Financial mess will get worse if we muddle along giving out mixed messages on strategy
Published 22/09/2011 | 05:00
The amount in 'haircuts' Michael Noonan wanted to impose on Anglo bondholders
Barely three months ago, Finance Minister Michael Noonan told reporters in Washington that he would seek to impose haircuts on around €3.5bn in senior, unsecured, unguaranteed bonds issued by Anglo Irish Bank and Irish Nationwide. He explained that he had the support of the IMF to raise the proposal with his European counterparts. Last week, outgoing ECB president Jean-Claude Trichet said no to the plan. Mr Noonan will return to Washington for his meeting with the IMF and World Bank with bad news.
So, in an extraordinary game of transatlantic ping-pong, Ireland is now delivering messages to and from her divided creditors; the US treasury secretary tried to help last weekend but ended up leaving Europe with a flea in his ear; and Europeans continue to disagree strongly among themselves -- and with the ECB -- on whether private creditors should bear some of the costs of the crisis.
There comes a time when confusion itself -- rather than the underlying economics -- drives a crisis. Confusion has already lowered growth projections in the eurozone and elevated its debt and contingent liabilities. Prospects for even the strongest members have dimmed.
This is a financial crisis, not a political or diplomatic crisis, and it cannot be resolved by muddling through and waiting for a solution to emerge. Financial muddling costs a lot of money and obscures the path to a solution. Whatever about its current incarnation, the eurozone of the future has already disintegrated into a series of imaginary structures ranging from political union to euro bonds and regional currencies. It is not possible to pursue all of these fantasies at once and the goal needs to be clearer if financial markets are to have something to support.
And the problem for countries like Ireland is that they cannot adopt all of these fantasy strategies at once -- the country needs to define its basic principles and economic direction.
Otherwise, there can be confusion and contradiction, as shown by last week's events. Trichet advised Noonan to resist imposing haircuts on bank bondholders in case recent improvements in yields on Irish sovereign bonds would be reversed. But a haircut on bank bonds would reduce the total debt outstanding and improve the chances that the sovereign component can be repaid. Therefore, yields on sovereign bonds should fall even further after such action.
But, says Trichet, Ireland's reputation as a debtor will be preserved if the bonds are repaid in full. This is very debatable -- because the bonds were issued by defunct banks and not by government -- and, in any event, the European Stability Mechanism (ESM) will be in place by 2013 and will insist that sensible debt reduction be an integral part of any future recovery programme. Moreover, as pointed out by Germany when it insisted on these provisions in the ESM, there would be dangerous moral hazard in any system that does not allow for the possibility of default.
Trichet's main concern, of course, is that some of the bondholders are themselves other banks and could be undermined. Let's at least be honest and admit what the parameters of this problem are: Ireland and Europe could benefit from such honesty and the mist of confusion might begin to lift.
So, there is a lot more at stake than possible savings on Anglo Irish bonds. Repeated calls for Ireland to "stick to the plan" are beginning to sound very hollow. And in the absence of a common vision for the eurozone, Ireland needs a clearer strategy. Only then will it rise above this crisis and become a stronger member of any future arrangement.
Gary O'Callaghan is Professor of Economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised numerous governments on macroeconomic policies