Exchange on Promissory Notes with an AAA-Rated Correspondent

This weekend, I received an email from an economist from a Triple AAA-rated Euro zone country in response to the briefing paper that I provided to the Oireachtas Finance committee. This person wished to keep their correspondence confidential so I’m not going to repeat their email. However, I think it might be useful to outline the nature of the exchange I had with them and to provide my response in public. While I don’t think this issue comes down to technical considerations, the exchange does shed some light on some of the technical matters likely being discussed behind the scenes.

My correspondent put forward a number of arguments.

  1. That Article 18.1 of the statute governing the ECB and Eurosystem says that lending from national central banks must be based on “adequate collateral” and that this applies to all lending, including ELA. They argued that the Eurosystem’s principles of collateral and haircuts should be considered “sacred”.
  2. That this means that the yield to maturity on promissory notes must be the same as the yield on marketable Irish government bonds, so any restructuring of the notes to reduce payments now must result in even higher payments later and this cannot help reduce Ireland’s debt burden.
  3. That publicly appealing to change the structure of the promissory notes amounted to the Irish government lobbying the ECB Governing Council to change its collateral policy, which undermined the Council’s independence, an issue which its members feel very strongly about.

In summary, my correspondent argued that a restructuring of the note that reduced Ireland’s debt burden was impossible and the Irish government arguing for such a restructuring would simply generate bad will among our European partners. The correspondent concluded by noting that they had nothing against the idea of some kind of deal aimed at reducing Ireland’s debt burden and made a brief reference to senior bank debt.

Here’s my response:

Dear X

I understand your arguments but I think this issue needs to be discussed in light of other recent events in the Eurosystem in recent months.

You may consider the practices of collateral valuation and haircuts to be sacred but you know that there has been a considerable shift in collateral policies over the past few years.  It’s a complicated crisis and lots of things previously considered unthinkable have happened.

You’re right that the Treaty mentions “adequate collateral” but it does not specify the meaning of “adequate”.  As I explained in my paper, it is my opinion that the letters of comfort and facility deeds provided to the Central Bank make the promissory notes different assets (more safe) than normal sovereign bonds which do not come with such assurances, so I don’t necessarily agree that they need to be valued in line with current Irish private bond rates.

You probably disagree with that argument but ultimately this is a judgment call for the Governing Council to make.  And now, with the GC having authorised €1 trillion in long-term loans, much of it against previously ineligible collateral, raising the question of a reworking of the collateral on a mere €28 billion is hardly unreasonable.

Even if you are right that the notes need to be valued using the current private bond rate, there is still some gain from a payment structure that backloads the repayments.  This would reduce the cash flow burden at a very sensitive time with Ireland attempting to return to the market to finance deficits and repay debts.  In addition, delaying payments on the note to a time when underlying fiscal retrenchment is over will allow for a smoother path of fiscal adjustment. (To understand the extent of adjustment so far in Ireland, I recommend page 20 of this PDF file of a Commission report on Ireland

I’d note that in recommending delaying payment on the notes, I am not recommending that ELA repayments cease. The IBRC is selling assets and taking in reasonably large quantities of loan payments. It has sufficient assets to repay much of the ELA over the next few years even if there were no promissory note payments over that period.

In relation to independence, I know how the Governing Council works and have always made clear to people in Ireland that any changes to the notes would need to be discussed among Eurosystem staff and then brought to the Council to be considered. This is not a matter of politicians lobbying for the notes to be changed and I would note that the Irish government have been extraordinarily low key in their approach to this issue, hardly ever mentioning the Governing Council. The discussions which are taking place are at a bureaucratic non-political level, though I don’t believe they are making any progress towards getting the notes changed.

Anyway, thank you for taking the time to engage on this issue. I will do my best to be clearer about the issues relating to collateral quality and ECB independence in future. It’s also good to hear you are not against lightening the debt burden for Ireland, though I would note that there is very little IBRC senior debt left (less than €1 billion) and it’s not really possible to consider restructuring the debt of the other banks which have now been recapitalised. So I think a reworking of the notes would be beneficial.

Regards and thanks,