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Anglo-Irish Bank is dead. Long live its debt?

Posted on December 02, 2013 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

Not that bank again! Much has been said and written about Anglo-Irish in the context of the banking collapse in 2008 and the sequence of historical events that takes us from the night of the Big Guarantee on 29th September 2008 (or perhaps a modern version of Oíche na gaoithe moiréWhen the Anglo-Irish Promissory Note deal was announced on 7th February 2013 many thought that this would be largely the end of the anguish associated with one zombie bank’s debt which accounted for approximately 20% of GDP because there would be:

  • no more promissory notes and no more ‘cash-burning’ in Dame Street’s Central Bank.
  • significantly lower interest payments by the Irish government counted by Eurostat/CSO in the annual statistics on the government deficit and therefore that bit less pressure on our public finances.
  • no need to repay any debt for a long time – at least not until 2040

It was almost a case of ‘Peace in our Time’ with proof, after all, that patient and pain-staking diplomacy pays off in terms of good will and incremental progress at European level (even if technically the European Central Bank said that they had ‘noted’ an agreement among Irish public agencies).  We can be sure that ECB and other European and national authorities had their paws all over this negotiation at least from the point of view that it would not jeopardise the current fragile European situation. In a similar way ECB and others were in the information loop and network of influence at all key moments from October 2008 (and possibly earlier depending on which version of events you believe). 

Some of the background to this development and how the debts associated with Anglo-Irish were incurred, in the first place, by the Irish government in 2010 in a working paper I presented at a special NERI seminar on 6th February a day before the announced deal. 

So, what has changed since February? Not a lot except that we are some months wiser about what the deal means and doesn’t mean. Lots of uncertainty still surrounds the outcome of this deal. A number of ancillary questions remain like the ultimate value of assets transferred to NAMA from IBRC (the new entity that brought Anglo-Irish and the smaller INBS) together in one zombie bank instead of two [for the benefit of readers not familiar with such acronyms these can be checked out here and there.

The biggest expectation raised last February was that the budgetary adjustment for 2014 and announced in October of this year would be less harsh than previously planned as a direct consequence of the deal. The outcome is much less than expected. The headline adjustment is unsure with conflicting claims that it is €3.1 billion or €2.5 billion. The true extent of ‘full-year’ new measures is unclear from the budgetary documentation provided in October.  In any case, nowhere in the documentation is there mention of the Anglo-Irish Promissory Note deal as a factor in easing the adjustment from the previously planned €3.1 billion to a lower figure (other factors are mentioned but the Prom Note deal).

Some realities still apply:

The total debt as encapsulated in the new Government Bonds held by the Central Bank and issued by the Government in exchange for the old Promissory Notes comes to €28 billion. This debt has not gone away and will not go away. It has been locked into storage for 25 to 40 years depending on the maturity of the bond (e.g. two tranches of €5 billion each are due repayment 2051 and 2053).

Although the bonds are held by the Central Bank and the money is technically owed by us (the Irish Government on our behalf) to us (the Central Bank of Ireland on our behalf) the agreement and plan is to gradually sell on these bonds to private investors in the capital markets beginning with a minimum sale of €500 million next year and a cumulative total of €2.5 billion by the end of 2018 followed by more sales up to 2032.

The deal of 7th February was described as a good deal by many at the time and even terrific by others while the usual sceptics complained bitterly that debt in the form of a flaky I.O.U. (written by the Irish Government as collateral on emergency liquidity loans to the now defunct Anglo-Irish in 2010) was being converted into a more solemn Government Bond with no write-down whatsoever in the value of the total loans outstanding. In simple terms the mortgage holder which was Ireland was given a very long extension on its mortgage debt along with a lower annual interest payment charge in the next few years. This is was welcome news for the mortgage holder except for the following:

The ‘mortgage’ had been a forced one in the first place to the extent that no money was borrowed. Rather the Irish Government wrote a rather large I.O.U. on a lump of private debt that was lying on the balance sheet of a recently nationalised bust bank saying that we promise to the Central Bank on behalf of the Irish people to pay over €3 billion each year for ten years plus interest and the Central Bank would withdraw the same amount of money from circulation.

There was absolutely no write-down in the amount of debt (€28 billion in all including a special arrangement in 2012 to pay off the Anglo debt in that year).

The interest payment will be lower for a while but could be a lot larger later (‘terms and conditions apply’ and ‘the value of loans can go up and down’ when the current ‘Anglo bonds’ are sold on to other investors which is the plan beginning in 2014.

On the upside the long-fingering of the debt repayments was seen as a victory to the extent that the present economic value of a loan to be paid in, say, 2050 is a lot less than the a loan to be repaid in, say, 2014. A combination of price inflation and real economic growth will (it is hoped) reduce the real economic cost and burden of what is a nominal debt. This is, of course, based on the assumption that growth will work its magic as it did all along economic history since the 17th century in reducing sovereign debt especially over decades following a major war (or a collapse in banking followed by a state bailout of lenders and depositors to the banks). However, apart from uncertainty about what may happen or not in the future, one thing is certain – what goes down goes up again at some stage. Currently, interest rates charged by central banks to other banks are at historically rock bottom levels reflecting concerns about the state of economic growth in the advanced economies. This will not last forever. Once the Irish Central Bank starts selling on the ‘Anglo Bond’ (my term but that is what they are – transformed Anglo-debt into public government bonds) we are running a large risk in having to pay significantly higher interest payments on the debt which will not be retired until decades to come. Whatever the present day economic value of future debt liabilities out to 2050 it is a moot point whether or not the total repayment plus interest bill will be more or less than might have applied under the infamous ‘Promissory Note’ deal which applied up to 7th February of this year. We may have traded a significant up front relief in interest payments for a locking in of flaky I.O.Us in the form of long-term government bonds subject to variable interest rate changes once these are sold on in the capital markets. It should also be borne in mind that the interest payments scheduled were going to the Irish Central Bank prior to 7th February and will continue to go to that bank and be recouped largely by the exchequer via dividends or profits remitted by the Irish Central Bank (not all of it however as some is remitted to ECB). That will begin to erode over time as the bonds are sold by the Central Bank to other lenders.

What can Government do about this debt? It has three options:

Do Nothing – meaning that since (it is argued) the deal of 7th February was the best (indeed only) available negotiating outcomes available to Ireland that is as good as we can get now or in the future (apart that is from any implementation of ‘mutualised’ legacy bank debt arising from the ‘game-changing’ statement of European Ministers on 29th June 2012 which looks about as likely as the late implementation of the 1691  Treaty of Limerick)

At least that Treaty was written on stone but the concord of 29th June 2012 was in a short and subsequently contested statement by ministers following a late night). As a rough rule of thumb most important public deliberation on private banking is done late at night (the night of the Big Guarantee in September 2008, PromNote night on 7th February 2013 and the European Council meeting in June 2012). A strong case for doing nothing further on the Anglo debt is that any talk of reopening this issue (even by way of a mild and humble request to the Authorities in Europe) could frighten the market horses and undermine Ireland’s delicate re-entry into the capital markets in full (without a precautionary credit line). This concern is a genuine one. However, talk of never, ever renegotiating the odious debt arising from a dead bank and which was never borrowed in the first place but was the subject of flaky I.O.U. is premature. Nobody would be advised to tie the hands of a future government in this matter – that is if they have any hands at all in matters fiscal and banking.

Default – as in not pay, or suspend payment or symbolically burn the bonds (which are owed by one branch of the Irish State to another branch with the knowledge of ECB). This course of action might be characterised as seeking forgiveness rather than permission with no direct consequences for anyone except that it might be interpreted setting a precedent for other countries with legacy bad bank debts and would be tantamount to ‘monetary financing’ (perceived to be a great evil by the Ordo-liberal establishment in Europe). Ironically, monetary financing has not been absent in the European crisis and the invention of the I.O.U. was a form of monetary financing in the first place. Lawyers might wish to context this in some European court. It is not a place that the Irish Government is going to go any time soon because of the unknown risks associated with such a ‘brave’ action even if would be morally justifiable from the standpoint that the debt in question was inappropriate if not downright illegal.

Pursue a middle way and long-game  - which does not involve unilateral action at any stage – or any threat of unilateral action but which probes, tests, reminds and sustains the pressure at European level over a long period of time. One option that should definitely be considered is to hold off on any sale of the existing ‘Anglo-Bonds’ as long as economic activity remains depressed and possibly not sell them at all if possible. This would, unavoidably, put Ireland not on a collision course with anyone but on a negotiating path in the context of a much larger debate about banking and fiscal policy where Ireland may have allies in other parts of Europe. It therefore comes down to timing and strategy and picking the right ground on which to mount a case. The current situation is not fair or not sustainable in so far as the Anglo debt which resulted from private gambling adds close to 20 percentage points to our total mountain of Government debt of 124% of GDP in 2013.  Dealing with this Anglo debt is part of a larger strategy to reboot the economies of Europe and address huge failures in corporate governance and public policy that led us to this sorry state.

Would it be time for people to think about linking the proposed Financial Transaction Tax (endorsed by 11 EU States but not Ireland or the UK) to an agreement on legacy banking debt? Just a thought….

 

 

Posted in: Macroeconomics

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