Archive for November 11th, 2010

Article 17 (2) Dáil Éireann shall not pass any vote or resolution, and no law shall be enacted, for the appropriation of revenue or other public moneys unless the purpose of the appropriation shall have been recommended to Dáil Éireann by a message from the Government signed by the Taoiseach.

Article 28 (4) (4) The Government shall prepare Estimates of the Receipts and Estimates of the Expenditure of the State for each financial year, and shall present them to Dáil Éireann for consideration.

Irish Constitution

It’s an odd feature about democracy in Ireland – we have a reasonable framework in which the finances of the State are managed. Like most democracies we have an annual budget which sets out at an overview level how money is to be spent and indeed how taxes and borrowing are to be handled – nothing unusual at all in the way we manage our budget. The fact that a scandal will erupt every now and again where State expenditure has been wasted or worse, criminally pocketed doesn’t take away from the propriety with which our overall budgets are set. There is a high degree of transparency, interested parties make pre-budget submissions, the potentials areas of change tend to be signposted and debated at length in the weeks preceding the budget and there tend not to be many surprises on the day itself. The odd feature is that in the past six months a new creature has emerged, the promissory note, which has practically no ex ante oversight whatsoever. And yet this new creation has the ability to commit the nation to, at present, €23bn of future expenditure and that is set to rise to almost €31bn by the end of this year – in addition because of our net debt position, the money will need be borrowed and present estimates suggest the interest on repayments will be €13.3bn. This entry examines this creature in our parliamentary ecology and in particular whether it is compatible with our constitution.

But first of all, let me try to entertain you with an imaginary meeting between our own Minister for Finance, Brian Lenihan and our new-ish Financial Regulator, Matthew Elderfield. The scene is the Minister’s office on Upper Merrion Street one dark and cold night in March 2010, after everyone else has gone home.

Brian Lenihan: Ah Mattie, it’s yourself, come on in and take the weight off.

Matthew Elderfield: Howya boss- I mean “Minister from whom I am independent” (wink)

BL: Harhh, har, so tell us, you say there’s another problem with the banks. And did I hear you right, NAMA is causing the problem?

ME: That is right. Look, they’re about to transfer the first tranche of loans to the agency and I understand from both NAMA and the banks that the haircuts that will be applied are even more severe than we thought (or you thought – remember I only started in the job in January). Instead of a 30% average haircut, it’s likely to be at least 50%. And that means that the banks are going to be insolvent when they crystallise the NAMA loss.

BL: Shoite, will they? But how did this happen? How much will they need?

ME: NAMA tells me that the lending practices and paperwork are so bad that in a significant number of cases, the loans are worthless, not worth a penny. Overall though and it varies from bank to bank, on average they think that they will only pay the banks 50% of the face value of the loans. Anglo is in the worst position and I figure they will need another €18bn of capital on top of the €4bn we gave them last year (and they’ll need €8.3bn of that when the first tranche is transferred in the next few weeks) and INBS will need another €2.7bn and even EBS will need €0.35bn. Now I know we’ve suspected for some time that the banks might be insolvent but it’s now fact, it’s happening now.

BL looks stunned for a moment, and then without saying a word, stands up and walks out of office to the photocopier, opens the bottom tray, removes one sheet of A4 and returns to his desk where ME is looking puzzled. BL scribbles something down on the paper and hands it to ME

ME: What’s this?

BL: What do you think it is?

ME: It’s a piece of paper –

BL: Wrong! It’s a piece of paper with my signature on it and the bit above it says “I promise to pay Anglo Irish Bank Corporation €8.3bn on demand”

ME: And what am I supposed to do with that?

BL: Well, that’s your capital problem sorted out.

ME: But (stutters), but – have you spoken to anyone about this?

BL: I might have mentioned it in passing to the chief but no, I haven’t spoken to the rest. They probably wouldn’t have understood anyway.

ME: What about the Europeans?

BL: Ah yes now, I have spoken to our Spanish friend in Brussels –

ME: Great, so they’ve approved-

BL: Well, no. In fact Joaquin was quite angry about the whole thing and told me to put it in writing. Wanted to know why we hadn’t realised months ago that this sort of funding would be needed. Said something in Spanish, I don’t know “Cojeme” “Que chingados”, “Loco Irlandes”, that sort of thing, no idea what he was saying but it didn’t sound good.

ME: But look I’m supposed to be complying with stringent international rules to make sure the banks are adequately capitalised. And you’re handing me a sheet of paper.

BL: (the colour drains from his face and he fixes ME with a stare and with all the earnestness he can muster) Look it is essential that we ensure the banks operate on a sustainable and credible basis.

ME: (twisting features into his trademark scowl – after all he does use the same media consultant as the Minister) But Minister, sufficient capital is an essential ingredient to ensure that banks can withstand future losses. According to Basle I, “voting common shareholders’ equity and the disclosed reserves or retained earnings that accrue to the shareholders’ benefit should be the predominant form of a bank’s Tier 1 capital.” What you’re suggesting is that your promise, which with all due respect depends on the State’s future ability to borrow which is by no means certain, should be on a par with real shareholder funds and audited profit and loss reserves?

There’s an awkward moment of silence between the two, which is broken by their spontaneous bursts of laughter as they realize they have no other practical option, if they’re both to continue in their jobs, but to capitalise Anglo with a promissory note. As ME makes his way out BL asks him how that €340,000 a year salary is working out for him? And ME says not bad at all thankful that he’s not US Treasury Secretary, Timothy Geithner being paid only €137,000, sure who could survive on that?

By the way, and to be clear, I am not suggesting Matthew Elderfield has acted in any way unlawfully or that the €340k a year salary has corrupted him but the notion that he is an “independent” Financial Regulator is risible. Does anyone believe that he would last five minutes in the job if he set himself at odds with policy coming from Upper Merrion Street?

So that’s what we have today according to the recent DoF explanatory note on the Promissory Notes – an estimated €31bn of promises by the Minister by the end of this year that will be funded over a 15 year period and will incur estimated interest charges of €13.3bn.

In terms of parliamentary oversight, it is clear that the Minister broke State-aid rules in December 2009 when he provided, in writing, a commitment to both Anglo and INBS that the State would pony up for any shortfall in their capital base without getting approval from the EU. A subsequent request for approval for capitalization was made to the EU and indeed the request was modified as it became clearer that Anglo in particular was more insolvent than previously thought. There was no debate on the matter in the Dail. On 30th March, 2010, the Minister delivered a statement which confirmed a fait accompli. There was no analysis of the sum or indeed if it was sufficient. Which it turned out not to be. At the end of June 2010 the Minister was again giving secret assurances with respect to Anglo and yet again the EU were called upon to give approval after the fact. And again on 30th September, 2010 the promissory note values increased yet again. And the value of the promissory notes could be €36.5bn at year end if what is claimed to be the worst case scenario for Anglo is realized and if EBS needs another injection of up to €0.5bn depending on the terms of sale of that financial institution. So possibly €36.5bn plus €13.3bn +++ in interest may be spent on behalf of the citizens of the State.

The Constitution seems to make it clear that expenditure by the State should be subject to oversight. And despite the enactment in 2008 of legislation to give effect to the bank guarantee, it should still be the case that the Minister comes back to the Dail before any further binding commitment is given to the banks.

It is unclear if the promissory notes have yet been called in. Anglo repaid some €7.9bn of bondholder debt at the end of September 2010 and it is not clear how they managed to do that and if the ECB was involved in the transaction. There is no parliamentary oversight when the promissory notes are exchanged for cash. Contrast this with the debate that took place prior to directing the National Pension Reserve Fund to invest €7bn in AIB and BoI (which saw the creation of new legislation – Investment of the National Pensions Reserve Fund and Miscellaneous Provisions Act, 2009) or the debate on the “investment” of €4bn in Anglo in 2009 which was preceded by actual EU approval. These investments were debated extensively beforehand. The promissory notes however have merely been announced without debate or voting. Are they constitutional? I would say it’s arguable they are not but it is certain that they are avoiding democratic oversight.


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