The Irish Mess (V)

Back in July, Rebel Economist noted how the Greek bailout actions had compromised the ECB:

The first concession made by the ECB was in the collateral requirements for its lending to eurosystem banks. These were set in terms of agency credit ratings, no doubt to distance the ECB from the task of differentiating between the creditworthiness of eurozone governments, with the inevitable consequence that a credit rating agency decision could render a country’s debt ineligible as ECB collateral at an inconvenient time. In particular, the likelihood that that Greek government debt would be downgraded below the ECB’s normal A- / A3 threshold threatened to restrict the ability of Greek banks to borrow from the ECB and would have removed a key benefit supporting the value of Greek government debt. On March 25th, however, ECB President Trichet said that investment grade (ie down to BBB- / Baa3) debt would be accepted for an indefinite period. And then on May 3rd, with the prospect looming that Greek government debt could even be downgraded to junk status, it was announced that Greek government debt specifically would be accepted regardless of its credit rating.

The most shocking climb-down by the ECB, however, occurred on the night of May 9/10th, when in association with the creation by EU finance ministers of a €750bn emergency funding mechanism available to any eurozone country, which added to a €110bn conditional loan facility for Greece agreed on May 2nd, the ECB announced an outright bond purchase programme. Since the ECB had previously consistently resisted appeals to follow the Federal Reserve, Bank of England and Bank of Japan in buying bonds to enhance monetary policy easing, this change raised questions about both the ECB’s commitment to inflation and its political independence.

…The retreat by the ECB is particularly disappointing because it represents a missed opportunity for Europe to interrupt the sequence of bailouts that have characterised the financial crisis since the demise of Lehman Brothers in September 2008 and to differentiate the euro as a reliably hard currency even in adverse circumstances.

It looks as if that train has well and truly left the station now. In the Irish Times, Morgan Kelly, Professor of Economics at University College Dublin, shows us how far the ECB has advanced down Rebel Economist’s slippery slope.

September marked Ireland’s point of no return in the banking crisis. During that month, €55 billion of bank bonds (held mainly by UK, German, and French banks) matured and were repaid, mostly by borrowing from the European Central Bank.

In other words, the exposures I suggested in my last, based on the 6-month-old numbers published by the BIS in September, are very out of date. Just based on the September action, the French, German and British banks are less firmly on the hook than I thought. If there has been significant ECB intervention in Irish sovereign debt since May, as well, as rumored, then that will again have tended to bail out those banks, and leave the ECB holding the bag. Kelly again:

With the €55 billion repaid, the possibility of resolving the bank crisis by sharing costs with the bondholders is now water under the bridge. Instead of the unpleasant showdown with the European Central Bank that a bank resolution would have entailed, everyone is a winner. Or everyone who matters, at least.

The German and French banks whose solvency is the overriding concern of the ECB get their money back. Senior Irish policymakers get to roll over and have their tummies tickled by their European overlords and be told what good sports they have been. And best of all, apart from some token departures of executives too old and rich to care less, the senior management of the banks that caused this crisis continue to enjoy their richly earned rewards. The only difficulty is that the Government’s open-ended commitment to cover the bank losses far exceeds the fiscal capacity of the Irish State.

Kelly suggests that the bailout interest rate, estimated at around 8%, compared with the 5% currently paid on (underwater) mortgages, or for that matter Kelly’s ’sustainable’ 2%, will simply tank Irish property prices and the wider economy some more, and the eventual result must be mass mortgage defaults. And even without that, he thinks the loan loss estimates of the Irish Government were far too small:

In my article of last May, when I published my optimistic estimate of a €50 billion bailout bill, I posted a spreadsheet on the website, giving my realistic estimates of taxpayer losses. My realistic estimate for Anglo was €34 billion, the same as the Government’s current estimate.

When you apply the same assumptions about lending losses to the other banks, you end up with a likely taxpayer bill of €16 billion for Bank of Ireland (deducting the €3 billion they have since received from investors) and €26 billion for AIB: nearly as bad as Anglo.

Indeed, the true scandal in Irish banking is not what happened at Anglo and Nationwide (which, as specialised development lenders, would have suffered horrific losses even had they not been run by crooks or morons) but the breakdown of governance at AIB that allowed it to pursue the same suicidal path.

Once again we are having to sit through the same dreary and mendacious charade with AIB that we endured with Anglo: “AIB only needs €3.5 billion, sorry we meant to say €6.5 billion, sorry . . .” and so on until it is fully nationalised next year, and the true extent of its folly revealed.

This €70 billion bill for the banks dwarfs the €15 billion in spending cuts now agonised over, and reduces the necessary cuts in Government spending to an exercise in futility. What is the point of rearranging the spending deckchairs, when the iceberg of bank losses is going to sink us anyway?

Please go and read the whole of Kelly’s very crisp and eloquent article. The Irish government has walked its people into a trap: the big Eurobanks and big countries drove the agenda, all along; which shouldn’t be a surprise.

For the European, as opposed to Irish miscalculation, the final word goes to Rebel Economist:

Many commentators claim that the eurozone authorities’ real reason to bail out Greece was that so much Greek debt was held by eurozone banks that even restructuring was likely to impose sufficiently large losses to bankrupt those banks and reduce Europe’s banking capacity enough to cripple its economy. If so, this was an unwise decision. First, bailing out a country means saving all its creditors, making it an inefficient way to protect banks. Second, unless banks are formally bankrupted, it is difficult to make full use of their shareholders’ and junior creditors’ money to absorb losses, making bank failure more costly for the taxpayer. And in Europe especially, bankrupting a bank need not involve disruptive closure and complete liquidation; it is easier to nationalise a failing bank in Europe compared with America where the public are more hostile to state ownership. As it is, the danger is that bank losses on sovereign debt are offloaded to the eurozone states, increasing their indebtedness and intensifying the pressure on the ECB for further accommodation. Ironically, in making concessions to abet the eurozone bailout of Greece to avoid a mythical banking meltdown, the ECB may find that it has opened a Pandora’s Box.

Originally published at naked capitalism and reproduced here with permission.