Thu Feb 3rd, 2011 at 09:59:57 PM EST
Apparently our suggestion that Ireland should stiff some bondholders are being considered. I got a mail from a lurker, asking for more concrete suggestions. I'm posting the exchange here (with permission, and only minor edits), so the regulars can supplement and poke holes in my recommendations.
I hope you don't mind getting an email on your eurotrib post.
I agree with you - we are sheep here in Ireland.
We are in the middle of an election for our next government, and all the main political parties are doing is tweaking the spending allowed by the IMF/EU loan, in order to take the same amount out of the economy this year. Nobody is addressing the terms of the loan - the fact that the amount of the 'bailout' (not for Ireland, for the banks who lent to us!) of 67.5bn (not counting 17.5bn we are contributing - decimating our pension reserve fund) is not going to allow us to proceed an 'orderly restructuring' (aka default) in 2014. In fact we will need in the order of 152 bn to get to 2014.
Nor is any politician questioning the terms of the loan which will see the stripping of our national assets, which would give us a foundation for growth.
We are in dire straits. We cannot borrow money in the markets. The ECB gave the ok to our Central Bank in December to print 51bn euro. I am not sure if this relates to the amounts disclosed in a newspaper last week.
Our government continues to pay the bondholders of the banks on foot of the guarantee given in 2008 (after Trichet left a message on the Minister for Finance's phone that we had to save our banks, and Irishman Peter Sutherland of Goldman Sachs etc said don't burn the bondholders). Last Monday 750 million was paid out to unsecured bondholders who were not covered by the guarantee. The December quarterly report of the Bank of International Settlements showed that foreign bank exposure to sovereign debt in three of the peripheral EU member states was reduced by 14% (some say by 18% in Ireland - I cannot extrapolate the figures)
Nobody is saying 'we repudiate this deal', because without it there is no money.
We have abundant , but undeveloped, energy resources. The EU needs our agreement to make the EFSF permanent (we require a referendum on that, something our government and the EU will try to avoid)
You say threaten to publish data on the solvency of the surplus countries private banks unless the ECB its doing its job. What do you expect the EB to do? It is already overexposed to Ireland, and no doubt, will expect us to borrow to buy back some of our dodgy bonds.
[...] Our current trajectory would leave us with no resources but the people, no growth and nothing left to sell.
What would you do? What terms would you seek?
My response is below the fold.
I'll start by responding to the specific question regarding the stress tests, then outline general negotiation strategy for sovereign defaults, and finally discuss possible objectives for such negotiations for the case of Ireland in particular, and the European Union in general.
First, on the subject of publishing the results of stress tests, it is my impression that this is mainly an option for Spain. Spain is large enough (and has large enough sovereign and interbank debts to the banks of major creditor nations) that the domestic Spanish bank stress tests should have given them a reasonable basis for guessing the solvency (or not) of the banks of major creditor nations. Ireland may or may not represent a large enough part of their balance sheets that you can pull the same trick. But it's certainly worth looking into. If you decide to pursue that strategy, my advice would be to gang up with as many of the other -zone debtor nations as possible, to get the most complete picture you can (and to avoid being the only country to incur the wrath of the powers that be when you stick it to Frankfurt and the City).
Second, on general negotiation strategy for sovereign defaults, it's actually fairly simple. You make a list of all your domestic creditors and all your foreign creditors, ranked in order of importance for the real economy (so manufacturing firms and bank depositors below 100.000 go on the top of the list, private pension funds somewhere in the middle and hedge funds and other bookies go at the bottom). Bond transactions should be notarised, so assembling this list should be no major problem (if bond transactions aren't, for some reason I fail to comprehend, notarised, you can always just give creditors a month to present proof of ownership and automatically default on everybody who fails to come forward).
Then you make two lines on each of the two lists: One line between people you really, really want to save (ordinary bank depositors, industrial firms, etc.) and people you kinda sorta want to save if you can (private pension funds, non-toxic investment banks - if you have any of those left - etc.), and another line between the people you kinda sorta want to save and the evil people who should take a long walk off a short pier (bookies, toxic investment banks, everything with a business address on Canary Wharf).
Then you mix the lists like this:
Evil (foreign and domestic)
All the people on the 'evil' part of the list should ultimately end up losing their shirts completely. Whether you want to unilaterally default on them before even entering negotiations or you want to pretend that they're negotiable for the sake of keeping up appearances will depend on your diplomats' assessment of what gives the best deal. I'm not a diplomat (as you'll have noticed if you've followed me on ET), so I'll defer that part to the professionals.
Then you decide what level of debt you will realistically be able to honour (be pessimistic - the EU could well be looking at a Japan-style lost decade). And then you save people from the top down, until you hit that limit. Three things can happen once you're done:
a) You are able to save all or part of the "foreign want-to-save" list. This is good. The people on that list are your bargaining chip in negotiating with other countries.
b) You are able to save all or part of the "domestic want-to-save" list, but none of the foreign "want-to-save" list. This is bad. Now you approach other countries from a position of weakness.
c) You cannot even save all the people you really want to save. Then you're screwed, if you'll pardon my French. You will be coming hat in hand to other countries.
By far the most probable outcome in the Irish case is a) - the bulk of your debt was recently incurred in a botched bank rescue, which means it's likely to still be located on the "evil" list.
OK, so now you have your some idea about your bargaining position. Then you need to know your objectives. This is where it gets political.
Ireland is somewhat unique in the -zone for having a genuine debt crisis. Greece, Spain and Portugal (and soon Belgium) are experiencing currency crises (similar to the one that caused the UK to leave the ERM back in 1992). So if you are negotiating in the narrow national interest of Ireland, you have no incentive to pursue structural reform of the -zone. Ireland runs a respectable trade surplus w.r.t. the rest of the -zone, so in the medium term, the current surplus-friendly setup works in favour of Ireland's narrow self-interest.
The narrow self-interest objective is to secure liquidity until the hysterical children in the international money markets are done panicking about your sovereign default (this takes a year to a year and a half). So your negotiating posture is basically "see all these nice creditors we have on this (foreign want-to-save) list? Would be a right pity if something went and happened to them. In other news, we need the ECB to guarantee that it will fix the price of Irish bonds for the next three years, in order to calm the money markets so we can roll over our remaining bonds in an orderly manner."
If, on the other hand, you want to negotiate for the interest of the European Union as a whole, your demands should be
a) Repeal of the misnamed Growth and Stability Pact
b) A change of the ECB's mandate, away from inflation targeting, towards having a supervisory role over the private banking sector, to prevent credit bubbles.
c) Repeal of the prohibition on direct ECB purchase of sovereign bonds, and a mandate to purchase sovereign bonds at a price no less than [the one corresponding to] the Frankfurt overnight rate plus some politically fixed acceptable yield curve (the precise shape of which is beyond the scope of this missive).
d) Creation of a Eurobancor, which creates, ex nihilo, new in the amounts required to balance intra--zone current accounts deficits, and deposit them with the deficit countries, earmarked for industrial policy focused on reducing the intra--zone imbalance.
The specific Irish needs are contained in bullet c) above.
Note that, perversely, prevalent attitudes in the core EU members mean that negotiating in Ireland's narrow self-interest is going to be considerably easier than negotiating in the wider European interest. So if you decide to negotiate in the wider European interest, you will need to assemble a coalition. The obvious place to start is the list I mentioned under the discussion of the stress tests. But to have a winning coalition, you will need to switch France from being aligned with Germany to being aligned with Spain. This should not be an insurmountable task, as France's current stance goes against their narrow national self-interest.
PS: If negotiations break down, and Ireland becomes faced with having no with which to pay her civil servants, you can always use the nuclear options: Default on all foreign debts, and issue scrip to pay your domestic creditors and operating expenses. (See, e.g., the Wörgl experiment) However, this amounts to a de facto exit from the -zone. And while leaving the -zone beats an IMF/ECB structural adjustment programme, it would not be in Ireland's medium-term interest. So handle with care.