Monday, December 20, 2010

Letter to FT on Lomborg's false dichotomy

The following letter was published in the Financial Times today (20 December, 2010), in response to this article by Bjorn Lomborg (from the FT, 9 December, 2010).


In the article “Time for Europe to show real vision on climate” (FT, 10th December), Bjorn Lomborg argues that "We will never succeed in making fossil fuels so expensive that no one wants them [...] Instead, we should make green energy so cheap that everyone wants it". There is an inherent inconsistency in this line of reasoning, as the decision to switch from burning fossil fuels to some alternative depends on the relative prices of each.

The figures quoted in the article seem to suggest that emissions reduction is very expensive, while developing green tech alternatives would be relatively cheap. These cannot be simultaneously true. If cheap alternative energy sources are developed then emissions reduction becomes cheap as a consequence. Incidentally, it is notable that no reference is made to the assumptions and uncertainties inherent in the types of estimates to which the author refers.

As regards his policy recommendations, Lomborg advocates supply side solutions to climate change without specifying how the necessary investment might be stimulated. Does he envisage governments giving large-scale subsidies to the green energy sector? Such schemes are unlikely to be cheap.

Private sector investment in green energy alternatives is constrained partly by uncertainty, which pushes up the risk premium required by investors. One way of reducing this uncertainty - and thus stimulating greater investment - is to formulate more coherent climate policy, something which Lomborg seems to think is no longer worthwhile.

The simple, but false, dichotomous interpretation of the available policy options presented in this article may be a good way of getting media attention, but it is not a good way of thinking about complex socio-economic or scientific policy issues.

Yours etc.

Tom McDermott & Stefano F. Verde, Trinity College Dublin

Tim Laing, LSE

and Aurelie Mejean, CIRED, Paris

Update: Lomborg's response to our letter is here.

Learning our Lessons

Letter to the Irish Times, 5 December 2010 (not published)

A chara,

Stephen Collins makes the now standard error of blaming wide swathes of Irish society for our current woes ("Bailout teaches what we should have learned years ago", 4 December). We will be living with the consequences of decisions taken by a reckless minority in this country for many years to come. However, we should be very clear about one thing: this bailout and the concomitant loss of sovereignty, has been precipitated by the actions of private banks - both Irish and others - actions which our present government and it's European 'partners' now expect Irish people to take responsibility for.

Is mise,
Tom McDermott

Monday, December 6, 2010

Breaking down the "bailout"

Phoenix magazine had a very clear breakdown of the "bailout" in its most recent issue. (I couldn't find it online - you need a subscription - so I'll just quote some of the key points here)

Total borrowing involved in bailout: 60.5bn euro (the remainder comes from Ireland's own funds - pension reserve and whatever cash the NTMA has stored up).

Of this:

- 22.5bn is from IMF at interest rates of around 3-4%

- 17.5bn from the European Financial Stability Facility

- 22.5bn from the European Financial Stability Mechanism

EFSF is mainly German and French money. It's a special vehicle set up to fund EU members in need of restructuring funds. It operates in conjunction with the German Debt Management Office.

According to the framework agreement which set up the EFSF, the interest rate to be charged is "intended to cover the cost of funding incurred by EFSF and shall include a margin [ie a profit] which shall provide remuneration for the guarantors". On top of this there is a service fee to cover operational costs and various fees, which is charged upfront at 0.5% of the total loan (ie 88m).

The rate applied is based on "the rates corresponding to swap rates for the relevant maturities" (today approx 2.7%) plus "a charge of three percent for maturities up to three years and an extrra one percent per year for loans longer than three years" (ie 6.7% - making a profit for the EFSF of 4bn over the lifetime of the, ahem, "bailout"!!!).

It gets worse.

"The anticipated margin that would accrue on each loan to its scheduled maturity date shall be deducted from the cash amount to be remitted to the borrower in respect of loan. The service fee and the net present value of the anticipated margin ... will be deducted from the cash amount remitted to the borrower in respect of each loan but shall not reduce the principal amount of such loan that the borrower is liable to repay and on which interest accrues under the relevant loan". [that quote also comes from the framework agreement].

(ie they take their 4bn of the 17.5bn they are lending us before the money ever gets to Dublin, while charging interest on the full amount!).

EFSM money will be charged at 5.7%, if we draw down the full amount. (Greece paid 5.2%).

Ireland's so-called "bailout"

What's happening now is a variation on what I complained about previously (in my unpublished letter to the Irish Times, posted here). Rather than using the "we all partied" line (and what a gem that is - the line now is this crap about the state running out of money, having no alternative etc., with Fianna Fail taking some culpability for some mistakes somewhere in the distant past (but sure the others would've done the same anyway), and ultimately we should be grateful to our Euro "partners" for bailing us out of this fine mess we've gotten ourselves into.

This is all a web of lies, deception etc. The only reason markets stopped lending to Ireland in the last few weeks is because of the bank debt that has been nationalised. WE CANT AFFORD TO REPAY THIS. The markets know this. Our banks have been shut out of international markets - because their losses on property etc. have been rising beyond any "worst case scenarios" previously envisaged, and because they had become entirely reliant on money from the ECB (this is its role remember: CB = lender of last resort to the financial system, so let's not feel too grateful/ashamed for requiring this facility either). Then the markets got really spooked when Merkel started talking about making bondholders share the pain without giving any details.

So Ireland was pressured into taking the bailout in an attempt to "stuff" the banks with cash (over-capitalise them is what Gov Honohan called it) and convince markets this was the end of it so they would start lending to our banks again. The whole point was to avoid "contagion" to the other Euro countries in trouble. This hasn't worked. Big surprise. The bit about using this money to fund the Irish state is a total sideshow.

We do need to make a big "fiscal correction" over the next few years, but that is totally doable.

So, yes I believe we do have an alternative. As David McWilliams has been saying, what we need is a new "bank resolution" law (I don't think any such legislation currently exists in Ireland, so creating an entirely new one should be straightforward). The law would simply state that in Ireland, when a bank becomes insolvent (the Irish CB could be allowed to decide when this is so) that bank's bondholders must share the burden. Specifically we would create a debt-equity swap mechanism. Bondholders who are owed money by an insolvent bank will have their debt converted into equity (or shares in the bank). The bank doesn't disappear. In fact the bank is now significantly healthier as it has rid itself of debt. Depositors would have to be protected by some sort of insurance. (The Irish government already guarantees anything up to EUR100k. I'm not sure if we would need European cooperation to guarantee bigger deposits.)

The bit about all the medium sized firms imploding in such a scenario is probably exaggerated. Our banking system wouldn't disappear over night. As it is, small firms are having a really hard time getting credit because whatever money goes into the banks is being used to pay down their debts and/or build up these extra capital requirements that are supposed to make them look like good banks again.

So the banks' bondholders would suffer losses. But they expect this, because it will become European law in 2013. Anyway, even if we piss off some investors, so what?! Would the markets ever lend to Ireland again? Of course they would. The 'markets' are not a single entity with some sort of institutional memory. They are made up of lots of different investors all over the world. Investors do not generally hold grudges. They make decisions based on future prospects of risk/return. Even if some of the specific individuals that get burned in this scenario did decide to take it personally and never lend to Ireland again it wouldn't matter. Ireland is small. So are our funding needs by international standards. There are plenty of more investor fish in the sea, so to speak.

An Irish state that is rid of its bank debt obligations would represent a very attractive investment (especially at the kind of rates we are paying for this so-called "bailout"). We will still have low taxes by European standards (even after we get our fiscal house in order). We have a young, well educated workforce. We have a hugely successful manufacturing and internationally-traded services sector, with highly profitable divisions of some of the world's biggest companies based here. We have a lot going for us. Yes this course of action involves some reputational damage, but would that really be worse than the reputational damage already done by fiscal and economic mis-management? And the reputational damage of having to be "bailed out"?? Distinguishing between the Irish state and the Irish banks might actually be a good way to begin restoring our damaged reputation overseas. Anyway, a damaged reputation (and some bruised egos) is a lower price to pay than the costs associated with this bailout and our continued commitment to pay for whatever losses are accrued by our reckless banks.