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February 7, 2013 12:59 pm
Early on Thursday, the Irish government dissolved the last remnants of Anglo Irish Bank, the bank that helped cause the Irish financial crisis and pushed Dublin into a €67.5bn bailout.
One of the reasons for dissolving the bank was to avoid a €3.1bn debt payment the Irish government owed by the end of next month – a payment required as part of the bailout package it used to shore up Anglo Irish in 2009.
But Dublin also sought to make political capital by drawing a line under the past through liquidating the bank that brought down the country.
Dublin has been trying to restructure the payment plan for almost two years, arguing the original structure of the so-called “promissory notes” saddles Dublin with such huge annual outlays – this year’s repayment, for instance, is about the same as the total austerity measures in its national budget – that it threatens its ability to emerge from its bailout when rescue funding runs out in November.
But the European Central Bank, which is keeping the desiccated remnants of Anglo alive so it can wind down its remaining obligations, has resisted any changes, noting better terms for the bank may violate the eurosystem’s rules against funding national governments.
The negotiations are fiendishly complicated and untangling them has proven much harder than either Dublin or EU leaders had anticipated. Jamie Smyth, the Financial Times’s Dublin correspondent, and Peter Spiegel, Brussels bureau chief, answer your questions:
Q: If the promissory notes are so troublesome, why did Ireland issue them in the first place?
A. Basically, Ireland was broke and had no other way to bail out Anglo Irish at the time.
It all started with the massive property crash that tipped Ireland’s banks into collapse in September 2008. That prompted Dublin to issue a blanket bank guarantee that tied the state’s fortunes its lenders.
By March 2010, the Irish government was struggling to meet its mounting obligations to provide cash to the banks and was being forced to pay exorbitant rates on the bond market to borrow money.
So, in consultation with the ECB, Dublin issued IOUs to Anglo and Irish Nationwide Building Society instead. They “promised” to pay Anglo the bailout cash at a future date – hence the name “promissory notes”. Anglo, in turn, was able to use that sovereign promise to borrow money to keep it from collapsing.
Ultimately the huge costs of bailing out Anglo and other banks proved too much, forcing Dublin to accept a €67.5bn bail out from the EU and International Monetary Fund in November 2010.
Q. How bad, really, were the terms of the promissory notes?
A. Well, you certainly wouldn’t want your mortgage to look like the promissory notes. The notes promise to pay €30.6bn of the estimated €34.7bn total cost of bailing out Anglo and INBS. The clincher was the fact that almost all the principal had to be paid over the course of the next decade; the vast bulk of the €3.1bn annual payments were for paying back the principal.
Eurostat, the EU’s statistical service, has already incorporated the €30.6bn into Ireland’s national debt. The interest on the notes adds an additional €17bn – bringing the total cost for the Irish exchequer to €47bn.
Dublin made a first €3.1bn repayment to the banks on March 31 2011 and is scheduled to make further €3.1bn repayments on March 31 every year for the next 12 years. Lower repayments kick in from 2024 until the notes are finally repaid in 2031. Every year the interest charges are added to the Irish deficit, forcing the government to either raise taxes or cut expenditure to meet its EU-IMF deficit targets.
Q. If this was a deal between the Irish government and Anglo, why does the ECB have a say in the matter at all?
A. This is the most confusing part of the whole deal and the one that sparks most anger among Irish voters – and increasingly among politicians.
Because of the Irish government’s guarantee that no bank would fail – a guarantee the ECB has forced Dublin to keep – the successor entities to Anglo had to keep servicing mortgages, paying bondholders and meeting all the obligations it held when it was a going concern.
But how do you run the day-to-day operations of a bank that has no income? Under any financial system, this is the role of a national central bank. Just like in the US, where the Fed offered emergency lending when banks struggled to find cash for their day-to-day operations after Lehman Brothers collapsed, the ECB steps in and provides “liquidity” loans to banks in trouble.
There’s a catch, however. The ECB can’t just give out money freely. Just like any normal commercial loan, it must get collateral in return. What happens when the bank is in such dire straits that it doesn’t even have any good collateral to exchange? Then it must go to “emergency liquidity assistance”, or ELA, which is provided by the national central bank – in Anglo’s case, the Central Bank of Ireland.
For Anglo, the only asset it had left that was really worth anything and could be used as collateral was the sovereign promise from the Dublin government: the promissory note.
However, the Irish central bank is now part of the eurosystem, which means the ECB must sign off on any ELA assistance for Anglo and its successors. Since the promissory note is, in essence, the one thing the ECB has as collateral for its loans, it has to make sure whatever replaces them is still legitimate collateral. That gives it a veto in any attempt to restructure the notes.
Q. Dublin’s pitch sounds pretty reasonable. It doesn’t want to get rid of the debt it owes on the promissory notes; it just wants to restructure them. Why is the ECB being so difficult about singing off?
A. The IMF, for one, has been making this exact argument and it has some sympathy within the European Commission. But legally, the ECB cannot do anything that amounts to what’s called “monetary financing” – literally, the bank can’t loan money to a national government.
Most central banks do this with some regularity – the US Federal Reserve and Bank of England have used monetary financing as a normal crisis-fighting measure in recent years but the ECB is barred form doing so in EU treaties.
The prohibition against monetary financing is something insisted on by Germany, which has a very bad history with central banks causing inflation by printing too much money.
So the legal staff of the ECB is very concerned that any leeway on the promissory notes will, in essence, amount to the ECB lending Ireland cash – or monetary financing. Given the political anger in Germany against signs the ECB is already overstepping its legal bounds on this issue elsewhere, there is some fear that any promissory note deal will be challenged in the German constitutional court.
So the ECB, in essence, needs to make sure that Ireland isn’t getting something for nothing. In other words, any new deal can’t be all that more generous than the promissory notes. This is why the ECB has shot down earlier proposals, such as extending payments over 40 years. Reports in recent days claim the ECB has even vetoed elements in the new deal that would extend payments to 15 years. This is probably the reason the ECB failed to sign off on the deal before the Irish parliament acted overnight.
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