April 25, 2011
Where do you think the financial markets assess Irish risk? What countries are we compared against? Surely we are still regarded as a European developed nation when it comes to risk?
Think again. After – or more likely because of – our recapitalisations and bailouts, the world regards us as a bigger default risk than Uruguay, Peru, Columbia, Tunisia, Kazakhstan or Guatemala.
Just look at the graph here to see the company we keep. It shows what is called the interest rate ‘spread’.
This is the difference between what either Germany or the US pay to borrow money compared to what other countries have to pay to borrow money.
All the eurozone countries are benchmarked against Germany. The others are benchmarked against the US.
It is comparing like with like, because most of the world benchmarks itself against US Treasuries, except those of us in the eurozone.
The chart reveals perceptions of default risk. The higher the borrowing cost, the higher the risk is that we will default. It tells us how much the people who might lend to us are demanding as compensation for the risk that we will default.
It also reveals that euro countries such as Ireland,
Greece and Portugal are not being downgraded enough by the ratings agencies. This is possibly because we are in the euro, when it is the straightjacket of the euro that is causing the risk to rise in the first place.
If you look at the thick line in the chart it reveals that there is a relationship between the market interest rate and a country’s credit rating.
The higher the interest rate, the lower the credit rating should be.
The markets now think that Ireland is much riskier than Jamaica, Belize or Senegal, yet the credit rating agencies can’t bring themselves to reflect this in their ratings.
This is because they believe that ultimately the Germans will pay the bill, or because they believe that the euro will blow apart and the ability of the likes of Ireland to pay future debt will improve after a default and devaluation.
Therefore, the markets are now mispriced.
Whatever the rating agencies’ reasons, the chart is extraordinary and it impales on the altar of reality the Irish establishment or consensus view that ‘we are doing the right thing’.
Not only are we not doing the right thing, but we could hardly be doing the more wrong thing (if that makes grammatical sense).
There was a lot of talk about the ‘group think’ of the boom last week.
Well let’s consider the same ‘group think’ in the bust. The same lads who told you there would be a soft landing are now telling you we must pay all the banks’ debts.
As a result, these stalwarts of the discredited Irish establishment insist that everything we are doing now will diminish the risk of default. Unfortunately, no one in the real world – outside the Irish insiders’ peculiar bubble – believes these so-called ‘serious people’.
With the publication of the latest McCarthy report, our self-delusion has become more pronounced.
When you stand back and look at the big picture, the idea of selling state assets now while at the same time buying all the banks’ toxic debt amounts to financial suicide.
We are buying toxic bank loans – which are worthless – at a premium, while we are going to sell state assets – which are worth something – at a discount.
How insane is that?
We are not making our balance sheet better; we are making it worse. Any fool can see that if you overpay for something that has no value and you cheaply sell something that has value, you are destroying your balance sheet.
Yet it seems that Irish economic consensus – the ‘soft landing’ group – is suggesting that unless we pay everything, including the bank debt, we will be seen as a risky place to do business.
In fact the evidence from the markets tells us that the opposite is the case. Examine what the figures in the chart are saying about the impeccable logic of reneging on bank debt, which isn’t ours anyway, drawing a line in the sand and moving on.
Today, because we are entertaining selling good assets cheaply and buying bad liabilities expensively, the market regards Ireland as a considerably bigger risk than Uruguay, a country that defaulted on its sovereign debt in 2002.
We are regarded as a bigger risk than Kazakhstan, a country which ‘burnt the bondholders’ in 2009.We are seen as a bigger risk than Tunisia, which has just had a revolution, and a bigger risk than Peru, which is about to elect a populist politician as president.
We are worse than the narco-trafficking centre of the world, Colombia, and worse than Guatemala, a country where 67 per cent of the population are under the poverty line.
How much more evidence do we need? We need to change tack immediately and see that this IMF/EU deal is destroying the country – and by destroying the country, it has the potential to destroy the euro.
Maybe we should be thinking of another way, which might get us out of this mess. Obviously, the IMF has traditionally insisted on privatisations as away to fiscal probity. Let’s for a moment accept this hypothesis (although it is full of holes).
Why not say to the IMF that privatisation is conditional on revisiting the bank debt issue?
This week, our banks were downgraded to junk.
Well, junk never pays its debts, which is why it’s junk. So let’s make a deal with the IMF/EU, which is that we will privatise only if we restructure the banks’ debts along the lines outlined in the table above. According to the Financial Regulator, there are â‚¬63.38 billion of bank bonds out there.
Why don’t we apply an escalating ‘haircut’ to all bank bonds, with the biggest haircut to the riskiest bonds – the subordinated bonds – and move up from there.
According to the table, we could save â‚¬30 billion this way, making the â‚¬5 billion we raise through privatisation meaningful. We could make our balance sheet better by making the privatisation ‘conditional’ on imposing on the lenders to the Irish banks the reality of their own stupidity.
This would make Ireland less risky and, by doing this, it will make the euro less risky. This is still our trump card. If we and the other countries in trouble, Greece and Portugal, together hinted that maybe we’d have to leave the currency, the Germans and French would panic and come to the table with a better deal.
We know this, they know this and the rest of the world knows this, so why not hint at it? They will claim we have no alternative, but clearly the chart above shows that we have. In fact, not only do we have an alternative but being in the euro is actually increasing our risk premium, not decreasing it.
In a game of poker, you have two minutes to figure out who the fool is. If you haven’t figured out who the fool is after two minutes, the fool is you.
As our American cousins might say: ‘‘Go figure.”