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The Deauville Declaration: should we look back in anger?


Shqiptar

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Inevitably, there will be many who say that regardless of what happened during that fevered autumn of 2010, Ireland would have needed a bailout anyway. Things were too far gone, they'll say. The bank guarantee of two years previously sank us. It was just a matter of time.

Perhaps they're right. But much seems to have been forgotten about or else glossed over in the flurry of events in the run up to Ireland's application for a bailout in late November. The Fianna Fáil/Green coalition was exhausted from over two years of crisis and knew it was about to be booted out of power. The opposition parties were mainly concerned with posturing for the election that could only lie a few months away.

In my humble opinion, one of these is the Deauville Declaration issued on October 18th by Angela Merkel and Nicolas Sarkozy to the effect that lenders in the sovereign debt market might face losses in future bailouts. It created quite a flurry around Europe at the time and Irish bond yields rocketed leading ultimately to the bailout. I've done a search here on Politics.ie and found very few references to it.

Some might say that such things had to be said - even if the Declaration was badly handled. However subsequent clarifications pointed out that private sector involvement would not be required before mid-2013. As it happened, even later, by November 28th, with Ireland safely in the bailout pen, Merkel was rowing back from the previous hardline position of October 18th. EU leaders agreed that the use of haircuts would be restricted: if a country was unable to borrow sustainably from the bond markets, it would simply get a bailout. Only in the most extreme circumstance, if the country were deemed insolvent by all other euro-zone members would the private sector face losses.

Of course, this is all water under the bridge. But the question must be asked even now: why float such a radical idea without specifying the restricted circumstances under which it would operate? Why do it without discussing it first with that part of the eurozone that's not Germany and France? Why do it in such a public manner when it clearly wasn't set in stone - as the u-turn of November 28th showed?

In the months and years that followed, various figures and sources have discussed Deauville. This is what they've had to say.

And there are many that blame loose talk by France and Germany in October 2010, about the ESM, for the rapid deterioration in Ireland’s finances late last year. What the French and Germans were suggesting in the Deauville Declaration was that if a country borrowed from the ESM, then the ESM would have first dibs if that country subsequently defaulted (actually second dibs, because the IMF always gets repaid first). The bond market considered this and thought “hang on a minute, if Ireland has to borrow from the ESM to fund its crippling deficit not to mention the black hole in the banks, then any money we lend now might be lost, because if Ireland defaults, which is a strong possibility, we’ll have to take our place in the queue behind the ESM”. And there are many that believe the consequence of the German and French loose talk was to drive up our cost of borrowing, and that belief is supported by the history of our bond prices.(1)
Unfortunately, Merkel's actions showed a poor understanding of how traders in the bond market discount future events. Even if it is true that the cost to the private sector will be borne only from 2013 onward, that is no reason why the cost of those future expected losses cannot be priced into government bond purchases today. The principal victim was not Greece, however, but Ireland. Once Merkel and Sarkozy made their Deauville declaration, the Irish bond market went into a rout.(2)
Private sector participation made perfect sense from the theoretical point of view. After all, taxpayers had been bailing out banks and private investors in virtually every European country since the beginning of the financial crisis. Arguably, private sector moral hazard - in particular the financial sector's irresponsible risk-taking behaviour and unique 'talent for privatising gains and socialising losses" - had led to the 2007-08 financial crisis. However, to introduce that idea in the midst of an extremely volatile market and without detailing how it would work was like adding fuel to the flames.

Indeed, borrowing costs soared for both Ireland and Portugal after the Deauville meeting[..](3)
In the run-up to the bailout in 2010, the Deauville declaration by the German chancellor, Angela Merkel, and the then French president, Nicolas Sarkozy, all but sealed Ireland’s fate when they said private investors would have to bear costs in future bailouts. It was a political statement, now widely seen as a grave error, that cost Ireland dearly.(4)
The Deauville declaration of October 18, when Angela Merkel, Germany’s chancellor, and President Nicolas Sarkozy of France bounced their EU partners into a plan whereby private investors would share the burden of future defaults with the taxpayer is particularly resented, not for its substance but its tin-eared timing, which would send Irish bond spreads through the roof.
“Nobody’s blaming Europe for the position we got ourselves into,” says a veteran Irish diplomat, “but they are blaming Merkel and Sarkozy for the manner in which this was done.” The crisis then became a Europe-wide battle in which Ireland was thrust into the front line.(5)
The Deauville pact struck by Ms. Merkel and Mr. Sarkozy hit Luxembourg like a bomb. Jörg Asmussen, Germany's deputy finance minister, printed out an email just after 5 p.m. outlining the proposal and passed it around to finance ministers. Not only had France and Germany decided that private creditors would have to worry about losing their money, but they had also cut a deal behind everyone's back.

"You're going to destroy the euro," Mr. Trichet shouted, in French, to the French delegation, according to people present.
[..]
Markets revolted. Investors dumped the bonds of Ireland and other weak euro-zone countries, accelerating a sell-off that started after the Deauville meeting. Shut out of debt markets, Ireland faced the prospect of default.

Mr. Trichet was furious: The governments had shattered investor confidence, leaving the ECB to clean up the mess.
[..]
On Nov. 28, finance ministers approved a €67.5 billion rescue deal for Ireland. They also presented the details of the permanent bailout fund first unveiled a month earlier.

But Ms. Merkel, frightened by the uncertainty that her deal with Mr. Sarkozy had unleashed, agreed to a partial compromise. Instead of taking the hard line envisioned by the Deauville pact, the leaders agreed to restrict the use of haircuts: In most circumstances a country unable to borrow from bond markets would simply get a bailout. Only if the country were formally deemed insolvent by all other euro-zone members would bondholders face losses.(6)
The European Central Bank chief warned the heads of Europe’s governments that a new rescue system they are designing for future Greece-style bail-outs could inadvertently drive up short-term borrowing costs, imperilling struggling eurozone debtor nations.

The warning by Jean-Claude Trichet, ECB president, came at a two-day summit where European leaders reluctantly agreed to a Franco-German push to reopen the EU’s treaties to set up the new, permanent bail-out mechanism, which would replace the current €440bn ($612bn) fund expiring in three years.(7)
While the responsibility for reducing Ireland to this state of prostration undoubtedly lies with the covens of politicians, bankers and builders who alchemically prolonged the Celtic Tiger boom of the 1990s well beyond the millennium, the heirs of Bismarck and Richelieu had a hand in tipping things over.

That part of the story begins in Deauville in mid-October. At the resort town on the Normandy coast Angela Merkel, German chancellor, did a deal with President Nicolas Sarkozy of France that took European Union finance ministers and the financial markets equally by surprise.

In essence, the chancellor gave up German insistence on sanctions against profligate eurozone members in exchange for Mr Sarkozy’s assent to a “crisis resolution mechanism” that would share the cost between private creditors and taxpayers of cleaning up after any future implosion such as Greece had undergone.
[..]

At the Brussels summit dinner of October 28, Mr Trichet warned Ms Merkel bluntly that her insistence on more pain for private investors in future eurozone bail-outs would simply send up short-term borrowing costs, deepening the crisis. That is exactly what happened.(8)

1. Another miserable week for Ireland as we get tossed around like a rag doll in Europe. « NAMA Wine Lake

2. Europe Today: A Twenty-first Century Introduction, p. 347 edited by Ronald Tiersky, Erik Jones

3. Resolving the European Debt Crisis: Special Report 21, pp 77-78 By William R. Cline

4. 2053: What does the 40-year payback mean? - The Irish Times - Sat, Feb 09, 2013

5. Irish resentment towards ECB grows - FT.com

6. As Ireland Flails, Europe Lurches Across the Rubicon - WSJ.com

7. Trichet warns on bail-out system dangers - FT.com

8. FT.com / Registration / Sign-up
 


Iphonista

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Great thing, hindsight. I doubt that many would deny that EU leaders' response to the crisis hasn't always been perfect. It has been an unprecedented situation and we're not out of the woods yet.

The banks needed more money anyway. We'd have tipped over at some point
 

Shqiptar

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Great thing, hindsight. I doubt that many would deny that EU leaders' response to the crisis hasn't always been perfect. It has been an unprecedented situation and we're not out of the woods yet.
Not every dilemma they faced was unprecedented. A 10 year old child could have told S&M that their statement of October 18 would have spooked international investors.
 

stopdoingstuff

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So, borrowing costs on the 10 year had hit 7% even before Oct 18th. That's not sustainable.
It is even less sustainable if all future buyers were to be pushed one step lower in the order of repayment.
 

Boy M5

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Yes. And now Sarko seeks a comeback.
 

Shqiptar

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If my reading of this graphic from NAMA Winelake is correct, the 10Ys were below 6% before Deauville hit. By mid-November, they were around 9%.

 

Iphonista

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It is even less sustainable if all future buyers were to be pushed one step lower in the order of repayment.
It was clarified in due course that this would only apply from H2 2013. Did bonds return to where they were before Oct 18? No, clearly there were a number of factors at play.
 

stopdoingstuff

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It was clarified in due course that this would only apply from H2 2013. Did bonds return to where they were before Oct 18? No, clearly there were a number of factors at play.
There certainly were other factors at play, including taking on another 67 billion in debt at an initial rate of almost 6%, and the combined effect of more 20billion+ deficits. Ah well, at least the senior bondholders were not inconvenienced.
 

sondagefaux

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So the complaint is a statement that burning bondholders would apply in the future? Isn't that the preferred policy of much of the Irish opposition?

Maybe we should look back in anger at 2000:

Former minister for finance Charlie McCreevy warned that foreign investors believed the Irish economy was “heading for trouble if the boom is let rip” in a secret aide memoire for Cabinet in 2000.

...

He also identified “widespread, unrealistically high” expectation among the public about wage increases, tax relief and current spending, which he said threatened to undermine competitiveness. The “significant uptick” in construction costs was another development which Mr McCreevy believed “seriously threatened” Ireland’s ability to maintain economic and social progress.
What action did the Irish government take in 2000 and subsequent years to deal with the overheating of the Irish economy?

McCreevy warned in 2000 of threat to economy if 'boom is let rip' - The Irish Times - Mon, Feb 18, 2013
 

stopdoingstuff

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So the complaint is a statement that burning bondholders would apply in the future? Isn't that the preferred policy of much of the Irish opposition?

Maybe we should look back in anger at 2000:



What action did the Irish government take in 2000 and subsequent years to deal with the overheating of the Irish economy?

McCreevy warned in 2000 of threat to economy if 'boom is let rip' - The Irish Times - Mon, Feb 18, 2013
About as much as the EU did when some of the bigger countries were let off the hook for being in breach of the SGP and when the interest rate was being set for their needs.
 

Iphonista

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There certainly were other factors at play, including taking on another 67 billion in debt at an initial rate of almost 6%, and the combined effect of more 20billion+ deficits. Ah well, at least the senior bondholders were not inconvenienced.
That 67bn at almost 6% pa was one of the bailout conditions. I think the OP is concerned with matters before that and whether or not the Oct 18 declaration led inevitably to the bailout. Caused it, even....
 

stopdoingstuff

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That 67bn at almost 6% pa was one of the bailout conditions. I think the OP is concerned with matters before that and whether or not the Oct 18 declaration led inevitably to the bailout. Caused it, even....
It was one of the proximate causes.
 

sondagefaux

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About as much as the EU did when some of the bigger countries were let off the hook for being in breach of the SGP and when the interest rate was being set for their needs.
Ireland had plenty of policy tools at its disposal, including not introducing tax breaks for property development, not overspending (McCreevy's complaint) on current expenditure, not implementing benchmarking, which became a means of bribing public sector workers into voting for FF, not failing to regulate bank lending policies and practices, not introducing the SSIAs, which didn't encourage saving but spending, not ignoring the warning signs which were obvious in 2000...

BTW, what effect did other countries breach of the SGP have on Ireland?
 

stopdoingstuff

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Ireland had plenty of policy tools at its disposal, including not introducing tax breaks for property development, not overspending (McCreevy's complaint) on current expenditure, not implementing benchmarking, which became a means of bribing public sector workers into voting for FF, not failing to regulate bank lending policies and practices, not introducing the SSIAs, which didn't encourage saving but spending, not ignoring the warning signs which were obvious in 2000...

BTW, what effect did other countries breach of the SGP have on Ireland?
Yes but the issue is at least as much about how the problem was dealt with as how it was created. The response in general was disastrous and clumsy, and it involved the sacrifice of the economic well being of entire generations of young people in particular just to protect the faith based project known as European unity, and to make sure that the mistakes of one particular class was borne by everyone else.

The effect of other countries breach of the SGP had an impact on everyone, not just Ireland. First it sent the signal that there were no rules to be obeyed- it is not a coincidence that both Portugal and Greece escaped sanction when they were in breach. Rather than accepting discipline those countries continued to borrow, so that by the time they got into real trouble and the crisis became systemic, it meant that Ireland was constrained from burning those who should have been burned for fear of causing a chain reaction. If those countries had been disciplined and had reformed earlier, the risk of such a chain reaction and such a powerful chain reaction would not have been as bad.

Next, when the French and Germans were let off the hook in early 2005, it was after running excessive deficits for some time. The fact that they were in bad shape for so long magically prompted almost 4 years of ECB interest rate reductions, and all at the same time that there was general international inflation of the money supply. Being so accommodative even at a time when Eurozone inflation was either at or mostly above their 2% target (another rule disregarded, another risk ignored) for the French and the Germans added to the wave of liquidity that swept across Europe and lowered Irish borrowing costs at a time when they should have been rising, thus fuelling our asset boom and several others. But other than that, it was totally harmless.
 
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ibis

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So we should look back in anger at statements that bondholders should be burned just as much as at statements that they shouldn't?

It may be, of course, that the reason the Deauville Declaration gets so little air-time these days is because it fits very poorly with the popular national narrative of Germany bullying us to "save their banks". Merkel and Sarkozy suggesting burning bondholders contradicts their supposed positions directly, while the way the markets reacted contradicts the idea that burning bondholders would have had no effect, and rather bolsters the 'contagion' position taken by the ECB and the Irish government.
 

stopdoingstuff

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So we should look back in anger at statements that bondholders should be burned just as much as at statements that they shouldn't?

It may be, of course, that the reason the Deauville Declaration gets so little air-time these days is because it fits very poorly with the popular national narrative of Germany bullying us to "save their banks". Merkel and Sarkozy suggesting burning bondholders contradicts their supposed positions directly, while the way the markets reacted contradicts the idea that burning bondholders would have had no effect, and rather bolsters the 'contagion' position taken by the ECB and the Irish government.
Giving someone three years notice does not qualify as burning.
 

ibis

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Giving someone three years notice does not qualify as burning.
Apparently it does - from the OP:

Unfortunately, Merkel's actions showed a poor understanding of how traders in the bond market discount future events. Even if it is true that the cost to the private sector will be borne only from 2013 onward, that is no reason why the cost of those future expected losses cannot be priced into government bond purchases today. The principal victim was not Greece, however, but Ireland. Once Merkel and Sarkozy made their Deauville declaration, the Irish bond market went into a rout.
Bond horizons are quite long. A five-year bond from 2009 would potentially be affected by arrangements for a bail-in in 2013.
 

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