Thursday, July 21, 2011

Ireland Gets Lower Rates on Bailout in EU Deal on Greece, But Default Still Possible?

The Irish newsmedia is reporting that Ireland will benefit from the new bailout agreement being hammered out at the EU summit. These reports seem to have more finality than is discernible from the leaked draft of the announcement. I looked at the draft and here are some key provisions with my comments in blue:

We reaffirm our commitment to the euro and to do whatever is needed to ensure the financial stability of the euro area as a whole. We also reaffirm our determination to reinforce convergence, competitiveness and governance of the Euro area.
Nothing new here as a matter of policy, they've repeatedly stated a commitment to the euro. The real consequences will depend on follow up action in new legal instruments.

We have decided to lengthen the maturity of the EFSF loans to Greece to the maximum extent possible from the current 7.5 years to a minimum of 15 years. In this context, we will ensure adequate post programme monitoring. We will provide EFSF loans at lending rates equivalent to those of the Balance of Payment facility (currently approx. 3.5%) without going below the EFSF funding cost. This will be accompanied by a mechanism which ensures appropriate incentives to implement the programme, including through collateral arrangements where appropriate.
Structural funds should be re-allocated for competitiveness and growth under a European "Marshall Plan".
Greece is in a uniquely grave situation in the Euro area. This is the reason why it requires an exceptional solution. The financial sector has indicated its willingness to support Greece on a voluntary basis through a menu of options ...
EU leaders know that absent a bold plan, the contagion risk is very real. That might explain the Marshall Plan language. It is plainly a ploy to set up an exceptional situation to justify the extraordinary measures and to separate Greece from other countries like Ireland and Portugal. In the end it might be all talk and the markets may not be persuaded that Greece is all that different.

All other Euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms. The Euro area Heads of Statesor Government fully support this determination as the credibility of all their sovereign signatures is a decisive element for ensuring financial stability in the Euro area as a whole.
This is once again a ploy to allay contagion fears and to reassure markets that Ireland and Portugal will not default. Does a statement of this sort really mean that Ireland will not default? Or that the markets will discount the likelihood of that happening? Given recent experience, it will take a lot more than words and a selective default by Greece might well signal a likelihood of Ireland doing something similar notwithstanding this "inflexible determination" to honour its commitments. Words alone from a sovereign are worth very little, especially given the track record in this area.

We welcome the progress made on the implementation of the programmes in Ireland and Portugal and reiterate our strong commitment to the success of these programmes. The EFSF lending conditions we agreed upon for Greece will be applied also for Portugal and Ireland. In this context, we note Ireland's willingness to participate constructively in the discussions on the Consolidated Common Tax Base draft directive (CCTB) and in the structured discussions on tax policy issues in the framework of the Euro+ pact framework.

The troika's recent review said as much about Ireland, but the markets did not pay a lot of positive attention. And there is the recent downgrade to junk status suggesting that Ireland is not being rewarded for its belt-tightening. The CCTB language was probably to appease Sarkozy and signals that Ireland is continuing to receive pressure in this area despite its best efforts at resisting tax harmonization.

All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest. In this context, we welcome the budgetary package recently presented by the Italian government which will enable it to bring the deficit below 3% in 2012 and to achieve balance budget in 2014.

These commitments are not new. The EU has looked away in the past when states including Ireland ran up deficits several times the permissible limit. What is needed is enforcement, and binding legal commitments that entail monitoring. One can expect the Germans to be more aggressive than they have been in the past as these mechanisms are fleshed out.

We look forward to the rapid finalization of the legislative package on the strengthening of the stability and growth pact and the new macro economic surveillance. Euro area members will do their utmost to help reaching agreement with the EP

We commit to introduce legally binding national fiscal frameworks as foreseen in the fiscal frameworks directive by the end of 2012.
As I wrote previously in the Wall Street Journal, the original Greek bailout is illegal. This summit statement is an acknowledgement of that reality. One hopes that the EU comes up with a legal framework that allows for transparent mechanisms to address such situations as they arise.

We agree that reliance on external credits ratings in the EU regulatory framework should be reduced, and look forward to the Commission proposals in this respect.

This is pure hogwash. The EU is living in la-la land if it thinks it can ignore market credit ratings and bully ratings agencies into hiding the truth. While the ratings system has many faults, these agencies have been willing to tell uncomfortable truths on sovereign credit. That might not please the politicians but it has kept them from selling us whoppers.

The full draft announcement is available here. My article calling for a hybrid conservatorship for Greece is available at Huffo here.