Why the ECB are being unreasonable on bonds

This is an expanded version of a opinion piece published in the Irish examiner 5-November 2011: http://www.examiner.ie/business/ecbs-demands-on-ireland-are-unreasonable-172952.html

This weekend the kilkenomics festival runs for the second time in Kilkenny. It’s a mixture of comedy and economics. To the casual onlooker it might be difficult to distinguish between when this festival stops and the normal run of Irish economic policy-making begins. It must be a comedy when a bankrupt country pays €700 million that it doesn’t have to, and misplaces  €3.6 billion in its national accounts. If it isn’t a comedy then it must be a tragedy.

Without a shadow of a doubt the most tragicomic element of this week was the payment by Anglo Irish bank (which of course has no money other than that which we the taxpayer provide) of $1 billion, over €700 million. This bond was unsecured, relying in other words upon the solvency and good faith and credit of Anglo Irish bank; it was also unguaranteed, in that it was not covered by the disastrous government guarantee of banking liabilities in 2008. Although technically not insolvent, because of the promissory notes which will cost the Irish taxpayer upwards of €80 billion with by the time all said and done, Anglo is economically bankrupt. The government faced a storm of protest, including what one can only imagine was a tongue in cheek contributyion on the inequity of such payments  by Fianna fail. It’s very clear looking in the round that the government, the taxpayer, payed  this private debt because they are being strong armed by the European central bank. From the European central banks perspective they see it as imperative that no senior bondholder in European banks should be forced take a loss. They have a point in this. In September Eurozone banks had approximately €10.7 trillion in deposits and €12.5 trillion in loans, plus some other assets. The difference deposits and other assets is accounted for by some €3 trillion in bonds issued by these banks. It is this €3 trillion that the ECB is concerned would be seen to be at risk were the miserable €700 million of Anglo Irish bonds not repaid. The argument, so the ECB say, is that if Anglo Irish bank do not repay their bond then markets will ask why any other bank would do so?. The consequence of this would be that sooner than later European banks would find themselves forced to either pay significantly more for bonds or reduced dependence on same. Either of these would result in a downgrading of euro area economic prospects, via more expensive bank credit and a deleveraging, that is to say a reduction in supply of credit.

The last thing that the European economy needs is a further blow to its economy. Eurozone growth prospects are low, with the OECD forecasting only a 0.3% growth;  industrial manufacturing based on purchasing managers surveys is in decline; unemployment is over 10%. Already the requirement to increase their capital ratios to 9%, agreed as part of the latest final solution to the twin bank-greek crises, is likely to result in some deleveraging. Indications are that the banks will not raise additional funds to strengthen their capital base but will instead adjust their assets, that is to say deleverage. So, the ECB, from a Eurozone perspective,  are doing the right thing in insisting that the Anglo bond be repaid.

The difficulty is that this Anglo bond is coming out of state funds. Anglo has been recapitalised multiple times, the only money of houses taxpayers money. From the Irish perspective it is both odious and irksome that not only are the Irish taxpayer is expected to be the ultimate prop for the Eurozone bank fund market  but they are getting very little back from the ECB in return. Irish banks remain critically dependent for liquidity on the ECB, but this liquidity is only advanced on a series of rolling short-term sales and repurchases. The ECB, quite bizarrely, has set its face against the provision of a structured medium-term liquidity provision. It is hard not to see this as simply a desire on the part of the ECB to keep the Irish government in line, via a threat, quite unrealisable in fact, that deviating from the ECB line of no bondholder being burned will result in the withdrawal of liquidity and the crashing of the Irish banking and financial system. The government claim that keeping the ECB ‘onside’ will allow them to negotiate with the Troika on the cost of the promissory notes, but this negotiation will be conducted, in part by the NTMA/Dept of Finance, who somehow mislaid 3.6b, a bookkeeping error so gargantuan as to hardly inspire confidence in their ability to deal with complex and large sums.

All this is against the backdrop of an Irish economy which, although anaemic halting and critically dependent on a small group of exporters, is beginning to show signs of stabilisation. We appear to have reached close to the bottom of the economic cycle, and although we will probably bumps along the bottom for quite some time we at least can begin to see a clear path. A functioning Irish banking system could only help, particularly if that banking system was adequately capitalised, appropriately supervised, structured in such a way that credit would float productive rather than bubble lending, friendly to small and medium enterprises, a true utility banking system. We will be a long time waiting for that.

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2 thoughts on “Why the ECB are being unreasonable on bonds

  1. Pingback: Planning for the post euro Irish economy…. | Brian M. Lucey

  2. Pingback: What Will Happen When the Eurozone Collapses? | Bock The Robber

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