The G7 Needs To Act, This Weekend, On Ireland

Look at the latest Credit Default Swap spreads for European sovereigns (these are the data from yesterday’s close).  As we’ve discussed here before, CDS are not a perfect measure of default probability but they tell you where things are going – and changes within an asset class (like European sovereigns) are often informative.

European CDS have been relatively stable – albeit at dangerously high levels – for the past month or so.  But now Ireland has moved up sharply (the green line in the chart).  We’ve covered Ireland’s problems here before (banking, fiscal and – big time – real estate); type “Ireland” into our Search box for more.

My point today is simple: a key warning sign just moved from orange to red. 

The G7 ministers of finance and central bank governors need to focus on this problem during their discussions today and tomorrow.  What is the strategy for Ireland?  Does the European Union come in to help?  Is this a job for the IMF? 

Just don’t, please, tell me more about the “basic principles” of financial reform (and similar nostrums in the draft communique) unless and until you have addressed the Irish Problem.  And don’t tell me, “the Irish have to sort this out for themselves.”  Eventually, the world always comes to help; check your notes on Iceland.  It’s much better and much cheaper to come in early and decisively – of course, the Irish will have to do some painful things, but we really can help (or, if we can’t, this will be a long dark winter for the eurozone).

We need a plan of action for Ireland, and we need it now.  What we don’t need is another Iceland-type situation.

11 thoughts on “The G7 Needs To Act, This Weekend, On Ireland

  1. Really, it should be the job of the European Central Bank, though it may not have legal authority to intervene.

    Someone noted earlier the relationship between European countries and the EU is similar to that between states and the federal government in the lack of ability to print money/devalue the currency.

    One option is for the ECB to float a low interest loan to the EU which props up the Irish govt but demands concessions – like state wage cuts. Call this the IMF-flavor solution. Problem is, they have a real estate bubble too. Wage cuts drives further local deflation/unemployment/lower spending, which drives further bankruptcies. Also, the problem isn’t solved – it’s just transferred to long term debt obligations that ultimately will cripple spending power.

    Another solution is for the EU/ECB to absorb bad debt, which the rest of the EU countries will never swallow. This may be efficient, but no one would tolerate ‘rewarding’ Ireland for its bad behavior, least of all the Germans.

    Another solution is for the ECB to loan money to the EU which distributes it to all the member nations. The Euro devalues, and the member nations can use the excess cash to fund local stimulus, pay off debt, or in the case of Ireland, prop itself up. This does not overly reward Ireland (the Irish have to pay down their obligations rather than spend on investment and other stuff).

    This is – really – the exact equivalent of the US printing money and distributing it to the states for infrastructure investment, which is what the US _should_ be doing (but can’t seem to accomplish because Congress wants to control the money themselves). Those states that have a solid balance sheet get to keep the cash (lower taxes or fund investment) while those that have a weak balance sheet must use it to shore up that balance sheet.

    Of course, this means inflation and devaluation of the Euro, but for the EU this should be beneficial. Their economy largely got killed because of the export contraction. I suppose the long term risk is that investors will not think the ECB’s commitment to low inflation credible if it “renegotiates”. Although with possible deflation, one could argue it is precisely consistent with the ECB target of 2% inflation.

  2. A 355bp spread isn’t really THAT high, and it’s definitely not a “danger zone” level. A reference has moved into the danger zone when its CDS start trading on a points upfront basis. Ireland is still a good 200bps away from trading on points upfront.

    Iceland’s CDS was being quoted at around 20 percent upfront plus 500bps running a couple weeks before the IMF had to bail them out. Ireland is still a LONG way from those levels.

    I’m not saying the G7 shouldn’t put together a plan for dealing with Ireland this weekend (I’ll defer to your expertise in that area). I’m just saying that Ireland’s CDS spreads definitely don’t indicate an imminent default.

  3. Do you really epxect the G7 to come through? Empirical evidence strongly suggests that governments cannot respond in a sane and timely manner in this crisis.

    And a suggestion for a Beginner’s article — explain what all of these Gx summits are (G20, G7, etc.).

    Thanks for the great site and insight!!

  4. While the Irish fiscal and economic situation is severe, Ireland does not require any external assistance. It has a low public debt, an asset-rich sovereign wealth fund and plenty of capacity to raise taxes and cut public spending after a decade of rapid fiscal expansion.

    Moreover, it is quite unhelpful for outsiders to call for intervention, since it adds fuel to ill-founded concerns about sustainability.

    The CDS dynamics are similar to those of a speculative attack on a currency. While speculative attacks can be self-fulfilling if the fundamentals are weak enough, plenty of speculative attacks peter out and this is the most likely scenario in the Irish case also.

  5. The ‘outsider/insider’ distinction in my comment is badly judged. I would have the same opinion of a domestic commentator that called for external intervention.

  6. The Irish banks are somehow joined at the hip with the Germans. Someone needs to report on the Wisconsin school districts that lost tons of money when they had borrowed using their buildings as collateral in the hope of achieving higher results in the market. It was an Irish bank that specialized in this market and it may be pervasive in other municipalities. What happened to the concept of preserving capital as one ages and moves towards retirement? My guess is that there wasn’t enough of a history of financial astuteness for the Irish to do more than grow potatoes and make beer. Someone from either London or the continent was insinuated into their situation helping them be cunning.

  7. Ireland; like many developed and lightly regulated economies; has been discovering quite seriour ‘skeletons in the cupboards’ at a time when least wanted (in the midst of a global and national economic meltdown).

    When the ‘dust settles’, banking irregularities are washed out and all bad debts (present and future) are accounted for in bank reports, Ireland should be relatively secure as there is sufficient scope for tax increases and other measures.

    My reading of the Ireland situation is when we believe we have visibility of everything, another scandal internal to the Irish banking community raises it’s head – the recent CDS spike reflects the news that one bank deposited €4BN – €7BN to support another banks annual report.

    Only when Ireland adopts a policy of treating white collar crime as it should be and impose the correct detterents will confidence return. However Ireland has a history of ‘public enquiries’ (no criminal charges – merely a report) when dealing with the crimes of their ‘elite club’.

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