Archive for July 15th, 2011

A phenomenon of the current financial crisis has been the colossal sums of money involved – the banks may cost us €70bn to bailout, we have an annual deficit of €18bn, our national debt is likely to peak over €200bn. For a country with a population of 4.6m, these numbers are truly gigantic. Indeed they are so big that we sometimes lose sight of what the numbers will mean to us individually or as communities. Having already suffered levies and charges to our wages, we have also seen cut-backs to services, and these look set to intensify. The closure of the Roscommon Accident and Emergency facility may have attracted a lot of headlines, but in truth there are 1,000 Roscommons coming down the track. Meantime, week-in and week-out we continue to repay bondholders in Irish banks. Two months ago we repaid €200m in unsecured unguaranteed senior bondholders at Anglo, the zombie bank. That’s just under half of the €470m annual cost of the nationwide Jobs Initiative, it’s three times the €65m saving from recently-announced cuts to the fuel, electricity and phone allowances for social welfare recipients which charities say will have a detrimental impact on vulnerable older people and if I understand the figures here correctly, it’s twice the annual cost saving of the planned closures to accident and emergency services at selected hospitals throughout the country. When you consider these comparisons, the billions start to come into focus and become relevant to our lives.

Since March this year, there has been a weekly protest march in the village of Ballyhea in Cork, just south of Charleville along the N20 going to Mallow. It’s a non-political 10-minute march each Sunday before the 11 o’clock Mass through a stretch of the village. Here’s a picture of a typical Sunday morning’s march:

And since March 2011, the villagers have also held a special march in Thurles, and then in June 2011, there was an extraordinary week-long journey on foot or bicycle from Ballyhea to Leinster House to hand in a petition. In recent weeks, its march has been replicated in Charleville. This community is not going “gentle into that good night”. And this week, the community in the person of local resident, Diarmuid O’Flynn, has launched a Facebook page to keep track of when we repay bondholders and how much. It also encourages discussion on what these repayments might alternatively be used for. There are plans to email the IMF whenever a bond is repaid, and ask why the IMF is standing idly by and abandoning its principles of burden-sharing and making a special case of forcingIreland to repay debt that many say is unsustainable. The IMF has only just managed to shrug off an image of savage interventions in developing countries where adjustments have been accompanied by wide-spread societal damage. The IMF will be reminded of the week-in, week-out damage being wrought on this country by its inaction. And the European Commissioner for Economic and Monetary Affairs, Olli Rehn, will be routinely asked why he supports a programme which drives Ireland further and further away from the 60% debt:GDP cap enshrined in the Stability and Growth Pact and which our Finnish friend was supposed to police alongside the 3% deficit:GDP cap. Indeed the ECB itself will be a recipient of regular communication so that it too understands the disproportionate damage being wrought on this nation, by its adopted position on protecting bondholders. And of course the Facebook page may become a stick to poke our own politicians.

The data used on the Facebook page has come from Bloomberg and you can read more about its sourcing here. There are some discrepancies with the totals provided on a once-off basis by the Central Bank ofIreland in April 2011. Unfortunately it has not been possible to clarify the discrepancies with the CBI which overall total some 10% of the total figures.

The Facebook page has just been launched and will grow to feature graphic tables on bonds just paid and bonds about to be paid imminently.

Now to add balance to the above, at least two issues should be made clear

(1) It might be worth understanding the bait-and-switch scam before reading the following. This is a scam where something attractive is offered to you, perhaps at a cheap price, but when it comes to completing the transaction, a substitute is provided so you end up over-paying, compared with your initial perception. Hold onto that concept.

Ireland’s current economic woes are only partly tied to cost of dealing with the banks. In addition, we have a nasty budget deficit – what we take in, in tax is a lot less than what we spend on social welfare and the public sector. The primary deficit, excluding bank and interest costs, is presently €15bn a year, in other words we take in €41bn in tax and we spend €56bn on running the country with health (€11bn), social welfare (€14bn) and education (€8bn) being the biggest outgoings. And at this stage, we know inside-out the reason for the deficit: during the boom years of the 2000s, we matched our expenditure with our revenues, we reduced taxes, increased welfare rates and public sector spending. And the engine which largely drove that growth in the 2000s, banking and property, has suddenly and disastrously ground to a near-halt. So we have spending left high and dry at Celtic Tiger era levels but tax revenue has taken an immediate hit. A lot has been written about the causes and the blame, but the fact is, we’re left with a mismatch, a deficit and we need to eliminate that. Lots of other countries have been hit with similar mismatches in the past and we can be thankful we didn’t have a war or a natural disaster; we had a fiscal shock and it might have been worse. As for sorting out our deficit, we hope to have economic growth over the next four years, during which time, the plan is to eliminate the deficit. This economic growth will take some of the strain because if more money is being generated in the economy, we can keep the same tax rates but tax revenues will increase. Also there is, on some views, likely to be more emigration which might reduce the strain on the dole queues. But we should be in no doubt, 13% compound economic growth between now and 2015 and some emigration will not solve our deficit. And most of the adjustment will come from increased taxes and reduced expenditure on welfare and the public sector.

The projected primary deficit for the five years 2011-2015 is in the order of €45bn which, considering we need borrow to fund these deficits, if you add interest costs of 5.8% for 7.5 years gives you a total cost of €65bn.

So when we encounter a new tax or a cut to services, it should be remembered that a portion of that pain is attributable to reducing the deficit. But this is where the switch-and-bait comes in. The routine message at a political level at present is that the cuts are ENTIRELY to deal with the deficit. Yet when it comes to the use of the money cut from services or generated from new taxes, that money goes to reducing the deficit AND paying for the banking crisis.

How do you apportion between cutting the deficit and repaying bondholders? That’s a very difficult calculation. This was the bondholder position in Irish banks in April 2011, according to the Central Bank ofIreland(on the left) and by this blog based on information from Bloomberg (on the right)

There is a discrepancy as noted above between the CBI and Bloomberg, it seems, and the CBI has not meaningfully responded to a request to clarify the discrepancy between the two sets of figures. But put that to one side, and accepting the CBI’s numbers, €21bn of senior bonds are guaranteed, €20bn are unguaranteed but secured by collateral at the banks and €16bn are unguaranteed and unsecured. There was also €7bn of subordinated bondholders who are largely now being burnt to the tune of 60-90%. The focus so far has been on unguaranteed unsecured senior bondholders at Anglo and INBS which total just €3.5bn. Add in lending costs to Ireland of 5.8% for an average term of 7.5 years then the total cost would be €5bn. So €5bn compared to the €65bn cost of the deficit is plainly a small proportion.

If all €16bn of senior unguaranteed bondholders were 100% discounted then the saving, including interest costs on borrowing to repay the bondholders, would be €23bn, one third of the deficit cost. There are arguments around the unguaranteed senior bondholders and whether or not the guarantee can be revoked. If it were the case that the guarantee could be revoked, then the maximum saving would rise to €52bn. There are also arguments about how secure the “secured senior bondholders” are, especially after the passing into law of the Credit Institutions (Stabilisation) Act which allows the state take draconian action against banks in receipt of state funding. Add these into the pot and the total rises to €82bn.

So you could argue that most of the cuts and austerity, will not be to eliminate the deficit but will be to repay bondholders. But with smaller savings from imposing haircuts on subcategories of bondholders, the proportions will tip more towards the deficit being the main reason for adjustments.

Watch out also for the reverse bait-and-switch by those who say ALL of the austerity is to repay bondholders. It’s not. The truth is that we presently plan to cut the deficit AND repay bondholders.

(2) The European Central Bank, based in Frankfurt, has been portrayed as some pantomime villain in the bondholder story. It seems to be the case that the main obstacle to imposing haircuts on senior bondholders is the ECB, whose position appears to be that Ireland must not impose haircuts and if it does, the cheap funding provided at present on a massive scale to Irish banks, which wouldn’t be able to source the funding elsewhere, might be withdrawn. Truth be told however, neither the ECB or its president, Jean-Claude Trichet are the embodiments of evil and they adopt their stance for logical reasons. In the past few days I have asked the ECB to explain its position on Ireland’s expressed wish to impose haircuts on senior bondholders, and the best that has been provided in response has been a series of historical statements – here and here and here and here – from the ECB which merely refer to the need to follow the plan. And sadly there is no real justification for the position but here’s my view of the reasons

(a) Contagion. We hear that term a lot, and it’s almost  become the economic equivalent of telling a persistently curious child “that’s so why”. It’s supposed to end debate. But what does “contagion” mean? It might mean that a strong French bank has a €100m bond due to it from Anglo. And if Anglo didn’t pay that €100m, then that strong French bank would suffer a loss. If it was indeed strong, then that might be the end of the matter because it might be able to absorb the loss. But what if it was a weak Spanish bank that held the €100m bond? Might the loss make that bank insolvent, and if so might that bank need default on its bonds. Irregardless of whether it is a strong French bank or a weak Spanish bank, it is still €100m of loss, it’s not growing to €110m. So Ireland might reasonably ask why the €100m debt is not shared between the Irish bank and the strong French bank and the weak Spanish bank. After all, France’s GNP is 14 times that ofIrelandso if state assistance is required inFrance, it will be proportionately less of a burden than inIreland.

(b) Higher funding costs for European banks. The ECB is concerned about the well-being of 330m citizens, including the 4.6m inIreland. There appears to be a concern that if Ireland does impose haircuts on senior bondholders then lenders to all EuroZone banks will demand higher rates of interest to compensate them for the risk that banks will, like Ireland proposes, impose haircuts. This concern needs more research but it does have a ring of credibility to it. On the other hand, Denmark has now twice imposed losses on senior bondholders, though of courseDenmarkis outside the EuroZone. Is there any evidence of an elevation in the interest rates demanded by senior bondholders when buying new bonds in Danish banks?


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