Monday 22 April 2019

Colm McCarthy: Summit offers a decent chance of saving the euro

A decent day's work as EU finally recognises responsibility for bank debt is too onerous, writes Colm McCarthy

Colm McCarthy

Colm McCarthy

When a big eurozone country got into serious trouble in the bond market the game was always going to change. That is the essential message from the Brussels summit.

Full responsibility for private banking debt was forced on to the Irish government's balance sheet by the European Central Bank in October and November 2010. This formula could not be imposed on Spain, which would have been forced from the bond market, to be followed inevitably by Italy and the likely collapse of the common currency project.

The applications of Spain and Cyprus for financial aid bring the number of distressed eurozone sovereigns to five, out of a total membership of 17. The reality is finally being acknowledged that there were serious design flaws in the eurozone and that the system needs to be re-engineered.

The prime ministers of Spain and Italy, Mariano Rajoy and Mario Monti, had serious cards to play on Thursday night and appear to have played them well. They will be meeting again on Sunday in Kiev, Mr Monti's compatriot Mario Balotelli having spared Chancellor Angela Merkel the journey with his knock-out performance in the Euros 2012 semi-final. Not a good night, on the face of it, for the German chancellor, but she should not be too despondent. The German football team is young and will fight another day. More importantly, so will the euro, which has been flirting with a real prospect of disorderly failure over these past few weeks.

Thursday's summit was a good day's work for the prospects of fixing the eurozone. Some important issues of principle were finally decided, including the establishment of a pan-European structure for bank supervision and the first steps in breaking the disastrous link between fragile banks and over-indebted sovereigns. Both measures had been resisted by Germany, which had also delayed the inevitable Greek default for far too long.

If the haemorrhage of confidence in the survival of the common currency is stanched over the coming months, acquiescence in these unavoidable measures could in time come to be seen as in Germany's best interests. A euro break-up would have had enormous immediate economic costs and could have de-railed the project of European political integration, the cornerstone of German policy for more than 60 years.

Some commentators have drawn attention to omissions from the brief summit communique and to vagueness about the measures actually included. This betrays a failure to understand the manner in which Europe's leaders do their business. The procedure is as follows: a serious crisis is permitted to emerge. It is then allowed to fester and intensify. Token palliatives are agreed. Experts pronounce that these measures will not work. The set of policy actions that might actually work comes to be widely understood, and each of them is decisively ruled out by the leaders of the larger countries, playing to domestic political audiences. The crisis worsens to the point where unacceptable outcomes become certain. Eventually a meeting convenes in Brussels and somebody has to cave in to the inevitable, usually at about 3 o'clock in the morning. A brief communique is then hacked together and released to the bleary-eyed media.

The handling of the eurozone crisis -- the most serious in the history of the EU -- has followed this extraordinary script to the letter.

The communique is briefer than this article. It contains numerous nits to be picked over by the commentariat, who have radio and TV schedules to keep and newspaper columns to fill. It is unwise to treat any summit communique as a considered plan of action painstakingly prepared by business-like people following adequate deliberation. It is a press release agreed by tired middle-aged politicians in the middle of the night in a poorly ventilated conference room in Belgium. Quite why intelligent politicians agree to have their work arranged in this haphazard and stressful manner is quite beyond me.

The measures agreed will ensure that European funds made available to Spain (and potentially to others) for bank recapitalisation are kept off the state balance sheet. The details of how this is to be done are too complex to be fully worked out at 3am. The concession of this principle is important to Ireland since no such arrangement was offered in our case.

It is clear that Mr Kenny has succeeded in opening up the possibility of retrospective sharing with European partners some of the burden of bank rescue costs. The following two sentences in the communique could mean the difference between exit from the debt crisis a few years hence and reliance on continuing bailouts:

"The eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally."

Notwithstanding the fact that Ireland has already incurred most of the bank bailout costs, this means that some form of retrospective burden sharing is accepted as necessary. The specific mention of "sustainability" in this context means debt sustainability and the reference to equality of treatment is also important. The cases of Ireland and Spain are similar in the sense that neither can retain (Spain) nor regain (Ireland) bond market access because of exposure to bank-related debt. The other two countries already in rescue programmes, Greece and Portugal, did not get mentioned explicitly, so the connection being drawn by the explicit reference is between Spain, where the toxic link between government and bust banks is to be broken, and Ireland, where the link created in the November 2010 deal has finally been recognised as a mistake. Had the European leaders needed an excuse for leaving this issue unaddressed, failure to meet the terms of the Irish programme over the past six quarters, or a rejection of the fiscal compact referendum at the end of May, would have done nicely.

Adhering to the troika budgetary programme and resisting the temptation of a foot-stamping 'No' vote in the referendum is a policy that required some favourable external development to progress Ireland's case for improved terms. The difficulties in the Spanish and Italian bond markets provided that external development and the policy of realism and patience has begun to yield dividends.

Some of the Irish media comment on the summit communique has been disappointing, with reporters seeming to demand an immediate relaxation of budgetary discipline as evidence that something useful was achieved on Thursday night. The Irish budget deficit is unsustainable and needs to be eliminated over the next few years in any scenario. Without some relief on bank-related debt, tight budgets would not have been enough to make the debt level sustainable. Immediate budgetary relaxation, consequent on expectations of some debt relief, would offset the (unquantified and, for now, undelivered) benefit of the debt relief, restoring the debt level to unsustainability. Think of it like this: your mortgage is too high and cannot be serviced. The bank offers to consider some relief on the total due, but cannot say how much. You respond with an immediate celebration-spending splurge.

It will take at least six months, and possibly a year, to get the new bank supervisory functions transferred to the ECB, and new financing arrangements through the ESM (the permanent bailout fund) are conditional on progress under this heading.

The negotiations will be difficult and there will be efforts at back-sliding. The total cost of bank rescue in Ireland equals the €63bn directly expended, plus likely Nama losses, minus whatever the acquired bank shares might eventually be worth. The net figure will be somewhere in the €60 to €70bn range. A small reduction in this total will not make enough difference to regain sustainability and the Government should aim high.

An important angle is whether ESM financial support will rank senior to other government debt, reducing its attractiveness and inhibiting market re-entry. The communique seems to promise non-seniority only to Spain. If Ireland ends up using ESM access (quite likely) the sentence "similar cases will be treated equally" will come in handy.

There are 8,000 banks in Europe and supervision of the smaller ones will be delegated to national supervisors. It would suit Ireland if it can be ensured that all Irish-based banks large enough to trouble the exchequer were supervised directly by the ECB.

Finally, direct responsibility for bank supervision could see the ECB conflicted and required to depart from the troika arrangements, leaving just the actual lenders -- the EU and the IMF.

Sunday Independent

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