The European Central Bank's executive board member Jorg Asmussen visited Dublin last Thursday and expressed confidence in Ireland's prospects of an exit on schedule from the EU/IMF programme and a successful return to the bond market next year.
He also addressed the question of Ireland's relations with the ECB, revealing a refreshing awareness that the ECB's Irish fan club is not extensive. The principal reason for this state of affairs is that certain of the ECB's discretionary actions are perceived in Ireland as inimical to the outcome he professes to desire, namely an early return to the markets.
The new Fiscal Advisory Council released a sobering report the week before last which received less attention than it deserves. The Irish fiscal adjustment commenced almost four years ago, with the reductions in spending announced in July 2008. After the series of substantial spending cuts and tax increases which followed, the budget deficit was still stuck at the quite unsustainable level of 10 per cent of GDP in 2011. The country had meanwhile lost the ability to finance itself and had been forced, in November 2011, into the arms of official lenders in circumstances which remain controversial. The Fiscal Council has calculated that, had no fiscal cutbacks been pursued, the deficit in 2011 would have been no less than 20 per cent of GDP, so the current unsustainable position is not due to a lack of effort by successive governments. It is due to the direct impact of the banking crash which has added more than €60bn to the State debt, and to the indirect impact depressing the overall economy and government revenue.
When the ill-advised bank guarantee was introduced in October 2008 the banks were believed to be illiquid rather than insolvent, and the guarantee was expected to have no cost to the State. Had these assumptions been fulfilled the fiscal crisis would be over by now and there would have been no resort to bailout. It is in this sense that the Irish crisis is a banking crisis, and
quite unlike the debacle in Greece.
The Fiscal Advisory Council report makes it clear that a successful exit from the EU/ IMF rescue programme is subject to grave uncertainties. The council notes in particular that macroeconomic forecasts cannot be taken for granted, and that downside scenarios must be taken seriously. For example, the figures which were given in the projections underlying the first crisis budget in October 2008 foresaw growth at -1.3 per cent in 2008, followed by -0.8, +3.7 and +3.7. The actual out-turns have been -3.0, -7.0, -0.4 and +0.7.
The average undershoot in GDP growth has been almost four per cent. Subsequent forecasts have also erred on the optimistic side. Official forecasts of Irish GDP growth are 1.3 per cent in 2012, followed by 2.4 per cent next year and a healthy three per cent for the two years following. Ireland's debt is meant to peak at 119 per cent of GDP next year under this scenario. The Fiscal Council notes that a mere one per cent undershoot would see the debt ratio failing to stabilise at all. The recent Central Bank report noted additional risks from further mortgage default and Nama losses, and the IMF has expressed similar concerns. An early Irish return to the markets is seen by many Irish economists as unlikely.
The critical ECB contribution to the Irish sovereign debt crisis has been its insistence that bank senior bondholders, including unguaranteed bondholders, be made whole by a government which is itself unable to borrow. Mr Asmussen is quoted in last Friday's Irish Times as follows: "No senior bank bonds anywhere in the eurozone have been defaulted on since the crisis erupted in 2007."
He makes this sound like an achievement. In its Irish manifestation it is also a first in central banking history. No central bank has ever forced a sovereign already in a debt crisis to pay 100 per cent to bondholders in a bank which has been placed in resolution. The principal bank in question, Anglo Irish, has lost more than eight times its capital and has written off almost half of its loan book.
Mr Asmussen recollects the events leading up to the Irish programme in November 2010 as follows: "I know that the decisions concerning the repayment of bondholders in the former Anglo Irish Bank have been a source of controversy. Decisions taken by the Irish authorities such as these are not taken lightly. And the consequences of subsequent actions are weighed carefully. It is true that the ECB viewed it as the least damaging course to fully honour the outstanding senior debts of Anglo. However unpopular that may now seem, this assessment was made at a time of extraordinary stresses in financial markets and great uncertainty. Protecting the hard-won gains and credibility from the early successes in 2011 was also a key consideration, to ensure no negative effects spilled over to other Irish banks."
Note that the decision was "taken by the Irish authorities", and that the negative spillovers would affect only "other Irish banks". The late Brian Lenihan, Ireland's finance minister at the time, recollected things a little differently.
"I don't think the commission were anxious to bounce member states into a programme. That was my strong impression from my discussions with Commissioner Rehn," he told Dan O'Brien of the Irish Times, adding that "the ECB clearly subscribed to a different view." (April 23, 2011). Three days later, the same reporter wrote: "He said he also raised the issue of senior bondholders making a contribution and there was a considerable amount of dialogue on the issue. He said the IMF was more sympathetic to the Irish view than the other two members of the group."
The ECB has acknowledged the existence of a letter to the Irish authorities dealing with these issues but has declined to release it. Until such time as the full records are released, ECB officials will have to accept the perception in Ireland that actions over which it had discretion imposed costs of several billions on Irish taxpayers and sovereign bondholders in pursuit of an ECB agenda (protecting Europe's bank senior debt market). This perception has weakened domestic political support for necessary further fiscal effort and has fed anti-European feeling in Ireland.
Mr Asmussen's remarks as actually recorded contain a significant difference from the version on the ECB website. The final sentence finishes: " ... the main reasoning was to ensure that no negative spillover effects would be created to other Irish banks or to banks in other European countries." (My italics.) This is the first admission by an ECB official that the protection of the European senior bank debt market was the ECB's objective in requiring a country entering an IMF programme to pay unguaranteed bondholders in a bust bank. Jorg Asmussen is intimately familiar with these events. At the time he was the most senior adviser to Germany's finance minister. The Sunday Independent reported on April 24, 2011, that "Germany's Asmussen provided the clearest statements to date on the reason for rejecting the Government's proposal to haircut senior bank bonds. He said it had not been tried in the past and "we have no idea how market participants and investors would react".
Senior bonds in bust banks in Denmark have been hair-cut, so this is a eurozone, not an EU policy, and appears to have enjoyed Mr Asmussen's support, and that of the German government, at the time. Had Denmark chosen to join the euro, its national debt would now be larger. There is no provision in the Maastricht Treaty, in the ECB statutes or in any EU directive which says that states must pay bank bondholders without limit and to the point of state insolvency. The policy will, of course, be abandoned if a large member state gets into trouble, since a sovereign debt crisis in a large state will collapse the European financial system. The policy is "no bank bondholder left behind", but only at the cost of smaller states and their sovereign bondholders. All banks are TBTF (too big to fail), but only some states are SETF (small enough to fail).
When banks go bust, the shareholders take the first hit. If this is not enough the division of losses between other categories of creditors and taxpayers is a political decision, as in Denmark. In the Irish case this political decision was usurped by the European Central Bank. Unelected European executive agencies have no mandate to behave in this manner.