Tag Archives: Anglo Irish Bank

Another Stress Test – Another Media Circus

Hmm…must be that time of year, or something..  Anyway – European bankers are gearing up for another stress test. Yes, their third. But, hey! This time they promise to get it right.  The ECB has even hired the best external stress tester in the business to do the job.  US-based financial consultancy firm Oliver Wyman, a company who has a proven track record for coming up with the right numbers. However, not always the most accurate ones.

“This is the last opportunity to reestablish confidence in the European banking system.”

Jörg Asmussen


Stress testing of European banks is actually one of the most entertaining parts of the financial crisis. It’s almost hilariously funny to watch the troubled bankers desperately trying to cork a swiss cheese with a soft gun – the holes just multiply and keeps getting bigger.

sterss 1For every “the worst is over” statement, the laughter grows… We’ve gone from booing to cheering…

And the preparations for stress test #3 are also promising.

strress 4

Last week the ECB announced that it had hired the US-based consultancy firm, Oliver Wyman, to conduct the test.   These guys are no strangers to the European stress testing.

  • In 2006, it famously said the Anglo-Irish Bank was the best bank in the world. Three years later, the bank had to be nationalised and almost bankrupted the Irish state, which then needed a euro zone bailout.
  • In 2012, during the Spanish bank bailout, Oliver Wyman provided the euro zone decision-makers with the numbers they expected and which were politically acceptable – around €60 billion instead of a much larger gap that the banks actually had.
  • Also 2012, Oliver Wyman did consultancy work in the Portuguese bailout, according to the central bank of Portugal.

The EU observer writes:

“The worry in euro zone central banks, according to one insider, is that if banks are reviewed too thoroughly and their problems exposed, they will stop lending and revive the financial crisis.”

stress 2Thanks for carving it out, but I think we kinda guessed that already.

But there’s another factor in play this time.

You see, the ECB is planning to step up to the role as EU’s chief supervisor next year and I believe they want to know what they’re supposed to supervise.

stress 5The ECB plans to put 130 major European banks to the test before it assumes regulatory supervision of the institutions in the fall of 2014.

“This test is not a threat,” says Jörg Asmussen, former state secretary in the German Finance Ministry, now  a member of the executive board of the European Central Bank (ECB).

“But after two failed stress tests, this is the last opportunity to reestablish confidence in the European banking system.”

stress 3I’m sorry, but I think that ship sailed the moment you signed the deal with  Oliver Wyman, Mr. Asmussen.

Additionally, many substantial estimates have already been made over the potential magnitude of the gaps the test will uncover.

stress 7SPIEGEL Online reports that Deutsche Bank estimates that Europe’s banks will need €16 billion in additional capital. Depending on which criteria the ECB applies in its tests, the gap could be much bigger.

The Bundesbank, Germany’s central bank, has just estimated that the seven largest German banks alone need an additional €43 billion in capital to satisfy the new international capital requirements.

stress 8I don’t think any stress test dares to go higher than that!

A comparison with the United States gives indications on how bad shape the Europeans really are in.

US financial groups are reporting record profits, while banks in the euro zone have lost more than €80 billion ($108 billion) in the last two years. In the United States, 10 times as many ailing banks were closed and balance sheets were more consistently relieved of bad debt than in the euro zone.

stress 6

The European leaders seem to have  failed to adequately address their banking crisis.

But they won’t give up!

So, what can we expect in the next 8 to 10 months?

stress 10My guess is – for what it’s worth – is that we will see a slow, dramatic build-up. with ECB’ers and politicians lining up to give their pledges about the truth and nothing but the truth, followed by a series of suspicious leaks, causing some market turmoil and a little bit of liquidity squeeze, and by this time next year the ECB will take on the European banking supervision with a huge off-balance sheet and the uncertainty of the euro zone bank sector will be unchanged.

stress 11

And finally we start all over again with stress test #4.

We can party for ever!


Full history of European bank stress testing:


Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics

Europe In Debt (Part 1): Creating a Monster

This is the first of a comprehensive three-part in-depth analysis of the European economic havoc currently haunting the Union like a malicious worm, mutating itself again and again, threatening the very core of EU’s financial system. It’s a so-called “Must Read” for everyone trying to understand what’s going on – on stage and behind the scenes. These three articles has recently been published by the independent research center EVRO Intelligence ASBL at their website eurointelligence.com. Former derivative trader, Satyajit Das, provides exceptionally valuable insight and some harsh conclusions.

“In order to restore solvency, overburdened borrowers must stabilize debt and begin to reduce the level of borrowing. This requires GDP Growth exceeding interest rates, a budget surplus (through spending cuts and/or tax cuts) or a combination of these.”

Satyajit Das

“In early 2010, drawing on the military leadership of President George W. Bush, European leaders declared the economic equivalent of “mission accomplished”. A bailout – whoops support! – package of Euro 750 billion had shocked and awed speculators into submission. Like the Bush pronouncement, the European prognosis provided premature. The return of European sovereign debt problems in late 2010, culminating in the bailout of Ireland highlighted the deep seated and perhaps intractable problems of some over indebted European nations,.”

And here we go!

Mission Interrupted

In the first half 2010, the trigger was the large budget deficits and high debt levels of the “PIGS” (Portugal, Ireland, Greece and Spain) or “PIIGS” (including Italy). For Greece, a lethal cocktail of the need to finance maturing debt and deficits, use of derivatives to disguise debt levels and general lack of candor about its borrowing, exacerbated the problem.

The European Union (“EU”) responded ultimately with a variety of measures, including an Euro 110 billion bailout for Greece and the Euro 750 billion European Financial Stability Funds (“EFSF”) designed to underwrite the liquidity of the besieged Euro-zone members.

The European Central Bank (“ECB”) separately supported the EU measures. The ECB’s role, presumably with the tacit agreement of the EU and members, was crucial, avoiding the problems of lack of consensus and disagreements at the political level.

The ECB purchased bonds issued by Greece, Ireland and Portugal in the secondary market to support prices. By mid-December 2010, the ECB had purchased Euro 72 billion as part of these operations.

More importantly, the ECB supported banks in the troubled companies, providing funding when money markets would not finance these institutions.

The funding was at attractive rates (around 1%), against security of government bonds lodged as collateral for the loans. A delicious arbitrage and backdoor way of financing the troubled borrowers ensued.

“The illusion that the countries had access to commercial funding sources at reasonable rates was maintained. The banks also earned large returns, the difference between the yield on the bonds and the ECB funding rates.”

Domestic banks in Greece, Ireland, Portugal and Spain purchased their own government’s debt, ensuring crucial demand and “successful” auctions. The purchased bonds were used as collateral to secure funding from the ECB. The illusion that the countries had access to commercial funding sources at reasonable rates was maintained. The banks also earned large returns, the difference between the yield on the bonds and the ECB funding rates.

As of August 2010, the level of ECB funding was as follows:

Euro (billions) % of Deposits % of Gross Domestic Product
Greece 96.1 26 40
Ireland 95.1 14 60
Portugal 50.1 15 30
Spain 119.0 5 11

Following the Irish crisis in the second half of 2010, the funding demands on the ECB have increased. Ireland’s borrowing from the ECB has reached Euro 136 billion (86% of Gross Deposit Product (“GDP”)), around a quarter of Euro-zone member drawings on the facility.

The ECB has expressed concern about Europe’s “addicted financial groups“. But with banks affected by their sovereign’s debt problems and maturing debt not being rolled over, the ECB has little option but to continue the arrangement.

The approach of the EU/ ECB assumed that the problem was temporary liquidity not solvency. The solution was to ensure that the troubled countries could continue to finance. The restoration of confidence would enable a rapid return to market financing and the status quo.

“It was a pure confidence trick.”

Nothing exemplified this better than the ill-conceived and poorly designed EFSF.

Amongst the multiplicity of problems were the limited guarantees from Euro-zone countries and a reliance on CDO rating methodology.

The preliminary analysis of the EFSF by the credit rating agencies confirmed the view that the facility was not designed for use. Close inspection also revealed that the facility was only capable of being drawn for an amount as low as Euro 250 billion, well short of the advertised Euro 750 billion. It was a pure confidence trick.

As concerns about the underlying solvency of the countries continued, markets became increasingly nervous.

The uncertainty manifested itself in the increased interest rates on European sovereign borrowing, which rose to levels above those at the time of the Greece bailout.

Irish Futures

The tensions focused around Ireland. While the problems of Ireland are well documented, the sequence of events was curious.

Ireland had sought “prime mover advantage” in austerity, reducing its budget deficits through severe cuts in government spending and tax increases. It established a state bank restructuring agency – National Asset Management Agency (“NAMA”) – to deal with bad loans made by banks. Ireland had completed its 2010 financing program, not expecting to come to market until early 2011.

It also had Euro 20 billion in surplus cash.

A series of related events focused attention on Ireland. Bank bad debt problems re-emerged, especially at Anglo-Irish Bank. Forecast loan losses were revised upwards significantly, in turn increasing the demand on the state to finance the bailout of the banks. The cost, still unclear, was estimated at around Euro 50 billion (30% of Ireland’s GDP).

This had the effect of pushing the 2010 Irish budget deficit to around 32% of GDP.

“They say if a politician denies that he is going to resign stridently often enough, he almost certainly will.”

German Chancellor Angela Merkel raised the prospect of bondholders being forced to “share” losses in any debt restructuring. After a sharp increase in rates for many European countries in response to the suggestion, at the G-20 summit in Korea, European leaders clarified the proposal. It would only apply after 2013, when the current bailout arrangements expired. This drew attention to the temporary and short term nature of the EFSF and related support mechanisms.

Independently, Anglo Irish Bank offered to repurchase its outstanding subordinated debt for 20% of face value, warning that the return to investors in bankruptcy or restructuring would be far worse. This highlighted the risk of loss on Irish State or bank debt.

At the same time, Austria withheld its share of the due installment of funds to Greece, arguing that key hurdles had not been met. While the Austrian posturing was mainly driven by domestic politics and funds were eventually released, the fragile nature of European support for the troubled borrowers was highlighted.

The parlous state of Ireland’s economy was unhelpful. The Irish economy shrank by 1.2% in the third quarter, a surprise to economic forecasters.

Markets pushed up yields on Irish debt inexorably. Higher rates caused losses on holdings of Irish bonds, triggering further selling.

As rubber-necked accident voyeurs joined the party, the costs for Ireland to borrow commercially reached economically unsustainable levels closing access to financial markets. Depositors started shifting their money abroad, threatening a fully-fledged bank run.

They say if a politician denies that he is going to resign stridently often enough, he almost certainly will. Strenuous denials of the need for a bailout ended inevitably in one. A grim Irish Prime Minister Brian Cowen announced that Ireland would be receiving aid from the EU subject to meeting EU/ International Monetary Fund (“IMF”) conditions. It would, the Taioseach insisted, “secure Ireland’s future.”

No one believed him.

Bailing Times

The Irish bailout facility totaled Euro 85 billion, made up of Euro 35 billion for the banking system (Euro 10 billion for immediate recapitalization and Euro 25 billion to be provided on a contingency basis) and Euro 50 billion to cover the financing of the State. The average interest rate would be of the order of 5.8% per annum, depending upon the timing of the draw-down and market conditions.

Euro 67.5 billion of the facility was to be provided by the EFSF (Euro 22.5 billion), the European Financial Stability Mechanism (“ESM”) (Euro 22.5 billion) and bilateral loans from the UK, Sweden and Denmark and the IMF Extended Fund Facility (EFF) (Euro 22.5 billion). The remaining Euro 17.5 billion was to come from Ireland’s National Pension Reserve Fund (NPRF) and other domestic cash resources.

The limited level of funding from the EFSF and the new ESM, a permanent successor to the EFSF, tacitly acknowledged the shortcomings of the funding mechanism proposed earlier. The raid on Irish pension fund reserves brought back memories of Argentina’s confiscation of Central Bank reserves and pension funds to finance the State.

After a brief rally, familiar concerns re-appeared. Estimates suggested that the Irish banks alone required around Euro 16 billion in capital and a further Euro 38 billion in financing. This totaled Euro 54 billion, 64% of the Euro 85 billion package. Given that Ireland required Euro 70 billion to meet maturing debt until 2013, the size of the bailout facility was arguably inadequate.

As in the case of Greece, the bailout package dealt only with short-term liquidity, failing to address Ireland’s longer term solvency.

The arrival of an IMF/ EU team to prescribe a “cure” did not inject the expected confidence in an imminent recovery. Ireland had been self administering the same medicine for some time, with indifferent results.

The Irish economy has not recovered from recession, with GDP only registering growth in one quarter since 2007.

Overall, the economy has shrunk by nearly 20% from its peak. Gross National Product (“GNP”), which is a better indicator of living standards, has fallen for nine successive quarters.

The official unemployment rate is around 14%, though the level of real unemployment and under employment is greater. House prices are 36% below their 2006 level.

Consumer spending has fallen sharply, the result of lower income and increased savings levels of around 12% of income (an increase from 3.9% two years ago).

Cuts in government spending and higher taxes have mired the economy in recession. Falls in tax revenue necessitate increasingly deeper cuts in spending to try to stabilize public finances. In 2010, the budget deficit was forecast at 12% of GDP, even after spending cuts and tax rises worth Euro 14.5 billion

The problems of the banking sector are increasing due to the poor economic conditions. Hitherto largely confined to commercial property, problems are now spreading to the broader economy. Unemployment and lower incomes mean that householders are unable to meet payment obligations on mortgages and other loans.

Weak economic conditions have affected businesses, increasing default levels.

“The maturity of the bailout package is likely to be extended, acknowledging that it cannot be repaid.”

Following the bailout, the Irish government announced further cuts in the budget deficit of Euro 15 billion, with Euro 6 billion scheduled for 2011.

The package included Euro 10 billion of spending cuts covering social welfare, health care, education and the public sector.

There were Euro 5 billion of tax increases, including increases in value added tax (VAT), income taxes and property taxes. Controversially, the low 12.5% corporate tax rate, crucial to maintaining Ireland’s competitive position, remained unchanged, despite complaints and pressure from the EU.

The ability to meet the required targets is uncertain. Forecasts are predicated on “aspirational” growth of 2-3%. Moody’s Investor Services, the rating agency, cut Ireland’s debt rating by five notches Baa1, two notches above junk, with a negative outlook.

The experience of Greece under the IMF/ EU plan is instructive.

While there has been some progress, Greece is struggling to meet its budget targets due to a shortfall in tax revenues, forcing ever more aggressive spending cuts exacerbating Greece’s deep recession. Planned asset sales and structural reforms are unlikely to stabilise public finances. Faced with the unpalatable choice of withholding funding due to non-compliance with the plan or allowing default, the EU/ IMF have continued to disburse funds propping up the economy.

The maturity of the bailout package is likely to be extended, acknowledging that it cannot be repaid.

In the absence of strong economic growth, inflation and a massive devaluation, the peripheral economies, such as Ireland and Greece, may be unable to shrink themselves to solvency.

Changes In Government Debt = Budget Deficit + [(Interest Rate – GDP Growth) X Debt]

In order to restore solvency, overburdened borrowers must stabilize debt and begin to reduce the level of borrowing.

This requires GDP Growth exceeding interest rates, a budget surplus (through spending cuts and/or tax cuts) or a combination of these.

“There is little prospect of many European countries returning to balanced budgets any time soon.”

EU/ IMF assistance to Ireland was designed to address the high yields on Irish bonds, which curtailed the State’s ability to borrow. But the 5.80% cost of the bailout debt requires an equivalent growth rate and a balanced budget simply to stabilize debt at current very high levels.

Based on the IMF’s best estimates, there is little prospect of many European countries returning to balanced budgets any time soon. Given the toxic conjunction of high cost of funding, low growth and high starting level of debt, it is near impossible for these countries to contain the spiral to a restructuring of their debt or default.

The difficulty of managing outcomes is evident. ECB President Jean-Claude Trichet told the Financial Times on 23 July 2010:

Given the magnitude of annual budget deficits and the ballooning of outstanding public debt, the standard linear economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable. In extraordinary times, the economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors.

When asked for directions, the old joke is that some wise guy pipes up: “If you want to go there, then I wouldn’t start from here.”

The same could be said of rescuing overburdened European countries.

By Satyajit Das


(Satyajit Das is the author of “Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives.”)

1 Comment

Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics, Philosophy

Spanish CDS Spreads Surpass Iceland

This was unthinkable only a year ago: Iceland‘s sovereign CDS spread being closer to the German benchmark than the Spanish. This means that the credit market believes that it’s safer to lend money to a bankrupt little community out in the North Sea rather than to the ninth largest economy in the world.

“The problem is that Greece, Ireland and Iceland all said the same thing shortly before they were forced to receive help.”

Gavan Nolan

This is an apple!

The Markit iTraxx SovX Western Europe hit 190 basis points for the first time, Friday. Spain and Portugal hit record wide of 325 and 515 bp’s respectively. Ireland’s bailout last weekend has caused the credit markets to hone in on the other likely candidates for financial distress; Portugal and Spain.

“Ireland and Iceland have been compared often in the last two years. The two island nations in the North Atlantic are emblematic of the excessive financial debt that precipitated the global recession,” credit analyst Gavan Nolan points out in Markit Credit Wrap.

A recent blog post by Paul Krugman highlights Iceland’s strong performance relative to Ireland since 2009, which he attributed to the Nordic country’s “heterodox” economic policies: capital controls, a large devaluation and considerable debt restructuring.

“The CDS market reflects this view – Iceland’s spreads are trading at half Ireland’s level. Even Spain is now wider than Iceland, a scenario that would have seemed far-fetched at the beginning of this year,” Nolan writes.

Adding: “The dire fiscal state of the eurozone’s peripheral economies is well-established. But the last week has seen the situation deteriorate, with sovereign spreads reaching unprecedented levels today.”

Both Portugal and Spain were forced to issue denials that they needed external support today.

Portuguese government spokesman says that reports of fellow EU members pressurizing Portugal into accepting a bailout are “totally false”, Financial Times report, The passing of the government’s austerity budget – a major point of contention with the opposition parties – did little to relieve the pressure on the sovereign’s spreads.

Meanwhile, Spain did also issuing robust denials of bailout rumours. The country’s prime minister Jose Zapatero says  there is “absolutely” no need for a rescue.

“The problem for both countries is that Greece, Ireland and Iceland all said the same thing shortly before they were forced to receive help. Investors are all too aware of the credibility issue, and this is reflected in sovereign spreads,” Gavan Nolan writes.

More details of a bailout that is definitely happening, that of Ireland, are expected over the weekend.

A report in the Irish Times today that revealed the timetable caused bank spreads to widen sharply.

The report indicated that the EU-IMF mission in Dublin is looking at ways of making senior debt holders share the burden of the bailout, i.e. taking haircuts.

“A fear of such a measure has been bubbling under in the markets for some time now, particularly after the Anglo-Irish Bank debt exchange “offer” was first announced. If does come to fruition then it will be a significant moment in the recent history of financial market,” Nolan notes.

“Senior bondholders will no longer be considered untouchable, and this will inevitably have an effect on bank borrowing costs. On the other hand, if there is no mention of such a measure then it could cause spreads to snap back,” he concludes.


In other words – it’s gonna be another interesting Monday…


Select Your Language:

English * Arabic * Chinese * Danish * French * German * Hebrew * Italian * Japanese * Norwegian * Portuguese * Russian * Spanish * Swedish * Turkish

Comments Off on Spanish CDS Spreads Surpass Iceland

Filed under International Econnomic Politics, National Economic Politics