Jim Stewart: Whatever the Taoiseach thought he was doing at the press conference last Sunday) in announcing the EU/IMF net loans to Ireland of €67.5 billion, he was not as he claimed, addressing ‘the Irish People’. At least the Secretary General of the Department of Finance adopted the right tone by wearing a black tie. Nevertheless in the rather rambling responses there are some nuggets of information.
The Official Announcements
There are a number of very disappointing features in the Government statement about the receipt of EU/IMF Funds for Ireland. The most is the failure to ensure that the debt of all bank bondholders is written down. This follows the poorly thought-out “National Recovery Plan 2011 - 2014”. One feature of this plan is, in places, its simple reflection of narrow sectional interest. For example (p. 94), the view is expressed, as argued by the pensions industry, that tax deferred on accumulated funds for pension provision is not a cost as it is in effect ‘deferred income tax’, and the open invitation to the pensions industry to lobby for ‘alternatives’.
There are some surprises :- Why is the contribution from the UK €3.4 billion rather than the much-publicised €8 billion? Could it be related to the proposed interest rate on UK borrowing? (A direct question on this subject was asked but not answered at the press conference announcing the rescue fund). Or was it reduced to ensure that State discretionary funds were reduced?
There are some perfectly reasonable proposals: we will no longer have to contribute to the Greek rescue fund, although the two documents together repeat the same mistakes that started with the September 2008 guarantee (see endnote)
The Bond Holders
Yetm in dismissing the write-down of the value of bonds to senior debt holders, one argument has been dropped, and that is that Senior Debt cannot be restructured (writen down in value, extending maturity etc.) because it ranks ‘parri passu’ with depositors, meaning senior debt and depositors have the same rights. Other legal issues have been hinted at.
In answer to a question regarding whether the ECB ‘vetoed’ debt write downs by banks, the Taoiseach stated that there was no ‘agreement from the EU for such a policy and, to a second question on the same issue he answered that there was no political or institutional ‘support’ for such a move. Ajai Chopra, the leader of the IMF mission, again in answer to a question refused to categorically say that bond holder write downs might not be an option in a future period (Morning Ireland 28/11/2010). The reported lack of support at EU level for such a policy is surprising, given recently enacted German banking laws which the Financial Times state will ensure that “creditors take losses rather than the State” (Jennifer Hughes and James Wilson, Financial Times November 11).
The Financial Times (November 30) quotes the Central Bank governor as stating that ‘Dublin’ had refrained from taking action against [bond] investors in return for a “liberal attitude” by the ECB – in another article this is explained in terms of funding of Irish banks. This funding is likely to have increased from the reported figure of €130 billion (Irish banks borrowing from the ECB is likely to be less than this) on 29th October, because of liquidity strains on Irish Banks due to large deposit outflows. Similar outflows are likely to be taking place in other countries where government bond prices have fallen such as Portugal, Spain and more recently Italy. In providing such liquidity, the ECB is acting as a normal Central Bank. The ECB has been reported as opposing senior debt restructuring by insolvent banks. As a result, it is in effect imposing private sector liabilities on a sovereign State in the case of those bonds not subject to a government guarantee. There cannot be any legal basis for such a position. There is certainly no economic basis.
It is likely that, in the event of liquidation or wind down in the case of Anglo Irish bank and the Irish Nationwide, any competent insolvency practitioner could reorganise assets so that depositors and bond holders were in separate legal entities. The one with depositors' funds could be rescued. The other not. This is unlikely to require any legislative changes or the introduction of a Special Resolution Regime, as it could be performed under existing law. Bonds with a government guarantee could be written down at the expiration of the guarantee.
As in the case of junior bond holders, no legislation is required to ensure bond holders suffer losses through falling market values. Policy should be to drive down the value of this debt and then negotiate with senior bond holders. The Anglo Irish subordinated debt write down did not require legislation. Nevertheless various statements that legislation to require restructuring is in preparation pose a threat, even though it is currently proposed that this should relate to subordinated bondholders. This action coupled with refusals to categorically rule out such a policy will help achieve the desired objective. More is needed. Some bond traders have been reported as already anticipating such a policy. Many bond holders may have covered potential losses via credit default swaps, passing the ultimate liability to counterparties.
Writing down senior unsecured debt issued by Anglo alone, and not covered by a guarantee, by 80% would reduce required State funds by €3.2 billion. Writing down senior unsecured debt covered by the guarantee would reduce State funding by €2.1 billion (See Parliamentary Answers to Joan Burton, 27 October, 2010). Current actions to write down subordinated debt by 80% will reduce required State funding by €1.88 billion
Some argue a debt for equity swap could be instituted. This is only likely in one case. The Bank of Ireland is in the best-placed bank to raise additional capital and may be able to do so in conjunction with a debt for equity swap. Bond holders would convert debt into equity and subscribe for new shares. A debt for equity swap where bank capital requirements and access to capital from markets are uncertain, would introduce additional complications and cost to bank financing. As in the case of debt write downs, debt for equity swaps are unlikely to result in sufficient additional capital. Any shortfall is most likely to come from the State.
The Austerity Programme: What Options Remain?
One effect of the ‘austerity package’ in the National Recovery Plan and the EU/IMF “Programme of Financial Support for Ireland” (http://www.finance.gov.ie/) (not entitled Memorandum of Understanding as in the case of Greece) is to lock any incoming administration into existing policies, by extensive prescription of budget balances and monitoring, but especially by removing options relating to the use of National Pension Reserve Fund, Options still remain - not all the fund will be used. There are possibilities for utilising the exceptionally high savings rate to partially fund the exchequer borrowing, as noted in the National Recovery Plan, but this could be extended to fund skill enhancing programmes such as placement schemes, work experience and employment creation. The government has control over aspects of tax policy and social welfare policy; initiatives can be introduced to create and sustain jobs; further efficiencies can be derived from the public sector; our state owned enterprises could be used to rebuild our economy, as their assets and liabilities are not subject to EU/IMF approval. This could be particularly important as the EU/IMF document, in contrast to the National Recovery Plan, specifically states that “any additional unplanned revenues must be allocated to debt reduction” (p. 13). This assumes that State-owned companies are not privatised - an option discussed in the National Recovery Plan but not in the EU/IMF programme.
An incoming administration will have many problems. One that receives little or no attention in the National Recovery Plan or the EU/IMF Programme is how change may be achieved in the attitudes and outlook of ‘official Ireland’. One symptom of this is the failure to recognise how far out of line pay and conditions of senior personnel in the public sector (academics, hospital consultants, judges, politicians, regulators, senior civil servants, etc) are in comparison with other countries in absolute levels, and as a multiple of average earnings. At at the same time the minimum wage will be reduced and the scope of the “inability to pay clause” widened (EU/IMF Programme pp. 10-11). There are even greater pay disparities in the private sector between those at the top of organisations and those on average earnings. These disparities have been an essential ingredient in creating our economic problems.
An incoming administration will have to work with the existing civil service, the IDA, etc. Some of these have contributed directly to the problems we face, some have a strong economic ideology, disguised as ‘economic science’, but there are many who would welcome change, and would also welcome debate about the policies that have led to the collapse of modern Ireland.
Endnote: some Issues with current Policy
(1) The belief in the austerity fairy’, that is cutting expenditure and raising taxes will lead to an economic recovery, without any other policies; and that recapitalising the banks will lead to economic recovery;
(2) The absence of proposals to create and sustain jobs, or proposals to develop and sustain indigenous firms such as a Loan Guarantee Scheme. Labour market reforms (much loved by the IMF, OECD and other institutions), such as cutting the minimum wage will have little impact on job creation. Wage costs have fallen considerably as acknowledged by IBEC (See Irish Times, 27/11/2010). This is partly due to the growing prevalence of short week contracts (particularly in retailing).
(3) The State is now a major owner of property (hotels, office blocks, houses) yet there is no statement as to how economic value might be obtained from these assets. Where are the plans to vastly expand the tourism sector and visitor numbers?
Dr Jim Stewart is Adjunct Associate Professor at Trinity College Dublin. His research interests include Corporate Finance and Taxation, Pension Funds and financial products, Financial Systems and Economic Development.
He is widely published and his titles include Mutuals and Alternative Banking: A Solution to the Financial and Economic Crisis in Ireland (2013), Choosing Your Future: How to Reform Ireland's Pension System (co-author, 2007) and For Richer, For Poorer: An Investigation of the Irish pension system (2005).