Taxpayers to benefit as Europe's leaders change tack yet again

Sat, Jun 30, 2012, 01:00

ANALYSIS:The long campaign for bank debt relief has eventually paid off – the door is now open

THE DEAL struck in the pre- dawn hours yesterday marks a fresh attempt to solve the riddle of Europe’s stricken banks and becalm the finances of the countries they have burdened with their debts.

For the first time since Brian Cowen’s government guaranteed all Irish banking liabilities, the move clears the way for an eventual deal to ease the burden yoked on taxpayers at that time.

In the third summer of the debt emergency and the fifth year of the global financial crisis, EU leaders have changed course yet again in their relentless struggle to assert control.

Although the nitty-gritty of the operational arrangements remains to be pinned down, the leaders have instructed the euro zone finance ministers to implement the new plan at their next regular meeting on July 9th.

Given the deepening schism between the naysaying German chancellor and the leaders who urged her to go further and faster, the change of approach is both abrupt and profound.

Drill through the deliberately ambiguous language in the euro zone communique and it is clear that a new principle has been established: Europe will recapitalise banks directly if their requirement for external support risks overwhelming the member state concerned.

This changes the fundamental rule that the ultimate responsibility for rescuing banks goes no further than the borders of individual countries. Not only that, but the leaders’ declaration that “similar cases will be treated equally” means Spain won’t get special treatment just because the country is too big to fail.

What is more, the communique binds the finance ministers into an assessment of “the situation in the Irish financial sector with the view of further improving the sustainability of the well- performing adjustment programme”.

In essence, this is a deal to do a deal. Months into the Government’s long campaign for bank debt relief, the door is now open. It helps in this context that the Government’s performance has been favourably reviewed time and again by the EU-IMF troika inspectors. Neither is the passing of the fiscal treaty referendum a hindrance.

However the inner workings remain to be agreed, thus the true impact on the State’s finances or future budgets cannot be predicted. This will depend on the amount of relief given. As it stands, the Irish bank rescue costs roughly €62 billion. Figuring out how and by how much this is reduced will be a matter of negotiation. The bigger the cut, the bigger the gain. Yet the reverse is also true.

Although it is difficult to divine what exactly might be on the table, the basic aim should be to ensure a clear return to private bond markets as the EU-IMF programme unwinds at the end of next year. Few observers believe this can be realistically achieved under the deal as cast originally.

It follows, therefore, that a substantial measure of relief may yet be in store to avoid any scope for failure. Europe, too, has an entrenched interest in a successful conclusion to the current phase of the Irish rescue programme.

Nothing can be taken for granted, however, and the Government still faces a titanic battle to control the budget deficit. Even if there were no banks to be rescued, the glaring gap between tax income and expenditure must still be made up.

As it is, Ireland will continue to be bound by the policy terms set by the troika. What is more, the leaders’ communique makes it clear that any direct banking aid would rely on “appropriate conditionality” which should be “institution-specific, sector- specific or economy-wide” and would be formalised in a memorandum of understanding. This is not exactly a free lunch.

Indeed, the particular reference to “economy-wide” conditionality heralds the prospect of severe new conditions being set in return for an extension of aid to Ireland.

Still, this sets Europe on a path towards an eventual form of bank debt mutualisation.

Angela Merkel wouldn’t hear of the notion until days ago. The chancellor’s démarche – gently described as a “clarification” by one whispering Berliner – reflects anxiety that the original plan for Spain would not work and that the resultant turmoil could sunder Italy’s tenuous access to private debt markets.

The spin-off benefits for Spain are clear. If the original arrangement was predicated on the country retaining access to private debt markets for regular borrowing, the availability of direct aid changes the picture.

At the same time, EU leaders resolved to remove seniority status from the loans Madrid receives from the European Stability Mechanism fund.

This is a response to concern that private investors would be more inclined to avoid buying new Spanish bonds if they were lower down the pecking order in a debt- restructuring scenario. Europe insists the Greek case is unique, but the ESM’s preferred creditor status emerged as a big issue in markets.

Italian technocrat leader Mario Monti made a big play for immediate steps to tame market pressure on the country’s borrowing costs. Although the communique still clears the way for the EFSF and ESM to deploy their power to buy up sovereign bonds “in order to stabilise markets” for their debt, it makes clear that this should be done within the ambit of a memorandum of understanding.

Neither Monti nor French president François Hollande wanted that, but it might just have been the best arrangement available.

Now for the execution of the new deal, as ever the most difficult part. This story ain’t over yet.