What do we do if there's no debt deal?

The Soviet defector Igor Gouzenko is widely believed to have started the Cold War in 1945 with his defection to Canada carrying secret USSR papers. In his novel Fall of a Titan, Gouzenko wrote that "[political] promises are given according to motive, but are fulfilled according to circumstance”.

Gouzenko would have been at home around the table during the negotiations between Ireland and its EU partners.

Ireland is trying to secure some deal on its debt, in particular its banking debts, with a view to putting a much more manageable payment schedule on most of it.

Friday’s statement by Angela Merkel that there would be no direct recapitalization of legacy debts of banks by the new EU bailout fund the European Stability Mechanism sent sphincters into spasm. The spinning began almost immediately. Oh look, she’s up for election, anything she says has to be taken with a barrel of salt. Oh look, she was talking about Spain, not Ireland. Oh look, she was talking about recapitalization. Sure aren’t Ireland’s banks the best recapitalized in the world? And so on and so on.

Frantic calls ensued and we were told in Sunday night’s joint statement from Enda Kenny and Angela Merkel that there is a hard and sure commitment to examine Ireland’s debt, in particular its banking debts, with a view to putting a much more manageable payment schedule on most of it. Ireland is to be recognized as a special case.

Ireland’s net government debt is about 167 billion euros, excluding NAMA. The value of Ireland’s national output is about 161 billion euros. It has pumped approximately 100 billion euros into the banks covered by the 2008 guarantee just to cover loan losses. The one thing these banks don’t need is more capital. Ireland’s banks are the most capitalized in Europe.

So Ireland’s banks need more capital like fish need bicycles. Dr. Merkel’s comments are, effectively, meaningless. The recapitalization question is not something we need to worry about. So move on, and unclench the national sphincter.

What Ireland really needs is a resolution to three problems.

First, the 25 billion euros of promissory note debt needs to be repaid at a slower schedule. Right now we’ve to pay 3.1 billion euros a year for the next 8 years. Stretching that series of payments out to 20 makes a lot of sense, because our annual borrowing would go down substantially, making us a much better and more likely bet for international bondholders.

Second, some of the money pumped into the banks was pumped in as, essentially, shares. Roughly 21 billion euros from the National Pension Reserve has been invested in acquiring ownership stakes in AIB and Bank of Ireland. We’d like to sell those shares, but they are worth a lot less than 21 billion. Say they would be worth 8 billion on the open market. The game for the government is to do a deal with the EU and ECB to buy these shares for more than 8 billion but less, obviously, than 21 billion. This was the problem everyone began overclenching about on Friday. Dr. Merkel’s comments were seen as a signal the ESM would not be used to buy these shares.

Third, we need a resolution to the problem of unpayable household debt. This has not, and will not, go away, despite the big stakes EU level deals.

Here’s my question: what happens if Gouzenko’s maxim holds true and the promises to ‘examine’—remember words are very important here, they aren’t promising to ‘fix’—Ireland’s debt levels don’t come good? What if circumstances stop Dr. Merkel from fulfilling her promise? Or if, having ‘examined’, the authorities decide to do nothing?

Then Ireland will have a much harder time accessing funding from the markets. The implied bid yield on Ireland’s government debt shot down from 6.39 to 5.28 after the June announcement precisely because the markets know that Ireland freed from the odious debt previous leaders have piled on us is capable of growth and development, meaning these investors will most likely get their money back. A row back on a banking debt deal would send borrowing costs up again.

An Ireland fiscally crippled by legacy banking debt won’t be able to grow as fast and may experience social and political instability when people wise up to the fact that austerity is for life, not just for Christmas. That’s why Ireland is a special case. Ireland is selling itself as the poster child for austerity. If austerity won’t work here, it won’t work anywhere.

But does that mean that we won’t be able to survive without a deal on our debt?

It does not. Every prediction and every model has concluded that Ireland can make its way out of its difficulties if we see a little growth. Now the models have been wrong before, but realistically, if there’s no deal on the debt, Ireland will continue—perhaps in a second EU/IMF programme—to grow sluggishly and repay all of these debts.

The cost won’t be so much financial as social. An Irish State unable to spend on labour market activation programmes or retraining is a State committing itself to long-term unemployment in double digits or large scale emigration. The State will survive, but the cost will be horrendous.

Here’s the dilemma: being the best kid in class is nice for the teacher, but the noisy kid at the back gets the breaks. We can’t simultaneously try to do everything we’re asked, trumpet our successes, and then expect help when it is required later on. For the masters of Europe, there are other, larger concerns. Like Spain. And those European concerns will trump any promises to good little Ireland.

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