Presentation on promissory notes by TASC policy analyst and economist Tom McDonnell

1. A Briefing Note on Promissory Notes

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. 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. 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. 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. Emergency Lending
Assistance
 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. 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. 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. 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. 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. 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. What happens when the ELA is paid
back 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. 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. 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. 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 down
When we are making the repayments
◦ Changing the schedule of repayment –
holiday, postponement

16. Risks in promissory note
suspension/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. Risks to
suspension/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. Risks to
suspension/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. Decision makers - ECB Governing
Council
 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. The need for a success story

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