OPINION:Economist Morgan Kelly is too pessimistic: Ireland is moving towards "self-help" status and that is what we should promote, writes DONAL O'MAHONY
YES, WE are all bond market vigilantes now. The gyrations of Irish government bond yields are fast becoming a national obsession, with talking heads dominating all media outlets in a manner that leaves the dogs in the street straining to get a decent bark in. Market opinions are many and varied, ranging from the Room-101 musings of ivory-towered inhabitants to the breathless whisperings of the shoe-shine brigade.
There is plenty to opinionate about. Irish bond yields have catapulted higher over the past month, the benchmark 10 year rising from 6 per cent to circa 9 per cent currently, the highest since 1995. Spreads against benchmark German bunds have surged to 6.5 per cent, levels unseen since the mid-1980s, a period during which currency concerns were embedded in all risk perceptions surrounding the Irish market.
Now, currency fears have been replaced by credit fears, epitomised by the spike in Irish sovereign credit default swap spreads to 6.2 per cent, this market thus ascribing a 51 per cent default probability over the next five years.
Investors are evidently reappraising Ireland’s willingness and/or ability to service its obligations, beset as it is by higher banking and fiscal consolidation costs, renewed political instability and, not least, destructive media commentary both at home and abroad.
Bearish commentary has focused in part on the increased burden of fiscal adjustment (€15 billion versus €7 billion) now required during the 2011-14 consolidation period. However, such adjustments owe nothing to the (in-line) budgetary out-turn of the past 12 months, and everything to the more conservative assumptions for Irish growth prospects over the forecast period. In normal times, this combination of conservative fiscal assumptions and front-loading of budgetary adjustments would be deemed credible by bond market players, and rewarded accordingly.
Unfortunately, current circumstances are far from normal. One untold story of the past several weeks has been the calamitous fallout in Irish bank debt markets engendered by the proposed default of €2.4 billion in subordinated bonds issued by Anglo Irish Bank.
LIABILITY MANAGEMENTexercises on subordinated debt have been a feature of the bank recapitalisation story (at home and abroad) over the past 18 months, but all being conducted without the compulsion of investor participation, such that issuers (the Irish included) might still be seen to be honouring their liabilities in full.
Now, with the enforced “burden sharing” for Anglo subordinated bond holders, unintended consequences have engulfed the Irish debt markets. The ratings agencies quickly assumed the loss of “systemic support” for similar categories of subordinated debt issued by both Bank of Ireland and AIB and, in awarding them “junk bond” status, triggered a self-feeding spiral of higher debt yields.
Contagion spread rapidly to the senior bank and sovereign debt markets, while German chancellor Angela Merkel’s subsequent “bail-in” proposal for a post-2013 sovereign debt restructuring mechanism only added fuel to the fire of an Irish debt-spiral. The appalling vista this morning is of a recapitalised Bank of Ireland, trying to make its way in the world to support Irish economic recovery, but now with the millstone of 10 per cent (guaranteed), or 13 per cent (unguaranteed) funding costs weighing heavily around its neck.
How depressingly ironic, therefore, to read Morgan Kelly’s recent contention on these pages that “what is driving our bond yields to record levels is . . . the bank bailout”, the Irish authorities having missed September’s opportunity to default on €55 billion of maturing guaranteed bank debt in order to resolve the banking crisis “by sharing costs with the bondholders”.
Those who have wondered aloud about the outcome of a laboratory experiment to assess the impact of an orchestrated default in the Irish financial system now have their answer. Those who advocate bond defaults, but then seek alternative explanations for rising bond yields, betray breathtaking ignorance of bond market dynamics.
THE ARTICLEwas equally breathtaking for its thinly veiled attempt to conscript a "powerful political constituency" of 200,000 would-be defaultees to engage in a "Mortgage War", on the basis that "you too were mauled by the Celtic Tiger after being conned into taking out an unaffordable mortgage".
It is apparent that the author believes strongly in his own powers of persuasion, those expectations for “mass mortgage defaults” guiding his apocalyptic forecast of additional €42 billion taxpayer losses at Bank of Ireland and AIB. His expectation for AIB losses appears particularly heroic, covering the vast bulk of AIB’s €27 billion mortgage book.
Most breathtaking of all, however, is the hubris displayed in second-guessing the “stress-test” findings of the independent financial regulator regarding Irish bank balance sheets. One can only guess at the superior font of knowledge out of which the author sups, as his €42 billion loan loss forecasts are without substantiation, and therefore appear more designed to scarify the readership than to make a genuine attempt to inform.
To be sure, delinquency rates are rising in the Irish mortgage book, but levels remain relatively low (4.6 per cent of the total at last count) and the banks now have Matthew Elderfield’s blessing for “taking a responsible, reasonable approach of forbearance by allowing customers to reschedule”.
With the labour market finally stabilising, there are clear grounds for optimism that ultimate mortgage-related losses will fall within the realms of the regulator’s “stress-test” assumptions. On that basis, the surviving and recapitalised Irish banks will have been bestowed with a more than sufficient buffer for the residual loan impairment risks ahead.
If the “Mortgage War” article serves any purpose, it is to highlight yet again the destructive forces wreaked by the politics of anger in this country. The author may protest his innocence in this regard, as will his legion of acolytes, but the upshot of such diatribes is to provide further cheap fodder to the Financial Times headliners and internet bloggers who are apt to display a schadenfreudian delight at Ireland’s current misfortunes. Widespread media recycling of such material at a time of heightened overseas investor anxiety towards the Irish story simply reinforces the pervasive bearish sentiment, and liquidation, that is now playing out in our markets.
TRUE TO ITSnihilistic endeavour, the "Mortgage War" article offers no solution of the author's own to the nation's current predicaments. For the author, Ireland's economic and fiscal sovereignty is beyond repair, such that henceforth "we can only rely on the kindness of strangers". Thankfully, the economic prognosis begs to differ, with Ireland's "twin-deficit" vulnerabilities fast receding as the external sector rebalances.
The corollary is that Ireland is moving increasingly towards “self-help” status, whereby the ongoing borrowing requirements of the public sector can, in principle, be absorbed by the accumulated surpluses of the private sector. Of course, practice can differ from principle in this regard; hence the need for more enlightened self-interest in the ways in which we disburse the investments of the pension fund and insurance industries, the National Pensions Reserve Fund, and indeed the domestic banks themselves.
In delivering his supportive Rehn-check on the Irish situation this week, the EU economic and monetary affairs commissioner proffered the old Finnish proverb that “better not paint the devil to the wall unless you can wash it off from there”, meaning that exaggerating one’s problems can exacerbate those problems.
In this respect, it is the kindness of one particular EU stranger that is now exhorting us to eschew the “self-destruct” path for a “self-help” alternative.
Citizens, politicians, academics and media, please note.
Donal O’Mahony is global strategist with Davy, a Dublin-based stockbroking, wealth management and financial advisory service. The company is also a primary dealer in Irish government bonds