Tom mcdonnellpromnotes240112


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Presentation by TASC policy analyst and economist on the Anglo promissory notes

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Tom mcdonnellpromnotes240112

  1. 1. A Briefing Note on Promissory Notes
  2. 2. Anglo & INBS Crash 2008 – Irish property bubble spectacularly bursts September 2008 bank guarantee ◦ 2009 – Merrill Lynch states “Anglo is financially sound” ◦ 2009 – Anglo is nationalised ◦ March 2010 – Anglo posts the largest loss in Irish corporate history (€12.7 billion for 2009) ◦ March 2011 – Anglo then breaks its own record (€17.7 billion loss for 2010) ◦ The INBS numbers are proportionally even worse ◦ Both banks insolvent
  3. 3. Now - The IBRC Anglo Irish Bank = €29.3 billion ◦ Defunct – no new deposits and no new loans ◦ Insolvent ◦ Under criminal investigation Irish Nationwide Building Society = €5.4 billion ◦ Defunct – no new deposits and no new loans ◦ Insolvent €30.6 billion promissory notes – to pay for ELA ◦ Letters of comfort ◦ Never brought before the Oireachtas €4.1 billion exchequer payments
  4. 4. Guarantee The Anglo/INBS debts were originally guaranteed by the Irish State in September 2008 as part of the blanket bank guarantee The Irish Government made an initial payment of €4 billion to cover Anglo‟s debts in 2009. This was paid out of the exchequer finances. €0.1 billion was paid to INBS Over the course of 2009 and 2010 it became increasingly clear that Anglo and INBS were insolvent
  5. 5. Averting Collapse If the insolvent banks were to collapse their debts would have fallen back on the Irish State and become sovereign debt - a consequence of the bank guarantee To prevent this the Irish Government had to obtain external funding – the Eurosystem of Central Banks was the only realistic source of this funding Anglo did not have sufficient eligible (i.e. good quality) collateral to obtain the required amount of Emergency Lending Assistance (ELA) from the Central Bank
  6. 6. Emergency LendingAssistance To prevent their collapse the Government negotiated a mechanism with the Central Bank of Ireland setting out the conditions under which the Central Bank would provide Anglo/INBS with sufficient Emergency Lending Assistance (ELA) This required the implicit consent of the European Central Bank (ECB) governing council. Any future changes to the agreed mechanism also require the consent of the ECB governing council
  7. 7. Paying Back the ELA The ELA provided by the Central Bank to the IBRC is what enables the IBRC to pay-off its obligations Most of the bondholders have now already been paid using this ELA The ELA is also used to pay-off creditors/depositors and to enable the IBRC to retain its banking license Eventually the ELA has to be paid back to the Irish Central Bank This is done through promissory note repayments
  8. 8. Promissory Note The Irish Government negotiated with the ECB governing council to create a „promissory note‟ as a liability owed to the IBRC (Anglo/INBS) The promissory note is therefore an asset of the IBRC This asset can be used by the IBRC as collateral to obtain the necessary ELA from the Central Bank This is because the Irish Government is backing the promissory note with „letters of comfort‟
  9. 9. The price A promissory note is a negotiable instrument ◦ one party (in this case the Government) makes an unconditional promise in writing to pay a defined sum of money to the other party (in this case Anglo/INBS – now called IBRC), on specified future dates or on dates to be determined, under specific terms The State‟s obligation is to pay down €30.6 billion over 20 years (2011- 2031)
  10. 10. How it works The promissory note repayments are paid to the IBRC – the IBRC then reduces its ELA obligations to the Central Bank In practical terms the Irish Government has received a loan from the Central Bank to pay off the bondholders It is ultimately a transfer of wealth from the people living in Ireland to the bondholders that lent to Anglo/INBS The bondholders and other creditors continue to be paid using the ELA from the Central Bank – the promissory notes represent our commitment to eventually repay the Central Bank
  11. 11. How much it costs The Irish Government is scheduled to make over €47 billion of promissory note related payments between March 2011 and March 2031. This is composed of: ◦ €30.6 billion capital reduction – the €30.6 billion owed ◦ €16.8 billion in interest repayments Much of the funding for this will need to be borrowed unless the State is running substantial fiscal surpluses. This is very unlikely in the medium-term These borrowings will therefore also have to be financed ◦ at an assumed 4.7% interest rate on borrowings the total cost to the State will reach €85 billion by 2031 ◦ Some of which will eventually return to us due to the circular nature of the payments
  12. 12. What happens when the ELA is paidback to the Central Bank? Central Bank of Ireland (CBI) Asset side of their balance sheet ◦ CBI reduces its ELA assets by €3.1 billion Liability side of their balance sheet ◦ CBI expunges €3.1billion from the system ◦ Inflationary impact if this is not done – increasing the money supply (monetisation of debt)
  13. 13. Socio economic implications Over 2% of GDP will be drained out of the State each year up to 2023 to make the promissory note repayments ◦ this will be through an additional €3 billion to €4 billion of fiscal consolidation (tax increases/spending cuts) IMF research (Leigh et al, October 2010) indicates that each 1% of fiscal consolidation: ◦ reduces GDP by 0.5% to 1% and ◦ Increases the unemployment rate by 0.3 percentage points
  14. 14. Socio economic implications The €3.1 billion promissory note payment due to be made by the state on behalf of the former Anglo on March 31 2012 is: ◦ greater than the total cost of running Ireland‟s entire primary school system for an entire year and ◦ greater than the estimated cost to provide a next generation broadband network for all of Ireland (€2.5 billion). €30.6 billion is equivalent to just under 20% of Ireland‟s current GDP or €17,000 for each person working for pay or profit in the State. €47.9 billion is 30% of Ireland‟s current GDP.
  15. 15. The issue The interest rate is not the issue ◦ A red herringThe real issues are:The size of the principal ◦ Reduction in the principal – write downWhen we are making the repayments ◦ Changing the schedule of repayment – holiday, postponement
  16. 16. Risks in promissory notesuspension/postponement?1. “The ECB will cut off funding to our pillar banks”2. “It will impact on the European banking system”3. “It will undermine investor confidence in Ireland”4. “It is a condition of the EU/IMF Memorandum of Understanding”Are these risks plausible?
  17. 17. Risks tosuspension/postponement? “That the ECB would cut off funding to our pillar banks” ◦ Remove funding and the pillar banks will fall ◦ But this would trigger the very contagion the ECB has been trying to prevent ◦ ECB cannot give the pillar banks inferior T&C to other Euro zone banks “Impact on the European banking system” ◦ Promissory note payments do not involve the European banking system ◦ No precedent created as IBRC is not a functioning bank
  18. 18. Risks tosuspension/postponement? “Undermine investor confidence in Ireland” ◦ Not a sovereign default ◦ Ireland is already shut out of the markets and locked into an official programme of assistance until the end of 2013 ◦ Amelioration of the Anglo/INBS burden improves Ireland‟s debt dynamics and makes Ireland better placed to pay its other debts “A condition of the EU/IMF Memorandum of Understanding” ◦ The promissory note repayments are not a condition of the deal agreed with the troika
  19. 19. Decision makers - ECB GoverningCouncil ECB concerns: ◦ Precedent regarding repayment of debt obligations – parachute drop analogy - floodgates ◦ Adherence to rules and protocols – is flexibility legal? ◦ Mildly inflationary – monetization of the debt But the ECB need a success story ◦ The Greek programme has already failed ◦ The Portuguese programme is failing ◦ Italy is in the firing line ◦ Promissory note flexibility can help prevent the Irish programme from failing
  20. 20. The need for a success story
  21. 21. What about the bond? €1,250m of Anglo Irish Bank senior bonds ◦ Not covered by the guarantee ◦ Not secured against Anglo‟s assets Disingenuous to say we are not paying it Moral hazard and the ECB