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« When it comes to EU debt deals, always (always) look a gift horse in the mouth
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Colm McCarthy on EU debt deal

July 1, 2012 by namawinelake

With apologies to irisheconomy.ie where this type of blogpost would normally have been created, but at midday today it hasn’t been. Veteran economist Colm McCarthy today writes in positive terms about the EU deal reached in the wee hours of last Friday morning. As well as welcoming the latest developments in the context of the pan European project, he believes the deal will be positive for Ireland. Let’s hope he is correct, but he seems to be optimistically latching on to some hooks offered on Friday, and this optimism may turn out to be unjustified.

The only solid black-and-white hook we have is the brief summit communiqué and in particular its first paragraph shown here with emphasis added.

“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”

There are three hooks in the statement

“it is imperative to break the vicious circle between banks and sovereigns”

This is potentially positive but also potentially negative, but what does it mean for Ireland where most of the losses in the banking system have already been crystallised. Might this mean that our premature good-faith intervention to rid our banks of property related losses, through NAMA and stress testing, with consequently massive recapitalising bills, mean that Ireland has ruled itself out of future measures to address bank failures? A distinction needs to be drawn between a European fund like the ESM recapitalising viable banks which have the potential to repay the capital on one hand, and zombie banks that have incurred losses so big resulting in such large recapitalisation requirements that the capital will never be repaid. I cannot see the ESM funding the latter, and that’s what we mostly had in Ireland with Anglo, Irish Nationwide, AIB, EBS and Irish Life, and to a large extent Bank of Ireland. And the ESM fund to which Ireland contributes may be used to capitalise non-Irish banks, and Ireland will be on the hook for additional losses should that capital be ultimately lost.

“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”

Colm says that sustainability means debt sustainability, but here there is a problem, because both our Department of Finance and the bailout Troika believe our debt is sustainable – take a look at the quarterly IMF staff report, there’s a whole section on debt sustainability and even with 120%-plus debt:GDP, the IMF gives this country a big tick for having sustainable debt. Our Department of Finance believes that if you can show debt reducing from a peak, then that meets the definition of sustainable, regardless of the underlying fiscal adjustment needed. So if “sustainability” means “debt sustainability” then why would there be grounds for optimism. And let’s not forget that the EU regards Greek, Italian and soon Portugese debt:GDPs of 120%-plus as acceptable.

“Similar cases will be treated equally”

Colm believes this means that any concessionary treatment of bank debt in Italy and Spainwill be retrospectively gifted to Ireland. Again, it seems unlikely from this perspective that the ESM will gift dead money to individual countries’ banks. If it does, who will foot the bill? At best, it seems the ESM might buy the State’s shares in Bank of Ireland, AIB/EBS and Irish Life. What are those shares worth today. A couple of billion perhaps, better than a kick in the teeth but derisorily small in comparison with the €68bn cost of the bank bailout to date – €63bn in cash, loans and promissory notes and €5bn of NAMA state aid for which we may need pay in 2020.

I hope Colm’s belief in the promise of the latest developments is justified, and that his interpretation of the words above is correct. I wouldn’t bet on it though.

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Posted in Banks, Greece, IMF, Irish economy, Politics | 9 Comments

9 Responses

  1. on July 1, 2012 at 2:27 pm Dreaded (@Dreaded_Estate)

    As I posted on another thread.
    The current plan for Spain is to get ESM funding for the sovereign to recapitalize the Spanish banks. To separate banks and the sovereign Spain will need a retrospective deal on banking debt.
    Yes, it is clearer what debt was incurred to bailout the banks in their case but the principle still applies. Spain will need retrospectivity in a few months for deals done now, Ireland will need retrospectivity for deals done a number of years ago. More complicated but the underlying principles are still the same.

    Also I don’t really understand your point on the ESM only be willing to provide capital to banks where there is a good chance that they will get their money back.

    When the state, or potentially Europe, steps in to recapitalize banks it is only done where private funding is impossible to source and there is a very strong likelihood, I would say close to a certainty, that they will lose money.


    • on July 1, 2012 at 2:40 pm namawinelake

      @D_E,

      If the ESM loses money, where does that money come from?

      It presumably comes from the 17 states that contribute to the ESM. Ireland pays about 1.5%. Germany pays 27%. Germany will have most to lose should the ESM lose money.

      And why do you think Germany will enter into a commitment which will see it lose money? Do you honestly think that if there emerges a Spanish Anglo needing €29bn of funds, almost all of which will never be repaid, that Germany will cough up €8bn for just one bank, never to see that funding again? And as Spain has an economy six times bigger than Ireland, the Spanish Anglo is likely to need a contribution (non-refundable!) from Germany of €48bn. Has anyone asked the Germans about this?


      • on July 1, 2012 at 4:19 pm Dreaded (@Dreaded_Estate)

        Hard to know but that seems to be the way we are heading. I fully expect that will be lots of terms and conditions attached to any banking bailout paid for my Germany but if you are moving the costs of banking from sovereign to the European level then there must be some acceptance that this will not be free. If it was there would be no stress on the sovereign to start with.

        But the alternative could cost Germany much more.

        If Spain was forced to absorb the losses of its banking sector it would not be able to borrow from the markets and would have to seek full ESM funding for deficits plus debt roll over. Where Spain goes Italy could quickly follow.

        And then you are talking some really big numbers and some really big risk for Germany.


  2. on July 1, 2012 at 3:54 pm otto

    “And why do you think Germany will enter into a commitment which will see it lose money?”

    Well, because it may be better than the other ways of losing money e.g. Euro-breakup as Spain and Italy sink under the waves.


    • on July 1, 2012 at 6:01 pm Vince

      Except of course the when the injection would matter. Had we allowed the banks to hit the wall then the central bank could have borrowed to re-establish new ones.
      Eventually Germany and the other creditor nations will have to reinvest, but why on earth would you reinvest your cash when there is a certainty of loss.
      The only relatively painless way to revalue within a currency union is via bank collapse. What we are about has nothing to do with economics but all to do with social position.
      What we should have done four years ago was to allow the banks to fall, half the pay on a slide above €40k for the civil service, establish a clear tax policy with the novel notion that it’s paid and reduce fuel tax by 70%.
      And oh, being in a small open economy is not an excuse for the administration to do SFA, but a challenge to justify their very existence.


  3. on July 1, 2012 at 5:45 pm John Gallaher

    Also to get under the hood….but in the Irish context maybe not such a bad thing!
    Fascinating,to observe the commentary and media reaction,little or no complaints/objections about delegating/giving up supervision of the banking sector,will the Central Bank require that planned new headquarters.The Germans were just a tad upset about the cowboys at Depfa,run out of the IFC.

    “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.”

    May have implications for IFC,NAMA is flogging sorry financing a sale there with the tenant,Hypo/Depfa.
    Why bother with a Dublin office…..if their is a single regulator,thin edge of the wedge,financial tax to follow,harmonization of corporate taxes down the road.

    “However, documents produced by the German parliament investigation show that on March 20, 2008 — months before Lehman’s collapse — financial-markets regulator Bafin passed on to the German Finance Ministry a report Bafin had requested from the Bundesbank on Hypo’s funding.

    The Bundesbank’s report, which included a special audit of Hypo’s Dublin-based Depfa Bank PLC unit, raised an alarm about Hypo’s massive short-term borrowing needs, as well as its risk management. The report also said that Hypo’s compliance with key banking regulations on managing liquidity and other market risks “must be seen as nonexistent.”

    At a hearing earlier this year, Bafin said it was unable to act, according to documents reviewed by the Journal. Like 43 other German banking groups, Hypo has a holding company as a parent, and German law doesn’t allow Bafin to regulate holding companies.”
    http://online.wsj.com/article/SB124346085723259931.html


  4. on July 2, 2012 at 9:40 am Rich

    To me the line ‘similar cases will be treated equally’ appears to be directed at the other program countries, a lure to encourage them to follow suit with a ‘well performing adjustment program’, the extent of the lure is the big question though other countries including Germany, the Netherlands, Belgium etc have previously recapitalized their banks and would also qualify on good behaviour grounds so they should also be included. If one uses debt to GDP levels to define access then a definition of sustainability will be needed, judging debt levels in this way would undermine those countries that qualify. A set of qualification criteria will be needed though in my opinion


  5. on July 2, 2012 at 10:32 pm grumpy

    On ESM ‘investment’ in IBRC and the other banks – they have to invoke Article 19 first and then Article 20 dictates the price they then pay.

    ARTICLE 20
    Pricing policy
    1. When granting stability support, the ESM shall aim to fully cover its financing and operating costs and shall include an appropriate margin.
    2. For all financial assistance instruments, pricing shall be detailed in a pricing guideline, which shall be adopted by the Board of Governors.
    3. The pricing policy may be reviewed by the Board of Governors.

    posted on IE

    http://www.irisheconomy.ie/index.php/2012/07/01/wolfgang-munchau-states-the-obvious/#comment-304142


  6. on July 2, 2012 at 11:39 pm John Gallaher

    Is that the transport/train or upwards only rent review web site!
    Overseas commentators were much more muted in their response,viewed as a good starting point,but if you supervise or fail too you own it!
    Bust banks financial/instructions don’t get bailouts,they go out of business,the “sovereign” borrowed the money,not the “banks” Ireland is paying a very hefty price for “light touch” or hands off regulation and supervision.The Irish govt. bailed out the bust Irish banks,not the EU/ECB/ESM,were they forced too?
    Was there misrepresantion or downright fraud involved,so far no prosecutions.

    http://www.reuters.com/article/2012/07/02/us-ecb-nowotny-idUSBRE8610Q920120702
    http://www.nytimes.com/2012/07/02/business/global/doubts-greet-plan-for-euro-zone-bank-regulator.html?_r=1&pagewanted=all



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