Wednesday 13 December 2017

Emmet Oliver: Eurobond idea would curb bad decisions by ministers

He is unlikely to be seen as a great central banker by historians, but Jean Claude Trichet certainly looks like the great improviser of his age.

Just three days ago it looked like Italy and Spain could be heading for international bailouts, but Trichet's decision -- against ferocious opposition internally -- to extend the bank's bond-buying programme to Italy and Spain was a brave call that worked a charm.

Cleverly, Trichet also managed to wring concessions from the Italians and Spanish in exchange for buying their debt. While the ECB's balance sheet is starting to resemble something Bear Stearns would have published in 2008, Trichet has been an effective man in the gap this week.

Although successful, he is only providing temporary relief. The long-term solution remains a eurobond mechanism, where Europe borrows collectively and creates a true competitor to the US Treasury market, which, in case anyone hadn't noticed, has been suffering from a few structural issues recently.

While proposals for eurobonds are still facing German opposition (better described as a veto), there is no doubt that recent events are creating an almost irresistible pressure in support of the idea.

Michael Noonan, while hardly a pivotal force in the debate, is, not surprisingly, more than willing to give the idea a governmental airing. Who wouldn't want to make the rest of Europe joint and severally liable for our €173bn of national debt?

But what politicians don't understand here is that the eurobond idea would have grave implications for them too and that is the genius part of the concept.

Reality

Firstly, if the eurobond idea goes ahead -- and it could be years before it becomes a reality -- countries like Ireland would have to stick rigidly to EU debt limits of 60pc of GDP.

That would massively reduce the scope to borrow for any Irish minister for finance. Yes the limit is already there under the Stability and Growth Pact, but few countries are currently obeying this rule.

Secondly, expenditure plans from member states are likely to face greater scrutiny for the simple reason that if the entire eurozone is joint and severally liable for the debts of each fellow member, dangerous exposures and dangerous spending trends would rightfully have to be exposed at EU level each year and, occasionally, budgets could be sent back. Ireland's reliance on property-related taxes for instance might have been spotted by outside experts.

Thirdly, and crucially, eurobonds, which would replace core national borrowing, would only be allocated to countries for permitted borrowing limits.

Go outside these EU limits and countries would have to borrow on their own, paying higher interest rates and consequently incurring the wrath of the markets, the public and ratings agencies.

This would be a strong form of discipline that could curb spendthrift ministers and force them not to balance their annual budgets per se, but to trim them back to acceptable levels where large crises are negated. The problem before the financial crisis was that nobody could separate the required forms of borrowing and the spendthrift forms of borrowing.

All risk was priced the same way -- not very well. Eurobonds change that.

After the checkered pasts of Irish finance ministers, including Mssrs McCreevy, Lenihan and Cowen, we shouldn't fear handing over additional financial sovereignty to others and taking it away from our own politicians.

Banks and government shy away from laying off workers

We've all learned over the last three years that expanding a bank's balance sheet is easy, shrinking it is the hard part.

This week's results from Bank of Ireland highlighted a clear trend -- despite solemn talk about taking hard decisions, costs continue to be out of control at Ireland's banks and large scale staff cuts appear too hard to stomach for senior bank management and possibly the government.

Bank of Ireland is an example.

Its cost-to-income ratio actually rose in the latest financial results from 61pc to an eye-watering 83pc. Yes there were lots of reasons behind this figure, but the cost burden of the bank still appears outsized.

Raw

The raw numbers tell the story far better though. In the last year staff numbers at the bank have dropped from 14,350 to just slightly lower at 14,004, meaning just 346 people either retired or departed the company. Yes staff costs dropped overall, but clearly this wasn't mainly the result of departures, but reductions in pay and other staff overheads.

It will become harder and harder for the banks to squeeze any more reductions in this manner in future, leaving them with the one decision they don't want to take -- letting large amounts of bank staff go. Bank of Ireland's new private sector owners, though, may take a different view.

S&P make themselves look silly over US debt

SO a bond issued by the government of the Isle of Man is safer than one issued by the United States? Technically this is true following the weekend downgrade of the US to AA+.

The same goes for little ole Liechtenstein, tax-haven Luxembourg and don't forget tiny secretive Guernsey -- all three have stronger credit ratings than the world's largest economy apparently.

While a close look at the AAA-rated club highlights the silliness of S&P's criterion, many in the financial world are baulking even more at the inclusion in this club of the UK (annual budget deficit of 11pc of GDP) and France (debt is approaching 90pc of everything the country produces).

The US, of course, doesn't really have a debt problem. It has a failure-to-tax-properly problem. If it moved towards the tax norms of the rest of the world, its budget deficit would be reduced to a speck and S&P would have to re-instate its AAA rating.

While one has to admire S&P's courage in standing up to its largest customer, neither France nor the UK are on negative watch, meaning that a downgrade of either is not even comprehended at this time by the agencies.

This is truly baffling. Do the agencies really believe that France is more prepared for austerity and future spending reductions than the US? Apparently so.

However, criticism by the White House of S&P will always have to be muted. It was the same for Ireland in 2009 when S&P took this country out of the AAA club.

The reason is simple. Politicians like to toast the far-sightedness of the agencies when they hand out the AAA ratings, making it somewhat difficult to then criticise the same agencies when they take them away.

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