It’s worth noting a flurry of Greece-related chatter coming into a quiet news cycle on New Year’s Eve. The context: Greece has a 3 year stand-by arrangement from the IMF and a parallel arrangement with the EU, meaning that it gets the money over those 3 years, but has to repay fairly soon afterwards. It’s easy to lapse into the Greek mythology to find a metaphor for the looming repayment schedule from 2014 onwards but suffice it to say that no one likes the look of it. So for over a month, reports have circulated that a loan extension was close to a done deal — up to 11 years according to one report.
Author Archives: P O Neill
Other people’s money
USA Financial Crisis Inquiry Commission, “primer” issued by the Republican party defectors from the project —
If the bank uses deposits to fund poorly performing projects, depositors can become concerned that eventually their bank is going to fail and they will not get their deposits back. If a bank lends too much of its deposits to finance long-term projects, depositors might begin to worry that they will not be able to withdraw their money according to their needs. Therefore, banks hold enough cash on hand, or “liquidity,†to be able to honor withdrawal requests and offer confidence to depositors that their money will be there when they want it. If depositors lose confidence in their bank, the only rational thing to do is to withdraw their money and move it to a safer place. With each depositor withdrawal, the bank becomes more leveraged, the mismatch between its assets and liabilities becomes more pronounced, and liquidity on hand is further diminished.
With the credentials that one assumes qualified them to be on the commission in the first place, you’d hope to do better than what you’d get from putting “bank run” into The Google. But do you?
Ireland crisis loan conditions become clearer
Ireland’s department of finance has released the draft loan program agreement with the European Union and IMF. It is still preliminary and subject to various approvals, but the government was under pressure to show the basics of what had been agreed prior to the budget vote on 7 December. A quick perusal of the document reveals the following:
The EFSF apparently asked the government to post collateral for the EFSF loan. This rumour had circulated during the negotiations but a reference in the letter confirms it. But the government found “legal and economic constraints” to do it … those acquired-helpnessness Irish lawyers strike again.  Anyway, the apparent disagreement over collateral provides indications both of the risk EFSF may see in the package, and so the interest rate that has drawn so much attention.
In the better-late-than-never department, the opening letter includes the statement “The Irish owned banks were much larger than the size of the economy.” The government may be groping towards an understanding of the difference between “Irish banking system” and “Irish banks.”
The government is leaving open the option of more wage or number cuts in the public sector (p13) … it will consider “an appropriate adjustment, including to the overall public sector wage bill, to compensate for potential shortfalls in projected savings arising from administrative efficiencies and public service numbers reductions.” Note that under the Croke Park Agreement, those savings are supposedly pledged to reversing previous wage cuts, in reverse order of wage level. But now it appears that those savings are part of the fiscal targets and wages/numbers may be on the table to meeting them. Note: that’s a 2011 decision, left to a future government as the current one feathers its personal nests.
Bank resolution legislation is coming (various described as end December or February); under it, the Central Bank can appoint a special manager, transfer assets and liabilities of distressed institutions, and establish bridge banks. It is unclear whether this is the same as or separate from legislation that will impose burden sharing on subordinated bondholders in banks.
Finally, it looks like the deficit targes are being set in currency terms and not in percentage of GDP, which may indicate some thinking that the ratios have been misleading or added statistical doubt to the numbers. And, in the final sign of how there’s a new sheriff in town, there will be a lot of new monitoring and reporting to overseas agencies under the agreement.
EU to Ireland: Do you want your pensions or your banks?
In assessing the effectiveness of the EU/IMF emergency lending package to Ireland, it’s important to distinguish the financial market impact from the political impact. In terms of market impact, the package is surely a success. All talk of restructuring, for sovereign debt let alone senior debt in banks, is off the table. Through IMF and bilateral involvement, the call on EU lending has been kept in the low range: note the heavy use of the EU-budget backed stability mechanism relative to the use of the financial stability fund — the EFSF’s powder has been kept dry in case it’s needed elsewhere. Furthermore, the lender of last resort checklist is looking good: if not quite lending freely at high rates against good collateral, all the EU money comes in at a large headline amount, with a fairly high rate (above IMF and Greece program), and the collateral coming from conditions to which the Irish government had already agreed. This money will get paid back.
In terms of domestic politics — and therefore with broader implications for the EU as political project — the package is much more problematic.
Can Irish saving save Irish banks?
The government of Ireland released its 4 year plan for fiscal consolidation and structural reform earlier today. Finance Minister Brian Lenihan gives the optimistic version in the Financial Times. Speaking of optimism, here’s an interesting bit of the underlying economic analysis (page 28) —
This combination of current account surpluses and substantial (though declining) budget deficits implies the continuation of a large private sector financial surplus throughout the period of the Plan.  Much of this accumulation of financial surplus by the private sector will take the form of increased deposits with and reduced borrowing from domestic banks. The result will be a very substantial fall in the loan-to-deposit ratio of the domestic banking system and a corresponding reduction in the domestic banks’ reliance on external sources of funding.
So the expenditure compression coming from continued austerity will form part of a slow-motion solution to Ireland’s banking crisis, because deposits will go up and loans go down. With Bank of Ireland and Allied Irish Banks currently on loan-to-deposit ratios of about 160 percent, this effect certainly goes in the right direction. But it takes a long time to work relative to the speed with which wholesale funding can disappear. And it’s a very fine balancing act. In the section on risks, the same 4 year plan says —
… domestic risks are tilted towards the downside. The most significant of these risks is that households maintain savings rates at current very high levels which would represent a continued constraint on personal consumption.
So the same saving that might help the banks could undermine expenditure growth in the economy.  But most of all, the optimistic scenario regarding banks’ funding needs assumes that these Irish household savings flow into Irish banks.  Whether the traditional home bias of Irish savers — as is true for savers in most EU countries — can be assumed to continue is an open question. Without confidence in domestic banks, the assumptions in the four year plan look heroic.
Ireland: Lead us not into temptation
Wall Street Journal Europe editorial —
Ireland’s plight is not the result of collecting too little tax. The country is a victim of the global credit bubble, which tended to hit hardest the countries that had the largest and most innovative financial industries: Ireland, the U.K., Spain, the U.S. and, in its especially perverse way, Iceland.
From the report of Klaus Regling (yes, that Mr Regling) and Max Watson into the macroeconomic and global sources of the Irish crisis (page 29) —
Concerning credit growth …. what occurred in Ireland over the past decade was simply and squarely a massive financial sector and property boom. Moreover, this boom was not marked by the esoteric complexity of financial instrument design that proved the downfall of nstitutions elsewhere. The problems lay in plain vanilla property lending (especially to commercial real estate), facilitated by heavy non-deposit funding, and in governance weaknesses of an easily recognisable kind. Together, these factors led to acute vulnerabilities and then to deep economic and social costs.
To spell it out, although you can use various words about Irish banks, “innovative” is not going to be one of them. Yes there was cheap money but bad lending practices (including investment loans payable on demand and non-recourse loans to developers) are at the root of the crisis. However, it remains a Eurozone article of faith that bondholders who lent money to banks to engage in such dodgy lending practices shouldn’t lose a cent.
Ireland: The timidity of the lawyers
Perhaps the biggest puzzle of Ireland’s 2+ years of economic crisis is the lack of progress on restructuring the banking sector, and in particular the reluctance to follow through on the implications of having guaranteed the liabilities of insolvent financial institutions. As with many of Ireland’s problems, there is no single explanation so in this post we focus on just one — a mindset in the Irish government that springs from the legal background of several of the principals in it.
DSK on QE2
IMF Managing Director Dominique Strauss-Kahn gave an interesting interview to Stern magazine. The transcript on the IMF website seems more comprehensive than the story based on the interview in Stern.  DSK covered a lot of ground but his comments on the US Fed quantitative easing were especially interesting. In addition to offering the standard pro-QE2 position that what’s good for the US economy is good for the world, he had this exchange —
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Question for Eurozone finance ministers
Today in the lower house of the Irish parliament, Minister for Finance Brian Lenihan repeated a statement that he made on Irish radio yesterday concerning European endorsement of the Irish government’s policies in relation to the banking crisis. Specifically, he told the house —
The fact is that every finance minister in Europe [Eurozone] indicated the other evening that the [blanket bank liability]Â guarantee was the correct policy at the time [September 2008].
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The basis is this paragraph from the Eurogroup statement following their Monday meeeting
We welcome the measures taken to date by Ireland to deal with issues in its banking sector, via guarantees, recapitalisation and asset segregation. These measures have helped to support the Irish banking sector at a time of great dislocation. However, market conditions have not normalised and pressures remain, giving rise to concerns that further reforms and stabilisation measures may be appropriate.
Since this statement is like all such statements written to be vague enough to encompass what all the parties want it to mean, it’s worth being more specific. So: do the finance ministers support a policy of open-ended liability guarantees to insolvent banks regardless of their size? Because that’s what Ireland did in 2008. And the minister is now using the claimed endorsement of his European colleagues as a basis for being angry at the opposition for even having forced a vote on the extension of the revamped guarantee yesterday.
One from the files
With so much new reading material being generated on the evolving Ireland situation, we’d like to recommend that you go back just over 6 months to this really excellent and prescient opinion piece in the FT  from David Bowers, global strategist at Absolute Strategy Research. We want to be nice to the FT and not cut and paste from the articles as they request, but focus in particular on the idea that we are headed for a world of increased official capital flows, with political conditions attached. With Klaus Regling, CEO of the European Financial Stability Facility, telling us just now that he’s been shopping the EFSF fund-raising to sovereign wealth funds and central banks, we could be getting into a world of Asian/petrodollar flows, via Brussels, Washington, and Frankfurt, to the European periphery.