Michael Burke: Frightening people into submission is a fairly easy trick. One tactic is to frighten them with an outlandish demand – then soften the blow with a somewhat less outrageous demand. This might be called the Dick Turpin school of negotiation.
In the days leading up to the release of the latest instalment of the bank bailout programme, all sorts of numbers circulated about the size of the latest bank recapitalisation. Now, it is widely presented in mainstream media and elsewhere as a relief that ‘only a further €24bn’ is needed.
The insouciant recommendations of further debts that amount to €5,000 for every woman man and child in the state, while at the same time slashing public spending are remarkable. Another €24bn for the banks is entirely manageable, it seems, while benefits to lone parents, jobs seekers or the disabled amounting to tens of millions of Euros must be slashed, for fear of destroying the public finances
There are two practical reasons why further bailout for the banks should be rejected. First, the current level of projected debt is insupportable. Secondly, the current level of projected debt is wildly understated.
Unsupportable debt
The €24bn, even if it were the last recapitalisation, would take the bank debt to unsustainable levels. The Department of Finance table below shows the bank recapitalisations to date.
It is variously argued that the €24bn is the last of the bailouts, that this recapitalisation contains a ‘buffer’ against adverse developments and that there is a residual value in the banks. It might be objected that:
• we have heard the ‘one last heave’ argument before
• that the buffer is nothing of the kind as even the ‘stress test’ scenario includes assumptions that are more optimistic than the current situation
• and that the combined market capitalisation of AIB and BoI, the new ‘pillars’ is now only around €800mn, reflecting market expectations that the authorities are determined not to wipe out shareholders in full, if necessary by further capital injections.
These objections need to be fleshed out. But for now, they are largely beside the point. The cost of the bailout funds is close to 6%. Before these policies led to the state being excluded from financial markets interest rates had reached much higher levels. 10yr government yields are still close to 10%. On €70bn an annual average interest rate of 6% produces an interest bill of €4.2bn.
Under the terms of the impositions from the EU & IMF there is a total of €6bn in spending cuts and tax increases planned for this year, and an average of €3bn in same planned over the following 3 years. That is, very rapidly, the interest paid on the bank debt of €4.2bn exceeds the supposedly vital measures to secure public finances and reduce the deficit. It is argued that these cuts/taxes are permanent, whereas the bailout measures are temporary, and will be concluded within the life of this Dáil.
Putting it politely, this claim is pure fiction. If, as advocates for bailing out EU banks with Irish taxpayers’ money assert, interest will only have to be paid for a short number of years, where on earth are the funds to repay the principal going to be found - all €70bn of it?
If the principal cannot be repaid in that timeframe then interest will continue to be paid on it until it is repaid. It does not appear as if the IMF, still less the EU Commission and the ECB are about to become charitable institutions.
Therefore Irish taxpayers will either have to fund €70bn is a few years’time- or, more accurately will for many yeasrs to come, be paying greater interest on bank-related debt than the ‘savings’ made from a fiscal consolidationthat is billed as necessary to save the finances of the State.
Unstated debt
These numbers are an understatement of the true position, both currently and prospectively. NAMA has issued €28.6bn in bonds. Although the DoF seems desperate not to have them classified as government debt, the classificialtion is immaterial as to the source of the interest on them- Irish taxpayers. In a re-run of the net asset argument and the eventutality that the NAMA assets will at some point be worth something,that is entirely possible but again besides the point. They are ‘non-performing assets’ currently, ie bearing no interest, and taxpayers are paying interest to acquire them. Jam tomorrow is never a convincing argument. It is irrelevant when dealing with an immediate crisis.
The terms of the bailout are set out in the 'Financial Measures Programme Report' from the CBoI. This has had a wide airing in the media, but not a very criticial one. For example, in 88 pages of the report there are references to but no examiation of the impact of pojeced ECB interest rate increases over the next period.It is certainly daunting to contemplate the likely impact on the Irish economy.
It may be that the scenarios included in Appendix C include adverse changes to interests (and the possibility they are greater than currently projected by the money market yield curve), but, if so, these are not stated. There are also a number of key assumptions inboth the ‘base’ and ‘stress test’ scenarios which are highly questonable:
• The projected fall in property prices reflects the experienceof Finland, Britain and Sweden in the 1990s, none of whom were in a monetary union and responded with lower interest rates, not higher ones as the ECB threatens
• Even so, both base and adverse sceanarios project rising propoerty prices from next year (Exhibit 7), despite the earlier admission that even in those countries in the 1990s, ‘house prices tend to follow a pronounced decline for a protracted period’ (p.51)
• The base case interest yields on Irish debt are below (8.63% at 10yr) the current level (9.8%)
• Both the base and adverse cases for the fall in 2010 GDP (-0.2%) are below the latest offical estimate of the decline (-1.0%)
• The uenmployment rate for this year is variously estimated at 13.4% (base) and 14.9% (averse) when the starting-point is 14.7% and rising
Whatever the outcome, the consistent pattern is the current indicators are closer to the adverse of ‘stress test’ senario than the base scaenario.
There has been much discussion on the gap between the Blackrock projected €40bn in lifetime loan losses and the CboI’s recommendation of €24bn in recapitalsation and the assertion that this includes a large ‘buffer’. (The buffer is just €2.3bn in total, plus €3bn in continegent capital (Table 18)). But the CBoI’s own assessment is only for 3-year losses, and under the (undemanding) stress test this amounts to €27bn (Table 10, p.29).This is greater than €24bn, buffer included.
And, as with the €70bn repayment argument, is it seriously suggested that AIB and BoI will be genrating profits in 3 yeas’ time? Without the capital injections, all he insitutions would have negative capital (that is,worth less than zero) in 2013 (Table 14).
Crucially, the entire exercise is premised on large scale ‘deleveraging’ of the banks’ balance sheets, that is a further disposal of loans. There are two avenues for this, commercial disposals and public ones- NAMA. To date, total disposals have amounted to €120bn, but only €49bn of this has been commercial disposals (including write-offs). €71bn has come from dsposals to NAMA.
Over the next period a further €84.1bn delveraging is projected to take place mainly through the run-off and disposal of non-Irish loans, described as ‘non-core’. Therefore, to some extent, the whole plan relies on finding a buyer for these assets at book value- even though it is widely known the Irish banks are forced sellers. Realising further losses, beyond any write-down in loan values to date, may be inevitable under this plan. Surveying the world economy, it is certain that an optimal loan book would not be 100% concentrated in Irish and British lending, which is now the aim of policy.
Conclusion
Finally, in effective the same authorities who produced an economic and fiscal crisis leading to the impositions of the EU and IMF are now arguing that the related banking crisis can be resolved by parallel measures; assets sales and the protection of capital at the expense of labour. But Adam Smith noted long ago that all value is created by labour. Diminishing productive labour, failng to optimise its skill levels, increasing its naked exploitation and expelling a portion of it from the country for a prolonged period will damage the entire economy. Clearly, policymakers who have embarked on this course do not understand that economic principle or care less.
But, if they cut the wages of public sector workers and their numbers, and thereby hope to promote a ‘demonstration effect’ of lower wages in the private sector, and mortgage defaults rise as result, guess what the arguments will be? We need more capital for the banks and more cuts in public spending.
It has already begun here and here.
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