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Euro zone -- successfully hiding default [ClearOnMoney]
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Commentary

Euro zone -- successfully hiding default

8 Feb 2013 by Jim Fickett.

A pattern is emerging in how the European debt crisis is being handled:

(1) For as long as possible, try to talk the markets down, and do little else of a concrete nature. This avoids bailouts, if possible, and aims to keep the total cost of the crisis contained. So far this approach is working in the case of Spain.

(2) If a country is bailed out, wait until circumstances are desperate. This forces the wayward debtor to agree to real reform. Recall the last-minute negotiations in the cases of both Ireland and Greece.

(3) When a bailout is agreed, impose impossibly onerous terms. This, again, may help force real reform. It also makes the taxpayers in the creditor countries feel a little better, and reduces political backlash.

(4) After the fuss dies down, restructure the debt, i.e. allow partial default. This lets the debtor country sufficiently off the hook that they can hope to really recover in the long run without leaving the euro.

Step 4 happened last year in Greece and on Thursday happened in Ireland as well. In the original bailout of failed Irish banks, the Irish government issued promissory notes for about 28 billion euros. Most of the principal was due over 12 years, and the interest rate was 8%. They have now renegotiated terms so that they can pay the debt over 40 years, at much lower interest rates. Although the principal will indeed be paid, this is, in fact, a partial default on the original terms. With the net present value of the debt, used for loan collateral with the central bank, lower, this increases the risk that the ECB could eventually take a loss as the assets of failed Irish banks are wound down.

From the Financial Times:

Under the deal, Dublin plans to issue long-term government bonds with maturities of up to 40 years to replace €28bn in promissory notes – in effect government IOUs – which it issued at the height of its financial crisis in 2010.

These notes have been used as collateral by Dublin to draw down “emergency liquidity” from the Irish central bank, with ECB approval, to fund the wind up of Anglo Irish and another failed lender Irish Nationwide Building Society.

The promissory notes have become a lightning rod for public anger over austerity and Ireland’s treatment in its international bailout at the hands of the eurozone authorities, particularly the ECB. The annual payments of €3.1bn to repay interest and principal are more or less equivalent to the value of austerity measures implemented by Dublin each year.

Under the plan, Irish taxpayers will still have to pay back the €28bn, but repayments will be stretched out over a longer period, thereby easing the government’s short- to medium-term financing needs.

Dublin hopes that pushing out the debt repayments over a longer period will help the country exit its international bailout this year. Inflation over time should also reduce the overall burden on the state, it says.

Dublin said its plan would result in a €20bn reduction in the country’s market borrowing requirements over the next decade. The average interest rate on the new bonds would begin at 3 per cent, compared with an interest rate of 8 per cent on the promissory notes.

This hides default in plain sight, but that seems to work. Spiegel, which often has articles on the unhappiness of the German citizenry with bailouts, had absolutely no mention of Ireland on its home page.