The Irish Mess (IV)

The domestic politics of Ireland are still on a tightrope. Their coalition government, which had has been studiously ignoring three empty parliamentary seats, has now been told by the Supreme Court to get on with it and hold by-elections for one of them, which has been unoccupied for a scandalous 18 months.  The by-election is to be held before the December 7th budget vote; the budget is going to be another slasher, even more than the previews suggested, which isn’t going to please a remarkably patient crowd of electors all that much, despite efforts to hide the full impact by way of some accounting wheezes. One of the Government’s supporting MPs just upped and resigned this week, so now there is a fourth vacant seat. The government has a three-seat majority (when I looked a couple of weeks ago, it was two; there must be a spot of horse-trading going on, or maybe my sources can’t count).

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.

In the mean time, international politics and the bond markets aren’t running the Irish government’s way, at all. Merkel’s line in the sand exacerbated the freakout in the Irish bond markets; and in the Portuguese and Spanish ones, too. At last Ambrose Evans-Pritchard (last four paras here) and Charles Butler sorta agree about something to do with Spain. That is a portent of the apocalypse, if ever there was one.

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.

Which leaves the Eurozone holders of the less reliable Eurozone debt in a very “interesting” position. A quick look at the BIS quarterly report for September 2010 (p16) shows that:

As of the end of the first quarter of 2010, the foreign claims of UK, Japanese and US banks on the public sectors of Germany and France represented 67%, 65% and 57%, respectively, of their foreign claims on all euro area public sectors (Graph 4, centre panel). By contrast, that fraction was equal to only 27% for euro area banks. The ordering of these shares is completely reversed when one focuses on reporting banks’ holdings of higher-yielding euro area government debt (Graph 4, right-hand panel). Euro area banks’ claims on the public sectors of Greece, Ireland, Italy, Portugal and Spain represented close to 54% of their overall holdings of euro area government debt. By comparison, these fractions were equal to 27%, 23% and 20% for US, Japanese and UK banks, respectively.

Got that? The big non-Eurozone holders of Euro debt really like the good stuff (French and German bonds). The big Eurozone holders (French and German banks) really like the, umm, less good stuff. Details in the table; note also the UK banks’ fondness for Irish private debt. The exposures of our wards of state, HBOS and RBS, will loom large in that total.

The BIS make some good points in their discussion of possible reasons for this phenomenon, but skate all round one really obvious one: moral hazard. If the Eurobanks think they will be bailed out, they can just sit back and trouser the extra yield.

Given the size of the exposures, that complacency, if that is what it is, could be a big problem if there are Irish/Greek defaults (which seem to be inevitable) along with the threat of defaults by Portugal and Spain too (which seem less likely to me, but who knows, if we get a bit of a panic going). What is the effect of Merkel’s line in the sand of there is a default or two, or three? A sovereign debt crisis will always catch someone out, and spawn some sort of banking crisis. What steps have been taken to fend that off?

Unfortunately the mechanism that’s been devised, the EFSF, is a bailout fund, and looks decidedly like a bluff, to boot. To fund themselves, the distressed sovereigns

may well have to turn to the European Financial Stability Facility (EFSF) . The headline number here is €440bn, but because of the facility’s structure available funds are likely to be a lot less.

We hear from Deutsche Bank, for instance, that EFSF reps were in London last week presenting to investors, and “clarifying” that the €440bn includes the 20 per cent extra guarantees. That plus a withdrawal by Greece means that the €440bn is already reduced to €428bn. According to Deutsche then, the maximum funding figure is about 100/120 per cent of that, or €356bn. Given that currently 72 per cent of the guarantee volume is covered by triple-A-rated countries, that would imply the EFSF can only lend some €257bn if it is to maintain its own triple-A rating.

But even deploying that €257bn might be a difficult exercise, to say the least.

From Gary Jenkins at Evolution Securities:

Ireland does not have pressing immediate funding needs, with cash holding expected to cover spending requirements until mid 2011. Portugal needs to raise in excess of €30bn of funds in 2011 according to our estimates, with nearly €20bn of redemptions in H1 (bonds and bills). If investor confidence continues to fade, it is probably only a matter of time before one of the more fragile Eurozone countries will need to request the support of the European Financial Stability Fund (EFSF). If this were to happen then the key might be just how much issuance the EFSF would need to undertake. If the amounts involved were significant then the pricing of the securities would be a very delicate matter. Yields too low and you may as well buy Bunds. Slightly too high and it might discourage investors from purchasing the likes of Italian and Spanish bonds. After all, if the yield levels are similar why not buy the German quasi guaranteed debt? This is one reason why the EU would no doubt prefer not to utilise the EFSF, because if they do it will be a very difficult balancing act.

That was Tracy Alloway at Alphaville again (um, fixing some typing; I wouldn’t normally do that, but it’s a key arithmetical fluff). Short version: it is really the French and Germans who will be doing any bailing out, and it will be because of their own banks’ exposures.

It will be interesting to see whether and how Merkel resists the pressure when it really comes to it.

The tightrope is getting crowded: not just Ireland, but really, in the end, the whole Eurozone, is on it; and, given the couplings via debt holdings, public and private, the UK, too.

More uncomfortable watching to come.

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  1. rental_paradise

    ‘It will be interesting to see whether and how Merkel resists the pressure when it really comes to it.’
    Like nationalizing HypoReal, and having the shareholders take a bath while replacing the people in charge? Or semi-nationaling Commerzbank, and replacing the people in charge?

    Though politics plays a role in everything a politician does, Merkel is not exactly a patsy – which just might explain why so much attention always seems focused on just how impractical she is, at least when it comes to firing bankers, changing laws (like hedge fund regulation), or otherwise telling the financial world to recognize that they aren’t really in charge of everything.

    And guess what? If Merkel loses, the winners will be the Greens, the normal socialists, and the really old-fashioned socialists – which is not exactly something the bankers are looking forward to. She will do what she needs to to try and stay in power – and that includes the sort of firmness to pressure from financial power centers that is so easily surrendered to most everywhere else (Sarkozy is also on the way out, but French politics tend to be murkier than German – his successor is as likely to come from his political side as the other – this is not true of Merkel at this point).

  2. Jim Haygood

    Thanks for a very timely report, Richard, as Irish default swaps rise for a ninth day in a row, to a record.

    As you say, Irish and Greek defaults seem to be inevitable. More austerity measures mean shrinking GDP, and a further rise in Ireland’s already unsustainable debt-to-GDP ratio.

    The milling herd of bondholders is pawing the ground nervously, dimly realizing that the ramp they’re being funneled into leads to the slaughterhouse.

  3. DownSouth


    Despite the incessant cant of the insolvency deniers, default or principal reductions are the only resolution to the debt overhang.

    The PIIGS are essentially in the same position as homeowners and state and local governments in the U.S., because they have no sovereignty over the currency in which their debts are denominated. And even nations which have not surrendered sovereignty over their currencies find their options limited—-moves to devalue the currency are more often than not met with countermoves by other nations to prevent the desired devaluation.

    The deluge cometh.

  4. leroguetradeur

    “default or principal reductions are the only resolution to the debt overhang.”

    Yes, agreed. The point in the second para is essentially that it does not help much if you do run your own currency. Yes, you do have another option for the means of default, and that may be better in the sense that more options are better than less. But it still is a default, it still has the consequences of a default.

    You also have to trade off the gain of the additional option against the loss that occurred earlier in being part of a larger currency area. Running your own currency is not a cost free exercise, it costs in transaction costs, which it turn affects economic activity, trade and so on.

    Ireland is going to default, its just a question of when, and even if it ran its own currency it would default too. California and Illinois are also going to default or go into serious austerity, and even if they too ran their own currencies, they still too would.

    I do see that in the Irish situation, they are in a downward spiral, where lack of activity spurs lack of tax revenues. But the underlying fact is, there is no way those loans secured on all that real estate are ever going to be made whole. Just get it over with, get the assets sold off, the debt liquidated, the losses taken, and then you can start growing the economy again.

  5. Siobhan

    Point of information: the Irish government was told by the High Court, and not the Supreme Court, to get on and hold one of the by-elections in Donegal. The date for that election has now been set, November 25th, but the government is challenging the High Court ruling in the Supreme Court. Apparently, this is to get a definitive ruling on the issue of the holding of by-elections and the ability/ right of the courts to make recommendations on the issue.

    Completely agree with what’s been said here. Reaction to the government announcement of €6b in cuts in the December budget has not been favourable with the cost of borrowing hovering around 7.6%. Remains to be seen what will happen when the government returns to the market but it’s not looking too good right now.

  6. F. Beard

    Poor Ireland, fooled into borrowing a strong currency which it now feels compelled to pay back.

    Ireland, you should never have abandoned your sovereign right to issue your own money. Sovereign governments should NEVER borrow money.

    Now, be a good country and default on your debt for the sake of your citizens, and issue your own currency.

  7. sean

    Many here and elsewhere have eloquently defined the reality as Irish taxpayers paying up for the loans made to busted Irish banks and developers by German and French banks.
    The straight jacket of euro membership,a stalled economy,the largest budget defecit of any developed country (32% for 2010),rampant corruption amongst Irish politicians and business elites and the neverending stream of bad news has paralysed the populations senses and intellect.

    Last Sunday the Independent newspaper(largest Sunday circulation)published poll findings one of which was that 87% of people believe we would be doomed if we were out of the euro.
    That to me this is indicative of a population still in denial and wanting to believe the deceit that eurozone membership is in their interest and the bigger lie that the EU,ECB are directing the austerity measures to safeguard their future.(The issue of German and French banks role along with their enforcer the ECB is not mentioned).

    It should be stated again and again until there is a eureka moment that it was German and French banks that lent to Irish banks;The Sovereign which is defined in the Irish Constitution as the people of Ireland had no liability whatsoever for those loans.

    When reality does hit home perhaps those corrupt politicians and business people will face their end as condemned traitors in a second Republic with a newly restored death penalty.
    For anyone living in Ireland knows there is enough energy building in peoples anger to drive such oucomes.

    1. DownSouth

      sean said: “When reality does hit home perhaps those corrupt politicians and business people will face their end as condemned traitors in a second Republic with a newly restored death penalty.”

      That’s exactly what I’d like to see happen in the United States. The death penalty, however, may be too good for these sociopaths. A little trip to North Korea or Syria for some extraordinary rendition might provide a stronger measure of justice.

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