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Archive for May 20th, 2012

Just 11 more days to go before polling day on 31st May and the debate on the Fiscal Compact is certainly generating a lot of light and heat. Here’s a review of the past week.

The economics
The debate as to whether the Fiscal Compact will mandate more austerity continues, with the “no” side still maintaining that the reduction in the structural deficit from 3.5% in 2015 to 0.5% will mean a further €6bn of austerity. This is disputed by the “yes” camp and probably the most enlightening article during the week was Seamus Coffey’s setting out the numbers and challenging the “no” camp. The position on here tends to agree with the “yes” camp in that there will be an adjustment but it is likely that economic growth and reform will do the heavy lifting, and in any event, the existing rules require us to get to a structural deficit of 0.5% and it makes sense generally that in the long-term, we live within our means.

Citigroup came out on Friday last and said that even if Ireland rejects the Fiscal Compact ““we believe a second program would be forthcoming if requested, probably initially without private sector involvement unless the Irish government itself insisted that PSI is needed, which is unlikely in our view”

We did seem to get a straight answer from Minister Noonan during the week which confirmed that the EFSF would be available for new and additional loan applications up to June 2013.

The politics
The “yes” side comprise 80%-plus of the Dail so numbers alone indicate they will make the most gaffes, and this week there have been a few, from An Taoiseach Enda Kenny’s awkward encounters in Athlone, to Minister for Enterprise Jobs and Innovation Richard Bruton saying, and then retracting, that Ireland would vote again if the first referendum returned a “no” and we were faced with no other funding option, to Minister for Finance Michael Noonan whose “feta cheese” comments indicated a frivolousness and insensitivity to the economic situation in Greece and by implication overall, but that was probably unfair since the minister was talking to an international audience and he was trying to illustrate in simple terms the limited economic ties between Ireland and Greece. Several Independent TDs have yet to declare their position, notably Shane Ross and Mattie McGrath. Deputy Ross tried to introduce a Bill which would allow the referendum to be deferred but that was torpedoed by a Government seemingly obsessed with the notion of confidence and certainty. True to his word, Fianna Fail deputy, Eamon O’Cuiv has kept schtumm on his opposition to the Fiscal Compact but you can still read in detail his reasoning for his opposition here.

Opinion polls and betting

 

Last Sunday’s Red C poll certainly gave a boost to the “yes” side but two polls during the week, indicated a slight weakening in the “yes” vote though it still remains dominant. It is a curiosity on here that Red C does not count the “wont vote” category and it was indicated in last Friday’s Red C poll that “just under two thirds of the population (59%) claim they will definitely vote in the referendum at the end of this month.” So it would seem on here that there is still everything to play for with convincing the “undecideds” and “wont votes”. Red C’s Irish competitor, Millward Lansdowne Browne produced its own poll during the week which significant diverged from the Red C poll in indicating only 4% “wont vote” and 35% “undecided” compared with Red C’s 16%. Younger voters 18-24 appear to be most undecided. Here’s the history of polls

Paddy Power has gone on a roller coaster in its odds offered on the referendum outcome. Last Sunday it raised the odds of a “yes” from 8/15 to 1/5 and raised the odds even further during the week before reducing the odds back to 1/5 which is the present pricing.

The view from outside the Pressure Cooker
There is still little coverage internationally on the Irish referendum which is seen as a side show because the Fiscal Compact will come into effect once 12 of the 16 ratify it, and so far only Greece has fully ratified the Compact with Slovenia, Portugal and Poland having given parliamentary approval but are awaiting presidential assent. But that leaves 14 more EuroZone countries and seven EU non-EuroZone countries. A “no” vote in Ireland is still seen as contributing to a negative odour in Europe. Francois Hollande assumed power inFrance this week and seems to be maintaining his rhetoric in insisting on changes to the Fiscal Compact. Will Germany bend?

Endorsements
Declan Ganley and the Libertas Institute colourfully joined the campaign on Monday last, advocating a “no” vote and stealing limelight during the week with graphic posters and provocative debates. The Campaign against Household and Water Taxes advocated a “no” vote. The Dublin Chamber of Commerce and brother of Fine Gael’s referendum campaign director, Patrick Coveney advocates a “yes” vote as does any chamber throughout the country that I am aware of  – the overwhelming majority of the business community expressing a view on the referendum continue to advocate a “yes” vote, which it claims will underpin confidence which will protect and attract investment.

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“We will not have “defaulter” written on our foreheads. We will pay our way. We have never looked for a debt write-down, although we want an extension of flexibility from these facilities to help our taxpayers and in dealing with our deficit, and to help repay our debts in a more realistic fashion. It is in that regard that intensive discussions are now taking place” An Taoiseach Enda Kenny speaking in the Dail on 24th January 2012

A “no” vote in the forthcoming referendum on 31st May is being advocated on here for three main reasons – see here – but the primary reason is to help renegotiate Ireland’s debt which will stand at close to €200bn next year. So far we have racked up €64bn in bailing out the banks. Linking this referendum with the national debt and referring to the Fiscal Compact as the “Bank Debt Treaty” has generated some puzzlement, because on the face of it, there is nothing in the Treaty that you can immediately associate with renegotiating the bank debt. At the same time, there are important advantages in voting “yes” – more certain access to the ESM fund and investment confidence, being the main two. So it’s time to justify the advocacy of a “no” vote in a more detailed way, and that is what this blogpost sets out to do.

Facts and history
In 2007, Ireland had a so-called General Government debt of €47bn which represented 25% of GDP of €190bn. In 2013, the latest projection from the Department of Finance is that we will owe €190bn which will be 121% of GDP. Our debts have ballooned for two main reasons – when the financial crisis unfolded our tax take collapsed but our outgoings remained constant so we borrowed to fill the gap, and secondly we bailed out the Irish banks. To date we have sunk €63bn into the banks, comprising €32bn in cash from the National Pension Reserve Fund, from our tax receipts and from our first bailout and €31bn in promissory notes. What is at issue is the extant funding of the promissory notes of €25bn-plus – we paid a total of €6bn off the notes in March 2011 and March 2012 – and less than €10bn of bondholders in IBRC and AIB. Overall in terms of bank debt that is still to be funded, we’re talking about debt which represents about 20% of our GDP. Of course if we borrow to pay for this part of the bailout, we will also need pay interest on the borrowings.

Ireland competes for investment with other EU countries, particularly so-called Accession countries, and we have already witnessed the high-profile departure of much of Dell’s operations to Lodz in Poland. These are the debt levels of EU countries at the end of 2011, and make no mistake about it, we compete with these countries for investment. Over dinner tables in Warsaw today, they are wondering how they can access a higher portion of EU foreign direct investment. Starting out with a 56% debt:GDP,Poland and countries like Poland have the potential to invest in ways not available to Ireland which is collapsing under the weight of 120% debt:GDP

“Renegotiating our bank debt”
Here are what are believed on here to be the bases for a negotiation.

Ethics – this is the popular and populist one and it goes like this : the banks privatised their gains during the 2000s and socialised their losses when they hit the buffers in 2008. That’s SO unfair on society. Not only that, but the beneficiaries of our bailed-banks have been furriners, generally portrayed as Brits, Krauts and Frogs who lent profligately to our banks in the 2000s and are now getting repaid in full at citizens’ expense. Again that is SO unfair. And whilst other countries have had to step in to help their banks, in Ireland’s case the cost will be 40% of GDP which is well beyond what any country is contributing. SO unfair. On the other hand, non-Irish eyes might observe that in September 2008, Ireland offered a guarantee to its banks which was not welcomed internationally, and indeed for a while we were Jack the Lad telling depositors in London and elsewhere that their money was safer in Irish banks. Non-Irish eyes might also observe that it was our lawfully elected national parliament that voted for the guarantee, so our representatives acting on a mandate given to them by us voted for a measure which is now disastrous. And the ECB and our partners in the EU listen to our whining and say “too bad, we’re sorry for you, but you made your own bed”.

Economics – there is a reason why the Maastricht Treaty tried to set limits on countries running up huge debts. As the debts balloon, the chances of default and contagion worsen.Maastricht set the debt limit at 60% of GDP. Economists believe that debt:GDP levels of over 80% eat into future economic development and over 100% we are in the “Red Zone”. Ireland’s debt:GDP is forecast to peak next year at just under 121%. So shouldn’t we be able to tell our creditors that our debts are too high and we are going to default and arrange an orderly default. You’d think, but our creditors in the EU might point to Greece,Portugal and Italy which have or will have debt:GDP greater than Ireland’s, and we know that our EU partners are not moved to assist these other countries. So why would we think they would move to assist us?

Default – Inevitable forced default has not been accepted by our partners, or if it has they’re not saying – nearer to home, our own Government TDs are acknowledging that a default, a soft or agreed default hopefully, is in prospect. What about unilateral default though? We know from An Taoiseach that such a threat – and it would be a threat – has not been made. This is the red line position in any negotiation, it is the position that gives negotiations traction and regardless of the consequences, it is the only red line position we have.

Collateral – this topic deserves special attention, particularly after the manoeuvrings of the ECB in March 2012. Our debt comprises sovereign debt – bonds, treasury notes and state savings – and non-sovereign debt – promissory notes and the remaining debts of banks owed to their creditors, including bondholders. Sovereign debt is underwritten by the nation. Promissory notes were sheets of paper on which Minister Lenihan wrote “I-O-U” So dodgy are these sheets of paper that the governor of the Central Bank of Ireland apparently sought so-called “letters of comfort” in which Minister Lenihan wrote “I really REALLY promise to honour these promissory notes”. Can Ireland tear up these IOUs? The position on here is that we can, though there may be consequences. We do know that the ECB is anxious about the collateral underpinning the promissory notes because in March 2012, Minister Noonan said “you could take it that the ECB were never particularly happy with the collateral provided by the promissory notes and would like stronger collateral”. Oddly enough that theme disappeared from the media when it was leapt on, on here. That may be misplaced vanity, but the fact remains that the ECB is not 100% happy with the collateral, and the view on here is that this is the weakest point in our campaign to get a debt reduction, and as the weakest point, we need to devote our resources to pummelling the living daylights out of it.

How do we know this Government couldn’t negotiate its way out of paper bag?
We don’t! With respect to Minister for Finance, Michael Noonan, we know he is a hugely experienced politician that has a lifetime of success and failure under his belt, and we would naturally assume he has good negotiation skills – if politics is indeed the “art of the possible” then we should be able to take it as read that a veteran politician is a skilled negotiator.

But here’s why I think he and his team are out of their depth in these negotiations. Even taking into account the lousy financial condition of the country which places us at a disadvantage in negotiations, it is truly baffling as to how we arrived at such poor outcomes over the past year as these following:

(1) In March 2011 just after coming to power, Enda Kenny set about renegotiating the interest rate on Ireland’s bailout funding. He was sent away with a flea in his ear by France’s Nicolas Sarkozy after reportedly “grandstanding” at what become known as “the Gallic Spat”. Meanwhile at the same meeting,Greece was granted a 1% reduction in its interest rate.Portugal wasn’t yet in a bailout programme (see below)

(2) In July 2011 at the EU summit, Ireland came away with a reduction in interest rates that will save this country some €10bn in repayments on the bailout programme. Well done to Ireland’s negotiating team, except no-one believes the reduction was conceded except to save Greece, and Ireland merely benefited on the shirt-tails of Greece. But at this stage,Portugal was also in a bailout programme and Portugal also benefited from the interest rate reduction. But the difference was that Ireland had to give a commitment on our corporate tax arrangements in return for the interest rate reduction,Portugal didn’t. And by the way, the interest rate reduction applied going forward from July 2011, we lost north of €10m as a result of Enda Kenny failing to get the same interest rate reduction as Greece did in March 2011.

(3) The Anglo promissory note “deal” in March 2012. Recall that negotiations on the promissory notes were ongoing since at least last September 2011. At the 11th hour in March 2012, Minister Noonan announced a “deal” to the Dail, and then scampered for three weeks without offering any elaboration. Notwithstanding the fact that Bank of Ireland has yet to schedule an EGM to put the “deal” to its shareholders and notwithstanding the apparent error in Minister Noonan’s calculations in his announcement in March – which will be the subject of a blogpost on here next week – it was quickly established that the ECB had done no deal with Minister Noonan, and all that happened is the Government raided NAMA’s piggy-bank to repay the notes in full and on schedule.

(4) Ireland needs to contribute to the ESM fund even if we remain in a bailout programme. That’s a serious change to the arrangements under the existing EFSF programme – you’ll recall that we paid €346m over to Greece in 2010 for its bailout but our contributions were suspended after we needed our own bailout. However with the ESM, we are required to pony up €1.27bn in cash in the next two years to the ESM’s initial €80bn firepower plus we may be called on to contribute an additional €9.9bn to bring our overall contribution to €11.145bn. And should Spain or Italy need bailout funding then that €11.145bn of funding will be more than a theoretical concept! And Minister Noonan signed up to that Treaty!

(5) Despite the fact that there is a substantial probability of this country needing a second bailout, we have signed a Treaty which doesn’t set out the pricing of a bailout. All it says is the ESM will charge a rate which covers its financial and operating costs and “an appropriate margin”. If the aim was for Ireland to have access to cheap funding, why did we allow the term “an appropriate margin” to be written into the ESM Treaty. We can hope the “appropriate margin” is nil or insignificant but what if the powers that be in Europe decide the ESM should be a deterrent to countries getting into difficulty in the first place and it charges a healthy deterrent premium?

(6) Despite the fact that there is a substantial probability of this country needing a second bailout and that membership of the ESM will deter the bond markets from charging a premium, Minister Noonan signed a revised ESM Treaty and Fiscal Compact in February 2012 which makes access to the ESM funding conditional on ratification of the Fiscal Compact. What class of eejitry is this? Perhaps it isn’t classified yet, but it certainly exposes poor negotiation skills on Ireland’s part.

How does a “No” vote improve our prospects for getting a write-down on the bank debt?
A “no” vote on 31st May 2012 is the first step. The second step will be the default on bank bonds, and the Government will have a perfect opportunity on 26th June 2012 to default on a perfect bond – an unsecured unguaranteed senior bond at what was Michael Fingleton’s Irish Nationwide Building Society (INBS).  The details of the two bonds that fall due on 26th June, 2012 are

XS0306307694 Issued 26th June 2007 €598,100,000 outstanding
XS0306306613 Issued 26th June 2007 GBP 28,800,000 (€23,240,801) outstanding

INBS has received a bailout of €5.4bn – €0.1bn in cash and €5.3bn in promissory notes – to date and the betting on here is that it will need more.

On 27th June, if the bondholders haven’t been repaid in full, then chances are they will launch legal action in Dublin’s High Court to pursue the debt owed. The Government at this point will need renege on the promissory notes and threaten to wind-up IBRC, the new bank that emerged from the merger of INBS with Anglo.

At which point, the ECB would be directly involved because if IBRC is wound up MINUS the promissory notes, then the ECB will shoulder an enormous loss in respect of the nearly €40bn of loans it has given to IBRC.

A “yes” vote on 31st May shows that the nation continues to provide support to a government which is campaigning for a “yes” vote, a government which swept to power last year with a mandate based on the belief that it would seek, and get, a write-down in bank debt, a Government which has admitted it has not sought a write-down in debt. If there is a “no” vote, the Government can legitimately say that the prospects are that we will have a hard default at the end of 2013 if we don’t have access to the ESM, and the Government can legitimately say, with the support of the nation, that it is better to default now on debt at one of the most insolvent banks in the world, than to have a hard default on sovereign debt in 2014. Better to default when we are still on our feet now, than in 2014 when we will be on our knees without access to the ESM. A “no” vote will set this course in train and with a credible threat, the ECB will negotiate.

But is it really acceptable for us to threaten the ECB which is providing €131bn of funding to our banks?
Well, we wouldn’t be having a monopoly on threats. Remember the ECB threatening Ireland last year in these terms : “In the meantime, we may have to come to the conclusion that it doesn’t really make sense for the ECB to keep putting €100 billion into Irish banks.   What we are doing is actually illegal, but we have being doing it because we want to help Ireland.  Maybe we might come to the conclusion that we should stop”

Unfortunately for the ECB, events have moved on. Whereas Ireland was in November 2010 the recipient of an estimated one quarter of the ECB’s total lending which was completely out of proportion to our economy which is only 2% of the EuroZone’s, these days, Irish banks have €131bn of support from the ECB, €87bn from the ECB directly and €44bn from the Central Bank of Ireland. The ECB has a balance sheet of €3tn these days, so our demands on lending are much more in line with the size of our economy, and remember the ECB has been shoving trillions out the door in longer term lending to other EU banks, just over €1tn in two operations in December 2011 and February 2012 alone.

So the ECB might try to threaten us again, but with the rest of Europe teetering and the probability that the ECB would only get a fraction of its lending back if it pulled the plug which might be unlawful anyway, should we really be concerned?

Hmm, where do I get a second opinion?
Economists? No, or at least not based on their expertise in economics. Economists will be able to tell you about Ireland’s debt:GDP, what it means for the country now and in future. They may have an historical perspective which will explain how other countries have dealt with elevated debt levels and Deputy Stephen Donnelly frequently refers to research which shows our debt levels are unsustainable by historical standards and we are heading for default. Economists should be able to tell you how Ireland will perform relative to lower debt competitors in the decade ahead.

Laywers? Are more relevant to this issue because on 27th June 2012 if we don’t repay €600m to unsecured, unguaranteed bondholders at INBS, you can bet your bottom cent that the bondholders will initiate legal action to recover the full par value of the bond. And it will be the courts that determine if their case succeeds. But even lawyers can have divergent views – after all that’s why we get court cases.

Negotiators? Yes, but alas we’re ALL negotiators. What you need are the negotiators who are actually negotiating with the ECB and they’re not likely to be formally introduced. We can ask their masters, the politicians. We could insist that our politicians haul the negotiators before an Oireachtas committee and demand to know why they have been so unsuccessful, so far. But I don’t think that will happen before May 31st.

You. Weigh up what is argued for above, challenge politicians supporting a “yes” vote and review the history of our negotiations yourself. But remember the prize of getting a debt write-down is huge, we can always vote “yes” in a second referendum and if we have any measure of success, you might just about feel that you are living in a decent society, not burdened with other people’s debts.

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