Friday 20 September 2019

Emmet Oliver: European debt masters must study their part in our downfall

Emmet Oliver

Stony-faced IMF and ECB officials touched down in Dublin yesterday as they make yet another attempt to solve the Irish banking crisis.

This crisis is now almost three years old if you take the starting point to be the so-called 'St Patrick's Day massacre' of 2008 when Anglo Irish Bank's stock price plunged by 15pc.

Despite plans to spend 36pc of everything Ireland produces on this one segment of the economy, all policy interventions to date have not only failed to shore up the system, but in some cases have made it even more unstable.

While the primary responsibility for this failure must lie with our outgoing Government, wider culpability stretches in a southern direction to Brussels, then onward to Frankfurt.

Last year economists Klaus Regling and Max Watson, in a key report, made it very clear the causes of Ireland's financial crisis were primarily homegrown, but deep involvement of European institutions in trying to solve the problem is undeniable.

As reported previously in this newspaper the president of the ECB, Jean Claude Trichet, has been intimately involved in attempts to stabilise the Irish banking system right from September 2008.

In fact, former Minister for Finance Brian Lenihan phoned Mr Trichet on the night of September 29 to inform of him of how the Irish Government was planning to help the banks here to starting funding themselves again -- by providing a guarantee scheme, with apparently no upfront costs.

Since that date the European and Irish authorities have been locked arm-in-arm in trying to bring the crisis to an end with European involvement coming in many forms.

The ECB has provided liquidity of €117bn according to the last set of figures, while the EU's competition directorate has nodded through a series of capital injections into banks, the most expensive being Anglo Irish. This part of the EU's apparatus also gave its seal of approval to NAMA.

The most crucial of all interventions from Europe is the most secret. Last November when it was reported the Irish authorities were negotiating with the Commission about a rescue package, the EU and ECB are believed to have vetoed far-reaching restructuring of the banks that would have involved some portion of senior bank debt being restructured.

The concern, though again not publicly voiced, was that such restructuring -- across even the smallest institution -- would cause "contagion'' for other European banks trying to raise money from the bond market.

This idea that contagion would erupt across European markets if Ireland acted unilaterally over its own banks has been at the heart of the European response to the Irish banking problem.

But it makes sense to look more closely at precisely what is meant by this concept of contagion. What countries would be impacted by market contagion in an Irish context?

According to data released by the respected international organisation, the Bank of International Settlements (BIS) last year German banks were owed some $138.5bn (e99bn) by Irish banks and the Government, while French banks were owed $43.5bn (e30.8bn).

While these figures can be distorted by lending to IFSC banks, there is little doubt that key German and French banks have (and continue to have) huge exposures to the Irish bank system.

While it may not be the key component of European banking policy in relation to Ireland, the protection of German and French creditors has been one of the key by-products of policy over the last two years.

Equally, one of the reasons a future restructuring (effectively a reduction) in Irish bank or government debt may not be feasible is because the German and French banks simply don't have balance sheets strong enough to withstand the kind of damage. (Complex questions over whether such an event is actually necessary is a debate for another day).

For example this year alone €9.7bn of Irish bank debt comes due. Most of the holders of this debt will be paid in full as most of it is not junior (or subordinated) in nature. Based on the size of the German banking sector much of it will be repaid to that country's lenders, followed by UK and French lenders. Next year another €16.6bn of bonds come due and yet again most of the investors holding these assets will get paid in full, including both their principal and their interest payments (coupons).

Many argue this is as it should be -- the principle of senior debt remaining free from government imposed write-downs is central to the whole funding system for banks worldwide. But equally, what of those who funded dangerously under capitalised and risky banks like Anglo Irish and Irish Nationwide, many of them German and French banks?

The interest rate on Anglo and Irish Nationwide bonds was attractive during the boom, often stretching between 4pc and 4.5pc. Anglo and Irish Nationwide were always seen as "good payers'', as one analyst said yesterday.

The appetite of German banks for Anglo Irish bonds for instance was extremely strong in 2007, just as the crisis was brewing. That year some 37pc of those who took an Anglo bond, maturing in 2012, were German or Austrian. Ironically the entire bond issue was sold into the market by French banking giant BNP Paribas.

But do these investors now deserve to be repaid no matter how much risk they took investing in banks with lopsided balance sheets and what is known as mono-line business models i.e. a heavy reliance on property?

These lenders financed Anglo Irish on a European basis, using the eurozone's advantage of no currency risk. Even the names of how they funded these banks makes this abundantly clear -- they funded them under "European medium term note programme''.

But the crucial question is does Ireland have the capacity to make good on these debts? Many argue not. If you accept that assertion then the Irish banking problem becomes a European banking problem, a French banking problem and a German banking problem.

It is now time for that to be recognised by those arriving in Dublin today.

Irish Independent

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