Workers Solidarity Movement

Today the markets gave their reaction to the government's 4 year austerity plan unveiled yesterday.  They were not impressed. Irish soverign bond prices plunged again and Europe's biggest clearing house, LCH.Clearnet, raised the margin call on Irish sovereign debt for the third time this month.

 

LCH.Clearnet is one of the companies that guarantees (or clears) trades in the repurchase agreement trades, known collectively as the repo market, for short. In a repurchase agreement a holder of Irish 10 year bonds, say Bank of Ireland, who needs to borrow short term cash, sells the bonds to a buyer at a discount on face value, with an agreement to buy them back at face value a short time in the future. A clearing house, such as LCH.Clearnet guarantees that should the repo seller not have the cash to buy back the bonds on the agreed date, the repo buyer will be reimbursed the full value of the securities by the clearer, in exhcange for the bonds. However, in return for this service of absorbing the risk, the clearing house charges the seller a percentage of every deal they guarantee, called the margin, depending on the riskiness of the bonds or securities being swapped for cash. If the perceived risk associated with any bond, in this case Irish sovereign bonds, increases, then the clearing house can announce the margin they charge for deals on those securities will increase and the sellers have to give more cash to them to cover the deal.

 

This is what has been happening for the last 2 - 3 weeks. Originally the margin for Irish sovereign bonds was 5%. On November 10th LCH.Clearnet incrased the margin by 15% up to 20% and on November 17th this went up again to 30%. This meant that Irish banks who had borrowed money from the repo market on the basis of government bonds were suddenly faced with having to find nearly a quarter of the value of they'd borrowed to pay off the clearing house. That in turn means they have had to sell bonds to get the cash for the margin call into a market where the only buyer is an increasingly pissed off ECB.

 

As the bond prices drop, the ratings agencies like Standard & Poor's downgrade Irish debt (as happened earlier this week), forcing pension funds to dump the bonds (as they are generally bound to hold only bonds rated to a certain level) and prompting the clearing house to consider upping the margin call further. It's a self-reinforcing death-spiral.

 

So today's response by the bond market and its main clearing house to increase the rate of descent, is their verdict on the 4 year plan. Cowan and Lenihan may insist that they believe that this savagely deflationary programme will not push the Irish economy into default, but the markets have put their money where their mouth is - anywhere but Ireland.

 

WORDS: Paul B