September 12, 2011

What happens when contracts can't be paid?

Posted in Banks · 13 comments ·
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A few months ago, Ruairi Quinn – a former Minister for Finance and a man who clearly understands the economy – declared that the country was in ‘‘economic receivership’’.

It is an interesting phrase, and worthy of some consideration.

If a country is in economic receivership, what does that mean for existing state contracts signed at a time when the state was solvent? Can they be honoured? Is there a receivership mechanism for a country in receivership? And if there is, who are the preferred creditors? Clearly, the state can’t deliver on old contracts because it simply doesn’t have the money. So who suffers?

This is an extremely important question, because, over the coming months the state will have to change the terms of many contracts entered into when times were better. Take the issue of golden handshakes for top dog mandarins, as just one example. Last week, we saw what seems to any reasonable person like an exceedingly generous golden handshake to a senior civil servant.

How does a state, and one which is bankrupt, deal with these types of contracts signed when we had loads of money but delivered when we are bust?

The same goes for large-scale capital projects and thousands of employment contracts governed by the Croke Park Agreement. This is particularly crucial if we accept that the most important contract in Ireland – as a functioning republic – is the contract between the state and the general citizenry, rather than the state as a specific group of citizens or a specific interest group.

You are probably sick to death of these obscene state payouts that our politicians condemn as unfair and yet claim that, legally, there is nothing they can do. Or worse still, what do you make of the outstanding payments to Anglo Irish bondholders? It’s your money after all.

And if it is not your money, it is your children’s money, their inheritance, because these monies get paid only because the state has the ability to tax citizens. Therefore, rather than face up to the changed reality now, the state borrows from tomorrow to pay for yesterday and, in so doing, forgets about today.

So we are like a country in receivership but with access to someone else’s cash (our children’s) to pay creditors. So it’s not a receivership in the real sense of the word.

But let’s imagine for a moment – to use Quinn’s analogy – that the state was put into receivership. We would then have to choose a bankruptcy regime based on a hierarchy of creditors. Let’s think about it for a moment. In a normal commercial receivership, there are three types of creditors. At the top of the pile, there is the ‘secured creditor’. Usually, this is a bank that has lent to the company and has taken a ‘‘charge’’ over all the assets of the company so that, in the event of a bankruptcy, the bank gets paid first.

Below this is the ‘preferential creditor’. In the case of a company, this would be the Revenue. At the back of the queue comes the ‘unsecured creditor’. This, in the case of an everyday company, might be the lad who sold photocopiers to the company and is now waiting for payment.

Let’s say, for the sake of example, that the company folds and a receiver sells off the assets of the stricken company. At the outset, there are €500,000 of secured creditors, €400,000 of preferential creditors and €5,000,000 of unsecured creditors. The receiver comes in, sells everything for only €1 million. This €1 million is then divvied up.

From the €1,000,000, the secured creditor gets all his €500,000 back. Then there is only €500,000 left. The preferential creditor gets all his €400,000 back and this leaves only €100,000 to be divided among the €5,000,000 of unsecured creditors.

That’s the harsh world of receivership. Nowlet’s consider the entities the Irish state owes money to. Where would they come in the pecking order if we were to deploy the weapon of receivership and start again? What if a government were to come in and decide to raise no more new taxes to pay for old follies, but deal with the situation and set up a hierarchy of deserving creditors, from the most deserving – whom we have to pay – to the least deserving – who can be treated like unsecured creditors? As money is tight, we have to make a choice. I know it is only an exercise, but it helps focus the mind.

Where would Anglo bondholders come in your pecking order? Would they be paid and treated the same way as Our Lady of Lourdes Hospital? Where would the golden handshakes of the best-paid top civil servants in Europe come? Would their pension top-ups, on already generous pensions, be classed as secured creditors which had to be paid? A re they more deserving of the last of the state’s meagre money than nurses or bin men?

Of all the people the state pays, who would be the most deserving and who would be the least? At the moment, looking at the cuts and where they are likely to fall, it seems that our state has decided that the top-dog civil servants and the so-called professional financial institutions – the bondholders – are secured creditors who have to be paid back in full. In contrast, the average citizen is the ‘unsecured creditor’ who gets the bare minimum when all the rest have been paid. This does not seem to be fair or wise.

The ‘‘fairness’’ argument is self-evident, but the ‘‘wisdom’’ one needs more teasing out.

Is it wise to pay good money to the bondholders of a bust bank? It is only wise if the sanction for non-payment is greater than the payment itself.

The argument made by the establishment has been that if we didn’t pay the bondholders, we would be frozen out of the bond markets. Well, the truth is that we were frozen out of the bond markets precisely because we paid Anglo bondholders.

By paying the debts of Anglo and the other banks, we made the Irish balance sheet weaker, not stronger, and consequently undermined the financial stability of the country. Eventually, the markets said ‘enough of this carry-on’ and shut us out.

Using the same logic, it appears obvious that the reverse is true and that the markets would actually reward us for non-payment because not paying that dead money means there is more money for real, dynamic investment. This is what has happened in Iceland and all the Asian Tigers. The latter are thriving and the former now recovering.

As for the position of top civil servants, it is clearly unfair to pay individuals huge golden handshakes as well as a huge pension when budgets are being cut everywhere. It is also unwise simply because there is no sanction against non-payment.

The top civil servants are not going to jump ship, because they have nowhere to go. They are unsecured creditors if I ever saw one.

With the country in ‘‘economic receivership’’, it is interesting to think about the pecking order of who is deserving of the limited spoils of the country. At the moment, the state regards the banks and the highest paid civil servants in Europe as secured creditors and much of the rest of the society as unsecured creditors. With the budget focusing minds in the next few weeks, this receivership pecking order must change.

David McWilliams has devised and will teach a new economic diploma, Economics without Boundaries, from September 27. See www.davidmcwilliams.ie or www.independentcolleges.ie


  1. Malcolm McClure

    David : Excellent insight to a preferred solution to a very knotty problem. Let’s hope that TGs have taken it on board. Problem is that politicians are scared of the power of top civil servants whose business is to ‘know things’. Politicians business is merely to ‘say things’ and what ministers say is usually penned by top civil servants.

    Regarding the pecking order of creditors, perhaps it is naiive to expect the matter of ‘fairness’ to be adjudicated in this world? –Surely that is the prerogative of St. Peter and his cohorts in the next? –And some might consider that the expenses of Our Lady of Lourdes’ Hospital should be left to the tender mercies of Bernie herself?

    • Adam Byrne

      What are ‘TGs’ please Malcolm?

      • Malcolm McClure

        Actually, Adam, assuming they were not products of a simple typo, I suppose TGs must be the incestuous offspring of TD and FG. –If ministers don’t get their act together, St. Peter will be obliged to consign them to the tender mercies of Lucifer, as their fallen alter ego, ‘DFs’.
        –I think D stands for Dumb but I can’t remember what the F stands for.

  2. Adam Byrne

    subscribe.

  3. This “Pecking Order” is the clearest indication of the self-preservation amongst our political establishment.
    To tinker with salary, lump sums and pension arrangements would be sacrosanct to people who truly believe that
    “Public Service” actually means “Public Serve Us!”

    In my honest opinion I believe that public representative numbers should be culled and then Reps could be volunteers or seconded from currently held positions.
    They should be given free travel passes and put up free in Dublin in a Government Hotel given to the state by NAMA.

    Why?….. just look up “Public Service”

  4. Original-Ed

    If only the poor citizen could walk away with the bare minimum as in any receivership – instead he’s going to be shaken down to pay the secured creditors. This is not a receivership, it’s robbery pure and simple

  5. Sovereign Receivership

    I studied the example of distribution of monies received .What about the costs of receivership ? That is usually a very profitable slice for the Sovereign Receiver Proceeds and in multiples of what he would normally earn elsewhere in his practice. Chop Chop Chop Chop …that means the Enslaved Soverign Taxpayer is left with pittance .

    On another issue in the above have you heard about ‘Skiing’ ? : ‘Spending kids inheritance ‘.

    It makes sense sometimes.

    • Adam Byrne

      September 12th (and 11th) has come and (almost) gone John Allen. Time to put the crystal ball back in moth balls, or better still chuck it off the cliffs at Dun Aengus. I’m afraid to say you have about as much credibility as Harold Camping at this juncture. Nothing personal John, sorry.

  6. It is sickening

    An unemployed friend was told she needs a Barrister’s letter to get on the local authority housing waiting list. New rules you see. You need a Barristers letter to prove that you are of ‘sound character’

    What an insane and fucked up country this is!

    • Sickening indeed and it seems you don’t have to have a character reference to be a TD;

      http://www.dailymail.co.uk/news/article-2036014/Fake-expenses-shame-Dail-Eireann-So-culprit-investigated.html?ito=feeds-newsxml

      What’s blatantly obvious about the attached is how the system closes ranks to protect “its good name”.

      BTW did the Gardai ever charge Callelly for forgery?…..Unlikely…..he’s probably on a cruise somewhere?

      • Praetorian

        Putting people through the loops, I have seen it with other unemployed, if there was this must fact checking and form stamping in the Regulators office, there wouldn’t have been a bust.

        As for politicians fiddling expenses, hardly comes as any surprise.

      • MarbleGirl

        Callely was awarded circa €17,000 compensation in Jan ’11, for loss of pay during his suspension, after the High Court quashed the Seanad ruling. Nice little earner for a suspension of all of 20 days.

        Apparently, a “grievous and egregious” breach of his constitutional rights did “untold damage” to him….

        He is currently busy suing the Independent and Mail newspapers over separate articles about his declarations of interest.

        Sure with all that on his plate, where would he get the time to be charged with forgery by the Gardai?

  7. coldblow

    “Are they more deserving… than nurses or bin men?” Well, it was an Irish nurse who, in response to my tentative suggestion years ago that the differential between the top earners in the country and the lowest (private and public) should not exceed 20:1, indignantly protested that there should be no upper limit. I think Will Hutton in England chaired a work group on the matter of fairness recently and came up with a similar differential.

    I was talking to a psychiatrist (no, not in her prof capacity – she’s a friend of my sister) last month and she said that nurses see themselves nowadays as managers rather than nurses. That chimes with my mother’s experience last year where the public health nurse came round and explained what she needed to get done. My mother (herself a district nurse once) replied: I know that already, dear. I’m 94 and I need someone to do it for me. (nothing against nurses by the way)

    Civil servants pay a proportion of their wages into their pensions, be they at the top or at the bottom of the ladder. (This is aside from the pension levy.)

    It’s tricky. If you can rewrite public sector terms and conditions then you can do the same for other ‘rights’ such as wealth, both earned and unearned. I’m not saying it can’t or shouldn’t be done, but I wouldn’t fancy the job.

    Who will be the ‘preferred creditors’ when the reckoning comes? I suspect that, rather like Pauldiv’s housing list, it will probably boil down to how much pull you have. Perhaps we will dispense with any tiresome analysis of each group’s merits and the deserving few will just be hailed by popular acclaim.

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