When Europe’s leaders gathered in Brussels at the end of June, they decided to break the ‘vicious circle’ between bust banks and the countries that host them. Otherwise, the fear was that its banks could bring down Spain much as happened in Ireland.
Importantly, and in line with long-standing EU practice, it was agreed that favorable terms applied to Spain would be applied retrospectively to Ireland. Moreover, the Irish bailout was to be looked at with a view to ‘improving its sustainability’, recognizing implicitly that it was not on a sustainable path as things stood.
The agreement was hailed as a ‘game changer’ by some, a ‘seismic shift’ by others, and universally as at least a step in the right direction. Partly in expectation of a deal on its bank debt, Irish benchmark borrowing rates have fallen below 5% to levels not seen since before the 2010 bailout.
Vague as the wording may have been, and despite Angela Merkel’s prevarication at and after the most recent Council summit in Brussels, the agreement of 29th June still stands. While it may signal their intention to play hardball when hammering out the final details, neither the Chancellor’s campaign rhetoric nor the press release of the finance Ministers of the creditors’ axis – Germany, Finland and the Netherlands – trumps the consensus of all 27 members of the European Council.
For reasons of optics, the Irish government would dearly love to have a deal in place before budget day. They are right, however, in saying that a good deal is better than a quick deal. A meaningful deal any time before mid-to-late 2013 would give Ireland a fighting chance of sustained re-entry to international bond markets, and hence exit on schedule from the troika bailout.
Given that any final deal on Irish bank debt relief is dependent on the prior establishment of a European Banking Union, it is clear that we may be waiting some time yet.
Having recognized that Ireland is not on a sustainable path to debt sustainability, and in desperate need of a bailout success story, it is likely a question of when, not if, a deal will be struck. With the creditors’ axis determined to drive a hard bargain on the details, however, what is certain is that the deal will ultimately disappoint many in Ireland.
There are those that suggest anything short of a full write-off of the entire 64bn pumped into the banks is unacceptable because ‘Europe made us do it’. In accordance with the orthodoxy of the time, it is commonly understood that the ECB would not countenance upon expiry of the original bank guarantee, at the time of the troika bailout, or at any time since, the imposition of haircuts on unsecured bondholders. Indeed, this is what rightly makes Ireland a ‘special case’.
It should be remembered, however, that it was a sovereign Irish government who first decided to suspend the normal rules of capitalism when they guaranteed all senior and many subordinated bondholders in 2008. People may recall that our European neighbors were not exactly enamored with our government’s ‘socialism for bondholders’ at the time. When the original guarantee expired, for instance, only 6.4bn of legacy Anglo bonds remained unpaid, less than a fifth of the funds pumped into the bank.
In 2010, the IMF made clear that it viewed repayment in full of bondholders in bust banks as foolhardy, but it relented in the face of ECB intransigence. Flash forward another two years, and the prevailing European orthodoxy has come back to Earth. The rules of capitalism are apparently to be respected ‘going forward’, and bank investors are to be ‘bailed in’, sharing the pain before taxpayers take a hit. This, a common-sense bank resolution mechanism, alongside a Eurozone-wide deposit guarantee scheme and the unification of banking supervision under the auspices of the ECB, are the three prongs of the evolving European Banking Union.
So, what is in prospect in any final debt deal? There are two probable angles: re-engineering the promissory notes and transferring the state’s bank shareholdings to the European Stability Mechanism, the proceeds being used to pay down the national debt.
Re-engineering the 30.7bn promissory notes will likely involve an extension of the repayment schedule, and possibly a delay in principal repayments, by replacing the notes with long-dated bonds. This would not make any overnight dent in Ireland’s debt burden, but it would ease the cash-flow situation in years to come, making austerity a little less onerous. Simply writing off the promissory notes in their entirety is not a runner, because this would effectively give individual Eurozone members a green light to print money.
This leaves the sale of the state’s stakes in Bank of Ireland, Allied Irish Banks / EBS and Irish Life & Permanent to the newly established European Stability Mechanism. In return for ceding ownership of the ‘pillar banks’, the government could expect to get back some, if probably not all, of the 28.1bn (nearly 18% of GDP) it has pumped into them.
The transfer of this amount off the government’s books combined with a reduction in the annual payments on promissory notes, may not live up to the hopes of everyone, but it would make a significant difference, bringing the peak debt-to-GDP ratio down closer to 100% than to 120%.
We would still have a mountain to climb, but at least we might catch a glimpse of the summit. Anything much short of this best-case scenario – or if growth greatly disappoints – and achieving debt sustainability will be like scaling Everest’s north face.