Tuesday, March 22, 2011

One domestic consequence of default

With talk of “unsustainable debt” and “inevitability of default” growing ever louder I think the following graph from a previous post is important.  While much of the noise has focussed on the liability side of our ailing banks this looks at some of the assets they hold, and in particular assets issued by Irish residents. 

Irish Securities held by Covered Banks

Irish exposure to Irish debt is getting ever larger.  The full implications of a banking- and/or sovereign-debt default need to be examined and this is something that those who are shouting loudest tend to ignore.  Here is the blurb that went with the graph.  This is a point that should not be lost.

The covered banks are holding more and more debt securities issued by Irish residents.  These have increased from €11 billion in January 2008 to €84 billion in January 2011.

Everything is going up.  The increase in “private sector” bonds here are mainly those issued by NAMA in return for the transfer of developer loans from the banks.  Bonds by “monetary financial institutions” are bonds issued by the covered banks themselves.  The almost vertical rise seen in January 2011 is because the banks issued €17 billion of bonds to themselves to use as collateral with the ECB.  As we saw previously, the remainder of this category is €15 billion of bonds the covered banks hold in each other.  Burning these bondholders will just mean more promissory notes will have to be issued.

I cannot really explain the rise in the holdings of “general government” bonds by the covered banks.  It seems unusual that at a time when the State was pumping billion to prop up the banks, these very same banks were using €11 billion to buy bonds issued by the State.  It appears they now hold about one-eighth of Irish government bonds in issue.  Guess who will be hit if there is a sovereign default??

Some insight into the banks’ buying of Irish government bonds is given in this May 2009 article from the Sunday Business Post.


  1. Seamus

    How can the banks issue bonds to themselves to use as ECB collateral? Genuine question.

    Does it mean that the remains of my humble mortgage is now in the hands of Mr Bini Smaghi or some such?

    In the event of a default by the bank does the holder of the collateral (mortgage) have any right superceding that of the mortgage deed. In other words could the ECB or some third party tell me "Hey Patrick, pay up the full mortgage balance right now or pack your bags".

  2. Hi Tumbrel,

    I don't think these self-held bonds are a huge issue.

    It is like moving money from your wallet to your pocket and then writing an IOU from your pocket to your wallet. You still have the same amount of money and the IOU is largely meaningless as you if you pay it off there is again no change.

    The addition in the case of the banks is the ELG which guarantees these self-held bonds. It was for this reason that the ECB was willing to take them as collateral. At least we thought that was going to happen.

    When these bonds were issued in January it was thought the banks would use them to reduce their reliance on the Central Bank's ELA and allow them to access the cheaper money from the ECB. When the Central Bank's February balance sheet was released a week or two ago we saw the level of ELA rise from €50 billion to €70 billion (instead of falling to about €33 billion!). It is only when we get the covered bank's balance sheets next week that we will see what happened to the level of borrowings from the ECB in February.

    I don't think it has an impact on mortgages, though these may be affected by previously issued secured bonds but it will never be to change the terms. A creditor will have signed up for the collateral as is.

    In the event of a default these bonds simply evaporate from the banks' balance sheets as they appear on both the liability and asset sides. The net effect to the banks would be zero. If that were to occur and the ECB had them as collateral then the ECB would ask for replacement collateral and get it hopefully. Failing that the ECB would ask the State to honour the guarantee on these bonds. This is like getting someone else to pay back the money your pocket owes to your wallet.

    The big problem with the ECB money is that we can't pay it off quick enough. It can be largely paid off but because it is going to fund mortgages and other loans the money will be a very long time coming in. The Irish banks funding was very short term and precarious, and all this creative accouonting is the consequence of it. The chances of our bank's getting any reasonable funding on interbank markets are close to nil.

  3. http://www.irishlifepermanent.ie/~/media/Files/I/Irish-Life-And-Permanent/Attachments/pdf/2010/annualreport2010.pdf

    H/T Lorcan Roche-Kelly...

    Goodness, haven't they been calling in their debts...