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1 Don Walshe Economics Dept, UCC Tel: 021-4549212 E-mail: don.walshe@ucc.ie Budget, Banks and Bailout Economics Webinar December 8 th, 2010

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2 Bond Vigilantes Irelands creditworthiness questioned on multiple fronts: Inability of State to absorb banking losses (scale) Austerity measures in NRP a drag on medium-term growth Ad hoc, opaque, and uncordinated response from EU/ECB undermines effort to stabilise debt/GDP ratio If sovereign investors are forced to assume bank risk, they will charge a bank cost of capital (7.5% plus) As a consequence, bail out should involve moving bank risk to where it is best borne (i.e. not with domestic taxpayers) This is the agenda of the bond vigilantes

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3 Not a Bail Out but a Restructuring Package Emphasis on Systemic Risk management Recapitalise (Taxpayer) Restructure/Downsize (Taxpayer/Private Capital) Recourse to Market Funding (Private Capital) Forced risk-sharing i.e. investor bail in is not a feature Loss burden not to go higher than equity and junior lenders As a result, de-leveraging of bank sector amounts to raising 113bn (restructuring) to payoff senior debt Contentious as bail-in measures such as debt/debt, debt/equity swaps commonplace in other IMF programmes such as the South East Asia in 1998.

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4 The Euro Dimension is Critical ECB decided (Nov10) that its exposure to Irish Banks unsustainable (90bn + 30bn emergency liquidity from CBFSAI) ECB pushed Government to apply for external assistance and difficult to say no given extent of liquidity support from ECB ECB/EU require Irish Government to buffer (via NPRF) losses for senior bondholders even for the obviously insolvent banks such as Anglo and Irish Nationwide Moreover, special legislative regime will also find it difficult to burden-share with juniors as State injects first loss capital Funding to come from IMF( @ 5.7%)/EFSM( @ 5.7%)/EFSF( @ 6.05%) Not bail-out terms, but terms to force bank restructuring

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5 Walking a Tightrope Plan secures large package of funding for bank re-cap and commitment from ECB to provide large share of ongoing funding Systemic fears insulating bondholders for the time being Key issues Can banks be re-organised and sold to well-funded outsiders quickly? Can additional bank losses be contained within the NPRF portion of the funding? If so, Irelands creditworthiness can be restored and reflected in lower bond yields If not, default is inevitable and the systemic consequences will have to be dealt with by the ECB

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6 Thank you!