PAT RABBITTE WASN’T pulling any punches last week. The Communications Minister told RTE’s The Week in Politics that “We didn’t pay the promissory note this year and as far as I am concerned we are not going to pay it next year”; that the Government will have secured a deal on Ireland’s promissory notes before the next repayment falls due in March; and that “We can’t pay. This was an IOU entered into by the previous Government when the Anglo Irish Bank collapsed and the notion of us paying it next March doesn’t arise.”
Them’s fighting words. But is it realistic to state that Ireland can unilaterally insist upon a negotiation, or not pay at all? Well, no.
To recap: the promissory note represents an IOU signed by former Minister for Finance Brian Lenihan, in return for €30 billion worth of ‘Emergency Lending Assistance’ paid by the Central Bank to shore up Anglo Irish Bank and Irish Nationwide Building Society, now known as IBRC. IBRC, a state-owned institution, must now pay back this money in exchequer-funded scheduled repayments over the next 14 years, amounting to annual installments of €3.1 billion until 2023 and smaller installments after that, about two percent of GDP every year for the next ten years.
The Central Bank does not, as is still sometimes mistakenly assumed, use these repayments to repay Anglo and INBS bondholders. The majority of these bonds have already been repaid. Instead it uses the repayments to write off the paper debt it recorded when it provided funding for Emergency Liquidity Assistance, so the money is essentially retired from the system.
Hand that feeds us
The only thing that repayment achieves is a reduction in the relatively small amount of interest the Central Bank pays on the outstanding promissory note to the ECB (0.75 per cent), a penalty incurred under the ECB Intra-Eurosystem that aims to control Eurozone liquidity.
But even though there is no material benefit from repayment to anyone, IBRC cannot simply renege on this debt because it would be acting in direct defiance of a host of EU laws and – to put it simplistically – would really, really annoy the ECB, on whom we are dependent for a whole host of reasons. Arguing that we can unilaterally choose not to repay is like a small child running away from the mother who cares for it; we would be shunning the hand that feeds us.
And so to the crux of the matter: the chief reason the ECB will not allow us to refuse to pay the promissory note is because that would mean the Central Bank of Ireland was allowed to print money out of thin air to the tune of €30 billion in 2008. The Central Bank can legally print money in this way in exceptional circumstances under the Irish Central Bank Act of 1942. However it is prohibited under EU law and there is nothing the ECB is more strict on than the printing of money.
Its primary reason for existence is to ensure price stability in the Eurozone and prevent excessive inflation, and the most obvious risk of the largescale printing of money by a national Central Bank is inflation.
The payment of Emergency Liquidity Assistance in the first place was only permitted in the context of a strict system governed by the ECB that can veto the procedure at any point if two thirds of the ECB Governing Council take issue with it, and that has reporting procedures in place so the ECB can monitor the effect of the payments on Eurozone liquidity. And if Ireland was allowed to print money in this way, what is to prevent Spain, Portugal, Italy and Greece seeking similar leniency?
What is likely instead is a renegotiation, since the current repayment schedule is truly punishing. Again, we can’t just unilaterally insist upon a renegotiation; it will have to legally be approved by two thirds of the ECB’s Governing Council.
What form is a renegotiated deal likely to take? Lots of commentators argue that the IOU should be funded by the creation of a long term Irish government bond. The Government could issue IBRC with a €30 billion sovereign bond that matures in, say, 40 years.
(Incidentally, this is what the government actually did to fund the first €3.06 billion repayment that was due this March. Instead of paying up it delivered a long-term sovereign bond of equivalent value to IBRC. IBRC used this to secure the necessary financing from Bank of Ireland. Pat Rabbitte told RTE that ‘We didn’t pay the promissory note this year’ – not quite).
IBRC could use the bond as collateral to borrow the required amount from the ECB at a low interest rate, rolling over on the loan for 40 years until the bond matures. This option allows the Government to avoid having to stump up principal repayments every year until the promissory note is repaid. Instead it would only have to pay interest for 40 years, removing the pressing funding requirements it currently faces.
Since a sovereign bond sends the money right back into state coffers its issuance would make no meaningful dent in the exchequer. Deferring the principal repayment for 40 years also gives us wiggle room; we can still decide to default on the obligation if, years down the line, that looks like the most viable option.
However, notwithstanding the fact that the ECB haven’t approved this option in the past, the biggest negative associated with replacing the promissory note with a full-blown government bond is that it means we are unlikely to ever be able to truly separate this bank debt from sovereign debt and share its burden among Eurozone countries, as might be possible depending on the ultimate terms of the ESM.
The introduction of the ESM and the likely direct recapitalisation of Eurozone banks by the ECB that it will facilitate is taking far longer than predicted, in part because EU finance ministers are divided as to whether the ESM should be used to fund ‘legacy’ bank debt, which means retrospective debt that has already been accrued.
To compact two years of intense debate at the highest levels of the EU into one sentence: Angela Merkel et al say it shouldn’t, Ireland and Spain say it should. If by some miracle the ESM is extended to encompass legacy bank debt, then the promissory note could potentially be subsumed under a larger financing programme funded by the entire Eurozone and Pat Rabbitte can sing it from the rooftops.
Sarah McCabe is a law and finance journalist. You can find her on Twitter at @sarahmccabe1.