11/2/2013: What's David Hall's Case is Now About?

In light of the recent changes to the IBRC position and the Promo Notes, there can be some confusion around the case David Hall has taken against the Minister for finance. In particular, the confusion can arise due to the claims that we have made a "deal" on the promissory note and in light of the IBRC Bill 2013 provisions (Article 17). Let me try to (speculatively, I must add) shed some light.

The promissory notes were a product of the Credit Institutions (Financial Support) Act 2008 passed by the Dail Eireann on October 2, 2008. More specifically, the Minister for Finance, in allocating capital funds to the insolvent Irish banking institutions (see more of the background on this here: ), relied upon the provisions of the 2008 Act, Section 6. However, article 6.3 of the Act clearly stated that “Financial support shall not be provided under this section for any period beyond 29th September 2010, and any financial support provided under this section shall not continue beyond that date.” Furthermore, the Minister was given such powers (limited by the above date) to appropriate “all money to be paid out or non-cash assets to be given by the Minister… may be paid out of the Central Fund or the growing produce thereof” (Section 6(12)).

Furthermore, to the point of Defense in the case, Article 6(4) of the Act stipulates that “Financial support may be provided under this section in a form and manner determined by the Minister and on such commercial or other terms and conditions as the Minister thinks fit. Such provision of financial support may be effected by individual agreement, a scheme made by the Minister or otherwise.” This section is still covered by the 29th September 2010 cut-off date, but in so far as it covers (potentially) multiannual commitments created before that date but with a maturity beyond that date, it is unclear if this section covers the duration of the original Promissory Notes. Regardless of whether it does or not, the section is constrained explicitly by Section 6(5) which states: “Where the Minister proposes to make a scheme under subsection (4) – (a) he or she shall cause draft of the proposed scheme to be laid before each House of the Oireachtas, and (b) he or she shall not make the scheme unless and until a resolution approving of the draft has been passed by each such House.”

David Hall is claiming that in a democracy and under article 17 of the Irish Constitution the Dail and our elected representatives have the power to appropriate funds from the central fund (which, like all the rest of the Government funds, is made up of receipts and our taxes).

The point here is that David Hall is saying that it is not constitutional that one person, namely the Minister for Finance, or any future Minister for Finance, could spend monies (or future moneys) through issuance of bonds, various securities, even using another Promissory Note without any upper limit being set on such payouts and without any cabinet or Dail approval or vote.

According to David Hall’s case, this constitutes the core threat to the democracy enlisted within his claim. He believes that under the constitution that TD should have to vote on such expenditure and that they cannot give away their constitutional powers.

The fact that the current Promissory Note (and only in relation to IBRC notes) has been changed and eliminated does not alter the risk of future breaches of constitutionality (if David Hall is correct in his challenge) or abuses of the public purse.

11/2/2013: Bailout 3.0 and precedent research

Ireland Bail-out 3.0 (this time more benign than 1.0 - the original Troika lending arrangement, but less benign than 2.0 - the 2011 alteration to the terms of the Troika lending arrangement in the wake of Greek bailout 2.0... I know, one can wreck one's head on this forest of bailouts) has been heralded as a 'historic' achievement.

Here is the original (unedited) version of my paper from 2010 on

1. the necessity of such a deal, which makes me deem the deal to be net positive, and 
2. the volumes of relief that we need (well in excess of EUR4.3-6.9 billion NPV benefit my model estimates the deal will provide over 40 years duration) which makes me deem the deal to be insufficient in terms of relief provided.

Read, again... http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1985617

Note, the title of the book in which this featured as a chapter is What if Ireland Defaults.

7/2/2013: Trading Debt for Cash Flow Relief?

Muy thoughts (quick one between lecturing) on the deal:

As I understand it,

1. We have converted quasi-governmental debt into pure Government bond.
2. Maturity profile is very good - long dated, no restriction on NTMA raising funds at 20 year + 
3. We are gaining some cash flow improvements up front (where they matter most), but 
4. We are not getting a major write down on the debt overall. 
5. Deficit impact is one-off 500mln, that will be absorbed into improvement over 2014 Budget and that's it as it becomes 'repeated measure' equivalent in 2015 and after. 
6. So material saving to the economy is really 500mln and that is at the peak (2014-2015), after that the savings will decline, until finally, around ca 2020-2025 (needs more precise calculations here) the savings will become negative as we will be paying more in interest than we would have been paying before.
7. Additional second order effect is that improved bond markets profile is likely to result in slightly lower borrowing costs over time, but this impact is off-set by the reduced Central Bank revenues remittable back to the Exchequer. 

The deal is not putting any final closure to the Anglo or INBS 'odious' debt, but simply constitutes an extension of the debt. 

It can result in the lower real value of the debt over the period of time, assuming Ireland can issue bonds at negative real interest rates (bond coupons below inflation rate), which is unlikely. 

Neither is the deal reducing the debt overall, which means the deal has no effect on the adverse impact of debt drag on growth. The Government never asked for a debt writedown (reduction in the overall debt levels).

The deal is a net positive, but materially not significant enough.

Basic summary - as expected last night on VinB.

31/1/2013: Summary of David Hall's Case on Anglo Promo Notes

With the latest twist in David Hall's case on IBRC Promo Notes constitutionality, I decided to post, at last, the summary of David's case as was read out (note - this is not an exact transcript, but darn close to it) in the court earlier this week.

Needless to say, I am disappointed with the ruling issued today, in so far as it simply rejected consideration of the merits of the case, and thus, the case remain outstanding.

Here are the main points of the High Court action taken by David Hall against the legality/constitutionality of the IBRC and EBS promo notes that was presented this week in the court by the Plaintiff. I could not attend the defence statement due to ill health.

Please note, I am no legal expert, so will try to offer the below without a comment on the constitutional or legal issues.

Per Plaintiff's presentation, in a statement made by the Minister for Finance to Dail Eireann on the 30th of March 2010, the Minister announced provision of capital support by the State to the Anglo Irish Bank. The announcement referenced capital injection during that week in the specific form of the Promissory Note payable over the period of 10-15 years. The Minister for Finance, therefore, supplied capital of EUR31 billion to 3 financial institutions: ca EUR25.3 billion to Anglo, EUR5.4 billion to INBS (split as EUR5.3bn in Promissory Note and EUR100mln as a Special Investment Scheme) and EUR350mln to EBS (split as EUR250mln in Promissory Note and EUR100mln in Special Investment Scheme).

The Minister for Finance has also provided the Central Bank of Ireland with the letters of comfort, confirming that the Government of Ireland would indemnify the CBofI in the case of any losses arising from the ELA provision to the Anglo, INBS and EBS. The above financial institutions were thus enabled to borrow, using the Promissory Note as collateral, from the Emergency Liquidity Assistance funds (ELA) of the Central Bank of Ireland.

The key point of this is that the Promo Notes and SIS measures were entered into the General Government Deficit in 2010, raising the headline figure to 32% of GDP and adding to the General Government Debt in 2010, however, since the requirement for these payments did not arise until during the course of 2010, none of these expenditures estimates appeared in the forecasts made in Budget 2010 that were prepared back in December 2009. The next point it that the Government, pursuant to Article 28 of Bunreacht na hEireann, prepared and presented to Dail Eireann the 2011 Estimates of Receipts and Expenditure for the year ending 31st December 2011. Payment of the Promissory Notes was contained in Note 6 under 'Non-Voted Capital Expenditure'. Non-Voted Capital Expenditure means that the Dail did not vote on the expenditure.

Key points: The Dail Eireann did not vote in the Promissory Note expenditure in Budget 2010 or Budget 2011.

The case taken is based on the constitutional argument relating to:

Article 28.4.4 of Bunreacht na hEireann: The Government shall prepare Estimates of the Receipts and Estimates of the Expenditure of the State for each financial year, and shall present them to Dail Eireann for consideration.

Article 17.1 of Bunreacht na hEireann: 1. As soon as possible after the presentation to Dail Eireann under Article 28 of this Constittution of the Estimates of receipts and Estimates of expenditure of the State for any financial year, Dail Eireann shall consider such Estimates. 2. Save in so far as may be provided by specific enactment in each case, the legislation to give effect to the Financial Resolution of each year shall be enacted within that year.

Article 17.2 of Bunreacht na hEireann: Dail Eireann shall not pass any vote or resolution, and no law shall be enacted, for the appropriation of revenue or other public monies unless the purpose of the appropriation shall have been recommended to Dail Eireann by a message from the government signed by the Taoiseach.

Article 21.1.1 of Bunreacht na hEireann: Money Bills shall be initiated in Dail Eireann only.

Thus, Bunreacht na hEireann gives to Dail Eireann a constitutional primacy in the area of State finances and mandate the actual, real and continued involvement of Dail Eireann in the appropriation of revenue and/or public monies. Central to the democratic nature of the State is the oversight of public expenditure by the elected representatives of the People who under Article 6 of Bunreacht na hEireann are sovereign and from whom all power is derived.

As Plaintiff stated, the Promissory Notes were created and funds for their financing were allocated by the Minister for Finance, including the related letters of comfort without involving the elected legislators. Furthermore, the issue of letters of comfort purported to appropriate and has appropriated public funds in an unspecified and unlimited amount in relation to the provision of liquidity assistance in the banking sector.

Per key points 1 & 2 above, the members of Dail Eireann did not consider the making of the Promissory Notes and/or the giving of letters of comfort, did not vote on whether or not to make the Promissory Notes and/or grant such an indemnity; and did not mandate or otherwise authorise the Promissory Notes and/or letters of comfort.

Considering that the Promissory Notes and letters of comfort were extended funding commitments over the time horizon of originally envisioned 10-15 years, the making or provision by the Minister for Finance of Promissory Notes, extending over such a long period of time and over such enormous sums of public funds and/or provision of a purported indemnity to CBofI constituted an attack on the democratic nature of the State and was unlawful and is unconstitutional being contrary to Articles 6 and/or 15 and/or 17 and/or 22 and/or 28 of Bunreacht na hEireann.

As I'd say, Bang! Up to 6 articles of Constitution potentially violated by the previous Government.

Plaintiff requested in the case for the Minister for Finance to identify the precise statutory or other legal basis authorising then provision of the Promissory Note. Alas, to-date there has been no response to this request. Two acts potentially can be argued provide such basis: 

-- Credit Institutions (Financial Support) Act, 2008 and/or

-- Anglo Irish Bank Corporation Act 2009

However, per Plaintiff statement in court, neither makes adequate legal provision for the financial assistance of the extent and/or nature and/or duration committed to by the Minister for Finance. Here are the reasons - as argued by the Plaintiff - for this.

Regarding the Credit Institutions Act 2008:

-- In 2010, the provisions of the Section 6 of the Act prohibited the giving of financial support beyond the 31st of December 2015 and from the 23rd of November 2010 beyond the 20th of June 2016. Of course, the promissory Notes extend to 2025 and thus, could not therefore have been authorised by the said Act.

-- The above provisions cannot be construed as authorising the making of Promissory Notes appropriating public monies, absent a requirement for a resolution of Dail Eireann prior to the provision of same having regard to the requirements of Bunreacht na hEireann.

-- The provisions of section 6(1) Credit Insitutions Act, 2008 do not provide for or allow or permit the Minister to make such large scale and long term financial support to a third party credit institution and did not permit for the provision of support equally a sum in excess of EUR31 billion to the Notice Parties herein.

Regarding the Anglo Irish Bank Corporation Act 2009:

-- There is no lawful basis for provision of financial support through the Promissory Notes to continue to 2025 or at all and the making and provision of such Promissory Notes was ultra fires the power of the Minister of Finance with the consequence that the said Promissory Notes are null and void.

-- Neither the 2009 nor 2008 Acts can act to excuse the absence of a resolution providing for Promissory Notes voted upon by Dail Eireann in accordance with Article 17 of Bunreacht na hEireann.

The implications of the case are massive. The Plaintiff actually argues that

-- The Promissory Notes and the associated letters of comfort are unconstitutional and, if that is proven to be the case, these instruments are illegal and have no real validity. 

-- The repayment of the Notes in March 2011 was illegal

-- The swap for direct Government debt of the note in March 2012 was illegal

-- The Minister for Finance actions constitute the unlawful delegation or transfer of constitutional power from Dail Eireann to the Minister.

Beyond this, the Plaintiff case argues that the creation of the Notes was in contravention of the Article 123 of the Treaty of the Functioning of the European Union by:

-- Extending financing from the public purse to third parties (as prohibited by Article 123 (2) of the Treaty) and clarified by the Council Regulation (EC) No 3603/93 of 13 December 1993.

-- Violation of Article 123 in provision by the Central Bank of Ireland of ELA to the IBRC.

-- Absence of lawful basis for the issue of the letters of comfort

The Plaintiff stated in court that in the absence of the Promissory Notes, the Irish Central Bank has accepted that the IBRC is insolvent and that the provision of ELA to an insolvent credit institution is illegal. Thus, the provision of Promissory Notes to the Anglo Irish Bank was an unlawful ruse to create the pretence of solvency so as to enable the provision of ELA. Fighting words these are. But there's more. The provision of ELA was in turn used to repay third party liabilities of Anglo Irish Bank. Further it was intended by the Minister for Finance and by the Central Bank of Ireland that the Irish people would in effect, over the period of the Promissory Notes, repay the ELA on behalf of Anglo Irish Bank. The members of Dail Eireann were expressly removed from and denied any involvement in this decision which was an egregious attack on the democratic nature of the State.

I hope to provide a summary of the State responses to the statement as delivered in court.

1/4/2012: Flightless dodo - the Hunt of Chief Noonan

I am not usually prone on updating my past posts, but the Promissory Notes 'deal' announced last week by Minister Noonan just keeps on giving more and more backlash and analysis. So:

• My original post here.
• Note the updates in the above
• FT Alphaville view here which is broadly in agreement with my view and with links I posted in the original post updates.
• Interesting information coming out of ECB on Minister Noonan's claims that the 'deal' is a part of some 'broader plan' - via the Irish Times, here.

Reiterating my view:

• Promo Notes have been paid, not deferred
• Payment of Promo Notes was originally to be based on Government borrowing cash from the Troika. Under the 'deal' it has been replaced by the Government borrowing cash from BofI
• Payment of Notes under the 'deal' cost us more in new debt and increased deficit in 2012, but will decrease interest payment in 2013 compared to original arrangement. Net effect on interest cost - nearly a wash.
• The 'deal' is NOT (see ECB official statement) a part of any 'broader deal'.
• The ECB are now clearly on a defensive - which means they will be unlikely to support any further 'deals'.

Having gone out with a brave claim to spot a bald eagle soaring in the sky and get a feather for his war bonnet, Chief Noonan came back with a smudgy mud-print of a dodo, a bill for €400mln+, and a promise to go hunting again. Next stop, trading gold for glass beads... oh, they sparkle so nice.

(Obviously - an allegorical analogy. For those rare readers lacking in humor department.)

On a serious note - I find it discomforting and sad that an excellent seasoned politician and a very promising Minister for Finance has been forced into this position of defending the failure. Let's hope his luck (and progress) change in the nearest future.

29/3/2012: Promissory Note 'deal' 2012

Trying to sort out the convoluted 'deal' announced by the Minister today and juggle two kids, plus struggle against the computer on a strike from too many files open is a challenge. I might be missing something, but here's my understanding of the thing.

1. €3.06bn will be delivered not i cash, but in a long-term Government bond of the equivalent fair value
2. We do not know maturity, but 2025 was mentioned before. Ditto for coupon rate, though Prof Honohan mentioned 5.4% coupon.
3. Current pricing in around 88% of the FV, so €3.06*0.88=€3.47bn issuance to deliver fair value. If average  over longer term horizon is taken - that would go up. If yield is higher - that will go up. It is unclear what fees will be involved as the transaction is complicated (see following).
4. As is - at current market pricing, there will be an increase in Government debt of roughly €410 million, plus the cost of transactions.
5. As described above, and as indicated by Minister Noonan, Government deficit will increase by €90mln (approximately: 5.40%*410mln=€22mln plus margin on Government bond yield over interest rate holiday under Promo Notes in 2012).
6. IBRC will receive the bonds and will repo them to Bank of Ireland on a 1 year deal. In other words, Bank of Ireland will buy the bond from IBRC then put it into ECB repo operations. LTRO being now closed, this will have to be normal repo with ECB. Bank of Ireland will repo IBRC-owned Government bond at ECB Repo rate (1%) + 1.35% margin. In effect, margin is the gross profit to the Bank of Ireland on this transaction.
7. Before Bank of Ireland formally approves the transaction, bond will be financed by NAMA against IBRC collateral (now, imagine that - NAMA holds IBRC's assets and has a working relationship with IBRC. IBRC has no collateral that is equivalent to Government bonds - hence it cannot repo anything at ECB. So by definition, the collateralized pool backing NAMA-IBRC repo will have to be stretched). A year later, BofI might reconsider and roll the deal, but one has to assume that the margin will remain either fixed or go up, plus whatever the repo rate will be then?
8. NAMA, as far as I understand, has no mandate to carry any of these operations, thus potentially acting outside its legal mandate.
9. Minister for Finance will guarantee the entire set of transactions, including Bank of Ireland exposure. In effect, Minister will guarantee Government bonds (which is silly), collateral from IBRC, NAMA exposure, Bank of Ireland exposure and so on.
10. NAMA will use own cash to finance the bridging transaction.
11. Having received the funds from the repo, IBRC will remit these to (€3.06bn) to the CBofI to cancel corresponding amount in ELA.
12. Has Net Present Value of the debt been altered? We do not know. We need to have exact data on bond maturity and the coupon rate, plus on overall profile of the rest of the notes to make any judgement here. Any change in the NPV under the above outline (1-5) is immaterial. 
13. The positive factor of so-called 'more flexible fiscal buffer' is a red herring, in my view. The idea is that we are 'saving' cash allocation of €3.06bn this year, making it 'available' for borrowing in 2013. This is rather stretching the reality - the 'cushion' has been pre-provided to us by the Troika deal and is specific to the Promissory Notes. There is no indication that it can be used for any other purposes. Even if it were to be used for any other purpose, it would be an addition to the bond issued, so our debt will increase by the amount we use from the 'cushion'. Furthermore, the deal runs out in 2013 and thereafter no 'cushion' is available. So on the net, we have just paid 400mln increase in debt, plus 90mln in deficit to buy ourselves an 'insurance' policy that should we need 3bn in 2013, we will be able to ask for it from the kindness of the EU and have it for no longer than a year. That's pretty damn expensive insurance policy.
14. The negative factor is that we now have almost 3.5bn worth of extra debt that is senior to the promissory notes it replaced and once it is repoed at the ECB it will be senior to ELA exposure. 
15. Furthermore, this debt is in the form of Government bonds. So suppose we want to return to the debt markets in 2014. We have higher stock / supply of Government bonds (albeit 3.47bn isn't much - just a few percentage points increase) that markets will price in. Higher supply, ceteris paribus, means lower price, higher yield on bonds we are to issue in 2014. 
16. Minister Noonan and a number of other Government parties' members have mentioned 'jobs creation' capacity expansion as the result of this deal. The only way, in theory, this deal can lead any jobs creation is if the Government were to use €3.1bn allocation available for Promo Notes under the Troika deal for some sort of public spending programme. Which, of course, means our debt will increase by the very same amount used.

Brian Hayes on Today FM described the 'deal' (H/T to Prof Karl Whelan) as 'A creative piece of financial engineering.' Presume safely that Brian Hayes has a firm idea that this description is a 'net positive' for the Government.

Following the announcement by the Minister, there were no questions allowed by Dail members and the Minister moved on to the really important stuff - straight to press briefing in the Department of Finance. He might have opted for the right move, however, since the Dail, without any interrruption vigorously engaged in a debate on this important topic:

On that note, the last word (for now) goes to Prof Whelan: "Ok, after exchanges with very wise @OwenCallan I have decided that this deal defers the 3.1bn payment by only one year. Worse than hoped for" (quoting a tweet).

Welcome to the wonderland of wonderlenders.


Updates:

Adding to the above, it is worth postulating directly - as I have argued consistently, ELA is the only debt we can - at least in theory - restructure and promo notes are a perfect candidate for such a restructuring. By converting a part of these into Government debt we are now de fact increasing probability of a sovereign default or restructuring.

Karl Whelan has an excellent post on the 'deal' - here.

ECB statement on Ireland's 'deal' is here. This clearly states that there is no deferral of any payment on Promo Notes and that the Noonan's 'deal' is a one-off. Thank gods it is - because at a cost of €400mln in added debt, plus €90mln in deficit, repeating this exercise in PR spin would be pretty expensive.


Update 30/03/2012:


Today Irish Times is reporting that:

"Minister for Finance Michael Noonan said the big benefit was the money would not have to be borrowed to pay this year’s instalment on the promissory notes, the State IOUs paying for the bailouts."

A truly extraordinary statement, given the state will borrow the money (some €410mln more in principal and €90 mln more in interest than actually it had to borrow) using a Government bond to pay said IOU!

The Irish Times headline reads: "Government wins backing on €3.06bn payment". Yet there is no any 'backing' from anyone on this deal, because the deal does not change the payment itself. Read the above-linked ECB statement on the 'deal'.

In another extraordinary statement, the Irish Times (this is their own claim) says: "Further talks on a long-term deal on the remaining repayments as part of a wider restructuring of the banks will continue between the Government and the troika of the EU Commission, the ECB and the International Monetary Fund." Is there ANY evidence that any such negotiations are ongoing? Where is this evidence? Please, produce!


And an excellent piece from Namawinelake on the above: here.

21/3/2012: Anglo's Promo Notes - perfect target for debt restructuring

This is an unedited version of my Sunday Times article from March 18, 2012.

At last, courtesy of the years of economic and financial mess, Ireland is waking up to the problem of our debt overhang. For those of us who have consistently argued about the unsustainability of our fiscal and real economic debts predicament, this moment has been long coming. The restructuring of some of the debts carried by the Government directly or indirectly, on- or off-balancesheet is a matter of when, not if. Enter the debate concerning the Promissory Notes.

Per international research, State debt in excess of 90-95% of the real economic output is unsustainable. In real economics, as opposed to fiscal projections, debt becomes unsustainable when it exerts a long-term drag on future growth.

At the end of 2011, official Government debt in Ireland has reached 107% of our GDP or 130% of GNP, according to NTMA. The Irish economy is now operating in an environment of records-busting exports, current account surpluses, and healthy FDI inflows, and yet there is no real growth and unemployment remains sky-high. By comparatives, Irish economy is a well-tuned, functional car stuck in the quicksand – engine revving, power train working, wheels engaging, with no movement forward. This is a classic scenario of a debt overhang crisis – the very same crisis that Belgium has been struggling with since 1982, Italy – sicne 1988, Hungary – since 1991, and Japan – since 1995.

Something has to be done to deal with this problem in Ireland no matter what our Government and the EU say in public.

Uniquely for a euro area country, Ireland’s debt overhang did not arise solely from fiscal or structural economic shocks, but was strongly driven by the country response to the financial crisis rooted in a number of forces, including policy and regulatory errors by the EU and ECB. Also, Ireland has undergone the most severe adjustments in its fiscal position to-date compared to all other ‘peripheral’ economies, proving both our capability and commitment to reforms.

Lastly, in contrast with all other countries, Ireland’s economy is capable of getting back to sustainable levels of economic activity. Irish economy needs a supporting push out of the quicksand of banks-linked debt overhang to deliver on its sovereign debt commitments, and become once again a net contributor to the sustainable fiscal system within the euro area.

The IBRC Promissory Notes are a perfect focal point for such a push for a number of reasons.

First, the magnitude of the Promissory Notes allows for significant room to reduce Irish Government’s future liabilities, combining €28.1 billion of debt, plus 17 billion in interest repayments. These represent 29% of our GDP. Eliminating this liability will restore Ireland back onto sustainable fiscal and growth paths. Restructuring the Notes will not constitute a sovereign default. Although their value is counted in Irish Government debt, they are not traded in the markets. The Notes are, de facto, Irish Government IOUs to the Central Bank of Ireland with IBRC acting as an agent.

Second, Promissory Notes underwrite €28 billion of €42 billion IBRC debts to the ELA programme run by the Central Bank of Ireland. ELA funds are not borrowed by the Central Bank from the Eurosystem or the ECB, but are created by the Central Bank under its mandate. There is no offsetting physical liability the Central Bank needs to cancel by receipt of payments from the Government. The Notes also do not constitute Central Bank funding for the Government as they finance stabilization of the Irish (and thus European) banking system. Lastly, the ELA funding extended to the IBRC is already in the financial system. Removing requirement on the Irish state to monetize the Promissory Notes will not constitute an inflationary quantitative easing.

The Government is correct in focusing much of its firepower on the IBRC’s Promissory Notes. Alas, efforts to-date suggest that it is not setting its sights on the real solutions needed. This week, Minister Noonan has identified the direction in which the talks are progressing: restructuring the Promissory Notes repayment time schedule, plus possibly reducing the interest rate attached to the notes via converting the notes into ESM debt.

The problem with this approach is that a transfer of liabilities to ESM will convert Promissory Notes into a super-senior Government debt. This is likely to have a negative effect on Ireland’s ability to borrow funds from the markets in the future and make such borrowing more expensive.

In addition, lowering interest rate on the Promissory Notes carries two associated problems with it. The move can only have an appreciable effect on Exchequer finances after 2014, when interest on the notes ramps up to €1.8 billion from zero in 2012 and €500 million in 2013.

Delaying repayment of notes instead of reducing the principal amount owed on them will not provide significant relief to the Exchequer in the future and will make the period over which the debt overhang occurs even longer than 20 years envisioned under the current Notes structure. This will pose serious risks. History of business cycles suggests that between now and 2025 when Notes repayments will fall significantly, we are likely to face at least two ‘normal’ or cyclical recessions. During these recessions, Notes repayments will coincide with rising deficit pressures and national income contractions that will exacerbate the Promissory Notes already adverse impact on Irish economy. Extending the period of notes repayments risks compounding more recessionary cycles in the future.

Furthermore, delaying notes repayments can risk increasing the overall future demand for debt issuance by the state. Currently, Ireland is facing two debt-refinancing cliffs during the life of the Promissory Notes: €45.6 billion refinancing over 2013-2016 and €62.4 billion over 2017-2020. If Notes repayments are delayed, their financing will stretch further into post-2020 period, just when the subsequent roll-overs of Government bonds will be coming due.

In more simple terms, current proposals for Promissory Notes restructuring are equivalent to making quicksand pit shallower, but much wider.

Ireland needs and deserves a direct restructuring of the ELA. The most optimal outcome of such a restructuring would be de facto cancellation of ELA requirement for repayment of IBRC-borrowed €42 billion. Once again, such a move would have zero inflationary impact on the economy as on the net no new money will be created in the euro system over and above the amounts already present.

There remains, however, one sticky point. Allowing Ireland to restructure its ELA can, in theory, lead to other Central Banks following the suit. This problem of moral hazard can be easily mitigated by ECB by ring-fencing Irish ELA restructuring solely for the purpose of winding down IBRC. Making ELA writedown conditional on shutting down Anglo and INBS, plus potentially Permanent tsb will disincentives other countries from using their own ELAs to rescue solvent banks. Irish restructuring can be further isolated by tying ELA writedown to progress already achieved by Ireland in tackling fiscal deficits and restructuring its banking sector. Put simply, with such a proviso in place, no other Euro area country would want to dip into its National Central Bank vaults if the associated cost of doing this will amount to over 50% of its GDP.

Ireland’s crisis is unique in its nature and its resolution provided a buffer to cushion the credit crisis blow to the entire euro area banking sector. Ireland both deserves and needs a breakthrough on the debts assumed by taxpayers in relation to the insolvent IBRC. Even more importantly from Europe’s point of view, the ECB needs a positive example of a country emerging from the deep crisis within the euro system. Ireland is the only candidate for success it has.

Source: NTMA and author own calculations.

Note: In computing second round of rollovers, only Government bonds are included and taken at 95% of the principal amount. All other debts are excluded.

Box-out:

In the wake of last week’s Quarterly National Household Survey release, the Government was quick to point to the improvement in the number of employed on a seasonally adjusted basis as the evidence the employment policies success. Overall numbers in employment rose in Q4 2011 by 10,000 or 0.56% compared to Q3 2011, once seasonal adjustments were made. Furthermore, per seasonally adjusted data, full-time employment was up 8,700 – accounting for 87% of this jobs creation. Alas, this is not the entire picture of the job market health. Year on year, seasonally adjusted employment was down 17,800 or 0.97%. More ominously, unadjusted employment was up just 2,300 in Q4 2011 compared to Q3 2011 – an addition of statistically insignificant 0.1%. Interestingly, full-time unadjusted employment figure fell by 700 jobs (-0.1%), while part-time employment rose 3,000 (+0.7%). At the same time, number of part-time workers who are underemployed has jumped 5,800 in a quarter and 28,100 year on year. Two reasons can help explain the above disparities. First, Government training programmes have been aggressively taking people out of unemployment counts, increasing employment numbers. In the case of Job Bridge, for example, these are unpaid ‘internships’ with questionable rate of post-internship transition to work so far. Second, since Q1 2011, CSO has used a new model for seasonal adjustments, which may or may not have an effect on seasonally adjusted headline numbers. Lastly, seasonal adjustments can increase, not reduce quarterly data volatility at the times when trends change. Particularly, with flattening out of the employment figures after years of steep declines, seasonal adjustments can introduce a temporary bias into subsequent data. In short, making conclusions about the actual changes requires more careful reading of the numbers than a simplistic headline figure referencing. With all annual indicators pointing to a shallow decrease in employment, the Government would be best served to have some patience and see how subsequent quarters numbers play out before jumping to conclusions on the success of its policies.

15/3/2012: What's up with 'collateral'?

An interesting point made today by Michael Noonan that carries some serious implications with it (potentially).

"You could take it that the ECB were never particularly happy with the level of collateral provided by the promissory notes and would like stronger collateral," Mr Noonan said in an interview with RTÉ." (as reported on the Irish Times website).

What can this mean? Collateral for the Notes themselves is Government guarantee plus letters of comfort to the CB of I. In other words, the Notes collateral can only be enhanced by making them fully-committed formalized Government debt - aka bonds. Now, Noonan in the recent past had implicitly linked Promo Notes to ESM.

And herein rest the main problem. Right now, Promo Notes are quasi-governmental obligations and as such are ranked below ordinary Government bonds (hence collateral quality concern of the ECB). Although the Notes are counted into our total debt, they are still not quite as senior as other forms of debt. This, in turn, has marginal implications in the valuation of our bonds. Although at this point this is academic, should we return to the markets, potential buyers of Irish Government bonds will consider them as secondary, since the Notes are not traded in the market and represent a tertiary (quasi- bit) claim on the state after ordinary bonds (secondary) and EFSF-IMF-EFSM (soon to become ESM) debt (so-called super-senior obligations of the state).

By converting these notes into ESM funding, the Government will in effect risk making these Notes super-senior, exceeding in seniority those of ordinary Government bonds. Now, the total amount of debt under the Notes - principal plus interest - is €47-48 billion or roughly-speaking 30% of our GDP and ca 27% of our Government debt. This is hardly a joking matter.

It can have material implications for our ability to access bond markets in the future (both in terms of amounts we can raise and rates we will be charged). But more ominously, it can fully convert quasi-public debt into super-senior public debt.

This will satisfy ECB's concerns about the quality of collateral, but it will also mean that these notes will be put beyond any hope of future further restructuring.