Deal does nothing to address our insolvency

So now we know — it’s Frankfurt’s way, all the way.

One can only wonder what was going through the minds of the Labour Party ministers as they signed off on the deal that irrevocably linked the Anglo debt to the State. Was it the words of Collins on his signing the Anglo Irish treaty, in a political sense? Or was it the words of Mr Rabbitte on the distinction between electioneering and governing? Or was it simply thanks that there was a deal, any deal, that didn’t require a payment on March 31?

In any sense, we now have the full foul flower of the 2008 banking deal. Having sunk €30+ billion of cold hard cash into the wreck of the banks, we have now sunk a further €30bn of taxpayers cash into an arguably worse deal, paying for the folly of the guarantee to the Anglo subordinated bondholders.

This deal makes a mockery of the moves towards banking union in that it demonstrates explicitly the fact that the national State remains on the hook. This national banking approach is evident in more than this. All round, there is are nationalisation in the financial sphere and this deal is part of that.

In acquiescing to this ECB-driven linkage of the banking debt to the sovereign, the Irish Government has consented to this renationalisation.

What of the deal itself? Like any deal, it has good and bad points. I remain convinced that the economically and morally appropriate thing to have done was not to pay. However, we have now done so. The deal is complex. It in essence involves IBRC being liquidated, the Central Bank seizing the asset (promissory notes) that was used as collateral for it extending liquidity, and the Government and the Central Bank agreeing to swap this worthless wretched note for proper NTMA bonds. These bonds are of a longer term and at no more cost than the promissory note, so in terms of the present-day value they are less. How much less is a matter of some conjecture, as the terms of the newly-issued bonds are floating. But a reasonable conjecture would be that the value is 40%-60% of the total amount.

Before we start doing cartwheels of delight, however, several notes of caution must be struck. First, there is a requirement in the deal that the Central Bank will not hold onto these bonds to maturity in total. They will have to sell some. This introduces a degree of uncertainty as to the deal.

Second, the cost is unclear, but we know that we are right now at a low point of the interest rate cycle, and the cost of the bonds fluctuate, as do interest rates. The bonds are pegged to a cost over six-month Euribor rates.

Nobody can forecast with any certainty the rate of Euribor, that rate at which large banks lend to each other over the next few months, never mind the next few decades. At a low point in the interest rate cycle, a truly favourable deal would have fixed the cost now. The average six-month Euribor rate over the last 20 years has been just over 4%. By comparison a rate set at the ECB main refinancing rate would have been cheaper.

Third, much is being made of the argument that, over time, inflation and GDP growth will erode the “real value” of the bonds. This is in one way merely a restatement of the fact that the present value is lower than the total nominal amount. But it also seems to ignore that the ECB have an inflation target (and it has shown itself to be a strong inflation fighter) of 2%. The value will take a long time to fall.

Fourth, even if we were to take the present value as being 50% of the face value we have still, at a stroke, added one year’s deficit. This is hardly consistent with fiscal prudence.

Fifth, there is a worrying line of argument, from the Taoiseach down, that saving the billion a year in funding as we are, we can thus relax austerity measures by a concomitant amount. Even as we are looking at structural budget balances forecast to be over 5% in 2014 (versus a surplus in Greece) it is hardly time to raise expectations that this deal is a game changer. Rather than relax the adjustment process (which can only be for party gain) the adjustment should be continued and in effect accelerated with this additional fiscal benefit.

Finally, we have been here before. In 2008, we saw the Oireachtas rush to judgment with complex legislation in the mistaken belief that the issue was one of liquidity rather than solvency. Then it was the banks, now we are doing the same with the State.

Saving cash on an ongoing basis is a liquidity issue.

The deal does nothing to adjust the solvency of the State; that is what this deal should have done.

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