Head of bailout fund Klaus Regling says Ireland’s debts are sustainable and default would be ‘unwise’
IRELAND’S EXPANDING bank rescue just got bigger, Portugal’s plight worsens by the day and Greece seems as far away as ever from salvation. But Klaus Regling, chief of the euro zone bailout fund, insists EU leaders have finally turned the corner in their titanic battle against the sovereign debt crisis.
“In the summer of last year, the majority of market people in New York thought the euro would have disappeared in three years. This was not the situation east of here. In Asia, people had a different view. But in London, New York, that perception that existed last summer, has turned around,” he says in his sparse Luxembourg office.
“My conclusion from that very clearly is that the strategy that was adopted to preserve financial stability in the euro area is working. It doesn’t mean that all problems have been resolved, but overall the euro is no longer questioned. We are now dealing with a difficult situation in three countries and that’s very different from six or nine months ago.”
Regling, who may yet succeed European Central Bank president Jean-Claude Trichet this autumn, was handpicked by euro zone finance ministers last June to lead the nascent European Financial Stability Facility (EFSF).
This is the temporary rescue fund from which Ireland will draw down a total of €17.7 billion in the course of its EU-IMF bailout. Also in train is a permanent new fund, the European Stability Mechanism (ESM), whose operations start in 2013.
A crisp German with a direct no-nonsense style, Regling is known in Ireland for writing an unsparing dissection of the banking debacle for Brian Cowen’s government.
Reviewing Ireland’s present situation, he holds rigidly to the line that the mountainous debt burden is sustainable and that there should be no move to scorch senior bank bondholders. “We have a strategy which works without breaking promises,” he says in an interview with four European papers.
None of that should come as a surprise, but it is at odds with the stance adopted by Irish Ministers right up to the conclusion of the stress tests. The latest recapitalisation bill is enormous, but Regling points out that it does not exceed the €35 billion set aside for banks in the EU-IMF package.
“As that number is around €25 billion, it is well within the existing programme. We have the judgment of the IMF and the [EU] commission that this programme, if everything is implemented on the Irish side also, will lead to a sustainable situation.”
Minister for Finance Michael Noonan arrived in office uttering dire warnings that the increasing bank debt could overwhelm the State, but Regling believes Ireland can carry the burden. This means debt restructuring – code for default – is not in prospect.
“These are scenarios which are discussed in the media, by academics but not by us, not in the policy world. We have a programme with Ireland. There’s another operation with Greece, which was done before the EFSF was created, and we don’t have any other at the moment,” Regling says.
“The assessment of the three institutions that have the task to make this kind of assessment – the IMF, the European Commission and the ECB – is that these countries will reach a sustainable debt situation at the end of their programmes.
“They are the competent bodies and I will not tell you today that the three competent bodies which have hundreds of economists working on these issues are wrong; and also the euro area finance ministers will not do that.”
Rejecting the argument that banks have been treated more gently than people since the eruption of Ireland’s financial crisis, Regling says it would be very unwise for the Government to break its “legal commitments” to senior bondholders.
“In Ireland you know better than me, two of the five banks have been nationalised so the shareholders have been wiped out, they lost everything 100 per cent,” he says.
“Some of the junior bondholders lost almost everything. But then there are different categories and the senior bondholders have the same status as private depositors, it’s the same status, and deposits are fully guaranteed by the Government, so there’s an obligation.”
“Otherwise one would move away from a legal obligation that was put in place at the beginning of the crisis. So that’s a very serious retroactive change, so that’s not so easy. So where it was possible – for junior and non-guaranteed debt – bondholders lost a lot of money.”
Senior bond investors are in a different category, he says, adding that it would be “a serious thing” for the Government to repudiate such debt. “It would be a very drastic step, that’s not in line with the present approach which we try to implement, which everybody tries to implement.”
He acknowledges fear of market contagion in this context, but says that is not the sole consideration.
“If one government in the euro area breaks a promise, a legal commitment, then of course some people might say this can also happen in other countries. But it’s only one further element because in the first instance there would be a break in the legal commitment of the Irish Government.”
Regling says it is clear that Ireland’s problems will continue for some time to come. “We have the three countries that have serious problems and they will last for a while and they need to continue to do their homework. Greece has taken courageous steps, but they need to continue that for a number of years, the same for Ireland,” he says.
“Portugal is struggling internally whether they should ask for assistance or not, we shall see, it’s their decision. It’s these three countries that will have serious problems for a while, but not the euro area as a whole,” he adds.
“Spain overall is in much better shape. There’s no programme, no need for financial emergency assistance in Spain.”
It was early last year when the then minister for finance Brian Lenihan asked Regling to examine how Ireland’s banks imploded.
He didn’t hold back, notably drawing a direct causal link between Brian Cowen’s policies in the Department of Finance and the banking crisis.
Was he shocked by what he encountered in Ireland? “Yes,” he says immediately, adding that he was also shocked at what happened in Greece and Portugal.
“When you read it, it’s very clear that it’s a failure of several things, a failure of several institutions and several things going wrong at the same time,” he says in reference to his report on Ireland.
“So you cannot blame one or two people or institutions – it’s a combination of things. Otherwise, it would also be hard to explain why the crisis is so deep. But it includes the banks, it includes supervisors, it includes fiscal policy and many [others] involved.”
Regling, formerly the top civil servant in the commission’s economics department, says Irish institutions were not uniquely to blame when asked about John Bruton’s critique of failings in the European institutions.
“The failures of Irish institutions and bodies was against a background of the global scene. We had too much liquidity globally, we also say that in the report so I’m not blaming only the Irish institutions,” he says.
“It was against this background worldwide. That’s why we have the global crisis in the end. Things went wrong globally. The Irish situation has been in this global context.
“It was also at a time when we opened financial markets in Europe, so other EU banks at that moment entered the Irish market and drove interest rates down even further, which had already had been coming down because of [economic and monetary union]. So it was really in this context overall, many things happening at the same time contributing to the crisis.”
Regling, who has also held a senior position in Germany’s powerful finance ministry and in the IMF, was centrally involved in the creation of the euro in the 1990s.
He says the advent of the single currency brought “beautiful things” like low inflation and low interest rates, but that the gaps in the system were clear from the outset. “The full magnitude of these problems . . . was multiplied exponentially through the crisis.”
While lax oversight of the euro zone economies meant “nobody was really in charge” of macro-prudential surveillance before the crisis, he believes ongoing efforts to deepen economic governance and the toughening of regulation will prove significant.
“You can say every one is a small step, but it’s a sum of many small steps and I think that’s quite important,” he says.
“This is not new. When you go back the last 60 years, big steps towards integration always happened after a crisis. That seems to be normal.
“I would have preferred not to have had the crisis, but we do see progress here and this is real progress. My view is that monetary union will work better in the future than in the past with these additional steps, with these reforms.”
It was the resignation of former Bundesbank chief Axel Weber that prompted a wave of speculation about Regling succeeding Trichet. Although Bank of Italy governor Mario Draghi is now seen as a favourite, there is anxiety in political circles that the nomination of a “southern European” might not wash with Germany.
It is in this context that Regling might prevail, even though he is not a central banker. However, he denies it. “I am not a candidate and I’m happy to be here to manage the EFSF and to prepare the ESM.”
