Friday, April 1, 2011

Reorganizing Irish Banks

Going into the week when the Irish bank stress tests would be made public on March 31st, the Irish government  tried to build a consensus for EU burden sharing with a proposal that the deleveraging of Irish banks be slower than previously agreed, that the EU provide medium term lending to make that possible, that holders of senior bank bonds share investment losses, and empower the EFSF to be a provider of last resort in the bank recapitalization.  The Irish threat of haircuts was blunted by rumors that the ECB was preparing a new liquidity facility for troubled eurozone banks and that the plan would initially be tailor made for Ireland, but analysts quickly began speculating that the new liquidity facility would allow guaranteed collateral of a lower quality than previously accepted by the ECB.

Ireland and Europe braced themselves for the results as the belief grew that the banks would need more liquidity than previously estimated.  The 24 billion euro identified recapitalization need in the stress test report was actually less than estimates of 26-30 billion euro, but it came with a warning to the Irish government from Governor Honohan of the Central Bank of Ireland that a unilateral imposition of losses on the senior bond holders without the agreement of the EU state would not be a net gain for Ireland.  At the same time the Irish Department of Finance issued a bank reorganization plan which paralleled the stress test and the finance minister editorialized on the need to radically reorganize Irish banks to be smaller and more sustainable.  The ECB did issue a ratings agencies preemptive strike by announcing a suspension of "... the application of minimum credit rating threshold in the collateral eligibility requirements for the purposes of the Eurosystem’s credit operations in the case of marketable debt instruments issued or guaranteed by the Irish government. The suspension applies to all outstanding and new marketable debt instruments..." until further notice.

However, the ECB's governing council were in disagreement and refused to provide the necessary the medium term funding facility which had been so publicly leaked earlier in the week on "legal concerns" it would violate European treaties.  Actually, some governors argued that Ireland should be left to itself while other (like Weber) favored bond holders being bailed-in.  Bottom line, it was a warning to Ireland -- if you want monetary assistance, forget about your sovereign rights and threats to make senior bond holders share in the losses of their investment.  Ireland capitulated to the ECB and yielded to demands to protect senior bond holders which are German, French, and UK banks among others.  While some have argued that the EU has invested large sums already to prop the Irish banking system up, it remains that the Irish banking system is being used as a firewall to protect European banks at the indentured expense of the people of Ireland.  Whether Ireland will have market access given the conditionality of the proposed ESM for 2013 and if burden sharing by the senior bond holders will not happen anyway appears questionable to many in Ireland.  Is it reasonable for the people of Ireland to just live with it if the European nations persist in this self-defeating policy?  At some point in time, if the European nations keep on this monetary union without fiscal union course of credit destruction, a eurozone nation will just say no to the suffering and assert its sovereignty.

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