## _eur1501 ## Source details **Canonical URL:** [_eur1501](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/dp/2015/_eur1501.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/dp/2015/_eur1501.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/dp/2015/_eur1501.pdf.json) --- ### Stabilizing and Healing the Banks - Crisis chronology and objectives: - Property bubble burst coincided with global financial crisis, causing severe recession in 2008–10 and rapid rise in public debt. - Program supported by €67.5 billion of financial assistance from the European Union (EU) and IMF in late 2010 aimed to: - restore viability of the banking system; - put public finances on a sustainable path and return to market funding; - restart economic recovery and improve growth potential. - Recapitalization and resolution sequencing: - Recapitalization occurred over multiple rounds; comprehensive bottom-up assessment earlier would have been preferable. - NAMA transferred large property loans in excess of €20 million, disposing based on market conditions; extending NAMA to smaller commercial property loans was seen as potentially useful. - Total gross capital needs and injections (six covered banks): Total: 79.8 (100%); government provided €64 billion and €15.5 billion from exchanges on subordinated debt and some private equity. - March 2010 PCAR amounted to €32 billion; PCAR 2011 led to an additional capital injection of €24 billion; troika staff penciled government cash injections as high as the €35 billion; ultimate requirement came out at about a half of the €35 billion. - Liquidity-solvency dynamics and central bank support: - Central bank funding approached almost 100 percent of Irish GDP during peak liquidity stress. - Outcomes: loan-to-deposit ratio down to 110 percent; banking sector much reduced in size; all banks passed the ECB asset quality review. - NAMA and legacy assets: - Transfers to end-2011 by covered banks: Nominal loan value Total: 74.2; Transfer value Total: 31.8; Realized loss by banks Total: 42.4; Overall discount: 57%. - Almost 60 percent of bad assets were taken over from Anglo and INBS (IBRC). - Remaining banking challenges: - Nonperforming loans (NPLs) up to 25 percent on bank balance sheets. - Property loans remaining on bank balance sheets: CRE loans and mortgages almost €160 billion at end-2013; about €74 billion of large CRE loans transferred to NAMA by end-2011; about two-thirds of property loans stayed on banks’ balance sheets. - With impairment rates: Mortgages impairment rate: 18 percent; CRE impairment rate: 57 percent; more than €40 billion of impaired property loans remain in the banks. - Policy recommendations for banking sector: - Recapitalization going forward should be conditional on banks writing down nonperforming loans. - Intensify write-offs of bad loans and set explicit policy targets for writing off bad loans when taxpayers fund bank recapitalizations. - Ensure capital shortfalls are assessed comprehensively and bottom-up, aided by external consultants. - Strengthen macroprudential decision-making and consider inclusion of external members on financial stability committees. - In the Banking Union, recommend ESM direct recapitalization after resolution measures to cut the bank-sovereign loop. ### Banking Assets, Cross-Border Credit, and Financial Cycle - Asset growth and composition (Table figures preserved): - Total assets (In € billion): 2002: 600; 2003: 708; 2004: 873; 2005: 1,128; 2006: 1,412; 2007: 1,607; 2008: 1,672; 2009: 1,577; 2010: 1,462; 2011: 1,264; 2012: 1,124; 2013: 972. - Domestic assets (In € billion): 2002: 366; 2003: 444; 2004: 544; 2005: 719; 2006: 890; 2007: 819; 2008: 872; 2009: 904; 2010: 930; 2011: 743; 2012: 676; 2013: 590. - From EU (In € billion): 2002: 175; 2003: 202; 2004: 263; 2005: 330; 2006: 388; 2007: 625; 2008: 670; 2009: 570; 2010: 436; 2011: 389; 2012: 328; 2013: 279. - From third countries (In € billion): 2002: 60; 2003: 62; 2004: 66; 2005: 80; 2006: 134; 2007: 163; 2008: 130; 2009: 103; 2010: 96; 2011: 132; 2012: 119; 2013: 103. - Shares (percent of total assets) — Domestic: 2002: 61%; 2003: 63%; 2004: 62%; 2005: 64%; 2006: 63%; 2007: 51%; 2008: 52%; 2009: 57%; 2010: 64%; 2011: 59%; 2012: 60%; 2013: 61%. From EU: 2002: 29%; 2003: 29%; 2004: 30%; 2005: 29%; 2006: 27%; 2007: 39%; 2008: 40%; 2009: 36%; 2010: 30%; 2011: 31%; 2012: 29%; 2013: 29%. From third: 2002: 10%; 2003: 9%; 2004: 8%; 2005: 7%; 2006: 9%; 2007: 10%; 2008: 8%; 2009: 7%; 2010: 7%; 2011: 10%; 2012: 11%; 2013: 11%. - Financial-cycle mechanisms and procyclicality: - Minsky stages listed: 1. credit expansion, characterized by rising assets prices; 2. euphoria, characterized by overtrading; 3. distress, characterized by unexpected failures; 4. discredit, characterized by liquidation; 5. panic, characterized by the desire for cash. - Cross-border credit played a larger role in Ireland than in other euro-area countries; foreign credit (from EU and third countries) was 50 percent of overall credit in Ireland at the height of the financial crisis. - Residential property prices almost doubled from 2002 to 2008; total banking assets almost tripled from 2002 to 2008. ### Restructuring, NPLs, and Household/SME Debt - Outstanding loans and impairments (end-2013, Table 4 figures preserved; In € billion unless noted): - Mortgages outstanding (Total): 121.3; Impairment rate (mortgages): 17.7%; Impaired mortgages (value): 21.5. - CRE impairment rate: 56.9%; Impaired CRE (value): 20.8. - SME impairment rate: 25.1%; Impaired SME loans (value): 6.9. - Corporate impairment rate: 25.1%; Impaired corporate loans (value): 3.0. - Consumer impairment rate: 6.1%; Impaired consumer loans (value): 0.4. - Total outstanding loans: 204.6; Overall impairment rate: 25.7%; Total impaired loans (value): 52.6. - Mortgages in arrears and household debt: - Mortgages are 59 percent of outstanding loans. - Mortgages in arrears (end-September 2014): Principle dwelling houses (PDH): 20 percent of outstanding mortgage balances (all arrears); Buy to let (BTL): 36 percent of outstanding mortgage balances (all arrears). - NPLs (90 days or more): PDH: 16.5 percent; BTL: 30.5 percent; Weighted average NPL for mortgages: 19.5 percent. - Duration: proportion of arrears over two years is well above 20 percent (number basis); about 75 percent of arrears in value terms are over two years past due. - Household debt remains high at 190 percent of disposable income. - Number of private households: 1,650,000; outstanding PDH mortgages: about 760,000; Mortgages in arrears: 118,000; Up to 7.2 percent of Irish households have a mortgage in arrears. - SME debt and arrears: - SME debt-to-turnover distribution (percent): Total — Zero debt 33.8; 0 to 1/3 49.9; 1/3 to 1 9.3; >1 7.0. - Combining Table 4 (25 percent of loans impaired) and Table 5 (66 percent of SMEs have a loan) indicates 16.5 percent of SMEs have arrears on their loans. - Conservative interpretation: up to 20 percent of SMEs and 10 percent of households suppress new investment and consumption due to arrears or debt overhang. - Bank provisions and write-offs: - Provisions for NPLs: 53 percent in June 2014 (Central Bank of Ireland). - Write-offs as a percentage of provisions: 5.2 percent in June 2014. - Forbearance issues: banks optimistic about recoverability limited write-offs and more liberal restructurings. ### Fiscal Consolidation: Speed, Effects on Growth, and Policy Implications - Consolidation chronology and magnitude: - Ireland undertook a large consolidation over the past five to six years (text phrasing preserved), with adjustments in 2008–10 between 6 and 10 percent of GDP and a second consolidation during 2011–14 of similar magnitude. - IMF estimates for the two consolidation plans: about 14–15 percent of GDP; Irish government and Fiscal Policy Council estimate total fiscal effort over the two periods close to 20 percent. - Ireland took seven years to bring the deficit to below 3 percent of GDP in 2015. - Empirical findings on multipliers and hysteresis: - Blanchard and Leigh cross-country methodology produced multiplier results supporting the hypothesis that fiscal consolidation impacted potential GDP and suggested consolidation in Europe had been self-defeating during recent years. - Regression results (Fatás and Summers approach) reproduced: coefficient on Fiscal Consolidation for GDP growth forecast error: –1.170** (standard error (0.437)); for potential forecast error: –1.365** (standard error (0.524)); Observations: 1514; R-squared: 0.550 (GDP), 0.422 (potential). Significance notes preserved: *** p<0.01, ** p<0.05, * p<0.1. - Interpretation preserved: a fiscal consolidation of 1 percent of GDP resulted in a decrease in potential output of 1.365 percent (long-term multiplier interpretation). - The coefficient of –1.17 implies the actual multiplier is about 1.7 (Blanchard and Leigh interpretation). The implied hysteresis parameter η around 0.8 is much larger than values typically below 0.2 used in some self-defeating consolidation scenarios. - Composition matters: - Irish consolidation leaned heavily on expenditure cuts and cutting back public investment had a severe impact per multiplier analysis; a more growth-friendly composition of adjustment recommended. - Debt mechanics and scenarios: - Steady-state primary balance formula: Primary balance (as percent of GDP) = (r - g) / (1 + g) * d* (notation preserved). - OECD example projections for Ireland: effective nominal interest rates = 4.7 percent and nominal growth rate = 4.3 percent; required primary balance to keep debt at current levels (around 110 percent) is very close to zero under that scenario. - Projected debt paths under maintained primary surpluses: - If Ireland maintains 3 percent primary surplus going forward: debt-to-GDP ratio ≈ 68 percent by 2030 and ≈ 11 percent by 2050. - If Ireland maintains 2 percent primary surplus going forward: debt-to-GDP ratio ≈ 85 percent by 2030 and ≈ 50 percent by 2050. - Policy implications and political economy: - Program success elements: clear National Recovery Plan, phased measures, "under-promise and overachieve" strategy, flexibility and collaborative troika discussions. - Program design should focus on ultimate objectives and allow flexibility; include social indicators and consider grants for social purposes. - Political sustainability is difficult; prolonged dissatisfaction risks political instability and rise of extreme parties. - Recommendation to explore the relationship between fiscal policy and potential GDP more fully and to strive for countercyclical policies where feasible. - Conclusion on speed: - The speed of adjustment, as measured by announced actions, was judged to be clearly too fast in the euro-area context; a slower pace could have reduced output losses though counterfactuals are not definitive. ### Euro-area Institutional Issues, ECB Role, and Burden-Sharing - ECB exposure and influence: - ECB held an unprecedented exposure to Ireland in 2010—about one-quarter of the ECB’s total lending—while Ireland’s share in ECB capital was described as about 1 percent (text bracket preserved). - ECB pressured Irish authorities to request a program in 2010; opposed imposing losses on holders of €19 billion of senior unsecured and unguaranteed debt. IMF initially favoured a haircut of roughly 50 percent; ECB’s position prevailed. - Treatment of creditors and promissory notes: - Corridor figure discussed: about €16 billion of unguaranteed bonds; two gone-concern banks accounted for less than a third. - The government provided IBRC with €31 billion of promissory notes generating roughly €3.1 billion annually for the first 13 years; restructured into long-term bonds in February 2013 reducing present value by roughly 33 percent. - Institutional reform recommendations: - New Banking Union: direct recapitalization by the ESM after resolution measures recommended to cut the bank-sovereign loop and provide effective risk-sharing. - ECB (not national central banks) should provide ELA to banks under ECB supervision in the Banking Union. - Reforms since crisis: single supervisor, harmonized deposit insurance, resolution mechanism, resolution fund — effectiveness depends on full implementation and funding. ### Key statistics and preserved factual figures - Program financing: €67.5 billion of EU and IMF assistance (late 2010). - Bank recapitalization funding provided up to €64 billion (about 40 percent of GDP). - Total gross capital needs and injections (six covered banks): Total: 79.8 (100%). - Troika staff projected cash injection as high as the €35 billion; ultimate requirement about half of the €35 billion. - Corridor figure of about €16 billion of unguaranteed bonds discussed. - Nonperforming loans on bank balance sheets up to 25 percent. - Provisions for NPLs: 53 percent in June 2014; write-offs as percentage of provisions: 5.2 percent in June 2014. - CRE and mortgage stock: almost €160 billion at end-2013; about €74 billion transferred to NAMA by end-2011. - Ireland’s consolidation occurred over the past five to six years (text phrasing preserved). - Current spending rose by 77 percent in real terms between 2000 and 2008. - Indigenous exports estimated at €18 billion in 2014; overall growth in exports of goods and services likely in the region of 8 percent (2014 assessment). - Total unemployment reduced by 87,100 since early 2012; employment increased by 80,000 in the same period. - Irish debt peaked at 123 percent of GDP; at the end of 2014 it was around 110 percent of GDP. - Projected gross debt under 100 percent of GDP for the end of 2016; net debt around 90 percent. - Euro area average debt cited as 94.5 or 94.6 percent of GDP. *International Monetary Fund — excerpted content from content unit _eur1501.* ### INTRODUCTION ________________________________________________________________________________4 ### INTRODUCTION ### Background and crisis chronology - Ireland’s major property bubble burst coincided with the global financial crisis, plunging the country into a severe recession in 2008–10. - Public debt climbed rapidly as revenues collapsed and banks’ rising loan losses required public support. - The “sovereign-bank loop” emerged after the Greek crisis in spring 2010, causing the government to lose access to market financing at manageable interest rates. - Ireland entered a three-year program supported by €67.5 billion of financial assistance from the European Union (EU) and IMF in late 2010. - Program goals: - restoring the viability of the banking system; - putting the public finances on a sustainable path and returning to market funding; - restarting economic recovery including by improving growth potential. - A large bank recapitalization in early 2011 helped stabilize deposits and other bank funding. - Government market access was progressively regained from mid-2012, allowing Ireland to exit the program at the end of 2013 and rely fully on market financing at highly favorable terms. - First signs of recovery: strong job creation from the second half of 2012 and growth of about 5 percent in 2014. ### Conference purpose, timing, and organizers - Conference title: “Ireland—Lessons from Its Recovery from the Bank-Sovereign Loop.” - Date and venue: January 19, 2015, at Dublin Castle. - Convened by: Central Bank of Ireland (CBI), Centre for Economic Policy and Research (CEPR), and the IMF. - Conference participants included Irish government representatives, European officials, academics, journalists, private sector representatives, other stakeholders, and the IMF’s Managing Director. - Conference organizers listed: - Craig Beaumont, Assistant Director, European Department, IMF - Stefan Gerlach, Deputy Governor at Central Bank of Ireland and CEPR Research Fellow - Philip Lane, Trinity College Dublin and CEPR Research Fellow - Presentations, discussant slides, and videos are available at the conference website referenced in the source. ### Key findings from Session I: Stabilizing and Healing the Banks - Analytical framework and diagnosis: - Dirk Schoenmaker applied a Minsky framework to Ireland’s financial cycle, noting cross-border credit played a larger role than elsewhere in Europe. - Importance of macroprudential authority to stabilize credit and housing cycles, e.g., containing loan-to-value ratios. - Favor of including external members on financial stability committees to reduce groupthink. - Recapitalization and resolution sequencing: - Recapitalization occurred over four rounds; a comprehensive bottom-up approach earlier (as in 2011) would have been preferable. - National Asset Management Agency (NAMA) disposed of large property loans based on market conditions to reduce overall cost; extending NAMA to smaller commercial property loans could have been useful. - Europe should have shared more burden arising from lack of bail-in of creditors holding banks’ senior debt—centralized resolution, burden-sharing, and supervision align with Schoenmaker’s view of how banking union should operate. - Direct recapitalization should be a standard approach, not a last resort. - Nonperforming loans and debt overhang: - High level of nonperforming loans at 25 percent; many firms and households still have larger debts than they can service. - Banks have taken large provisions but are not writing down loans, leaving a debt overhang that impedes new investment. - Recapitalization going forward should be conditional on banks writing down nonperforming loans. - Progress and sequencing of reforms: - Ann Nolan emphasized sequencing: major legislative changes (including personal insolvency), internal bank restructuring, and establishment of collection systems. - Mortgage arrears: 100,000 mortgages have been restructured with an 80 percent success rate; time delays exist between restructuring and removal from nonperforming classification. - Overall, more progress on loan resolution has been made than yet visible, but work remains. - Liquidity-solvency and bank-sovereign loops: - John Fell highlighted interplay of bank-sovereign loop and a liquidity-solvency loop; market funding runs threatened fire sales, requiring central bank funding approaching almost 100 percent of Irish GDP. - Program measures included downsizing noncore assets guided by loan-to-deposit targets and an ECB waiver to accept bank collateral regardless of Irish sovereign rating, which reduced funding uncertainties. - Outcomes noted: loan-to-deposit ratio down to 110 percent; banking sector much reduced in size; all banks passing the ECB asset quality review. - Implementation and leadership: - Jonathan McMahon credited gradualist deleveraging, avoiding fire-sale asset sales, and strong leadership from Irish officials and bank management; troika partners developed trust and reached timely agreement on fundamental measures. ### Key findings from Session II: Putting the Budget on a Sound Footing (introductory points) - Fiscal context: - Antonio Fatás emphasized that Ireland began the crisis with a relatively low public debt-to-GDP ratio, but public debt “exploded” over a few years back to levels not seen since the 1990s—a major “debt surprise.” - Core policy question: - How should fiscal policy respond to a major surprise jump in debt? While previous fiscal plans may no longer be sustainable and require adjustment, it is not necessarily appropriate to aim for a large reduction in debt immediately. - Timing of debt reduction (now versus later) lacks a clear, general answer in the economic literature and depends on factors including the cost of taxes, benefits of spending, and the interest rate. - Scope and focus: - Fatás focused primarily on the impact of fiscal consolidation on growth, setting aside other aspects such as redistribution. *International Monetary Fund — _Ireland—Lessons from Its Recovery from the Bank-Sovereign Loop_ (conference volume, January 19, 2015).* ### conclusion that fiscal consolidation to reduce debt should be implemented over a short ### _eur1501 - conclusion that fiscal consolidation to reduce debt should be implemented over a short ### Fiscal consolidation and growth - Ireland undertook a large consolidation over the past five to six years, on a scale similar to that of Portugal and Spain, but smaller than that of Greece. - Analysis drawing on the Blanchard and Leigh cross-country methodology produced multiplier results that: - Supported the hypothesis that fiscal consolidation had impacted potential GDP. - Suggested that fiscal consolidation in Europe had been self-defeating during recent years, consistent with the view that consolidation had been too fast. - Caveats to the multiplier/self-defeating-consolidation interpretation: - Estimates of potential growth and structural deficit are unobservable and sensitive to sample composition (exclusion of Greece alters results; Ireland is an outlier). - Measurement issues could account for some puzzles in the paper’s findings. - Composition matters: - The Irish consolidation leaned heavily on expenditure cuts. - Multiplier analysis indicated a severe impact from cutting back public investment; a more growth-friendly composition of adjustment was recommended. - Policy implications: - Explore the relationship between fiscal policy and potential GDP more fully, incorporating structural reforms and other factors affecting potential GDP to guide program design. - Strive to run countercyclical fiscal policies more effectively, recognizing practical difficulties in implementation. ### Program design, implementation, and political economy - Key elements of Ireland’s program success: - Existence of a clear plan—the National Recovery Plan—with specific measures and phasing that the troika reviewed and accepted. - Program effectively funded the authorities’ plan; the new government elected in 2011 endorsed the plan while retaining flexibility to adapt implementation. - Deliberate strategy to set realistic targets with adequate buffers and contingencies—“under-promise and overachieve”—enabled meeting every quarterly target. - Flexibility and collaborative discussions with troika teams helped tweak conditionality to avoid self-defeating actions. - Lessons on program timing and flexibility: - The EU-IMF financing enabled a more phased adjustment than would otherwise have been possible, but official financing limits constrained phasing. - Program design should focus on ultimate objectives and allow flexibility; actions and deficit targets are means to an end, not goals in themselves. - More attention to the social dimension is needed; inclusion of social indicators and consideration of grants for social purposes were noted as desirable. - Political sustainability: - Sustaining political support during long consolidation is difficult; prolonged dissatisfaction risks political instability and rise of extreme parties opposed to the European Project. ### Banking resolution, sovereign-bank link, and burden-sharing - Pre-crisis and crisis-era policy shortcomings: - Inadequate controls on banks (governance and supervision) and inadequate external oversight from EU institutions and the IMF. - The broad, September 2008 guarantee of bank liabilities contributed to sovereign exposure. - Uncertainty about ECB liquidity support and Emergency Liquidity Assistance (ELA) policy constrained alternatives to a blanket guarantee. - Bail-in versus bailout: - Irish authorities sought bail-ins rather than bailouts; the troika precluded bail-in of senior bondholders in the program, a significant flaw in program design according to some commentators. - The corridor figure discussed was about €16 billion of unguaranteed bonds, of which the two gone-concern banks accounted for less than a third. - The new European Bank Recovery and Resolution Directive (BRRD) negotiated in 2012 calls for bail-in of unsecured wholesale funding in banks with losses like Anglo and INBS; this reform came too late for Ireland. - Recapitalization and interest-maturity terms: - Troika penciled government cash injections as high as the €35 billion projected by troika staff; after the March 2011 stress test and some burden-sharing/bail-in of subordinated debt, the ultimate cash injection requirement came out at about a half of the €35 billion. - Over time, interest rates on official lending were sharply reduced and maturities extended (from mid-2011), a turning point in restoring market confidence. - Suggested euro-area institutional reform: - In the new Banking Union, direct recapitalization by the European Stability Mechanism (ESM) after resolution measures is recommended to cut the bank-sovereign loop and provide effective risk-sharing. ### Remaining financial-sector challenges and restructuring of loans - Banks still not fully healed: - Irish banks carry up to 25 percent of non-performing loans. - A small but important group of highly indebted households and firms faces debt overhang, suppressing consumption and investment. - NAMA and recapitalization: - Establishment of the bad-asset agency (NAMA) is an international example of bad-asset management. - Up to €64 billion was provided to banks (amounting to about 40 percent of GDP). - Operational and policy shortcomings slowing resolution of nonperforming loans: - Delays in finalizing legislative changes and limited operational capacity at banks delayed effective arrears resolution. - Banks showed persistent optimism about recoverability, limiting write-offs and more liberal restructurings that might have reduced future redefaults and supported recovery. - Policy recommendations: - Intensify write-offs of bad loans and set explicit policy targets for writing off bad loans when taxpayers fund bank recapitalizations to capture social returns. - Ensure capital shortfalls are assessed comprehensively and bottom-up so the full scale of problems is revealed. - Strengthen macroprudential decision-making (including possible inclusion of external members) to mitigate future credit boom-busts. - Complement ECB supervision with an ESM direct recapitalization instrument when justified. ### Key statistics and factual figures preserved from the text - Ireland’s consolidation occurred over the past five to six years. - Current spending rose by 77 percent in real terms between 2000 and 2008. - Ireland took seven years to bring the deficit to below 3 percent of GDP in 2015. - Some 269 actions to cut spending and increase taxes were taken to reduce the deficit. - Indigenous exports estimated at €18 billion in 2014. - Overall growth in exports of goods and services is likely to be in the region of 8 percent (2014 assessment). - Total unemployment reduced by 87,100 since early 2012; employment increased by 80,000 in the same period. - Bank recapitalization funding provided up to €64 billion (amounting to about 40 percent of GDP). - Corridor figure of about €16 billion of unguaranteed bonds discussed in negotiations. - Troika staff projected a government cash injection as high as the €35 billion; ultimate requirement came out at about a half of the €35 billion. - Irish debt peaked at 123 percent of GDP; at the end of 2014 it was around 110 percent of GDP. - Projected gross debt under 100 percent of GDP for the end of 2016; net debt around 90 percent. - Euro area average debt cited as 94.5 or 94.6 percent of GDP. - Nonperforming loans on bank balance sheets up to 25 percent. *International Monetary Fund — excerpted content from the source PDF.* ### 1. credit expansion, characterized by rising assets prices; ### 1. credit expansion, characterized by rising assets prices; ### Stages of the financial cycle (Minsky framework) - 1. credit expansion, characterized by rising assets prices; - 2. euphoria, characterized by overtrading; - 3. distress, characterized by unexpected failures; - 4. discredit, characterized by liquidation; - 5. panic, characterized by the desire for cash. ### Mechanisms driving boom–bust dynamics - The displacement sets in a boom fueled by credit. As a boom leads to euphoria, banks extend credit to ever more dubious borrowers, often creating new financial instruments to do the job. - At the top of the market some traders begin to cash in profits; the onset of panic is often heralded by a dramatic event, such as a bank not being able to meet its obligations. - Losses on loans mount and the value of loans falls relative to liabilities, driving down the capital of financial institutions. With less capital, financial institutions cut back on their lending (deleveraging). ### Sources of procyclicality (as highlighted by Minsky and others) - Risk assessment: - Risk tends to be underestimated in good times (euphoria with “low risk”) and overestimated in bad times (distress with “high risk”). - Risk can be endogenous: selling an asset to reduce risk can further depress its price. - Leverage: - The amount of debt (leverage) is key in explaining the depth of financial crises; more debt in the upswing leads to more severe deleveraging in the downswing. - This argument supports more equity financing in general and more equity capital for banks. - Adrian and Shin (2010) show banks increased leverage prior to the crisis, resulting in a declining leverage ratio, defined here as equity divided by total assets. - Collateral and informational insensitivity: - Gorton and Ordoñez (2014) stress the procyclical role of collateral: short-term lending (for example, via repos) against collateral can occur without costly information production. - Informationally insensitive debt allows low-quality collateral borrowers to access credit, generating a credit boom; fragility builds as information about counterparties decays and a small shock can trigger information production incentives. - Capital requirements: - Banks must keep minimum capital against new loans. In good times retained earnings boost capital and enable more lending; in bad times capital shrinks through losses, hampering new credit extension. ### Financial cycle vs business cycle (Borio and others) - Borio (2014) argues that both credit and house prices are important macro-drivers of financial cycles. - Figure 1 (referenced) shows: - The financial cycle (measured by credit and house prices) can amplify the business cycle (measured by GDP). - The amplitude of the financial cycle over the 1970–2013 period is five times that of the business cycle in the United States. - The duration of the financial cycle tends to be longer than that of the business cycle. ### The macro-finance side of the Irish crisis - For a full review of the run-up to the Irish banking crisis, the text refers to Regling and Watson (2010), Honohan (2010), and Nyberg (2011); weak supervision and macro-factors both played important roles. - House prices and credit growth are examined as components of the financial cycle in Ireland. - House prices: - Residential property prices almost doubled from 2002 to 2008; commercial real estate prices were also rising fast. - The Nyberg (2011) report indicates “groupthink” among bankers, supervisors, and central bankers may explain why the dangers of the strong buildup of house prices were not appreciated — characteristic of the euphoria stage. - The strong rise in property prices led to massive new construction in Ireland, and with hindsight the construction bubble caused a misallocation of resources, aggravating problems. - Credit growth and banking assets: - Ireland experienced strong credit growth, with total banking assets almost tripling from 2002 to 2008. - This credit growth was fueled predominantly by credit flows from other EU countries. - Domestic banking assets and third-country banking assets (a minor component of 10 percent, as Table 1 shows) grew with an overall rate of 250 percent over 2002–2008. - EU country banking assets increased by almost 400 percent over this period. - The relative share of banking assets from other EU countries rose from 30 percent in 2002 to 40 percent in 2007/2008, and later returned to 30 percent. - Foreign credit (from EU and third countries) was 50 percent of overall credit in Ireland at the height of the financial crisis. ### Comparative context - Spain: - Both domestic credit and credit from other EU countries grew at a more or less even pace. - Credit from other EU countries went up to 300 in Spain (index base 100 in 2002). - Portugal: - Credit growth was mainly domestic and more subdued than in Ireland or Spain. - Ireland had both higher and more foreign-fueled credit growth preceding the global financial crisis than did Spain and Portugal; credit from other EU countries rose to close to 400 in Ireland (index base 100 in 2002). ### Key statistics from Table 1. Irish Banking System, 2002–13 (In € billion; percentages) - Total assets: - 2002: 600 - 2003: 708 - 2004: 873 - 2005: 1,128 - 2006: 1,412 - 2007: 1,607 - 2008: 1,672 - 2009: 1,577 - 2010: 1,462 - 2011: 1,264 - 2012: 1,124 - 2013: 972 - Domestic assets: - 2002: 366 - 2003: 444 - 2004: 544 - 2005: 719 - 2006: 890 - 2007: 819 - 2008: 872 - 2009: 904 - 2010: 930 - 2011: 743 - 2012: 676 - 2013: 590 - From EU: - 2002: 175 - 2003: 202 - 2004: 263 - 2005: 330 - 2006: 388 - 2007: 625 - 2008: 670 - 2009: 570 - 2010: 436 - 2011: 389 - 2012: 328 - 2013: 279 - From third countries: - 2002: 60 - 2003: 62 - 2004: 66 - 2005: 80 - 2006: 134 - 2007: 163 - 2008: 130 - 2009: 103 - 2010: 96 - 2011: 132 - 2012: 119 - 2013: 103 - Shares (percent of total assets): - Domestic: 2002: 61%; 2003: 63%; 2004: 62%; 2005: 64%; 2006: 63%; 2007: 51%; 2008: 52%; 2009: 57%; 2010: 64%; 2011: 59%; 2012: 60%; 2013: 61% - From EU: 2002: 29%; 2003: 29%; 2004: 30%; 2005: 29%; 2006: 27%; 2007: 39%; 2008: 40%; 2009: 36%; 2010: 30%; 2011: 31%; 2012: 29%; 2013: 29% - From third: 2002: 10%; 2003: 9%; 2004: 8%; 2005: 7%; 2006: 9%; 2007: 10%; 2008: 8%; 2009: 7%; 2010: 7%; 2011: 10%; 2012: 11%; 2013: 11% *International Monetary Fund* ### 3. Banking Assets, Ireland (Foreign vs. domestic) ### 3. Banking Assets, Ireland (Foreign vs. domestic) ### Banking assets and the financial cycle - Growth in total assets of the Irish banking system is split into domestic, from the rest of the EU, and from third countries; figure represents an index with 2002=100. - 80 percent of the new credit in Ireland went to housing and commercial real estate (Gerlach 2014). - Mortgage lending loosened markedly in 2005–2006: - In 2005, half of first-time buyers had LTV rates above 90 percent, with very few above 100 percent. - By 2006, two-thirds of mortgages to first-time buyers had LTV rates over 90 percent and one-third over 100 percent (Honohan 2009). - Applying the Taylor rule, Jorda, Schularick, and Taylor (2014) estimate the policy interest rate was 5 to 10 percent too low for Ireland and Spain during the 1999–2008 period. - Mortgage debt doubled relative to GDP in about eight years; house-price-to-income ratios in Ireland and Spain rose by 65 percent to 75 percent over the same time frame. - Mortgage credit as a share of banks’ balance sheets rose from about one-third at the beginning of the 20th century to about two-thirds today (Jorda and others 2014). ### Crisis management — stabilizing banks (stages and overview) - Crisis management took place in several stages: - Stage 1: public policies to stabilize the banking system. - Stage 2: restructuring of loans to firms and households (mainly mortgages). - Blanket guarantee and early recapitalization: - Irish government introduced a blanket guarantee covering virtually all Irish bank liabilities on September 30, 2008 (Gerlach 2014). - Initial capital injections and nationalizations revealed solvency problems over an extended period from late 2008 to 2011. - Central Bank of Ireland estimated loan losses and calculated capital shortfall via a Prudential Capital Adequacy Review (PCAR); the March 2010 PCAR amounted to €32 billion. ### Recapitalization — summary figures and phases (Table 2 overview) - Capital injections and recapitalization occurred in several rounds. Key elements: - Phase 1: Early 2009 — initial capital injections and nationalization - BOI: 3.5 - AIB: 3.5 - Anglo: 4.0 - INBS: 11.0 - Phase 1 share: (14%) - Phase 2A: March 2010 (PCAR) - BOI: 2.7 - AIB: 7.4 - Anglo: 18.0 - INBS: 2.6 - EBS: 0.9 - Phase 2A total: 31.6 (40%) - Phase 2B: September 2010 - BOI: 0.0 - AIB: 3.0 - Anglo: 7.3 - INBS: 2.8 - EBS: 0.1 - Phase 2B total: 13.2 (16%) - Phase 3: March 2011 (PCAR) - BOI: 5.2 - AIB: 13.3 - Anglo: 1.5 - INBS: 4.0 - Phase 3 total: 24.0 (30%) - Total gross capital needs and injections (six covered banks): - BOI: 11.4 - AIB: 27.2 - Anglo: 29.3 - INBS: 5.4 - EBS: 2.4 - ILP: 4.1 - Total: 79.8 (100%) - Note: amounts are gross capital needs, which exceed the capital injections by the state. - March 2010 PCAR amounted to €32 billion. - PCAR 2011 exercise led to an additional capital injection of €24 billion. - Table 2 summarizes overall capital injections amounting to €80 billion into the Irish banks, whereby €64 billion was provided by the government and €15.5 billion from exchanges on subordinated debt and some private equity. - A further €40 billion can be added for losses by the non-Irish banks (McArdle 2012) (note in source). ### Expiration of the blanket guarantee and ELA - The blanket government guarantee was for two years, expiring on September 30, 2010. - Emergency Liquidity Assistance (ELA) became necessary as bank paper matured and deposits were not renewed; backing moved from government to the central bank. - EU-IMF program provided funding to the Irish government for recapitalization; EFSF did not recapitalize banks directly. - Bondholder burden-sharing contested: - Subordinated bondholders bore losses of €15.5 billion (Honohan 2012). - Senior bondholders were exempted due to ECB and U.S. Treasury pressure. ### Nationalization, mergers, and sector consolidation - Anglo Irish Bank nationalized in January 2009; Irish Nationwide Building Society (INBS) nationalized in August 2010. - Anglo deposits moved to AIB; INBS deposits moved to Irish Life and Permanent (ILP). - Anglo and INBS merged into the Irish Bank Resolution Corporation (IBRC); IBRC was put in special liquidation in February 2013. - ILP split: Irish Life (insurance) sold; banking part renamed permanent tsb (PTSB). - EBS restructured and acquired by AIB in July 2011. - Result: consolidated domestic banking system with two broad banks (BOI and AIB) and one small bank (PTSB); foreign-owned resident banks stopped or downscaled operations in Ireland. ### Restructuring — NAMA and bad assets - NAMA (2009) allowed transfer of large property-related loans to NAMA at discounts; only loans in excess of €20 million were transferred. - Transfers to end-2011 by covered banks (Table 3): - Nominal loan value: - BOI: 9.9 - AIB: 21.3 - IBRC: 43.0 - Total: 74.2 - Discount: - BOI: 43% - AIB: 56% - IBRC: 61% - Overall: 57% - Transfer value: - BOI: 5.6 - AIB: 9.4 - IBRC: 16.8 - Total: 31.8 - Realized loss by banks: - BOI: 4.3 - AIB: 11.9 - IBRC: 26.2 - Total: 42.4 - Almost 60 percent of bad assets were taken over from Anglo and INBS (IBRC), reflected in IBRC’s higher discount of 61 percent. - NAMA could not take smaller commercial loans (below €20 million) and mortgages. ### Small loans, NPLs, and provisions - Nonperforming loans (NPLs) as a percentage of total loans: - Ireland: 25 percent in 2013. - Italy: 15 percent (approximation in source). - Spain and Portugal: 10 percent (approximation in source). - Irish banks’ provisions and write-offs: - Provisions for NPLs: 53 percent in June 2014 (Central Bank of Ireland). - Write-offs as a percentage of provisions: 5.2 percent in June 2014. - Property loans remaining on bank balance sheets: - CRE loans and mortgages amounted to almost €160 billion at end-2013. - About €74 billion of large CRE loans were transferred to NAMA by end-2011. - About two-thirds of property loans stayed on banks’ balance sheets. - With impairment rates: - Mortgages impairment rate: 18 percent. - CRE impairment rate: 57 percent. - More than €40 billion of impaired property loans remain in the banks. ### Outstanding loans and impairments, end-2013 (Table 4) - Outstanding loans (by bank) and impaired loans; impairment rates and impaired loan amounts: - Mortgages outstanding: - BOI: 51.6 - AIB: 40.7 - PTSB: 29.0 - Total mortgages outstanding: 121.3 - Impairment rate (mortgages): 17.7% - Impaired mortgages (value): 21.5 - CRE outstanding: - BOI: 16.8 - AIB: 19.7 - PTSB: 36.5 - Total CRE outstanding: (implied in source) - Impairment rate (CRE): 56.9% - Impaired CRE (value): 20.8 - SME outstanding: - BOI: 13.6 - AIB: 13.7 - PTSB: 27.3 - Impairment rate (SME): 25.1% - Impaired SME loans (value): 6.9 - Corporate outstanding: - BOI: 7.8 - AIB: 4.3 - PTSB: 12.1 - Impairment rate (corporate): 25.1% - Impaired corporate loans (value): 3.0 - Consumer outstanding: - BOI: 2.8 - AIB: 4.3 - PTSB: 0.3 - Total consumer outstanding: 7.4 - Impairment rate (consumer): 6.1% - Impaired consumer loans (value): 0.4 - Total outstanding loans: - BOI: 92.6 - AIB: 82.7 - PTSB: 29.3 - Total outstanding: 204.6 - Overall impairment rate: 25.7% - Total impaired loans (value): 52.6 - Source for outstanding loans: annual reports 2013 of banks; impairment rates from Central Bank of Ireland. - Note: Only five of the six Irish banks participated in NAMA; Anglo and INBS merged into IBRC; EBS was acquired by AIB. ### Sectoral distribution and SME debt - Outstanding loans by sector, end-2013 (percent of total): - Mortgage: 59% - CRE: 18% - SME: 13% - Corporate: 6% - Consumer: 4% - Nonperforming loans by sector (2010–14) rose to about 25 percent for SME, corporate, and consumer loans. - SME survey data (Table 5) — debt-to-turnover ratio by firm size (percent): - Micro: Zero debt 36.1 | 0 to 1/3 49.8 | 1/3 to 1 8.3 | >1 5.9 - Small: Zero debt 32.2 | 0 to 1/3 52.9 | 1/3 to 1 9.4 | >1 5.4 - Medium: Zero debt 32.4 | 0 to 1/3 45.0 | 1/3 to 1 11.0 | >1 11.7 - Total: Zero debt 33.8 | 0 to 1/3 49.9 | 1/3 to 1 9.3 | >1 7.0 - Combining Table 4 (25 percent of loans impaired) and Table 5 (66 percent of SMEs have a loan) indicates 16.5 percent of SMEs have arrears on their loans. ### Mortgages in arrears and household debt - Mortgages are 59 percent of outstanding loans. - Mortgages in arrears (end-September 2014): - Principle dwelling houses (PDH): 20 percent of outstanding mortgage balances (all arrears, including up to 90 days). - Buy to let (BTL): 36 percent of outstanding mortgage balances (all arrears). - NPLs (90 days or more): - PDH: 16.5 percent. - BTL: 30.5 percent. - Weighted average NPL for mortgages: 19.5 percent. - Duration of arrears: - Proportion of mortgages with arrears over two years (720 days past due) is growing and well above 20 percent for both PDH and BTL (number basis). - About 75 percent of arrears in value terms are for accounts over two years past due for both categories. - Household debt and incidence: - Household debt remains high at 190 percent of disposable income. - Number of private households: 1,650,000. - Number of outstanding PDH mortgages: about 760,000. - Mortgages in arrears: 118,000. - Up to 7.2 percent of Irish households have a mortgage in arrears (noting some households have more than one mortgage). ### New lending and policy measures to support SMEs - New lending to domestic nonfinancial corporations remains extremely weak. - Interest rates are at slightly above 5 percent for loans up to €1 million. - Public initiatives: - Strategic Banking Corporation of Ireland: - Will lend to SMEs via banks on longer and more favorable terms. - Will have €800 million to lend; initially financed by KfW, EIB, and the Ireland Strategic Investment Fund. - Ireland Strategic Investment Fund (ISIF): - National Pension Reserve Fund valued at €6.8 billion being reoriented to support economic activity and employment domestically. ### Assessment and policy lessons (macroprudential and institutional) - Three features stood out in the Irish build-up: - Groupthink among policymakers and bankers. - Loosening of mortgage credit standards (LTVs well above 90 percent). - Strong contribution of cross-border banking flows from other European countries. - External reviews can help counter groupthink; incorporation of external views into macroprudential decision-making is powerful (example: U.K. Financial Policy Committee has four external members). - With one-size-fits-all EMU monetary policy, country-specific macroprudential policy is crucial for small economies like Ireland (contribution to euro area less than 2 percent). - HKMA example: time-varying LTV policy to contain housing and real estate prices. - LTV ratios at the high end (e.g., 95 percent or higher) contributed to high mortgage-debt-to-GDP ratios. *Source: Author calculations based on ECB Structural Financial Indicators and text from the IMF chapter "3. Banking Assets, Ireland (Foreign vs. domestic)".* ### Section 2. But more recent evidence suggests that such high LTV ratios have become less ### _eur1501 - Section 2. But more recent evidence suggests that such high LTV ratios have become less ### LTV/LTI and macroprudential framework - International experience suggests maximum LTV ratios of 80 percent. - Central Bank of Ireland (2014a) consultation paper proposals: - Restrict lending by banks for primary dwelling purchase (PDH) above 80 percent LTV to no more than 15 percent of the aggregate value of the flow of all housing loans for PDH purposes. - Limit buy-to-let (BTL) mortgages above 70 percent LTV to 10 percent of all BTL loans. - Proposals assume application to all mortgage providers (not only banks) and recommend dynamic (time-varying) application of LTV ratios. - Lower LTVs require households to have sufficient savings for equity; examples of mechanisms that encourage equity accumulation: - Germany: bausparen system. - Canada and Switzerland: ability to draw on pension fund assets for equity financing of first homes. - Macroprudential authority role: - Minimum responsibility: increase resilience of the financial system against financial shocks. - Preference by some (Gersbach and Rochet 2014) for countercyclical policies to constrain financial booms and “stabilization of the credit cycle.” - Countercyclical capital buffer (CRD4) and LTV ratio are residence-based—domestic and foreign-owned banks face same buffers for Irish borrowers, enabling containment of domestic and cross-border banking credit. ### Policy Lessons (from Section 2 and related text) - 1. The Central Bank of Ireland, as macroprudential authority, should aim to stabilize the credit and housing cycle. It should adopt among other things time-varying LTV ratios, which in the long run should not exceed 80 percent. - 2. The Central Bank of Ireland may consider establishing a formal Financial Stability Committee with external members. A separate committee with published minutes also increases accountability. ### Crisis management — stabilizing banks - Early crisis responses: - Department of Finance and Central Bank of Ireland proactive in stabilizing banks. - ECB Comprehensive Assessment outcome: BOI and AIB passed; PTSB experienced a capital shortfall. - Blanket guarantee of Irish bank liabilities: - May have addressed wholesale funding pressures initially but forestalled timely resolution with creditor burden-sharing. - Expiration of the two-year government guarantee was a watershed; absence of a clear exit strategy was problematic. - Senior debt holder treatment contentious: trade-off between writing down to absorb losses vs. protecting due to contagion risks. - Argument: if contagion concerns justify protecting senior debt holders, related costs should be borne at the European level. - IMF staff recommendation: ESM should recapitalize banks directly and not through government books. - Goodhart and Schoenmaker (2014): ECB (not national central banks) should provide ELA to banks under ECB supervision in the new Banking Union. - Financial trilemma: choice of two out of three objectives—financial stability, cross-border banking, national financial policies. Banking Union implies choice toward supranational financial policies for supervision and stability. - NAMA establishment: - Targeted bad property loans in excess of €20 million. - Instrumental in allowing banks to recognize losses and remove uncertainty. - Freedom in asset run-down allowed NAMA to realize relatively good asset prices. - Recapitalization process: - Happened in several rounds; early top-down calculations were imprecise and insufficient. - Advice: slightly overdo recapitalizations (no-regret policy), then return excess funds later if needed. - Bottom-up assessments aided by independent consultants are preferable; second PCAR in Ireland was bottom-up. - Example: Dutch government’s secret hiring of consultants to value U.S. houses underlying ING’s Alt A portfolio when providing guarantees. ### Policy Lessons (crisis stabilization) - 3. In the new setting of the Banking Union with ECB supervision of the large euro area banks, the ECB and the ESM should provide directly the liquidity and capital backstop to these large banks when needed. - 4. Ireland followed international best practice by setting up NAMA, an asset management agency to run down the bad assets of the Irish banks. Releasing bad assets from bank balance sheets is instrumental in the path to recovery. - 5. Assessment of capital needs for troubled banks should be comprehensive, aided by external consultants, and, ideally, bottom-up. Ad hoc assessments may lead to repeated rounds of recapitalization. ### Crisis management — restructuring banks - Restructuring actions: - Closures and mergers; Anglo and INBS put into liquidation. - EBS became a subsidiary of AIB. - Resulting system: two-pillar banking system with BOI and AIB as two broad banks and a smaller PTSB. - BOI and AIB: €80 to 90 billion in total loans (see Table 4). - PTSB: €30 billion in total loans. - Concern: two-pillar system may reduce competition, raising interest rate margins and borrowing costs. - Alternative considered: - Merge EBS and PTSB to create a third bank — two broad banks with €70–90 billion and one medium-sized bank with about €45 billion. - Example: SNS in the Netherlands nationalized as stand-alone and adopted challenger strategy. - Foreign bank competition limited due to disaster myopia; many foreign banks running off Irish operations; Ulster Bank (part of RBS Group) recorded to remain active. ### Cleaning bank balance sheets and legacy problems - NPLs at 25 percent — substantial work remains. - Banks have built sizable provisions (up to 53 percent), approaching the discount of 57 percent on property loans transferred to NAMA. - Forbearance (“wait and see”) issues: - Banks hold out for write backs when economy improves rather than writing off bad loans. - For banks: outstanding NPLs create uncertainty, reducing new lending. - For borrowers: debt overhang suppresses investment and consumption. - Policy responses for credit provision: - Department of Finance created the Strategic Banking Corporation of Ireland (SBCI) to support SME lending via banks on longer and more favorable terms to offset legacy credit conditions. - Debt overhang statistics and estimates: - Calculations in Section 4 suggest that 16.5 percent of SMEs and 7.2 percent of households face payment arrears. - Conservative interpretation: up to 20 percent of SMEs and 10 percent of households are suppressing new investment and consumption (some indebted but meeting payments also suppress activity). - Ireland’s legal and cultural context: - Between Anglo-Saxon easy credit provision (nonrecourse mortgages) and Roman system of strong creditor’s rights (recourse mortgages, antiquated personal bankruptcy). - Ireland has modernized personal bankruptcy procedures but borrowers still find it difficult to free themselves from old debts. - Bankers reluctant to write off loans due to moral hazard concerns. ### Policy Lessons (restructuring and legacy) - 6. The Irish authorities made some bold restructuring decisions, such as replacing management and closing two troubled, property-lending banks. While banking consolidation is a key tool of crisis management, it is important to ensure that the banking system remains competitive postcrisis. - 7. Taking sufficient provisions for NPLs is a first step to heal banks. A necessary second step is to write off bad loans in order to clean up bank balance sheets. On the first step, Ireland has been proactive; on the second, progress is very slow. - 8. Recapitalization of ailing banks may be needed for economic growth. When providing financial support to banks, the government should set targets for banks to partially write off bad loans to corporates and households. ### Conclusions - Ireland faced a very severe banking crisis when the credit-fueled property bubble burst. - Overall assessment: Irish authorities were successful in crisis management and stabilization, contributing to economic recovery. - Emphasis was stronger on stabilizing banks (restoring solvency, replacing management, closing bad banks) than on restructuring loans; banks are not yet healed with NPLs at 25 percent. - A minority of highly indebted households and firms remain sidelined by debt overhang, limiting broader recovery. - Intensifying write-offs of bad loans would broaden economic recovery and increase the social return on publicly funded recapitalizations. - Irish taxpayers bore full costs of recapitalization while some European authorities benefited from stability without sharing burden—recommendation that ESM should directly recapitalize troubled banks after resolution measures to promote risk-sharing and cut bank-sovereign loop. - To avoid repeat of “irrational housing exuberance,” recommend proactive use of macroprudential tools (countercyclical capital buffers and LTV ratios) and establishment of a financial stability committee at the Central Bank of Ireland with external members to reduce groupthink. *International Monetary Fund — extracted from the provided section content.* ### 1. Introduction ### 1. Introduction ### Context and central argument - By 2007 Ireland was seen as a poster child of fiscal discipline following early euro years; government debt had fallen to 24.6 percent in 2007 after a reduction of more than 80 percentage points from a 1987 level of 110 percent of GDP. - By 2010 private capital stopped funding the Irish government; a large crisis combined with support to the banking sector increased debt by a factor of four. - The paper presents evidence that the negative growth effects of fiscal consolidation have been very persistent and have had an effect on potential output. The estimated value of these effects suggests that, from a macroeconomic point of view, the fiscal consolidation was too fast because it probably became self-defeating through its effects on potential output. - Despite this, achievements include regained access to capital markets at low interest rates, growth returning faster than anticipated, stabilization or initial decline in the debt-to-GDP ratio, and delivery on promised adjustment magnitudes. ### Scope and structure of the paper - Focus: the macroeconomic debate around the consolidation that took place during the crisis and the potential negative effects that the fiscal contraction had on GDP growth. - Structure (as described): Section 2 — overview of debt evolution; Section 3 — theoretical analysis of costs of government debt and discussion of optimal speed of reduction; Section 4 — detailed data analysis of Irish fiscal consolidation and comparison with other euro area countries; Section 5 — policy options and conclusion. ### Key finding on consolidation speed - The fiscal consolidation likely became self-defeating: persistent negative effects on growth more than compensated for reductions in spending and tax increases. --- ### The Debt Surprise (summary of Section 2) - Historical trajectory: - 1987: government debt ≈ 110 percent of GDP (one of the highest among future euro members). - 2007: debt-to-GDP ratio = 24.6 percent. - 2007–2013: Irish government debt climbed to 116 percent of GDP. - Major contributors to the debt increase (2007–2013): - Very large recession: fall in real GDP of more than 9 percent and as high as 16 percent in nominal terms during 2007 to 2010, causing large falls in tax revenues and larger budget deficits. Ireland’s reliance on taxes associated with the booming real estate market made revenue losses especially large. - Direct fiscal support to the banking sector: significant capital injections and broad guarantees. - Loss of confidence and higher interest rates: increased interest costs contributed to a spiral of higher deficits and further debt accumulation. - Policy responses: - Initial adjustment plans during 2008–10: adjustment in the range of 6 to 10 percent of GDP. - Follow-up adjustment of similar magnitude over the subsequent four years; became the blueprint for the troika program imposed after November 2010. - Objective of adjustments: stabilize the debt-to-GDP ratio by 2014 and bring budget deficits under the 3-percent limit around the same time. - Outcome: broad delivery on planned fiscal consolidation, but stabilization around a high debt level (~116 percent of GDP) implies continued fiscal sustainability efforts for years or decades. --- ### Need for Fiscal Consolidation and Optimal Debt (summary of Section 3) - Two rationales for adjustment after the debt surprise: - Sustainability: higher debt combined with revised growth forecasts makes prior budgetary plans inconsistent with sustainable fiscal policy. - Direct cost of debt: high debt may be costly in itself, prompting spending cuts or tax increases to reduce the level of debt. - Theoretical perspectives: - Barro (1979) result: if government spending and income grow at similar rates and Ricardian equivalence holds, tax rates should be constant over time; sudden changes in initial debt need not require debt reduction (debt as a random walk). - Deviations from representative-agent/Ricardian settings (e.g., Leith, Moldovan, and Wren-Lewis (2011)) can justify reducing debt today to lower future distortionary taxation. - Crowding-out argument distinguishes government spending (which appropriates resources) from debt per se; interest payments are government spending but timing of repayment matters for distortions. - When the interest rate paid on debt exceeds the social discount rate (and when market access is impaired, as in 2010–2011), rapid debt reduction can be more compelling. - Empirical evidence and policy benchmarks: - Literature is inconclusive on a strict debt threshold; Reinhart and Rogoff (2010) argue for detrimental effects above certain thresholds while others contest magnitude or existence (Herndon, Ash, and Pollin, 2013). - Policy practice: “prudent” debt targets commonly used by OECD and IMF; typical medium-term targets around 50 to 60 percent of GDP. Maastricht Treaty: 60 percent level. - Ireland’s gross debt (~110 percent of GDP; higher as percent of GNP) exceeds these benchmarks and will need a downward trajectory under EU norms and Irish rules. --- ### Stabilizing and Reducing Debt: mechanics and numerical examples - Steady-state primary balance consistent with target debt d*: - Primary balance (as percent of GDP) = (r - g) / (1 + g) * d* - Where r is interest rate on government debt and g is GDP growth. - Given current projections for r and g for advanced economies including Ireland, r - g is expected to be small. - Example OECD projections for Ireland: effective nominal interest rates = 4.7 percent and nominal growth rate = 4.3 percent. - Under that scenario, the required primary balance to keep debt at current levels (around 110 percent) is very close to zero. - Any increase in interest rates by 1 percentage point will require an increase in the primary balance of about 1.1 percentage points of GDP. - EU debt rule for countries above 60 percent: reduce the excess by at least 1/20 per year on average. - Projected debt paths under maintained primary surpluses (using OECD r and g): - If Ireland maintains 3 percent primary surplus going forward: - debt-to-GDP ratio ≈ 68 percent by 2030 - debt-to-GDP ratio ≈ 11 percent by 2050 - If Ireland maintains 2 percent primary surplus going forward: - debt-to-GDP ratio ≈ 85 percent by 2030 - debt-to-GDP ratio ≈ 50 percent by 2050 --- *Source: _eur1501 - 1. Introduction* ### 4. The S ### _eur1501 - 4. The Speed of Adjustment during the Crisis ### Context and motivation for Ireland’s fiscal consolidation - Fiscal consolidation in Ireland started early in the crisis: - During 2008–10 the government implemented adjustments between 6 and 10 percent of GDP. - During 2011–14 a second fiscal consolidation of similar magnitude occurred. - Stated motivations: - Reestablish sustainability under a new economic scenario. - Bring debt levels down and reestablish credibility after a sudden stop of private capital flows requiring access to institutional funding (EU, IMF, ECB). - Negotiations with funding providers partly determined the speed of adjustment; market-imposed sudden stops reduced policy choice. ### Magnitude and timing of the Irish adjustment - Pre-crisis (2007): balanced budget and gross debt below 25 percent of GDP. - 2008: - Real GDP growth collapsed by more than 7 percentage points. - Budget balance moved to a deficit of 7.1 percent. - Nominal GDP growth was –5.1 percent. - 2009: - Real GDP declined by more than 6 percent. - Budget deficit increased to 13.3 percent, of which 2.3 percent was related to banking assistance. - Nominal GDP growth was –10.5 percent. - Government / Fiscal Policy Council estimate of budgetary adjustment in 2008–09: €12–15 billion (about 10 percent of GDP). - IMF calculation of budgetary measures in 2008–09: around 6.2 percent of GDP. - IMF estimates for the two consolidation plans (across both periods): about 14–15 percent of GDP. - Irish government and the Fiscal Policy Council estimate the total fiscal effort over the two periods to be very close to 20 percent, while the IMF suggests the efforts were closer to 14 percent. ### Measures of consolidation: primary and structural balances - Primary balance trajectory (excluding one-offs): - Primary deficit grew from 6 percent in 2008 to close to 10 percent in 2009. - Primary deficit then decreased steeply toward 0 percent by 2014. - Cyclically adjusted measures (EC vs IMF): - IMF cyclically adjusted indicator: consolidation from 2008 to 2014 is more than 10 percentage points of GDP. - EC cyclically adjusted indicator: consolidation from 2008 to 2014 is less than 7 percentage points of GDP. - Observed puzzle: structural balance changes are smaller than the narrative/announced discretionary measures (narrative measures substantially exceed the documented change in structural balance, which ranges between 7 and 12 percent depending on adjustment). ### Cross-country comparisons (Ireland vs Portugal, Spain, Greece) - Primary balance patterns: - Spain most similar to Ireland: surpluses in 2006–07, jump to a deficit of about 10 percent by 2009, reduction toward zero by 2014. - Portugal and Greece: started with small deficits in 2006–07, deteriorated to 7–10 percent deficits, then faster early reductions; Greece shows the largest adjustment due to worst initial deficit. - Structural adjustment (EC and IMF measures): - Ireland appears to be adjusting at a pace similar to or slower than Spain, and slower than Portugal and Greece. - According to EC calculations, by 2012 Portugal and Greece had turned structural primary deficits into surpluses. - Composition of adjustment: - Ireland relied most heavily on spending reductions versus tax increases among the compared periphery countries. - Ireland exhibited the largest fall in the ratio of government spending to GDP and the least reliance on tax increases measured as a ratio to GDP. ### Explaining the divergence between announced consolidation and measured outcomes - Three main explanations: 1. Cyclical effects: fiscal consolidation reduces GDP which reduces the measured budget improvement; cyclical adjustment should capture this effect if it is transitory. 2. Errors in cyclical adjustment and changes in potential output: if potential GDP falls, the target for adjustment moves and structural measures understate the required fiscal effort. 3. Permanent effects: fiscal consolidation itself could reduce potential output (hysteresis), meaning consolidation may reduce both actual and potential GDP and thus be partially self-defeating. - Empirical observations for Ireland: - From 2009 to 2014, the IMF cyclically-adjusted primary balance (CAPB) reduced by about 9 percentage points—the change is very similar to the unadjusted primary balance reduction. - Output gap evolution (IMF estimates) shows deterioration from 2007 to 2009, then a stable or improving output gap after 2009; this can offset cyclical impacts of consolidation in the CAPB. - Potential output in the IMF WEO (October 2014) is only 2 percent higher in 2014 than in 2007 in real terms and is significantly below pre-crisis trend; nominal potential output grew at almost the same rate (3 percent) over 2007–2014. - Real-time estimates of potential output (as of 2007) were revised downward ex post; the downward revision implies the fall in potential output was larger than shown by revised series. ### Analytical framework for how consolidation affects measured balances - Notation and relationships (as in the source): - Let S_t be government balance, G_t spending, T_t taxes, Y_t level of GDP in year t. - Planned change in spending: ΔG_t = G_{t+1} – G_t. - Expressed relative to potential GDP Y^P: ΔG_t / Y^P. - Fiscal multiplier μ links change in output to change in spending: ΔY_{t+1} = μ ΔG_t. - With marginal tax rate τ, change in budget balance: ΔS_{t+1} = ΔG_t – τ ΔY_{t+1} = (1 – τ μ) ΔG_t. - As percent of potential output: ΔS_{t+1} / Y^P = (1 – τ μ) (ΔG_t / Y^P). - Implication: the actual change in the budget balance is reduced relative to the announced plan by factor (1 – τ μ), tying the outcome to fiscal multipliers and tax cyclicality. - If the GDP change is cyclical, the cyclical adjustment should capture it; the Irish case shows structural balance changes smaller than the announced measures, implying either cyclical adjustments are incorrect or potential output changed. ### Cyclical adjustment in presence of permanent shocks - Standard output-gap-based cyclical adjustments do not capture permanent (level) changes in GDP that change taxes and spending in proportion to actual GDP. - A 1 percent permanent fall in GDP will affect the budget balance much like a transitory fall in the short run; but output-gap measures treat permanent falls as structural deterioration (expansionary policy) rather than cyclical. - For Ireland: - The relationship between real GDP growth and government balance is tight and consistent across 1990–2014; changes in GDP have a large effect on the balance irrespective of cyclicality. - When using output gap instead of growth, the relationship is less tight; years 2007–14 lie below the trend—deficit is “too large” relative to the output gap. - Regression results: slope of government balance vs output gap pre-2007 ~ 0.6; post-2007 slope ~ 1.0, indicating measured cyclicality increased after 2007. ### Evidence on permanent effects of consolidation (Fatás and Summers / Blanchard and Leigh approach) - Methodology: - Use April 2010 WEO forecast of change in structural balance for 2010–2011 as fiscal consolidation measure (ΔS^2010,2011). - Compare forecast errors of potential output for 2014 between April 2010 WEO and October 2014 WEO; regress forecast error for potential output on fiscal consolidation. - Key regression result (reproduced from Table 1, Fatás and Summers 2014): - Dependent variable: forecast error of GDP growth (column 1) and potential (column 2). - Coefficients on Fiscal Consolidation: - GDP growth forecast error: –1.170** (standard error (0.437)). - Potential forecast error: –1.365** (standard error (0.524)). - Constants: - GDP growth regression constant: 0.951** (0.439). - Potential regression constant: –2.343*** (0.688). - Observations: 1514. - R-squared: 0.550 (GDP growth), 0.422 (potential). - Note: Robust standard errors in parentheses; significance: *** p<0.01, ** p<0.05, * p<0.1. - Interpretation: - The coefficient values imply that larger announced fiscal consolidations in 2010–2011 are associated with larger negative forecast errors for both GDP growth and potential output by 2014. - Replacing output with potential output increases the point estimate magnitude (from –1.170 to –1.365), consistent with fiscal consolidations having measurable negative effects on potential output. ### Policy-relevant implications and considerations - Structural balance measures may understate the true fiscal effort when potential output falls or when cyclical adjustment is uncertain. - The EC’s discretionary fiscal effort (DFE) indicator attempts to reconcile narrative (bottom-up) and structural (top-down) approaches: - DFE uses bottom-up treatment for taxes and unemployment benefits but standard cyclical adjustment for other spending. - Example: For Ireland in 2012, structural revenues declined by about –0.15 percent of GDP (signaling expansionary stance), while the discretionary indicator suggests taxes increased by about 1 percent of GDP (capturing actual consolidation). - Policymakers should account for: - Uncertainty in potential output estimates and the possibility of permanent output losses following large crises. - The multiplier (μ) and tax responsiveness (τ) which reduce the realized budgetary improvement relative to announced plans via factor (1 – τ μ). - The risk that large consolidation could reduce potential output (hysteresis), thereby requiring even larger adjustment and possibly creating a self-reinforcing negative dynamic. *Italic: Source — IMF chapter “4. The Speed of Adjustment during the Crisis” from _eur1501* ### 0.5 built into it. So the fact that the coefficient of the first column is about –1.17 means that the ### _eur1501 - 0.5 built into it. So the fact that the coefficient of the first column is about –1.17 means that the ### Findings on multipliers and potential output - The coefficient of the first column is about –1.17, which implies the actual multiplier is about 1.7 (interpretation of Blanchard and Leigh 2013). - For potential output, a large coefficient (–1.365) should be interpreted as the long-term multiplier. - The effect of a fiscal consolidation of 1 percent of GDP resulted in a decrease in potential output of 1.365 percent. - Using DeLong and Summers (2012) logic, given these multiplier sizes, the change in fiscal policy during these years was self-defeating: - Despite consolidation efforts, policy actions led to an increase in the debt-to-GDP ratio rather than a decrease because of negative effects on potential output. - The coefficient estimated can be viewed as the product of the hysteresis parameter η and the standard short-term fiscal multiplier. - Given that the multiplier is estimated to be –1.7, and the coefficient is –1.3, this would imply a value for η around 0.8 (as reported in the text). - This value (around 0.8) is much larger than the value required for a self-defeating fiscal consolidation in DeLong and Summers (2012), typically below 0.2. ### Validation and broader evidence - Ball (2014) validates that a large cyclical shock changes potential output in his analysis of the long-term effects of the Great Recession. - International Monetary Fund (2009) findings: - Financial crises tend to have large and permanent effects on output; GDP never returns to previous trends due to permanent effects on labor markets, capital accumulation, and productivity. - Economies that apply countercyclical fiscal and monetary stimulus in the short run to cushion the downturn after a crisis tend to have smaller output losses over the medium run. - This evidence is consistent with the analysis of euro area data for the post-2009 sample. ### Methodological concern and responses - Potential criticism: the IMF could be putting too much weight on actual output changes when estimating potential output, exaggerating the fall in potential output. - Responses: - It is difficult to imagine euro countries fully regaining their precrisis trend level, so some losses are permanent. - If cyclical movements are being confused with permanent ones, then fiscal policy is still being misdirected: - Underestimating true fiscal contraction. - Pushing for further consolidation when not needed. - As structural balances are judged relative to potential GDP, mismeasurement leads to inappropriate policy. ### Irish experience: Too slow or too fast? - Summary assessment: - Irish fiscal plans stabilized the debt-to-GDP ratio and as of 2014 put it in a downward trajectory. - Stabilization was achieved via large budgetary adjustments and commitments fulfilled with minor delays, despite downward revisions in macro outlook. - Ireland regained access to international financial markets after the sovereign debt crisis. - Costs and trade-offs: - The crisis was made worse by fiscal contraction; the impact on growth is debatable but estimated here as significant—more so if potential output was affected. - Estimates for euro countries suggest effects that possibly put some into a self-defeating path: spending reductions causing potential GDP to fall and the debt-to-GDP ratio to increase, prompting further adjustments. - The speed of adjustment measured by actions taken (not outcomes) was judged to be clearly too fast. - Limitations: - Impossible to produce a counterfactual of a slower consolidation pace; econometric analysis only offers a hint that slower consolidation could have led to faster debt reduction. - Assumes there was a choice on adjustment speed; for countries without credit access, choice may have been illusory. - For the euro area as a whole, a different adjustment path was possible if there had been consensus among EU members (and the IMF) and credible policies before capital markets. ### The road ahead: medium-term challenges and policy assessment - Long-term fiscal pressures: - High levels of government debt require sustained fiscal effort over years and decades. - Demographic pressures will weigh on government budgets and likely reduce growth while increasing spending needs. - Historical context: - Pre-euro debt reductions benefited from an environment of fast growth (Ireland was a standout); such growth is unlikely to repeat. - Debt-reduction prospects vary by country and depend on economic and political developments. - Example: Italy never managed to reduce its debt despite the EU fiscal framework and a 60 percent debt ceiling. - New EU rules aim to impose an adjustment path toward 60 percent, but enforcement history shows room for renegotiation and creative interpretation. - Ireland-specific trajectory: - No explicit target on a particular debt level; EU-based fiscal rules (MTO, adjustment path condition, expenditure benchmark) provide a framework expected to lead to debt reduction. - Current medium-term government plans respect this framework, though margins are small and could lead to noncompliance depending on actual numbers (Irish Fiscal Advisory Council 2014a). - Possibility of faster adjustment: - A faster path than implied by EU framework is possible only if growth is strong and there is enough domestic consensus. - The 2015 budget illustrates difficulties in accelerating adjustment: - 2015 budget is consistent with previous plans and EU rules but drawn criticism that the government is not taking enough advantage of improved growth. - Irish Fiscal Advisory Council calls the 2015 budget a “missed opportunity to move the public finances more decisively into a zone of safety.” - IMF assessment: the 2015 budget plan “shows fiscal restraint but makes less progress than desirable.” - European Commission: tax cuts and expenditure increases in the 2015 budget conflict with the EDP recommendation to seize opportunities to accelerate reduction of the gross debt ratio back towards 60 percent of GDP. - Risk of adjustment stopping or slowing: - Possible if another large economic crisis occurs in the short to medium term (2008 debt surprise linked to the global financial crisis). - Large-crisis planning and risk management are constrained by technical and political feasibility and by the difficulty of estimating event probabilities. - Fiscal sustainability heavily depends on assumptions about potential growth: - Excessive optimism leads to unsustainable behavior. - Excessive pessimism can lead to lower growth, especially during a crisis. - Current practice: best characterized as guessing potential GDP growth rates, revising history as developments occur, and relying too much on short-term GDP forecasts—creating a difficult environment for long-term budgetary planning. *Source: Excerpt from IMF content unit _eur1501 - 0.5 built into it. So the fact that the coefficient of the first column is about –1.17 means that the (PDF).* ### References ### _eur1501 - References ### Major empirical and methodological sources - Bibliographic listings include works on long-term output effects of recessions, fiscal consolidation, public debt dynamics, fiscal multipliers, hysteresis, debt sustainability, and banking crises. Key cited works (authors and years preserved) include: - Ball, Laurence. 2014. - Barro, Robert J. 1979. - Berti, Katia, Francisco de Castro, and Matteo Salto. 2013. - Blanchard, Olivier J., and Daniel Leigh. 2013. - Blanchard, Olivier J., and Lawrence H. Summers. 1986. - DeLong, J. Bradford, and Lawrence H. Summers. 2012. - Escolano, Julio. 2010. - European Commission. 2013a; 2013b; 2014. - Eyraud, Luc, and Anke Weber. 2013. - Fatás, Antonio. 2000. - Fatás, Antonio, and Lawrence H. Summers. 2014. - Herndon, Thomas, Michael Ash, and Robert Pollin. 2013. - IMF country and topical reports: IMF 2007; IMF 2009; IMF 2012; IMF 2013; IMF 2014a; IMF 2014b. - Irish Fiscal Advisory Council 2014a; 2014b. - Kanda, Daniel. 2010. - Lane, Philip R. 2011. - Leith, Campbell, Ioana Moldovan, and Simon Wren-Lewis. 2011. - Leith, Campbell, and Simon Wren-Lewis. 2013. - Merola, Rossana, Peter Hoeller, and Douglas Sutherland. 2012. - Reinhart, Carmen M., and Kenneth S. Rogoff. 2010. - Schmitt-Grohé, Stephanie, and Martín Uribe. 2004. - Weymes, Laura. 2012. ### Appendix: Government debt in Ireland — data sources and measurement notes - All data used in the paper come from the October 2014 online database of the IMF World Economic Outlook (WEO). - Three series compared for Irish gross government debt (percent of GDP): - WEO database from April 2014 (does not include shift to ESA 2010 national accounts). - WEO database from October 2014 (includes shift to ESA 2010 accounts for GDP). - AMECO database from the European Commission (December 2014) (includes ESA 2010 changes to GDP and related fiscal account changes, notably inclusion of the Irish Bank Resolution Company in 2011 and its removal in 2013). - Key measurement findings and exact figures preserved: - The upward revision of GDP figures has reduced the debt-to-GDP ratio by about 6 percentage points. - The treatment of the Irish Bank Resolution Company modifies data for 2011–13 but leaves the final number around 110 percent of GDP, consistent with the IMF WEO October 2014 data used in the paper. - The difference between gross debt and net debt has increased by about 5 percentage points of GDP over the period 2008–14. - Observed asset trends: - The level of assets remains higher than in precrisis years (such as 2005–06), although a recent fall represents a clear break from the previous trend toward fast accumulation of financial assets. ### The Irish crisis and the EU: analysis and findings (Barry Eichengreen excerpt) - Crisis context and unique features: - Ireland’s 2008 banking crisis was the first major banking crisis in a euro-area member state and was shaped by euro-area membership constraints and cross-border financial market integration. - Claims on the Irish banking system peaked at some 400 percent of GDP. - The crisis reflected: - High mobility of financial capital within the single market. - Freedom for Irish banks to establish and acquire subsidiaries in other EU countries. - Perception of eliminated exchange risk in a monetary union, encouraging wholesale funding and risk-taking. - Absence of a banking union and single supervisor contributed to national supervisory lapses and insufficient attention to cross-border spillovers. - Pre-crisis regulatory and surveillance shortcomings: - Weaknesses in bank governance and risk management: high loan-to-deposit ratios; rapid loan book expansion; declining lending standards; large portfolio concentrations; lax internal controls; connected lending; loans backed by personal guarantees; valuation issues for collateral; managers borrowing from their own banks. - Central Bank and Financial Regulator identified problems but took little corrective action. - External surveillance shortcomings: - Committee of European Banking Supervisors (CEBS) focused on standards and best practices more than on member-state conformance; CEBS reports display little scrutiny of excesses in Irish banking practice. - European Commission surveillance focused on fiscal policy and praised budget surpluses, giving little attention to financial sector vulnerabilities. - IMF 2007 Article IV Consultation flagged rapid loan growth and high shares of lending to construction and real estate, but staff conclusions welcomed indicators confirming the soundness of the Irish banking system and stress tests suggesting cushions were adequate. The adverse scenario posited a cumulative two-year 22 percent decline in house prices. - Home prices rose by roughly 70 percent in the five years through the end of 2006. - Crisis response and the 2008 guarantee: - Timeline and rationale: - The blanket guarantee of the banks’ liabilities was issued two weeks after the failure of Lehman Brothers, during extreme market fragility. - EU officials (Commission and ECB) do not appear to have been implicated in the decision and were not consulted; the Commission and ECB were informed early on the morning of September 30th prior to public announcement. - Constraints on alternatives and role of ECB/ELA: - Emergency Liquidity Assistance (ELA) from the Central Bank of Ireland was an option but required assent (lack of objection) from the ECB governing council and could have activated sovereign-bank doom-loop concerns because ELA is an obligation to the Irish central bank that the government would have to stand behind. - Absence of a stigma-free liquidity facility and absence of a mechanism for direct bank recapitalization were factors pushing Irish officials toward a blanket guarantee. - Selective alternatives existed (guarantee deposits and new wholesale funding; haircuts for existing bondholders; guarantee liabilities of banks other than Anglo-Irish and Irish Nationwide while seizing/recapitalizing troubled institutions) but required better information to distinguish insolvency from illiquidity. - Consequences and dynamics: - ELA borrowing effectively worked to bail out bondholders as maturing bonds were repaid; the Irish sovereign paid off maturing debt it guaranteed and funded itself through summer of 2011. - ELA and Eurosystem support grew large; retrospective assessment notes “the level of liquidity provided by the Eurosystem in support of the Irish banking system had reached about €140 billion (including ELA), or about 85% of Irish GDP, by November” (text as provided). - Reliance on ELA and ECB discomfort contributed to wholesale funding runs and pressure for Ireland to negotiate a troika program; letters indicate President Trichet threatened termination of ELA, forcing application for aid. - Lessons and policy implications emphasized in the text - Need for pre-established crisis resolution strategies and clarity before crises occur. - Importance of information and capacity to distinguish insolvency from illiquidity rapidly. - Importance of quickly resolving insolvent institutions rather than prolonged life support. - Preference for bailing in uninsured creditors where appropriate. - Importance of transparency in crisis response. - Need for independent assessments of financial regulation, particularly in small economies susceptible to regulatory capture. - Support for institutional reforms: single supervisor and banking union to internalize cross-border spillovers and reduce national-regulatory blind spots. *Italic: Content derived from _eur1501 - References (source PDF content provided).* ### 2010. This represented about one-quarter of the ECB’s total lending at the time—an unprecedented level of exposure ### _eur1501 - 2010. This represented about one-quarter of the ECB’s total lending at the time—an unprecedented level of exposure ### ECB exposure, influence, and the sovereign-bank doom loop - The ECB held an unprecedented exposure to Ireland in 2010—about one-quarter of the ECB’s total lending—while Ireland’s share in ECB capital was [only] about 1 percent. - The ECB’s actions and positions: - Pressured Irish authorities to request a program in 2010; decision to request a program was made by the Irish authorities but “under duress.” - Opposed imposing losses on holders of €19 billion of senior unsecured and unguaranteed debt; the IMF initially favored a haircut of roughly 50 percent, supported by the Irish government, but the ECB’s position prevailed. - Its involvement in program design and monitoring was exceptional and controversial, and its opinions “carried weight.” - Consequences: - Threat or uncertainty that the ECB might withdraw funding if senior bondholders were bailed in caused Irish authorities to hesitate. - The monetary union in 2010 lacked a mechanism to directly recapitalize insolvent banks; this absence contributed to the sovereign-bank doom loop. ### Treatment of bank creditors and public reaction - Troika program creditor treatment: - Holders of equity bore losses, but other bank creditors were shielded from losses at the time, placing the fiscal burden on Irish taxpayers. - Public outrage arose because of absence of burden-sharing; this undermined public support for the program. - Institutional dynamics: - The IMF’s role as a “junior partner” (contributing only a minority of finance alongside regional entities) raised questions after it was outmaneuvered or felt obliged to give way. - Some commentators suggested Trichet insisted that Irish authorities not bail in bondholders to protect French and German banks; this is contested. ### The promissory note deal (IBRC rescue mechanism) - Structure and cash flows: - The Irish government provided the Irish Bank Resolution Corporation (IBRC) with €31 billion of promissory notes that generated roughly €3.1 billion annually (2 percent of GDP) for the first 13 years and smaller amounts thereafter. - The Central Bank of Ireland accepted the promissory notes as collateral and provided cash via ELA. - The scheme effectively guaranteed repayment of the promissory notes by the government, ensuring ELA extension approval. - Fiscal trade-offs and restructuring: - Paying out €3.1 billion required cutting an additional 2 percent of GDP from the budget or, once market access returned, refinancing ELA by borrowing at considerably higher cost. - In February 2013, the government restructured the promissory notes into long-term bonds with maturities of 27 to 40 years, eliminating principal repayments for the next 27 years and reducing the present value of the obligation by roughly 33 percent. - Circularity and risks: - Central bank profits remitted to the government could create circular flows if the central bank held these government bonds; selling the bonds to private investors was part of the deal. - Selling the bonds “as soon as possible, provided that conditions of financial stability permit,” risked depressing bond prices and adding fiscal strain. - The ECB governing council was studiously silent; a presumed “non-objection” was required for the deal to proceed. - Remaining questions: - Whether the €25 billion of long-term bonds (mentioned as related bank-rescue obligations) should remain sovereign obligations given later empowerment of the ESM to directly recapitalize banks is opaque. - Direct ESM recapitalization requires evidence of inability of the member state to assist without “very adverse” debt-sustainability consequences, systemic relevance of institutions, and a sound fiscal and macroeconomic record—conditions Ireland likely would have met in 2010. ### Macro forecasts, program design, and external shocks - Growth forecasting and outcomes: - The program used overly optimistic assumptions about growth domestically and in the euro area. - Euro area growth in 2012–13 was sharply lower than forecast; by 2013 euro area GDP was more than 5 percent lower than expected at the outset of the program. - Initial program anticipated Irish growth of 5.4 percent between 2010 and 2013; actual growth was 2.7 percent. - GNP growth in 2010–13 was 3.6 percent (noted as a more favorable lens). - Fiscal multipliers and consolidation: - The IMF acknowledged underestimating fiscal multipliers in an environment of near-zero interest rates and simultaneous consolidation across multiple European countries. - Hindsight suggests a slower pace of fiscal consolidation in Ireland and partners could have moderated output losses and unemployment while doing relatively little to slow the decline in the debt-to-GDP ratio. - EU-related shocks and policy messaging: - The Deauville declaration (October 19, 2010) that bondholders would be automatically bailed in in future crises caused a sharp increase in Irish sovereign spreads; subsequent backtracking did not fully repair the damage. - Greek crisis management and delays in private creditor restructuring spilled over and worsened Irish spreads. - Banking-sector adjustments: - The Irish program anticipated deleveraging largely via asset sales; the pace of fire sales has been criticized for depressing asset prices and increasing costs for the Irish taxpayer. - Persistent large stock of nonperforming loans raised questions about capital adequacy (Central Bank of Ireland 2014, 21). - More rapid and comprehensive write-downs of debts to bank bondholders could have mitigated these problems. ### ECB monetary and credit policy effects - Policy moves and effects: - ECB tightening in 2008 and 2011 was unhelpful for growth. - ELA was provided at roughly 75 basis points above the ECB’s refinancing rate, which was close to zero. - Even when Ireland regained market access in March 2013, yields on new 10-year bonds were on the order of 4 percent. - Godl and Kleinert (2014) do not find that announcement of the Securities Market Program and Long-Term Refinancing Operation had a favorable impact on Irish spreads. - President Draghi’s 2012 “do whatever it takes” statement was crucial in taking the specter of euro break-up off the table and likely essential for a clean euro-area exit from the troika program. ### Lessons learned, policy reforms, and unresolved issues - Criticisms and institutional failings: - The EU failed to anticipate the banking crisis, delegated supervision to national authorities, and lacked systematic effective financial surveillance pre-crisis. - The absence of a mechanism for direct recapitalization in 2010 allowed the sovereign-bank doom loop to operate. - The ECB influenced Irish policy choices: pressuring for a program request, opposing haircuts to senior unsecured debt, accelerating asset sales, and selling central bank-held long-term bonds at a risky pace. - Reforms since the crisis: - Creation of a banking union with a single supervisor, harmonized deposit insurance, a resolution mechanism capable of directly recapitalizing troubled banks, and a dedicated resolution fund. - These reforms aim to reduce supervisory capture, strengthen surveillance, prevent blanket national guarantees, and assuage contagion fears. - Remaining implementation challenges: - Making banking union reforms effective requires giving the single supervisor “real teeth,” fully funding the resolution fund, and allowing the ESM to assume meaningful amounts of credit risk. - Whether these steps will be fully implemented remains to be seen. *Source: INTERNATIONAL MONETARY FUND (content unit: _eur1501).* ### References ### _eur1501 - References ### References - Attinasi, Maria-Grazia, Cristina Checherita, and Christiane Nickel. 2009. “What Explains the Surge in Euro Area Sovereign Spreads During the Financial Crisis of 2007-09?” ECB Working Paper 1131, December, Frankfurt. - Blanchard, Olivier, and Daniel Leigh. 2013. “Growth Forecasts and Fiscal Multipliers,” Working Paper 13/1, IMF, Washington, January. - Central Bank and Financial Services Authority of Ireland. 2007. Financial Stability Report. Dublin: Central Bank and Financial Services Authority. - Central Bank of Ireland. 2014. Macro-Financial Review 1. Dublin: Central Bank of Ireland. - De Santis, Roberto. 2012. “The Euro Area Sovereign Debt Crisis: Save Haven, Credit Rating Agencies and the Spread of the Fever from Greece, Ireland and Portugal.” ECB Working Paper 1419, February, Frankfurt. - De Sousa, Carlos, Andre Sapir, Alessio Terzi, and Guntram Wolff. 2014. “The Troika and Financial Assistance in the Euro Area: Successes and Failures.” Study on the Request of the Economic and Monetary Affairs Committee, European Parliament, February. - Draghi, Mario. 2015. “Letter to Mr. Matt Carthy, Member of the European Parliament,” Frankfurt: European Central Bank (17 February), L/MD/15/86. - European Central Bank. 2014. “Irish Letters.” http://www.ecb.europa.eu/press/html/irish-letters.en.html. - European Stability Mechanism. 2014. “Guideline on Financial Assistance for the Recapitalisation of Financial Institutions.” Luxembourg. - Gonzales-Paramo, Jose Manuel. 2011. “The ECB’s Monetary Policy During the Crisis.” Speech to the 10th Economic Policy Conference, Malaga, October 21. http://www.ecb.europa.eu/press/key/date/2011/html/sp111021_1.en.html. - Hoggarth, Glenn, Jack Reidhill, and Peter Sinclair. 2003. “Resolution of Banking Crises: A Review.” Financial Stability Review, Bank of England (December): 109–123. - Honohan, Patrick. 2010. “The Irish Banking Crisis: Regulatory and Financial Stability Policy 2003–2008.” Report to the Minister for Finance by the Governor of the Central Bank, Dublin, May 31. - International Monetary Fund (IMF). 2006. “Ireland: Financial System Stability Assessment Update.” IMF Country Report 06/292. Washington, August. - International Monetary Fund (IMF). 2007a. “IMF Executive Board Concludes Article IV Consultation with Ireland,” Public Information Notice N117, Washington, September. - International Monetary Fund (IMF). 2007b. “Ireland: Staff Report for the 2007 Article IV Consultation.” Washington, August 2. - McSharry, Ray. 2014. in Brian Murphy, Mary O’Rourke and Noel Whelan (eds), Brian Lenihan, In Calm and in Crisis. Dublin: Merrion Press. - Mody, Ashoka. 2014. “The Ghost of Deauville,” Vox (January 7). www.voxeu.org. - Nyberg, Peter 2011. “Misjudging Risk: Causes of the Systemic Banking Crisis in Ireland.” Commission of Investigation into the Banking Sector in Ireland, Department of Finance, Dublin, March. - Pisani-Ferry, Jean, Andre Sapir, and Guntram Wolff. 2013. “EU-IMF Assistance to Euro-Area Countries: An Early Assessment.” Bruegel Blueprint 19, Brussels. - Whelan, Karl. 2013. “Ireland’s Promissory Note Deal.” February 12. http://karlwhelan.com/blog. ### Biographies of the Speakers - Welcoming Remarks - Brendan Howlin: Appointed Ireland’s Minister for Public Expenditure & Reform in March 2011; elected as Leas-Cheann Comhairle of Dáil Éireann in 2007; former Labour Party Spokesperson on European Affairs, Constitutional Matters and Law Reform, and Human Rights; Minister for the Environment (1994–1997); Minister for Health (1993–1994); member of Seanad Eireann (1982–1987). - Session 1: Stabilizing and Healing the Banks - Dirk Schoenmaker: Professor of Finance, Banking and Insurance at the VU University Amsterdam; Dean of the Duisenberg School of Finance; member of the Advisory Scientific Committee of the European Systemic Risk Board; Chairman of the Institute for Integrity and Reliability of Finance Professionals; former roles at the Dutch Ministry of Finance and the Ministry of Economic Affairs; author of Governance of International Banking: The Financial Trilemma. - Laura Noonan: European Banking Correspondent at Reuters, based in London; CFA charter holder; former business and banking correspondent at the Irish Independent and The Sunday Business Post. - John Fell: Deputy Director General for Macro-Prudential Policy & Financial Stability in the ECB since 2010; former Head of the Financial Stability Division and Editor of the ECB’s Financial Stability Review; chaired the Comprehensive Assessment Stress Test (CAST) team; led ECB input into EU-wide stress tests (2009, 2010, 2011, 2014); led ECB financial sector work for EU/IMF financial assistance programs; holds postgraduate degrees in economics (1987) and in finance (1993) from University College Dublin and Dublin City University. - Jonathan McMahon: Chief Risk Officer and executive board member at St. James's Place plc.; worked for the Central Bank of Ireland (2009–2012) on restructuring and recapitalization of the Irish banking system. - Ann Nolan: Second Secretary General at the Department of Finance, Ireland; Deputy Head of Department; Head of the Financial Services Directorate; member of the Pensions Authority; board member of the Strategic Banking Corporation of Ireland; 29 years in the Department of Finance with extensive policy experience. - Session 2: Putting the Budget on a Sound Footing - Antonio Fatás: Professor of economics at INSEAD; Research Fellow at the Centre for Economic and Policy Research; consultant for IMF, OECD, World Bank; research on business cycles, fiscal policy, and European integration. - Dan O’Brien: Chief Economist at the Institute for International and European Affairs; Senior Adjunct Research Fellow at University College Dublin’s School of Politics and International Relations; former European Commission economist and Economist Intelligence Unit senior economist and editor. - Gillian Edgeworth: Sovereign analyst for Wellington Management; former Chief European Emerging Market Economist at Unicredit Bank and economist at Deutsche Bank; senior member of the Political Economy of Financial Markets program at St. Antony’s College, Oxford University. - Tom Healy: Director of the Nevin Economic Research Institute; former roles at ESRI, Northern Ireland Economic Research Centre, OECD, National Economic and Social Forum, Department of Education and Skills; holds a Ph.D. (economics and sociology) from University College Dublin. - István Székely: Country Director in the European Commission’s Directorate-General for Economic and Financial Affairs; former IMF Mission Chief (1999–2007); former General Manager and Advisor to the governor of the National Bank of Hungary (1996–1999); holds a Ph.D. in economics from the University of Cambridge; honorary professor at the Corvinus University of Budapest. - Robert Watt: Secretary General of the Department of Public Expenditure and Reform in Ireland; leads public sector reform program; member of the government’s Economic Management Council; economist with public and private sector experience. - Keynote Speech - Patrick Honohan: 10th Governor of the Central Bank of Ireland, appointed September 2009; former Professor of International Financial Economics and Development at Trinity College Dublin; Senior Advisor on Financial Sector Policy at the World Bank; former Research Professor with ESRI (1990–98); former economist at the Central Bank of Ireland and the IMF; Ph.D. in economics from the London School of Economics (1978); research focused on monetary and financial-sector policy. - Session 3: Ireland’s Market Access and Euro Area Policies - Barry Eichengreen: George C. Pardee and Helen N. Pardee Professor of Economics and Professor of Political Science at UC Berkeley; Pitt Professor of American History and Institutions, University of Cambridge, 2014–15; Research Associate of the NBER; Research Fellow at CEPR; author of Hall of Mirrors, From Miracle to Maturity, and Exorbitant Privilege. - Seán Whelan: RTÉ's Economics Correspondent since 2010; former RTÉ Europe Editor; former Deputy Foreign Editor; previous print journalism roles; writes a weekly column in the Sunday Business Post. - Alan Ahearne: Professor and Head of Economics at National University of Ireland, Galway; member of the Board of Directors of the Central Bank of Ireland; member of the Central Bank's Audit and Risk Committees; former Senior Economist at the Federal Reserve Board; served as Special Advisor to Minister for Finance Brian Lenihan (March 2009–March 2011); holds a B.B.S., an M.Econ.Sc., an M.Sc., and a Ph.D. in economics. - Agnès Bénassy-Quéré: Professor of Economics at Paris School of Economics, University of Paris 1 Panthéon Sorbonne; Chair of the French Council of Economic Analysis; member of the Commission Economique de la Nation and the Cercle des Economistes; former positions at Universities of Cergy-Pontoise, Lille 2, Paris-Ouest, École Polytechnique, and the French Ministry of Economy and Finance. - Colm McCarthy: Occasional lecturer at University College Dublin School of Economics; former economist with the Central Bank of Ireland and ESRI; author of Ireland’s European Crisis: Staying Solvent in the Eurozone (2011); regular contributor on economic affairs to Irish media. - High-Level Panel Discussion - Wolfgang Münchau: European economic columnist for the Financial Times; author of The Meltdown Years and other books; co-founder of Eurointelligence.com; member of the Euro50 Group and the European Council on Foreign Relations; holds master’s degrees in mathematics and journalism. - Michael Noonan: Re-elected to Dáil Éireann in 2011 and appointed Minister for Finance in March 2011; first elected to the Dáil in 1981; former Leader of Fine Gael (February 2001–May 2002); former Fine Gael Finance Spokesperson and held several ministerial posts including Minister for Health (1994–1997) and Minister for Justice (1982–1986). - Benoît Cœuré: Member of the Executive Board of the ECB; Chairman of the Bank for International Settlements’ Committee on Payments and Market Infrastructures; former CEO of Agence France Trésor and senior French Treasury official; graduate of École Polytechnique; author of Economic Policy: Theory and Practice (Oxford University Press, 2010). - Valdis Dombrovskis: Vice-President of the European Commission in charge of the euro and social dialogue; former Prime Minister of Latvia (March 2009–January 2014); former member of the European Parliament; former Latvia Minister of Finance (2002–04); co-author with Anders Aslund, How Latvia Came through the Financial Crisis (2011); awarded the Order of the Three Stars (Triju Zvaigžņu ordenis) in November 2014. - Christine Lagarde: Managing Director of the International Monetary Fund (IMF) since 2011; graduated from University Paris X and obtained a master’s degree from the Political Science Institute in Aix-en-Provence; former French Minister for Foreign Trade, Minister for Agriculture and Fisheries, and Finance and Economy Minister; former Chairperson of the Global Executive Committee of Baker & McKenzie. *Content derived from _eur1501 - References* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/dp/2015/_eur1501.pdf_