16/05/2011: Debt Restructuring - two insights

What if, folks... what if default or debt restructuring is the end game?

Here are two sets of thoughts on the topic. The first one is from the Lisbon Council and the second set is adopted (via my edits) from here.

Lisbon Council launched last week Thinking the Unthinkable: Lessons of Past Sovereign Debt Restructurings See , an e-brief by Alessandro Leipold, chief economist of the Lisbon Council and former acting director of the European Department at the International Monetary Fund (IMF). See www.lisboncouncil.net for full details

Mr. Leipold argues that "European debt resolution requires a much more forward-leaning, information-driven approach, involving

• Supplying markets with better, more timely information (including tougher banking stress tests - I would give credit here to CBofI which did carry out much more rigorous testing of Irish 4 than the EU has ever allowed to take place across the euro area)
  
• Abandoning untenable timelines (such as the “no-restructurings-before-2013” mantra), and
  
• Staying ahead of the game via recourse to tools such as pre-emptive bond exchange offers

Mr. Leipold draws five key lessons from past sovereign debt restructurings:

1. Avoid Detrimental Delays. Delays in restructuring are costly (output losses, entail “throwing good money after bad” via increasingly large official bailouts, and ultimately require a larger haircut on private claims). Realistic debt sustainability analyses are needed to detect, and communicate, the possible need for debt restructuring. The EU’s “read-my-lips: no-restructuring-until-2013” sets an arbitrary and non-credible deadline: the sooner it is abandoned, the better.
2. Repair the Banking Sector. The equation “euro debt crisis = core European bank crisis” needs to be broken. I might add that the equation 'euro debt & banks crises = European taxpayers destruction' must be broken even before we break he debt-banks link. This requires getting tough on bank stress tests, enhancing their rigour and credibility, possibly by associating the Bank of International Settlements (BIS) and IMF with European Union supervisors. Banks tests must be accompanied by much greater pressure from EU supervisors to speed up bank recapitalisation and to close down non-viable entities. Banking resolution legislation should proceed rapidly, as should creation of an EU-wide bank resolution mechanism.
3. Remove Politics from the Driver’s Seat. The current set-up, including the European Stability Mechanism (ESM), which will begin operations in 2013), "virtually ensures that EU creditor countries’ domestic political interests will play a front-and-centre role. The recent attempted quid pro quo with Ireland whereby Europe would agree to a reduction in the cripplingly high interest rate on its loans in return for changes to the Irish corporate tax code is but one indication of this. Put simply, the decision-making and governance mechanism should be distanced from the high-pitched political positioning characteristic of EU ministerial meetings, thereby also facilitating constructive communication with markets, and helping shape expectations as needed to promote crisis resolution". I can only add to this that politicization of the economic concept of debt restructuring is also evident within the PIIGS themselves. In Ireland, we have now a virtual army of pundits - many well-meaning, of course - arguing against the restructuring on the basis of (1) 'default'=evil, (2) our debts are sustainable, and (3) current path of delaying restructuring until post-2013 is the optimal choice. These are supported, in some instances via lucrative public appointments, by the political elite.
4. Stay Ahead of the Curve with Preemptive Exchange Offers. "Traditional bond exchange offers, made preemptively, prior to an actual default, worked well in several emerging country debt restructurings over the last decade or so, including Pakistan, Ukraine, Uruguay and the Dominican Republic. Experience indicates that such voluntary restructurings need not, contrary to some claims, be too “soft” for the debtors’ needs. Reasonably priced, and with proper incentives, deals can be concluded rapidly with negligible free riding."
5. Do Not Expect Too Much from Collective Action Clauses. "Contractual provisions such as collective action and aggregation clauses no doubt help at the margin. But they have not shown themselves to be decisive in debt restructurings. Furthermore, they cannot help in dealing with the current stock of debt".

Much of the above prescriptions/warnings is echoed in the tables summarizing debt restructuring options available to the PIIGS that I have edited based on their original source (here).

Both provide one core lesson to us - any state close to the point of no return when it comes to its debt levels (and no one is denying that we are close to that point, all arguments today are about whether we have crossed it or not) should be:

1. Prepared to act
2. Prepared to act preemptively
3. Be transparent about the problems faced

On all 3 so far our officials are failing miserably, although we are making some progress on the 3rd point...

15/05/2011: Some data on electricity prices comparatives

Here is some interesting data on electricity prices comparatives from Eurostat (note: chart below refers to simple EU averages for EU27 and weighted EU averages for EU15, while table below is based solely on weighted EU15 averages):

15/05/2011: Public procurement

Ireland's "Social Partnership Capitalism" illustrated in one chart:
And it's getting worse. Data taken from eurostat shows that openly advertised procurement contracts for public sector purchasing have risen from 2.6% of Irish GDP in 2005 to 3.4% in 2007 before falling back to 2.2% in 2009.

14/05/2011: Euro area growth leading indicator

An excellent blog post from the Zero hedge on the ECB's absolutely outrageous treatment of public disclosure rules when it comes to the Greek's Enronesque accounting fraud: here. Absolutely worth a read.

Now, on to the post. Eurocoin - leading indicator of economic activity for the Euro area - needs to be updated to reflect couple of months of my absence from the blog. So here it is:

After couple of months of static activity, the Euro-coin is back on the rise in Q2 2011. This increase in the leading indicator, however, is driven primarily by external trade. Blistering exports performance is in turn driving expansions of manufacturing (industrial output) in Germany, France and now Spain, while Italy's industrial output remains largely stagnant.

Consumers are striking across the Euro area with retail sales for March coming in at -1.0% (-0.8% in EU27) month-on-month. This reverses 0.3% rise in retail sales volumes for Euro area recorded in February (+0.1% for EU27). Year-on-year retail sales fell 1.7% in March 2011 for the Euro area and 1.0% for EU27. Although EU economy has never been explicitly focused on the objective of internal markets improvements for the sake of consumer, these figures suggest that 'exports-only-led' recovery is coming in at the expense of the already weakened European households.

Here are two charts on the latest retail sales indices:
Industrial production latest data, released after euro-coin data, shows some pressures on the manufacturing sector: March 2011 seasonally adjusted industrial production1 fell by 0.2% in the euro area and by 0.3% in the EU27 month-on-month. This follows an increase of 0.6% and 0.4% respectively in February 2011. Year-on-year March industrial production expanded by 5.3% in the euro area and by 4.6% in the EU27.

13/05/11: CBofI accounts

Update: Namawinelake blog has an excellent post on the lunacy of Government treasury management exposed by the CBofI's latest accounts - read it here.


On April 7, 1775, Samuel Johnson made his famous pronouncement: "Patriotism is the last refuge of the scoundrel". This statement caught the chord with many other illustrious thinkers. Ambrose Bierce's The Devils Dictionary: “In Dr. Johnson’s famous dictionary patriotism is defined as the last resort of a scoundrel. ...I beg to submit that it is the first." In 1926, H. L. Mencken added that patriotism "...is the first, last, and middle range of fools.”

Whether one can separate a scoundrel from a fool or the first refuge from the last, in recent years we have seen Government officials who have exhibited all four attributes of false 'patriotism'.

No doubt, the decision by the Irish Minister for Finance to instruct NTMA to deposit €10.6 billion of state money with the Irish banks were not supposed to be amongst one of them. However, motivated by a 'patriotic' desire to provide a temporary support for the zombie institutions, artificially increasing their deposits base, this was a significant mistake from the risk management point of view.


Irish banks are experiencing a severe liquidity crisis, as the latest figures from the CBofI clearly show (Table A.2, column E). Lending to Euro area credit institutions has risen from 30 April 2010 levels of €81.25 billion to the peak of €136.44 billion by the end of October 2010 and now stands at a still hefty €106.13 billion (April 29, 2011), down €8.37 billion on the end of March. That's folks - our banks debts to the ECB. As far as banks debts to the CBofI itself are concerned, these have declined by some €12.64 billion to €54.15 billion March to April 2011. Chart below plots combined ECB and CBofI 'assets' that are loans to the Irish banks.
So the banks are still under immense pressure on the liquidity front.

As far as their solvency is concerned, BalckRock advisers estimated back in March 2011 the through-cycle expected losses in excess of €40 billion for just 4 out of 6 Irish 'banks'. Although these relate to 'potential' losses, the likelihood of these occurring is high enough for the CBofI to provision for €24 billion of these.

Either way, Irish banks are not really the counterparties that can be deemed safe.

There is an added component to this transaction - under the deposits guarantee, the Irish Exchequer holds simultaneously a liability (a Guarantee) and the asset (the deposit) when Mr Noonan approved the transaction. Before that, the Exchequer only had an asset. In effect, balance-sheet risk of this transaction was to reduce the risk-adjusted value of the asset it had.

Lastly, the entire undertaking smacks of the Minister directly interfering in the ordinary operations of NTMA which is supposed to be independent of exactly such interference.

So whether Minister's 'patriotism' of supporting Irish banks was the first or the last resort or the first and the last range, the outcome of his decision to prop up banks balance sheets with artificial short-term deposits was an example of a risky move that has cost NTMA its independence and reputation. The move achieved preciously little other than destroy risk-adjusted value of Government assets. Not exactly a winning combo...

Economics: Op-ed in the Irish Examiner 12/05/2011

This is the unedited version of my and Declan Ganley's op-ed in yesterday's Irish Examiner.

As you have undoubtfuly heard, I will be moving to a full-time role with StColumbanus AG - a Switzerland-based Asset Management company - on June 1, 2011. I will be setting up economic and financial markets research capabilities within the company and will remain based in Dublin, Ireland. I will also continue teaching in Irish universities and conduct academic research.

This blog will continue its independent existence.


"In December 2010, Olli Rehn joined those of us that had long been forewarning of financial contagion in Europe, when Mr. Rehn declared, “We have to stop the bush fires turning into a Europe-wide forest fire.” Yet the fires continue to rage on, fueled by ever increasing amounts of debt ultimately provided by European taxpayers, an unfairly disproportionate share of them being Irish.

Now, nearly 6 months later, the dead wood of Europe’s financial sector is far from secure against the potential of an even greater conflagration this summer. The ECB-supplied liquidity intended to douse the flames of many local bush fires sparked during the summer of 2010 has grown to proportions few had foreseen – proportions that few are willing to continue subsidizing as evidenced by the growing intransigence of some of Mr. Rehn’s compatriots in Finland who have said, “Enough”.

The Greek spark that initially lit the European forest fires of debt risks is now becoming a consuming fire – after collapse of the interbank lending, many sovereign borrowers today no longer can find a market for their debts. Contagion from the sick banks to the Governments’ balancesheets and now back to the banking system across the EU is nearly complete.

In the same way that planting new saplings is essential for forest management after a major forest fire, there is a need for new institutions to emerge now, in the midst of the crisis, to establish themselves in order to serve the economy in years to come and to grow into a more substantive role as the failed institutions are finally allowed to fail.

St. Columbanus AG is committed to a long-term vision for economic vitality based upon sound business and investment practices in order to create the commercial opportunities for growth and development necessary for a strong European future.

The approach of Switzerland as a global financial center is shifting; the old model of "tax-neutral" capital is fading. A new model of secure "tax-declared" capital is developing, based firmly on the
foundations of sound risk management and long-term investment strategies. Thus, throughout the current crisis, Switzerland continues to provide Europe its traditional role of a safe haven.
St. Columbanus seeks to participate in this push toward tax-declared assets/capital, to learn from it and to develop on the basis of Swiss financial model new products that can address the concerns of today’s clients.

In the past years, we have seen an overemphasis upon derivatives and exotic products that maximize profits for a few people, but to what real benefit of society as a whole? Our own analysis, as well as global market research, clearly show that ordinary investors today are now more concerned with safety, security, long-term growth, transparency and clarity of products and strategies.

On the other hand, failed model of financial engineering has taken hold of the policy responses to the crisis. This makes the world around us inherently less safe. Consider for example the new strikes in Greece as a sign of "social stability" made possible by the efforts to financially engineer Greece's balance sheet?

In our view, Europe today needs competition, and sound financial innovation that is in tune with the clients needs and not with the margin demands of the asset managers. We need to create and to sustain an healthy financial sector. Playing a part in this renewal is the long term vision of our asset management initiative. We will seek to fully participate on several levels in strengthening the fundamental financial landscape across Europe.

Returning to Mr. Rehn’s metaphor, a Forest take generations to grow and only hours to destroy. While a single undertaking like St Columbanus AG cannot be the sole driver of the change required to renew Europe’s financial health, we hope to play a role in this by planting one of the first saplings of the new asset management model.

Declan Ganley & Dr. Constantin Gurdgiev."