The Irish debt trick the ECB doesn’t want you to learn

Liquidation time.
Liquidation time.
Image: AP Photo / Peter Morrison
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This item has been corrected.

Irish and European central bank officials struck a deal today that will help Ireland kick a big part of its debt obligations far down the road. But it’s not clear what kind of precedent it will set for other countries in similar straits.

The issue at hand revolved around Irish government’s attempt to keep two banks afloat. Anglo Irish Bank and Irish Nationwide, which subsequently became Irish Bank Resolution Corp (IBRC), were nationalized in 2009. But the government, with its own finances in tatters, couldn’t raise money from bond markets or other traditional sources of funding to keep the bank solvent. So it issued a promissory note, a guarantee to pay IBRC €3.06 billion every March for 10 years. The IBRC used this as collateral to borrow money from the central bank. That temporarily solved the bank’s liquidity problem; but it left the government with a debt millstone around its neck, made worse by the fact that it had accepted crippling austerity measures as part of a €67.5 billion loan package from the EU and International Monetary Fund.

Two events that broke in the last 24 hours removed that millstone.

First, in a rowdy midnight parliament session, Irish lawmakers voted to liquidate IBRC. This gave the government direct control over the bank’s assets, and allowed it to replace the short-term promissory note with longer-term government bonds that begin maturing only in 2038. Then earlier today, prime minister Enda Kenny announced that the ECB had approved these newly converted bonds as sovereign debt, which it accepts as collateral—allowing the banks to borrow cash from the ECB.

That would relieve Ireland of the burden of being the only euro-zone country indebted with promissory notes as well as ordinary government bonds. And with the debt bullet dodged, it hopes to be on track to pay off the EU-IMF bailout package at the end of this year, freeing it from the austerity measures. “The new plan will likely materially improve perceptions of our debt sustainability in the eyes of potential investors in Ireland,” Kenny said, according to Reuters. ”A successful Irish exit from the bailout by the end of this year would prove that a combination of intensive national reform efforts and European solidarity can deliver results.”

Still, the ECB was long uneasy about the deal, because creating a promissory note can be interpreted as the equivalent of printing money in order to finance debt—something that is illegal under the EU’s Maastricht treaty—and so turning it into bonds would be equally problematic. (It’s not yet entirely clear how the ECB overcame its qualms.) So this sets an uncomfortable precedent. In theory, any country that has been shut out of the bond markets could now do an end-run around them, by creating an impossible-to-meet promissory note, then wheedling the ECB to let it convert that into more manageable sovereign debt. What if Spain or Italy decided to do the same? Presumably, the ECB will not let that happen, but it might find it harder to explain why.

Correction: An earlier version of this article mis-spelled the first mention of the Irish prime minister’s last name as Kelly instead of Kenny.