Don Walshe Economics Dept, UCC Tel: 021-4549212 E-mail: don.walshe@ucc.ie

1. Don Walshe Economics Dept, UCC Tel: 021-4549212 E-mail: don.walshe@ucc.ie “Budget, Banks and Bailout” Economics Webinar December 8th, 2010

2. Bond ‘Vigilantes’ • Ireland’s creditworthiness questioned on multiple fronts: • Inability of State to absorb banking losses (scale) • Austerity measures in NRP a drag on medium-term growth • Ad hoc, opaque, and uncordinated response from EU/ECB undermines effort to stabilise debt/GDP ratio • If sovereign investors are forced to assume bank risk, they will charge a bank cost of capital (7.5% plus) • As a consequence, ‘bail out’ should involve moving bank risk to where it is best borne (i.e. not with domestic taxpayers) • This is the agenda of the bond ‘vigilantes’

3. Not a ‘Bail Out’ but a ‘Restructuring’ Package • Emphasis on Systemic Risk management • Recapitalise (Taxpayer) • Restructure/Downsize (Taxpayer/Private Capital) • Recourse to Market Funding (Private Capital) • Forced risk-sharing i.e. investor ‘bail in’ is not a feature • Loss burden not to go higher than equity and junior lenders • As a result, de-leveraging of bank sector amounts to raising €113bn (restructuring) to payoff senior debt • Contentious as ‘bail-in’ measures such as debt/debt, debt/equity swaps commonplace in other IMF programmes such as the South East Asia in 1998.

4. The Euro Dimension is Critical • ECB decided (Nov’10) that its exposure to Irish Banks unsustainable (€90bn + €30bn emergency liquidity from CBFSAI) • ECB pushed Government to apply for external assistance and difficult to say no given extent of liquidity support from ECB • ECB/EU require Irish Government to buffer (via NPRF) losses for senior bondholders even for the obviously insolvent banks such as Anglo and Irish Nationwide • Moreover, special legislative regime will also find it difficult to burden-share with juniors as State injects first loss capital • Funding to come from IMF(@5.7%)/EFSM(@5.7%)/EFSF(@6.05%) • Not ‘bail-out’ terms, but terms to force bank restructuring

5. Walking a Tightrope • Plan secures large package of funding for bank re-cap and commitment from ECB to provide large share of ongoing funding • Systemic fears insulating bondholders for the time being • Key issues • Can banks be re-organised and sold to well-funded outsiders quickly? • Can additional bank losses be contained within the NPRF portion of the funding? • If so, Ireland’s creditworthiness can be restored and reflected in lower bond yields • If not, default is inevitable and the systemic consequences will have to be dealt with by the ECB

6. Thank you!