We can either be forced into a disorderly, unmanaged default, or we can engage in organised restructuring now, writes Constantin Gurdgiev
LET’S do a simple exercise in accounting. Between now and the end of 2014, the Government will require some €120 billion-€130 billion in financing in excess of tax receipts in order to cover continuation of its banking and fiscal policies.
Net of the cash and assets reserves we currently hold, Government-assumed or underwritten debt (ex-Nama) will rise to a massive €210bn-€220bn in the next four years.
This number can be broken down into the following components. Currently, exchequer debt stands at €90 billion. In 2011-2014, deficit financing, even under the latest four year plan, will swallow some €60bn-€65bn of borrowing.
Bond redemptions at higher interest rates than those achieved in previous auctions will imply at least an additional €1 billion in funding demand. On the banks side, commercial and investment loans writedowns will likely cost €35bn-€37bn in new cash, recapitalisation of existent banks to 12 Tier 1 capital ratios will cost at least €10 billion and residential mortgages can be expected to yield some €15 billion in losses over the cycle.
Decline in banks deposits and lack of banks operating capital, including the interest that we owe on banks loans to the ECB, will cost some €30 billion to undo, under extremely conservative assumptions.
Taking into the account the blended rate charged on Irish borrowings by the EU, IMF and ECB troika under the Government-struck ‘bailout’ deal, the interest rate on the Irish governmental and quasi-governmental deal will come at around €12.6bn-€13bn per annum. Again, this is before we factor in the costs of operating Nama. In other words, close to 30% of our total tax revenue can be swallowed up by the repayment costs on the debt.
In announcing the bailout package, the Taoiseach has claimed that the overall debt burden in 2014 is likely to be below that witnessed in the late 1980s. This is simply misleading.
The figures quoted by the Government do not include Nama-related debt, or the debt to be used to finance the banking sector recovery measures in excess of what is provisioned for under the EU/IMF deal.
Even more crucially, the figures completely ignore the fact that back in the 1980s, Irish public sector obligations were by far the largest share of the total debt burden carried by the economy. This time around, public debts will come on top of a massive pile of the banking, corporate and household obligations.
All in, once again using the rate agreed between Ireland and EU/IMF, we will be paying at least €35 billion in annual interest payments in 2014, or roughly 20% of the entire domestic income.
Recognising that a large share — at least 18%-20% of that income is accounted for by the international transfer pricing, this implies that almost a quarter of the total national income can be swallowed by interest repayments on Ireland’s combined private and public sectors debt pile.
Put simply, our economy is bust. Were Ireland Inc a company, the only way forward for the country would be a wholesale restructuring, with across the board write-downs on public and private sectors debt.
The very similar scenario is now virtually unavoidable for this country, despite the memorandum signed the by the Government that de jure prevents us from restructuring banks debts. Being a sovereign state within the EU constraints complicates the process of our recovery.
Take a look at the composition of the total debt carried by Irish economy. Roughly a third of the total expected 2014 debt in Ireland will accrue to the Irish state and a quarter to households. Over 40% of the debt will relate to our banking sector, once we include state-financed support measures.
Restructuring official Exchequer liabilities is perhaps the costliest and least productive undertaking. Reputational damage to the Exchequer is much harder to undo over the period of time than that incurred by private institutions, such as the banks. The Exchequer cannot be substituted for by the alternative services providers in the short run and in many areas of services, even in the long term.
In contrast, restructuring banking debt would be the least painful and least costly alternative.
A combination of debt-for-equity swap and direct write-down of the face value of Irish banks debts can yield €42 billion or more in savings on the total bill of restructuring the banking sector.
In addition, it can be used to dramatically reduce Irish Exchequer exposure to banks debts going forward. A haircut of 16% — the expected value of losses currently being priced by the bond markets into the Government’s own debt valuations would imply roughly €32 billion in direct debt write-downs.
In addition, a transfer of the entire equity holdings in Irish banks to current lenders to the sector will eliminate the need for taxpayers to put fresh cash into banks to recapitalise them.
The state guarantee can then be lifted on the entirety of banks’ bondholders and retained on the deposits up to, say, €200,000 to ensure that ordinary depositors retain confidence in their security. This, in effect, will reduce Exchequer potential exposure to the banking crisis by some 50%.
No one can deny that there will be significant reputational and risk-related costs to such a restructuring. In the immediate aftermath of these measures, Irish banks will have difficulties in accessing inter-bank lending markets and will experience tightness in raising operating funding.
But the very same banks are currently already completely shut out of the lending markets and are fully captured by the ECB discount lending.
In these circumstances, to argue that Irish restructuring of banks debts will trigger significant reputational and funding costs is equivalent to saying that a patient in a coma induced by a massive stroke might have a problem cooking his dinner.
Furthermore, our European partners — namely Germany, Britain and France — will find themselves carrying losses on their own banking and financial sectors balance sheets.
No amount of taxpayers’ funding, combined with ECB and EU funds can cover these liabilities of our banking system, estimated to be around three times our entire economy. As the holders of large quantities of Irish banks debts, these very foreign institutions are also responsible for the excessive borrowings undertaken by our banking system in the past. In simple terms, Germany and France didn’t escape an ECB-created property bubble. They had theirs in Ireland instead.
The ECB will itself have to shoulder some of the hit, not via another series of loans to the banking sector here, but via a direct write-down of some of the assets it holds against the Irish banking institutions. Again, one can easily argue that this would constitute a fitting denouement to the poor management of monetary policies by the ECB during the years of boom.
Courtesy of the last week’s EU/IMF deal, the lack of prudential monetary policy management by the ECB since 2001, the inability of the EU to devise a functional method for resolving systemic banking and fiscal crises in the member states and our own banks and regulators failures, Ireland, alongside other countries of the eurozone, is now facing stark and deeply unpleasant choices.
We can either wait for the reality of insolvent banking sector across Europe to force us into a disorderly, unmanaged default, or we can restructure the existent balance sheets, reducing overall levels of debt and alleviating the pressure of such an adjustment on ordinary households and the rest of productive economy. For our own sake and for the sake of Europe and the euro, I certainly hope we can choose the latter.
- Dr Constantin Gurdgiev is Adjunct Lecturer in Finance with Trinity College, Dublin
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