BY FT ON IRELAND, AGAIN: FT.com / Columnists / Wolfgang Münchau – Ireland’s taxpayers have shouldered too much
No matter how much debt you might have, there always exists a projected income growth rate at which you can pretend to be solvent. The projected rate of growth is the issue on which I differ most with those who claim that Ireland is fundamentally solvent. They are moderately optimistic about future growth whereas I am not.
The Irish government last week recognised the scale of the country’s banking problem, and it deserves credit for that. The decision to recapitalise Anglo Irish Bank, the bank at the heart of Ireland’s property meltdown, will raise the country’s deficit to 32 per cent of gross domestic product this year. I am not worried by that number or by the projection that the debt-to-GDP ratio is headed towards 100 per cent. What I am worried about is the combined effect of bad policies in Ireland and a deteriorating external environment on Ireland’s solvency.
First, Dublin is still not realistic about what constitutes a worst-case scenario. A fall in commercial property prices by 65 per cent with no subsequent increase this decade hardly qualifies. This is merely a description of a medium-sized bubble – not the real-estate madness we have actually witnessed. Should that not be the central scenario?
Second, and most important, the Irish government and several private sector economists are delusional about the effects of a financial crisis on growth. History tells us it takes a long time for economies to revert to normal after a big financial crisis. In the case of Ireland, where the crisis is one of the biggest ever recorded, a real worst-case scenario would include stagnation for up to a decade, mass emigration, further falls in house prices, a significant fall in tax revenues, more austerity in response, and the further banking problems that would result from such a toxic mix. I am not predicting this scenario, but it is at least as plausible as Dublin’s naively optimistic V-shape-recovery assumptions.
Third, the monetary environment is going to be tough. The Irish government currently pays an interest rate on 10-year bonds of well over 6 per cent at a time when goods prices are stagnating and asset prices declining. This implies real long-term interest rates approaching double-digits. A bail-out through the European Financial Stability Facility is not going to help. The EFSF will offer finance when others do not. It will be useful when markets seize up. But rates are hardly going to be more attractive than current market rates.
Short-term finance from the European Central Bank is still cheap, but I expect European short-term rates to go up soon. Last week, overnight eurozone interest rates had already more than doubled to 0.9 per cent. It looks as though the ECB is preparing the ground for a shift in monetary policy, and we should factor this into our calculations. The euro’s exchange rate is an additional source of tightness. After a brief period of weakness earlier this year, the euro is back to a level that I would consider moderately overvalued.
So if you combine all these factors with an observed slowdown in the global economy, it is unreasonable to assume that Ireland will return to normal growth rates once the acute phase of the crisis is over. Even a decade of stagnation is hardly a worst-case scenario.
So what should Ireland do? Recognising the scale of the problem was a good decision. The fundamental problem with the Irish government’s approach was the decision to dump almost the entire adjustment burden on to the taxpayer, rather than to accept or negotiate a partial default.
I am aware that there are legal impediments to the participation of the bondholders in the bank rescue costs. You cannot simply apply a haircut on a bond unless the issuer has formally declared bankruptcy. Dublin is now preparing legislation that would allow it to apply a haircut to the subordinate debt. First, coming two years after the beginning of the crisis, this is absurdly late. More importantly, it is just peanut-sized symbolism, especially as no haircut will be applied to holders of senior debt. My concern is that Dublin is overburdening the taxpayer, and might worsen the downward spiral.
This is not just an Irish problem. European governments everywhere are scared of touching bondholders. I had been wondering about this default-phobia for some time. The most plausible explanation I have heard is based on an asymmetry of risk. Haircuts are a legal minefield, and politicians find it more expedient to dump the problem on the taxpayer than to risk a hugely damaging defeat in court. Some politicians are inclined to always agree with the last person they have spoken to, and the power of the banking lobby is clearly a factor. For a risk-averse politician, dumping the cost on the taxpayer is easy. For the economy it is a nightmare. It is also politically dangerous in the long run, as the distributional unfairness will favour extremist political parties.
The European political establishment recoils so much at the idea of default, it is willing to accept extreme hardship. Just look at Latvia. But Latvian brutalism is not going to be realistic for Ireland. Brian Lenihan, the Irish finance minister, might wish to ponder whether his monumentally unfair taxpayer bail-out is what will ultimately “bring down Ireland”.
BY REUTERS on AIB and its down grade TODAY: S&P cuts AIB; downgrades Irish banks’ sub debt | Reuters
DUBLIN, Oct 8 (Reuters) – Standard & Poor’s (S&P) cut Allied Irish Banks’ (AIB) (ALBK.I) credit rating to BBB+, three notches above junk, on Friday and warned it could be lowered again as Ireland’s once largest bank relies on the state to survive.
S&P also cut its ratings on all Irish bank lower Tier 2 subordinated debt to junk due to a higher risk of default after the government said it would renegotiate subordinated debt in nationalised lender Anglo Irish Bank [ANGIB.UL] and building society Irish Nationwide [IRNBS.UL] to help cover their losses.
S&P said Dublin’s decision to force losses onto subordinated bondholders in Anglo Irish and Nationwide meant that Allied Irish Banks, Bank of Ireland (BKIR.I) and Irish Life & Permanent (IPM.I) all now face a risk that their lower Tier 2 debt will be restructured.
“This indicates to us that there has been a structural shift in Ireland in the position of lower Tier 2 debt relative to senior issues,” the agency said in a statement.
Ireland’s government is making subordinated bondholders in Anglo Irish and Irish Nationwide pay part of a bill that could top 50 billion euros ($69.48 billion) to clean up years of reckless lending by its banks.
The financial regulator Matthew Elderfield stoked concern about the country’s attitude to senior debt on Wednesday when he said the government could seek a voluntary renegotiation of senior bond debt owed by Anglo Irish and Irish Nationwide. [ID:nLDE695108]
To reassure investors, the country’s debt management agency issued a statement on Thursday saying the government did not plan on reneging on agreements with holders of senior debt issued by any of its banks.
The National Treasury Management Agency also said that any reorganisation of riskier subordinated debt would only apply to institutions which are not listed on a recognised stock exchange, in 100 percent state control, and could not survive in the absence of total state support.
But there are concerns that, in particular, if Allied Irish Banks’ financial situation worsened the government would make subordinated bondholders share some of the losses.
Reflecting these concerns, rival rating agency Fitch downgraded AIB’s lower Tier 2 subordinated debt to sub-investment grade last week. [ID:nLDE69027W]
Ireland’s government will take a majority stake in AIB, possibly as much as 90 percent, to help it plug a 10.4 billion euro capital hole.
S&P cut AIB’s rating to BBB+ from A- and put its outlook on negative due to its likely continued reliance on government and ECB support, uncertainty over its disposal plans, and risks to a recovery in the bank’s earnings.
S&P downgraded AIB’s lower Tier 2 debt rating to BB, junk status, from BBB+.
Bank of Ireland’s lower Tier 2 was cut to BB+ and Irish Life & Permanent’s to BB. (Reporting by Carmel Crimmins; Editing by Sharon Lindores) ($1=.7196 Euro)