Ireland and Bondholders

http://www.independent.ie/opinion/analysis/stephen-donnelly-heres-why-the-64bn-is-ours-for-the-asking-3251469.html

Independent TD (Irish Member of Parliament) Stephen Donnelly has written a superb piece for today's Irish Independent. Its not regularly recognised that the main reason Ireland as a whole is in financial trouble is because the Irish government, as a sovereign state, undertook to not only rescue the various large Irish banks, who were bankrupt as a result of bad loans, but to honour most of the debts of the banks, including repaying all senior and most junior bondholders in full.

Stephen Donnelly, it must be remembered, is a smart guy, UCD, MIT and Harvard, and worked as a management consultant with McKinsey & Co.

Meanwhile, Ireland's Taoiseach (PM, pronounced tea-shock) is a primary school teacher.

The question Donnelly asks is how do we get the ECB to forgive repayment of €64 billion Euros in promissory debt.

This debt is essentially loans, promissory notes, issued by the Central Bank of Ireland, using European Central Bank funds, which were given to the Irish government for the purposes of recapitalising the banks.

First of all, you might be surprised that Ireland still technically has a Central Bank. It is true, each Eurozone state retains a Central Bank, although most of its important functions, such as the right to issue new currency, have been outsourced to the European Central Bank in Frankfurt. So I guess we've got two Central Banks, because one can never have enough of a good thing.

The national central banks allegedly play a role in regulating the banks of the country, along with various financial regulator offices, and gather some statistics, with the aid of various statistical organisations.

If you're getting the impression that the European banking system is designed in an irrational way, you can be forgiven. I think so too.

And that irrationality extends all the way down the line too.

For instance, banks which take more risks with their money, usually earn more profit, in the short term, and thus can afford to pay more interest on deposits and on senior bonds. In the short term. Until they can't.

Then it's bailout time. The shareholders, at least are wiped out. When you buy your shares, nobody promises you that they are worth anything. So at least the shareholders have to eat their loss like good capitalists should.

Next, depositors are protected. If they aren't, they get antsy, and start queuing up outside the bank, waiting to take their money out in cash. That can get real akward, when the manager has to go and explain to a bunch of angry yokels that they can't all withdraw their cash cos the bank doesn't have it any more, the bank having either lent it out or gambled it away. The technicalities of banking finance usually go unappreciated by yokels, and several bankers have been killed while trying to get straight the details of fractional reserve banking.
"lets see now, the reserve ratio is proportional to the ... hey what are you doing with that dynamite"
Anyway, one of the dumbest lessons people took from the experience of bank runs, especially in the crises of 1929 and 1933 during the Great Depression, is that depositors must be protected at all costs. And there were a lot of hard luck stories, people worked hard all their lives, only to be left with nothing, zero, when the bank in which they had so assiduously put all their savings collapsed. Not even an apology.

But banks are supposed to pay interest on deposits, and reward without risk is alchemy, as Mervin King from the Bank of England has pointed out.

So, if people want to save, it would be more logical to let them do so directly in government securities or something. Depositor protection just encourages rate tarting, where people will deposit their money in whatever bank offers the best rate, or other incentives (which have included toasters, among other things).

But what about our precious bondholders?

Bondholders traditionally had to eat their loss just like everyone else, but have been a protected species of late, at least in the Anglosphere. The precedent was laid in 1984, when Chicago's Continental Illinois failed, and was saved, bondholders and all, by the US authorities.

You've got to realise that they are usually other banks, sometimes pension funds, usually politically powerful organisations. The Guido Fawkes Blog purportedly published a list of Anglo bondholders in 2010. Both the ECB and the US authorities have made it clear to the Irish government that senior bondholders are not to be touched.

The reason for that may be due to risk of contagion, because of high levels of leverage not enough capital is available to take the writedowns on Irish bank debt (which would be of the order of at least 50%). Of course, some of it is just down to money. Yes, money is real and it matters. Who would have thought it?

So what of our €64 billion Euro schuld? Well, apart from politicians, (who are pathological liars) very few of the people I have spoken to in Ireland, think we can pay back our current debt, and off them an awful lot don't think we should, even if we could. At the minute the Irish debt is well over 100% of GNP (since Ireland exports so much from marginally attached non-Irish multinationals, the GNP rather than the GDP is a better measure of our ability to repay).

Our government deficit is between 10 and 15% of GNP, and balancing the budget should lower GNP by at least this amount, more if Keynesian multiplier effects are considered (for general government expenditure in Ireland the Keynesian Multiplier is about 1.5).
There is also an additional €15 billion in NAMA debt with is still unaccounted for, NAMA being a so called "Special Purpose Vehicle", a SPV, financed by government bonds but which no one is allowed to peer inside.

But that's a post for another day.

Corrections welcome.