So the ECB has, years late and trillions short, decided to act rather than to react. Having passively allowed its balance sheet, shrink By €1 trillion over the last two years it has now decided to inflated its balance sheet by €1 trillion over the next two years. One of the things that central banks are supposed to do is to ensure stability. Looking back from the end of 2016 the gyrations of the ECB balance sheet will hardly inspire. Nonetheless the proposal to engage in quantitative easing, of a sort, is welcome. But its more a constipated squeezing than real quantitative easing. Continue reading
Tag Archives: Promissory Notes
We don’t have to pay a cent to the Anglo junior debtholders but we probably will. Below I walk through why the Government are either misled or misleading and opine on how we can avoid payment. We have a legal template, which could be tabled. FF should continue to drink its tall glass of STFU on Anglo, so it is down to the opposition. Sinn Fein are busy posturing on meaningless motions on the Taoiseach, the anti-austerity-unless-its-a-party-leaders-allowance-before-logic-party is doing whatever it does, so really its down to people like Shane Ross, Stephen Donnelly, Tom Pringle and so on, the (apparently ) concerned left and right, to table this. Continue reading
This is a version of my column in the Irish Examiner of 25 Jan 2014 .Europe’s banks are broken. Very broken. We have always suspected that, but recent evidence in indications suggest that nearly six after the crisis first began to manifest itself seriously they are still grossly impaired. The drive towards meaningful banking union has stalled again amidst squabbling about whether or not there should be and if so how much of a common pot for resolution. German banking giant Deutsche unveiled a billion euro loss just this week, underscoring how fragile both the banking system and the economy remain, even at the core. Without a working banking system the economy cannot prosper.
Recall what it is that banks do – despite the mystique and the bluster, its actually pretty simple. Some people have money and others need it. Banks act as a middleman to facilitate those that want it to get it from those that have it, in return for them taking a cut of the interest charged. This can be across space (savings flow from region to region) and/or time (mortgages and longer term loans) . Lending money out is risky. That is why banks charge an interest rate on loans that is greater than that which they pay on deposits – apart from needing to make a profit and cover costs, they need to put some money aside for the inevitable defaults and bad loans. These retained profits, plus some other ‘safe’ assets, are the banks reserves, or its capital
There is a persistent fallacy that banks lend out reserves. They don’t. People such as Frances Coppola have been banging on about this fallacy for some time now (see here and here) Its more complicated than that and revolves around the fact that banks can create credit (money) by issuing loans. However, banks do need, under prudential regulation, to hold a certain amount of capital, a proportion of the assets they have (loans made). If banks have more capital they are in a position to expand. The problem for European banks is that they are stymied by the fact that they have written down bad loans to an extent sufficient to impair their capital base but by no means enough to clean their balance sheet of the these bad loans. Caught in a double bind, they are unable to efficiently do their job as intermediaries and as credit creators.
As part of the ongoing efforts to get to the root of the problem the ECB have initiated an asset quality review. This is in effect yet another stress test. Previous not-terribly-stressful tests have been greeted with derision as they in effect claimed that all was well when it was manifestly not. Thus this stress test, to be credible, needs to fail some banks – any banks. It is reminiscent of Admiral Byng, who was shot not for failing at his task of taking Minorca, more or less impregnable and a rock on which others had foundered, but ‘pour encourage les autres’. European banks all stand in danger of being the financial Admiral Byng of 2014. One or more large banks needs to fail to show the virility of the tests.
Recent research has looked at what holes might be lurking in the capital. As has been the case throughout this crisis while high level public data cannot give a precise amount it has been remarkable how using such data the gross magnitude and nature of the money sink de jure has been accurately estimated. Looking at the 109 largest banks with €22 tr in assets a hole of between 5b and 66b is found even assuming no further deterioration of any assets – an unstressed situation. The biggest holes are in the core – French and German banks and the smallest in the periphery. Ireland, if things don’t get any worse, does not need any more capital in its banks.
But what if things do go south? They stress the banks rerunning a severe financial crisis, and further suggest that any residual bad loans are written off. Writing off bad loans of capital weak banks is the only way to kill zombie banks who crowd out and hinder the banking system. In this stress situation the banks are woeful. Assuming reasonable levels of reserves to be held, European banks may need between 500b and 750b. Again the worst holes are in the core banks especially French German and Belgian banks. Top of the list are the giant french banks – Credit Agricole, BNP and SocGen, and Deutsche Bank. Bank of Ireland and AIB are not immune, possibly requiring 6-13b euro more. But sure were good for that, havent we turned the corner and exited the bailout to a land of green shoots…
So what to do? Senior bondholders are sacrosanct and while depositors of unimportant nations such as Cyrus (whose banks are still bunched beyond reasonable hope of redemption) might be bailed-in that wont happen to real depositors, those of the core. So banks will limp along. But there is a potential solution – promissory notes. The notes were created to shore up the capital base of Anglo Irish Bank, and allowed it to access liquidity from the Central Bank of Ireland. Which it did. Ok, Anglo was a hopeless case but the principle is good. The problem with the notes was not per se their existence – it was that they were required to be extinguished over a fairly swift timetable, placing unbearable strain on an already strained exchequer and that it was done to put a figleaf on the notion that Anglo was a going concern.
Were these or national equivalents to be created by the national authorities of the core, we could well imagine much longer periods for extinguishing being placed in play. If the Anglo ProNotes had been repaid over 300 years instead of 30 they would not have been an issue, except morally. While the numbers seem large, in the context of the (shrinking ) ECB balance sheet of 2.2b even the largest amount required is not unbearable. Part of the ECB objection to the notes was that the liquidity created was done so “outside its control”. A system of central banks cannot have individuals pursuing their own monetary policy in an uncoordinated and national focused way – that is what brought down the Rouble zone. But as a once off final fix for the banks? Its worth a shot. In all probability the 750b would not be required in full. While the 40% fall over 6 months in equity values is high, this does not happen very often – but it does happen about 1 time in 25. Doing this would ‘cure’ the banks, in so far as it would allow, in fact would have to be accompanied by, a full write-down of impaired loans and thus position them for regrowth. It would allow a clean start to be made. Clean the mess up once and for all, and restart.
Alas, the inflation hawks and their fears dominate the ECB, fears never more imaginary than now with deflation staring the Eurozone in the face, will not allow this. The consequence is that we flirt with a further crisis not merely knocking out the periphery but the core. As we have throughout the crisis we face a choice of unpalatable alternatives. European banks will follow the irish lead – either via partial or full zombification with the odd twitch of life now and again while hoping that the economy does nothing remotely scary all the time barely functioning and taking a decade or more to get back to any health, or by the solution which worked, in that it allowed a bank to be cleansed and to br resolved.
This is a extended version of a column published in The Irish Examiner 9 February 2013
So now we know – its Frankfurts way, all the way. One can only wonder what was going through the minds of the labour party ministers as they signed off the deal that irrevocably linked the Anglo debt to the state. Was it the words of Collins on his signing the AngloIrish treaty , in a political sense? Or was it the words of Mr Rabbitt on the distinction between electioneering and governing? Or was it simply thanks that there was a deal, any deal, that didn’t require a payment on 31 March? Regardless it is now clear that they have swapped a shortterm loan of dubious legality and even more dubious morality for a longterm loan of impeccable national standing. There is zero chance of ever getting out of this now. Zero. All major parties have now voted for the linking of state and private debts. Labour which stood against the 2008 deal, mainly because it gave too much power to the minister and was rushed through has now rushed through a deal that gives sweeping power to the minister. The view within the tent must be so much better than without.
In any sense, we now have the full foul flower of the 2008 banking deal. Having sunk 30+ billion of cold hard cash into the wreck of the banks we have now sunk a further 30b of taxpayers cash into an arguably worse deal, paying for the folly of the guarantee to the anglo subordinated bondholders. This deal flies in the face of all the talk (or as Pat Rabbitt might call it “Auld Palaver” ) at the European level of delinking banking and sovereign debt. It cements and accelerates at the European level the move away from an integrated and globalized banking system and reinforces the trend towards national based banking systems. It makes a mockery of the moves towards banking union in that it demonstrates explicitly the fact that the national state remains on the hook. This national banking approach is evident in more than this. Despite a desire and despite the evident need for one the European leaders still cannot put in place a proper banking union template – national taxpayer cofinancing for bank failures will still be required. In the UK the moves to increased regulation include a move towards a sharper distinction between UK, other EEA and non EEA banks. We have seen a continual concern in the core about TARGET2 balances viz a viz peripheral countries, with the most convincing explanation suggesting that these flows demonstrate a pulling back to the core of credit previously extended to the periphery. All round there is a renationalization in the financial sphere and this deal is part of that.
While financial globalization has brought problems to us, the evidence is by and large that it brings benefits. Deeper, broader more responsive banking systems are associated with greater economic growth. There is an issue as to the lags, and there is an issue also about what we might call utility (the basic money transmission and simple savings/loans) versus industrial banking, but overall the evidence is favourable. In acquiescing to this ECB driven linkage of the banking debt to the sovereign the Irish government has acquiesced in this renationalization.
What of the deal itself? Like any deal it has good and bad points. I remain convinced that the economically and morally appropriate thing to have done was not to pay. However, we have now done so. The deal is complex. It in essence involves IBRC being liquidated, the central bank seizing the asset (promissory notes) that was used as collateral for it extending liquidity, and the government and the central bank agreeing to swap this worthless wretched note for proper NTMA bonds. These bonds are of a longer term and at no more cost than the promissory note so in terms of the present day value they are less. How much less is a matter of some conjecture as the terms of the newly issued bonds are floating. But a reasonable conjecture would be that the value is between about 40-60% of the total amount.
Before we start doing cartwheels of delight however several notes of caution must be struck.
First, there is a requirement in the deal that the central bank will not hold onto these bonds to maturity in total. They will have to sell some. This introduces a degree of uncertainty as to the deal.
Second, the cost is unclear, but we know that we are right now at a low point of the interest rate cycle. As the cost of the bonds fluctuates upwards as do interest rates the cost must rise as do interest rates. The bonds are pegged to a cost over 6m EURIBOR rates. Nobody can forecast with any certainty the rate of EURIBOR, that rate at which large banks lend to each other, over the next few months never mind the next few decades. At a low point in the interest rate cycle a truly favorable deal would have fixed the cost now. The average 6m EURIBOR rate over the last twenty years has been just over 4%. By comparison a rate set at the ECB Main Refinancing Rate would have been cheaper. This leaves aside also the issue that the cy calculation of the EURIBOR itself is under scrutiny and threat, with panel banks pulling out of its calculation right left and center.
Third, much is being made of the argument that, over time, inflation and GDP growth will erode the “real value” of the bonds. This is in one way merely a restatement of the fact that the present value is lower than the total nominal amount. But it also seems to ignore that the ECB have an inflation target (and it has shown itself to be a strong inflation fighter) of 2%. The value will take a long time to fall.
Fourth, even if we were to take the present value as being50% of the face value we have still, at a stroke, added one years deficit. This is hardly consistent with fiscal prudence.
Fifth, there is a worrying line of argument, from the Taoiseach down, that saving the billion a year in funding as we are, we can thus relax austerity measures by a concomitant amount. Even as we are looking at structural budget balances forecast to be over 5% in 2014 ( versus a surplus in Greece ) it is hardly time to raise expectations that this deal is agame changer. Rather than relax the adjustment process (which can only be for party gain) the adjustment should be continued and in effect accelerated with this additional fiscal benefit.
Sixth, the bill contains sweeping powers for the minister for finance. Enabling acts that allow ministers to override commercial judgement on bank asset purchases, create at their own judgement securities (whatever happened to the idea of the Dail having a say on money bills?), or override and instruct the liquidator do not seem to me to be good laws. When dealing with billions of public money the elected representatives should always have the final say.
Finally, we have been here before. In 2008 we saw the oireachtas rush to judgment with complex legislation in the mistaken belief that the issue was one of liquidity rather than solvncy. Then it was the banks, now we are doing the same with the state. Saving cash on an ongoing basis is a liquidity issue. The deal does nothing to adjust the solvency of the state. And that is what a deal should have done.
@JohnGilroyTeam: i think that there will have to be a general election if promissory notes are to be paid
John Gilroy is the labour spokesperson in the Senate on finance. Throughout the last two years he has been one of the few people in politics who has engaged openly on social media. Most of his engagement has been in the issue of these wretched notes. He’s a serious sober thoughtful politician. People like him are the ones that if it comes will constitute the bulk of those in labour calling for an exit. Coming in the wake of the report that the Tainiste has suggested no deal would precipitate s government breakup is clear that the stakes in the game are ratcheting higher.
Have we the “bottle for the battle”?
To recap..A Reuters report yesterday, still unmodified, notes that the ECB has rejected the proposal made by the government on dealing with the Anglo Promissory notes. Ireland's national broadcaster NASA report which says that the ECB have denied this. However that latter states that baldly and gives no detail.
The proposal was that the government would issue a long term (term unclear but presumably more than 10years) bond
Irish Finance Minister Michael Noonan had proposed converting the note into long-term government bonds that would be taken up by the Irish Central Bank with the intention of keeping the bonds in its portfolio for a long period.
This was unsurprisingly rejected by the ECB as tantamount to monetary financing. They don't, can't, do. That.
So why did the Irish givernment, two years into the negotiations, propose that? Was it naivety? Stupidity? cunning? We're they proposing something so impossible that the ECB would reject it?
As things stand we pay 3.06b each march 31 through 2023, 2.2b in 2024, 0.9b 2025 to 2030 and a final 0.1b in 2031. That is 23 years, a generation, after Anglo imploded and the FF government pushed the taxpayer into the black hole after it.
There are only three things that can be done with a debt to reduce its impact; reduce the amount, the interest rate or the time. For complex reasons better explained by Karl Whelan here the interest rate issue doesn't matter. So we deal with the time (stretching it out longer means less, in today's terms, of a burden) or the amount. The deal proposed seems to have been a too clever by half attempt to deal with the time issue. A bond of say 50 years would be “cheaper”. Exactly how much would depend on the time span and the interest rate but it could be a few billion.
My view is that we cut this at the core. Pay nothing. The promissory notes were another too smart by half attempt to fool the markets by the bright boys in the FF government, by a structure that both locked the state into keeping Anglo alive and tried to keep the cost of same off the national books. Nobody treats the debt a not real debt so one argument is why not simply convert to actual NTMA debt, and be honest and open.
To my mind there is no downside to the government stating now that it will not pay the note due now or ever. Three arguments are advanced.
First, the ECB will “cut us off”. Gov Honohan, who sits on the ECB board, alluded to this or something else by saying that th ECB would not look kindly on such a move. The ECB could, in theory do a number of things if we defaulted on the Anglo payment. It could invoke the risk control framework and deny Irish NTMA issued bonds as being eligible for collateral at the discount window. That would cut Irish banks , good bad and indifferent, and indeed any holders of Irish bonds, off from liquidity. The result would be that to keep the ATMs fed and money flowing in the economy we would have to issue own liquidity. we would in effect be expelled from the euro. Think of this : the only succes of the troika, doing something to ensure its long term fiscal stability, being subjected by a troika member to exemplary punishment. What would the effect of same be on her other peripheral nations? Would they calculate that there was literally nothing that would satisfy the fetishistic desires of the ECBundesHawks and contemplate leaving? Would the IMF like to see massive currency instability in an already fragile currency environment? Maybe the mooted IMF “it's a standby not a bailout” trailed last week is evidence of some forward planning here… My view is that the ECB would be extremely miffed and would like to but would balk at this. They are not a suicide squad.
Other issues suggested were we to walk are that MNCs will depart, that we will lose credibility and that…errr…that's it.
why an MNC would leave a country making itself more stable, not less, is beyond me. I haven't seem or heard a single MNC executive address this. I haven't heard the IDA say walking from the Anglo deal would make their job more difficult. Maybe I missed them. As for reputation, to whom does it matter? Again, as this is not government debt it's not a default. The bond markets, truth be told, care less about what we do with Anglo. It only enters into the mix in so far as it gives an indication of whether we are more or less credit worthy on real NTMA issued debt, Removing the rotting albatross that is Anglo makes the state more, not less, creditworthy, more liable to repay and in full on time, not less. Patrick Honohan in 2009 stated
mature reflection by the financial markets would recognize that a country honouring its debts and guarantees to the letter–and not beyond–was more creditworthy than one which handed over money lightly to unguaranteed risk investors
What went, but was ignored, for Anglo and bondholders in 2009 goes double for handing over money to a central bank to destroy it. It's morally, economically, politically and in every way wrong.
The essence of democracy is under question in the case taken by David Hall against the minster for finance which starts in the high court Tuesday January. 22nd. Hall is challenging the legality of the wretched Anglo promissory note . He is saying as I understand it that the constitution requires that all expenditure be approved by the Dail. That is where the power is. People elect TD' s who then in a democratic way vote on various matters including expenditure. The dail gives the government the money to spend . In 2010 the finance bill allowed the minister for finance to provide funds to the banks. Hall maintains that the dail can not give its constitutional powers to anyone else. Although not a lawyer my understanding is that one cannot alienate ones rights, not you, nor I nor the Dail.
The minister for finance on the strength of the 2010 bill created the now infamous promissory note. Halls constitutional challenge questions weather the promissory note was created legally as it was never approved by the Dail. It's hardly a small sum so it does seem odd that this was never subjected to a Dail vote.
A lot is riding on this case which will ultimately end up in the Supreme Court. If Hall succeeds then the Government will be faced with a very difficult situation of having to vote in the Dail and this might cause some issues for TD'S. this might be a chance to really negotiate with our European “friends. The government has put in place a high powered legal team to defend that which it is saying in Europe is indefensible. Expect these lawyers to do a super job, and expect the government to then face these arguments it is relaying to be used in evidence against it (and us) in Europe. This case won't be just about the constitutional niceties, but will inevitably raise issues of economics and bank solvency.
A smart government would not fight this case with rigour, but would let it lose, and then note that there was no way it could get something through the parliament. In reality they migh be hoping that the case, won or lost in the High Court, would result in a delaying of the need to pay the €3.1b in end march. That would put it up to the ECB. But Michael Noonan is not a man to eschew legal advice as the family of Bridget MCCole. Expect this one to run and run…..