The Irish programme deconstructed

What’s at stake: Europe's leaders have put together a programme for Ireland which overwhelmingly appears inappropriate, as it doesn’t credibly ensure a return to solvency; doesn’t credibly isolate and solve banking related issues and risks domestic political backlash. Given the inadequacy of the response, the risk now is that markets consider the Irish case unresolved and intensify stress on the eurozone as a whole.

History 101

Harold James argues that the European solution seems to be repeating the same time-buying tactics of the lost decade of the 1980’s in the developing world. There is the same combination of international support, highly unpopular domestic austerity measures (which are bound to set off major protests), and the apparent absolution of banks from financial responsibility for problems that they produced.

Kenneth Rogoff argues that what Europe and the IMF have essentially done is to convert a private-debt problem into a sovereign-debt problem. Have the Europeans decided that sovereign default is easier, or are they just dreaming that it won’t happen? By nationalising private debts, Europe is following the path of the 1980’s debt crisis in Latin America. There, too, governments widely “guaranteed” private-sector debt, and then proceeded to default on it. Finally, under the 1987 Brady plan, debts were written down by roughly 30%, four years after the crisis hit full throttle.

It’s solvency, stupid!

Barry Eichengreen argues that the Irish “programme” simply kicks the can down the road. A public debt that will now top out at around 130% of GDP has not been reduced by a single cent. The interest payments that the Irish sovereign will have to make have not been reduced by a single cent, given the rate of 5.8% on the international loan. After a couple of years, not just interest but also principal is supposed to begin to be repaid. Ireland will be transferring nearly 10% of its national income as reparations to the bondholders, year after painful year.

Karl Whelan wonders how do we get from a weighted average of 3.12% and 4% current SDR rates to the government’s figure of 5.7%? The answer appears to be related to the fact that the IMF lends in SDRs at a floating rate, but if that is the case, this suggests that the cost of swapping a floating rate SDR loan into a fixed rate Euro loan is somewhere between 170 and 258 basis points, which seems very high. Similarly, it is not clear where the EFSF 6.05% rate comes from. If you follow the formula as provided by the EFSF FAQ, you get something closer to 7%. The 6.05% figure apparently does not include the up-front service fee or the role played by the cash buffer.

Kevin O'Rourke argues that it had been clear for a long time that the blanket guarantee given to the liabilities of Ireland’s rotten banks had saddled the State with a debt that was too big for it to handle. The biggest Irish joke which underpinned the bank guarantee in the first place was that if we wanted investors to retain confidence in the creditworthiness of the Irish State, we needed to make sure that nobody who invested in our (private sector) banks ever lost a penny. The latter decision is the one that sank the country. On the night the guarantee was announced, Morgan Kelly pointed out that while it was the right policy if the Irish banks were facing a liquidity crisis, it was a terrible policy if they were insolvent, which was in fact the case.

Wolfgang Münchau argues that the Irish mess is another repeated attempt to address solvency problems through liquidity policies. It happened in October 2008 with bank guarantees. The European Central Bank’s never-ending liquidity support is another example. So is the Greek bail-out. And so is the European Financial Stability Facility, the €440bn ($588bn) bail-out fund. Set up in May as a mechanism to resolve financial crises, it became a cause of the Irish crisis in November. What triggered last week’s panic was the sudden realisation by investors that, with an interest rate of 6% and an ongoing no-default guarantee to bank bondholders, Ireland is insolvent.

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