EU Banking Crisis & Financial Signals

An Irish Perspective with a pan-European Solution

Patrick A. McNuttwww.patrickmcnutt.com

We begin…Irish Government ‘captured’

(Hidden) Bank indebtedness

Pre-2008

Government Guarantee all

creditorsSeptember 30th

2008

Sovereign bail-out

November 30th 2010

EU/IMF

Signalling cycle evolves….

SELL: Financial

News

Signals

BUY Rumo

urs

History of a crisisGFC and convoluted

debt instruments1999 Euro entry and

cheap wholesale funds

Rent-seeking expenditures and ‘pet risky projects’

Construction, construction and construction!!!

Neglect of small risksCompetition in

mortgage market‘Fly-fishing for tuna’

with speculation on mortgage spreads

Deterioration of bank balance sheets

Government ‘captured’ by savvy bankers

Second-best solutions emerge…EU cannot fix debt

crisis unless it fixes the banks

Irish and many EU banks are insolvent

Treasure hunt of potential default nations

Common pool problem 1/n

Bank debt ‘crowd-in’ sovereign debt

De-list insolvent banks for a 2 year period

Restructure for IPODebt for equity swap Debt obligations

arrangements put in place

Optimal pan-European solution:Template

One-bank model for defaulting Member States

All banks = One bank = post IPO Start-Up Bank plc structured as IPO and sovereign ‘default’ bond issue

Sovereign ‘default’ bonds issued

(i) RSUs in a ‘debt for equity ‘swap

(ii) China as a ‘most favoured’ investor in a bespoke Euchina bond – ‘internationalisation ‘ of RMB

RSUs..explainTraditional shareholders and institutional shareholders could be allocated restricted stock units (RSU) which convert to equity only after an IPO and cannot be resold on any exchange. During the moratorium period, the banking sector would be consolidated in an efficient and timely manner, balancing redundancies and redeployment with financial innovation measures to restore solvency and liquidity. Debt exchange arrangements, reminiscent of the private sector, would then be put in place.

RSUsExamples - Facebook and

other private sector IPOsRSUs allocated during

moratorium period [de-list]

Differs from present ECB arrangement of ‘addicted bank’ financing

Signals embed into sovereign default probability

• Signals from financial media• Probabilities

Signalling cycle

No currency crisis…yet?

July 2011 No Euro crisis in FOREX

markets

Waiting costs for permanent ‘rescue

package’ ESM in mid 2013

Does China want to internationalise the

RMB? Yes.

EU as ‘off-shore’ market for RMB

Euro-debt crisis continues & a signalling cycle evolves

Liquidity support & Internationalisation of

RMB

Euchina BondDoes China want to internationalise the RMB? Yes. It would preserve the value of China’s foreign reserves and facilitate China’s role in the world’s economic and financial affairs. Trade settlement with RMB is already open in Hong Kong. Trade with China can be settled in RMB. Russia, India, Brazil, New Zealand and South Africa now settle trade with RMB. Corporate bonds denominated in RMB are sold in Hong Kong. 

The Euro debt crisis presents an opportunity to introduce Europe as an ‘offshore’ market for RMB.

If we take the EFSF €500b provision as a benchmark, China buys the €500b Euro debt as (say) a ‘Euchina bond’ in return for a first stage in the internationalisation process of the RMB.

Example: EUCHINA Bond = 500bn

• RMB flows out of China into the EU

Stage 1

Prognosis: avoid debt-deflationSecond-best solution Template solutionDeposits migrate across

Member StatesMoral hazard with ESM

‘permanent rescue’ Indicators of ‘black

economy’ activity and structural unemployment

Increased savings (paradoxically) with credit card indebtedness.

Pan-European solution that supports the Euro as an international reserve currency

Liquidity support for RMBAvoids a debt-deflation

cycle embedding into EU’s real economy

Process: De-list insolvent banks to IPO to efficient consolidated EU banking sector.

We conclude…Euro crisis ‘Template’ solution

De-list insolvent banks, IPO and consolidation

Search for a global solution as EU ‘off-shore’ hub

for RMB

Euro crisis morphs/dissolves

into a new financial

innovation

"Old age hath yet his honor and his toil.Death closes all; but something ere the end,Some work of noble note, may yet be done,Not unbecoming men that strove with Gods."-Alfred, Lord Tennyson, "Ulysses

Thank Youwww.patrickmcnutt.com