Will Merkel grant ‘austerity model’ Ireland retroactive bank recap mutualisation?

A key sticking point in the European policy debates over the banking sector concerns bank recapitalisation. As one would expect, the countries in crisis that have experienced a property bust like Spain and Ireland, would like to strip away some of the loss socialisation that is taking place as government takes on the debts of the financial sector. Germany has not allowed this to occur.

In fact, Germany completely backtracked on the June deal to bailout Spanish banks. Initially, the talk was of a EuroTARP which severed the link between sovereign and financial sector distress. But, as Merkel began to face heavy criticism at home for doing this deal, she walked back this talk and forced Spanish PM Rajoy into a humiliating defeat that would narrow Spain’s options down the line. Immediately after it became obvious that all of Spain’s financial sector woes would fall completely on the Spanish sovereign along with regional government debt rollovers, Spain’s yields shot up, forcing the ECB into the OMT as bailouts had become politically toxic. Spain is in big trouble because of this.

Essentially, Rajoy was hoodwinked, and now the country faces a deflationary spiral due to the crushing austerity program it is being forced to undergo. In Ireland, it is different. People are talking about recovery. To wit, Ireland has consistently outperformed all the euro zone peers on the most recent few months of PMI manufacturing reports, even better than Germany. 

Nevertheless, there is concern in both Ireland and Spain about the lasting effects of having to socialise its banking system losses by having government pick up the tab. Spanish newspaper ABC notes that the Irish are putting pressure on the German government to mutualise these losses by retroactively providing a recap for Irish banks via the European bailout funds once EU-wide oversight is in place. German Chancellor Merkel has already said that Spain would not receive such a retroactive recap. But Irish PM Enda Kenny and Merkel are said to have discussed “the unique circumstances of Ireland’s banking crisis and sovereign debt and plans for Ireland’s return to the [public] market” for government debt. According to ABC, both the German government and the Irish government believe that Ireland is a “special case” that is somehow different from Spain – hence the belief that Ireland will get retroactive bank recaps.

Let’s remember here that Angela Merkel is keen to avoid bailout extensions during a German election year. I have discussed this in the context of Portugal in the past because Portugal cannot make the grade in cutting its deficits quickly enough to get public market debt financing access before the existing Troika program ends. Ireland is another story, especially since they have already gone to market on several occasions to test demand for Irish sovereign debt. My sense here is that Merkel, ever the pragmatist, will see the benefit of getting Ireland off of a Troika program in order to be able to present the country as an example of what happens when countries do austerity the right way. Ireland will then be the carrot for Portugal, Italy and Spain if they continue to obey the austerity stick that is being dished out. Greece, of course, is too far gone for it to be fully considered in this calculation.

German government spokesperson Steffen Seibert denied that Ireland would receive “special treatment” even though the Irish are busy leaking just the opposite story. But clearly, nothing is true until it has been officially denied. So you can take these stories as evidence that these ideas are under consideration right now and are actively being discussed in Ireland and in Germany and elsewhere in the euro zone.