Damien Kiberd: Altar boy actmust end in fiscal failure

Assuming budget targets are met, the 2011 to 2014 general government deficit will still eat up €42 billion. This assumes a systematic programme of deflation that could adversely affect government cash flows from important tax categories and make that deficit deeper.

The cost of increasing bank capital ratios to 12% of risk assets will be €10 billion initially but, depending on future shocks on the bank capital assessment, could absorb as much as €35 billion if the entire EU-IMF contingency fund is drawn down.

Several factors could lift the bank rescue bill to even higher levels. These include an EU-IMF-mandated firesale of bank assets and any further loan losses arising from future defaults on domestic mortgages.

There’s a further difficult issue: if more toxic assets are sold to the National Asset Management Agency (Nama), the banks’ capital requirements will grow quickly in accordance with the haircuts imposed.

The programme for government suggests there will be no further transfers to Nama. But the EU-IMF deal requires an extra €16 billion in toxic loans to be sold to the agency by AIB and Bank of Ireland. It is unclear how this contradiction can be reconciled.

Neither is it clear how the state or the Central Bank of Ireland will meet the cost of redeeming existing government stocks as they fall due — another €28 billion between 2011 and 2014.

On top of this, there is the cost of honouring existing senior and guaranteed bank bonds from 2011 to 2014. The best estimates put this at €41 billion, with a further €20 billion to follow at later dates.

Finally, there is the unpredictable cost of replacing cash draining out of the banking system as deposits are withdrawn. Some €17 billion was taken out in January alone, but the numbers arising over the next four years cannot be accurately forecast.

The domestic banks are lubricated already by €70 billion from the Central Bank and circa €100 billion from the ECB. The overall totals suggest a minimum external cash requirement of €150 billion to €200 billion. Ideally, Ireland Inc would raise this cash cleanly from the capital markets — but the world is far from ideal.

There is no prospect today that any of this cash can be raised from a source other than the Irish and European exchequers. In effect, the government’s cash flows are spoken for into the foreseeable future.

Assuming we can walk this cash tightrope, what do we get in return? The money will be used to keep the exchequer ticking over while paying off public and bank debts. It will fund banks that provide money transmission services, but are more or less defunct as providers of new credit.

Turning the ship of state into an elaborate debt repayment agency will please the EU and Franco-German banks. It will avert the reputational damage feared by Bruton and others. But it signals almost certain political death for the new administration, possibly within a short timeframe.

The alternative is to seek and secure a radical solution to the debt issue right now.

Bruton last week suggested that the EU summit in late March should provide for bank recapitalisation across all of the eurozone. He suggested some culpability for Ireland’s bank debt problem attached to the ECB and to German, British, French, Belgian and other banks. He expressed little confidence that Ireland could get a meaningful cut in the interest on bailout loans.

If the new government is to have a real chance of political survival, then it must secure in the coming weeks a plan for burden-sharing, not just with the creditors of the Irish banking system but also the European Union and the ECB. Ireland at present carries the burden alone, while the ECB affects a certain immunity to events here.

But the ECB cannot be insulated from the cost of the Irish banking crisis. For example, Anglo Irish Bank confirmed in mid-February that it owes €45 billion to the Irish and European central banks. It owes another €6 billion to bondholders.

This money may never be recovered from what is now a run-off bank that has been shorn of its deposit base and its Nama bonds, almost all of which were sold to AIB.

The ECB could insist on full recovery of its exposure to Anglo, but this would merely move the problem to the Irish finance ministry. Anglo’s biggest residual asset is €25.7 billion in promissory notes issued by the Irish state, which itself became technically insolvent in late November 2010. Will the ECB write off some or all of this debt? Or would such an approach be anathema to Germany, Austria, Holland and others?

Patrick Honohan, governor of the Central Bank, has repeatedly expressed hope the big clearing banks will be bought by big overseas institutions. The bill for loan losses and recapitalisation at Ulster Bank and Bank of Scotland (Ireland) were picked up by RBS and Lloyds, but big foreign banks won’t buy into AIB and Bank of Ireland unless they can see a route back to profit.

If creditors of the big clearing banks — including bondholders and the ECB — could be forced to take a haircut on monies owed and if the resultant improved balance sheets could be fully capitalised by the Irish government from the bailout funds, it might be possible to convince third parties to acquire these banks for a nominal fee.

A sale of AIB and Bank of Ireland would remove very big headaches from the Irish and European exchequers, including the need to provide emergency liquidity and further share capital. The priority for the state is to preserve the payments and money transmission systems. Realistically, the resumption of new credit creation in Ireland would be a bonus.

Official policy has forced AIB and, to a lesser extent, Bank of Ireland to get rid of profitable business units, making them less attractive to suitors. The latest policy is to force both banks to conclude asset sales, even at a substantial loss, to squeeze cash to pay off bondholders and the ECB.

Will a government which has reached an advanced stage in dismantling Anglo and Irish Nationwide repeat the dose at the two clearers? Remember: in this saga, what seems fanciful today is realistic tomorrow. As recently as September 30, Brian Lenihan, the former finance minister, told the Dail his banking policy was predicated on the need to retain access to capital markets and to prevent the large scale removal of deposits from the banking system.

The primary creditor in the Irish banking fiasco is the Irish state, which is exposed for €45 billion so far, not counting its exposure through Nama; the ECB, which is owed €100 billion; the bondholders owed €63 billion; and the Central Bank of Ireland owed €70 billion.

Though much of the recent soothing rhetoric has been supportive of the interests of the bondholders, it is the solvency of the other three that is actually at stake.

The capacity of the Irish state to long-finger the problem by issuing IOUs and tapping the ECB is almost exhausted. It’s time that much greater attention was given to this issue by the EU, the ECB and the EFSF.

In the parlance of the markets, it is time for a bail-in, rather than a bailout.

PS: Pat Rabbitte, the new energy minister, should hasten slowly with any bid to leverage the assets and cash flow of firms such as the ESB to release cash for job creation programmes.

The company’s cost of borrowed funds has already been pushed up by the exchequer’s fiscal problems. The idea that bits of the organisation be sold off piecemeal could prove just as misguided. Why break up a firm that is working well?