The Irish-European mess
What's at stake: The tension surrounding the Irish situation is now calling for a quick resolution; otherwise contagion risks spreading concerns to fragile eurozone member states such as Portugal. The Irish government seems ready to call for financial support but insists it only struggles with liquidity and with its banking system. which therefore begs the question of the tools that could be deployed to ringfence and solve the banking system, allowing the fiscal consolidation efforts to follow their course. The European Central Bank, which has so far been the primary provider of liquidity to the Irish banking system through its repo operations, wants a more sustainable solution in a move that very much echoes the inception of the Greek crisis. The resolution still to be found will need to balance the need for support of the financial system with the limited Irish appetite for conditionality, in particular with respect to its tax system.
Irish banks, sovereign solvency and the ECB
John McHale writes that the Irish government has pushed the line in recent days and that the flair up in the crisis is all about the banks. There is little doubt that the trigger was ECB concern about their large and rising exposure to the Irish banking system. But the idea that the banks are the problem and the state is fine – happily pre-funded as it is through the middle of next year – is nonsense. The vanishing credibility of the ELG guarantee, along with the creditworthiness of the state, is the major cause of the banks’ increasing reliance on the ECB. The intensified banking crisis is a (very significant) symptom of a deeper problem.
Gregory Conor writes the problem for the ECB is that it is sharing the risk capital allocation with the Irish government. The government came up with a clever alternative to providing the banks with solely Irish taxpayer risk capital by issuing non-tradable Nama bonds to the banks in exchange for their troubled assets, and arranged with the ECB that the banks could take these Nama bonds to the ECB repurchase facility and use them as collateral for borrowed cash. The Nama bonds are Irish-government guaranteed, but that is no longer an AAA-promise. If the banks default on their repurchase and the government defaults on its bond guarantee, then the ECB is at risk of big losses. Should the ECB be willing to absorb that risk or does that go beyond its remit?
Charlemagne writes that the option being considered is to label the bail-out money a move to help restructure the banking sector. There is some logic to this, as the sector’s collapse is the heart of the problem. The hope is that it can be made sturdy enough for some of Ireland’s banks to be bought up by foreign ones. That would, in turn, help ease the Irish banking sector’s liquidity crisis. Given the state’s blanket guarantees to the whole banking sector, it is hard to distinguish where the banking crisis ends and the sovereign fiscal one begins. Still, this finesse would save the Irish government’s amour propre, and allow it to claim that it has not (yet) abandoned Ireland’s hard-won sovereignty. A “precautionary” fund could still be set up to help Ireland’s state finances as a back up.
Manoeuvring the legal constraints and other practical issues
Charlemagne writes that one option being considered is to use initially only the commission’s money (perhaps backed by some IMF money, too) in order to address Germany’s constitutional constraints. The idea would be to use only some of the several pots of money that went to create the €750 billion safety net for the euro zone. Most of this, €440 billion, is made up of guarantees from 16 individual euro-zone countries in the European Stability Financial Facility (EFSF). Some €60 billion comes from the European Commission, and €250 billion will be provided by the IMF. The political attraction is that the commission’s money can be released more quickly, as it requires only a vote by qualified majority of the 27 members of the EU, instead of the unanimous vote of 16 euro-zone members needed to release money from the EFSF. And being part of the “European” budget, it helps reduce the perception that Germany is dipping into its own pockets to save foreigners yet again. The assumption is that the Karlsruhe court would be less critical of community funds being used in such a manner.
Alphaville argues that rerouted aid might be a faster and more visible substitute, especially as systemic margin calls home in and time runs out for Irish bank funding. ‘Availing of help to stabilise banks’ is of course a slippery euphemism indeed for the actual rescue proposals out there, which involve various devices for unlocking loans from a) the EFSF; b) its EU budget-backed cousin the EFSM; c) bilateral UK loans; or d) all of the above. Direct loans to banks are ruled out for the EFSF or EFSM, hence the emphasis on rerouting. We’d suggest paying particular attention to CreditSights’ suggestion that EFSF loans could be substituted for promissory notes issued by the Irish government to cover banks’ recapitalisation.
Tracy Alloway points out that the EFSF is not prefunded. That is, the money isn’t sitting in a pool somewhere, just waiting to be used. It needs to be raised. But raising it in the midst of an EMU crisis could be trickier than many expect. The problem is that if EFSF bonds, collateralised by Irish (and EU guaranteed) bonds, fail to attract investors, then the negative impact to sentiment will push up borrowing costs for the other sovereigns (which do have near-term financing requirements) anyway.
The dynamics of contagion
Eurointelligence flags out an FT editorial that says that Ireland has to choose between the solvency of its banks and its own solvency, a choice that may soon be confronted by other European countries. There is little hope, the editorial says, that the EU will be able to disarm the other ticking time bombs. The immediate issue at stake now is the solvency of the Irish banks. If Irish banks collapse, this would trigger bank failures across the European continent. This, not sovereign default, is the real threat in the short term. Europe does not yet seem willing to give up a diabolical bargain that has core states lending to peripheral ones in order to support their banks; all to save financial institutions in the core from losses. This game of bail-outs on the sly cannot be sustained for much longer.
Simon Johnson and Peter Boone argues it’s time for the Europeans to decide: Who gets unlimited liquidity support because they are essentially solvent, and who has to restructure their debt – with bridge financing and help from the outside? This will be painful and intense. The case for debt restructuring in Ireland and Greece is clear. What about Portugal and, even more controversial, Spain – and other eurozone sovereign borrowers?
Emma Saunders argues that bailing out Ireland wouldn’t end the bail-outs any more than bailing out Greece did. Indeed, it would support the expectations we are forming that officials’ flashmobs are a normal response to market turbulence. Contagion is a very misleading term for what is happening in the eurozone: ‘curing’ one patient is not going to help nearly as much as changing the environment of all the patients. Having the money physically at hand, but not required, must surely rank as one of the most market-reassuring options available - assuming, of course, that market volatility is caused by the possibility of default. But what if volatility is caused by uncertainty over what happens in the case of default? Does family friction subside when the patient is pronounced cured but their will is in disarray?
Jeffrey A. Miron argues that the risk of a default contagion is real, but spillovers to other countries might do more good than harm. The other countries at risk of default are themselves facing unsustainable debt burdens; they need to make further fiscal adjustments and their creditors need to take a hit. The sooner this happens, the sooner these countries can begin renewed growth on a sounder footing.
Should Europe back-up or move forward with its bail-in plans?
Nouriel Roubini argues that Irish woes should speed Europe’s default plan. In the short term, the EU will kick the can down the road via a temporary Irish bail-out, just as it did with Greece. It is likely to do the same with Portugal. But it has finally dawned on the EU that a rolling process that places private bank losses on to public balance sheets could leave its governments insolvent too. Based on the experiences in Pakistan, Ukraine, Uruguay, the Dominican Republic, Argentina, Russia and Ecuador, Roubini argues that a formal legal mechanism is simply not necessary to implement the orderly restructuring Europe must soon introduce.
Jacob Funk Kirkegaard argues that the best – perhaps only – way to prevent such a situation from arising next time around is to use the current crisis to make the necessary changes and solidify future political support. With the ECRM discussion at least under way to include “private sector participation” in post-2013 bailouts, voters will be offered at least a long-term way out of the dilemma of having to shoulder the cost. This is progress, regretfully overshadowed by inept communication, but progress nonetheless.
The Irish corporate tax rate issue
Philip Lane argues that given the importance of a pro-growth plan and the downside risks to the export sector of varying this tax rate, it does not seem wise for the international debate to focus on this topic.
Kevin O’Rourke writes that Irish people should remember that our solo run on the suicidal bank guarantee was deeply resented by other European countries. Other member states face political economy constraints. Sarkozy said a year or two ago that it is hard to argue that citizens of a high-tax jurisdiction should fork over their money to the citizens of a low-tax jurisdiction. I would say that he was reflecting the views of a lot of people on the Continent.
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