Let's not get our hopes up for pot of gold at end of debt saga
OPINION:Any new accord on the promissory note used to inject capital into the two Irish ‘dead’ banks is unlikely to involve a reduction in our debt
THE DUST appears to have settled, at least for now, on the recent intense diplomatic interchanges between the Irish and German governments. The issues at stake have been temporarily delegated to the finance ministers to try to solve.
However, much ambiguity remains. Not for the first time, resort has been made to diplomatic language, such as Ireland’s “unique circumstances”, to paper over important substantive differences.
There are two avenues under discussion to address Ireland’s banking sector debt. The first involves the possible scope and timing of the plan agreed in principle at the June summit to allow the European Stability Mechanism to inject capital directly into banks (such as the Irish “pillar banks”). This would break the link between banking-related debt and the sovereign and thus improve the latter’s creditworthiness.
The second involves a possible renegotiation of the terms of the promissory note arrangement used to inject capital into the two Irish “dead” banks, Anglo and INBS.
It is no secret that German chancellor Angela Merkel reluctantly conceded the principle of direct ESM recapitalisation only after considerable pressure from the Italian and Spanish prime ministers, who warned of major bond market turmoil otherwise.
There remains considerable opposition to using ESM funds (that come mainly from German taxpayers) for this purpose. It is feared that with the debtor government “off the hook”, the banks in question will have less of an incentive to achieve profitability, including by means of aggressive loan recovery.
This may be a particular problem in the case of some Spanish banks where a good part of their excessive lending is believed to be associated with political intervention at the regional level.
The June summit communique reflected Merkel’s insistence that any ESM recapitalisation would require that a new pan-European financial regulator be in effect established beforehand. There are major substantive issues at stake here which go beyond what are sometimes wrongly dismissed as “technical details”.
These include the relationship between the new regulator and the European Central Bank (reflecting fears of a conflict between the ECB’s monetary policy mandate and potential pressures to “bail out” stricken banks), the treatment of non-euro zone EU banks, and the number and size of banks to come under the regulator’s umbrella. These aspects are unlikely to be resolved until well into next year at the earliest.
The German chancellor threw another spanner in the works by rejecting the use of ESM recapitalisation to deal with the problem of “legacy bank debt”, ie that incurred up to now. According to her, only when a pan-European regulator is in a position to ensure appropriate prudential behaviour should European-wide funds be available to take care of any regulatory mistakes. Until that point national governments should bear the financial responsibility for any failures that occurred on their watch.
The Irish response was one of consternation as such a position would appear to preclude ESM recapitalisation of our stricken banks. The Irish “special case”, broadly speaking, rests on three arguments.
First, since much of the credit extended by the banks to finance the property bubble came from European lenders, Europe should share some of the cost of the banking collapse.
Second, the Irish bank guarantee of September 2008 in effect protected European banks and lenders, and subsequent attempts by the Government to “burn the bondholders” have been vetoed by European fears of euro area contagion.
Third, it is in Europe’s interest that a country such as Ireland that has adhered faithfully to the terms of the current bailout programme succeed in regaining market creditworthiness. This in turn requires some alleviation of the potentially unsustainable debt burden.
In any negotiation, it is wise to first understand, if not necessarily appreciate, where the other side is coming from. German thinking (and that of other like-minded creditor countries) tends to be somewhat sceptical of the first of these arguments.
It is pointed out that while all euro area countries had access to unlimited cheap credit, Ireland was the most extreme in generating a massive property bubble, that Irish taxpayers enthusiastically voted for governments that did not stop the “benign neglect” by the Irish Financial Regulator that permitted this bubble, and that the September 2008 guarantee was aimed first and foremost at preventing a run on Irish banks.
Neither is it forgotten that Depfa, the German-owned bank that availed of the “light regulation” regime of the Irish Financial Services Centre, ended up costing the German taxpayer dearly.
The second part of the Irish argument is more nuanced. It is well known that at the time of the bailout negotiations in November 2010, the IMF team developed a plan that would have entailed some burning of senior unguaranteed bondholders.
However, aside from predictable ECB opposition, the plan was vetoed by the US secretary of the treasury, Timothy Geithner, on the grounds of contagion vis-a-vis the credit default swap market. In this sense, Ireland can justifiably claim to have “taken one” for Europe and, indeed, global financial stability.
As with most debt controversies, the moral debate about who should end up owing what to whom is likely to remain unresolved. Thus, the third, pragmatic argument, namely, that a second bailout must be avoided, is likely to be the most powerful.
Although some precautionary back-up financial arrangements may still prove necessary, a failure to exit the current programme successfully and regain market access would be seen as a telling indictment of current euro area strategy.
These considerations also apply to the second avenue, obtaining a deal on the promissory note vis-a-vis the ECB. Although there are complex technical and legal issues to be resolved, resistance may be less overtly political. Moreover, domestic political pressure on the Government not to effect the next payment of €3 billion, due at the end of March 2013, could be very strong.
That said, the potential financial benefits of a “deal on the debt” are likely to be considerably less than some may have come to believe. In the case of ESM recapitalisation, the potential gain would be the difference between the current value of the State’s equity in the pillar banks (some €10 billion) and the price the ESM would pay. Although a matter for negotiation, it is difficult to imagine the ESM paying a great deal “over the odds” for the shares, since it is supposed to operate as a profitable entity.
Similarly, any deal on the promissory note is very unlikely to involve any reduction in the amount of debt, although a major stretching out of the repayment period and (possibly) some reduction in the annual interest burden would certainly improve Ireland’s underlying creditworthiness.
But all told, a very large part of the €64 billion pumped into the banks by the State would remain unrecouped.
There is also major uncertainty about when the process, especially the ESM recapitalisation component, might come to fruition. In these circumstance, it appears wise to dampen any expectations of an early breakthrough or of a “pot of gold” awaiting Ireland at the end of the day.
A failure to deliver on such expectations, despite the best efforts of the Government, apart from possible political difficulties, could cause public disappointment and discourage confidence.
DONAL DONOVANis a member of the fiscal advisory council and was a staff member of the IMF from 1977 to 2005 before retiring as a deputy director. He is adjunct professor at the University of Limerick and a visiting lecturer at Trinity College Dublin