By Karl Whelan

The announcement that Ireland is accessing an EU-IMF “rescue plan” is a damning indictment of the government’s banking policies of recent years. In the space of just over two years, the government has shifted from claims that the banks were fully solvent and that the state guarantee was the world’s cheapest banking bailout to Brian Lenihan’s frank admission that the banks were too big a problem for the country to solve on its own.

We have also gone from a position where, only a few weeks ago, it was widely believed that the state had enough money to fund itself through until next summer to an agreement to use funds from the EU and IMF to fund the state over the next three years. How exactly this swift change of position came about has not been well explained to the Irish public.

The trigger mechanism for the bailout talks appears to have worked as follows. Because the original Irish liability guarantee ran out at the end of September, the Irish banks had a large amount of bond funding that matured in September as well as many corporate deposits with terms set to run up to the end of the guarantee. The banks failed to obtain new bond market funding and turned to borrowing from the ECB, and in some cases where banks had run out of eligible collateral for ECB loans, to the Irish Central Bank for emergency liquidity loans underwritten by the Irish state.

It appears that during November, the ECB decided that its exposure to the Irish banks had grown to an unsustainable level (€90 billion to the domestic banking group and about €30 billion in emergency liquidity assistance from the Irish Central Bank). At this point, the ECB directed the government to access a bailout in order to fix the Irish banks once and for all. With the banking system so reliant on ECB support, the government seem to have had little choice but to comply. And with the ECB still providing large amounts of liquidity to the banks, there has been a reluctance from the government to publicly complain about the ECB’s role in pushing Ireland towards seeking external assistance.

So, have we been rescued by this plan? There are plenty of reasons to believe that we have not.

On the banking side, the details of the plan released at the time of writing include a long list of vague statements about restructuring and deleveraging. However, despite the promise of an introduction of a special legislative regime to deal with distressed banks, there is little sign that there will be burden-sharing with senior bond holders of even grossly insolvent banks such as Anglo or Irish Nationwide.

The Taoiseach has said that this was a decision of the European arm of the rescue team but I have not seen anything legally binding in the agreement requiring the Irish government to continue bailing out bondholders at insolvent banks. Getting subordinated bondholders to accept their part in the losses is also being complicated by the apparent plan to first put in large amounts of state money in the form of equity to take losses ahead of bondholders.

If we are not going to get any sharing of losses with bank bondholders, then we should at least hope that the main Irish banks will be re-organised and sold to well-funded outsiders as quickly as possible.

This would most likely require our government to provide insurance on their loan books so that unforeseen losses still end up costing the Irish taxpayer, with funding provided by the EU and the IMF. But at least the economy would then be better served by having banks that make lending decisions on the basis of the commercial merits of borrowers, rather than restricting credit to raise capital ratios in the hope of avoiding nationalisation, as we have seen over the past two years. Of course, in light of the misguided and poorly-executed nature of the banking policies that we have seen thus far, hoping for a rapid and efficient solution of this sort may be wishful thinking.

What about fiscal policy? Here, we have even less reason to feel rescued. The average interest rate of 5.8% offered by our external rescuers is about the same as seen in the bond market in September and, at that time, there were serious concerns about the sustainability of borrowing at such an interest rate. That the rate is lower than what would be on offer now from the bond market is cold comfort.

The structure of the adjustment is also somewhat harsher than is necessary. I had argued in recent months for a sharply front-loaded adjustment to get the deficit below ten percent in a bid to restore access to the sovereign bond market. With this target now beyond us, there was a strong case for a smoother adjustment that would have been less disruptive to growth in 2011.

Finally, where do we stand in relation to the sustainability of our debt burden? Ireland seems likely to have a debt-GDP ratio of over 110% in 2014. By that time, Europe may have agreed on how to implement sovereign default procedures for Eurozone countries with Greece as the likely first test case. It is easy to imagine a scenario in which sovereign debt markets still refuse to lend to Ireland even if it has succeeded in reducing its deficit. The high yield on our sovereign bonds trading in the secondary markets suggests that eventual default is viewed as likely by those with money to invest.

We may have been rescued from the wolves. However, it is open for debate whether our rescuers are planning to feed us to the lions.

Dude, where’s my prefunding?

Posted on by admin

Anyone that has kept an eye on Irish Politics over the past few months will be very familiar with the phrase “Ireland is pre funded into the second half of next year.”

So, being a nosey sort, I went looking for it.

The first port of call was the National Treasury Management Agency (NTMA) website

They list the total outstanding national debt at €88.5bn. This, of course, is the Net national debt, ie it is total borrowings less any cash reserves.

To get the total amount of borrowings, we have to go to ‘Instruments comprising the national debt’ page

click to enlarge

Note that the figures on this page have not been updated since the end of September.

So good, so far. There is the number on the page. But, where is the money?

I briefly had nightmares about the NPRF keeping the money on deposit with commercial banks, but a quick email to their (surprisingly helpful) press people sorted that out.

The NPRF keep their pre-funding on deposit at the Central Bank.

And here it is, plain as day in the financial statement of the central bank:

click to enlarge

Ok, maybe ‘plain as day’ might have been a little untrue. But it is there under ‘Liabilities to other euro area residents in euro’.

So, that’s good news isn’t it?

Well, maybe.

Not be one to miss an opportunity to kick a hornet’s nest, I wondered what happens the financial statement of the Irish central bank as the government draws down the money they have on deposit on the central bank.

After all the financial statement does balance, so surely a reduction in liabilities would lead to a reduction in assets.

There is an entry on the other side of financial statement called ‘Securities of other euro area residents in euro’. These seem to be a bit of an odd fish, described in the central bank annual report as

“‘Other securities’, which includes
marketable and non-marketable securities that are not related to the monetary policy operations of the Eurosystem.”

So I figured I could graph these against the government deposits and see if they match up:

Basically, they did, but they don’t anymore. Also there doesn’t seem to be anything else on Assets side to meet the drawdown of €24bn (ish). – there is an entry called ‘other assets’ but they are not really worth anything at all, I wrote about them previously here

So, confused by all this, I sent a little note off to the Central Bank asking them how they deal with draw downs on the government account. I eventually received this (very opaque) reply/slapdown:

Further to the text below any reduction in Government deposits at the Central Bank of Ireland would not give rise to a need to sell Financial Assets.

Your analysis is not accurate as Government deposits are a so-called autonomous factor on a Central Bank’s balance sheet and movements thereon affect monetary policy assets NOT financial/investment assets. Any change on this liability item will have a liquidity impact in the euro area money market and lead to a correspondent change in the amount of money lent in Eurosystem credit operations.

For instance, in the event of a fall in the amount of government deposits with the Bank, the Bank’s liability to the government will fall while the contra entry depends on what the government does with this money. There are two scenarios:

1. The government places the funds with an Irish bank and liability item Government Deposits decreases on the CBI balance sheet. Assuming the Irish bank retains this additional liquidity, its need to refinance through the Eurosystem via the CBI falls and this leads to a corresponding fall on the asset side of CBI’s balance sheet.

2. The government places the funds with a German bank and liability item Government Deposits decreases on the CBI balance sheet. As this payment is made to a German bank, the CBI’s TARGET liability item under ‘other liabilities’ increases by a corresponding amount while the asset side of the CBI’s balance sheet remains unchanged. Assuming the German bank retains this additional liquidity then it has a reduced need to take recourse to Eurosystem lending via the German central bank.

At first reading that all seems very sensible.

But, there is a huge assumption in 1. above. The government only draws down money to commercial banks for current spending. The assumption seems to be that the cheques the government write end up back in the same banks they are drawn against – ie zero leakage closed economy model.

2. above talks of a Target Liability in ‘other liabilities’ on the financial statement. (Now I have to call BS on this one. How can a liability be a target? How can that be accounted for? I searched the balance sheet and there is no entry in the ‘other liabilities’ column called ‘target’ presumably because a target can only be accounted for as zero.) Thanks to Eoin below for pointing out that TARGET is not a target, rather it is this. So, note to self, don’t take anything a Central Bank says at face value :) For more info on the how the ECB deal with entries like this in finacial statements, the ECB have helpfully sent me this note explaining the situation. Note also that the central bank are assuming again that the German bank retains the money.

The bank does not show what happens if the government draw down money to pay a non euro area bill (for example a UK holder of Treasury bills).

All of this has left me very confused.

So, when I heard that as part of the EU/IMF programme Ireland would be coming up with €17.5bn from the National Pensions Reserve Fund and the NTMA, I decided to do some maths again.

I’m working off the September figures above which show a cash balance of €24.5bn at the end of September.

The remaining outstanding repayments then for 2010 totaled €5.883bn

That leaves €18.667bn.

In early 2011 the rest of the outstanding treasury bills fall due. I cannot find the maturities of the commercial paper programme, but will update these numbers if I do. In the meantime I will have to be a little arbitrary.

Total short term debt due in 2011 is €6.386bn. Seeing as this was short term debt (ie maturity under one year) and that amount was outstanding in September it is safe to assume that the majority of that will fall due in the first half of 2011. The treasury bill programme is finished in April, for example.

That leaves us with a running total of €12.276bn.

Now we have to take away the €5bn for the bailout and we are down to €7.276bn.

Still not looking to bad?

Between September and end November, the government actually ran a surplus of €26m so we can add that back on and we get €7.302bn.

But, every year December is the biggest month for government spending. Last year the deficit in December alone was €2.6bn. Assuming a repeat performance, we are left with €4.7bn

Because the tax system in Ireland means much of the tax is collected in November, the first half of the year tends to be fairly barren.

To end June last year, the deficit was €8.887bn. That deficit will have to be cut in half if Ireland really is funded to the second half of the year..

So, is Ireland funded to the middle of next year? It is now, if the IMF/EU package is voted through the Dáil next Wednesday.

The bigger question is, could the Central bank have afforded to give us the money?

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