With apologies to irisheconomy.ie where this type of blogpost would normally have been created, but at midday today it hasn’t been. Veteran economist Colm McCarthy today writes in positive terms about the EU deal reached in the wee hours of last Friday morning. As well as welcoming the latest developments in the context of the pan European project, he believes the deal will be positive for Ireland. Let’s hope he is correct, but he seems to be optimistically latching on to some hooks offered on Friday, and this optimism may turn out to be unjustified.
The only solid black-and-white hook we have is the brief summit communiqué and in particular its first paragraph shown here with emphasis added.
“We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding. The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally”
There are three hooks in the statement
“it is imperative to break the vicious circle between banks and sovereigns”
This is potentially positive but also potentially negative, but what does it mean for Ireland where most of the losses in the banking system have already been crystallised. Might this mean that our premature good-faith intervention to rid our banks of property related losses, through NAMA and stress testing, with consequently massive recapitalising bills, mean that Ireland has ruled itself out of future measures to address bank failures? A distinction needs to be drawn between a European fund like the ESM recapitalising viable banks which have the potential to repay the capital on one hand, and zombie banks that have incurred losses so big resulting in such large recapitalisation requirements that the capital will never be repaid. I cannot see the ESM funding the latter, and that’s what we mostly had in Ireland with Anglo, Irish Nationwide, AIB, EBS and Irish Life, and to a large extent Bank of Ireland. And the ESM fund to which Ireland contributes may be used to capitalise non-Irish banks, and Ireland will be on the hook for additional losses should that capital be ultimately lost.
“The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme”
Colm says that sustainability means debt sustainability, but here there is a problem, because both our Department of Finance and the bailout Troika believe our debt is sustainable – take a look at the quarterly IMF staff report, there’s a whole section on debt sustainability and even with 120%-plus debt:GDP, the IMF gives this country a big tick for having sustainable debt. Our Department of Finance believes that if you can show debt reducing from a peak, then that meets the definition of sustainable, regardless of the underlying fiscal adjustment needed. So if “sustainability” means “debt sustainability” then why would there be grounds for optimism. And let’s not forget that the EU regards Greek, Italian and soon Portugese debt:GDPs of 120%-plus as acceptable.
“Similar cases will be treated equally”
Colm believes this means that any concessionary treatment of bank debt in Italy and Spainwill be retrospectively gifted to Ireland. Again, it seems unlikely from this perspective that the ESM will gift dead money to individual countries’ banks. If it does, who will foot the bill? At best, it seems the ESM might buy the State’s shares in Bank of Ireland, AIB/EBS and Irish Life. What are those shares worth today. A couple of billion perhaps, better than a kick in the teeth but derisorily small in comparison with the €68bn cost of the bank bailout to date – €63bn in cash, loans and promissory notes and €5bn of NAMA state aid for which we may need pay in 2020.
I hope Colm’s belief in the promise of the latest developments is justified, and that his interpretation of the words above is correct. I wouldn’t bet on it though.