Kiberd agrees with Kelly on debt

Damien Kiberd is a sound commentator in my view. His article supports my abhorrence of the NAMA project from the outset. Brian Lenihan Jnr has not been a good Minister for Finance depite the rumours to the contrary. He could be worse in the usual Fianna Fail manner but he has been enveloped by the establishment from the beginning. Kiberd in essence details the evidence that forces him to conclude that Professor Morgan Kelly of UCD is correct in his recent apocalyptic pronouncements in the Irish Times article when he concluded we are bankrupt – only a question of time.

The bloated deficit undermining us

We have slashed wages, imposed taxes and cut social welfare. Yet we still run the highest deficit in the eurozone

Damien Kiberd

On April 18, I wrote here (Sunday Times)that the rising cost of the bank bailout could lift Ireland’s debt to gross domestic product (GDP) ratio to 120%. I said that the debt to gross national product (GNP) ratio could rise to 150%. The logic behind this argument is inescapable.

The state has invested €12.5 billion in Anglo Irish Bank. Another €10 billion is required, according to government nominees on Anglo’s board of directors. Anglo is 100% state-owned. After transferring loans to the National Asset Management Agency (Nama), it will retain a loan book of €35 billion, of which 53.5% is classed as impaired. Further losses will be the taxpayers’ responsibility.

The government has also pumped €2.7 billion into Irish Nationwide Building Society (INBS), but its final capital requirement will be closer to €5 billion. It, too, is 100% state-owned. Its debts are now ours.

So for the two problem children of Irish banking, the cost to the state is
€25 billion and counting. It is not unreasonable to assume that the bill will stretch beyond €30 billion.

The state has invested €7 billion in Allied Irish Banks and Bank of Ireland, but did not borrow to do so. These are pension reserve investments and recoverability depends on the stock market prices of shares in the two banks. Let’s assume a happy ending.

Nama is borrowing €40 billion to give to banks for toxic loans. Only 33% of these loans are “cash generative”. The legal work on many of the loans is a “litany of horrors”, to quote Nama’s boss, Brendan McDonagh. Any write-down on loans acquired is the taxpayers’ liability.

How much will Nama end up costing the state? Willie Slattery, the head of the State Street funds operation in Ireland, says the agency will end up losing €15 billion. So, if we add in provisions for further write-offs at state-owned banks, particularly Anglo, and take this insider’s view of Nama, the total cost will amount to about €50 billion.

Professor Morgan Kelly of University College Dublin uses a different method to calculate the scale of the bailout but arrives at much the same conclusion. His estimate is that debt will hit 115% of GDP or 140% of GNP by 2012 — if we are lucky.

He says the state is likely to become increasingly responsible for loan losses on credit given by these banks to developers, speculators, small and medium enterprises, consumers and mortgage-holders. He says the bill for write-offs will range from €50 billion to €70 billion. His loan loss projections are based on quite conservative assumptions of 20% default by small and medium-sized enterprises and big companies, 33% by property developers and 5% by mortgage-holders.

He picks the lower €50 billion estimate of the total cost before making his debt/output projections. Yet the resultant numbers are horrific, a truly gargantuan sum to be borne by 4m people and their descendants.

Britain is 15 times our size in terms of population. Gross the numbers up.
Would the UK’s voters accept a €750 billion tab for bank bailouts? I doubt it. The population of America is 300m. Would its electorate tolerate a $5 trillion bill for bank rescues? No.

Kelly’s solution is controversial. He says the state should not default on its core debt but should convert up to €65 billion worth of bank bond issues into bank equity.

Many analysts see this as far-fetched. Converting bank debt to equity might be impossible at Anglo and INBS, and unnecessary at AIB and Bank of Ireland. But it is right to consider radical proposals. The government is, after all, mortgaging our futures.

President Franklin Roosevelt’s first move after coming to power in the 1930s was to shut all the American banks for a fortnight and reopen them gradually over a two-year period. Against all advice from the economic establishment, he then used a minor piece of farming legislation to take the dollar off the gold standard and devalue the currency. His radicalism paid off.

But a dose of realism is in order too. Servicing the €50 billion bank bailout won’t come cheap. Even if the National Treasury Management Agency
(NTMA) is lucky, this money will be borrowed at rates of close to 5%. The rate will be higher if sovereign debt markets continue to deteriorate.

And this bill comes on top of the government’s core borrowing requirement, which is just under €20 billion a year.

We cannot afford to hang around when it comes to debating this issue. Our debt to GDP ratio was 25% at the end of 2007. It hit 65% last year. Gross debt, as defined by Eurostat, will reach 89% by the end of 2011, according to the Economic and Social Research Institute.

Greece was able to float 10-year sovereign bonds at 5% as recently as January. By April, it was being asked for rates of up to 18% on two-year finance. Effectively, the big European banks shut the doors of global credit markets on Greece.

Greece did not default, but the only thing that saved it was a €110 billion EU rescue package, which in effect underwrites the orderly repayment of Greece’s loans from Commerzbank, Crédit Agricole, Deutsche Bank and other lenders. The price came in the form of externally imposed austerity measures. Greece is bust in all but name.

Those who think any notion of renegotiating the terms of distressed Irish bank bonds are fanciful should consider the following: the two most eminent figures who suggested a pre-emptive negotiated debt restructuring by Greece (as a prelude to any rescue) were Paul Krugman, a 2008 Nobel prize-winner, and Nouriel Roubini, who is something of a prophet on Wall Street.

The latter claims that the Greek rescue money is in effect being wasted as it has not been preceded by debt restructuring.

Here in Ireland, we are attempting an even more astonishing task. We are running a country where tax income has collapsed from €48 billion a year to
€31 billion. The money value of our GNP is 25% below peak levels. We would normally be stimulating the economy, using Keynesian techniques. Instead, we have embarked on a massive austerity programme that remains to be completed.

We have cut the gross wages of public servants by 20%, while imposing additional taxes and levies on all workers. We have even cut social welfare. Yet we still run a bloated 14.2% deficit that is the highest in the eurozone and threatens to undermine our capacity to borrow money at reasonable rates. And yet nobody here talks about restructuring our debt.

A central and growing reason why we are in this vulnerable state is because we have socialised a maelstrom of unjustifiable and sometimes undocumented risks undertaken by the private banking sector. We take it as a given that the state should absorb the full cost of that risk and that the resultant “burden of adjustment” should be borne by public servants, welfare recipients, pensioners and businesses through local and national taxes and charges.

But while the gargantuan risks of private banks have now been fully socialised, the lesser risks of debt-laden citizens cannot be relieved by any public policy.

Suggestions that there should be a “Nama for little people” have been formally rejected in recent days by ministers. These same ministers have written a €2.7 billion cheque for the loan club operated by INBS. Patrick Honahan, the governor of the Central Bank, has described the Irish bank bailout as manageable. But is it tolerable?

PS: Alas Mary Harney, the minister for health, no longer has a political party to implement her finer ideas on economic policy. Outlining plans for a sell-off of VHI, Harney said it was not appropriate for the state to be simultaneously a participant in the health insurance sector and the regulator of that sector.

Shouldn’t the same philosophy then apply to airports, energy, broadcasting and — God forbid — banking. In broadcasting, the state is extracting a licence fee that acts as a direct state aid to one market participant RTE.

In electricity, we have price fixing by the regulator while the market share of ESB, one state firm, is being captured by Bord Gais, another state firm. The rates offered to depositors by subvented state banks far exceed the rates payable by truly private banks.

And if the ESB has been forced to cut its share of the electricity market, shouldn’t the same apply to the VHI? Sauce for the goose and all that.