Euro crisis: “Expect some late nights.”

More encouraging noises for the incoming Taoiseach from the European Union’s economic and monetary affairs commissioner, Olli Rehn.  As the Irish Times reports

“I can see that there is a case to reduce the interest rates paid by Greece and Ireland,” the commissioner said.

“In that context, it is important that we also look at loan maturities so that we can go beyond the hump of 2014 and 2015 and that also contributes to debt sustainability . . . The essential thing is to ensure debt sustainability of Greece and Ireland. We have to avoid the moral hazard at any cost. That is done through the rigorous conditionality of the EU-IMF programmes, rather than high level of interest rates.”

Howver, there is a political problem – in Germany. as the Irish Times‘ Arthur Beesley points out

The narrative from Berlin still suggests the chancellor may be struck down at any moment for helping to underwrite indigent Greeks, other lazy southerners and the ungrateful, incompetent Irish. The benefit the rebounding German economy draws from the single currency is mentioned less often.

Yet there is more to the German debate. When Kenny went to Helsinki on Friday for talks with Merkel and other centre-right figures, incoming tánaiste Eamon Gilmore travelled to Athens to meet socialist leaders. The chieftains of the left endorsed an economic plan which included eurobonds, an idea that finds favour with German social democrat leader Frank-Walter Steinmeier.

True, the centre-right is by far the most powerful force in European politics. But it cannot be beyond the bounds of possibility that the tidal wave of European austerity will result in leftward swing in the next election round. Would the response to the crisis be any different in that case? Would it not be better to examine now what the German leader finds unthinkable? Of course it would. Yet when Eurogroup president Jean-Claude Juncker called for debate on eurobonds in December he was all but exiled to purdah. This hardly smacked of tolerance for open democratic debate.

Add into all that an entrenched unwillingness to confront the deepest problems posed by the debacle and the tension is palpable.

Following Merkel’s lead, other heads of state and government want debt restructuring after 2013 but not before then. No one answers why.

Ask a top-ranking European official, someone with serious political responsibility, and the point is simply made that it is a good question.

The big concern right now is that something billed as a decisive Big Bang turns into a flimsy thing which again undermines confidence at a dangerous moment. It has happened here before. In this scene the argument is often made that nothing is agreed until everything is agreed. The problem is that nothing is agreed.

The BBC’s Europe editor, Gavin Hewitt, appears to think the threat of default can carry the argument

The Irish prime minister (Taoiseach) carries a grenade in his pocket. It is marked “default”. The Irish bank governor says that Ireland defaulting on its loans was not an option that was “attractive to any part of Irish society”. That may be true. But the EU fears an Irish default. It believes it would destabilise the entire currency zone. It would demonstrate that the current medicine of austerity and deficit-cutting has not worked.

But Ireland with a robust real economy might decide that the pain of a default would be relatively short-term and preferable to a bail-out that imposes austerity for a generation.

Danny McCoy of the Irish Business and Employers’ Confederation was in Brussels this week and made an impressive case that the real Irish economy – away from the banking system – was surging. Exports are booming. The Irish balance of payments is in surplus. Unit labour costs have improved dramatically. Companies are expanding, although that has not led to a sharp pick-up in employment. Ireland remains an attractive country to invest in. It has flexible labour practices, it is business-friendly, with a well-educated workforce.

The question is whether those early green shoots will be allowed to grow or whether they’ll be strangled by the terms of the bail-out and the debt that remains in the banking system.

So Mr Kenny should not hope for his few minutes with Chancellor Merkel. He can demand time. He can play the Irish rebel. He holds the cards. During the election he said the bail-out was “bad for Ireland, bad for Europe”. During the Irish campaign he presented himself as a fighter for Irish independence. His moment has come.

But, also in the Irish Times, Donal Donovan suggests a compromise solution.

Financing from the ECB (around €100 billion) is provided to banks against collateral (“ECB-eligible assets”), usually involving a substantial haircut. That is, if a bank holds collateral it believes to be of a certain value, the ECB may extend a loan of, say, 70 per cent of that amount, to protect itself against a fall in the asset’s value.

Central Bank funding (about €50 billion) in the form of emergency lending assistance, is typically provided to banks who have exhausted their stock of ECB-eligible assets. It requires prior approval by the ECB and has virtually all been used to repay government guaranteed debt. The collateral includes non-eligible ECB assets, as well as an Irish government guarantee.

The ECB is engaged in discussions as to how and when its outstanding lending to Irish banks can be reduced via the disposal of bank assets. One cannot say at this stage if the outcome will end up being sufficient to cover all the debt owed to the ECB. In the case of the government debt to the Central Bank, the bank could call in the government guarantee provided in respect of emergency lending.

All the institutions involved – the Central Bank, the ECB and the Government – are intertwined. If issues were to arise in respect of the settlement of either Central Bank or ECB lending, the focus of the discussions might shift towards Europe. If other countries were to experience similar difficulties, there could be talk of the need for some kind of a pan-European “public sector solution”, possibly involving taxpayer support.

It may well be that for the reasons outlined earlier, a “burning of the bondholders” option is not in the end pursued by Ireland. However, it cannot be excluded that, via the more circuitous route described above, European taxpayers will have to pay some part of the bill for the Irish bank guarantee.

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