Monthly Archives: January 2016

The Irish Central Bank is destroying our cash!

Arghhh!

Arghhh!

At least that’s what Diarmuid O’Flynn of Ballyhea says No would have you believe.

O’Flynn is various things. He’s a former staff sports writer at the Irish Examiner, which apparently qualifies him to advise Luke Flanagan MEP on “on economic and environmental affairs” (Flanagan appointed him as his Parliamentary Assistant in the European Parliament in 2014). He was also a candidate in the European Parliament elections in Munster in 2014, picking up a credible 30,000 odd votes. All of this came about from his involvement with Ballyhea says No, a group of people in Cork who go out every week and march in protest at the State’s handling of the banking crisis between 2008 and 2010.

O’Flynn regularly writes to the national and local media outlining his version of the arrangements to deal with the insolvency in the banking system. The narrative of these letters is generally the same, namely, the European Central Bank forces the State to borrow money, which the taxpayer must pay back, to give to the Irish Central Bank, which the Irish Central Bank then “destroys”. He obviously concludes that this is a terrible injustice and that the practice should stop forthwith.

Given the complexities of the banking crisis, which were spun out by the media as a vast conspiracy in which a cabal of politicians and bankers attempted to usurp the State, O’Flynn’s thesis is easily digested. What could be more evocative in the aftermath of a banker induced crisis that the biggest bank of them all is forcing the poor Irish to burn their own money? Its a story that writes itself and never stops giving (which is very handy to have when you’re asking people to vote for you).

Of course, like most theories offered by the likes of O’Flynn, Flanagan and the various other journeymen who emerged on to the political stage after 2008 (who were strangely absent in their criticisms when the good times were rolling), its a load of nonsense.

Let’s try and peg it down.

In 2010, the Irish Government was faced with the following situation. The 4 domestic banks – AIB, Bank of Ireland, Anglo Irish Bank and Irish Nationwide – were bankrupt, and living off emergency day to day funding from the European Central Bank. They were bankrupt because loans they had made were not being repaid and were never going to be repaid. If any one of them failed (ie if unpaid bondholders sought their liquidation), confidence in the system would be lost and the entire system would collapse, vapourising billions of euro in deposits held by ordinary citizens and small businesses.

Some of the banks were more bankrupt than others. AIB and Bank or Ireland were the better of the 4, and could be stabilised by transfers from the State’s current budget and the National Pension Reserve Fund. The other 2, Anglo and Irish Nationwide, were banjaxed, and needed far more money, about €30bn give or take, to keep them above water.

This kind of funding was not available to the State. The National Pension Reserve Fund was empty, and the interest rates being demanded on Irish Government debt were so high that it was impossible to borrow money from the bond markets.

In a country that doesn’t share its currency with others (like Iceland), this wouldn’t have been a problem. The State could have issued more currency (“printed money”) and used that to re-stock the banks. Ireland didn’t enjoy that luxury. We use the Euro, and only the European Central Bank can increase the supply of Euro, which it is legally forbidden to do for the purposes of financing deficits (eg bailing out banks) in member states.

At the same time, the European Central Bank had a problem. If the Irish banking system went bust, it could tear down the entire Euro system. A solution therefore had to be found, which became what we now know as the Promissory Note.

The Promissory Note  basically allowed the Irish State to pretend it had €30bn spare, when in fact everyone knew that that €30bn would have to be borrowed at some time in the future when the Irish State could again borrow money on the bond markets.

The Promissory Note was what it said on the tin: a note promising to pay the holder €30bn at some time in the future. The State gave this note to Anglo Irish Bank, who then went to the Irish Central Bank and borrowed a real €30bn using the Promissory Note as security. The Irish Central Bank got this money from the European Central Bank, who used a mechanism called Emergency Liquidity Assistance to increase the supply of Euro available to the system. Anglo paid off its creditors, so that they didn’t try to liquidate the bank, and the system survived.

All of this was a roundabout way of doing what the European Central Bank was legally prohibited from doing, namely giving the Irish state money to sort out its budgetary problems (the €30bn shortfall required to sort out Anglo and Irish Nationwide), so the European Central Bank secured a firm commitment from the State that the €30bn that had been magic’ed up out of nowhere would disappear again as quickly as possible, so that the European Central Bank was not seen to be breaking its own rules.

The agreement made was therefore that when the State paid the €30bn it had promised to pay the holder of the Promissory Note, the holder of the note (the Irish Central Bank) would not add those funds to their balance sheet as real money. In that way, the original “pretend” €30bn would disappear out of the system and not be used by the State to pay for real things like schools and hospitals.

This is why when the State transfers Promissory Note payments (via the National Treasury Management Agency, who raise money on the bond markets on the State’s behalf) to the Irish Central Bank, the Irish Central Bank does not pass those through to their balance sheet, which effectively deletes the money from the system. This is the process that O’Flynn and others refer to as “destroying our money”.

Of course, it all amounts to the same thing. We, the taxpayer, bailed out the banks.

Whether or not this was the right thing to do will be a question for historians. What we do know is that while the bailout was expensive, our banking system survived and our economy recovered. Whether this would have happened in the event of the banks being liquidated remains unknown.

The Ballyhea Says No campaign believes that the State should stop paying the annual Promissory Note payments to the Irish Central Bank.

This is an option for the State, but in involves enormous risks, which are never referred to by Diarmuid O’Flynn in his various correspondence.

(Update: See note at the end of the article.)

Principally, it would destroy the trust that exists between the Irish banking system and the ECB, would would leave the Irish banking system without a lender of last resort to finance its day to day operations.

It would also undermine the State’s credibility as a sovereign debtor, making it harder and more expensive for the State to borrow money to finance both current and capital spending.

Both of these outcomes would evitably push the State in the direction of Greece, and the inevitability of a euro exit.

Obviously, many people view that option favourably, but it is still an option that no one seems to be willing to be first to try.

Note: In 2013, the Promissory Notes held by the Irish Central Bank were replaced by long-term Government Bonds. The idea behind this move was that the repayment period could be extended and the bonds sold when market conditions were favourable, accruing a capital gain profit for the Irish Central Bank that would ultimately revert to the State. The same arrangement in relation to the deletion of the face value of the bonds still applies, however.