You can make a crisis out of a problem.

Just as I feared and forecast, the second phase of the Euro crisis has hit us.  The first phase saw Greece at the centre of the storm. It ended with the announcement of a bail out for Greece, and the provision of general facilities in case any other country got into difficulties. The authorities told us that would end the crisis. Up to a trillion euros were available as loans, guarantees and cash so that would take care of any member state getting into more trouble.
 
         So why didn’t the bail outs work last time? The Greek bond market was not very impressed. Investors wanted to see evidence that the Greek budget deficit was coming down. They seek honest figures showing progress. They wished to see how the Greek economy would recover and grow, as some growth is essential to getting the deficit down more rapidly. Disappointment soon set in, and Greek bond yields have remained very high.
 
         Ireland was  making progress in cutting spending to cut its government deficit. Meanwhile the European Central Bank was quietly making facilities available to various EU banks, including Irish ones, as a Central Bank should at times of difficulty. The German Chancellor decided to float the idea that bondholders who had lent money to Euroland economies under pressure should have to share some of  the costs of sorting out the problem.  She mused that “haircuts” or reductions in interest and capital repayments might be an appropriate way to share the pain of adjustment. This was bound to force up the price of borrowing for the Irish government  and force down Irish government bond prices. Later a partial retraction was issued, saying the haircuts might only apply to future bonds and not to money already lent.
 
        The EU let it be known that they thought Ireland should borrow money under one or more of the facilities on offer given the high cost of direct borrowing and the large borrowing needs. The official Irish position said they did not need to. It was then slipped into the media that the European Central Bank might wish to reduce its support for EU banks, at a time when   Irish banks  might   lose deposits and be in need of extra liquidity. Finally on Thursday it emerged  the Irish government would accept financial help for its banks.
 
           All of the public briefing and comment made the problem worse. Days of negotiation, proposal and denial led to a further loss of confidence in Ireland and its banking system. A Central Bank is  the lender of last resort to ensure sufficient liquidity so no-one need worry about getting their cash back from any bank in the system. The European Central Bank has been performing that role and should continue to do so. The banks should be regulated strongly to ensure they are solvent at all times, that their  total assets exceeed their liabilities. If they have a sudden large withdrawal of money the Central Bank supplies the cash so they can meet it. The bank then should sell as many assets as needed to repay the Central Bank to an agreed timetable which is best kept private.
 
           The European Central Bank appears to want unnamed Irish banks to raise more capital or have access to facilities outside the ECB. This of course involves the Irish Central Bank and government. The sooner they work out their respective responsibilities, the sums involved and issue a detailed package to the markets the better. They have talked themselves into a serious problem, and now need to dig themselves out by their deeds. 
 
          Will this second bail out work, when the first did not last for long? That will depend on what they do and say next.   Now  we want to see the colour of the money, to find out who is paying the bills, and to assess whether it will then work. The truth is arranging facilities is only part of the answer. The Irish government has to continue its work of cutting spending and boosting revenues to cut its own borrowing needs. The Irish banks have to continue selling assets, finding more profitable business and restricting their risks and balance sheet size in the meanwhile. The markets will judge them by results.

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11 Comments

  1. FaustiesBlog
    Posted November 19, 2010 at 6:16 am | Permalink

    Merkel’s remarks (were very damaging ed). (Shouldn’t there be) t a law against that?

  2. Michael
    Posted November 19, 2010 at 7:08 am | Permalink

    Thanks for the very clear explanation.

  3. lifelogic
    Posted November 19, 2010 at 8:10 am | Permalink

    When push comes to shove and Cameron finally is actually forced to have a battle with the EU then the fact that he has helped the Euro and the Irish – with billions of money that he will have to borrow mortgaged on his already over taxed 53% enslaved electorate – will weaken his negotiating position. Does he understand nothing of the art of bargaining?

  4. Brian Tomkinson
    Posted November 19, 2010 at 9:17 am | Permalink

    This has been a crisis generated from within the EU. It is suggested, particularly by France and Germany, that the price the Irish must pay for help from the EU, which the Irish were not seeking but have been forced into by the actions of the EU, is to be that Ireland must increase its attractively low rate of corporation tax. Just why they think driving out business and enterprise will help Ireland pay her debts remains a mystery but no doubt they hope it would to be very beneficial to their own economies.

  5. Jose
    Posted November 19, 2010 at 9:46 am | Permalink

    I really can’t remember the outcome of the ‘stress tests’ on Irish banks undertaken earlier this year.
    If they ‘failed’ the tests – what happened?
    If they ‘passed’ – how come?

  6. lola
    Posted November 19, 2010 at 9:50 am | Permalink

    A Central Bank is the lender of last resort No. We are. The wealth creating taxpayer who produces a surplus that we then save and can be loaned to the State via its captive central bank. These taxpayers are sometimes taxpayers in other countries, or other mercantilist countries sovereign wealth funds. But the ‘central bank’ is still not the lender of last resort. I am.

    • Andrew Gately
      Posted November 21, 2010 at 12:28 pm | Permalink

      That is exactly the rather daft taxpayer argument that has made the current crisis so much worse than it should have been.

      The solution to the problem is as John said the central bank provides the funds needed so that banks don’t go bust. The central bank charges a higher rate of interest to encourage the bank to repay the monies at the earliest opportunity.

      The idea that the govt. gives money collected in tax from it’s citizens to the banks is completely false socialist propaganda.

  7. Yarnesfromhorsham
    Posted November 19, 2010 at 11:21 am | Permalink

    Have I got this right? You buy bonds today in the knowledge that you might have to take a “haircut” – that really is going to stimluate the bond market.

  8. Alte Fritz
    Posted November 19, 2010 at 2:22 pm | Permalink

    We can only guess why so much of a confidential nature was given so drastic a public airing. One wonders why the markets would not now turn on Portugal and Spain if they can, in effect, extract a copper bottomed guarantee of their debts from the ECB etc. Can it make sense to be satisfied with the Irish deal to come? SO, internationally at least, this bail out may well solve nothing.

    Politically, one has heard from Irish interviewees and read in the Irish press that what now befalls them goes beyond the former ‘pooling’ of sovereignty in the EU. That is not a phrase we hear here nowadays, but the Irish establishment clearly will not accept that this bail out will not sell sovereignty. They have already done that years ago without realising that they had or who is now the boss.

  9. Mark
    Posted November 19, 2010 at 5:51 pm | Permalink

    We have had over two years of serious credit crunch (three if you count when the cracks in the system were first clearly visible to anyone who was watching, and more if you understood what was happening). That should be long enough to have conducted an audit of the true chains of liability if minds had been devoted to the task. Yet it appears that the ostrich approach has prevailed – “Boo-ka-pee, you can’t see me so long as I’ve got my head in the sand”. Now we will find out whether it was a nuclear testing ground for the Euro. Although BIS data were showing that Ireland was managing down its external gross exposure measured in dollars (from US$ 2.45 trillion in Q3 2009 to $2.13 trillion by end Q2 2010), it remains a massive multiple of GDP (close to 10 times).

    It looks like the EMU will be feasting on a can of worms.

  10. REPay
    Posted November 20, 2010 at 6:51 am | Permalink

    If, like Marx, you wish to control the means of production then state indebtedness is the perfect solution. when you are bust enough the govt. has the whip hand!

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    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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