Negotiating Ireland’s debt

The Irish Times – Friday, March 4, 2011
Smart thinking needed in our negotiations with a hardline EU

ECONOMICS: Delay of recapitalisation of banks will give new Government some time to nail down a more logical solution, writes PAT McARDLE

IT TOOK less than a year for us to go from hero to zero. Early last year, Ireland was hailed as a model for its fiscal policy; by year-end, the State was ignominiously bailed out in a soured atmosphere.

The change in attitude was most pronounced in the European Central Bank (ECB) and ostensibly had to do with the slow pace of action on the banks. Indeed, it does seem like ages since Brian Lenihan first signalled that a radical restructuring of the banking system was necessary. Talk to officials and they will tell you the delays were due to the EU but this became inconsequential.

The ECB lost either its patience or its nerve as its lending to Irish banks rose steadily and, to paraphrase the governor of the Central Bank, who sits on the council of the ECB, it decided it wanted its money back.

Few will forget that morning last November when Patrick Honohan telephoned RTÉ from Frankfurt to confirm the arrival of the International Monetary Fund (IMF). It is just another irony that in, so doing, they ensured that Ireland would be further downgraded by the rating agencies, prompting more outflows of bank deposits and, in turn, even greater reliance on ECB funding. I suppose in their eyes it was necessary to make the problem worse before it got better.

The troika of the commission, the ECB and the IMF made little change to Ireland’s fiscal policy and the programme is virtually identical to the outgoing Government’s plans. Instead, they focused on the banks and it has to be said some of their requirements are more reflective of annoyance and haste than common sense.

Thus we got the decisions to rapidly wrap up Anglo and Nationwide – no harm – but at the same time, we also got the extraordinary decision to recapitalise the banks by end-February – ie a month before the results of the latest stress tests.

The timing of this made no sense but risked sub-optimal behaviour by the banks, which are now largely owned by the taxpayer. The decision to postpone this action gives the new Government the challenge and the opportunity to have a more logical approach.

The other aspect not highlighted at the time was the downsizing of the banks. In effect, this is how the ECB will get its money back as further chunks of the banks are sold off. The real worry here is hasty action and while Honohan has said fire sales are ruled out, this one will bear watching.

Such is the background against which the new government hopes to renegotiate the bailout. Bailout is, of course, an inaccurate term. It is a programme of loans with strict conditions and a requirement to repay debt.

Moreover, the rate of interest on the loans is deliberately penal, modelled on the standard IMF approach and identical to that imposed on Greece.

The challenges are daunting. Opinion in Europe has hardened against us in recent weeks. This may well have something to do with the inflammatory rhetoric used in the early stages of the campaign. More importantly, these days everything in Europe quickly comes back to Germany which, now more than ever, is the paymaster. Angela Merkel, not noted for her pro-European stance, has become increasingly hardline as her domestic support wanes and her political clout diminishes. She is faced with a parliament that insists on ratifying everything she does, a Bundesbank that is at odds with the ECB over modest reforms, and a public that is determinedly against what they see as a “Transfer Union”. With half a dozen state elections due, her position is looking more and more uncomfortable. She is in a corner and, like any cornered animal, is likely to bite anything that comes too close. Moreover, Merkel and Nicolas Sarkozy have sidelined the commission, traditionally the guardian of the smaller states.

The “burn the bondholders” lobby got a bit of a fillip a few weeks ago when Denmark became the first EU country to go this route. When Amagerbanken failed, both depositors (above the €100,000 guarantee) and senior bondholders were hit with prospective losses of 41 per cent. This reflected the fact that there, as here, depositors and bondholders are legally equivalent and thus received equal treatment. No one in Ireland seems to have made this logical connection.

However, it is not a good model because Denmark: 1. is not in the euro; 2. is not bankrupt; 3. is not beholden to the troika with the paint hardly dry on a rescue; and 4. Amagerbanken represents just 1 per cent of the Danish banking system.

Central Bank figures show that most of our senior bank debt is either guaranteed or secured with just €16 billion unsecured and less than €4 billion of that related to Anglo and Irish Nationwide where action might be contemplated.

While a move against the latter could yield a few billion, more radical action against AIB and Bank of Ireland bondholders as well might yield another €5 billion. Though this would be at the cost of alienating the ECB (which has emergency loans of €150 billion to Irish banks at minimal rates of interest) not to mention major G7 countries such as France and Germany, whose banks are among the bondholders. It would also ensure an elevated cost of sovereign borrowing, assuming such were feasible, for a long time.

It is true, as Honohan reminded us, that we are doing the EU a favour by not triggering a banking crisis with global ramifications. The challenge is to convince our partners failure to act is not in their long-term interests. The risk is that they may feel they have done enough for the moment in providing the bailout.

It will require skilful negotiation to extract concessions beyond a reduction in the rate of interest applicable to the EU part of the bailout, and even that is likely to be general rather than Ireland-specific.

In contemplating more radical action, we are like a patient on a life-support system. Our main negotiating ploy is a threat to pull the plug: effective, but quite possibly terminal.