Irish Public Debt: A View through the Lens of the Argentine Default
Tony is a researcher at the University of Buenos Aires and a journalist in political economics. His website is http://projectallende.org/.
Reckless financing in the Irish construction industry combined with a lack of enforcement of national banking regulations with cheap Eurozone credit financed twenty years of Irish economic expansion. An overshoot in loan activity exposed both local and international financiers to speculative loans at the end of a prolonged real estate bubble. When the bubble burst the overextended construction sector collapsed, defaulting on its loans. This destabilised the Irish financial sector, resulting in the insolvency of almost all Irish private banks. Then came the rescue ….
This is the story of how one Irish government reacted to the 2008 financial collapse looking at choices yet to be made that will determine what happens next. The point of view is South American. South American debt initiatives are presented in an effort to determine their applicability to debt accrued in the financial rescue, the legacy of a Fianna Fáil coalition voted out of power in 2011. Here in Buenos Aires just a decade ago the Argentine economy imploded in a sovereign debt crisis. For Argentine economists, hindsight is 20/20. The good news from South America is that a number of non-conventional negotiation tactics can provide legal and tactical armour to a sovereign Irish government willing to defend itself against the debt markets. There is still time for Ireland to incorporate new ideas that can prevent an uncontrolled sovereign default, unnecessary payment of illegitimate debt, or both.
Stepping Up to the Plate
The Irish sovereign debt problems can be solved through hard work. First the new government needs to accept that there is a problem, and then the problem needs to be broken down to its essentials, determining its origin, and, finally, the problem can be dealt with in a proper timeframe.
Translating this to the case in point – any new government needs to admit that Ireland has a sovereign debt problem. This may sound ridiculous but such an admission can be politically difficult, especially when dealing with financial markets. Government denial and cover-up were the unhealthy reactions evident in Argentina in the late 1990s just before the economic collapse. Next up comes financial investigation: positive initiatives like the audit produced in the University of Limerick.1 Armed with this type of information the new government can determine how the debt came to be and who is responsible for creating it. This helps determine its legitimacy. By separating out illegitimate debt, the nominal debt may be reduced to that which is really essential to pay. Finally, having apportioned blame and begun prosecution of those responsible, one can begin the tough international negotiations to come to a just agreement with creditors. That done, all that remains is to pay off the reduced amount over a reasonable period of time.
During the recovery expert help and solidarity measures from partners can be crucial. The Argentine recovery, which began in 2003, would have been much more difficult were it not for timely solidarity funding from friendly governments.
Last but not least, one has to recognise that sovereign debt is a national sovereignty issue. Any government elected by the Irish people has to be willing to represent the sovereign interests of the nation. Failure to do this questions the sovereignty of the state itself.
Save the Banks!
In 2008 the Irish government scrambled to avoid a national financial collapse of the private banking sector. This involved some extraordinary decisions in the rescue of the insolvent financial system; decisions that were made by the Department of Finance and the Central Bank of Ireland.
A subsequent government enquiry into this rescue led to the production of a report to the Minister for Finance by the Governor of the Central Bank entitled ‘The Irish Banking Crisis Regulatory and Financial Stability Policy 2003–2008.’2 The conclusions of this enquiry are critical of the government rescue. In particular, they argue:
The inclusion of subordinated3 debt in the guarantee is not easy to defend against criticism. The arguments that were made in favour of this coverage seem weak: And it lacked precedents in other countries …. Inclusion of this debt limited the range of loss-sharing resolution options in subsequent months, and likely increased the potential share of the total losses borne by the State.
Subordinated debt is debt that a state does not usually pay when rescuing an insolvent banking sector. The handling of the 2008 financial emergency was unnecessarily generous. It resulted in a wholesale conversion of private bad debt (on the books of Ireland’s private banks) into government guarantees and public debt obligations for which the Irish taxpayer has ultimately been made responsible. Ireland is not the only nation that faced such a financial collapse; similar financial instability is evident across Europe and elsewhere. The Irish rescue has since been compared with other rescues internationally, notably by Joseph Stiglitz and William K. Black.
Nobel Laureate and former chairman of President Clinton’s Council of Economic Advisers Joseph Stiglitz compared some of these financial rescues. He describes the Irish rescue as ‘probably the worst model’, adding that ‘Iceland did the right thing by making sure its payment systems continued to function while creditors, not the taxpayers, shouldered the losses of banks.’
In an Irish radio interview on 15 February 2011, William K. Black, a key regulator and prosecutor in the savings and loans scandal in the United States, was even more emphatic as to the mistakes made in Ireland. Commenting on the parallels between the savings and loans bank rescue and the Irish rescue, he said:
… the whole concept of subordinated debt is that it is supposed to serve as risk capital. And so if the bank fails it is supposed to get nothing …. Every regulator knows that ….
Commenting on the Irish rescue, Black derided the generosity of the decisions made:
We’ll pay the subordinated debt holders with the Irish taxpayers paying the money! And of course without asking the Irish taxpayers. It is the most obscene policy. … We’ve looked at lots of other countries and nobody has responded to a crisis as stupidly as the Irish government responded. It just gratuitously took billions of Euros from the Irish people to give it to mostly German banks who had no right at all under the laws. They were supposed to lose that money if the bank failed. That was the deal they made.
Feedback on the Rescue
On a visit to Dublin in 2009 I was asked, ‘What’s the difference between Iceland and Ireland?’ ‘One letter and six months’ was the witty response. Sadly this was not to be the case. In Ireland the banking rescue took much longer than six months to be resolved; in fact it is not over yet. The financial problems have simply been shifted to the public sector. Ireland, unlike Iceland, did not collapse with a bang; it limped on with a whimper. The collapse of the banks in Iceland resulted in vast losses across the world and wholesale bankruptcy of the Icelandic banks. In Iceland the financial problem was so big it could not be solved; so it wasn’t solved. Local and international creditors took their losses, licked their wounds and tried to litigate for their money. Iceland is still in the process of recovery. In two national referendums Icelandic citizens said no to payments to foreign creditors, especially those in the UK and the Netherlands, but the cost of trying to rescue its local banking sector is still high and political unrest continues.
Public opinion in Ireland in 2011 is reluctant to make comparisons with Iceland. Maybe it should. The scale of the collapse of the Irish financial sector should not be underestimated. Michael Lewis, in his Vanity Fair exposé ‘When Irish Eyes Are Crying’, cites Theo Phanos, a hedge fund manager working in London at the time, who called Anglo Irish Bank ‘probably the world’s worst bank; even worse than the Icelandic banks.’
His opinion is supported by the British Independent Commission on Banking Report4 published in September 2011. In Figure 4.4 of this report, entitled ‘Losses suffered by banks in the crisis as a percentage of (RWA) risk-weighted analysis’, Anglo Irish Bank was the worst bank in Europe, ‘making the greatest cumulative loss over the period 2007/2010’ by this measure.
In 2008 Ireland had a largely insolvent financial sector, as did Iceland, but the Irish government’s handling of the problem was to shift most of these problems onto the shoulders of its taxpayers and trundle on. This is more akin to Argentina in the 1990s than to Iceland in 2008. In 2011 Iceland began to recover: it issued new sovereign debt at rates of about 5 per cent annually. Argentina had an even harder default in 2001–2002. Argentina is taking longer to recover but it is now on its way. The new Irish government inherited a mountain of sovereign debt; this still lies between Ireland and economic recovery.
Generous to Whom?
The Irish government began a sequence of costly rescue attempts of the private financial sector in 2008. It proved incapable of solving the problems in the Irish banks on its own. A tsunami of private bad debt overwhelmed government finances. The piecemeal nationalisation of the Irish banks was expensive. Irish banks had already sold off many of their best assets in an attempt to avoid nationalisation. The government used off-balance sheet mechanisms to obfuscate the scale of the problem, including the 2009 creation of NAMA (the National Asset Management Agency). NAMA is a ‘bad bank’ vehicle specialising in property. Since Ireland’s principal financial debt problems resulted from property speculation, NAMA represents a big part of Ireland’s financial problems. The end result of the rescue was the generation by various mechanisms, including bank guarantees, of what Standard and Poor’s (S&P) estimate is €90 billion in new sovereign debt (counting likely future losses in NAMA).
By rescuing Ireland’s banks the Irish government also let the Irish banks’ creditors off the hook. The money for the property loans loaned out by Irish banks was in turn borrowed from British and European private banks. The European banks insured many of these loans to Irish banks with ‘swaps’. A swap is an unregulated insurance policy, a financial product invented by the derivatives financial sector that is concentrated in the US. If the Irish banks had been allowed to default on their creditors, the European banks that loaned them the money could have called in the swaps (asking for payment).5
The US government salvaged its own financial sector in a similar manner with the 2008 rescue of American International Group (AIG). AIG was a major holder of swaps on debt, including sub-prime mortgages. The buck stopped with AIG, so the US government saved its derivatives sector by saving AIG, which in turn saved its banking sector that had leveraged the ability to generate swaps to ‘securitise’ debt. The Irish government’s wholesale rescue was apparently considered necessary to save the Irish banks but it had the side effect of plugging a hole in the dyke that threatened to drown the swap holders as well. Timothy Geithner answered questions on this matter in the Senate Banking, Housing and Urban Affairs Committee hearings where he discussed the systemic risk that the private European banking sector posed to the US financial sector in question time during the 2011 Annual Report to Congress of the US Financial Stability Oversight Council.
Apart from systemic risk factors, there is the issue of personal responsibility. In Ireland, executives of some major banks failed to declare secret loans that their own banks had made to them personally. For example, the former chairman of Anglo Irish Bank, Sean FitzPatrick, hid an €87 million loan even from his own shareholders. Mr FitzPatrick was arrested but then released. Other individuals absconded from the country without paying back the debt to their own failed banks. Again the apparent attitude of the Irish government is that the Irish taxpayer should take the hit for apparent corruption.
Calling in the Multilaterals
In early 2011 the Irish government rescue effort was finally overcome. The go it alone attempts to fix its broken banking sector did not work. The Fianna Fáil government called for help from multilateral lenders, principally the European Central Bank (ECB), the ECB’s new rescue fund (part of the European Stability Mechanism – the ESM) and the International Monetary Fund (IMF).
These multilateral banks endorsed the generous Irish rescue and provided short-term liquidity (funding to keep the Irish banks solvent) at a healthy interest rate. This gave the exposed Irish, European, US and other private financial institutions a chance to offload bad Irish debt. Bad loans were converted into loans and liquidity from the multilaterals for which the Irish government provided guarantees. The rescue left the Irish taxpayer with massive debt liabilities and interest to repay as a result of minimal write-downs on the debt. The new debt added further stress to Ireland’s economy, now plunged into a deep recession. Ireland became a member of the Highly Indebted Rich Countries club (HIRC) joining four other European members: Greece, Portugal, Italy and Spain. The global financial industry refers to these five European debtors as the ‘European Peripherals’. Global bond markets launched a speculative attack on the bonds of all five nations. This compounded their debt problems, raising the ante, and creating a regional sovereign debt crisis.
Passing the Buck
A transfer of political power during an economic crisis – loading the new government with the problems caused by the previous government’s financial mismanagement – is all too common in South America. Such a transfer of political power has already happened in Ireland, Portugal, Greece and Italy. Inheriting such a situation is not easy; resolution often implies a break with previous policies.
In the Third World budget deficits and government debt are often very high so sovereign debt carries a perceived default risk. High risk means high sovereign debt costs which adds to the drain on social budgets due to the need to siphon off money paying more interest when rolling over debt. Add corruption or perhaps corrosion to this toxic mix, in the form of a group of political and economic actors who believe they are immune from prosecution, and there you have it: your basic Banana Republic.
Loans to high-risk governments are considered of ‘sub-investment’ standard, which means the speculative bond markets view them with a mix of trepidation and avarice. Participating governments pay through the nose for bond issuance due to the perceived risk of default. As an Argentine default was becoming obvious to the markets, the Financial Times wrote in an editorial on 20 August 2001:
Investors in government debt would take losses. But they have been happy to receive the fat yields offered by Argentine paper: they must now be prepared to accept that rewards of this kind entail some element of risk.
In other words, investment risk is par for the course; the risk of default is already priced in with the high interest rates, analogous to sub-prime mortgage interest rates on high-risk personal mortgages.
Argentina was not always a third world nation. At the turn of the twentieth century it had a gross domestic product (GDP) similar to that of the US; not any more. If you fall out of the protected rich nations club then your cheap debt privileges are revoked; credit becomes expensive whether you default or not. It is better not to lose one’s membership as becoming a member is a difficult process. The European peripheral bond markets in 2011 are starting to look decidedly South American in nature; especially those of Ireland, Greece and Portugal. All three nations are hovering dangerously close to a debt spiral. Their new governments face tough choices.
Latin America has a sad history of sovereign debt and regional debt contagion. In Argentina’s case the government has been struggling with the issue of sovereign debt burdens since the first million pound loan by Baring Brothers to President Rivadavia in 1822. Experience has led to some Latin American governments developing useful techniques for dealing with the sovereign debt markets and the IMF. Some of these are less well known outside the region. Applying these techniques to the Irish situation might help avoid an uncontrolled sovereign default.
Tequila Effect, Ouzo Effect
Some sovereign debt crises are not about national economic problems; instead they are spread throughout a region by contagion. One example was the tequila effect that precipitated the Argentine economic collapse in 2001–2002. There are some parallels with the current contagion among the European peripherals.
Latin America’s most recent regional sovereign debt crisis was sparked off by the sharp devaluation of the Mexican peso in 1994. A tidal wave of financial damage spread across Latin America in the next few years. The national economies embroiled in the crisis had little in common except a high debt to GDP ratio. The sovereign bond markets meted out similar treatment to all. This sudden change of market confidence was referred to as the ‘tequila effect’. It hit Argentina in 1995, so Argentina turned to the IMF for help. After six painful years of slow collapse the Argentine economy finally succumbed, despite, and in some ways because of, advice from the IMF. The default lasted three more years until the Minister for Economics, Roberto Lavagna, finally reached a substantial agreement, partially restructuring the debt with creditors in 2005. This experience makes Argentine economists only too familiar with the relentless silent panic of a sovereign debt spiral. The longer it is drawn out, the greater the exit of capital and the harder the fall.
Ireland now finds itself enmeshed in a new regional sovereign debt crisis. The crisis began in Athens not Mexico City; might we call it the ‘ouzo effect’? Some characteristics are similar. A speculative attack is launched against various regional governments with high debt to GDP ratios. In a debt spiral, interest payments become unbearable leading to more debt and pushing governments toward default. The problem cannot be solved without international intervention so the IMF is called in (with the ECB in Europe). Speculators enter the market exchanging the risk of taking a nominal loss on bond investments for higher interest rates or cut-price bonds. Their strategy is clear: the longer the payments are drawn out, the less likely they are to lose money. The only hope for the bond buyers to walk away whole is a state rescue with minimal haircuts. As luck would have it, that is what they got from the Irish government.
Before we push this analogy too far it is important to note that Ireland (whose S&P bond rating in September 2011 was BBB+) does not yet pay the interest premium on new debt that Argentina does (S&P rating ‘stable’ B), but the quantity of Irish sovereign debt and the relatively small population (one-tenth that of Argentina) puts Ireland in 2011 in a similar position to Argentina in the late 1990s. Buenos Aires had different problems to Mexico City, and Dublin has more in common with Reykjavik (in terms of the source of its new debt) than Athens, but traders in sovereign debt derivatives differentiate little. A speculative attack means there is lots of money to be made (or lost) in risky sovereign debt in the European peripherals.
What can Ireland Learn from South America?
Conventional options available to the Irish Department of Finance to reduce sovereign debt obligations are few and far between. Growing the economy is currently not an option. It becomes less likely the harder the IMF-recommended austerity measures bite. The fact that Irish sovereign debt is denominated in Euro (a currency whose exchange rate the Irish Central Bank does not control) means that the common strategy of devaluing one’s way out of debt – ‘quantitative easing’ (or printing money) – is also out of the question.
A large increase in taxation is possible but this can also lead to economic contraction. The Irish government raised various taxes in 2010 and 2011. This unpopular option does help Ireland reduce budget deficits but there is too much debt to be paid off. Also, in Ireland’s case, the source of national debt is not chronic budgetary problems. Instead this debt is the result of a financial rescue gone awry. Ireland’s focus on austerity measures and interest rates is misplaced. Restructuring the rescue debt might be a more appropriate option.
When in 2011 Ireland called in the multilaterals, Dublin five-star hotels were filled with financial consultants. Local commentators described their visitors as ‘the carpetbaggers’ or simply ‘the Germans’. There were formulaic calls for austerity from the luxury suites. Investors were on the look-out for possible bargains in future privatisations. The IMF/ECB advisors mandated austerity, despite the advice of Nobel Laureates such as Joseph Stiglitz and Paul Krugman. Both argue that cutting national expenditure causes the national economy to contract, thus making the option of growing your way out of the debt spiral even less likely.
In the late 1990s in Argentina austerity measures were also an intrinsic part of the IMF’s ‘structural adjustments.’ Just as Stiglitz and Krugman now suggest, Argentine belt tightening pushed the economy deeper into recession. It delayed the default by about five years. This provided time to pressurise the government to a fire sale of state assets (as now advocated in Greece, Portugal and Ireland). A lack of capital controls also gave more time for outflows of capital that further aggravated the financial problems. Again we see parallels in the European peripherals.
In Argentina the IMF advocated privatisations of pension and energy assets. Removing access to pension funds proved especially egregious to public finances. The fire sale of public assets to private companies was unpopular but was managed with the assistance of corrupt representatives in the national parliament and senate. The largest sale was that of state oil company YPF to the Spanish multinational Repsol. Similar fire sales occurred all across Latin America. For example, in Brazil the state-owned Vale steel company was also sold off for an anomalously low price. It is now part of the world’s largest private steel company.
Argentine state finances were further weakened by the privatisations, resulting in the loss of public income. The government had even less economic control over critical infrastructure, especially in the energy sector. The privatisations occurred and then the default happened anyway in 2001–2002.
Given the lack of conventional economic options available to the Irish government in 2011 the consequences of Ireland’s debt spiral are quite predictable. Unless Ireland negotiates a reduction in sovereign debt, unless it employs other successful unconventional alternatives, or unless there is a miraculous improvement in economic conditions, the best case scenario is that the Irish taxpayers will pay more debt than they should, and in the worst case scenario Ireland will default sooner or later. If a default is inevitable it is better to do it sooner rather than later, employing tough negotiating practices, and in a controlled manner.
Lessons from the Argentine Default
If anything can be learned from the Argentine default it is that an uncontrolled hard default (such as that which occurs after a prolonged debt spiral) should be avoided at all cost. The Argentine economy resisted the pressures of the tequila effect for a few years but by the second quarter of 1998 the Argentine economy fell into steep decline. The GDP dropped 19 per cent and foreign direct investment fell by 60 per cent in five years. Many businesses failed and factories closed, primarily because of the artificially high peg of the peso exchange rate with the US dollar (1:1). This exchange rate affected the competitiveness of Argentine exports so local manufacturers could not compete with cheaper imports in a shrinking local market. Unemployment increased to 24 per cent, slightly above 2011 levels in Spain.
In 2001 the Minister for Finance, Domingo Cavallo, tried to prevent a run on the banks. He limited ATM withdrawals to 250 pesos per week. The ‘smart money’ had already left the country in dollars. The middle classes came into the streets demanding access to their accounts in marches (called ‘cacerolazos’) men, women and children marched beating pots and pans like drums. The political crisis escalated, each new government played ball with the IMF. The streets became more violent and police reacted with more violence: 34 people were killed. Many thousands more were to die in the next three years from suicide, health problems and malnutrition. Eventually, starvation occurred in remote regions of the country. The middle classes were decimated. The government collapsed again and again. In January 2002 the Argentine peso was devalued by 75 per cent. A peso was then worth between 25 and 30 US cents. Ordinary citizens lost much of their savings. There were more suicides.
Subsequent governments declared a unilateral cessation of debt payments including a cessation of interest payments (a default). The default continued for 38 months while the government used their taxes for national recovery instead of interest payments. Finally, just over 50 per cent of the debt was renegotiated (the technical term is ‘restructured’) with about 70 per cent of the creditors accepting just less than 40 cents on the dollar with no interest.
Sovereign debt was reduced but the financial problems did not end there. Argentina is still on a fragile road to recovery. One of the most obvious legacies is a more regressive distribution of wealth. The rich got richer and the middle classes got poorer. The poor, as ever, bore the brunt, and some of them starved.
In 2012 Argentina has about the same nominal sovereign debt as in early 2002. An average GDP growth rate of 8 per cent for a decade means this represents very much less as a percentage of GDP, which has almost doubled since 2003. A higher proportion of Argentine debt is now denominated in pesos. This is easier to pay as Argentina can print pesos.
Argentina is now a member of the G20. Though still shut out of the private debt markets for government bonds, it is currently renegotiating its debt with the ‘Paris Club’ (an international arrangement representing large groups of sovereign and private lenders which is the final arbiter in default negotiations, with offices in Paris),6 and is under extreme pressure to come back into the fold. Argentine loans from the Inter-American Development Bank are being blocked by the US.
The government has undone the privatisation of the national airline, national postal system, many city water services, and, critically for public finances, the private pension funds. All of this came at a very high cost to the Exchequer. Many services which were previously public remain privatised, their profits going to multinationals instead of being recycled in the local economy. The country faces countless litigations in the World Bank court (the International Centre for Settlement of Investment Disputes).
No one in Argentina would say that they wish to experience such a default ever again.
Unconventional Options for Irish Policy Makers
Unconventional economic thinking offers alternative policy options to Ireland’s new government. These have been employed in South America with varying degrees of success. Use of similar strategies in an Irish context might at least offer Ireland a fighting chance of avoiding a hard default or paying back too much sovereign debt. Two unconventional options may have applicability in an Irish context:
Option One: Sovereign Debt Audits
The independent University of Limerick debt audit (completed in September 2011) was modelled on the debt audit used by the Ecuadorian government to their advantage in negotiations with the debt markets; as an independent audit it lacked access to certain information not in the public domain. An audit cannot itself reduce debt, but it can provide negotiators with arguments for doing so.
The Ecuadorian government began a sovereign debt audit under a presidential decree signed in the National Palace in Quito on 9 July 2007. President Rafael Correa had just been elected. He had run on a platform that included debt renegotiation. He created the Commission for an Integral Audit of Public Debt (CAIC in Spanish).7
The idea of a national debt audit is simple: pare back the nominal public debt to the essential debt that the public is legally obliged to pay. To do this it is necessary to audit the legitimacy and the source of the debt. The CAIC audit committee was made up of a team of government, religious and civic representatives, with both national and international participation. The Ecuadorian sovereign debt audit was followed by active debt restructuring. Reuters journalist Felix Salmon analysed the first phase of this restructuring in an article entitled ‘Lessons from Ecuador’s Bond Default’ in May 2009. He cites Hans Humes, of Greylock Capital, who describes the Ecuadorian strategy as a ‘great blueprint now of how to do it.’ Humes called it, ‘one of the most elegant restructurings that I’ve seen’. The bond dealers were sanguine; the party was over! ‘The world has changed,’ said Humes:
… we’re now living in a world where not only Ecuador can default, but Iceland can default as well. And that’s a world where defaults by small emerging-market countries simply don’t have the systemic consequences that everybody thought they might have.
More information on the CAIC is available in the excellent Greek documentary Debtocracy8 and the final report of phase one of the Ecuadorian debt audit (published in English in 2008) is downloadable from the government website <AuditoriaDeuda.org.ec>.
Eric Toussaint of the Committee for the Abolition of Third World Debt (CADTM) was a consultant to the Ecuadorian CAIC audit in the sub-committee on multilateral debt. He argued in an article on 25 August 20119 that much of the peripheral unproductive (rescue) debt should be declared illegitimate. His argument goes as follows:
It is obvious that the conditionalities imposed by the Troika10 (massive layoffs in the civil service, the dismantling of social protection and social services, reduction of social budgets, increase in indirect taxes such as VAT, the lowering of the minimum wage, etc.) violate the UN Charter.
[…] It takes us back to a question raised by the doctrine of odious debt: who benefits from the loans?
Option Two: Solidarity Finance
Another unconventional option for governments out of favour with the debt markets is to seek solidarity finance. In Ireland’s case solidarity might be found within the European Union. Solidarity could preferably be coordinated with the other ‘peripherals’ like Greece and Portugal.
For a long time now the EU has been much more than just a common market. The EU is a political, monetary, economic and military community of nations. In fact it used to be called the European Community. It is in the interests of all community members to prevent a fellow nation’s financial collapse, especially when most European nations have private banks that are (or were) bondholders of peripheral debt. Negotiating solidarity measures makes sense: it is part of being a good neighbour. It could demonstrate to the debt markets that speculative attacks would be unprofitable.
The ECB is currently providing essential liquidity to the Irish banks, thus bridging the transfer of risks from private European banks to community taxpayers (at the cost of Irish government guarantees). An argument could be made that some of this cost should be socialised to the community itself. Various suggestions have been made to do this including Eurobonds (EU bonds backed by institutions of the European Union, not national bonds denominated in Euro).
In late August 2011 Christine Lagarde, the new director of the IMF, had another suggestion. At the US Federal Reserve Symposium in Jackson Hole, Wyoming, Lagarde said, ‘European banks may need forced capital injections to stop the spread of the Eurozone’s sovereign and financial crisis.’ In a curiously circular argument she added that European private banks would need this infusion of capital to ‘[be] strong enough to withstand the risks of sovereigns and weak growth [thereby] cutting the chains of contagion.’ Lagarde suggested that the private sector could take its share of losses but also added that an injection of funds might have to come from public European sources:
One option would be to use the European Financial Stability Facility to make direct capital injections into banks [so as to] avoid further stress on the finances of national governments such as Greece.
Presumably Christine Lagarde would also include Ireland in the list of peripheral governments with stressed financials, but Ireland is somewhat unique as much of the Irish sovereign debt (and guarantees) is the direct result of the rescue of Ireland’s private financial sector. Lagarde suggests that private European banks need to have capital injected into them by the European Financial Stability Facility (EFSF) so that they can improve their resilience to sovereign risks. In Ireland’s case it is too late to do this; in fact the Irish ‘sovereign risk’ is the result of the private rescue. It could be argued that this new ‘Lagarde doctrine’, if put into effect, would imply that the EFSF should intervene after the effect in Ireland’s case.
After the abrupt departure of Dominique Strauss-Kahn, Lagarde became the first female managing director of the IMF, having served as Finance Minister of France from 2007 until July 2011. The IMF is, as its name implies, an international monetary institution tasked with global financial stability (both private and public banks). Her call to save the private banks with public money in order to prevent risks to private banks from public defaults is a somewhat circular argument. In layman’s logic it is somewhat absurd but the financial world has its own logic. It does not mean that, if implemented, the plan would not work.
Lagarde’s idea to use the EFSF to protect Europe from a default on sovereign debt could be considered a call for an EU solidarity measure. In retrospect, implementing Lagarde’s suggestion in Ireland’s case would imply the use of European funds to rescue the private Irish banks (as against Irish state funds and guarantees). If the EFSF had intervened as Lagarde suggested in Ireland the Irish sovereign debt crisis would have been avoided altogether.
In other words, one way to save Ireland from default is to socialise the pain of rescuing the Irish financial sector. A transfer from the ESM could be used to partially eliminate the state guarantees and thereby pay down the sovereign Irish debt from the blanket rescue. The private sector could also be forced to share the pain. A default would be avoided. Problem solved! One could argue that Lagarde’s suggestions give Irish negotiators further leverage in negotiations with creditors in Brussels and Frankfurt. The Irish, the Greeks and the Portuguese might even ask the IMF to broker such a deal. The fact that this announcement was made from Jackson Hole would lead us to believe that such a solution would be acceptable to Washington as well. It is an alternative means to rescue US holders of swaps at Europe’s expense.
Regional solidarity was important to Argentina too. Unfortunately this solidarity came only after the political collapse when the new Kirchner government made new friends in South America. After the default, the private markets shut Argentina out of the ‘conventional’ sovereign debt markets. The government was in desperate need of financing to get out of the crisis so Argentina created peso bonds and sold them to Venezuela, who later sold them on at a profit.
Venezuela did not just buy bonds; it also offered up-front payments to prevent large Argentine companies such as SanCor (a dairy manufacturing cooperative) from economic collapse.11 The Venezuelans receive future exports from SanCor in return. In effect, solidarity funding is being paid off in yogurt futures: a creative and healthy choice. Solidarity credit gave Argentina an alternative debt market; it provided crucial funds that helped the Argentine government get back on its feet financially and allowed it breathing space to correct budgetary problems.
Option Three: The Default Option
The new Irish government should try to avoid a debt spiral by whatever means necessary (conventional or not). Failing this, there is the worst-case scenario: a hard default on Irish sovereign debt. This was the fate of Iceland in 2008 and Argentina in 2002. The effect on the Irish economy of an uncontrolled default would be extreme and unpredictable. Ireland would also risk currency devaluation with the resultant loss in the purchasing power of citizens’ savings and in difficulties paying off Euro-denominated debt.
Devaluation happened in both Iceland and Argentina. If it were to happen in Ireland this would imply a break with the Euro, analogous in some ways to Argentina’s break with the dollar peg in 2002, but worse, as Ireland has no obvious currency to fall back on. In Argentina’s case the peso dropped from $1.00 to $0.30 in days (in September 2011, 1 peso was worth 23 US cents). In Iceland, 75 kroner bought €1 before the crisis; after the crisis €1 cost 180 kroner.12
In Iceland’s case the country was able to return to debt markets within three years; not so Argentina. The markets were unwilling to accept peso-denominated bonds, especially after yet another Argentine default in 2002, and due to high internal Argentine inflation.
Some Irish pundits blame everything on the Euro but the Euro was not to blame for Ireland’s financial problems. The problems in Ireland are not Euro–punt issues. The Euro is a competitive currency to the US dollar; the punt was always a dependent currency aligned with the British pound. Neither is Ireland’s relationship with the Euro analogous to the peso peg to the US dollar in Argentina: for Argentina the dollar is a foreign currency. Membership of the Eurozone is, at least in theory, a more reciprocal relationship. The true extent of this Euro reciprocity still remains to be tested. Reverting to a new Irish punt would make Ireland more prone to speculative attacks against its new currency. It would be hard to convince financial markets of the stability of a defaulted and devalued currency. The resultant devaluation could be severe, making payment of Euro-denominated debt obligations more difficult in a weak new national currency. The state would have to maintain high foreign currency reserves to stabilise the value of the new punt. A break with the Euro is far from optimal, but it is possible. If it proves necessary it may be the least-worse scenario.
The Moral of Argentine Sovereignty
The fair distribution of the cost of debt restructuring gives governments a chance to recover by spreading the pain more equitably through society. Investor rights are important but so are human rights, as is national sovereignty. New human rights litigation was begun by former President Nestor Kirchner in 2003 and continues to this day under the presidency of his widow, Cristina Fernandez de Kirchner (re-elected in October 2011). Most trials are for crimes during the last dictatorship but these are not unrelated to Argentina’s sovereign debt. During Argentina’s latest dictatorship, between 1976 and 1983, sovereign debt rose from $7.8 billion to $46 billion. Some calculations put this increase at about 20 per cent of Argentina’s current sovereign debt obligations.
One of the most questionable economic measures was a law pushed though in the latter years of the dictatorship that effectively cancelled the foreign debt of much of the private sector. This has analogies in Ireland but the scale of the rescue of the Irish private financial sector is responsible for much more than 20 per cent of Ireland’s nominal sovereign debt. A government-sponsored audit, like that which took place in Ecuador, has yet to happen in Argentina, but an extraordinary investigation was begun by an individual, Alexander Olmos, after Argentina’s return to democracy in 1983. Olmos was so incensed by fraud during the dictatorship that he spent much of the last two decades of his life active in this prosecution.
In 1990 Olmos wrote an analysis of the fraud in his book, The Sovereign Debt: All that You should Know but which They Kept from You. The Olmos litigation13 ended on 13 July 2000, just months after Alexander Olmos’s premature death. It resulted in 470 commercial and financial proven irregularities. Criminal and correctional judge Dr Jorge Ballestero released his conclusive findings:
Companies of significant importance and private banks with international debt, by socialising costs, even now compromise public finances servicing the sovereign debt …. The existence of an explicit relationship between the sovereign debt … and the sacrifice of the national budgets since 1976 cannot have gone beyond the notice of the IMF who supervised international negotiations.14
The de facto government collapsed shortly after losing the Malvinas/Falklands war in 1982. Taking private debt public was a naked transfer of wealth from future Argentine taxpayers to influential private firms. Later studies indicated that this had negligible stimulus effects. The studies also showed that firms with the closest political contacts to the dictatorship received higher rates of debt alleviation. Much of the debt that companies claimed to have on their books (for which they received public guarantees) never even existed.
Redacted documents used by the Dáil committee investigating the bank rescue show that since early 2008 the Irish government had been debating how to rescue its financial sector. It received considerable advice from PriceWaterhouseCoopers, Merrill Lynch, Goldman Sachs and Morgan Stanley, and from the British government (which had the recent experience of nationalising the British bank Northern Rock).
On 19 July 2011, the Financial Times Alphaville blog published a story entitled ‘Inside Ireland’s Secret Liquidity’ by Joseph Cotterill, which cited the same redacted documents used by the Dáil committee. Cotterill’s examinations make Brian Lenihan’s blanket rescue of the banking sector look even more like a rogue event, demonstrating that it flew in the face of direct advice from the secret overview of a financial stability resolution dated 8 Feb 2008, from the Irish Department of Finance. That advice included the following statement:
As a matter of public policy to protect the interests of taxpayers any requirement to provide open ended / legally binding State guarantees which would expose the Exchequer to the risk of very significant costs are not regarded as part of the toolkit for successful crisis management and resolution.
Once the new government is clear as to why this advice was not heeded, they should be in possession of information pertinent to the tough negotiations ahead.
From Argentina we wish them well.
Endnotes
1 Sheila Killian, John Garvey and Francis Shaw (2011) ‘An Audit of Irish Debt’, available from: <http://www.debtireland.org/news/2011/09/14/debt-audit-gives-people-clear-picture-of-irelands/>. Anyone who reads this document will see that the access of the academics in Limerick to necessary information was only partial but it is a good start for a government-sponsored audit.
2 Downloadable from the Commission of Investigation into the Banking Sector in Ireland website: <http://www.bankinginquiry.gov.ie>.
3 Subordinate debt has less value than normal debt and is normally written off in liquidations.
4 Available from the Independent Banking Commission website at: <http://bankingcommission.independent.gov.uk/>.
5 This actually happened in 2011 when AIB defaulted on its debt, which triggered cash payouts of €500 million: <http://www.bbc.co.uk/news/business-13752758>.
6 See <www.clubdeparis.org>.
7 The results of the audit were published online here: <http://www.auditoriadeuda.org.ec/>.
8 To watch the film online with English subtitles please visit <http://www.debtocracy.gr/indexen.html> or <http://www.dailymotion.com/video/xik4kh_debtocracy-international-version_shortfilms>.
9 ‘Greece, Ireland and Portugal: Why Arrangements with the Troika Are Odious’, CADTM, available from: <http://www.cadtm.org/Greece-Ireland-and-Portugal-why>.
10 The ‘troika’ is the European Commission, the IMF and the ECB.
11 The company Adecoagro, with investments from the Soros Fund, was reputedly interested in purchasing SanCor in its distressed state.
12 The Icelandic krona later rose in value against the Euro (in January 2012 €1 was worth approx 161 kroner).
13 For more on the financial irregularities of nationalising private debt see Anthony Phillips (2007) ‘Fourteen Billions between Friends’, Project Allende, available from: <http://www.projectallende.org/deuda/www-deuda/mdeh.pdf>.
14 Conclusions quoted in Spanish in full: <http://www.argentinaoculta.com/deuda/dictamen031.htm>.