Note: Mr McKenna asked for this to be retweeted, so we are taking this as license to post it here. Additional comments by us are in [square brackets and italics]; we have also underlined what we regard as important points. We’ve also taken the liberty of reformatting some of the text into bullet points for greater visual clarity.
[PS: comments are meant to be constructive – and secondary – to what is a great piece of analysis. You can download the original here]
The Irish taxpayer has a 31 Billion Euro + exposure to the Irish Bank Resolution Corporation (IBRC) (formerly Anglo Irish Bank and the Irish Nationwide Building Society). This is the equivalent to more than one third of Ireland’s total 90 Billion Euro banking debt.
What follows is a consolidated explanation of Ireland’s debt obligations in relation to IBRC. It also examines the options open to the Irish government in its attempt to minimize taxpayer exposure to the “bank’s” debt.
In recent weeks, there has been a renewed interest in IBRC and the taxpayer’s exposure to its toxic debts. This isn’t surprising given the fact that, just weeks ago, the taxpayer paid out 1.25 Billion Euro to IBRC bond holders and a further payment of 3.1 Billion Euro is due to that institution in March.
However, confusion is a common theme in almost all debates on the subject.
Media debates in recent weeks have exposed a serious lack of understanding of all things IBRC. It is hardly surprising that confusion prevails given the fact that the present government, and its predecessor, failed to adequately explain the issues involved. For that reason, few commentators have attempted to explain this key subject.
Background: incurring the Debt
In early 2008, as the fall-out from the property bubble was emerging, it became clear that Anglo Irish bank was heavily exposed to the property market. However, the extent of its losses was not clear.
Later that year, under the direction of the European Union (EU),
- the Irish government nationalized Anglo Irish Bank.
- The government took a 75% stake in the bank in return for a 1.5 Billion Euro cash injection.
- A further 4 Billion Euro followed soon after.
- By March 2010, it was becoming clear that the 5.5 Billion Euro cash injection that Anglo had received was not enough to solve the banks problems.
Cognizant of the political reaction that would follow a further hard-cash injection, Brian Lenihan decided not to inject any further hard-cash in to the bank.
- he issued Anglo with 31 Billion Euro in IOUs, or promissory notes.
- Anglo Irish Bank took these IOUs or promissory notes and lodged them with the Irish Central Bank (ICB).
- The ICB effectively created 31 Billion Euro which was then given to Anglo, a process known as Exceptional Liquidity Assistance (ELA). The money given to Anglo by the ICB was not borrowed from the European Central Bank (ECB) nor was it created by the ECB. It was created solely by the ICB since money creation is decentralized in the Eurozone system. [R-A.org note: while technically correct in a narrow sense, the wider political truth – as seen below regarding permissions – is that the ICB is effectively a local franchise of the ECB under monetary union]
In August 2010, the Irish Nationwide Building Society (INBS), another errant bank, was effectively nationalized when
- it received a 5.4 Billion Euro cash injection from the State.
- On the 1st of July 2011, INBS’ assets and liabilities were transferred to Anglo Irish Bank in a court-mandated merger that created IBRC.
- In effect, this ensured that INBS could enjoy the 31 Billion Euro injection that Anglo had received from the ICB.
At present, when IBRC’s debts to the ICB are excluded, its assets are roughly equal to its liabilities. In other words, IBRC is able to pay back most, if not all, the money it owes bondholders, depositors, the ECB and others from its current assets (money it is owed by borrowers and the money it received from the ICB etc.).
The only liability IBRC is not able to meet is the money it owes to the ICB.
Repaying the Money
At the insistence of the EU and the ECB,
- the ELA (31 Billion Euro) given to IBRC by the ICB must be paid back by IBRC.
- Not only that, interest payments on the ELA must also be made.
- Ultimately, these payments must be made by the State since IBRC is an arm of the State given the fact that its two constituent banks were nationalized.
Repaying the ELA: Main repayments
- The state must pay IBRC 27.9 Billion Euro in installments of 3.1 Billion Euro every March for the next nine years.
- The first 3.1 Billion Euro installment (bringing total repayments up to 31 Billion Euro) was paid in 2011.
- IBRC will then repay this money to the ICB, which will dispose of the money in a similar manner to which it was created.
In addition, the State will also pay interest to IBRC.
- In total, the State, at the insistence of the EU and the ECB, will pay IBRC 16.9 Billion Euro in interest payments.
- IBRC will use a small proportion of the money it receives in interest payments from the state to pay the interest it must pay the ICB.
- Any interest paid to IBRC by the state that is over and above the amount of interest IBRC owes the ICB can be retained in IBRC as profit, which can be returned to the exchequer at a later date.
Determining the interest IBRC owes the ICB is no easy task given the fact that the rate the ICB is charging IBRC has not been disclosed. In fact, that rate is top secret. However, that rate has been estimated at 2.5%. Any interest payments made by IBRC to the ICB, however, can simply be returned to the exchequer by the ICB since the ICB, like IBRC, is an arm of the State.
Does the interest payments made by the State to IBRC and the ICB matter? No [R-A.org note: In the real world of flesh and blood people – ¡Yes! See below]. Since IBRC and the ICB are arms of the state, any interest payments made to IBRC and the ICB by the State can simply be returned to the exchequer at a later date [R-A.org note: “In the long term, we’re all dead” – Keynes]. Therefore, the interest payments being made by the State to IBRC and the ICB, totaling 16.9 Billion Euro, are irrelevant and do not constitute a cost to the State [But only an incorporeal state – or a salaried economist! – can take this point of view].
However, in the short term, these interest payments have a negative impact on the State’s budgetary process. [This is what concerns us – the opportunity cost to people affected by the budgets]
Eurostat views the 16.9 Billion Euro interest payments to be made by the State to IBRC and the ICB as part of the Government’s General Deficit (GGD) despite the fact that these payments do not constitute real government liabilities since these payments will be recouped by the State at some point in the future.
If the Government is to meet its GGD targets, as set out by the EU and the IMF, it must make savings (through tax increases and spending reductions) each year that are equivalent to the amount of interest due that year.
- the Government is scheduled to pay IBRC 1.8 Billion Euro in interest payments in 2014.
- Therefore, to meet its GGD targets that year, it will have to make up 1.8 Billion Euro in tax increases and spending cuts on top of other savings required to reduce its budgetary deficit.
- Similar budgetary adjustments will be required every year from 2013 until 2030 under the current interest payments schedule.
The taxpayer’s total exposure to IBRC is 31 Billion Euro plus the interest rates the State will pay to borrow it from the EU/IMF and/or the international markets.
Follow the Money
Figure 1: Flow chart depicting the movement of money between the State, IBRC and the ICB.
Actual Repayments Schedule
The current repayment schedule involves the payment of 3.1 Billion Euro every year from 2012 up until, and including, 2020.
- As noted previously, the first 3.1 Billion Euro installment was paid in 2011.
- In theory, 16.9 Billion Euro in interest payments are due in gradually reducing amounts each year thereafter until 2031.
- However, It is envisaged that IBRC will be wound-up by the end of 2020 or soon thereafter. In this scenario, no interest payments would actually be made by the State to IBRC (or the ICB) since any interest payments it makes would be simply returned to the exchequer at a later date. Therefore, actually making any interest payments to IBRC (or the ICB) would be pointless.
What Can be Done? Minimizing Taxpayer Exposure to IBRC
- The government must raise 27.9 Billion Euro over the next 9 years if it opts to repay the ICB in full.
- In order to do that, it must borrow the money and pay interest on it and/or raise the money itself through the form of increased taxes and spending cuts.
- Either way, 27.9 Billion Euro will be taken out of the Irish economy over the next 9 years.
- This will stifle any prospects of economic recovery. There will be less money available in the economy leading to reduced consumer spending, further job losses, higher rates of unemployment and poverty.
- Moreover, any prospects of Ireland returning to the international money markets in 2013 will be greatly reduced since the State’s debt to GDP ratio will be well beyond what would be considered reasonable levels for any potential bond investor.
The government has two options available to it in its attempt to reduce the taxpayer’s exposure to IBRC. If pursued, both of these options have the potential to significantly reduce Ireland’s banking debt.
Fortunately, both of these options have one thing in common – they do not involve reneging on debts owed to bondholders, depositors or the ECB. However, they do require that a number of political and economic hurdles be overcome. Fortunately, none of these hurdles are insurmountable.
Option One: Write off the debt in its entirety
- This option involves the complete non-payment of the Promissory notes.
Although this may appear drastic, its impact could be minimal.
The only “loser” in this scenario is the ICB [and thus the ECB / Euro] since the Promissory notes are owed solely to that institution.
However, the ICB, like any other Central Bank, but unlike other institutions that would simply become insolvent if they incurred losses on this scale, is able to absorb the losses it incurs on the Promissory notes because it can simply create money [this is strictly true as an exercise in national sovereignty – ie as a national power exercised unilaterally by the state]. An institution that can create its own money cannot go broke provided that the money it creates is accepted by those who use it [ie is legal tender, or national currency]. Central Bank losses are only a notional concept. Taking this approach would significantly reduce Ireland’s debt burden and, therefore, increase the likelihood of rapid economic recovery.
However, this option is not without its pitfalls.
Other Eurozone countries could seek similar arrangements for their own indebted banks. If this arrangement was carried out wholesale across the Eurozone it would lead to significant Euro inflation.
Moreover, such an approach would need approval from the ECB [Unless Ireland unilaterally decided to decouple from/leave the Euro – even temporarily]. The ECB could disallow such a move if two thirds of its governing council deems it to be contrary to the ECB’s objectives. [it might – unless e.g. a credible threat existed that Ireland could reintroduce the Punt…]
Some may argue that such a move would be contrary to the ECB’s objectives since it has the potential to increase inflation, a deep-seated fear in the ECB [but massive credit – and the following asset-price – inflation, was inflicted on Ireland because of ECB credit issuance to suit a sluggish German economy; what Ireland is undergoing is the cost of internal credit and asset deflation to save the ECB and Euro, because we cannot undergo the external deflation with an independent currency that has saved Iceland].
It could be argued, however, that the risk of inflation would be minimal if Ireland was given sole permission to take this action. Europe-wide political approval would, in theory, also be required. Obtaining ECB and wider political approval would not be easy but it is not impossible. [Especially if we had a credible threat in our negotiations… and politicians with the spine to use it]
Option Two: Repay at a later date and over a longer period of time
This option is the more conservative of the two options and involves the complete repayment of the Promissory notes while significantly reducing the immediate burden on the taxpayer.
- Under this plan, payments could be scheduled to begin at some future date when the economy has reached a specified degree of recovery. Feasibly, this may occur at some point in the next 5 – 10 years.
- Moreover, the payments schedule would also be restructured such that smaller annual repayments would be made over a greater period of time. Payments could be restructured such that all payments are made over a period of, say, 60 years, instead of the current 19 years as specified in the current repayments schedule.
- This option would ensure that all obligations are met, provide the taxpayer with an “austerity holiday” and ensure that fewer cuts are required in future budgets.
Agreement would have to be obtained from the ECB governing council. However, it is possible that such an agreement could be reached given the minimal impact of this approach and the potential it offers in terms of economic recovery.
It is feasible, and legally possible, that approval could be obtained for one of these options since it is in the interest of both Ireland and the wider Eurozone that Ireland returns to full financial health with the prospect of returning to the international money markets in the near future.John Paul Mc Kenna, February 2012. Suggested Reading
- Karl Whelan (February 15, 2012). Briefing Paper on the IBRC, ELA and Promissory Notes. Prepared for the Oireachtas Joint Committee on Finance, Public Expenditure and Reform. http://www.karlwhelan.com/IrishEconomy/Oireachtas-Feb-2012.pdf
- Karl Whelan (January 27, 2012). The IBRC, ELA, Promissory Notes and All That. Presentation delivered at the UCD/UL/Dublin Economic Workshop Conference. http://www.karlwhelan.com/IrishEconomy/Whelan-‐-‐-‐CrokePark.pdf