In negotiations, understanding where you have leverage relative to your counterpart is key. Ireland appears to be engaged in a quiet staredown with the EU, evidently with the objective of securing a rescue of its banks rather than its government.
In case you managed to miss it, Ireland is in the midst of a long running budgetary crisis that has reached an acute phase. The implosion of a real estate bubble has left the country with banks up to the gills in bad loans. The government set up a “bad bank” entity, and the commitments per taxpayer, which were over 25,000 euros per taxpayer as of July, just keep rising. Deep budget cuts to meet eurozone fiscal deficit targets have put the economy in freefall, with nominal GDP falling nearly 20% and unemployment at 13%.
The immediate trigger for panic over Ireland was Merkel’s announcement that bondholders would have to take their lumps in any Eurobailouts. That immediately put Irish and other periphery country bonds under pressure. And although Merkel was beaten a bit back into line (all bondholders will supposedly be protected through 2013), the damage was done. As Richard Smith noted two weeks ago:
Since the Irish budget is fully funded for a few more months (ex any revenue surprises, or God forbid, further bank loan writedowns), they can in principle trundle along like this until their date with destiny in Q2 2011, when they have to raise funds again. But somehow it’s hard to believe that that is going to be the way things go. We will see if the budget gets thrown out or not; or the government. It will be close, on either count. Either eventuality brings forward the timetable for the Irish crisis proper, but it’s coming, one way or the other…
The folk close to the action think this yield blowout is long-only investors, getting the hell out. But which ones? Macro Man thinks it is the non-Eurozone holders of the less reliable Euro sovereign debt; plausible, for all the reasons he gives.
In a related wrinkle, the Eurobanks have been lightened up their exposures to Ireland (banks debt in particular) via the ECB.
There was considerable pressure on Ireland to start negotiating a rescue package over the last weekend, which the Irish government pointedly ignored. But an EU rescue would result in further curtailment of national sovereignty, as well as taking on debt that would be well nigh impossible to restructure down the road. Hence the Irish officialdom continued with Plan A, which was to stick with their normal budget timetable. Whether you see the Irish stance as sang froid or cluelessness, it has confounded the Eurozone finance leaders.
The ante in this high-stakes poker game are rising. Irish banks are in the throes of a slow-motion bank run. Per the Financial Times:
Were it not for the European Central Bank’s emergency liquidity programme, many banks would have virtually no funding at all. It was this kind of liquidity evaporation that lay behind the collapse of the biggest failure of them all, Lehman Brothers. Over the past two months, Ireland has overtaken Spain to become the most dependent on ECB funding of the eurozone banking systems….
At the same time there has been an outflow of customer deposits….
“You don’t see people queueing around the block but it seems there’s a silent run on corporate deposits,” says Hank Calenti, credit analyst at Société Générale.
Bank of Ireland admitted last week that it had lost €10bn of corporate deposits – around 12 per cent of its deposit base – in a matter of weeks following September’s credit rating downgrades. On Wednesday, Irish Life & Permanent confirmed the trend, admitting to an 11 per cent fall in its customer deposits in August and September.
Both banks said deposit levels had stabilised since then, despite anecdotal suggestions that customers were continuing to desert the Irish banks.
Nevertheless, Brian Lenihan, the Irish finance minister, maintained that the banks had “no funding difficulties”. And narrowly speaking, that’s accurate. The ECB is providing support.
Now one can argue that the some Irish banks are close to tapping out their facilities. But as the old saying goes, if you owe the bank $1000, it owns you, but if you owe $100 million, you own it. Is the ECB really willing to deny an Irish bank access to credit? The failure of one bank could easily take down all Irish banks, send Irish government bond yields skyward, and spike up yields in other at-risk Eurozone countries. And such heavy-handed action would likely send political shock waves through the Eurozone.
If the Irish government understands the leverage it has, it will refuse to accept a government rescue and will instead press for more formalized support for its dud banks. There are signs that things are moving in that direction. From the Guardian:
“Despite a large range of measures adopted by the government, Ireland is a small country and, if the banking problems in the country are too big for this small country to manage, Europe is making it clear that they will help and help in every possible way to secure the system because we are part of the euro system,” Lenihan told Irish radio.
Ireland has agreed to let an EU-IMF-ECB delegation perform an “urgent assessment”. Bloomberg depicted the effort as working on “possible aid for Ireland’s debt-laden banks.” EU and UK leaders are signaling a great deal of anxiety about wrapping up a deal in the next few days.
But there is also the possibility of an outtrade. The rescue delegation will not doubt want to bailout the banks through the Irish government, while Ireland will want to preserve what remains of its sovereignty. There are lots of opportunities for missed signals in high-stakes, short timetable negotiations and the Irish do not appear to be assuming the usual prostrate position of the about-to-be-rescued. The intent no doubt is to cobble together something announcement-worthy by the end of this weekend, but the two sides may find they are far apart on what the solution should look like.