WITHOUT a shadow of a doubt, the most tragicomic element of this week was the payment of $1 billion — over €700 million — to Anglo bondholders.
This bond was unsecured, relying in other words on the solvency and good faith and credit of Anglo Irish Bank; it was also unguaranteed, in that it was not covered by the disastrous government guarantee of banking liabilities in 2008.
Although technically not insolvent, due to promissory notes which will cost the Irish taxpayer upwards of €80 billion by the time all is said and done, Anglo is economically bankrupt.
The Government faced a storm of protest, including what one can only imagine was a tongue-in-cheek contribution on the inequity of such payments by Fianna Fáil. It’s very clear that the Government paid this private debt because they are being strongarmed by the European Central Bank.
From the ECB’s perspective, they see it as imperative that no senior bondholder in European banks should be forced to take a loss. They have a point in this.
In September, eurozone banks had approximately €10.7 trillion in deposits and €12.5tn in loans, plus some other assets. The difference between deposits and other assets is accounted for by some €3tn in bonds issued by these banks. It is this €3tn that the ECB is concerned would be seen to be at risk were the miserable €700m of Anglo Irish bonds not repaid.
The argument, so the ECB says, is that if Anglo Irish Bank does not repay its bond then markets will ask why any other bank would do so? The consequence of this would be that sooner than later European banks would find themselves forced to either pay significantly more for bonds or have a reduced dependence on them.
Either would result in a downgrading of euro area economic prospects, via more expensive bank credit and a deleveraging, that is to say a reduction in supply of credit.
The last thing the eurozone needs is a further blow to its economy. Eurozone growth prospects are low, with the OECD forecasting only a 0.3% growth; industrial manufacturing based on purchasing managers’ surveys is in decline; unemployment is over 10%.
Already the requirement to raise capital ratios to 9%, agreed as part of the latest final solution to the twin bank-Greek crises, will likely result in some deleveraging.
Indications are that the banks will not raise additional funds to strengthen their capital base but will instead adjust their assets, that is to say deleverage. So, the ECB, from a eurozone perspective, are doing the right thing in insisting that the Anglo bond be repaid.
The difficulty is that this Anglo bond is coming out of state funds. Anglo has been recapitalised multiple times. From the Irish perspective it is both odious and irksome that not only is the Irish taxpayer expected to be the ultimate prop for the eurozone bank fund market but they are getting very little back from the ECB in return.
Irish banks remain critically dependent for liquidity on the ECB, but this liquidity is only advanced on a series of rolling short-term sales and repurchases. The ECB, quite bizarrely, has set its face against the provision of a structured medium- term liquidity provision. It is hard not to see this as simply a desire on the part of the ECB to keep the Irish government in line, via a threat, quite unrealisable in fact, that deviating from the ECB line of no bondholder being burned will result in the withdrawal of liquidity and the crashing of the Irish banking and financial system.
The Government claims that keeping the ECB “on- side” will allow them to negotiate with the Troika on the cost of the promissory notes, but this negotiation will be conducted, in part by the NTMA/Department of Finance, who mislaid €3.6bn, a bookkeeping error so gargantuan as to hardly inspire confidence in their ability to deal with complex and large sums.
All this is against the backdrop of an Irish economy which, although anaemic, halting and critically dependent on a small group of exporters, is beginning to show signs of stabilisation. We appear to have reached the bottom of the economic cycle, and although we will probably bump along the bottom for some time, we at least can begin to see a clear path.
A functioning Irish banking system could only help, particularly if that banking system was adequately capitalised, appropriately supervised, friendly to SMEs — a true utility banking system. We will be a long time waiting for that.
*Brian M Lucey is Professor of Finance, School of Business Studies, Trinity College Dublin.