Friday, November 12, 2010

Germany's Irish Hair Shirt

The bond market fears on Ireland's guarantees of the liabilities of three Irish banks, of which the Bank of Ireland has already essentially recapitalized with only 36% government ownership, and the nationalization of  two smaller mortgage financing  banks has spread to the stock markets as Irish bank stocks sold off yesterday.

The Wall Street Journal had a good article, which was profiled by Felix Salmon, on the development of the current concerns and how the banks loans collateralization and value had been under reported and underestimated.  A blog post by one of the article's writer makes some additional observations and then veers off into lesser, minor issues with respect to mortgages, lending practices for mortgages, property leverage, and the Irish tax code as if they were major players in the current credit/liquidity crisis.  Felix Salmon also concludes that Ireland's guarantee of the liabilities was a mistake as we have written and maintained for months.  However, this is a credit/liquidity crisis and not a banking crisis which has shifted from the banks to the government of Ireland.

Of far more interest is why Ireland made the decision, or was encouraged to make the decision, to guarantee the liabilities of the banks and protect the senior bondholders as well as the depositors.  As we have written, this decision is the very core and crux of the current credit/liquidity crisis and brings into the spotlight the necessity of the European Monetary Union and the ECB to take a proactive and consistent supportive position despite the counterproductive position of Germany which wants sovereign bondholders to share in the burden of any eurozone nation bailout by the ESFS, which has yet to be activated, with a proposal which would require a treaty change.  Merkel's statements have not only created a bond market reaction, as Merkel's statements on this subject have done in the past, but Germany refuses to back away from a concept that has a legitimate point but is being put forward at a time when it cannot be considered and effectively decided and implemented in any timely fashion while significantly aggravating the current situation.  Germany's position is particularly perplexing as we have shown in "On the Road Out of Ireland" that the BIS statistics (p. 6) show German banks have the largest exposure to Irish private debt and, consequently, should be receiving the largest protection from the Irish government's guarantees on the private Irish banks' senior bonds.  Apparently, Merkel finds the unusual protection of risky private investments by German banks acceptable but finds that German bank risk assumed by sovereign debt guarantees of a nation which is not Germany unappealing.

EU leaders have sought to reassure the bond markets that sovereign bondholders would not be affected and issued a statement from the G20 meeting that the ESFS activation does not require private sector involvement.  A proposal from Breugel as commented on by the blog The Irish Economy would create a mechanism for the resolution of a sovereign debt crisis.

EuroIntelligence has been adamant in its reporting and opinion that Ireland is going down and on the verge of seeking a bailout from the ESFS.  To me this seems premature.  If the ECB and EMU do not publicly demonstrate support for Ireland, and the ECB tends to be too secretative about its support efforts, then I would expect the IMF to publicly support Ireland and force the hands of the EMU and ECB, particularly as this has had direct negative effects on the bond and swaps cost of Portugal, Spain, Greece, and Italy.

The relevant articles on Ireland and this issue have become voluminous.  Here are some for your review without additional comment:

Investor concerns hits banks
Central Bank of Ireland Governor Honohan comments
2000 billion euro contagion
Ireland on brink as beggar for aid
Irish borrowing costs hit high
Honohan wants foreign buyers for banks
Bank of Ireland profit down
repo margin increased
Irish investors head for exits
income tax rates to rise
EU commissioner sees light at end of tunnel
no confidence 3% deficit target will be reached
corporate tax revenue
make European defaults not bailouts
revised Irish risk parameters
eurozone bond records
sovereign debt doubts grow
Berlin cast doubt and spreads contagion (Spanish)
Europe ready to split in two or recover (Spanish)
wait until mortgage defaults hit home
ECB bond purchasing
bond buyers strike
Irish debt revives concern about Europe
costs rise on financing fears
sovereign risk and budget woes

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