EU Banking Crisis & Financial Signals

1. EU Banking Crisis & Financial Signals An Irish Perspective with a pan-European Solution Patrick A. McNutt www.patrickmcnutt.com

2. We begin…Irish Government ‘captured’

3. Signalling cycle evolves….

4. History of a crisis • GFC and convoluted debt instruments • 1999 Euro entry and cheap wholesale funds • Rent-seeking expenditures and ‘pet risky projects’ • Construction, construction and construction!!! • Neglect of small risks • Competition in mortgage market • ‘Fly-fishing for tuna’ with speculation on mortgage spreads • Deterioration of bank balance sheets • Government ‘captured’ by savvy bankers

5. 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 IPO • Debt for equity swap • Debt obligations arrangements put in place

6. 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

7. RSUs..explain Traditional 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. • RSUs • Examples - Facebook and other private sector IPOs • RSUs allocated during moratorium period [de-list] • Differs from present ECB arrangement of ‘addicted bank’ financing

8. Signals embed into sovereign default probability

9. No currency crisis…yet?

10. EU as ‘off-shore’ market for RMB

11. Euchina Bond Does 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.

12. Example: EUCHINA Bond = 500bn

13. Prognosis: avoid debt-deflation Second-best solution Template solution • Deposits migrate across Member States • Moral 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 RMB • Avoids a debt-deflation cycle embedding into EU’s real economy • Process: De-list insolvent banks to IPO to efficient consolidated EU banking sector.

14. We conclude…Euro crisis ‘Template’ solution

15. "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

16. Thank Youwww.patrickmcnutt.com