Firstly, please excuse the op-ed nature of this blog-post.
Recently I have often found myself discussing the unsustainable levels of debt the Irish sovereign is taking on. My main argument centres on debt dynamics - where the interest payments on the debt so outpace the sluggish growth in the economy that the portion of national income that goes on debt servicing increases every year.
Works like this : sovereign debt = 100% of GDP. Interest on debt is 5%. If growth in the economy is less than 5%, then the economy will shrink by the difference. (this is a massive simplification of the process, but will do for this post). If the economy fails to grow by enough to meet interest payments, then the following year the debt will remain the same, but the economy will have shrunk, so then sov debt = 102% of GDP.
If this cycle continues over a number of years, then the debt quickly becomes unsustainable.
Unfortunately, Ireland continues to run budget deficits which will add to the level of the sovereign debt, and also has continuing guarantees over (and ownership of) the Irish banking system.
Very simply, looks like this:
Now, we can take that €149bn + €Xbn bubble and put it in a new chart to see how it is funded:
If we look at these sources, there are obvious problems with some of them as a source for future funding, in the short to medium term. Ireland has not issued any new debt since September, and is unlikely to be able to issue any anytime soon. So we can ignore ‘Bonds’ for a minute, and the only short -term debt that is coming in is increases in Irish consumer post-office savings, which is hardly a reliable source of funding.
The IMF have pledged €22.5bn, of which Ireland has drawn €5.8bn already. The EFSF and the EFSM, along with some non-euro EU states have pledged another €45bn, of which €8.5bn has been drawn down.
The Promissory notes account for €31bn of the debt, and I will come back to these in a minute.
To get a full idea of where Ireland is, we also have to look at the position of the Irish banks, and their access to funding.
First, Irish banks do not have access to the markets. This much is obvious. So they have been relying on the ECB and the Irish Central bank to provide liquidity, and more recently, on the Irish state to provide guarantees for funding provided by those central banks.
Lets chart the two ways Irish banks are using the state to allow them access funds:
For more on FRNs see here, for more on ELA, see here.
Let’s look at the Promissory notes for a minute, because they are of particular interest.
Anglo Irish Bank was fully nationalised in Jan 2009. This is important, as it illustrates the fully enclosed circular nature of this transaction:
The state hasn’t ponied up any cash for the promissory note, it simply wrote it. (A promissory note does exactly what it says in the tin - it is a promise to pay at some point in the future).
Currently the state has promised to pay the promissory notes off over a 10 ten year period, at an assumed average interest rate of 4.7%.
So, the promissory note cost the state nothing, is going to have ‘reasonable’ interest costs for the term, and was readily turned into cash by the Central Bank.
Here is where the Heresy starts..
The Central Bank have already decided that it can accept promissory notes for its own (outside of ECB) monetary operations. The state has decided that it is ok to use an arm of the state (the CB) to create money to bail out another arm of the state (Anglo) via the accountancy trick that is the Promissory note.
So, let’s wrote another note. Only do it properly this time.
First, nationalise the bits of the banking system that are not already nationalised. This will make everything neater. Also, under the Credit Institutions (stabilisation) Act, it will mean that the minister for finance can act without any fear of share-holder action.
The Minister for finance then writes a promissory note for the total of all outstanding debt in issue by the Irish state plus all debt in issue by the Irish banks plus all liquidity provided by the ECB plus a bit to cover for future loses of the Irish banks he owns.
About €250bn should cover it.
The advantage of the government writing the promissory note, is that it gets to set the terms of that note. The interest on the current promissory note is set with reference to the 10 year Irish bond yield. This note could be set with reference to anything, but it would probably be fair to set it at the same level as the EU/IMF bailout. Of course, 5.9% of €250bn is €14.75bn. Paying that will be no improvement of Ireland’s situation, will it?
Well, actually it will, because we will be paying the interest to ourselves. We will either be paying the €14.75bn to a bank that we own, or to a central bank that we own. We pay them €14.75bn, they make profit of €14.75bn and pay that back to their shareholder - the state. The payment is circular, so the interest rate doesn’t matter, we are paying it to ourselves.
Most important is the term (the point in the future where we actually pay this back). Ireland does not need to worry about any debt roll-overs coming in the near future, so make it a 100 yr term. We will ‘promise’ to have this paid back by the 2111. Hopefully, inflation will have taken care of some of the burden by then. With this exceptionally long term ,we are not disadvantaging any of our creditors, because they will have been paid their money up front, via the nationalised banks. The drop on the ‘real’ value of the debt will not matter at all, becasue we owe the money to ourselves.
Interest payments would still be high, but they would (to quote Patrick Honohan) be manageable.
There has been a precedent set by the current cycle of the promissory notes for an operation just like this, and it could be argued that the monetary effect of this operation would be minimal. After all, the entire thing happens with a closed loop. The Irish state would own every side of the transaction, just as it does with the Anglo notes.
There are many arguments against this move - not least being the uproar it would cause among our eurozone ‘partners’, but there also are strong arguments in favour of it, not least being that we cannot pay the liabilities that are coming down the track.
Also, it is hard to get away from the fact that we are already doing this to the tune of €31bn..