November 22, 2010
Travelling on the 11am Aircoach from Cork to Dublin, wi-fi working fine, hurtling down a new motorway, it’s difficult to imagine that the International Monetary Fund (IMF) is already here.
At a certain level, the place seems almost prosperous.
Granted, over the past year the type of person on the bus has changed, but apart from that, not much else screams ‘bankrupt country’.
Last year, the bus was full of students, immigrants and the elderly. Last Friday, there was a significant increase in the proportion of swankier commuters, many well-heeled types, with quite posh luggage, heading to Dublin Airport.
This proves the point that, in a recession, it’s not that the middle classes don’t go on holiday, it’s just that they take the bus and fly Ryanair. It also suggests that, for some people, austerity hasn’t begun to bite.
But it will be felt, and the IMF will make sure of that.
The question we need to ask is will they – the EU and the IMF – make things better or worse.
Let me paint a picture of how they could make things immeasurably better. In order for this to happen, we, the Irish people, must show our government that we support the option which applies the basic rules of capitalism in such away as to strengthen Ireland as fast as possible.
Again, the solution begins and ends with the banks and the nature of the bank bailout.
If the IMF/EU simply follow the course of action that the present shambolic government is pursuing, we are doomed.
That policy of paying every creditor in full is flawed and will lead to a further crisis down the road.
The only way out of this banking mess is to have a bank resolution or law passed which turns the existing creditors of the banks into shareholders, whether they like it or not.
At a stroke, the huge debts of banks disappear and are borne by the creditors – which they should be – and we start again.
The Irish taxpayer is no longer on the hook and we do what the US did in the savings and loans debacle in the early 1990s: we apply a market solution to a market problem.
This will not be pretty, but it will work.
Are we too far down the ‘pay all bondholders’ road to do this?
No, we are not; in fact, the arrival of the IMF makes a reversal of the financially suicidal policy easier.
Why might that be?
There are four reasons: one based on law, a second on the reality of the bond market, the third based in the reality of corporate finance and the fourth based on personal vanity and ambition.
First, we have no bank resolution law in Ireland, so we can do what we want from here. We could now pass a law that says the Irish approach to bank resolutions will be based on debt/equity swaps, where shareholders and subordinated debt holders take the first hit.
Anyone who knows anything about banks will know that the only things of value in a bank are core deposits.
The reason is very simple: core deposits are what makes a bank a bank.
And when all the fancy stuff is done, the only things a bank will buy from another bank are deposits, because deposits are the type of capital you want: steady, cheap and largely sticky.
A bank with a good deposit base has strong foundations.
This is why Anglo Irish Bank was a boiler house: it had little by way of a real deposit base, at least as we traditionally understand the term deposit.
So the resolution law protects depositors with an ECB-backed deposit insurance scheme.
Once the law is passed, expect some legal challenges, but as these challenges will be in Irish courts, it will be difficult for us to lose.
Creditors will then split into realistic creditors, who take the deal constituting the new reality and get on with the business of forward-looking capital, and rogue creditors, who will try to drag us to court threatening all sorts of sanctions.
Well, frankly, let them at it.
This will not matter after awhile.
The second reason we can do this under the umbrella of the IMF is that the IMF’s involvement here means we don’t have to go back to the bond market for at least three years. So it gives us time to sort out our house, without having to worry about bond traders determining our next move.
Don’t forget that the markets are not wise, they are bullies, and the way to stand up to a bully is to threaten him.
We threaten him with a new debt/ equity-based bank resolution law and he will be brought to heel.
In addition, after the debt/equity swap, the overall financial position of Ireland becomes immeasurably stronger.
Our balance sheet becomes much more attractive and the consequent risk of investing here diminishes.
This means that the bond yields will fall rapidly, not rise. The third reason that there might be a way out for us relates to corporate finance. Think about what is happening.
The IMF/EU are injecting fresh capital into Ireland. The rules of capitalism say that new capital always takes precedence over old capital.
This means that IMF money will be ‘senior’ to all the other money invested by anyone up to now. As a consequence, the process of dilution of old creditors is already under way.
So the ECB and the bondholders who are already in the game now realise that they are ‘junior’ to the new capital and this means in plain English that they won’t get their money back on the terms they originally thought they would.
Not pretty, but no one said lending to a bankrupt country would be pretty.
Finally, there is the issue of vanity and ambitions.
The president of the IMF is Dominique Strauss-Kahn and guess what job Domo wants next? Yes, you got it: he wants to be president of France.
Now wouldn’t it be great for Domo if he saved Ireland and in the process saved the euro with a sensible debt/equity deal which allowed Ireland to grow, penalised hedge funds in the subordinated debt market and made bondholders realise that there are risks in reckless lending?
By saving the euro and Spain from contagion, Dominique could appear to be what all French presidential hopefuls want to be: a great international statesman.
We could facilitate this for him, if only he’d see the wisdom of a large IMF and EU sponsored debt/equity swap.
The course of action outlined above is one way the humiliation of the IMF can be turned to our advantage. Can we do it?
Yes we can. But it can only be executed by people who have the interest of Ireland at heart, who can see clearly in the crisis and who understand that, in these negotiations, everyone needs away out. We need a way out, the EU needs away out, the ECB needs away out and the IMF needs a way out.
The above is one such way.
By the way, government ministers reading this, you can have the advice for free. It won’t cost you tens of millions in fees.
Yours, a concerned citizen
David McWilliams starts the Outsiders national tour in Kilkenny on Saturday and in Cork on Sunday.