I agree with Colm McCarthy entirely here. The Opposition must learn from this national experience. My view is that the party whip system is hugely disruptive to rational politics. That is what FG should try and reform if the executive has the nerve.

High price to pay for our credit binge


The Government’s need to borrow is not being met by a willingness to lend, creating a deeper crisis, writes Colm McCarthy

The Irish debt crisis intensified during the week, with market yields on 10-year government bonds reaching 9 per cent on Thursday. Financing either the Government or the banks at rates as high as these is not feasible, and something has got to give. The debt crisis should be seen as having two elements.

he Government has a large deficit, since its revenue falls well short of spending. So it must seek to add to its outstanding debt for as long as the deficit persists. But both the Government and the banks also have substantial outstanding debts to the international markets, and the bank debt is guaranteed by the Government. These debts are not in the form of a permanent overdraft but are for fixed terms. They have to be repaid as their term expires, so new debt (at today’s interest rates) has to be issued continuously to pay off the maturing liabilities. At current interest rates, this is simply not feasible. The markets have flashed the yellow card and it is turning red day by day.
Think of your own household. You have loans with the bank which mature and have to be paid back at various intervals over the next few years. You are also overspending, and would like to take out some fresh loans to finance this, as well as the loans needed to replace the ones that mature. The bank is worried and is quoting interest rates which are not affordable. It looks as if you cannot re-finance the maturing loans, nor can you find lenders for the new borrowing to finance the overspending.
You may be convinced that you have the capacity to meet the interest costs in the years ahead and that you will be able to repay the bank in due course. But your opinion does not matter a whit unless it is believed. The lenders, after all, are volunteers, and it is now clear that Ireland’s need to borrow falls short of the willingness of lenders to lend. This has ceased to be just a deficit crisis, something to be worried about over the medium term, and has become an immediate debt crisis.
How did it come to this? After all, Ireland’s outstanding national debt before the crisis began was not excessive, and the Government budget was balanced until 2007. The combined Government and bank debt (guaranteed by the Government) has escalated so rapidly that the total is now seen as excessive, particularly given the plans to run deficits for several more years and market fears that we have yet to see the final reckoning for the losses at the banks. The sheer speed of the descent into a debt crisis is unprecedented and there have been several key ingredients. The credit bubble fuelled a tax revenue bonanza, based on employee taxes from the construction sector, extra VAT, as well as stamp duties and capital gains tax. The Government responded by increasing expenditure (“when you have it, you spend it”) on the strength of this temporary revenue boost. An unsustainable bubble was mistaken for durable economic performance.
The credit-fuelled property bubble is the direct and indirect source of Ireland’s debt crisis. If the bubble had been prevented by the bankers or their regulators, Ireland would now be suffering a mild recession rather than an existential threat to economic sovereignty. The biggest direct contributor to the debt crisis has been the failure to pursue a prudent and cautious budgetary policy over the last 10 years, in particular the extraordinary increases in public spending under all headings. It is fair to recall that every boost to spending was mocked as too timid by the opposition parties. Most of the public debt burden represents the accumulated deficits in the Government budget. The second contributor is the decision, in September 2008, to extend a sovereign guarantee on the liabilities of the Irish banks.
This decision was taken by a Government poorly advised, by its own Central Bank, about the risks to the credit-worthiness of the State which this guarantee entailed. It is the sum of the accumulated budget deficits and the costs to the Exchequer of the bank rescue that have proved to be too much for the lenders. But both have their origins in the bubble, manifested in bust banks and a bust Exchequer. This was not caused by Lehman Brothers. The domestic policy failures have coincided with an unprecedented dislocation in the debt markets consequent on the international credit crunch. European countries which pursued careful fiscal policies, and which avoided credit bubbles, have weathered the storm. The lesson is that improvident economic management exacts a high price in small trading economies.
Neither the Government nor the banks are able to borrow in the international markets at affordable interest rates and the critical issue is whether credit to Ireland will again be extended short of an IMF/European bailout. The leaders of the world’s largest economies met in Korea during the week and the European countries represented felt it necessary to release a statement designed to reassure the markets about the Irish debt crisis. But Friday’s positive market reaction matters little: the real issue remains the willingness to lend when the Government seeks to borrow again in the New Year.
Whether Ireland can resume borrowing in the markets, or must resort to bailout, has limited consequences for the conduct of budgetary policy. The deficit must be reduced if the markets are to be persuaded to lend, but if they decline, the terms of bailout will likely involve a severe budgetary adjustment anyway. Central Bank Governor Patrick Honohan was right to stress this important point during the week: there have been suggestions that bailout is a soft option, which would defer facing the music. The task for Government, and for any alternative government, over the next several years is to re-balance the public finances and to bring an end to the build-up of debt. This can be undertaken, if lenders are persuaded by a sovereign Irish government, or it will be imposed by the IMF and the European bailout fund.
Public anger is being manifested in some strange ways, including expressions of indifference as to which outcome emerges. Numerous contributors to internet discussions, and some newspaper commentators, have been asserting that the loss of sovereignty in a bail-out should be welcomed, on the presumption that external management of the Irish economy would somehow be better than trying to sort things out for ourselves. This is not just a counsel of despair, it is naïve. We have seen in the last two weeks that some European leaders perceive the debt-laden European periphery as a nuisance.
The Greeks fiddled the figures; the Irish went on a credit binge, and neither is deserving of further indulgence. Supervision of Irish policy from Brussels and Frankfurt might be very unpleasant and the Government’s efforts to avoid this resolution of the debt crisis coincide with the national interest. The budgetary measures for 2011 and the four-year plan will dominate public discussion over the next few weeks, but the banking crisis has not gone away. It is quite unrealistic to expect that a decent economic recovery can be executed with the Irish banks in their current condition. Bank of Ireland is in better shape than AIB, but cannot borrow to sustain even its much-reduced post-NAMA balance sheet in the open market. AIB has suffered a near-death experience and will shortly be a nationalised bank, complete with the fig-leaf of a stock market listing. Once the Budget is out of the way and the debt crisis resolved through success in the markets or through bail-out, these two banks need to be returned to normal functioning without government guarantee. The economy is in limbo until this task is addressed.

Colm McCarthy lectures in Economics at University College, Dublin
Sunday Independent

Sunday November 14 2010