Bank Crisis will sink country. Mad bank policy impossible to sustain.

I have never been convinced that the bank guarantee of 30th September 2008
should have been supported by the opposition or by Fianna Fail backbenchers
who could count. As a non-member of the establishment, it is easier to see
the direction that the herd is going and the cliff waiting for them around
gtghe next corner. Alan Aherne v Morgan Kelly: UC Galway v UC Dublin. The
UCD boy is correct and will pass his exam. Aherne will be back in the
Autumn for the resit.

As a paid adviser of the Minister for Finance, I demand from Alan Aherne a
reply to Professor Morgan’s thesis as set out below from the pages of the
Irish Times. Unfortunately, I am almost wholly in Professor Kelly’s camp.
We must ditch the banks. I have been opposing NAMA from the beginning and
continue to do so as you can see by going through this site. The current
version of NAMA is not as bad as the Minister’s first announcements but
that is only a consolation. We should always put Ireland first.

One area in which I disagree with Professor Kelly is in the isue of
Corporation tax of 12.5%. In my opinion, it is more likely that the EU will
frame budgetry policy to contain the overall borrowing within an updated
Stability and Growth Pact which will allow a choice for states to spend
within the overall financial corset and also raise taxes in their own way.
Otherwise we are knackered! scuppered! finished! f…ed!

Och Ochoin!

Anyone who says what would Bill know has a point because I never spent any
time in a business classroom in my life. But I have read a lot for a long
time and think I have the drift. But A BA in Business or MBA, I have not!

Burden of Irish debt could yet eclipse that of Greece

OPINION: What will sink us, unfortunately but inevitably, are the huge
costs of the September 2008 bank bailout, writes MORGAN KELLY

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

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.

Having received such a staggering transfusion of taxpayer funds, you might
expect that the Irish banks would now be as fit as fleas. Instead, they are
still in intensive care, and will require even larger transfusions before
they can fend for themselves again.

It is hard to think of any institution since the League of Nations that has
become so irrelevant so fast as Nama. Instead of the resurrection of the
Irish banking system we were promised, we now have one semi-State body
(Nama) buying assets from other semi-states (Anglo) and soon-to-be
semi-States (AIB and Bank of Ireland), while funnelling €60 million a year
in fees to lawyers, valuers and associated parasites.

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.

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.

The contraction is far from over, to judge from the two economic indicators
I pay most attention to. Redundancies have been steady at 6,000 per month
for the last nine months. Insolvencies are 25 per cent higher than this
time last year, and are rippling outwards from construction into the rest
of the economy.

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.

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.

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?

Morgan Kelly is professor of economics at University College Dublin