– Olli Rehn, noted scholar of Latin (‘pacts are binding’)
If you’re just tuning into the great Anglo Irish promissory notes dispute between the European Central Bank and the Irish government …
Ireland issued €31bn in ‘promissory notes’ to fund its rescue of Anglo Irish and two other broken banks, avoiding a massive jump in its deficit numbers because of the accounting of the notes (eg. a two-year interest payment holiday was added in 2010). Effectively state guarantees which would give the banks income over time, the notes were pretty bonkers instruments.
Being bonkers, they’ve since been pledged to the Irish central bank as collateral for emergency liquidity assistance. ELA is done at the Irish central bank’s own risk but does need ultimate approval of the ECB’s board, because it’s outside normal collateral rules … and the ELA angle is what makes this messy. Messy, and uncomfortably entwining for the fiscal and monetary authorities.
The immediate dispute was … this:
Technically, Ireland has to hand over €3.06bn in principal repayments on the notes to Anglo Irish (which is now lumped in with the wreckage of Irish Nationwide as the Irish Bank Resolution Corporation — sorry if this is getting absurdly byzantine) by March 31.
That has an air of general nuttiness because the payment is effectively to itself, and because €3.06bn is about three times the size of Ireland’s austerity measures this year. Nutty, but paying off the promissory notes means a reduction of ELA. Irish bank ELA has continued way beyond the usual lifespan of central bank emergency liquidity ops. Hence a campaign to restructure or reschedule the promissory notes, met by pushback from some in the ECB over monetary propriety.
European economic commissioner Olli Rehn insisted last week that the payment is made, barging in on months of negotiations between Ireland and the ECB (which as policeman for ELA is the agency that matters most here).
In fact, according to Bloomberg and the Irish press, Ireland’s central bank governor will talk to colleagues at the ECB about a deal to avoid simply paying off €3.06bn to the shell of a dead bank. Ireland’s finance minister said on Wednesday that the payment ‘could be settled by the delivery of a long term Irish Government Bond’. In other words — IBRC could immediately reinvest the €3.06bn cash in this bond, with Ireland avoiding paying it off until the bond matures.
What is interesting, we think, is where the bond could be pledged as collateral. Maybe not ELA but at the ECB’s normal liquidity ops, allowing a small reduction to ELA? (but shifting IBRC funding to the ECB.) We’re not sure. It does look like a better collateral asset than a funky promissory note.
But what happens to the rest of the promissory notes? Ireland faces the same €3.06bn payment every year, for a long time, unless there’s a deal on the rest.
So it still depends what a broader restructuring of the notes might look like, maybe through extending their principal repayment further out into the future, or lowering interest payments. As the FT reports, there might also be a move to replace the notes with bonds issued by the EFSF (which would suggest ECB eligibility, right?). There’s a great paper from Karl Whelan on how this could be done and why it matters for Irish fiscal costs, and which also breaks down the whole promissory notes and ELA connection very well indeed.
JPMorgan’s Flows & Liquidity analysts also made some interesting points on a restructuring in a note last week:
The main benefits for Ireland in extending the duration/lowering the coupon of promissory notes are a reduced near-term government borrowing requirement, which at the margin makes it easier to return to public debt markets, and lower interest payments. But the former (extending duration) rather than the latter (lowering the coupon) matters far more. This is because interest flows from the Central Government to IBRC (at 7%-8% via existing promissory coupons) to the Central Bank of Ireland (CBI at ~3% via ELA) to the Eurosystem (at 1% via Target2). So the net cost to Ireland as a whole of funding promissory note payments is around 3.7% (the cost of government borrowing from EU/IMF) less 1% (what Target2 charges the Central Bank) i.e. around €84m per annum to fund €3.1bn.
The split between interest and principal payments does makes a difference in the short term from an accounting point of view: promissory note payments classified as interest, rather than principal repayment, increase the Eurostat measure of the government deficit. So classifying a larger proportion of the payment as principal would reduce the deficit from 2013 onwards (when interest payments start, amounting initially to around 1% of GDP).
The main sticking point is that extending the promissory notes means that it will take longer to pay off ELA. That requires the ECB’s consent. The ECB Governing Council can block ELA by a 2/3rds majority. In addition, the longer the maturity of the lending, the more it becomes akin to a fiscal rather than a monetary policy operation.
You could say that the promissory notes have long since fudged the fiscal and the monetary (including, maybe, this possible interim solution of substituting a special government bond for a cash payment on the notes).
You could also say, Irish ELA no longer sticks out like a sore thumb given the trend of eurozone monetary policy since the middle of 2011. The relaxation of ECB collateral rules around the LTROs wasn’t ELA, but this did involve national central banks taking on risks that the ECB itself will not bear, in return for avoiding a credit crunch.
Final words here go to Karl Whelan in a recent blogpost:
…the reality is that the promissory note/ELA deal involving IBRC is an exceptional one and one that the ECB Governing Council has agreed to. The ECB has taken a number of bold steps in recent months including radical changes to its collateral framework. Against this background, it should not be considered unimaginable that the collateral for IBRC’s ELA could have its payment structured altered.
Salus populi suprema lex esto
ELA coverage – FT Alphaville