Tag Archives: Irish Times

Europe In Debt (Part 3): Exit On Main Street

After reading through all three parts of Satyajit Das’ comprehensive analysis of the European debt crisis, it is evident that the final end game is approaching. But what it might be, what might happen or how long it might take to turn the economy around, is anybody’s guess.  Das writes that there is increasing concerns about the fact that the European problems now threaten the global recovery. The most scary part, however, is that our politicians seems to have lost all control over the economy, and that the forces of the financial markets are about to dictate some kind of New World Order.

“In 11 May 1931, the failure of a European bank – Austria’s Credit-Anstalt – was a pivotal event in the ensuing global financial crisis and the Great Depression. The failure set off a chain reaction and crisis in the European banking system. Some 80 years later, European sovereigns may be about to set off a similar sequence of events with unknown consequences. As Mark Twain observed; history does not repeat, but it may rhyme.”

Satyajit Das

Politics now increasingly dominates the economics. Commenting about the EU bailout of Ireland, the Irish Times referred to the Easter Rising against British rule asking: “was what the men of 1916 died for a bailout from the German chancellor with a few shillings of sympathy from the British chancellor on the side”.

An Irish radio show played the new Irish national anthem to the tune of the German anthem.

In Greece, the severe cutbacks in government spending have resulted in strikes and violent protests on the streets of Athens.

“Faced with cutbacks in living standards, Europeans are fighting back. The Rolling Stones’ late sixties anthem has been resurrected in Europe: “Everywhere I hear the sound of marching, charging feet, boy- Summer’s here and the time is right for fighting in the street, boy.”


In many countries, governments, often unstable coalitions, are struggling to pass legislation, implementing necessary spending cuts or tax increases.

“In Ireland, the opposition parties have promised to re-negotiate the bailout package if elected at an election due early in 2011. In Germany, the paymaster and strength behind the EU, Europe’s biggest tabloid Bild asked “First the Greeks, then the Irish, then…will we end up having to pay for everyone in Europe?”

In December 2010, a special EU meeting, convened to discuss the situation, provided a clear pointer to how events might evolve. At the meeting, the German view, set out by Chancellor Angela Merkel, prevailed.

The meeting rejected any attempt to increase the scope and amount of the existing bailout facilities. The E-Bond proposal was quietly shelved. The EU agreed to formalize the ESM through a short amendment to the Lisbon Treaty.

The new facility would be inter-governmental with any Euro Zone member having a national right of veto. The facility was highly conditional, capable of being triggered only as a last resort.

A key element was the requirement for “collective action clauses”, effectively forcing lenders to bear losses. The provision, which must be included in all European government bonds after June 2013, would require the payment period to be extended in case of a crisis.

If the solvency problems persisted, then further extension of maturity, reductions in interest rates and a write-off in the principal would occur. In addition, new bailout funds would automatically subordinate existing debt and have to be paid back first.

Chancellor Merkel’s position reflects the views of the German constitutional court, which endorsed European economic and monetary union prescribed in the 1992 Maastricht treaty only on the basis of the treaty’s no-bail-out provisions.


This influences the need to impose losses on investors.

“It is clear that the stronger members of the EU, led by Germany, have decided to limit future liability in bailouts.

As membership of the Euro prevents large devaluation of the currency, economic adjustment will require reduction of the budget deficit and deflation.

As Greece and Ireland demonstrate, more rigorous deficit cutting may not return the countries to solvency.

The EU proposals implicitly recognize that over-indebted countries cannot sustain currency debt levels. The reduction of the debt burden will have to come through restructuring or default, with creditors taking losses.

“Unless confidence returns rapidly or the EU changes its position, it seems restructuring or defaults by several peripheral European sovereigns may be unavoidable.”

Investor concerns that the Greek and Irish did not solve the fundamental problems may be confirmed.

The safety nets are now seen as unlikely to be large enough to rescue larger countries, like Spain and Italy, if they require support.

Investors will need to take losses

Large volumes of maturing debt mean that the test is likely to come sooner than later. The heavily indebted European sovereign states face $2.85 trillion of maturing debt in the period to 2013. Portugal, Italy, Ireland, Greece and Spain have bond maturities of $502 billion in 2011.

“The financing needs of Greece, Ireland, Portugal and Spain over the last quarter of 2010 and 2011 are Euro 320 billion, rising to Euro 712 billion if Italy is included.”

In addition, private sector borrower in these countries face maturities of $988 billion of corporate bonds and $200 billion of syndicated bank loans over the same period. Likelihood of low economic growth, failure to meet IMF plan targets, further banking sector problems and credit downgrades exacerbate the risk.

If Europe muddles it way through the refinancing crisis, then the expiry of existing support facilities in 2013 and the changed regime of the ESM poses new risks and may continue the instability.


A Faraway Continent

In the prelude to World War 2, British Prime Minister Neville Chamberlain dismissed the German occupation of Sudeten arguing that it was “a quarrel in a far away country between people of whom we know nothing.” North American and Asia have been bystanders as the European crisis developed.

“Increasing concerns are evident, as European problems now threaten global recovery.”

China, which contributed around 80% of total global growth in 2010, has expressed growing concern about the problems in Europe.

Trade between China and the EU, its largest export market, totals around $470 billion annually, contributing a trade surplus of Euro 122 billion for China in the first nine months of 2010.

Any slowdown in Europe would affect Chinese growth. China is also a major holder of Euro sovereign bonds, standing to lose significantly if problems continue. China has indicated preparedness to use some of its $2.7 trillion of foreign exchange reserves to buy bonds of countries such as Greece and Portugal.

“A slowdown in China would affect commodity markets, both volumes and prices, and commodity exporters such as Australia, China and South Africa.”

Minutes of a 7 December 2010 from the central bank of Australia, one of the world’s best performing economies, indicated increasing concerns about developments in Europe.

A continuation of the European debt problems, especially restructuring or default of sovereign debt, would severely disrupt financial markets.

Losses would create concerns about the solvency of banks, in particular European banks. In a repeat of the events of September 2008 (when Lehman Brothers filed for bankruptcy protection and AIG almost collapsed) and April/ May 2010 (prior to the bailout of Greece), money markets could seize up, as trust about the ability of parties to perform contracts evaporated.

In turn, this volatility would feed through into the real economy, undermining the weak recovery.

“Unless resolved, the European debt problems will affect currency markets and through that channel the global economy.”

Any breakdown in the Euro, such as the withdrawal of defaulting countries or change in the mechanism, would result in a sharp fall in the new currencies. In turn, this would, in the first instance, result in large losses to holders of debt of those countries from the devaluation.

Depending on the new arrangements, the US dollar would appreciate abbreviating the nascent American recovery.

This may compound existing global imbalances and trigger further American action to weaken the dollar.

Further rounds of quantitative easing are possible, setting off inflation and de-stabilizing, large scale capital flows into emerging markets. In turn, the risk of protectionism, full-scale currency and trade wars would increase.

A breakup of the Euro would adversely affect Germany, which has been growing strongly.

A return to the Deutschemark or, more realistically, an Euro without the peripheral countries may result in a sharp appreciation of the currency, reducing German export competitiveness.

As the Australian central bank noted in its December 2010 minutes: “… the deterioration in the situation in Europe over the past month had increased the downside risks to the global economy. How this would ultimately play out, and the implications … were difficult to predict. It was possible that conditions could settle down, as they had after the episode of financial instability in May. Alternatively, an escalation of the current problems was not out of the question. If this prompted a fresh retreat from risk-taking in global financial markets, it would probably have more impact … than any trade effect.”

The End Game

Events since the announcement of the bailout package in early 2010 have been reminiscent of 2008.

Then, the optimism following bailouts of Bear Stearns and other troubled American banks produced premature.

The promise of China to purchase Portuguese bonds is similar to the ill-fated investments of Asian and Middle-Eastern sovereign wealth funds in US and European banks.

Eventually with each successive rescue and the reemergence of problems, the capacity and will for further support diminished.

The EU rescue of Greece and Ireland are also reminiscent of US attempts to rescue its banking system, with more and more money being thrown at the problem. The strategy was defective, preventing the creative destruction required to restore the system to health. The actions may have doomed the economy into a protracted period of low growth, laying the foundations for future problems.

At the time of the Greek bailout, the real question was: “If Euro 750 billion isn’t enough, what is?” Increasingly, markets fear that there may not be enough money, to solve the problem painlessly.

In 11 May 1931, the failure of a European bank – Austria’s Credit-Anstalt – was a pivotal event in the ensuing global financial crisis and the Great Depression.

The failure set off a chain reaction and crisis in the European banking system.

Some 80 years later, European sovereigns may be about to set off a similar sequence of events with unknown consequences.

As Mark Twain observed; “history does not repeat, but it may rhyme.”

By Satyajit Das

eurointelligence.com

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


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Ireland Applies For Bailout – IMF Plans Dramatic Spending Cuts

The Irish government will Sunday ask for the Cabinet’s approval of a financial bailout from the EU and the IMF, according to finance minister Brian Lenihan. The size of the emergency loan is still unknown. Irish financial politician Michael Noonan predict a dramatic call for spending cuts – all over the board – from the IMF.

“They’ll be looking for the dropping of programmes and a totally new way of delivering services to the public which will cost less with fewer people.”

Michael Noonan

Prime Minister Brian Cowen of Ireland

As the second EU member now prepares to be bailed out of its financial problems by the European Union and the International Monetary Fund, the IMF is getting more worried than ever and are planning a total spending overhaul.

Irish finance minister Brian Lenihan confirms that a formal application for an emergency loan from the EU/IMF is being drawn up.

The Irish Times reports that the Irish government will seek the Cabinet’s approval for the loan today, Sunday.

Following several days of negotiations with IMF/EU officials in Dublin, Mr. Lenihan says he would recommend that Ireland applies for an unspecified bailout loan.

Brian Lenihan

The minister also says he reviewed the negotiations last night and decided that the time was right to make an application for loans for both the State and the banking system.

In an  interview with RTÉ Radio Brian Lenihan says: “I will be recommending to the Government that we should apply for a program and start formal applications.”

He declined to be drawn on the exact size of the loan. When asked about the scale of the loan, Mr Lenihan confirm that the figures would be “tens of billions,” however  “nowhere near” the EUR 70 – 80 billion as indicated by economists and commentators.

The Irish minister points out that the interest rate charged on the loan has yet to be agreed on, but it will be signficantly lower than the rate currently available to the Government on international bond markets.

Mr. Lenihan also admits for the first time that the nation’s banks has become a too big a problem for the country to resolve on its own.

“The key issue all the time for the Government is to ensure that we do not have a collapse of the banking sector,” he says.

The euro zone finance ministers will conduct an emergency conference call Sunday evening to consider the Irish finance minister’s declaration.

According to The Irish Times, things are now moving quickly, and some believe the European authorities may seek to finalize a decision before the markets opens on Monday morning.

Predict Dramatic IMF Reform

In an interview with the broadcaster RTÉ’ earlier this week,  Fine Gael finance spokesman Michael Noonan, said that the IMF is planning a “fundamental restructuring of expenditure.”

Fine Gael is Ireland’s second largest political party, member of the European People’s Party – European Democrats Group and with representatives in the EU parliament.

The International Monetary Fund want “fundamental restructuring of expenditure and that’s where they’ll dictate, rather than on the specifics of the cuts”, the Fine Gael finance spokesman says.

“It’s not like slicing a salami or cutting the end off a cucumber,” Noonan says, adding that the IMF “wouldn’t probably specify a cut in the minimum wage but they’d say you have to get your labour market working properly.

“You have to do like they’re doing in the UK and ensure that work is always more valuable than welfare. And by setting the headlines and by indicating serious expenditure restructuring in a certain area the Government implementing has very few options.”

He believe a similar approach will be chosen to reform the public service sector.

The IMF had no interest in “taking a few civil servants out” here and there. “They’ll be looking for the dropping of programmes and a totally new way of delivering services to the public which will cost less with fewer people,” he says.

Mr. Noonan also predicated a “very dramatic” announcement shortly by the IMF, based on the way they operated in other countries.

He believe the first line of intervention by the IMF and other EU institutions would be the banking system rather than the government’s four-year budgetary plan and restructuring,  “which could be done very quickly,” and will be dealt with before anything else, The Irish Times writes.

He suggest the IMF might follow the “good bank/bad bank” formula used in the US where the good bank traded and took deposits and bad bank took the liabilities.

“It also took the creditors who had lent them money with senior debt and they had to work out their situation over years to get what they could out of it,” Noonan points out.

Last week Michael Noonan made the following statement in the Irish Dãli (parliament/House of Representatives):

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Ireland: "We Have Surrendered Our Sovereignty"

The Irish-EU bailout talks in Brussels have really upset the Irish people, at least the people of The Irish Times, who writes in an editorial Friday that the country now have surrendered its sovereignty to the European Commission, the European Central Bank, and the International Monetary Fund. Others call for prime minister Brian Cowen to resign.

“Politicians should certainly share some of the blame for Ireland’s ignominious position.”

Gavan Nolan


The Irish government has pledged to publish its four-year budget plan early next week as talks continue with IMF and EU officials in Dublin over a rescue package for Ireland, running into tens of billions of euro. Commentators call the whole thing a “shame,” while prime minister Cowen rejects the calls for his resign.

The dozen-strong IMF delegation includes several banking experts who are taking part in the discussions with more than 20 officials from the European Central Bank (ECB) and the European Commission and Irish officials at various locations in Dublin.

Prime minister Brian Cowen said Friday the talks were “going well in terms of being open and constructive,” saying the Government was conducting the talks “in a way for which the best outcome for Ireland can be achieved.”

Mr Cowen also rejected Opposition calls for him to resign, The Irish Times reports.

“The Government has a job to do here. We have a four-year plan that we are finalising which we are required to do,” he said. “We have a Budget to bring forward on 7th December. We believe we have a majority for that Budget and we have a job to do in relation to ensuring that the present issues affecting the euro, and as it is affecting Ireland, are resolved,” he says.

The Irish Times, however, makes a devastating attack on Cowen and his government in an editorial Friday morning.

“There is the shame of it all. Having obtained our political independence from Britain to be the masters of our own affairs, we have now surrendered our sovereignty to the European Commission, the European Central Bank, and the International Monetary Fund,” the newspaper writes, referring to the impending bailout – or loan, as the government would prefer to call it.

Prime minister Brian Cowen, fighting for his political life, commented: “I don’t believe there’s any reason for Irish people to be ashamed and humiliated”.

The sight of the IMF delegation arriving in Dublin have left many with mixed emotions.

“While politicians should certainly share some of the blame for Ireland’s ignominious position, it is the banks that are viewed as the prime instigators of the country’s slump,” credit analyst Gavan Nolan writes in Friday’s Weekly Credit Wrap from Markit.

The cost of supporting the sector has pushed Ireland’s budget deficit to a projected 32% of GDP this year.

Anglo Irish Bank is now 100% owned by the state and Allied Irish Bank is approaching that status.

“The latter bank posted an interim trading statement today, and it confirmed what the markets had feared. AIB has haemorrhaged EUR13 billion euros in customer deposits since the start of the year,” Gavan Nolan notes.

“This wasn’t a great surprise given the deposit withdrawals reported by Bank of Ireland and Irish Life & Permanent earlier this week. But it underlined the dependence of the Irish banks on funding from the ECB, a fact that is integral to the pressure being placed on Ireland to accept external assistance.”

AIB’s subordinated bonds dropped sharply after the news.

Subordinated debt was already falling in value following the “yes” vote for Anglo Irish’s debt exchange. This vote wasn’t for the exchange itself but a change in the terms that will allow the exchange to proceed.

Prices for lower tier 2 bonds were declining across Irish banks and elsewhere in Europe amid fears that such punitive exchanges could be implemented in other countries.

“It might be asked why bonds are being used as an indicator of sentiment rather than CDS. The derivative is often more liquid than the underlying bonds and thus more reliable. Often, but not always,” Nolan points out.

The chart above shows the number of subordinated CDS daily quotes received by Markit’s parsing service over the last few months.

It is clear that there has been a marked drop in recent weeks, particularly in AIB.

In truth, the Irish banks have never been among the most liquid in Europe.

But all three banks now have Markit Liquidity Scores of “4”, the second worst ranking.

“Liquidity has evaporated in tandem with the banks’ credit deterioration,” Gavan Nolan comments.

The bonds, on the other hand, paints a different picture. The number of weekly quotes for the three most liquid subordinated bonds issued by the banks has been on the rise in recent weeks.

“All have Markit Liquidity Scores of “1”, the highest ranking. This indicates that trading activity is centred on the bonds and in this case therefore they are better indicators of sentiment than the CDS,” Nolan writes.

But it’s the opposite for the Irish sovereign, which has highly liquid CDS.

Reports suggest that the EU/IMF delegation will reach an agreement with the government next week, according to Markit.

But the weekend will no doubt be a maelstrom of rumours and comment from undisclosed sources about the government’s four-year plan, which promises yet more pain for the Irish people.

“The soul-searching has just begun,” Gavan Nolan concludes.

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