Anglo “promissory notes” dilemma enters critical phase

Wednesday 09 May 2012 14.57

By Tony Connelly,  Europe Editor

Across Europe, news organisations will be preparing to cover the Irish referendum on the fiscal stability treaty.

It’s never been an easy topic for the uninitiated: in the past correspondents have had to grapple with complex and emotive campaign issues like whether or not the Lisbon Treaty (or the Nice Treaty for that matter) would force conscription on young Irish males, take away Ireland’s right to prohibit abortion, or force us to increase our corporate tax rates.

This time round the international media will be scratching their heads over Promissory Notes, and what part they might play in the referendum campaign.

This could be a crucial week for those offending IOUs since the governor of the Irish Central Bank Patrick Honohan looks likely to raise the issue at the Governing Council meeting of the ECB in Frankfurt. At stake is whether or not the ECB will agree to some kind of restructuring for the notes.

Until now the government has sought to keep the issue separate from the referendum, not withstanding Social Welfare Minister Joan Burton’s intervention, but recent reports suggest that moves are afoot to do something about the Promissory Notes, whether or not there is an intrinsic link with the vote on the Fiscal Compact.

The reality is that the decision falls upon the ECB Governing Council, and there are a limited number of options for the Council to decide if a deal is to be done before the referendum if, as expected, it takes place in late May or early June.

What exactly are Promissory Notes?

Between 2009 and 2010 when Anglo Irish Bank began to collapse, it needed money to pay off its depositors and creditors.  It got that money through a series of loans from the Irish Central Bank.  The loans came under the umbrella term “Emergency Liquidity Assistance” or ELAs.  By the end of June 2011 Anglo owed €38.4 billion in ELA.

In the meantime Irish Nationwide owed approximately €3.7 billion in ELA.

According to UCD economist Karl Whelan, who has made a presentation on the issue to the Oireachtas Committee on Finance, Public Expenditure and Reform ( ) by the time Anglo and Irish Nationwide were merged to form the Irish Bank Resolution Corporation (IBRC) on July 1, 2011, the combined ELA loans would have been about €42.2 billion.

How did the Irish Central Bank get the money to give to Anglo and Irish Nationwide?

According to Professor Whelan the money comes from nowhere.  It is conjured up out of thin air, because essentially this is what national central banks do:  they print money.

The ability to print money sounds like the fairy tale response to every financial crisis, but of course things don’t work like that.  The Irish Central Bank’s legal permit to print money in exceptional circumstances comes from the Irish Central Bank Act of 1942.  The Act allows the Central Bank to create money for an organisation in financial difficulty where to not do so could cause financial instability in the State.

Another reason why ELA was necessary in the Irish case was that the banks in question could no longer provide the kind of collateral demanded by the ECB in order to qualify for loans.

So, the discretion for national central banks, like the Irish one, to print money for a particular crisis, has a legal basis in national law because those central banks were around long before the creation of the single currency and the European Central Bank.

However, there are several legal restrictions which limit the scope for central banks in Paris, Dublin or Ljubljana to just print off money willy-nilly. This is because it’s not an Irish currency, it’s a shared European currency.

In fact, Article 4.14 of the ECB statute expressly forbids any activity which undermines the fundamental tasks of the ECB.  Under this rule anything which is outside the normal framework of ECB operations can be blocked by a two-thirds majority of the Governing Council if they deem it to be interfering in the smooth workings of the eurosystem.

In reality, the big fear is that largescale printing of money by one or more national central banks will stoke inflation, and the sacred mission of the ECB is to keep inflation at bay.

In effect, the Irish Central Bank printed €42.2 billion to pour into two insolvent banks.  And that is not what central banks are supposed to do.

That doesn’t mean that the Irish Central Bank issuing €42.2 billion in ELA to Irish Nationawide and Anglo Irish was done without Frankfurt knowing.  It is taken for granted that the ELA issued to those banks was done in close concert between the Department of Finance and the ECB Governing Council. This was done on the basis that the money would be paid back.

Who would it be paid back to?  Not the ECB, because the money was issued by the Irish Central Bank.  So the money is going back to the Dame Street.  A better way to think of it is that the repayment simply “neutralises” the original printing of the money and that this neutralising is what prevents a wider problem with inflation.

“The Central Bank does not acquire any new assets but simply reduces the size of its balance sheet, marking down both the value of its ELA asset and the value of its liabilities,” Professor Whelan points out in his working paper on the issue.

“The reality is that when the IBRC repays its ELA debts, that money is simply being taken out of circulation.  Effectively, it is as if it is being burned.”

It may be tempting to think that the Irish Central Bank could just write it off, but that would go against the ECB statute.  If every country in the eurozone printed off tens of billions of euro and put them into insolvent banks the result would be chaos.

The problem for the Irish government is that the repayment schedule to “clear” this debt is extremely onerous.  It’s not entirely clear who devised the schedule, but it means the government will have to “pay back” €3.1 billion per year until 2022 and after that pay €2.1 billion a year until 2024, €0.9 billion a year from 2025-2030 and a final payment of €0.1 billion in 2031.

The most realistic outcome for the government, argues Professor Whelan, is that the payments schedule is restructured.  It should be possible, he says, for the original Promissory Notes to be torn up and replaced with new ones which give the state a much longer time frame in paying the money back.

“If you can delay the payments as long as humanly possible there can be enormous benefits,” he told RTE News.  ”In the short term Ireland would have less to borrow, there’s also the time value of money:  in 20 years time €3.1 billion could be a much smaller amount of money.”

Not having to pay €3.1 billion a year for the next ten years would take enormous pressure of the exchequer and would help Ireland to emerge from its bailout programme to return to the open markets next year.

It would also bolster the narrative that Ireland has led by example: meeting its targets under the programme, increasing its competitiveness, lowering its borrowing costs.  That is why Ireland is regarded as the poster child of the eurozone’s response to the crisis.  But Ireland can only maintain that reputation if things proceed in a healthy direction.

While Ireland won plaudits for returning to growth last year the mood has changed. Our export markets are close to or in recession and that has lowered expectations that the good news will continue.

On many levels it appears a no-brainer for Ireland to be granted a more feasible repayments schedule for the Promissory Notes.  It would give the coalition a major boost going into a referendum campaign that “Europe” understands Irish concerns.

No-one is out of pocket since this money was generated by the Irish Central Bank and its repayment simply neutralises that original printing operation.

It also gives Ireland a substantial chance to return to the markets and prove that a country can receive a bailout then get back on its on feet.

These are all obvious political arguments.  The problem is that the Central Bank governor Patrick Honohan has to convince two-thirds of the Governing Council of their merits at a time when there are worrying divisions within the council over the direction of ECB policy under its new president Mario Draghi.

Already the German Bundesbank has criticised the ECB’s policy of   providing long term cheap loans to the banking sector and relaxing collateral requirements.  There is too a broader impatience among German politicians and the public over extending ever more favours to peripheral economies.

Even if the government can convince the Angela Merkels of this world that a restructuring makes perfect sense, the ECB is notoriously  - even agressively – proud of its independence from political interference.

It appears that the IMF and the European Commission support a deal for Ireland (referendum or no referendum).  The question is, will the ECB support it too?

9 Responses to Anglo “promissory notes” dilemma enters critical phase

  1. Ryan McGeough says:

    Very interesting article. Would like to hear more as the situation develops. Is there a worry that to allow Ireland to proceed with this action would encourage similar situations that could lead to a bigger problem?

  2. Trevor says:

    The promissory notes CAN be written off… Noonan has already burnt € 5 billion worth of bondholder junk last year. He has the opportunity to go further. He’s too busy capitulating to the illusion that we can continue when clearly we’re heading down the path of Greekification. The promissory note can be ring-fenced, thus separating it from sovereign debt and avoid being classed as a sovereign default.

  3. Informative but does not define what a “Promissory Note” is. The article should have started with a general definition of what a Promissory Note is and then an explanation of the IBRC issue.

  4. Superb piece Tony, well researched, unlike so many articles I’ve read on this subject, all the facts and figures well summarised.
    A few questions, however, fundamental questions that go to the heart of our ongoing protest here in Ballyhea; the €38.4 billion in ELA raised by Anglo, the €3.7 billion in ELA raised by Irish Nationwide – to whom did that money go? Did the Irish people see a cent of it? If not, how is this our debt? The ECB were the ones who demanded that these banks be ‘saved’, so their own bigger banks in Germany, France etc. would likewise be ‘saved’; surely then, in all justice, in all logic, the ECB should be the ones picking up the tab, and if they don’t want to do this directly, they should AT THE VERY LEAST allow us to print whatever extra money is needed to pay off all that bank bond debt.

  5. Gerry says:

    wher did you explain what a Promissory Note is? Did Anglo physically issue a piece of paper promissing to pay a schedule of payments to Bearer (CBI) If there is a piece of Paper then it is tradable. Can CBI sell it? Can it be broken down. Do CBI revalue this asset? Where would they get a price? Do Anglo revalue it? Why is it a Pro Note and not just a Loan? Lots to explain.

  6. John says:

    Nice article. explains what everyone is talking about in real detail but at the same time in lay-mans terms.

  7. Tim Gallagher says:

    Restructing the promissory notes is Not an acceptable answer – they must be written off by the government. Since a mini budget will soon be required, the time has come for the FG / LAB to stop breaking their mandate and deliver. There is little doubt among economists that Iceland chose the wiser path. Iceland, which had its investment-grade rating restored in February by Fitch Ratings, has stabilized net debt at 65% of gross domestic product and returned to financial markets. As for Ireland, we have another 4 years of austerity cuts impending. You would be silly to pay the household charge.

  8. stephen says:

    Iceland was not part of the Euro, it has more leeway. Icelands inflation was 18% and it had to freeze all foreign exchange transactions. Think what multinationals here would have been faced with and the job/investment decisions head office would have made.
    The CBI cash went to bank investors who presumed what the Banks were saying was true and that the regulators were doing their job. Investors presumed they would be paid back in full.

  9. Lukasz says:

    This is the example (see the link) that the only right way was/is the Icelandic way:

    Hopefully some media will cover this tomorrow.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>