Tag Archives: bond holders

IBEC and IBRC and the IMF

This is a version of a column published in the Irish Examiner

It must be dangerous to be a bird in Dublin these days. The government that promised transparency has instead adopted a kite-flying approach. The kites pop up, and like modern day Benjamin Franklins the government minister hangs on as it drifts into the storm, and then gauges the lightening. Occasionally they get singed, sometimes they escape, and withdraw for another day. And its not just the government. Every other aspect of social partnership is busy with economic bals and fiscal paper and silk, constructing and testing kites. In the best Japanese tradition, and as we are heading towards a Japanese style lost decade why not, we even see kite wars. Some kites are saw edged and designed to cut down others. Some kites get smashed down and then amended get relaunched.


IBEC have joined in this pleasant pastime recently, with their proposal that public sector increments be paused. The saving from this would be approximately 1b per annum it appears. The problem with such increments is that they are generally paid regardless – one is on a salary scale along which one advances by dint of survival. In a modern managerial environment that doesn’t make a lot of sense – there is little incentive to excel, and little disincentive to slack. Of course, we have know this for decades and for a long time it suited IBEC as a member of social partnership to allow this to go on. Peace at any price was the seeming mantra. Cutting a billion euro from the state budget is eminently justifiable in the context of borrowing a billion. However, throughout the crisis the argument on cutting public sector wages has been notable for a lamentable lack of follow on argument. Cutting X does not save X. At the most basic it saves less than X due to the fact that yes, public sector wages are subject to tax. So 0.7X might be the after tax savings. And then there is the knock-on effect…


we have seen recent estimation from the IMF of these effects. In economics the effect of changing one item on another is known as a multiplier. The assumed and conventional multiplier for government expenditure was in the region of 0.5-0.7. This would imply that cutting X would in the end result in a fall in overall economic output of 0.5 – 0.7X. In other words, cutting wages would not have the overall effect of reducing the economic cake by the same amount as the wage cut. This may now need to be revisited in the light of the IMF world economic outlook report which suggested that far from being less than 1 (implying that cutting public sector pay would result in a small fall in output) these shortterm multipliers may be significantly greater than 1. In other words, cutting X will result in a decline of 1.5 X– 1.9X .


Whatever the attraction from a government accounting perspective of cutting the short and medium term effects on the rest of the economy would be significant and negative. In the Irish case the effects are complicated by the GNP/GDP issue – while GDP can be growing or contracting slowly the GNP component can be falling more rapidly. Thus we cannot say with confidence that based on the IMF analysis the multiplier is too small we can take it that some very significant work on same needs to be done, pronto, by a combined ESRI-DFinance-C Bank team to ascertain the best evidence. In that context, we might want to hold fire on accelerating the pace of consolidation


IBEC have not, to my knowledge, come up with a comprehensive set of implementable performance metrics – that to be fair is not their job – but one must applaud their desire to save a billion. However, why stop at a billion? Why not save three times that much, and harm nobody? Part of the problem with cutting government expenditure is that it gets recycled into the economy. It is rare to have government expenditure which is totally isolated from the economy, and yet we have such.

Each year the government spends 3.1b feeding the IBRC (anglo/inbs) black hole. This year in a cunning plan instead of real money they issued a bond to the beast. The borrowed or tax derived money, you will recall, is given to the Central Bank of Ireland who then destroy it. As far as I can ascertain IBEC have not expressed concern about that, except in so far as the technicalities of the bond v cash 2012 payment impacted on government aggregates. It is abundantly clear that there is little appetite in the ECB for a deal on this money. At the very best we might replace this promissory note (which is not government debt) with a 40y bond. At worst we will be stuck with the full repayment schedule. It would cause nothing but the closure of IBRC and a technical temporary accounting headache for the Central Bank if the government were to announce that in framing the 2013 budget they were not going to make the March 2013 (or any subsequent payment). The ECB would be unhappy but I guess we can live with that. What they would not be able to do is to “cut us off” from liquidity. It would be nice if IBEC were to advocate saving 3.1b but then again IBRC is a member firm of IBEC. This money does not get spent in the Irish or European economies. It vanishes. We borrow it, and we destroy it. Why not…not borrow it.?


Euro deal saves Ireland? Maybe…

It’s not clear that it does. I’m not sure it’s a seismic (Enda Kenny) or massive (Eamonn Gilmore) deal. And it happened because of Spanish and Italian pressure.

So far as we can see at present there are three parts to this. The Spanish banks will be recapped directly from the EFSF and later the ESM (assuming there is one…) which will not have formal super senior status but will be more like the IMF and have quasi senior status. The ECB will get an enhanced supervisory role. Crucially for Ireland the deal also suggests that similar cases will be treated similarly. But there is no explicit retrospection.

We have spent, in very rough terms, 30b on Anglo promissory notes, 20b from the then National Pension Reserve Fund in direct bank recaps and about 12-14b more in other recaps, bailouts etc which forms part of the explicit borrowing now subsumed under the troika bailout..

We will not get that 20b back. It’s gone. We might, but it’s not clear, get a deal on the prom notes, but the mood music is that at best this quasi state debt will be converted to very much state debt albeit repayable in a manner that costs less per annum than the 3b cost of prom note redemption. We might or might not get a deal on the 12b, but there is no “Irish state bond for recapping banks” out that can be redeemed. So this would have to be dealt with as part of a general state debt not bank debt deal, which seems not to be o n the cards.

It’s a soda stream not a champagne moment.

Europe needs leadership but from where?

This is an expanded and updated version of a column published in the Irish Examiner
With the passing of the fiscal compact the government now find themselves in a position t once easy and difficult. It is easy in that the parameters of fiscal policy for the next number of years are set out, if not for the next decade. It is hard in that the implementation of these policies is going to result in wrenching adjustments to all aspects of irish life. In 2013-15 expenditure will fall by €2.25b, €2.0b and €1.0b, while tax increases (and these will be coming from an anemic economy) will 1.25b, 1,1b and 0.7b. Despite the ULA and related calling the referendum an austerity referendum, such terminology disguises the fact that there are at least in principle two different kind of adjustments to be made. First, we are still running a primary deficit, defined as government spending less interest payments still being more than government income. Bringing this into broad balance is going to be a sine qua non for accessing regular market bond financing. Second, and only then, we need to consider the issues facing us from the fiscal compact. As has been explained in great detail over the last number of months so long as any nominal growth emerges and so long as government net spending does not run out of control the parameters of the compact can be met

In recent months there has been a slight glimmer of good news for the government in terms of taxation. Income tax has shown strong growth, up 12% over the year (although that figure is somewhat distorted by changes in the way various taxes are allocated to headings). What is problematic is that expenditure is still rising, but this is largely driven by health and social welfare. In a deep recession it is unrealistic to expect these government functions to shrink. Nor might we want to cut too deep. We are not good in this country at realising the essential nonlinearity of much of the relationship between government expenditure and output. Put simply we have a pretty decent health and education system. Small, or even medium increases in expenditure are inherently unlikely to result in a proportional increase in output. The same cannot necessarily be said on the downside – a quality system requires constant high levels of quality inputs, and it is easy for the system to begin to fail with slight reductions in the quality or quantity of inputs. And the pressure will be to shrink. Despite the tax take rising unemployment remains stubbornly high, and the domestic economy has flatlined, as is evident from retail sales and the labour force both shrinking. Any measured growth in the economy for the next few years will only come from the high-tech low-job export sector.

The future of Ireland therefore is crucially dependent on the future of the European economy, both the eurozone and others. this future is now clearly resting on the shoulders of the ECB, shoulders that are being shrugged as if the crisis was nothing to do with it. Right now the epicentre of the crisis has moved to spain. Although spain has a reasonable debt-gdp level of about 80%, there are concerns about its banking system. In particular, there is grave uncertainty about the level of losses in its banks. It is the uncertainty about the level combined with the near certainty that the Spanish taxpayer will end up footing the bill that has spooked the markets. Spanish banks may be broke, but the ECB will not allow them to fail. Nor will they allow bondholders to be burned. A promissory note a la Anglo solution would allow Spanish banks to ease their liquidity problems, as might any euro area lending solution. It would not solve their solvency. So long as the ECB continues to (even with euro inflation low) to obsess about inflation it will not allow monetization via promissory notes. The ECB’s most recent meeting showed how it is now paralyzed by irrational fears of inflation, where they refused to cut interest rates. Paul Krugman has recently echoed the fears of many, that the ECB are repeating the mistakes of the 1930’s. History we are told repeats itself twice : it is our misfortune to be in the first such repetition, which we recall is tragedy.

To solve the euro crisis and the irish crisis will require coordinated movements. Banks must be allowed to fail, and senior bondholders must be forced to take losses. The disruption to financial markets that that will cause is less than will be caused if the euro breaks and in any case the ECB’s insistence on a sovereign-bank linkage has caused untold damage. That will assist in cleaning the Spanish quagmire. Existing bank recapitalisation in Ireland and the bulk of greek debt should be converted to a longterm low interest rate loan, on condition that we adhere to good governance standards. But most of all Europe needs leadership from a patently unwilling germany. Germany is an export led economy, and by definition therefore requires a strong market for its products. The shortterm political win of truculent arrogance will result in a longterm loss of incalculable dimensions. European leaders must make it clear to germany, which is now beginning to show signs of deterioration in its economic state, that mutual adjustment in the eurozone requires both sides to move. This is no longer economics, it is high international politics, a game in which we Irish have little experience or evident competence.