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Archive for December 2nd, 2010

There’s a book by a then young Polish man, Tadeusz Borowski, which deals with his own real-life experiences during the Second World War and in particular his detention in the Auschwitz camp in southern Poland where millions were gassed to death in chambers built to resemble a showering facility. Tadeusz was a worker in the camp and even though denied his freedom, his conditions were better than many because he wasn’t one of the groups targeted for murder by the Nazis. He was either a teenager or in his early 20s during this period and his story is brutally blunt and without the frame of reference or restraint that an older person would bring – it’s well worth reading. There is one episode I recall in which Tadeusz is playing soccer in the camp when a trainload of new arrivals comes in, some 3,000 men, women and children are led from the train towards the gas chambers. Unlike the popularised images of brutal guards using rifle butts and alsations snarling, the whole process is quite civilised. There is no rush as the 3,000 make their way past the makeshift soccer pitch towards the chambers. One middle-aged man, a professional and dignified man, drops his bundle and apologises profusely to the Nazi officer for the kerfuffle, no problem says the officer acknowledging the man and indeed waits patiently as the man gathers up his belongings and he tips his cap in a kindly way. Tadeusz has a throw-in of the ball and remarks to himself that between that throw-in and full-time, those 3,000 will be murdered. The book is called “This way to the gas, ladies and gentlemen”. And the present IMF/EU bailout deal which is presently before us for agreement instils a more general sense of that same dread that it will lead to our national ruin.

Yesterday the Minister for Finance published a statement and a set of documents which set out in some detail parts of the agreement reached over the past couple of weeks with the IMF and various parties from within the EU. I say “some parts” because it seems a secret side letter dealing with the banks is not being published at present. It seems bizarre that the documents were published only after statements on the agreement in the Oireachtas where Opposition parties were forced to comment on documents unseen. Why weren’t the documents published on Monday last before the matter was dealt with in the Oireachtas? For interest, the PDF consolidated document was created at 1.51pm yesterday. And I am still at a loss as to why the letters at the top of the consolidated document are dated “[] December”.

It was of course predictable that Opposition parties might attack the bailout plan in the Oireachtas on Tuesday. And it must be said that the Taoiseach gave a robust defence in which he pointed out that 5.8% was less than the rates practically available to Ireland at the moment, that the State was a half year away from running out of the cash to fund day-to-day spending (including pensions, social welfare and public sector pay), that Greece was now seeking the same bailout terms as Ireland and that we need a functioning banking system. He even managed to get a few laughs when he responded to Sinn Fein’s speech and remarked at how ironic it was that just as Sinn Fein were coming round to the idea of the State that they still weren’t aware that the State needed to be funded (unfair yet funny nonetheless). But he deployed at least three tactics in dealing with the onslaught from the Opposition which are worth examining:

(a) He didn’t reveal all of the terms of the deal. In particular we don’t know what has been agreed with the ECB from whom Irish banks appear to have €90bn+ of emergency liquidity assistance. He didn’t reveal why the banks need further capitalisation at this stage. He deployed misdirection as far as I was concerned to try to focus the bailout on “Garda and nurses salaries” instead of what it is really about : the banks. The interest rates are just now becoming known though they are not included in the document set published yesterday.

(b) He challenged the Opposition to produce a better alternative to the unpublished agreement. In principle this was a fair tactic because it is very easy to knock a solution to a difficult crisis without proposing an alternative. It would have been fairer though if the Opposition knew what deal was being proposed.

(c) He specifically challenged the notion that has gained mainstream traction in the State supporting “burning bondholders” and default. The Taoiseach claimed that the Opposition regarded these options as “cost-free”. Again a fair challenge but it would have been fairer if he didn’t use the extreme of claiming that supporters of default say it is cost-free, a more accurate assessment is that they said it would cost less than the present course.

So having studied the consolidated document published yesterday, is there an alternative and would default cost less than the proposed agreement? Before starting it needs to be acknowledged that we do not have comprehensive facts on what has been agreed with the IMF/EU and in particular we do not know what is proposed in detail with the banks, including the European Central Bank.

An alternative
Firstly I should say that I don’t see fiscal balancing, getting our revenues to equal our costs (excluding the cost of the bank bailout) to be an epic challenge. Nor do the politicians who believe we can achieve near equilibrium in 4-6 years. And frankly if those fuckers (that’s what our Taoiseach called them in the Oireachtas when he didn’t realise his microphone was on) in our competition quangos got their act together then we could see a re-basing of costs in the economy going forward (so if food, electricity, gas, broadband, phones, mobiles, education, medical and other professional services, clothing, consumer goods for examples) are all cut by 25-50% then frankly the fiscal adjustment would be a lot less challenging than many think – yes, there would be challenges in dealing with legacy debt, particularly mortgage debt, but that is a banking matter and will be dealt with below.

Despite the international perception that the Irish got drunk on a credit binge during the boom years, we did do some things right. We established a €25bn rainy day fund called the National Pension Reserve Fund – most countries fund pensions from current tax but we decided to set up a special pot which frankly can be used for any expenditure (and as we see in the current proposal, it is to be used to bail out the banks). We have also borrowed so that we have a €25bn cash balance on hand in addition to our pension reserve. These are our strategic cash assets and their use/loss should be very carefully considered because they provide us with freedom to manoeuvre today.

Ireland also has many State-owned companies and interests which would have been privatised decades ago in other countries. The State owns a major stake in Aer Lingus. The State owns the electricity and gas generation and most distribution companies. The State owns the public transport companies. These are likely to be disposed of under the current IMF/EU plan.

So our banks apart, Ireland can happily fund its day-to-day spending for the next two years plus, by which time our deficit is planned to be at 5% and on a downward trajectory in world where economies are recovering. You would have to say that if it weren’t for the banks and the debt their rescue will lumber us with, then in 2013-4 there would be no reason why the international markets mightn’t start lending to us again at reasonable rates.

As regards the banks, plainly the State needs a functioning banking system. But go back to first year at secondary school and the basic economics education provided then. The basic functions of our banks are to provide (a) a safe means of storing money (b) credit to households and businesses and (c) a payment system (cheques, credit cards, ATMs). In modern times, the State has always offered a limited guarantee to retail depositors (up to €20,000 before 2008 and of course it is either €100,000 or unlimited today). Against these simplistic facts we have ended up with a State-owned banking sector because our banks at their simplest borrowed colossal sums domestically (depositors and investors/lenders/bondholders) and internationally (investors/lenders/bondholders) and lent sums on projects which have collapsed in value (mostly property). Before the blanket guarantee in 2008, the State might have considered letting the bank fail, liquidating the assets (selling the loan books and banking operations) and paying off the depositors first and then the remaining lenders/investors with whatever was left.

The alternative is to ringfence the banking disaster from the nation whilst ensuring that we have a banking system which provides the most basic of services. That might involve the rehabilitation of the existing State-owned banking sector or the creation of a new State bank. The alternative involves introducing legislation to deal with legacy property and mortgage debt, by writing down some part of the outstanding debt. The alternative is then to repay depositors 100% and divvy up the remainder of the bank amongst the other creditors. Plainly the blanket guarantee legislation that was rushed through the Oireachtas in Autumn 2008 based on grossly inaccurate information needs to be repealed. This entry contains nearly 3,000 words and it would require many times that to detail the alternative but the above are the main headings.

Other alternatives –
(a) The common perception is that much of the debt owed by the State guaranteed banks is to French and German banks. If that is the case (which can presumably be readily verified by the government who own or control all of the banking system, either through investment, guarantee or license regulation) then why must we borrow at 5.7-6.05% for 7.5 years when the Germans can borrow on the bond market today for 10 years at 2.8%? If we as a nation are truly taking a bailout to protect German bondholders then surely the least that can be done is to provide that lending at the same rate that the German state can borrow today?

(b) If Ireland is to accept the debts of our banks on behalf of our partners in the EU, then why can’t those partners make available some emergency development funding to help offset the distress being caused by the cuts to the capital programme. We have a large backlog of construction projects, for example schools, telecommunications and transport. Such development funding which arguably in part rescued Ireland from its 125% debt:GDP in the 1980s would provide a needed stimulus to the economy and indeed make more probable that Ireland could repay the massive debt being foisted upon us today.

(c) The bailout is not immediately required for our day-to-day spending, it is required for the banks, particularly Allied Irish Banks and Bank of Ireland that were subjected to EU stress testing four months ago. Given the risks that attach to Ireland using its cash reserves and NPRF upfront, funding from the IMF and EU should be provided in the first instance and the NPRF deployed after our day-to-day funding runs out in “the middle of next year”. By reversing the order in which the funding is deployed, we protect our strategic reserves and also make it clear that this bailout is for the banks so that they can repay our partners in the EU that lent to us in such a profligate way during the 2000s (Ireland also accepts its share of responsibility as we are paying some €50bn of our citizens’ funds to rescue the banks so that they can repay German, French, British lenders).

Is default cost-free?
That is indeed a loaded question. Akin to the “Have you stopped beating your wife?” question. Nobody has seriously suggested that default would be cost-free. The relevant question is surely whether default costs less than the proposed course of action. How would you start to seriously compare the options

(a) Establish likely actions by our stakeholders. Providers of lending, according to the official line, would withdraw from providing lending to us and they may seek to punish us by blacklisting us even when we return to fiscal equilibrium. At the extreme this would mean that we need to return to fiscal equilibrium sooner rather than later (2-3 years) but is difficult to imagine lenders acting as a cartel and not investing in a fiscally balanced open economy country like Ireland from 2014 onwards. What about the other stakeholders? This gets more complicated and delicate. Apparently it is the ECB and EU that “unanimously” say we can’t default on senior bank debt. Or what? What gun was put to our head? What threats? What entreaties? What about MNCs on which Ireland depends? Well MNCs are already associated with a country that needs an IMF bailout and whose banking system is teetering. It is hard to see them taking a dimmer view of a limited default. There will be other stakeholders but surely it is for the government to set out the anticipated consequences of default.

(b) Compare the effect of the anticipated actions of our stakeholders with their anticipated actions if we pursue the present strategy which is likely to result in default anyway. What sort of Ireland will we have if we pursue the present strategy that will see even the official debt:GDP rate rise to 120%? Will that be a better Ireland than if we default on some bank debt today?

So as one that advocates limited default, I accept that there will be costs and that it will not be a cost-free option. Of course I readily admit I cannot predict all known and unknown consequences, but I feel they should be debated and subject to oversight so that we ensure we pursue the best option.

Perhaps it is the wintry conditions here. Perhaps it is because this crisis is the closest this modern nation has come to war but I leave you with another reference to the Second World War – and again it is from Poland. In 2008, the Polish film director Andszej Wajda brought us “Katyn”, the true story of the murder of 20,000 Polish officers by forces of the Soviet Union. The film is very well made and worth a watch but you might find yourself surprised about five minutes in from the start which deals with the opening days of the Second World War. Our notion is that the war started when the Nazis invaded Poland in September, 1939. About five minutes into the film we see refugees from western Poland fleeing eastwards being met on a bridge by refugees fleeing westwards. You see, the Soviets invaded Poland from the east on 17th September, 1939 ostensibly to protect its flank from the Nazis. But in truth in 1939 the Soviets had signed a non-agression pact with the Nazis, the Molotov-Ribbentrop accord which sealed Poland’s fate. Yet it was only in the 1990s – 15 years ago – that the secret codicil to that agreement was published. The secret side letter set out an agreement as to Soviet and Nazi spheres of influence and implicitly allowed the Soviets to invade and occupy large swathes of eastern Europe, Poland, the Ukraine, the Baltic states, Belarussia, Modova, Transdniestria.

I make this reference for two reasons – firstly, there is a secret (in the sense it has not been published) side letter in this agreement with the IMF and EU parties. It relates to the banks according to the Irish Times today but is confidential. This crisis is about the banks, first and last, yet we are not to see what is likely to be the most significant aspect of the deal. In particular we don’t know how the emergency liquidity assistance to Irish banks (€90bn at the end of October 2010) is to be replaced ; we also don’t know how we will roll over €12bn of debt that matures in 2011 though I suspect it has something to do with the ECB or the banks themselves. If this dubious position continues, then it will not be surprising if we find ourselves in the future on some bridge confronting some bizarre situation hidden from us now. The second reason for this reference is that in the film “Katyn”, it is the Soviets that are represented as the evil party. Neither Russia nor former Soviet states have any major involvement in our present crisis and perhaps the best known Russian in the country, economist Professor Constantin Gurdgiev is acknowledged as a friend to the country for trying to explain the crisis and forewarn the consequences of policy.  Just as the reference to Katyn is not an attack on our Russian friends, the reference at the top of this article is not used to personally attack modern day Germany for its orchestration of the present deals.

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