Sunday 15 September 2019

Take it or leave it, but this was the only deal on the table

The bailout could have been fairer, but the task now is to make the best out of a bad situation, writes Colm McCarthy

The financial terms of the bailout deal finalised last weekend with the IMF and the European institutions make no significant concessions to Ireland, but unilateral rejection is not a realistic option.

None of the cost of the enormous bank losses will be borne by the providers of the bailout funds and it was never likely that they would be. But the terms also constrain the Government's ability to impose more than a small portion of those losses on bank bondholders. The rate of interest on the overall facility is not generous either. The deal however had to be accepted and the task for this Government and the next is to make the best of a poor situation. Those on the political left, who have been ranting on about rejecting the deal, know perfectly well that this cannot be done, and are throwing sand in the eyes of the electorate.

This was always going to be a 'take it or leave it' offer. The Government had been out of the bond market since October, the state-guaranteed banks could not fund themselves in the markets either and were clearly in the early stages of a bank run. The Government's cash reserve would have been exhausted quickly, possibly in days, had it been deployed to replace funds lost in a run. External funds had to be sought but also had to be accepted. The alternative was the immediate closure of the banking system and those who pretend otherwise either don't understand, don't want to, or don't care.

The analogy of a poker game has been invoked, with the Irish negotiators having held, according to economist Antoin Murphy, no more than a pair of twos. In reality they held no cards at all, and could not bluff either. An Irish rejection would have created unwelcome but manageable problems for the eurozone banking system but would have brought immediate financial meltdown in Ireland. The inevitability of the latter is the reason why the bailout providers were in Ireland in the first place.

It is never credible to threaten suicide and criticisms of the Irish negotiators based on some notion that they possessed a viable threat of rejection are wide of the mark. The deal actually offered could have been more accommodating however, and the interest rate demanded is close to the rates which induced the Government to withdraw from the bond market in the first instance.

Unless the economy recovers quickly, debt service burdens could eat up tax revenues to the point where re-entry to the bond market on reasonable terms will be difficult, so the deal does not contain a clear and visible exit strategy from reliance on official external financial support.

A clear and visible exit strategy is always desirable in any financial re-structuring, and has not been forthcoming on this occasion.

The source of the difficulty is the bank losses, without which the Irish public finance crisis would have been manageable within the budgetary correction parameters already outlined by the Government, reflected in resolute budgetary actions since July 2008 and accepted by both Fine Gael and Labour.

These bank losses have turned out to be very substantial relative to the fiscal capacity of the state. In the nature of things they cannot be estimated with certainty until the loan recovery possibilities are clear, and we have not reached that position yet. At this stage it appears that the gross total lost in loans that will not be repaid will be about 50 per cent of GDP and could be higher. Not all of this will be paid for by the Irish taxpayers though. This is how it works.

First in line for bank loan losses are the shareholders in the various banks. In the case of the banks slated to disappear, Anglo and Irish Nationwide, the shareholders have been entirely wiped out. The foreign-owned banks such as Ulster, ACC, National Irish and Bank of Scotland (Ireland) have been made whole by their foreign shareholders. In the Irish-owned banks which survive, Bank of Ireland, AIB, Irish Permanent and EBS, there is little shareholder value left. In total, shareholders have absorbed about half of the total amount lost. (One prominent media guru announced a couple of weeks ago that the source of the crisis was that banks had been run only in the interests of shareholders -- if only!)

Next in line are junior and senior bondholders in the banks. To date, some losses have been imposed on bondholders through buybacks at a discount, and a further exercise along these lines, at a discount of 80 per cent, is under way for remaining junior bondholders in Anglo. It is clear that the Government wishes to explore the possibility of inflicting losses on junior bondholders in Bank of Ireland and AIB as part of the final re-structuring of these banks, whose survival is understandably seen as essential to ensure a functioning national banking system.

But senior bondholders have been spared and this has rightly been controversial. The taxpayer has in effect been recruited as a guarantor of senior bondholders since the decisions taken at the end of September 2008. Throughout the European banking system there has been a pronounced reluctance to inflict losses on bank bondholders, particularly senior bondholders, and it is clear that an Irish solo run on this issue is not now a practical option. Whether it was an option back in 2008 is an issue for historians rather than for economic policymakers.

So the large debts run up through the accumulated budget deficits of the last few years, plus the deficits planned in future, will be expanded by the taxpayers' share of the bank losses. This is frustrating and resented, but in round figures, the national debt, when it eventually stabilises, will consist of accumulated borrowings in the main, with about a quarter due to the bank losses.

Unless there is a Europe-wide decision to impose losses on senior bank bondholders it is difficult at this stage to see how the burden on the Irish taxpayer can be mitigated. But the eurozone crisis has still to be decisively addressed and a resolution which includes burden-sharing by senior bank bondholders is not impossible. Unfortunately the burden-sharing initiative apparently favoured by German Chancellor Angela Merkel does not explicitly address this issue. The Irish and European crises have their origins more in excessive borrowing in bond markets by banks rather than by governments, and a solution confined to future sovereign debt providers is not attractive for Ireland.

I spoke at a function in Dublin during the week where the master of ceremonies enjoined subsequent speakers to look forward, to discuss solutions rather than the allocation of blame. This sounds reasonable but is not enough. While there is no shortage of people who want to focus entirely on the blame game and to substitute anger for policy, it seems to me that the real challenge is to construct a coherent policy response while simultaneously ensuring that lessons are learnt, and this requires that blame be allocated.

The years from 2000 to 2008 constitute a prima facie case that the experiment with self-government has come off the rails. Accountability without consequences is a feature of the Irish way of doing things, particularly in the sheltered sectors of the economy.

To confine attention to the banking sector alone, it would appear that total loan losses will reach at least one-half of an entire year's output. Yet not one of the banks has offered a comprehensive narrative on how this happened, relying instead on the Government to conduct an inquiry. How many loan officers have been fired? At least in politics, there is continuing accountability to the Dail and the media, and ultimately to the electorate who can arrange for consequences. The response to the disaster by the Irish banks has helped me to understand how it happened.

Sunday Independent

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