Why is the Government Going to Pay the 700 million Unguaranteed Anglo Bond?

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I’m sure like me, readers of this have been consumed with the great debate going on in Ireland at the moment. Apart from the rain and receding flood waters, it’s all anyone wants to talk about. Of course the outcome of this discussion will be seen in the very near future, but still its good that there is a serious and informed engagement with this right across the Irish public whatever.

And no, I’m not talking about the fact that Sean Gallagher is just another Fianna Fáil bag man – that is old news. The only thing note worthy on that issue is that it seemed for a moment that Ireland’s de-politised, anti-intellectual, empty sound bite culture had found their man of the hour. That is, someone who was capable of repeating meaningless nostrums about entrepreneurship, being ‘modern’ and concentrating on the future, not the past, while finding it difficult to hide the fact that apart from a long history of fundraising for the kickbacks and brown envelopes party he couldn’t even match up to his own cliches.

The topic I’m referring to of course is the payment of the 700 million unguranteed and unsecured Anglo Irish Bank bond on the 2nd of November (or the Billion Dollar Bond, if you prefer). And of course, I’m being ironic about the debate. Even though its highly likely to be paid in full, its hardly being discussed at all.

However, briefly, it has been raised in a number of places and its important to highlight these. Firstly Namawinelake has a very thorough two part post which asks what would happen if “Anglo didn’t repay the $1bn bond maturing on 2nd November, 2011?” Having looked at the points of view of the various stakeholders NWL then argues, correctly, that the bond should not be paid.

In summary the argument is:

While no bank in the Eurozone has so far defaulted on bondholder debt Ireland has also not signed up to any agreement to preserve its banks at all costs.

“Ireland has not signed up to a system whereby 20% of GDP (€29.3bn) must be paid by the nation to enable unsecured, unguaranteed creditors in failed banks to be repaid and we have also not signed up to a system whereby a bank must be financially supported at all costs.”

When referring to the January 2008 scoping paper put together by officials at the Central Bank of Ireland which recommended a comprehensive guarantee to allow the Central Bank to provide emergency liquidity to “ailing banks” NWL notes that it also stated the principle established by Ecofin about how to deal with insolvent banks. From the January 2011 Sunday Tribune article:

“The January 2008 scoping paper also noted the “preferred outcome” for an insolvent bank was “failure and subsequent orderly wind-down” to prevent the costs of the insolvency transferring to the state.

That followed principles adopted by European finance ministers in October 2007 and referenced in the Department of Finance documents, which said creditors and uninsured depositors “should expect to face losses” in a bank failure.”

Similarly, NWL points out, the deposit guarantee for ordinary depositors in September 2008 was only €20,000, which was then raised to €100,000 and subsequently made limitless. So, in principle, before the guarantee there was the possibility that Eurozone banks who couldn’t cover their losses could go bust.

Then there is the argument that should the Irish government act unilaterally and not pay the bond (leading to Anglo going from a solvent but illiquid zombie entity with a banking licence surviving off emergency funds, loans and a restructuring of assets to an insolvent one), it is likely that ECB will stop providing emergency funding to our ‘pillar banks’, which allows it to issue covered bonds and limp on, or stop payments as part of the EU/IMF/ECB bailout (ATMs will stop working, nurses, doctors and teachers won’t get paid, flood clogged sewers will remain jammed etc).

Bascially, this would be a breach of the terms of the argreement because the paymement of these unsecured and unguaranteed bonds is not mentioned in the Memorandum of Understanding.

The final point is about the possibility of renegotiating the interest rate and the period to repay for the promissory notes – that scandal where we face an annual bill of €4.2 billion over the next 14 years, leading to a total cost of €65bn. An argument about changing this has already been made. However, NWL makes the additional point that if Anglo goes into receivership or examinership then “the validity of all of the promissory notes might be tested, and some suggest that these represent what is called “odious debt” in international law and would not need be honoured by the State at all”.

However, whatever about the technicalities of all this, one thing needs to be kept in mind regarding whether or not these bonds should be paid in full.

These payments are for investments made in an institution that made its fortune on the back of a series of disastrous economic policies established and built upon by all previous governments. There is not one government who challenged the giving of tax reliefs on property investment, and not one who went against the consensus that wealth could be created by speculating on land, both of which were important factors in the success and ultimately the failure of Anglo Irish Bank.

What is more German banks bought into this business as well. As  this March 16th 2011 article indicates:

“The interest rate on Anglo and Irish Nationwide bonds was attractive during the boom, often stretching between 4pc and 4.5pc. Anglo and Irish Nationwide were always seen as “good payers”, as one analyst said yesterday.

The appetite of German banks for Anglo Irish bonds for instance was extremely strong in 2007, just as the crisis was brewing. That year some 37pc of those who took an Anglo bond, maturing in 2012, were German or Austrian. Ironically the entire bond issue was sold into the market by French banking giant BNP Paribas.”

Now, as the Debt Audit has shown, because of the sale of bonds on the secondary market it is very difficult to know who currently owns the bonds that are to fall due on the 2nd of November. Its more than likely to be vulture-style hedge funds, another compelling reason why its probably a good thing to burn them. However, it is worth noting that one of the German banks that required state aid from the German government after the 2008 crash and which subsequently became Germany’s largest ‘bad banks’ was Hypo Real Estate Holding AG and its problems mainly stem from its acquisition of the Dublin based German public sector funding bank Depfa in 2008.

The difficulty of Depfa leading to an €180 billion euro loss in Hypo Real, which was a major source of tension between the Irish and German governments in 2008 remains a problem for the Irish government because the Central Bank of Ireland still has a €4bn exposure to Depfa-Hypo. It is also worth pointing out that Hypo Real Estate Holding AG and WestLB AG, another bank with a large subsidiary in the IFSC which subsequently got into serious trouble during the credit crisis, would be the hardest hit in the event of a Greek default, leaving German taxpayers to shoulder the bill a second time.  Hypo Real Estate, is also currently conducting bond swaps on its Greek debt, a move that it considered to be a ‘default’ in the eyes of ratings agencies. None of this points to a definite cause and effect, but surely its useful to know when we hear bluster from a Minister for Finance who claims that he knows that the ECB won’t accept Ireland not paying the Anglo bond because a nod is as good as a wink to a blind horse.

Now of course we have a new budget, with another round of austerity. Since the crisis began in 2007/8 we have seen €20bn (12% of GDP) taken out of the economy in an attempt to reduce the deficit. If these payments of €700 million (US$1bn) are made, then some of the €3.6 bn which is being taken out of the economy in the next year will be used to pay for it.

It is interesting then that the Irish government are now saying that the bond will not be paid by the taxpayer but that it will come from Anglo resources.

“What’s happening in relation to the Anglo bondholders is they’ll be paid from Anglo’s own resources, from the sale of its own property assets, for example.”

This is simply not true, as Karl Whelan has pointed out, just as its not true that the Irish government has to pay for the Anglo bond on the 2nd of November. This is the case even if someone argues, as John McHale does, that to default on this debt would exterminate the confidence fairy:

“My guess, for what it’s worth, is that the ECB would not cut off funding to Irish banks because of fears of broader contagion.   But we should remember that until quite recently Ireland was suffering a slow motion bank run, digging us deeper and deeper into the hole of foreign dependency.   The reason the run has stopped is because of confidence in the ECB/CBI to act as lender of last resort.   Doubts would build again if we looked inclined to play chicken.   The reasonable stabilisation of the bank funding situation has been a major success in Ireland’s stabilisation effort.”

Considering Michael Taft’s findings about the misleading use of data , the confusion of headings and the hiding of facts in footnotes in the Irish Fiscal Advisory Council report I think its perfectly reasonable to take the advise of the head of that council with a pinch of salt.

The IFAC said that ‘austerity is working’, even though the evidence for that success pointed to a partry 1.8% reduction in the deficit after removing over €20bn from the economy. Therefore, considering the reality that austerity isn’t working we should in future simply reverse the advice offered by John McHale.

In this case it is simple. He says we must pay, therefore it seems more than likely true that we should not. This is not a controversial position – after all this is what those hallowed markets think. This is what a commenter Yields or Bust on the John McHale post had to say about it:

“Probably unlike most commentators on this site I actually work in the so called ‘markets’ and have done so for many years so I’m more aware than perhaps most what the so called insiders believe in Ireland refusing to pay the unguaranteed bond holders of Anglo and the rest of the Irish banks.

The answer is that the ‘markets’ have made their minds up long ago – the clue is in the name aka ‘Unguaranteed’.

The owners of these instruments simply expect to lose all the money given the turn of events over the past couple of years.

There will be no contagion backlash because of a default on these instruments – the market participants are completely at ease with the fact that losses here are probable and expect such an outcome.”

The question remains, if there is no logical and technical reason why these bonds have to be paid why is the government more than likely going to do so, particularly when they have campaigned on the basis of not paying them and even now could gain considerable political kudos by not doing so. This is not a left or right issue, after all, Declan Ganley spoke at Charleville, the town which has conducted weekly marches against the paying of the bonds last week.

That unfortuantely is a question for another post.

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Donagh is the editor of Irish Left Review. Contact Donagh through email: dublinopinionAtgmail.com