Having studied the statements emerging this morning after yet another marathon EU summit, I am still scratching my head to see what all the fuss is about.
The markets certainly believe something has agreed which strengthens the debt sustainability of Spain, Italy and Ireland with bond rates tumbling this morning. Though having said that, Ireland’s benchmark 9-year bond is presently at 6.77% down from 7.1% yesterday, but 6.8% is the same as just a few weeks ago before Spain asked for a bailout or “credit facility”. Spain’s 10-year bond is at 6.6% which is down from the 7% yesterday, but still at an elevated unsustainable level.
So has there been a Big Bang, a new dawn in Europe and the seeds of a solution to the four-year old crisis?
If there is, I can’t see it.
There is no development apparent in the announcements which will see Ireland’s bank-bailout generated debt shared or reduced. And in Ireland’s case, that’s the issue – the 40% of debt:GDP which the country is shouldering to bail out banks. What we get is a fund which will loan money directly to banks. The fund will not absorb losses. The fund will want its loans back. There is no Santa Claus.
The summit statement from European Council president Herman van Rumpuy goes as follows:
“We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding. The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.”
Ireland’s banks are already recapitalized, in fact we have the most capitalized banks in the EU. There is a distinct possibility of additional capital being required for Irish banks – Matthew Elderfield has flagged €4bn of additional requirements, and if the mortgage crisis results in the crystallization of losses at the banks, then that too will generate a need more capital, as will a deterioration in the economy. But there is absolutely no indication that some Santa Claus will shoulder losses in individual countries’ banks.
What does this mean for us? Nothing, as far as I can see. No-one is suggesting any new fund will foot the bill for bank losses – past, present or future losses/losses in Ireland, Spain or elsewhere. Think about it – who would pay for such losses? Germany? France? China? Santa Claus?
Ireland gets a specific mention in the summit statement. And there is a compliment for our “well-performing adjustment programme” – so far we have met all financial targets in the Memorandum of Understanding, but with another €5,000 per household of adjustment needed with the “low hanging fruit” well-and-truly picked, that adjustment programme will be increasingly difficult to comply with. But what is meant by the “situation of the Irish financial sector”? We have bailed out the banks to the tune of €68bn – €28bn of extant promissory notes, €5bn in NAMA bonds and the rest in cash, which given we are running deficits, is borrowed. There is no suggestion of a refund for cash already injected into the banks, and if there is some debt writedown on the promissory notes, who will pay for that?
What we have got today from the EU is some more L’Oreal skin cream which smells pleasant, moisturises the skin and leaves a nice texture. What we have, however, is skin cancer and these announcements by themselves don’t deal with the disease of actual bank losses.
NAMA Wine Lake 
The statement talks about “recapitalizing” banks. You do not recapitalize a bank by lending it money. You have to take equity risk to do that. So it is different.
@Gobanian,
So Bank A has run up losses of €10bn. As a result, it needs new capital of €10bn to absorb the losses. The ESM may recapitalise the bank by providing it with €10bn. When do you think the ESM will get its money back? And if it will never get its money back, then who will foot the bill?
I agree with Gobanian – It depends upon how one interprets the phrase “recapitalize the banks”. It could mean injectiing bank equity capital in exchange for a fair-market-value return on the resulting equity position (no net benefit to the recipient country) or it could mean injecting bank equity even though there are diminished or nonexistent prospects that the capital injection will earn a fair market return. The Irish government was forced to do the latter – inject equity capital into the banks in return for very low or no prospects of a fair market return. Since the statement also acknowledges that countries in equal situations must be treated equally ,this seems to argue that Ireland can somehow have this “undone” so that Spain, Portugal, Cyprus and possibly others can avail of this bank recapitalization by the ESM at below-fair-market return.
@Gregory, of course you may be right but who do you suggest will pay for these losses which would result at the ESM for “injecting bank equity even though there are diminished or nonexistent prospects that the capital injection will earn a fair market return”
If the ESM injects 10 billion equity capital into a bank which prior to the crisis had equity value of 1 billion but then lost 9 billion in the crisis the ESM will end up owning 99% (or some wacking big percent like that) of a bank that cost it 10 billion but really is only worth 1 billion. It will not get great dividends (almost none paid probably during the time it holds the shares) and eventually ESM will decide to sell the stake (for which it paid 10 billion) for market value of 1 billion or so. So eventually ESM loses most of its “investment” but it was not done to generate a fair return.
@Gregory, what you suggest sounds about right for some banks, particularly in Spain and Ireland.
So the ESM loses most of its €10bn investment in your example.
Who shoulders that loss? Germany? France?
Who pays?
Like most people, I cannot follow much of the technical economic arguments surrounding Ireland’s bank crisis, though you always write very clearly. Am I to understand you as saying, basically, that the Germans & the French will never in fact give effective financial relief to the Irish & their banks because they do not perceive them to be *their* banks? Is your point that, for all the fine words that come out of these endless summits, when it comes to the crunch the Germans & the French do not perceive our problem to be *sufficiently* also their problem for them to assist to a degree that would make a significant financial difference to our position? Am I right to interpret you in this way?
@Marcus,
The technical arguments and the terminology can indeed become convoluted.
But to simplify the position, Ireland has debt to pay back. Some is the debt arose because as a nation we’re spending more than we earn, and that came about with the property/bank collapse in 2008. Some of the debt has arisen because we bailed out the banks after the losses in those banks threatened the survival of the banks.
So simply stated, we owe money to people who lent it. The terms on which we must repay the debt are specified, as with any loan.
So, if we are to see some reduction or relief in our debt, there will be an equal and opposite sacrifice made by our creditors.
And our creditors have no motivation to offer such a sacrifice. Our 120% debt:GDP is high but is akin to Italy’s and Portugal’s shortly. It is morally unfair that we have paid back bondholders but many of them were guaranteed by our duly elected government, so we made our bed and we sleep in it. We didn’t have to pay back other bondholders like the €1.1bn paid this week, but seemingly Minister Noonan interpreted a “nod and a wink” and did so anyway. So why should our creditors offer a sacrifice? From what I can see at this stage, there is no offer of a sacrifice on the table, and I am scratching my head as to what yesterday’s “deal” means for Ireland. I hope something positive comes from it, but can’t see it.
So to answer your question, “no” I don’t believe the Germans and French perceive our problem to be sufficiently also their problem to assist to a degree that would make a significant difference to our position. Unless there is unilateral action on our part or threat of unilateral action on our part, I don’t see that changing.
Many thanks for taking the time to reply to my question.
Your comment about Minister Noonan paying money he is not legally bound to is disturbing. One wonders if there is any other finance minister in Europe who would do this. What on earth is it about the Irish psyche that is so addicted to martyrdom?
More broadly, my own view is that the euro is failing because there is not a sufficiently strong sense of identification between the different nation states, & there is therefore an unwillingness to make the financial sacrifices between states that would save the system as a whole.
And this, I think, comes down simply to language. We will help – up to a point – someone with whom we can share a joke or an anecdote. But much less so someone with whom this is impossible.
This problem did not arise in the formation of the USA, or to a far lesser extent.
So we now have the absurd position where our young people in search of work go to Sydney (because there the jokes are the same), while our economy is run from Berlin (where the jokes are of a different kind altogether).
“We affirm that it is imperative to break the vicious circle between banks and sovereigns.”
Does that mean letting the banks go bust??? and states as well??? or is this quasi mutually-socialised-capitalism system getting deeper?
How does ESM paying the banks directly help, when the Soverign put the cash into the ESM in the first place… will institutions ‘gear up’ on the initial Soverigns ESM cash into Banks? only if back-stopped by the soverign?
Can’t see the ESM being ratified in Germany now that it’s obvious the German taxpayer may get burnt – oops.
meanwhile back in the real world the personal insolvency bill was published today… a bit of news management anyone….
Piling the crap higher, success in some peoples world.
Would this be a case for the ECB to print cash to recapitalise these banks? I guess its another way of reducing bond yields with LTRO? Perhaps a 30 year loan is another concept to allow such recapitalisation?
This all to regain access to a market that will lend us really expensive money even at 5% vs what we have to pay now. This will blow our deficit wide open once more
http://wp.me/p28tG9-hZ
someone has to pay alright
I can’t see any improvement in the Irish debt position as a result of this EU summit. The only country which has managed to get a concession is Spain – where the recapitalisation/investment for Spanish banks will not end up on the Spanish sovereign balance sheet.
Ireland, Greece and Portugal sovereign balance sheets respectively still retains the cost of borrowing for their nations bank’s recapitalisations.
If the Spanish bank recapitalisation was treated in the same way as Ireland/Portugal/Greece, Spain’s borrowing costs would become unsustainable and Spain would default immediately. The scale of Spain’s legacy debt – and the same will apply to Italy if Italian banks asks Italy for a bailout – ensure that a deal had to be struck in order to save Spain from defaulting. I guess it helps that Spain is the Eurozone’s 4th largest economy and the worlds 12th largest economy.
The costing of bailing out Spain’s banks will temporarily be placed fully on Spain’s sovereign balance sheet.
The plan is that this will be reversed once the details of the ‘deal’ are agreed upon.
This actually strengthens Ireland’s hand IMO. As Spain will have to get a retrospective reversal of its banking costs, even if this period is only a number of months, rather than a few years like Ireland’s.
How good the ‘deal’ will be is hard to judge at this stage but I think it is very likely that Irish solvency will be improved.
Just (another) fudge. Bank Debts, owed by governments, comes off the sovereign balance sheet and goes where? It still has to be paid back or rolled over forever, in reality, but there is a cost.
Typical political short termism; rearrange the deckchairs.
So the question is “Who is going to pay the €64 billion and more losses that the media have been blaming on the banks and developers, but in reality should be blamed on the politicians (because they laid it off on the Irish taxpayer)?”
The answer is “The European taxpayer will.” As NWL rightly says, if the Germans won’t allow the banks to default. the shortfall has to be repaid. In the end, the only “soft touches” are the European taxpayers. So the debts will be parked, restructured with low to negligible interest rates and paid down over a long time period. And while our exposure will be increased due to Spain and Italy’s debts being spread across the many; ours will also be spread over the whole eurozone rather than just ourselves. We should win out in the arbitrage.
What about Greece?
Greece does not have a banking crisis, it has a sovreign crisis which spilled over into the banks.
Ireland on the other hand, had a banking crisis and now 4 years into the mess our sovreign crisis is increasing.
So for Greece, does seperation of the banks from the Sovreign actually mean anything?