Morgan Kelly is professor of economics at University College Dublin and one of the few economists making serious dissenting noises about the Irish Government’s current economic strategy. I have quoted him at length before in Why God made Economists. Again he says it all so much better than I can…
Burden of Irish debt could yet eclipse that of Greece
It is no longer a question of whether Ireland will go bust, but when. Unlike Greece, our woes do not stem from government debt, but instead from the government’s open-ended guarantee to cover the losses of the banking system out of its citizens’ wallets.
Even under the most optimistic assumptions about government spending cuts and bank losses, by 2012 Ireland will have a worse ratio of debt to national income than the one that is sinking Greece.
On the face of it, Ireland’s debt position does not appear catastrophic. At the start of the year, Ireland’s government debt was two- thirds of GDP: only half the Greek level. (The State also has financial assets equal to a quarter of GDP, but so do most governments, so we will focus on the total debt.)
Because of the economic collapse here, the Government is adding to this debt quite quickly. However, in contrast to its inept handling of the banking crisis, the Government has taken reasonable steps to bring the deficit under control. If all goes to plan we should be looking at a debt of 85 to 90 per cent of GDP by the end of 2012.
This is quite large for a small economy, but it is manageable. Just about. What will sink us, unfortunately but inevitably, are the huge costs of the bank bailout.
We can gain a sobering perspective on the impossible disproportion between the bailout and our economic resources by looking at the US. The government there set aside $700 billion (€557 billion) to buy troubled bank assets, and the final cost to the American taxpayer is about $150 billion. These sound like, and are, astronomical numbers.
But when you translate from the leviathan that is America to the minnow that is Ireland, it would be equivalent to the Irish Government spending €7 billion on Nama, and eventually losing €1.5 billion in the process. Pocket change by our standards.
Instead, our Government has already committed itself to spend €70 billion (€40 billion on the National Asset Management Agency – Nama – and €30 billion on recapitalising banks), or half of the national income. That is 10 times per head of population the amount the US spent to rescue itself from its worst banking crisis since the Great Depression.
Burden of Irish debt could yet eclipse that of Greece
What ultimately matters for national solvency, however, is not how much the State invests in its banks, but how much it is likely to lose. It is alright to invest €70 billion, or even €100 billion, to rescue your banking system if you can reasonably expect to get back most of what you spent. So how much are the banks and, thanks to the bank guarantee, you the taxpayer, likely to lose?
Let’s start with the €100 billion of property development loans. We’ll be optimistic and say the loss here will be one-third. Remember, Anglo has already owned up to losing about €25 billion of its €75 billion portfolio, so we have almost reached that third without looking at AIB and Bank of Ireland. I think the final loss will be more than half, but we’ll keep with the third to err on the side of optimism.
Next there are €35 billion of business loans. Over €10 billion of these loans are to hotels and pubs and will likely not be seen again this side of Judgment Day. Meanwhile, one-third of loans to small and medium enterprises are reported already to be in arrears. So, a figure of a 20 per cent loss again seems optimistic.
Finally, we have mortgages of €140 billion, and other personal lending of €20 billion. Current mortgage default figures here are meaningless because, once you agree a reduction of mortgage payments to a level you can afford, Irish banks can still pretend that your loan is performing.
Banks in the US typically get back half of what they loaned when they foreclose, but losses here could be greater because banks, fortunately, find it hard to take away your family home. So Irish banks could easily be looking at mortgage losses of 10 per cent but, to be conservative, we will say five.
So between developers, businesses, and personal loans, Irish banks are on track to lose nearly €50 billion if we are optimistic (and more likely closer to €70 billion), which translates into a bill for the taxpayer of over 30 per cent of GDP. The bank guarantee may have looked like “the cheapest bailout in the world, so far” in September 2008, but it is not looking that way now.
Adding these bank losses on to the national debt means we are facing a debt by late 2012 of 115 per cent of GDP. If we are lucky.
He goes on…
There is more. The ability of a government to service its debts depends on its tax base. In Ireland the proper measure of tax base, at least when it comes to increasing taxes, is not GDP (including profits of multinational firms, who will walk if we raise their taxes) but GNP (which is limited to Irish people, who are mostly stuck here). While for most countries the two measures are the same, in Ireland GDP is a quarter larger than GNP. This means our optimistic debt to GDP forecast of 115 per cent translates into a debt to GNP ratio of 140 per cent, worse than where Greece is now.
And even this catastrophic number assumes that our economy does not contract further. For the last two years the Irish economy has not been shrinking, so much as vaporising. Real GNP and private sector employment have already fallen by one-sixth – the deepest and swiftest falls in a western economy since the Great Depression.
And on…
The Irish economy is like a patient bleeding from two gunshot wounds. The Government has moved competently to stanch the smaller, budgetary hole, while continuing to insist that the litres of blood pouring unchecked from the banking hole are “manageable”.
Capital markets are unlikely to agree for much longer, triggering a borrowing crisis for Ireland. The first torpedo, most probably, will be a run on Irish banks in inter-bank markets, of the sort that sank Anglo in 2008. Already, Irish banks are struggling to find lenders to leave money on deposit for more than a week.
Ireland is setting itself up to present an early test of the shaky EU commitment to bail out its more spendthrift members. Probably we will end up with a deal where the European Central Bank buys Irish debt and provides continued emergency funding to Irish banks, in return for our agreeing a schedule of reparations of 5-6 per cent of national income over the next few decades.
To repay these reparations will take swingeing cuts in spending and social welfare, and unprecedented tax rises. A central part of our “rescue” package is certain to be the requirement that we raise our corporate taxes to European levels, sabotaging any prospect of recovery as multinationals are driven out.
The issue of national sovereignty has for so long been the monopoly of republican headbangers that it is hard to know whether ordinary, sane Irish people still care about it. Either way, we will not be having it around much longer.
We have long since left the realm of easy alternatives, and will soon face a choice between national bankruptcy and admitting the bank guarantee was a mistake. Either we cut the banks loose, or we sink ourselves.
While most countries facing bankruptcy sit passively in denial until they sink – just as we are doing – there is one shining exception: Uruguay. When markets panicked after Argentina defaulted in 2002, Uruguay knew it could no longer service its large external debt. Instead of waiting for a borrowing crisis, the Uruguayans approached their creditors and pointed out they faced a choice.
Either they could play tough and force Uruguay into bankruptcy, in which case they would get almost nothing back, or they could agree to reduce Uruguay’s debt to a manageable level, and get back most of what they lent. Realising Uruguay’s problems were largely not of its own making, and that it had never stiffed its creditors in the past, the lenders agreed to a debt restructuring, and Uruguay was able to return to debt markets within a few months.
In one way, our position is a lot easier than Uruguay’s, because our problem is bank debt rather than government debt. Our crisis stems entirely from the Government’s gratuitous decision on September 29th, 2008, to transform the IOUs of Seán FitzPatrick, Dermot Gleeson and their peers into quasi-sovereign instruments of the Irish state.
So what must be done?
Our borrowing crisis could be solved before it even happens by passing the same sort of Special Resolution legislation that the Bank of England enacted after the Northern Rock crisis. The more than €65 billion in bonds that will be outstanding by the end of September when the guarantee expires could then be turned into shares in the banks: a debt for equity swap.
We need to explain that the Irish State has always honoured its debts in the past, and will continue to do so. However, the State is a distinct entity from its banks and, having learned the extent of the banks’ recklessness, we now have no choice but to allow the bank guarantee to lapse and to share the banks’ losses with their bondholders. It must be remembered that when these bonds were issued they had no government guarantee, and the institutions that bought them did so in full knowledge that they could default, and charged an appropriate rate of interest to compensate themselves for this risk.
Freed of the impossible bank debt, the Irish State could concentrate on the other daunting problems left by its decade-long credit binge: unemployment, lack of competitiveness and indebted households. The banks would be soundly capitalised and able to manage themselves free of political interference.
There are two common objections to sharing the banks’ losses with their bondholders, both of them specious. The first is that nobody would lend to Irish banks afterwards. However, given that soon nobody will be lending to Irish banks anyway, this is not an issue. Either way, the Irish State and banks are facing a period of relying on emergency funding. After a debt-for-equity swap, Irish banks, which were highly profitable before they fell into the clutches of their current “management”, will be carrying little debt, making them attractive credit risks.
The second objection is that Ireland would be sued in every court in Europe. Again wrong. Under the EU’s winding-up directive, the government that issues a bank’s licence has full power to resolve the bank under its own laws.
Chris Cook would undoubtedly agree to the debt for equity swap idea…
Of course, expecting politicians to sort out the Irish banks is pure fantasy. Like their British and American counterparts, Irish politicians have spent too long believing that banks were the root of national prosperity to understand that their interests are frequently inimical to those of the rest of the economy.
The architect of Uruguay’s salvation was not one of its politicians, but a technocrat called Carlos Steneri. The one positive development in Ireland in recent months is that control of the banking system has passed from the Government to similar technocrats.
This transfer did not take place without a struggle – one that was entirely missed by the media. When Anglo announced they wanted to take over Quinn Insurance despite the objections of the Financial Regulator, journalists seemed to view this as just another case of Anglo being Anglo. They should have remembered that Anglo cannot now turn on a radiator unless the Department of Finance says so, and what was going on instead was a direct power struggle between the Financial Regulator and the Minister for Finance.
Having been forced to appoint a credible Financial Regulator and Central Bank governor – first-rate ones, in fact – the Government must do what they say. Were either Elderfield or Honohan to resign, Irish bonds would straight away turn to junk.
Now you understand the extraordinary shift in power that lay behind the seeming non-headline in this newspaper last month: “Lenihan expresses confidence in regulator”.
The great macroeconomist Rudiger Dornbusch observed that crises always take a lot longer to happen than you expect but, once started, they move with frightening rapidity. Or, as Hemingway put it, bankruptcy happens “Slowly. Then all at once.” We can only hope that the Central Bank is using whatever time remains to us as an independent State to devise an intelligent Plan B – or is it Plan C?
Meanwhile, back in the make believe world of Irish politics…
Ryan rejects prediction of national insolvency
A SENIOR Minister has described UCD academic Prof Morgan Kelly as a “prophet of doom” for claiming the country will become insolvent unless the Government abandons its policies to bail out the banks.
Minister for Communications Eamon Ryan said yesterday he disagreed profoundly with the views expressed by Prof Kelly in an opinion piece in The Irish Times on Saturday.
In the article the UCD professor said that if allowed to continue the bank guarantee, Nama, and protections given to senior bank bondholders would leave Ireland with “a worse ratio of debt to national income than the one that is sinking Greece”.
However responding yesterday, Mr Ryan said the governor of the Central Bank, Patrick Honohan, who is an international expert in banking crises, had said the Government had got it right. “Most international commentators, including the European Commission, are saying the same.”
Well they would say that, wouldn’t they, given that it is international investor and bond holders in what were privately owned Irish banks that the Irish taxpayer is now being asked to bail out…
Prof Kelly argued that Ireland’s debt position was far worst when one excluded profits generated by multinationals and looked only at gross national product (GNP). But Mr Ryan rejected this analysis and said Ireland was trading in six key areas: tourism; food; energy; financial services; creative services; and high-tech FDI companies and manufacturers.
He said Ireland was doing well in all of those areas, and also argued the foreign companies created hundreds of thousands of jobs for Irish people who paid taxes.
He said Ireland’s trading position was much stronger than that of a country like Greece.
“We are trading in the positive. There is more money coming in than going out.
“When the international community look at that and see that Ireland is trading its way out of this, it will ultimately bring the debt burden down.”
Yes the real economy is doing relatively well in Ireland with “growth” expected to return this year. Nobody is arguing that foreign multi-nationals aren’t making a vital contribution to Ireland’s economy. However their profits are repatriated abroad and are not available to pay off Ireland’s Sovereign debt. So the more correct and accurate comparator for Ireland’s relative indebtedness is the the debt to GNP ratio which compares the size of our debt load to national income.
Meanwhile…
The Department of Finance has also disputed Prof Kelly’s analysis. In a statement issued over the weekend, it said it was based on serious inaccuracies.
According to the department, the academic’s analysis was extremely pessimistic.
The department also referred to a speech two weeks ago by Prof Honohan to the Small Firms’ Association where he said the cost of getting the banks out of trouble was manageable, and that most of them started the boom with a cushion of shareholders’ funds that would enable them to pay their debts from their own resources.
So why are Irish taxpayers being asked to stump up possibly another €30 Billion to recapitalise the banks? And what, precisely, are the “serious inaccuracies” in Morgan Kelly’s analysis? We are not told. Merely appealing to a speech by the Governor of the Central bank saying what Governors have always said: that “the cost of getting the banks out of trouble was manageable” is not exactly reassuring. That was precisely what the Minister for Finance said when he introduced the bank guarantee in the first place.
Ireland had a PDF: debt to GDP ratio as low as 25% as recently as 2007. That was always going to increase substantially after the fall of the Celtic Tiger and the world financial crisis. However the biggest single contribution to it rising to perhaps 125% will be the Bank guarantee scheme and the determination of the Government to turn private speculative debts into public sovereign debts.
Ireland doesn’t need to have a Sovereign debt crisis. It just needs to apply the laws of capitalism and let insolvent private banks – particularly a non systemic business bank like Anglo-Irish – go bust. Offering bond-holders a debt for equity swap – in what would normally be very profitable Irish banks – is in fact a reasonable way to proceed. Those who think this will make it impossible for Ireland to raise Sovereign debt again should remember the Latin American experience. Those who think that the “international investment community” will be forever grateful for Ireland Inc. bailing them out should remember the experience of the Obama administration:
Psychoanalyzing the Relationship Between Obama and Wall Street — New York Magazine
Considering the lengths to which the administration had just gone to rescue Wall Street from collapse, all this behavior might strike a (rational) person as ungrateful and even churlish. One explanation for it revolves around the industry’s endemic twin defects: short-termitis and amnesia. “Wall Street is focused on the next five minutes or the last five minutes,” says Roger Altman, a deputy Treasury secretary under Clinton and now chairman of the boutique investment bank Evercore Partners. “At the end of Obama’s speech at Federal Hall, he said that this community must remember the debt it owes to the taxpayers. But I’m not sure most of Wall Street does remember.”