Is the Ireland Bailout About to Become Bear Redux?

Not being an expert in either the Lisbon Treaty or the rules governing the ECB, I’m restricted in my ability to interpret an article in the Financial Times and the underlying position paper at the ECB on the legality of the Irish bailout. The Irish finance minister asked for a reading on the “draft law”, which is the Credit Institutions (Stabilisation) Bill 2010. There is a certain amount of grumpy harrumphing in the ECB response, namely, that it should have been consulted earlier and its preliminary reading has been made in more haste than it would like.

Regardless, it does not take a lot of expertise to get the drift of this gist:

In particular, the ECB has serious concerns that the draft law is insufficiently legally certain on a number of critical issues for the Eurosystem. For example, problems of legal uncertainty relate to the impact of, inter alia, Article 61 (effects of orders on certain other obligations) of the draft law on the rights of the Central Bank, the ECB and possibly other central banks within the ESCB, the scope of collateral rights of central banks given as security against ELA, as well as other issues. The ECB would expect that nothing in this Act would affect operations, rights or entitlements of the Central Bank or the European Central Bank, or any other central banks within the ESCB.

The FT reads the big issue as being the adequacy of collateral for lending:

The ECB’s concern is to ensure it holds enough collateral of sufficient quality to minimise its exposure were some of the funds it provides not paid back. The paper is the latest manifestation of the ECB’s worries about the risks it is carrying as it battles the eurozone’s mounting debt crisis.

This too should hardly be a surprise. The root of this wee problem is that central banks have taken to pretending that when banks keel over, all that is happening is a wee liquidity crunch and a bit of attendant market panic. Supply a lot dough and this will pass.

But as we have said from the get go, the rolling financial train wreck is at its root a solvency crisis. That means that the assets are worth less than the liabilities. So if you are going to preserve bondholders from taking losses (which had become the bizarre purpose of all these rescue operations, when bondholders are risk capital), and you get liquidity to do so from your friendly chump central bank, if you keep the game going long enough, you will quickly run out of good assets accurately priced for that central bank to lend against. The central bank will have to lend against overvalued assets. It’s inherent to this model.

But the embarrassing inquiry from the Irish, which is a bit like Toto pulling back on the curtain to expose the great Oz as a balding, short plump man, is that it also suggests that the Irish bailout as now structured might need to be retraded. If so, this could wind up being Bear Stearns redux?

Remember why that deal went from $2 a share to $10 a share? Because some hasty drafting resulted in an error which meant the contract had to be reopened. Now Bear management was mighty unhappy over the pricing of the deal to begin with, and being Wall Street types, they knew how to play the mistake to maximum advantage.

By contrast, the Irish knuckled under to the IMF/ECB/EU onslaught faster than they might have (they had wanted the rescue to be limited to the banks, and not to become a sovereign bailout). So even if this mistake leads to a renegotiation, it is not clear the Irish officialdom has the intestinal fortitude to exploit the opportunity as fully as they might.

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  1. Maju

    A key issue is what will happen in the elections early next year. The bailout-trap will be a major issue and is clearly going to take a major toll in the governing Fianna Fáil and its Green allies. However I have not the least clear what would major opposition parties (Fine Gael, Labor) do if they win (as it’s likely), so my only hope is that the Sinn Féin, which are known as honest and solidly in the Left and the Irish sovereignty camp, capitalize most of the discontent.

    Unlike Iceland, it does not seem to me that there are sufficiently brave politicians in Ireland (other than the Sinn Féin). But I may be wrong. I hope to be wrong. I think that Ireland deserves better than this Euroscam but, of course, Ireland must demonstrate it deserves better by choosing the right people to repeal the bailout-scam.

  2. Hubert

    I understand much less about the details.
    Just the big picture: Ireland is still a sovereign state. It can always credibly hint at default and thereby renegotiate the current or the next bail-out. It is unclear to me how far it would be “sanctionned” in case of default. They might have to leave the Eurozone, and, less probably, leave the EU. Bear Stearns had a legal opening to the deal which Ireland does not even need, though a pretext like this is always wellcome.
    I do not understand why commentators give so much significance to the details of these “Bailout-Deals”. The next one might already be discussed.
    I have no idea about Irish politics but in my view the Debtors cannot be held to pay back.
    That goes for Ireland and so much more for Greece. They had a boom, a party, a big fraud, whatever – they will not pay back short of military occupation which looks impossible to me. The assets are either not there or well hidden.
    So what might happen if the Irish play hardball? Best guesses ?

    1. Captain Teeb

      My best guess: the ECB bails out the bondholders directly, perhaps by buying up their impaired Irish paper (or lending against it, as in TARP). This seems to have been the real goal all along; putting in the Irish state as middleman is merely a fig leaf to cover the true nature of the deal (again, like TARP and the other alphabet-soup facilities).

  3. Bruce

    Why is it “bizarre” that the goal has become to protect senior bondholders? If they didn’t draw a firewall there, the bondholders such as other banks, insurance companies, and pension funds, might themselves become insolvent.

    The whole financial system is a giant CDO squared.

    1. Yves Smith Post author

      If the losses are deep enough to hit senior bondholders, the impulse IS bizarre. Senior bondholders of banks are risk capital.

      The IMF put out a study of 124 banking crises. The conclusion is clear. Extend and pretend results in bigger ultimate losses.

      1. Paul Repstock

        Yves, Yves. You know it isn’t the size of the loss that matters, but rather, who would be suffering the loss.

  4. sean

    It was revealed on Irish radio yesterday that whilst the IMF were happy to negotiate a writedown for bank debt guaranteed by the Irish State the ECB negotiators went ballistic.The Irish negotiaters caved in immediately.

    Irish politics are hopelessly corrupt and those who live there recognise our political system is more akin to a stereotypical third world failed state.The Irish political system is beyond redemption.It cannot cope with the reality it now faces.

    As regards the ECB it should be noted it has sought additional capital.Its base is just over 5.5 billion euros.It has effectively lent Irish banks 130 billion euros by taking their worthless assets onto the ECB’s balance sheet.
    Now that kind of lending ratio was nt even achieved by the now defunct Bear Stearns.

    1. Swedish Lex

      I presume that you reside on the Green Island. What are the odds that a new coalition government will be elected that will have a radically different mandate from voters? Are all parties corrupt in the same way, i.e. hand in hand with the banks and the property developers, or does the political corruption also go in the other directions? Is there enought angst in Ireland for voters to vote through a “go rogue” party (Sinn Fein?)?

      1. Swifts Ghost

        Is there enought angst in Ireland for voters to vote through a “go rogue” party (Sinn Fein?)?

        A good question that lot of people are asking.
        Polling suggests there may be the possibility of a Sinn Fein/Socialist/Independent Left coalition following a election next March.
        Sinn Fein won a recently won a seat in a by election that had been a safe FF saet for a couple of generations. A newspaper report yesterday suggested that a lot of alienated FF supporters would switch to Sinn Fein rather than other ‘establishment’ parties.

        Whatever the result, it is a safe bet that the current FF/Green coalition is going to be decimated.

  5. M.G. in Progress

    I still contend that there are a number of “bad banks” around particularly in Ireland. Other banks in the Eurozone are exposed to sovereign bonds of PIIGS countries in such a way that they risk becoming “bad banks”. The ECB itself is at risk becoming a “bad bank” if it continues to hold bonds of PIIGS…Can we stop this Ponzi scheme (bad banks – governments – bad banks) and get appropriate haircuts for those who deserve it having made wrong investments?

  6. Jim the Skeptic

    From the Post: “The root of this wee problem is that central banks have taken to pretending that when banks keel over, all that is happening is a wee liquidity crunch and a bit of attendant market panic. Supply a lot dough and this will pass.”

    Our high priests make the same assumptions about the US’s banks and they are all wrong. What has happened to the faith in capitalism? Our leaders are acting like third world dictators.

  7. sean

    The next government will more than likely be a coalition of FG and labour parties.
    As I said above,the Irish political system is beyond redemption and the election of FG/Labour is a case of tweedle dum tweedle dee.
    These parties have agreed in principle with the IMF/ECB ‘bailout deal’.

    Whats coming through more and more to those of us who live in Ireland is the loss of faith in all political and associated institutions.
    Organisations in civil society where ordinary people sought solace in past troubles are also discredited, such as the Church.
    When austerity measures kick off with full force expect Ireland to be in the vanguard of countries ripe for radical,extreme politics.There is nothing else to fill the void and there is no hope amongst the people.

  8. F. Beard

    But as we have said from the get go, the rolling financial train wreck is at its root a solvency crisis. That means that the assets are worth less than the liabilities. Yves Smith

    The fractional (fictional) reserve banks CREATE so-called assets (debt) when they CREATE new temporary money (credit). And since the principle of the debt is created but not the interest then some of the debt may be impossible to pay particularly if the banks stop lending.

    So our money system consists of temporary money backed by instantly created “assets” which in aggregate are not sound. And this rickety system is backed by the Fed and Treasury thus endangering the whole economy.

    And then there is the moral question of theft of purchasing power as the new loans are made, the cheating of savers of honest interest rates, the boom-bust cycle, Depressions and the need for socialism for the victims. And the last big Depression caused WWII and 50-86 million dead.

    We can’t do better than this for a money system?

  9. Allen C

    “Because if you rob people of their identity. If you rob them of their democracy, then all they are left with is nationalism and violence.” – Nigel Farage

    Perhaps the politicians will begin serving their electorate once more than a few are jailed for treason.

    The ultimate shareholders here are the Irish peoples. Like Iceland, the terms are subject to change. Payback of sovereign debts are ultimately voluntary – Unsecured notes with an implied restructure clause.

    I forecast a marked increase in Brady type bonds.

  10. brian

    As a northerner i am struggling to say this, but i hope sinn fein are the next negotiators sent to talk to the ECB. A bunch of murderers and bombers are exactly the people to talk with the ECB. I would like to be a fly on the wall during those talks.

    also, this is amusing if NSFW

  11. paul quigley

    Swedsih Lex

    ‘Sounds like only Guiness will help’

    Nope. I am not anti-alcohol, but Guinness will not help. We already have a serious problem with violent drunken marginalised teens. Many are moving on to heroin and cocaine.

    It’s most unlikely that Sinn Fein will get enough seats to join the next government, but they are probably the only party which can represent people who have given up on(or never saw the purpose of) voting.

    Emigration is the traditional solution when the Irish economy fails. In the absence of such opportunities, civil breakdown is a real risk.

    1. John Ockels

      To where would the Irish immigrate this time? What emerging economy in the world is needing millions of additional workers to empower its take-off?

  12. greg

    F Beard quoted:

    “But as we have said from the get go, the rolling financial train wreck is at its root a solvency crisis. That means that the assets are worth less than the liabilities.” Yves Smith

    And said:

    “The fractional (fictional) reserve banks CREATE so-called assets (debt) when they CREATE new temporary money (credit). And since the principle of the debt is created but not the interest then some of the debt may be impossible to pay particularly if the banks stop lending”.

    The ECB doesn’t get it. The more they lend the more is owed. And, because of interest, what is owed will always be more than what money is in the system. Higher interest merely hastens the day of reckoning, as it gradually becomes clear to all that the debtors are hopelessly in debt to the creditors, and that this situation is not natural, but has come about due to manipulation of the monetary system by the creditors, by the banks.

    It is fraud and theft from the start, and it is only a matter of time before more and more people realize they’ve been systematically cheated.


  13. disgruntled

    Yves, Swedish Lex.

    Irish politics has become entirely unpredictable. Anyone from here, and who’s used to the system, can give a probable outcome, from tweedle dum to tweedle dee and all that. But it’s really much more volatile than that. The segment of the electorate growing fastest is the undecideds. There is a large vacancy in the mind of the population that could be filled from any direction. And to be honest, I think by and large, for all the cronyism and corruption, the political system in a weird way reflects the population.

    At first, I didn’t know what to make of the governments financial stability bill, but you know in a strange way it fits. First look at Labour and the left. Labour make noises of support for the ECB/IMF deal on the one hand, and then refute it on the other, whilst Sinn Fein are doggedly sniping at them (they’re hard-line on this). Then there’s Fine Gael, whose support has been rising in the polls recently. But despite what “serious” commentators say, about this being due to their “serious” proposals and “responsible” politics, the truth is a lot more prosaic. They’ve recently learnt to be present and yet say nothing at all. They’re making smart soundbites and that’s it. Most people have a general understanding of their politics, but Fine Gael have decided to stop scaring them so often.

    So the two main opposition parties are either saying one thing and then another, or in fact, nothing at all. They’re both making lots of noise, sound and fury, little else.

    Now, to this mix: Ireland has made a strategic commitment to Europe. There’s a reason referendums were re-run when the populace voted against both Nice and Lisbon. Add a dash of corporatism, the insanely important multinational sector, the legitimate desire for a strong currency, etc, etc, and a basically ultra conservative mindset (not to be confused with old fashioned conservatism, but a more local variant of “we are where we are”, ie. don’t rock the boat – and yes the Irish people are like that too). Most people here have a very dignified view of the world. As I’ve said before, we don’t like making a song and dance about things (unless of course you mean literally song and dance).

    And this is it. Everything tells us to hold course. It’s strategy, it’s the basic way we do things. But to borrow from Yeat’s, “the centre cannot hold.” We’re going bust and not only do we know it, but, hundreds of thousands are personally experiencing it. Hundreds of thousands will either leave or are at least contemplating it. The country cannot survive that way. We’ve been here before, so many times its just not bloody funny. And each time one thing has happened: a change in course.

    The ground work is there: the disillusionment with the european body politic. When asked we have said no to Europe the last two times and only a massive campaign of fear and bribery was used to reverse those decisions. We now know that it made no difference whatsoever. Our fears have been realised anyway.

    So to get to the point. We have a government party which considers itself to be one and the same as “the people,” and which the people are about to politely tell to go and get stuffed. We have a cavernous space opening up, full of ambiguities and people who speak with both sides of their mouths. We are flirting with ideas, thoughts, what ifs, courting possibilities. And that’s why this bill makes sense. This is a tease. It appeals to that space. Allows for the possibility to do something. It’s a draconian piece of legislation from what I understand. The most centralised power ever awarded in this state. And they’ve brought it in just before an election they’re not just going to lose, but get destroyed in!?!

    It must be mighty tempting to the current government and if they don’t use it in the manner in which your post suggests then its there for the opposition to use and for which they can claim credit(as they see it anyway). Whether the next government will use it or not, (I’d normally say no). But we’re going bust and we know it. Reticence ain’t always spinelessness.

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