Ireland finds a pot of gold for its debt

It has taken just over a month but the Irish banking equivalent of white smoke that belched out of Dublin’s parliament in February looks like it has worked. The dramatic debt reduction technique Ireland put in place last month allowed it to successfully issue a 10-year bond at 4.15 per cent – its first capital raising since the international bailout in 2010. European neighbours will watch with interest, for what the Irish have done could be the start of a long-term solution to the European crisis.

Yet from a German perspective the Irish debt reduction is at their expense, so rather than white smoke it is more akin to a potential hand grenade. I suspect that the potential spread of the Irish debt reduction technique may have been part of the reason why this week Germany’s central bank, the Bundesbank, declared that the euro debt crisis was not over (Europe crisis not over: Bundesbank, March 12).

The great advantage Ireland has over troubled countries like Spain and Italy is that the Irish pay their taxes and the government has reined in the deficit.

At the same time in global share markets Europe has been put in the 'muddle through' basket. A year ago recent events like the Italian election or the Irish banking action would have sent shivers through markets. Now they are virtually ignored.

Yet the Irish are potentially showing other troubled European nations that a way out of their mess is to dramatically postpone payment, which effectively puts more of the debt liability on the Germans — something the Germans will not be happy about, if they wake up to what is happening. 

You will remember that Ireland was one of the first countries to get into a mess. Irish banks borrowed vast sums short-term on the international wholesale market and used the money to fund massive housing investment and speculation. The whole pack of cards collapsed and the government guaranteed the banks.

But Ireland had a banking problem rather than a government spending problem. Other European countries have both. A lot of the bad Irish bank loans ended up in the nationalised Anglo Irish bank and they were funded by a government promissory note to the Irish central bank, which in turn used this security to gain European funding for some €34billion covering assets of only about €12billion.

Suddenly last month, without warning, the Irish central bank, European central bankers or the Germans, and the Irish government moved to liquidate the Anglo Irish Bank. It will sell up the assets in six months. It’s generally believed that the value of those €12billion in assets will fall sharply if they are sold in six months.

In an associated liability swap the Irish have used “creative accounting” to effectively slash €6 billion from their debt and the security’s maturity has been pushed out to around 40 years.

Repayments by Ireland have been slashed and now we are effectively looking at 40-year securities, which is the first step to writing off the debt.

Last month the Irish government, after taking such a sudden and unexpected move, must have held its breath. Would the European Central Bank pull the plug on the country? The stunned Europeans neither accepted or rejected the Irish move – they simply noted it. The Irish had won.

There are many in Ireland who see that one way out of both its international and domestic debt crisis is to prolong the debt repayment, which amounts to forgiveness. In Ireland over 10 per cent of housing loans have fallen 90 days behind in payments and the percentage is about to skyrocket. The growing Irish view is that just as their European banking debt has to be either forgiven or postposed so a similar forgiveness will need to be made on the domestic market.

However, the Irish solution means that those countries or those consumers who receive debt elimination, either via forgiveness or long postponement, must then meet all their obligations. If the debt is effectively eliminated, then any country not meeting requirements should be thrown out of the euro. Ireland believes that they can meet their obligations if big chunks of their banking debt is effectively removed. The global bond markets are agreeing. But there could be some angry Germans.