Promissory Notes: No Magic Required

Here‘s an interesting article on promissory notes by Dan O’Brien of the Irish Times. Dan defends the ECB’s approach to this issue:

The ECB has been subject to criticism in this country for not letting Ireland off this portion of its debts. Difficult and all as it is for a taxpaying citizen of this State to concede, Frankfurt is entirely correct to refuse to magic away Ireland’s promissory notes.

Dan’s key argument is as follows

If the ECB was to delete some of Ireland’s debts at the click of a button, as some people advocate, it would not be long before other governments started issuing promissory notes and looking to Frankfurt for some monetising magic. Having the ECB make an exception for Ireland may seem appealing, but it could never be justified by a central bank serious about preserving the currency.

Thus, Dan sees the lightening of any debt burden as needing to be done via fiscal transfers of some sort

The monetary authority in Frankfurt has always insisted that any relief on Ireland’s bank debt is done by the fiscal authorities – i.e. other euro area governments collectively.

The moral case for doing this is very strong. In terms of the collective interest of the euro zone, the case is almost as strong – ensuring Ireland exits its bailout will benefit everyone. Easing the repayment terms on the promissory notes will help to achieve that.

In the event that an easing is not granted, criticism should be directed at those who deserve it. That would be other euro area countries, not the ECB.

The article is well argued but I don’t think the conclusions it arrives at are necessarily correct.

The point about magicking away the promissory notes is a straw man and it’s easy to win arguments with straw men. But it is a logical leap to go from accepting the notes won’t be magicked away to arguing that a restructuring of the notes within the current ELA arrangement is somehow impossible.

One can wave away arguments about a special deal as simply Irish exceptionalism that would set a precedent for everyone else to get such a deal. However, that misses the key fact that the IBRC promissory notes are an exceptional deal. Nowhere else in Europe has a country taken on debts of 20 percent of GDP to bail out an insolvent bank. Indeed, bank resolution proposal documents such as this one from the European Commission are partly premised on the idea that what happened in Ireland with Anglo is unacceptable and should not be repeated.

So the reality is that the promissory note\ELA deal involving IBRC is an exceptional one and one that the ECB Governing Council has agreed to. The ECB has taken a number of bold steps in recent months including radical changes to its collateral framework. Against this background, it should not be considered unimaginable that the collateral for IBRC’s ELA could have its payment structured altered.

The slippery slope on this issue is also a bit overplayed. The ECB’s mandate allows it to pursue a wide range of policies in support of the goals of the EU provided they do not “prejudice” its goal of price stability. Reworking the collateral on €28 billion of Eurosystem loans at a time when the system has just printed off €1 trillion hardly smacks of a systemic threat to price stability. But if other larger countries wished to print of large amounts of ELA in support of their banking systems, then clearly any decision on such proposals would have to keep price stability in mind.

I’m not saying that a final resolution of the promissory note issue won’t involve, for example, the government taking on a long-term loan from EFSF to allow the ELA loans to be repaid and the promissory notes retired. But it is not necessarily the only change from the current situation that would represent an improvement.