When the blanket bank guarantee was implemented (planned, legislation drafted, debated and voted upon in the Dail) in 2008, it might have taken a couple of years to collectively realise that we’d been kicked up the arse but yesterday’s announcements won’t need that long. The banking collapse in 2008 is set to cost us an officially derived maximum of €87bn, our neighbours in Europe are charging us 6.75% (possibly plus) for financial assistance, we must cede our freedom to manoeuvre by offering up our pension/cash reserves, we need extra funding beyond that announced to help us roll over/redeem existing debt, senior bank debt will not burden-share AND WHERE IS THE TEXT OF THE AGREEMENT WITH THE ECB?
The announcements came thick and fast yesterday, there was the news conference in Dublin with Taoiseach Brian Cowen and Secretary General at the Department of Finance Kevin Cardiff, there was another news conference in Dublin with the IMF, and yet another one in Brussels with the EU/ECB, the IMF published a statement on its website, the ECB published a briefer statement on its website, there was a press release from Bank of Ireland regarding its new €2.2bn of additional capital requirement, the Financial Regulator in Ireland published a joint statement welcoming the agreement and setting out new capital and liquidity requirements (the most informative statement of the evening). Minister for Finance Brian Lenihan took to the airwaves. A flurry of activity and announcements that made the snow blizzards here on Saturday night seem sedate. But despite the media onslaught from so many different organisations and even if Brian Cowen had disrobed and performed Von Rothbart’s finale in Swan Lake in the nip atop the desk of his news conference it wouldn’t have misdirected us from the following:
(1) The announcements were about the banks. The State funding of the banks is now set to increase from the €46-52bn announced on 30th September, 2010 (see below) to €56-62bn “immediately” with another €25bn in “contingency”. The bottom line is that funding the bank collapse is to cost up to €87bn, a sum that independent economists have declared to be the likely zone of costs when we finally get to the bottom of our banks’ loanbooks. Of course it is claimed that some of these funds might be recouped and some are contingency and may not be needed, that we are “overcapitalising” and “showing the firepower” ranged behind Irish banks. With respect to the final losses in the banks, I will frankly admit that I have only a vague notion and instinct as to what they will be. Like everyone else I observe that NAMA has levied discounts far greater than was expected and remembering they are valuing by reference to November 2009, I conclude that the non-NAMA loans are likely to suffer losses far in excess of those presently accounted for by the banks. Like everyone else I observe the way in which the 11% collapse in GDP is affecting businesses and households. In respect of mortgage debt I observed the experience of the State of Nevada which shares many similar characteristics with Ireland (the weather isn’t one of them! housing bubble, negative equity, unemployment, recourse mortgages were though) and I fear that mortgage default will balloon. I also observe that the Financial Regulator has yet to conduct a “granular review” of non-NAMA loans and that banks are still using the fantasy discretionary accounting of IFRS 9. Like many of you, I listened in horror yesterday as Pat Rabitte suggested the prospect of further major losses on bank derivatives in his interview on RTE’s “This Week”. So my gut instinct is that if the IMF is setting aside a further €35bn for the banks with €10bn “needed” immediately and €25bn of contingency, then my gut instinct is that it will all be needed and that the State funding costs of the banks will go from a maximum of €52bn at the end of September 2010 to €87bn. I dearly hope I am wrong.
(2) We are being charged 6.75% (possibly plus) by our friends in the EU for access to funds. There was an homogenous form of wording used in the press conferences, that the interest rate was convoluted and that it would take a considerable amount of time to explain. At the very least why could the Taoiseach not have told the nation “The range of interest rates being charged by our partners in the EU is xx% to yy%, dependant on zzz”. Yes by reference to 9% 10-year money today, 6.75% is cheaper but hardly much cheaper than the 7.1% 3-year money. In terms of deriving 6.75%, this comes from the following statements:
(a) The IMF will provide 1/3rd of any external bailout at a maximum interest rate of 4%.
(b) The EU will provide 2/3rd of any external bailout
(c) The “blended average” rate if all external bailout assistance is drawn down is 5.83% (note the 3 in the second decimal place).
The EU rates must be 6.75% because 1/3rd of 4% plus 2/3rds of 6.75% equal 5.83%. I say 6.75%+ because the IMF bailout costs start from just over 3% – see the IMF press release.
(3) The National Pension Reserve Fund (NPRF) is to be effectively wiped out to fund the banks. By that I mean that the fund had a value of €25bn-odd at the end of September 2010. Of this, c€7bn was already invested in BoI/AIB/ A further €3.7bn was committed for AIB. And yesterday’s announcement says “this action, along with early measures to support deleveraging set out below will result in an immediate injection of €10bn of fresh capital into the banking system, above and beyond that already committed [my emphasis]”. I therefore understand the announcements to mean the NPRF of €25bn will have €1-3bn left when this exercise is carried out and that is to be used for infrastructure/capital spending. In addition we need pony up €5bn from our €20bn-odd cash reserve. The State is throwing its freedom to manoeuvre, its “full funding to the middle of next year” (and beyond) away to secure funding for the banks. That is a very risky gambit involving our main strategic asset.
(4) WHAT AGREEMENT HAS BEEN REACHED WITH THE ECB? The ECB had signalled its withdrawal of emergency liquidity assistance funding in January 2011. What about the €90-100bn of such funding to the six State-guaranteed Irish banks at 29th October 2010? Will the ECB be providing the financing for rolling over some €12bn of maturing sovereign debt (bonds and treasury bills) in 2011? Will our banks be required to buy sovereign bonds? Will the interest rate on emergency funding to our banks (or whatever replaces that funding programme) be more than 1.5%? What effect will interest rate changes have on our domestic lending market? Will new Irish mortgages (and existing standard variable rate mortgages) cost 8% even when the main ECB rate is 1%?
(5) The bondholders. I must say I am getting a little annoyed by this term. Because having painstakingly examined the balance sheets of the six State-guaranteed institutions (you can see their latest and indeed their historical accounts here), I see that lending to our banks by others takes many forms – you would think from the analysis in the media that it was limited to subordinated and senior bonds but it’s not – it includes medium term notes (MTNs), certificates of deposit, commercial paper. When we’re talking about “bondholders” why are we excluding the other lenders? Senior bondholders account for some €33bn of debt – what about the other €80bn of (non central bank) lending plus the €13bn of subordinated bondholders? Europe says “no!” to applying a haircut to the senior bondholders. The Taoiseach practically guarantees that haircuts for subordinated bondholders at Anglo and INBS will be applied more generally which I take to mean AIB and BoI specifically.
So what to make of it all? The IMF’s Ajai Ckopra tells us this morning that we got a good deal compared with the existing costs of bonds. Ajai also praises the Irish negotiating team (John Corrigan and Patrick Honohan were credited yesterday but Eamon Ryan says that the Department of Finance and Matthew Elderfield also played a role). The government commends the deal. The Opposition is aghast at the loss of the pension reserve and the protection of “bondholders”. Olli “don’t mention the 60% debt:GDP limit in the Stability and Growth Pact. I’m not listening. Lalalalala” Rehn commends it as he sees it as providing wider stability in the eurozone. In Ireland the only stakeholders that seem capable of organising protest are the unions and although they criticise in general terms the austerity elements of the four year plan, the plan itself was sufficiently vague as to public sector reforms that it didn’t directly lance the unions’ interests so I’m not sure there will be further protests.
I have sympathy for our negotiators. Putting aside the fact that the terms of the deal with the ECB have not been disclosed, it seems though that we have paid a high price by not getting to haircut the lenders to our banks, a 6.75%+ interest rate from our European neighbours and the loss of a strategic asset up front. In return we continue to have a functioning banking system which is far from optimal and I doubt if the €35bn of additional funding would result in a “wall of cash”. If banking losses are ultimately in the €80-90bn zone then we will need default or at least restructure if we are to have a society that any of us would recognise as acceptable. Would a restructure at this point have weakened or collapsed the banking system? The scaremongers might claim that but I’m not so sure. What I do know is that if we decide we want to restructure in 12 months time we won’t have a strategic reserve and will be truly dependent on others that won’t have our national interests at heart.
What now? The agreements (and I hope this include agreement with the ECB) are to be set out in a Memorandum of Understanding which will hopefully be published and debated. The Opposition doesn’t seem to be confident that it will get a vote on the matter and is seeing the Budget 2011 vote next week as possibly the opportunity to reject the agreement. Constitutionally some Germans are seeking to have this latest bailout set aside (by amending their previous case which is yet to be disposed of and which related to Greece). Could there be a constitutional challenge here? Given that the banks are potentially getting €87bn of State money I think there is an arguable case that the government does not have a mandate to enter into this agreement without oversight, debate and voting in the Oireachtas. And I understand that a challenge is being mooted. If unions make use of their economists, they might arrive at the conclusion that a default or restructuring is inevitable that might lead to savage cuts for its members and that may bring more protest or indeed a general strike at this point when we at least have a strategic reserve.
Bottom line for me though – this wasn’t a negotiation for bluffing our way with threats of default or withdrawal from the euro, it was a negotiation where we needed to honestly address the scale of losses in the banking system and conclude that we need a partial default on debt – to that extent it was less about poker and more about chess.
UPDATE: 30th November, 2010. RTE report that the proposed deal will be debated in the Dail today though it is unclear if there will be a vote. The Irish Times raises the prospect of a constitutional challenge to the agreement on the basis that it is an international agreement and according to Article 29.5.2 of the Constitution accordingly requires a referendum.
The markets haven’t yet opened in the USA, but when they do I expect them to give their opinion on this agreement. It won’t be pretty.
I would expect the Euro to continue to fall and the pressure on Portugal and Spain to intensify.
Until it is accepted that there is going to be some meaningful default on debt this flimflam won’t fly.
You mention the state of Nevada, I thought it would be enlightening to see the overall picture in the good ole USA housing market. Please there charts below.
http://www.businessinsider.com/the-housing-problem-in-3-pictures-2010-11
[…] source https://namawinelake.wordpress.com/2010/11/29/they-sent-in-poker-players-to-play-a-game-of-chess/ […]
You say the maximum interest rate for the IMF is at 4% but Irish Times stated today that the maximum rate for the IMF (standard SPR rate) is understood to be 5.8%.
http://www.irishtimes.com/newspaper/ireland/2010/1129/1224284371942.html
Have you any idea what the EFSF rate, EFSM rate, UK rate, Denmark rate, Sweden rate could be?
They could all conceivably be charging different lending rates.
Thanks, will try to track down that news conference because I understand the reporting in teh Irish Times to conflict with what I heard the Taoiseach say last night when he said 5.83% (note the 3 in the second decimal place) applied to the €67.5bn external bailout.
I obtained the 4% from the IMF press release (link below) which says ” At the current SDR interest rate, the average lending interest rate at the peak level of access under the arrangement (2,320 percent of quota) would be 3.12 percent during the first three years, and just under 4 percent after three years”
http://www.imf.org/external/np/sec/pr/2010/pr10462.htm
Thanks,
It still seems unclear from anything that I can find what each of the individual lending parties rates will be, notwithstanding the average headline rate that may have been calculated.
Pat Carey said yesterday on ‘The Week in Politics’ that the maximum IMF rate was 5.2%.
It seems to me be all very unclear.
Only being charged nearly 7% is a good deal in comparison to what the market would charge – 9%. Great statement until you recall why ‘the market’ is charging 9% and who was in charge and did what to bring this 9% about in the first place. Reminds me of something Blair said in the Hutton Inquiry (I think), “If I had done something wrong I would have resigned, I haven’t resigned, so I mustn’t have done anything wrong… .” Oblooong circular logic.
p.s. calm down NWL, its not as if U2 have split over musical differences!
We have been sacrificed to save the Euro and it will not work because the markets are not convinced… This punitive interest rate will cause us to default after much pain, so how much better are we off. None. It seems none of the guys in either the IMF/EU/ECB or our own government have learned any lessons from history. The markets will always win….
This is like wrapping a ticking time bomb in a fire blanket and putting your fingers in your ears.
Thanks for this excellent essay.
If you have a few minutes to spare, could you please help me understand:
1. Is this agreement irreversible? Are our “strategic assets” literally going to be paid to a fund outside the country so that we cannot access them should some rogue, brave party seize power and decide to default?
2. How would the State suffer if we chose to default? I understand that we would be rated as junk and have to fend for ourselves without access to credit on the markets—but perhaps that would be possible with some aggressive cost cutting, tax increasing and perhaps some assistance from the IMF?
Hi Eoghan,
1. The legal status of the agreement is debatable – Labour and SF say it is an international agreement that needs to be debated and agreed by the Oireachtas. FF say it is merely a funding agreement and we don’t need debate and vote on the NTMA every time it holds a bond auction. The agreement is a drawdown agreement so I guess we don’t *have to* draw it down. However although some terms of the agreement are known, we still do not know what has been agreed with the ECB with respect to their €90-100bn short term funding of our banks or how we will roll-over ~€12bn of debt that is due to be redeemed in 2011 (and nearly €40bn in 2011-2014 inclusive). We are also unclear why the banks need more capital and indeed it seems that Patrick Honohan doesn’t believe they do.
2. Default is an option but it would carry known and unknown consequences. Yes, we would find it difficult (some say impossible) to access funds for our day to day operations (though with the NPRF and selling off assets we should be able to get to 2013 when our deficit would hopefully be 5% on current plans). We may eventually have to accelerate the fiscal balancing (cut social welfare, pensions, public sector pay and number, capital programmes and raise taxes). All of that is a known consequence but what we don’t know is how we would continue with our European partners who seem be telling us that default is forbidden.
Unlike Las Vegas, what happens in Dublin, doesn’t stay in Dublin and the contagion is spreading.
It’s the same pattern again. The EU agrees a bail-out, and the markets panic. This time it took them less than a morning’s coffee break. The EU’s credibility sinks with each inadequate agreement.
The euro continued to sink. It is sub $1.30 as I write this.
Ireland cannot afford to pay its debts. We are bankrupt and we have been given more credit but eventually we will bow to the inevitable and default.
Ireland’s interest rates under the EFSF will average 5.8%, and investors realise that this rate is too high to be sustainable. As the country’s nominal growth is almost certain to lie well below that number for many years to come, Ireland’s debt will be on an explosive trajectory that will match the space shuttle at its most spectacular.
The markets have come to recognise that Ireland is insolvent. Today, the yields on 10 years are close to 9.5% – which means that we are fast approaching default time.
Yields have been rising in Spain and even Italy yesterday afternoon, and the situation continued to deteriorate overnight. There will be three or more sovereign defaults in the next five years. The defaults of Greece, Ireland, and Portugal are certainties – they can’t be avoided.
The question now is only whether Spain can scrape through.
Since the higher interest rates themselves have a massively adverse impact on the situation, the probability of a Spanish default/restructuring are increasing by the hour. Italy and Belgium have also made it on the Richter scale of investors – and there are extreme external scenarios under which the solvency of both countries could be also be questioned.
The fiscal austerity “one solution fits all” being offered as “medicine” will turn out to be worse than the disease. It will exacerbate the downturn and unleash a debt deflation dynamic in all of the areas where it is to be implemented.
Where’s the old printing press blanks for the Punt? Because like it or not, as far as the Euro is concerned – we are “out of here”.