Ireland’s misery continues,what sort of bail out is this?

After waiting for what had felt like an interminable period we finally got some more meat on the bones of the proposed European Union/International Monetary Fund/European Central Bank bail out for Ireland. There was obviously pressure to get a deal agreed before markets opened in Asia for the start of the week. However this leaves me with two main thoughts. Firstly the deal has the feel of something of a patchwork quilt and this is not impressive considering that Ireland’s problems have been known for a while, why was a plan not ready? Secondly the panic over timing has very little to do with Ireland. As she had funding into the middle of next year  and could if necessary in extremis have drawn on her National Reserve Pension Fund (NPRF) to extend this period of not having to borrow, I am left with the conclusion that the timetable was forced by fear of contagion. This fear of contagion covers the Iberian peninsula for now with both Portugal and Spain at risk. To my mind the construction of this deal is almost as much a deal to try to save them as it is for Ireland.

The Statement from the Irish Government

The State’s contribution to the €85 billion facility will be €17½ billion, which will come from the National Pension Reserve Fund (NPRF) and other domestic cash resources. This means that the extent of the external assistance will be reduced to €67½ billion.  

The facility will include up to €35 billion to support the banking system; €10 billion for the immediate recapitalisation and the remaining €25 billion will be provided on a contingency basis. Up to €50 billion to cover the financing of the State. The funds in the facility will be drawn down as necessary, although the amount will depend on the capital requirements of the financial system and NTMA bond issuances during the programme period.

The purpose of the external financial support is to return our economy to sustainable growth and to ensure that we have a properly functioning healthy banking system.

The external support will be broken down as follows: €22½ billion from the European Financial Stability Mechanism (EFSM); €22½ billion from the International Monetary Fund (IMF); and €22½ billion from the European Financial Stability Fund (EFSF) and bilateral loans. The bilateral loans will be subject to the same conditionality as provided by the programme.

Fiscal Policy and Structural Reform

The Ecofin has acknowledged the EU Commission’s analysis that a further year may be required to achieve the 3% deficit target……The Council has today extended the time frame by 1 year to 2015. 

If drawn down in total today, the combined annual average interest rate would be of the order of 5.8% per annum. The rate will vary according to the timing of the drawdown and market conditions.

The Programme endorses the Irish Government’s budgetary adjustment Plan of €15 billion over the next four years, and the commitment for a substantial €6 billion frontloading of this plan in 2011. The details of the Programme closely reflects the key objectives set out in the National Recovery Plan published last week. The adjustment will be made up of €10 billion in expenditure savings and €5 billion in taxes.

As part of the Programme, Ireland will discontinue its financial assistance to the Loan Facility to Greece. This commitment would have amounted to approximately €1 billion up to the period to mid-2013.

Main Comment

The agreement starts with something which is really quite extraordinary and that is the claim that it is an “€85 billion facility” and the implication that Ireland will be receiving funds of this amount. Er no, as she is taking some 17.5 billion Euro’s from a combination of her National Pension Reserve Fund and her cash reserve. Accordingly the actual size of the bail out loans is 67.5 billion Euros rather than the 85 billion claimed.

Number Crunching: the interest-rate is not as implied and maybe much higher

There is an interesting claim about the interest rate too as it says that it would be 5.8% if all the funds were drawn down today. So let us do some number crunching.

85 billion Euros at 5.8% would cost Ireland some 4.9 billion Euros per year.

The 22.5 billion from the IMF can be borrowed for 3 years at 3.12% so this costs 0.7 billion Euros per year.

The 17.5 billion from the NPRF/cash reserve you could argue costs nothing but let us use 4.5% as an estimate of what it cost so 0.79 billion Euros per year.

So the remaining funds from the bilateral loans/EFSM/EFSF cost 4. 9 billion less 1.49 billion or 3.41 billion Euros per year. As they are 45 billion in total then the interest rate on them is approximately 7.5%. This is not what it has been badged at.

Here is the relevant section from the IMF website.

At the current SDR interest rate, the average lending interest rate at the peak level of access under the arrangement (2,320 percent of quota) would be 3.12 percent during the first three years, and just under 4 percent after three years.

Further Comments

1. If there was any real doubt that this is a bail out of Ireland’s banking system rather than her economy then the fact that ten billion Euros will go into her banking system immediately settles the matter.

2. Of the 35 billion Euros for the banks some 12.5 billion Euros is to come from the NPRF. The NPRF has a value of around 24.5 billion Euros but it has already invested around 7 billion Euros in Irish bank preference shares. So if the funds are drawn down it will only be left with 5 billion Euros. As it was only a few days ago it was supposed to be getting the ability to buy Irish government bonds then this is a very substantial U-turn! If any potential Irish pensioners are reading this you have my sympathies as by the time this is over there may not be much left of your fund. After all if you put this another way it is hard to avoid the view that money is being transferred from (future) pensioners to bankers….

3. Senior bondholders in Irish banks have been left unaffected which returns me to point 1 again.

4. Irish banks are being told by the European Central Bank that they will have to wean themselves off of the extraordinary amount of liquidity it has been supplying them. This has totalled some 130 billion Euros recently which is equivalent approximately to Ireland’s Gross National Product. The logical consequence of this is that interest rates in Ireland for mortgages and deposits are likely to rise in order to attract replacement funds.

5. The Irish banks will be forced to raise their core capital ratio to 12% which is the reason for the ten billion Euro capital injection,although rather curiously the Central Bank of Ireland estimates the cost at 8 billion Euros.

Conclusion

When I have considered what might help Ireland in her hour of need I was thinking of a bail out larger than this and at a lower interest rate. As I thought the bailout strategy had weaknesses already then it appears that this one now has very little chance of success. It may buy some time. Of course the bailout strategy has never appeared to include any form of debt restructuring and this looks ever more vital in any return to solvency for Ireland.

As to the Euro zone well it is weaker too. As time goes by more and more minds will start to wonder why in a bail out of a small country like Ireland funds needed to be deployed both from Irish domestic resources and from countries outside the Euro zone such as the UK,Denmark and Sweden.There are two possible reasons for this the first is that even the Euro zone has little faith in the shock and awe bail out mechanisms it has previously boasted about. The other is that it is keeping as much powder dry as it can for possible bail outs on the Iberian peninsula and beyond.

The sums here are simply not enough. Should Ireland’s property market continue to weaken then her banks will be hit by losses in this area too. So the danger is that she will need another one. However the foreign loans of 67.5 billion Euros represent some 15,000 Euros per head as it is. When we hit 2013 with a national debt to GDP ratio of  118% or a national debt to GNP ratio of 145% the numbers increasingly make Ireland look insolvent and a restructuring to be a vital component of any true rescue plan as this just “kicks the can down the road”.

The Irish may also be wondering why after contributing around 20% of their own bailout they have ending up paying an average interest rate more than 0.5% higher than the one applied to Greece.

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15 thoughts on “Ireland’s misery continues,what sort of bail out is this?

  1. Hello,

    Greek media sources mention that during the discussion regarding Ireland’s scheme, it was agreed that the repayment time of Greece’s loan should be on par with the Irish equivalent, i.e. 7+ years and up to 11.

    The exact details are not out yet, however it appears that the troika officials want the same plan to apply (broadly) to all affected countries.

    And yes, tapping on their sovereign pension fund does suck for Ireland…meh.

    Cheers,

    Ioannis

    • Hi Ioannis
      I understand that they have raised the interest rate on Greece’s borrowings too. This leaves me with the thought is there any part of the original deal which still stands?

      Also I felt Greece was in effect insolvent at the old lower interest rate so to raise it is a little bizarre. Although I guess it does improve other countried fiscal deficit slightly…

      • This makes sense for the Germans because of the 1) constitutional court and 2) the ‘moral hazard’ issue. I think the second is more central in their thinking. They want to basically punish the country so that 1) they are more careful in the future and do things like the Germans and 2) deter other countries to follow the bad examples and give strong incentive for fiscal discipline to other countries. The logic of making an example of bad behaviour with punitive measures for all to see reminds me so much of past German behaviour; however, I think they are pretty ineffective because the predictable failure of the countries in question because of the punitive interest rates and conditions will create such an outcry that will hardly be a deterent for the bad behaviour. All the indications are that when inevitably Greeks fail to go back to the markets and their debt has gone up and not down, Germany will blame the past Greek behaviour. They got what they deserved, they broke the rules. Of course the simple villager who will pay the price had no idea of the rules and who broke them… the inncoent will pay the price once again.

  2. I am struggling with the logic of them ‘keeping their powder dry’ for the subsequent bail-out of Portugal and/or Spain.

    Surely the absolutely basic requirement for this bail-out is that it works to calm the markets. If it achieves that then the risk of an attack on Portugal and spain recedes. If it doesn’t, then contagion is inevitable.

    If the idea is that this is a lost cause, and therefore we may as well hold a bit back to get ready for the next battle – then why do it at all? Surely, if they can’t save Ireland then there’s no chance of saving ayone else afterwards.

  3. I agree, Shaun, with your main sentiment – this is a pan-european bank bail-out. It was never likely that the Irish sovereign eligible liabilities guarantees given to senior debt holders would be abandoned – the litigation and contagion would have been enormous. If, as you say, the interest rate is punitive the Irish will take things to the limit to avoid full loan draw-down which could have counter-productive effects.

    What’s more important to my view is that Mr Osborne and his Ecofin colleagues are getting dangerously close to a pan-european sovereign underwriting of banks and systemically large institutuions. Its of little comfort to hear that after 2013 bond holders will share the pain for new loans. Next year and the year after will be crucial years for refinancing banks’ wholesale funding. Like it or not, Ecofin have just put themselves in to a de facto central bank role. The ECB must be delighted !

  4. I am sure you are right the timing is to protect Portugal and Spain. However, you had been asking for Europe to beat the markets rather than react to them.

    Also no one here has mentioned Andrew Sentance’s article “why Britain needs higher interest rates”. I know nowadays it is de rigueur that members of MPC speak of their decisions but this is very explicit I did not think it was allowed.

    Also I can not find how does the Governor get his role? I believe Gordon Brown gave the role to King. In which case it is a pseudo democratic decision like choosing our house of Lords. If the government has put him into this position can they not remove him: nothing personal to King per se but if a political party doesn’t obey its mandate then they tend to get voted out-Libdems be warned.

    • Hi Fletch
      I agree that I wanted the Euro zone to be definite and decisive but the truth is that they have not been. There is a real danger that the funds deployed here are insufficient and the interest rate could be too high.I did my calculations to illustrate the problem… It is easy to quote an ok average rate when you have components which are considerably lower. And also is 5.8% as an interest rate for Ireland ok? I am not so sure that it will leave her solvent in the longer-term.

      So an opportunity missed (again), perhaps in the spirit of Salomon Kalou’s miss yesterday! The market moves today pile on more pressure…

  5. Is this the ‘Credit Anstalt’ moment? I cannot help but think that we have spent three years chucking money down the drain on an insvolvent abnking system. If they had been allowed to go bust earlier this money could have been deployed far more productively. As it is we have effectively nothing to show except bigger sovereign deficits.

    Anyway any takers on Spain being balied out by Xmas?

  6. If I was an Irishman, I’d down a couple pints of stout and join the protesters. Draining the national pension fund, raising income taxes on all, slashing 24,000 jobs, slashing services to the people.. all to be followed by a deflationary depression ? No wonder Sinn Fein won the election in Donegal last week. Brian Cowen will take his place alongside Herbert Hoover in history’s outhouse.

  7. What is the long-term plan here, I wonder every day…
    The rescue plans do not make sense even if it is a bank bail-out, the countries will become bankrupt sooner or later and ECB will get all the bad debt. Of course it postpones the problem for later and I wonder if later the decision will be common fiscal policy one way or the other (probably by the back door). The envisaged (but not decided yet) loan prolongation for Greece and statements that new loans are possible from IMF provided that structural reforms get implemented plus the scrutiny of budgets from EU that will be established from now on signals a new era for all countries. I see benefits (e.g. great opportunity and probably ample time for Greece to reform in many ways) and dangers (is it possible to become competitive under Euro)…

  8. If bank bonuses in UK are allegedly £7 billion why not the banks pay this directly to the Irish to help their less fortunate partners!!

  9. I can’t make up my mind if the politians are stupid, arrogant or calculating.

    However if I was a bond fund manager I’d not be touching Irish, Portugese, Spanish or Italian debt with a barge poll. I’d be seeking to manage my exposure (hold until redemption/sell it to the ECB) and I’d not be taking anymore on.

    Assuming those making the decisions have arrived at this (and probably more far reaching conclusions). Spain is going to face punative interest rates and will fail. Who knows the fallout from when that happens. I expect the same fate to befall Italy.

    Hence :-

    Are they stupid? Don’t see this coming?
    Are they arrogant? Believe they can control events?
    Are they calculating? Economic meltdown to wrest polital automony from these countries (who it could certainly be argued can’t run themselves properly), moving it to brussels, when the German, French, Dutch and Belgiums can do it, frankly it has appeal!

    Take your pick.

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