Back in antebellum America, it was common for negro slaves to avoid marrying a spouse from the same plantation for a very poignant reason – no man or woman wants to see their beloved raped, humiliated, beaten or whipped before their very eyes, it’s more than can be borne, and for that reason slaves often married slaves from neighbouring or distant plantations to avoid the reality of their powerlessness in protecting their beloved.
Well, if you want to know the answer to that question you will have to buy my new book, which contains a bunch of essays.
Contributors include:
Aimed at the general reader and published by Orpen Press it is available from all good bookstores and from Amazon. An ebook/kindle version should be available by 6/April/12
Posted in Blogpost
Tagged Anglo, bondholders, competitveness, declan ganley, default, economy, Europe, financial economists, greece, ireland, literature, NAMA, politics, Promissory Notes, reform, research
Below is a version of the written presentation I circulated to members of the Oireachtas Committee on Finance at our discussions today on ELA and Promissory Notes.
ELA is money. It is not a bond. Dealing with ELA does not involve dealing with bondholder although the money so created was used to redeem (pay off) bondholders. The acronym ELA stands for Extraordinary Liquidity Arrangement, and the name of indicates what it is. It is first and foremost extraordinary, in that it is a facility extended to commercial banks by central banks when ordinary (usually taken to be interbank or regular central bank ) short or medium term funding is not available for whatever reason. It is liquidity, in that it is designed to allow a bank to maintain liquidity to its operations and customers, rather than a solvency arrangement, which is designed to ensure that the organization is well capitalized and able to trade in the longer term. It is a basic tenet of corporate finance that we draw a distinction between these two concepts ; solvency, achieved through capital, is a longterm concept while liquidity is a rolling short-term issue. Liquidity crises, for countries or for companies, can arise when lenders no longer have confidence in the solvency of the borrower. This is what happened in September 2008, the initial focus being on the solvency of Anglo and Irish Nationwide (now collectively known as Irish Bank Resolution Corporation, IBRC).
ELA is money. In the normal course of events in the eurosystem money is created under agreed mechanisms. Central Banks have the power to create money ‘by fiat’ that is to say they can create it from nothing. ELA is not part of the normal operation of this monetary creation but is allowed in extraordinary circumstances. ELA is carried as an asset on the balance sheets of the creating central bank, in the case here the Irish central bank. It is not created by borrowing from other central banks. It is not a bond. It is not money loaned to the central bank of Ireland from the ECB, nor money loaned from the other central banks. It is money, as real as any other form of credit agancy. It is pure money creation, by fiat, allowed in exceptional circumstances. As of end-2011 this domestically created money amounted to some €44billion.
How is this money mobilized? When Anglo/INBS became hopeless and obviously insolvent the Irish government recapitalised them. The largest part of this recapitalisation was via the creation by the irish government of a Promissory Note which was issued to the banks. This was not and is not a sovereign bond. We know that it was not and is not as the ECB refused to accept this for normal liquidity operations, forcing Anglo/INBS to instead go to the central bank of ireland and swap this for money which was then used to finance Anglo/INBS, including paying off senior bondholders, paying staff wages, payment of interest on deposits etc. In effect the Central Bank of Ireland monetized the government IOU. The government have agreed to pay off the Promissory Note over a 15 year period. As there is, to put it mildly, considerable doubt as to whether the remaining assets of IBRC are sufficient to generate income to repay its debts the Minister for Finance in March 2010 as well as creating the Promissory Notes also gave (as of this date secret) letters of comfort to the Central Bank (Sole shareholder, the Minister for Finance) promising repayment of the ELA were IBRC unable to repay. Thus the state in effect is indemnifying itself against its own actions. An analogy might be that we borrow from a bank, put that money into a pocket, then move it to another pocket, then take it out and burn it. The effect is the same. Money is destroyed in the same amount as it was created, in order that the european money supply does not increas
How much is this going to cost us? In essence, through the next 15 years the state will repay the promissory note at a rate of approximately €3.1b per annum.
This repayment is treated in the government accounts as a capital expenditure, and can be found in Note 6 of the 2012 estimates as show above. This expenditure cannot therefore be deployed to other, productive, usage. Each year a capital allocation is made for the repayment of these. This capital must be either raised from taxation or borrowed. The true interest issue therefore of the Promissory Note is NOT the implicit interest rate which is paid on them, rather it is the cost of the funds borrowed to, in effect, recapitalize the banks holding the Promissory Notes. Thus seekingconcessions on the interest rate element of the Promissory Note is seeking the wrong concession.
Another issue as to why this matters and why we are paying is that Eurostat decided that as the Promissory Note was irrevocable it was appropriate to treat this as a €31b increase in the national debt, resulting in a world-beating 32% of GDP deficit in 2010. There is no doubt in my mind that the nature of the note and the consequent realization that it was in fact debt played a large part in the slow but inexorable locking out of Ireland from the regular bond markets and the need to become wards of the Troika.
What can be done about this and who can do it? The essence therefore is as follows: the Central Bank of Ireland has created money, outside the normal course of Eurosystem operations for the creation of money. This it is allowed to do under delegated power. However, this delegated power is circumscribed. In effect the ECB council can veto the action of the national central banks when they act in the manner in which the Central Bank of Ireland has done, but only by a 2/3 majority. Thus the presumption is that in general when central banks act to extend ELA they are doing so in a manner that does not interfere with the normal actions of the ECB.
This is where the crux of the matter lies I submit. While the creation of €40b or so of additional money by the central bank of Ireland is small in the context of a Euro area M3 (broad money supply) of €9800b, amounting less than 1/2 of 1%, the ECB has a mandated inflation fighting role. Add to this the historic antipathy of Germany, the dominant power in european monetary affairs, to any form of inflation and we see that the creation of money in this manner is potentially problematic. Were the Central Bank of Ireland not to require the repayment of the ELA, and the writing down of the money supply, this would represent a permanent increase in the monetary base of the Eurozone. 1/2 of 1% is not much but what if other countries were to commence to refinance their banks in this manner? What if in fact countries were to take up a suggestion made that the debtor countries refinance their sovereign debts in this manner? Ireland issues a €X hundred billion promissory note to IBRC, IBRC swaps that at the Central Bank of Ireland for newly created money, the NTMA issue a €X hundred billion bond for 100 years duration at a low interest rate, and IBRC purchases the bond with the real money which the state now has on hand on deposit to fund itself while we restructure the financial and economic system. What if Greece were to do this? Clearly we could quickly find hundreds of billions of ELA created euros being added. This is what is known as monetising the debt and it is anathema to the ECB for reasons of inflation as well as being a de facto breach of the rule that the ECB is not allowed to finance government deficits directly. Such monetary creation is further anathema to countries such as Germany who have in the past suffered episodes of hyperinflation. I would note that at 3% inflation we are far from hyperinflation. European money supply (M3) has remained within a narrow band of €9.2tri to €9.8tri since the middle of 2008 and in recent months has in fact begun to fall sharply again, having fallen heavily (as might be expected) in the global financial crisis. We are a long way from inflationary pressures.
It is highly probable that were countries to seek to do this they would find themselves running a real danger of being cut off from further and ongoing liquidity support, might be accused of having the central banks funding the deficit (deficit financing) and be in breach of treaties. Such a move would only be used in extremis but it does show that ELA has the potential for unlimited monetary creation and should be treated as such. It should be noted that we have had experience of a large currency union breakup in the recent past, with the breakup of the Rouble Zone, which zone lasted after the political union of which it was the currency, the Soviet Union. . Nonetheless, such debt monetisation while a solution to the immediate liquidity problems of countries would in the long term pose a threat of inflation and would not in any case solve the solvency issues of countries or banks and might in the long term pose more problems than it would solve. However, in the here and now …
There are three ways in which we can deal with the cost of the ELA.
1. One is to extend the term of the ELA repayment from 15 years to a much longer period. Extending by 10 times, to 150 years would reduce the annual cost in the same manner. However, we would be ‘stuck’ with IBRC for potentially that period.
2. Another way we could deal with this cost is to simply write the whole issue off. This is NOT burning bondholders, nor is it burning ourselves. However, the consequence of removing the Promissory Note and associated Letters of Comfort might be to render IBRC technically as opposed to functionally dead. IBRC, if we write off the ELA and the associated Promissory Notes, would have remaining assets (loans not transferred to NAMA) and liabilities (some remaining ELA , some ECB loans, a small amount of deposits and some remaining bonds. If after restructuring the balance sheet IBRC is not able to service its liablities then it can and should be wound up. Again this seems to have been ruled our by successive governments and the ECB over the years, despite that it too would be the effect of saving the state the ongoing drain of €3.1b per annum.
3. A third solution would be to seek to defer, to continue in the kicking of the can at which successive governments and european institutions have excelled. We have already received deferment till 2014 of the implicit interest payment on the Promissory Notes, and if such were to be extended for a number of years the strain would be at least be deferred.
All of these however, of which I prefer the second, would require that the ECB accede to this request. The Irish voice on the ECB is not answerable to either this committee nor any organ of government, which is right and proper. It is in my view highly improbable that Governor Honohan has not raised these or similar proposals at the ECB, but the evidence is that so far there is no will from the ECB to allow movement. Why that is remains unclear as it has recently shown willingness to accept heretofore unpalatable actions in regard to Greece. Removing the burden of the Promissory Notes in some manner would only assist the government. It would assist it politically in terms of implementing the needed closing of the gap between state expenditure and taxation and it would assist in base monetary terms. If the Troika wish to have a ‘good example’ of its policies as opposed to a set of ‘horrible warnings’ they could do worse than quietly monetize the Irish banking debt, making clear that this is (at least in principle) a one off and reflects the reality that in doing so they acknowledge the role the Irish taxpayer has played in preventing contagion into the banking bond market in 2008/9.
Posted in Blogpost
Tagged Anglo, banking, bondholders, Central Bank, Dail eireann, ECB, ELA, politics, Promissory Notes, Seanad, Senators
One of the great Christmas pleasures is watching Wallace and Gromit. For me their masterpiece of comedy noir is ‘the wrong trousers’, in which an unfortunate (but of course arising from a well-intentioned) wardrobe malfunction leads to Wallace being in effect kidnapped by his TechnoTrousers. A series of Claymation japes and high jinks ensues, but all is put right at the end.
Something similar seems to have happened Michael Noonan. A well-intentioned effort to make a solid bank has taken him down a strange path. The proposal to impose up to 100% losses on the subordinated bondholders of Bank of Ireland arises from a good intention – that Bank be well capitalized, and that to do this it raises €4.2b by the end of the year. It is at present, despite a range of actions, some €350m short. So, the government is proposing to use its powers to in effect ‘burn’ subordinated bondholders, generating in that way the needed capital. Now, I have long argued that it was an immoral, unnecessary and needless waste of state funds to have kept ANY subordinated bondholders in play in the banks while the state invested taxpayers money. We invested €3.5b in 2008-9, and took up rights issues of €2b in total. The result is that the state now has approx. 15% of a bank plus a remaining high(ish) yielding preference share. At the time of the crisis, as show in appendix A, p 150, Bank of Ireland had €4.6b of dated subordinated debt, which was guaranteed and thus was at that stage unable to be deployed fully towards losses. Now, with the bank in essence almost out of the critical phase of the crisis this arises, which while perhaps welcome needs to be wondered at. It needs to be wondered at in the context of ….Anglo.
Bank of Ireland is, in my view, at first approximation, the only Irish bank that can exist outside longterm state control. And no, I don’t have shares in it. AIB has collapsed into the state and will require massive and on-going restructuring both of its finances and its operations if it is ever to be refloated or sold off. And then there is Irish Bank Resolution Corporation, the banks formally known as Anglo ad Irish Nationwide.
Faced with a choice the government decided to spend €1b of taxpayer funds on unguaranteed unsecured bonds of a dead bank. Anglo is dead, but zombie like will not stop moving and consuming. Putting money into Anglo is, as Constantin Gurdgiv described it “like gold plating a yugo and sinking it somewhere”. Putting money into Bank of Ireland, with the state taking a modest increase in its share for the sake of (hopefully) completing the rehabilitation of a working bank and one on which the state might eventually even get some return.
Government is about choices; the monies sunk into the banks are sunk, but the ongoing decisions about how to spend scarce resources on banks should revolve around the marginal benefit. One the one hand, the whiling vortex of money that is Anglo/INBS, on the other a quasi-viable bank. I know which I would choose.
