When Irish Eyes are Smiling

Location Date: 
March 14, 2013

With St. Patrick's Day right around the corner it is a pity the Irish have not had much luck the past few years. The Celtic tiger turned into a pussycat post the 2008 financial crisis. The Emerald Isle has been mirrored in an economic slump as property prices crashed, unemployment rocketed and austerity conspired to bring the economy to its knees.

That being said, the Irish recently decided to finally have a proper burial and wake for two of its now zombie banks who were responsible for a large part of the crisis. Anglo Irish Bank (AIB) and Irish Permanent (IP) were purveyors of ungodly amounts of lending to local real estate tycoons/zealots who in turn created one amazing property bubble and bust. Of course to get the money to lend, these banks had to heap plenty of blarney on unsuspecting and daft bankers in Germany, France and other sophisticated countries. When the 2008 crisis hit, the big Irish banks were essentially bust. Rather than do the Icelandic shuffle and tell creditors to stuff it, the Central Bank of Ireland (CBI) was forced by the Irish government, via the EU, to take on the bad debts. The public bailout was facilitated by the Emergency Liquidity Assistance (ELA) program set up by the ECB. The Irish got €67.5 billion and pledged a further €17.5 billion from their government pension accounts (nice) for a cool €85 billion. The Irish government issued a promissory note ("pnote") back to the ECB that had an interest rate of 8% and a short pay back period. And to pay back the pnote, the government put a nasty austerity program in place — pay cuts for the civil service, cut backs on services, etc. However, like all the other PIIGS, there was virtually no chance of actually paying back the debt... and everyone knew it! The Irish were paying €3.1 billion in interest and principal, while austerity was saving roughly the same amount — a Mexican standoff.

So enter a little Irish magic!

The government this past February announced, with the tacit support of the ECB, that they were taking AIB and IP off life support and restructuring a large portion of the pnote into a series of long-term bond obligations. The Irish Taoiseach (Prime Minister) stated, "Today's outcome is a historic step on the road to recovery."1Indeed!

The Irish get a lower interest rate (3%) and more critically they extend the term of the debt to over 30 years. In the parlance of economics this is debt monetization. Irish economist Karl Whelan commented that this reduces the NPV of their debt by over 40%1! Add in the fact that the government may still choose to not pay back all the debt or extend it even further down the road, means you could move the reduction in NPV to close to 100%!!

Of course there is a loser in all of this — yes, it is the Germans, French et al. The gory details of this arrangement were shrouded in a thoroughly confusing and detailed design intended to take advantage of the "mushroom principle" on its unsuspecting citizens. They won't see or understand that this is just monetizing bad debt.

While this agreement will help, Ireland is still not yet out of the woods. Its debt to GDP ratio of 120%2 (up from just 20% pre-crisis) and household debt per capita are amongst the highest in Europe. Still, this arrangement offers real breathing room for the government to redirect its revenues towards policies to get it back on its feet. S&P recently revised Ireland's outlook from "negative" to "stable" which will help allow it to exit the bailout program this year. Ireland is also tapping the 10-year debt market for the first time since the crisis. The markets are all aware of this — check out the performance of the Bank of Ireland (IRE:NYS) or the terrific deal that Great West Life of Canada secured in buying Irish Like (subject to regulatory approvals).

Some in German circles are crying foul but not very loudly. If Ireland had done what Iceland did and protect its depositors and taxpayers (rather than creditors), the Germans et al. would have been hurt badly. So at the end of the day, this 'settlement' seems to make sense. The real brunt though is felt by the Irish citizenry. Economists devoted to the Austrian school point out that the common man should not pay for the sins of the elite classes that caused the excessive speculation — fair enough, but this settlement at least ensures that both creditors and debtors take haircuts. And bankers and real estate moguls are targets for public scorn and prosecution in Dublin — unlike the United States and the UK. This arrangement is being touted as a way out for Europe at large. The democracies in Greece, Spain and Italy (as shown in the recent election) will not stand for more austerity. The only real way out is to partially monetize the debt and while the Germans and Mario Draghi are presently not in favour of this, it is hard not see this eventuality.

To me this story is analogous to a fabulous gem of an Irish movie called "Waking Ned Devine". It is the story of an elderly Irish sweepstakes winner living on the west coast who dies of a heart attack upon finding out he has won. With no next of kin, the townsfolk have to come together and create their own Ned Divine to claim the prize and share the winnings. 

Speaking of Irish movies, to get you in the mood for the big weekend ahead, why not consider watching some of my favourites with a few pints of your mother's milk (aka Guiness). Irish eyes will be smiling a bit brighter this year with the news of this arrangement. Just as St. Patrick drove all the snakes from Ireland, so to has the Irish government driven those nasty continental creditors away — at least for now!

Let's toast to your good health — Sláinte!

Jim McGovern

The Top Irish Movies 

The Quiet Man (Classic set in breath taking Connemara featuring John Wayne)
In the Name of the Father / My Left Foot (Both masterpieces of acting with Daniel Day-Lewis)
The Commitments / The Snapper / The Van (The Barrytown trilogy written by Roddy Doyle — amazing, especially the first two)
The Crying Game (The coming out movie for Jordan if you get it!)
Cal (if only for the music of Mark Knopfler)
The Field (to understand what life is like in rural Ireland)
Bloody Sunday

Waking Ned Devine (ok so it was shot on the Isle of Man — still great!)
When Brendan Met Trudy
 (great musical)

The Secret of Kells (extraordinary animation and wonderful story)

1.    Financial Times, Wolfgang Manchau, "Ireland Shows the Way with its Debt Deal", February 10, 2013
2.    Financial Times, FT Long Short, Ireland: Poster Child for Austerity, March 4, 2013