29 November 2010

Ireland bailout: what’s next?


Ireland bailout

The 12% of GDP Irish budget deficit (32% including a banking rescue) was unsustainable and a few details emerged about the bailout agreed Sunday:
The contribution from Ireland will come from the cash pile the Irish Treasury has accumulated and the National Pension Reserve Fund - a disgrace; the fund, which holds EUR 24 billion of assets, was set up in 2001 to pay pensions from 2025. This means that Ireland is its own contributor for 20% of the total rescue package which worries me.
The loan has a 7 ½ year tenor and will bear a 5.8% interest more than the 5.2% granted to Greece (which I do not know where it comes from since a 5% ceiling was agreed for Greece).
EUR 10 billion will immediately go to recapitalize Irish banks and EUR 25 billion for further needs, the balance, EUR 50 billion, covering budget deficits.
It is worth noting that Germany dropped its demand of having bondholders taking part of the burden. The ECB, and other European countries, feared that such a move would translate into higher cost of financing and even close the market for more countries adding new losses for banks. Banks have played the yield curve by borrowing at near zero cost with the ECB and investing in longer date sovereign (riskless!) bonds, compounding the crisis.
Another interesting paragraph not linked to Ireland: “The Eurogroup will rapidly examine the necessity of aligning the maturities of the financing for Greece to that of Ireland”. This confirms my analysis that Greece is in no position to reduce its budget deficit down to 3% of GDP in 2014, and even less to be able to repay the emergency EU and IMF loan after 2013. Is the interest rate going to be adjusted? Is it going to be the same as Ireland? In any case these rates are administered like Albania in the good old says… Where is capitalism?
One last question (and I did not find any answer anywhere or even any question about it anywhere): how do these rescue loans rank compared to senior debt…?
Finally, the EUR 40 billion loan represents an additional EUR 8.8 billion for Italy, EUR 10.0 billion for France and EUR 1.7 billion for Belgium (if Spain is not excluded as I did, it would add EUR 4.9 billion, or 4% of its debt requirements for 2011, and reduce pro rata the other countries ).
2. What’s next
Looking at the market this morning, this plan fails to alleviate fears of contagion:
  • After a short (small) rally bank stocks are down again
  • The EUR is also under pressure after a short rally
  • 10 year bonds in PIIGS countries are more or less unchanged
  • German 10 year bund yield is at a 6 months high
The second bailout of the eurozone is nothing more than hiding dust under the carpet; the rescue package is not a game changer since it does not improve competitiveness and does not reduce the debt overload, to the contrary: liquidity support does not work out insolvency. There are calls to double the EUR 750 billion commitments, since the current one would be insufficient to rescue Spain and Italy (besides Portugal and add Belgium and France).
Portugal will be the next country to ask for a bailout and Spain will follow quickly behind due to its exposure to Portugal (EUR 78 billion at the end of June); then if Belgium or Italy fails, France would be engulfed with an exposure of EUR 253 billion and EUR 418 billion respectively.
In order to repair their balance sheets instead of cleaning them up one for all, the ECB and European politicians (lobbied by banksters) encouraged banks to play the yield curve by investing in peripheral European sovereign debt to get a nice spread pick up over their financing cost, and then, when things started to look ugly earlier this year, the ECB bought this sovereign distressed debt whatever the rating (against the ECB rules, but who cares…). The only effect has been to compound the crisis for gaining 1 year maybe 2 or 3 at most.
And Trichet, alongside most European politicians, continue to play this game by refusing bond holder (read banks) to share the burden (I even do not see why we, the tax payers, should we pay for any bailout when investors made wrong decisions). This, in effect, (temporarily) transferred the insolvency from banks to States without getting to the roots of the crisis.
It will carry on until and unless Germany stops playing musical chairs; in-between the crisis will deepen with debt continuing mounting and inflating it late seventies/early eighties style, the only way out.
I continue to believe that an orderly bailout of over indebted countries and banks is the only way to cleanup the house and build again on sound foundations. This is not the way Europe has gone so far, preferring dogma over sound governance. Europe is facing enough challenges (an ageing population and pension payments being the most important) without having to drag ongoing debt problems: let’s investors who made wrong investment decisions bear the burden, this is how capitalism works and wash aside the socialist and interventionist approach which repeatedly failed.
Continue to stay clear of financial shares and buy precious metal on setbacks.
Council of the European Union: Statement by the Eurogroup and ECOFIN Ministers