Strategy for default on bank debts to prevent economic masochism

patslatt

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The government's guarantee of all bank debt was motivated by the fear that if Anglo Irish bank failed,as happens in banking crises the failure would bring down the entire banking system like a house of cards when one card is removed. Banking systems are vulnerable to cascading losses on interlocking loans to each other. In Ireland,banks were partners in huge syndicated loans to bubble property developments. If development financed by Anglo were deprived of funds,that would have resulted in firesale liquidations of property,undermining the collateral value of property for loans throughout the banking system which would have wiped out bank capital reserves and bankrupted the system. Unfortunately for Irish taxpayers,the bank debt guarantee and NAMA merely delayed the threat of bank system failure and the property crash instead of resolving it.

There is a plausible rumour that the European Central Bank influenced the government's decision to give the guarantee. Did it want to prevent at all costs the failure of any significant European bank, promising the government that if it cooperated in preventing the failure of Irish banks,the ECB would supply enough liquidity to keep them operating? The fact that the ECB has supplied €180 billion to Irish banks gives some credibility to the rumour.

So should the government have refused to guarantee the bank bondholder debt? The banks would have collapsed without the guarantee,forcing the government into temporary nationalisation of most of them to preserve their utility function as financial intermediaries. There are good precedents for this in President Roosvelt's shutdown of weak banks after his election in the Great Depression and in Sweden's successful nationalisation of banks in the early 1990s. Temporary disruption of banking services could have caused a recession as credit dried up completely and runs on banks occured in corporate deposits. That may have been a worthwhile price to pay for avoiding the crushing sovereign debt burden resulting from the bondholder debt guarantee.

Following a government reorganisation of nationalised banks,Irish bank bondholders could have been given control of the banks to satisfy their claims on the dubious assets. With the removal of the burden of bondholder debts through conversion to equity,the banks probably would have some positive net worth left over after depositors' claims but if they didn't,the government could have supplied some equity capital by participating in public offerings of shares.Presumably,the equity capital supplied would be a fraction of the debt guarantee burden. There would be no need for NAMA as the banks would do the loan workouts themselves.

What to do now? For the next year or so,Ireland is politically committed to the austerity programme needed to pay off bank bondholders and raise new capital to replace the ECB supplied capital to the banks. Should the world economy continue growing and the Irish economy grow at about 2% despite more budget tax frenzies,the government should stay with austerity.

But if austerity prevents the economy from growing in the next two years,we can't be debt masochists and should look for a negotiated sovereign debt default. We could legitimately claim that we had tried our best to pay our debts. The ECB which holds Irish government bonds as collateral for its loans to Irish banks would lose heavily and suffer a loss of reputation with the Germans. I suppose we could point out that in a fiscally united federal EU state,the losses would be monetised and the bailouts much bigger.
 
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paulp

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We'll be grand, Portugal, Spain and Italy are on our heals.
They'll need hundreds of billions - which will only be met by printing money which defacto writes down some of the debt
 

patslatt

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We'll be grand, Portugal, Spain and Italy are on our heals.
They'll need hundreds of billions - which will only be met by printing money which defacto writes down some of the debt
But the ECB is supposed to have the DNA of the German Central Bank which is paranoid about inflation.
 

TODevastated

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But the ECB is supposed to have the DNA of the German Central Bank which is paranoid about inflation.
after the Weimar Republic and its results would you blame them?

in any event why cant each country, especially this dump, have a prudent government which ensures that the criteria laid down by Maastricht is met year on year rather than the auction politics we have to put up with at each election?
 

nuj

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The government's guarantee of all bank debt was motivated by the fear that if Anglo Irish bank failed,as happens in banking crises the failure would bring down the entire banking system like a house of cards when one card is removed.....

There is a plausible rumour that the European Central Bank influenced the government's decision to give the guarantee. Did it want to prevent at all costs the failure of any significant European bank, promising the government that if it cooperated in preventing the failure of Irish banks,the ECB would supply enough liquidity to keep them operating? The fact that the ECB has supplied €180 billion to Irish banks gives some credibility to the rumour.
The guarantee was not motivated by any knowledge of how bad Anglo and INBS were. It was a stroke, pure and simple. A "cost-free" gun-jumping exercise, that alienated Ireland within Europe by forcing the hands of all other EU governments to go the same route, or risk Irish banks sucking money out of them.

Go back and check the cheesy triumphalism with which the announcement was made, and with which it was greeted. Those who came up with it, at political and advisory levels, all thought they were great chaps. And then remember all the "Anglo is a going concern" guff we had to listen to as events unfolded.

The sudden emergence, over the last couple of months, of the line that "The ECB made us do it" is strange. It would have more credence were it not being peddled on no evidence whatsoever, and mainly by those attempting to deflect blame for the hideous state in which we find ourselves.

It might be "plausible", but so are the best lies - it's what makes them work.

I'd like some evidence, before pointing fingers at Trichet.
 

patslatt

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Evidence

The guarantee was not motivated by any knowledge of how bad Anglo and INBS were. It was a stroke, pure and simple. A "cost-free" gun-jumping exercise, that alienated Ireland within Europe by forcing the hands of all other EU governments to go the same route, or risk Irish banks sucking money out of them.

Go back and check the cheesy triumphalism with which the announcement was made, and with which it was greeted. Those who came up with it, at political and advisory levels, all thought they were great chaps. And then remember all the "Anglo is a going concern" guff we had to listen to as events unfolded.

The sudden emergence, over the last couple of months, of the line that "The ECB made us do it" is strange. It would have more credence were it not being peddled on no evidence whatsoever, and mainly by those attempting to deflect blame for the hideous state in which we find ourselves.

It might be "plausible", but so are the best lies - it's what makes them work.

I'd like some evidence, before pointing fingers at Trichet.
THe evidence could be the absence of a single eurozone bank failure in the international banking crisis,unlike in the US where banks fail frequently.
 

SirHenryGrattan

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May 28, 2009
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The government's guarantee of all bank debt was motivated by the fear that if Anglo Irish bank failed,as happens in banking crises the failure would bring down the entire banking system like a house of cards when one card is removed. Banking systems are vulnerable to cascading losses on interlocking loans to each other. In Ireland,banks were partners in huge syndicated loans to bubble property developments. If development financed by Anglo were deprived of funds,that would have resulted in firesale liquidations of property,undermining the collateral value of property for loans throughout the banking system which would have wiped out bank capital reserves and bankrupted the system. Unfortunately for Irish taxpayers,the bank debt guarantee and NAMA merely delayed the threat of bank system failure and the property crash instead of resolving it.

There is a plausible rumour that the European Central Bank influenced the government's decision to give the guarantee. Did it want to prevent at all costs the failure of any significant European bank, promising the government that if it cooperated in preventing the failure of Irish banks,the ECB would supply enough liquidity to keep them operating? The fact that the ECB has supplied €180 billion to Irish banks gives some credibility to the rumour.

So should the government have refused to guarantee the bank bondholder debt? The banks would have collapsed without the guarantee,forcing the government into temporary nationalisation of most of them to preserve their utility function as financial intermediaries. There are good precedents for this in President Roosvelt's shutdown of weak banks after his election in the Great Depression and in Sweden's successful nationalisation of banks in the early 1990s. Temporary disruption of banking services could have caused a recession as credit dried up completely and runs on banks occured in corporate deposits. That may have been a worthwhile price to pay for avoiding the crushing sovereign debt burden resulting from the bondholder debt guarantee.
That's a nice summary but it ignores the fact the Bond Markets would have dumped Irish bonds if there was a systemic bank failure. Most countries have to borrow and Ireland would have had to go straight to the IMF/EU for emergency funding. It was this combined with a desire to save the Irish banking system and under estimate of banking liabilities that persuaded the Irish Government to indemnify the senior bond holders against losses. Of course the banking collapse has taken place anyway so maybe now is the time to restructure the debt. Promises of course can be broken especially by a new government. The Irish have the rest of Europe over a barrel because a default would threaten both the European banking system and the Euro.
 

patslatt

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That's a nice summary but it ignores the fact the Bond Markets would have dumped Irish bonds if there was a systemic bank failure. Most countries have to borrow and Ireland would have had to go straight to the IMF/EU for emergency funding. It was this combined with a desire to save the Irish banking system and under estimate of banking liabilities that persuaded the Irish Government to indemnify the senior bond holders against losses. Of course the banking collapse has taken place anyway so maybe now is the time to restructure the debt. Promises of course can be broken especially by a new government. The Irish have the rest of Europe over a barrel because a default would threaten both the European banking system and the Euro.
Going to the IMF for emergency funding would have been better than the government's slow motion austerity that still allows the most overpaid,overpensioned public sector in the EU. It would have forced a fast 25% cut in pay for the better paid PS and swift cuts in all social welfare. While that would have been deflationary,it was just the cure needed for international competitiveness in our open economy. It also would have avoided the sovereign debt burden that probably will cripple the economy for a decade barring either a strong international recovery or sovereign debt default.
 


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