the current 5.8%.

8. Package Deal including CPT

Here is the possible basis of a deal to ensure that Ireland is not forced to default on its sovereign debt:

  • Apply a token interest rate of 1% to borrowings under the EU/IMF package. This would save about €2.7 billion a year
    .
  • As previously indicated, about €37 billion of bank bonds could be restructured. A 50% haircut would save almost €19 billion in repayments and about a billion euro in annual interest (based on 5.8% rate). Obviously, the interest saving would much less if a token interest rate applied but the future cashflow benefits would still be highly relevant.  There might be some scope for a trade-off between securing a token rate and shaving some bondholders.
  • In return for the foregoing support, Ireland should reaffirm its adherence to the terms of an updated MOU to reduce the Exchequer deficit and agree to make changes to the Irish Corporation Profits Tax (CPT) regime along the following lines:

    • Introduce a levy on top of the current 12.5% CPT rate of, say, 3% to apply for the duration of the EU/IMF/ECB deal.
    • Offer additional tax credits and allowances for R&D and non-EU export marketing, sales and support undertaken from Ireland to mitigate the impact of the CPT levy while stimulating incremental innovation and exports outside the EU. There would be no basis for EU countries objecting to these provisions.

A package along these lines would help ensure that Ireland doesn't default. More importantly, it would restore confidence both within and about Ireland; stabilise its economy; and provide a platform for the resumption of growth.

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About this Entry

This page contains a single entry by Brian published on April 3, 2011 6:58 PM.

Prevent a National Default was the previous entry in this blog.

One Letter & One Month is the next entry in this blog.

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