Breaking the Link? It’s Getting Stronger. It’s Strangling Us

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While Eurozone Governments continue to debate the details of the banking union; while the Irish government continues to insist that the deal reached last year includes bailing us out for past bank debt; while commentators debate and measure the link between public and banking debt; while the ECB steps into the void with its own peculiar version of ‘breaking the link’ between banks and states – while all this is going on, that game-changer which would break the link between state and banking debt is becoming ever more elusive.

With the latest data from Eurostat we can track the impact of banking debt on the public finances of Eurozone governments.

Impa_bank_crisis1

2010 was the worst year – with plucky little Ireland contributing nearly half of the total €66 billion.  It eased off in 2011 but it came back with force in 2012.  In total, the banking debt has cost the Eurozone €138 billion but this is just the Eurostat’s accounting of the largely capital impact on General Government Debt.  It doesn’t include interest payments, cost to wealth funds (such as Ireland’s National Pension Reserve Fund) or the impact of contingent liabilities, never mind the impact on the economies in general.  So this is a narrow accounting of a cost which is much, much higher.

Who got hit in 2012?  Ireland didn’t.  In fact, we recorded a small income increase due to bank repayments (€1.6 billion).  The main victims, however, can be found in the periphery.  Spain, Greece and Portugal accounted for 86 percent of the net impact on the Eurozone in 2012.  Spain, in particular was hit, with an impact of €39 billion on their public books.  But other countries got hit: Belgium, Germany, Austria, France and the UK with minor impacts in other countries.  In short, 2012 was the second worst year since the crisis began.

But the fun doesn’t stop there.  There are two more tables which show the continuing bank-debt burden on the Eurozone.  First, is the relationship between the stocks of government financial assets and liabilities arising from the support of financial institutions in the crisis.

Impa_bank_crisis2

In 2012, Government liabilities rose to €526 billion – with assets valued at €362 billion.  What is noteworthy is the continued growth in liabilities and the widening gap with assets.  Net liability is now at €164 billion.

How does Ireland stand in this category?  In 2012 Ireland had €46.2 billion in liabilities while it held -€700 million in assets (yes, that’s right, minus €700 million – don’t cash in those AIB shares just yet) leaving a net liability of €47 billion.  That’s 29 percent of the Eurozone’s total liability.

The second category is contingent liabilities.  Most of these are comprised of guarantees (we know something about that).

Impa_bank_crisis3

Contingent liabilities have flat-lined since 2010, with half-a-trillion Euros potentially impacting on Government finances.   This is concentrated, again, in the periphery – 65 percent of contingent liabilities being shouldered by Ireland, Spain, Italy, Greece and Portugal.  Ireland finds itself with €113 billion of those contingent liabilities, the highest of any EU country.

Of course, only the most pessimistic among us would think that all these liabilities will find their way on to state books.  However, if this crisis has taught us anything, it’s that pessimism is the new realism.

But this is not a static picture.  Ireland should be released of some of these contingent liabilities with the ending of the bank guarantee (though we are still on the hook for the state-guaranteed borrowing under that scheme). And hopefully the assets we hold will start to grow in value. However, we have those bank stress tests coming up.  What are the odds on all our banks coming through that with clean sheets?

And that’s where the ECB comes in.  The EU’s official policy is to break the link between state and bank debt (ok, ok, it’s a dead letter – but it is an official dead letter).  But the ECB seems intent on strengthening that link.  Over 100 banks will undergo the ECB’s ‘asset quality review’, or stress test.  The banks that fail due to inadequate capital, will be required the raise more capital in the markets.  However, if they can’t the ECB has decreed that national Governments will make up the short-fall through further capitalisations.  And that’s where recourse to the European Stability Mechanism comes in; in effect, a bail-out.

This puts in train the prospect of new bank debts hitting the state books – over and above what Eurostat has identified above.  And that the results of the stress tests won’t be published until next year creates another period of uncertainty over bank debt.  In the case of Ireland, how will this impact on us as we exit the bail-out?  There are lots and lots of downsides.

So we have hundreds of billions in bank debt impacting on state debt with hundreds of billions more floating around looking for a new home –potentially, people’s pockets.   And there’s no sign of a let-up.

Let’s cut through all the language and technical papers and aspirations to confidence and stability. If you want to break the link between the state and bank debt you have to put the bank debt back where it belongs – in the financial sector.  Anything short means slapping people and state budgets with a debt they didn’t create.   Strategies going forward – for Ireland, for Spain, for all the peoples of the Eurozone and the EU – must begin again with this simple and fundamental principle.

For let’s be clear – the link between state and bank debt is, if anything, growing stronger.  So strong that it is strangling an entire region.

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