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Ireland: A problem soon to be shared

Stephanie Flanders | 13:59 UK time, Thursday, 30 September 2010

Small countries shouldn't make gigantic bets. That's the lesson that Iceland learned early. When the crisis hit, the country's three largest banks had foreign debts worth more than six times the country's GDP. There was never any prospect of Iceland's taxpayers covering that lot - and they didn't.

Irish euro

 

In Ireland, the decision was less clear-cut. There was always the possibility - however slim - that the Irish economy would be able to come through the crisis without stiffing the foreign creditors that lent the country the equivalent of five times its annual GDP.

So, Dublin has had a slow-motion crisis rather than an Icelandic bonfire of the creditors - and Ireland's roughly 2 million taxpayers are picking up the tab for tens of billions of misplaced private bets.

If the end result is similar, Ireland's citizens may well wonder whether the battle to preserve Ireland's good name in international markets was really worth all this pain.

But, as the finance minister Brian Lenihan knows well, Ireland has one crucial advantage which Iceland lacked. It is a member of the euro. That means its problems are also the eurozone's. It also means that the European Central Bank (ECB) - and other eurozone governments - will have a big say in where Ireland goes from here.

It's possible that Ireland wouldn't have got into quite such a mess outside the euro. It would have been able to take some air out of the boom - maybe - by raising domestic interest rates. And its banks and businesses would not have been able to borrow quite so cheaply from abroad. But all that is in the past. Since the crisis hit, being in the single currency has been an important crutch.

Anglo Irish has been deemed too big to fail

Anglo Irish has been deemed too big to fail

Ireland would almost certainly have gone the way of Iceland by now, had the markets not assumed that its fellow eurozone governments would ultimately bail it out, and - crucially - Ireland's banks had not been able to borrow unlimited amounts from the ECB. A year ago, Irish banks had borrowed an amount equivalent to 10% of their total assets from the ECB. The share has fallen a little since then (for reference, borrowing by Greek banks is running at about 20% of their total assets), but that more-or-less free liquidity from the central bank has been a crucial safety valve.

Robert Peston has described Ireland's situation in great detail in recent posts. As we have both pointed out, Mr Lenihan has protected himself from any immediate embarrassment in the markets, by pre-funding the deficit until well into 2011. The government is sitting on substantial cash reserves, and today's 6.4bn-euro injection into Anglo-Irish has also been designed in a way to avoid actually putting any cash in right now.

So, once again, this is a slow-motion crisis. But even though the government has done everything to avoid it, Ireland may still be forced to follow in the footsteps in Greece, and head to the eurozone and International Monetary Fund (IMF) for support.

In the case of Greece, European governments would not face up to the problem until it had got significantly worse. Now there is a formal support mechanism in place - the European Financial Stability Facility (EFSF) - you might think the process would be less fraught. But I wouldn't bet on it.

Unlike Greece - which wanted to go to the IMF from the start of 2010 - Ireland still thinks there a chance to avoid it.

Other eurozone governments won't want to seem to be pushing them in that direction. As we know, they were rather hoping that the sheer existence of the EFSF would be enough reassurance to the markets, and it would never actually have to be used.

But that leaves Ireland - and other countries on the eurozone periphery - in a difficult limbo. Ask anyone in the financial markets, and anyone in Brussels - they all expect the crisis in the eurozone to have plenty more rounds.

It also leaves the ECB sitting on a mountain of IOUs from Greek, Portugese and Irish banks, backed by collateral which is probably not very good. (Why give the ECB your best collateral, when it will take pretty much anything you've got?)

The ECB's head, Jean-Claude Trichet, would very much like to get out of the business of providing all of this "unconventional" support. But of course, the member governments would like to put off that day as long as possible. Why? Because once that below-the-radar safety net goes away, the eurozone might have to decide how far they are really willing to go, to ensure that every last penny of every bad bet on a eurozone country gets repaid.

Comments

  • Comment number 1.

    Walk away from your debts Ireland and return to the beloved punt.
    make sure you print your own money this time though.
    Alternatively join us with Sterling. We are about to reclaim it from the adultering private banks. You are welcome.

  • Comment number 2.

    The continuing bail out of private investors at taxpayer expense. Where is the repayment on the part of the banks and the investors? Shoring up the personal wealth of bank stockholders at public expense. The greatest transfer of wealth upward in history. The rating agencies were all telling the governments that the borrowing was sound, of course they were in collusion with the banks. Increased taxes to pay off the bad debts of private investors and banks will only prolong the economic troubles. The private banking and financial services industry pretends to be private and exercise control of interest rates and borrowing limits while administering public funds. Now that all the rationales have been turned on their heads the governments pretend that this all makes sense. The governments are more than willing to save the wealth of bank shareholders but not the personal wealth of the citizens who had their retirement accounts and investments stolen by the banks. These are policies of national significance and no one has asked the public to vote on these matters.....because they know what that outcome will be. The business of money is an ugly and corrupt business and now the public is paying to maintain, what can only be concluded to be, criminal enterprises of financial services and banking. When democratic institutions are corrupted this is the results. By failing the banks have gained in power.

  • Comment number 3.

    Ireland's citizens may well be wondering whether the battle to preserve Ireland's good name in international markets is really worth all this pain. It’s likely worth the pain, but the pain is being inflicted on the wrong people, the taxpayers. The pain should be hurting the too-big-to-fail investment banks that did the speculating, especially in derivative bundles and credit default swaps that caused all this financial agony.
    The European Central Bank (ECB) - and other eurozone governments - will have a big say in where Ireland goes from here, and I sincerely hope that the ECB is going towards taxation on all foreign exchange transactions.
    The Government of Ireland, the Governments of all European countries have NOT done everything to eliminate deficits without burdening the taxpayers.
    What else could they do?
    Greece was wrong to even think about going to the IMF which is heavily American-influenced and takes far too much control of internal economic policies. Other eurozone governments won't be pushed in that direction.
    Countries of the Eurozone are not in limbo; they are simply not schooled re Tobin Tax.
    The ECB's head, Jean-Claude Trichet, would very much like to get out of the business of providing all of this "unconventional" support. But of course, the member governments would like to put off that day as long as possible because they have not yet seen the advantage of a Tobin Tax and how such a tax could alleviate deficits.
    Nobel Laureate, James Tobin suggested imposing a small tax on all foreign exchange transactions to SLOW DOWN speculative trades in the foreign exchange market.
    Why oh why did we not listen?
    He suggested that the order of magnitude for such a tax would be around 0.1 percent, or US $1,000 per million dollars sold.
    Although this would be a negligible cost for long-term investors, for speculators speculating weekly or even daily, it would mount to 10 to 50%.
    The Tobin Tax is similar to taxes applied to control other forms of "externals," e.g. pollution. By imposing taxes on pollution emissions, polluters would be induced to lower their pollution levels or pay the tax. Similarly, a Tobin Tax would aim to slow down speculation by making short-term transactions relatively less profitable. This alone promotes far more stability in the markets.
    Much of the criticism of the Tobin Tax has focused on its technical feasibility.
    With US $1.6 trillion changing hands daily in foreign exchange markets, the sheer enormity of imposing the tax is mind-boggling.
    There are holes that will need blocking: e.g. Many believe that a tax on foreign exchange transactions could be evaded by shifting foreign exchange trading activity offshore or by using derivatives and other financial instruments to disguise trades in foreign exchange.
    But current research suggests that the tax is feasible if it’s applied to the interbank payments made to settle foreign exchange transactions rather than to the trades themselves.
    Because the infrastructure for settling foreign exchange trades is formal, centralized, and regulated, it is possible to monitor and access most interbank foreign exchange payments - regardless of the financial instrument used, WHERE THE PARTIES ARE LOCATED, or where the ensuing payments are made.
    For Tobin's tax to be feasible, it must be possible to tax individual foreign exchange payments in both offshore systems and domestic payment systems, and enforce the tax. Three features of the current settlement infrastructure of the interbank foreign exchange market accomplish this.
    Domestic payment systems can identify and tax foreign exchange payments because they process payments individually. This means that they can trace domestic financial payments to the originating trade. If a payment is not traced to a domestic financial transaction, it is because it is a foreign exchange payment and may therefore be taxed.
    By mid-2000, domestic payment systems will also be able to directly identify foreign exchange payments by tracing them to the originating trade. (How nice! If the trader gets into speculative shenanigans, we have an automated audit trail!)
    Central banks or their supervisory bodies regulate offshore activity and enforce regulations. The same mechanisms could be used to enforce a foreign exchange payments tax.
    So, what on earth is the EU waiting for?
    When will taxpayers catch on that thery need not carry the burden caused by investment banks too-big-to-fail?

  • Comment number 4.

    Stephanie

    It seems as if the use of a European Financial Stability Facility (EFSF) sits a little easier politically for the Irish government, with the markets and consumers than bringing in the IMF?

    If the use of the IMF facilities, or even its misrepresentation, as in the UK political debate before the General Election has similar connotations and popularity across the Irish Sea, it does not bode well for the Taoiseach.

    The Irish probably also have in their favour, as you point out above that only 10% equivalent of their total assets have been borrowed from the ECB, compared to 20% by Greece.

    Presumably the UK does not benefit from the EFSF, being outside the Eurozone? So if the UK's austerity budget does not work in the way that Ireland's has not? Will this force the BoE into more Quantitative Easing and or Credit Easing?

  • Comment number 5.

    If the ECB's loans do go bad, at least the money they've paid for the bonds will go towards creating an extra monetary stimulus to assist European economic recovery. With the ECB's current attitude, it seems that may be the only way to get one.

    But where did all Ireland's money actually go? To three separate sets of recipients...you may well ask yourself whether or not they deserved it, but it won't really be possible to get it back:

    http://www.knowingandmaking.com/2010/09/where-did-irelands-money-go.html

  • Comment number 6.


    The richer Eurozone countries will be forever hampered by the debts of the poorer ones. And the even poorer ones, currently waiting in the queue to join, are only going to make matters worse.

    I wouldn't be surprised if various European political parties start campaigning to leave the Euro. A very popular theme in some countries.

  • Comment number 7.

    I don’t think that Ireland has a prayer in paying off this debt.

    The debt was created in, and based on, a thriving economy, and if the economy continued to thrive the debt was serviceable. But it didn’t, so it isn’t. And let’s be honest now, that’s not a difficult concept to grasp is it.

    Given that 97% of all money is created as debt bearing interest, how on earth can existing debt, be serviced by the creation of even more debt.
    Ireland’s expected to pay around 6.5% interest on its debt, unless its tax receipts grow faster, it’s in a compound debt trap.

    Either debt in excess of the nation’s current capacity to service it, has to be written off, or the ECB will have to print some money and give it Ireland.

    All the Irish need is a finance minister with some backbone.
    And all he has to do is say ‘This debt was not racked up by the people, but by the fraudulent misuse of the fractional reserve banking system, and we will not pay it’.

  • Comment number 8.

    (The ECB's head, Jean-Claude Trichet, would very much like to get out of the business of providing all of this "unconventional" support. )i

    How ridiculous is that? That Central Banks should think commercial banks could create money supply pre-2008 (from foreign credit) with so little planning, let alone ordinary balance sheet auditing, supervision and regulation, and despite having surpassed the banking crisis stage, still these economists think that simplistic monetarist system modeling extends to huge banking systems.

  • Comment number 9.

    It does seem that Ireland is going further into the mire. Personally, I can see that they will start to get a more fractured society and anyone still left hovering on whether or not to emigrate may well now go.

    Being part of the Euro zone doesn't seem to be helping the people of Ireland very much; rising unemployment, benefit and wage cuts. They surely ought to be asking, 'well what has the EU done for Ireland?' Those people that can emigrate are leaving, thus making Ireland less productive overall than it has been. Their recovery [if it comes with any strength, they apparently claim to be out of recession] will be to a lower overall level of economic activity and they are likely to require more support from the EU; and that will include us in UK. There is nothing here to lift the spirits. I just wonder if these banks that are 'too big to fail' ought to be allowed to fail and have the losses fall on the shareholders and the financial sector. [I do remember what happened when Lehmann's went!]

  • Comment number 10.

    Stephanie,

    Your first sentence should read, I suggest: Countries should make bets only in proportion to their size! (not "Small countries shouldn't make gigantic bets.")

    The UK may be far larger that either Ireland or Iceland, but our gamblers(banks) are even larger, proportionately.

    We are really in a desperate and almost irrecoverable situation - that is my conclusion from the actions and statements of the Bank of England this week. For why ever else do they declare that they can never raise interest rates again from zero - can it be that they know it is all up with capitalism and economics. If it is they destroyed it through their stupidity.

    The reason for this must only be that the balance sheets of the British banks are full of very low quality debt that will cease to perform if the debt has to pay any interest - that is the banks are bust.

    Alternatively the Bank of England is so incompetent that they just haven't a clue.

    I prefer the latter explanation as I am and remain an optimist about capitalism's ability to recover from this disaster caused by bad regulation - the Bank of England however appears to think that it is all up with capitalism.

    To function Capitalism REQUIRES that money has a positive price. It simply cannot operate at zero to negative without dissolving into hyperinflation and complete currency destruction.

    We must at all costs get inside the Euro before our currency collapses along with our banks. We cannot afford to see society disintegrate. This is really serious - the Bank of England has shown us that this week.

  • Comment number 11.

    I am puzzled by the the apparent confusion in the BBC as to the location of the Irish REPUBLIC, which is not of course in NORTHERN Ireland. I would not expect the economists to be too sure on this point, their minds are occupied on a far higher plain, but surely the management are aware of this ??.

  • Comment number 12.

    7. At 3:52pm on 30 Sep 2010, Dempster wrote:
    I don’t think that Ireland has a prayer in paying off this debt. ~~~~~~

    All the Irish need is a finance minister with some backbone.
    And all he has to do is say ‘This debt was not racked up by the people, but by the fraudulent misuse of the fractional reserve banking system, and we will not pay it’.
    * * * * * * * *

    I largely agree with this view until the last part. Where will the consequences of default land? I don't know who has loaned Ireland the money so far, nor who would bear the Banks losses, can anyone help?

    A further consequence may well be that once one country does this, others will follow by doing the same. Germany and France, in particular, would be severely hurt and I expect the UK would be too. The jolt may well wreck the financial system and bring about the collapse that governments are trying to avoid. But maybe you are saying that the final collapse might be postponed, but it cannot be avoided – do I interpret your comments correctly?

  • Comment number 13.

    When countries are teetering on the brink how can anyone say that any bank is 'too big to fail'? Isn't this sort of comment likely to encourage ongoing ridiculous speculation if a bank believes (apparently correctly) that someone else will pick up the pieces?
    Surely better by far to encourage responsibility by first of all banning any form of bonus for any bank staff until all loans from governments or elsewhere have been repaid. Follow this by making it clear that banks then have a free hand in their operations, including payment of bonuses, but that there will be no bail-outs from any source whatsoever.
    This approach should produce an overnight volte-face in bank managements, and a degree of responsibility in their actions which will never happen when statements like 'too big to fail' are being made.

  • Comment number 14.

    Another problem of a bombed out economy (like Ireland) is the reduction in earning power amongst its ordinary citizens (who are left carrying the can here).
    Imagine that you are working in Irish agriculture, for example, how can you expand your efforts to cope with the extra burdens of debt reduction? You can't.
    In these circumstances, I would expect active populations to vote with their feet. Economic migration and "brain drain" will be a big problem for the stability of the original Eurozone concept.
    The shadow of Detroit will fall over great parts of Europe.

  • Comment number 15.

    "But, as the finance minister Brian Lenihan knows well, Ireland has one crucial advantage which Iceland lacked. It is a member of the euro."

    If you look at the current exchange rate of the Euro and Ireland's inability to influence either it or its interest rates then you could just as easily say.

    But, as the finance minister Brian Lenihan knows well, Ireland has one crucial disadvantage which Iceland lacked. It is a member of the euro

  • Comment number 16.

    The key issue in the Irish meltdown has to be how deregulated banking led to excessive speculative property lending and levels of risk that were far above anything signalled by the ratings agencies or the economics community.

    In a free market, companies are free to take risks and either make money, or lose it as they see fit - and go to the wall if they get it really wrong. A Receiver comes in - and tries to sell as much of the business and recover as much money for the shareholders and creditors as possible - then pulls the plug.

    However with large banks this is not the way it works because if they are allowed to fail they will take down large parts of the economy with them and even threaten the credit rating of entire countries - Iceland is effectively bust - it looks like Eire is heading the same way - the queue of countries grows by the day - and in the end even the EuroZone won't be able to prop them all up - let along the IMF.

    But there is huge pressure on banks to lend to businesses to fund economic activity and expansion - this means that risk is being concentrated into heavily leveraged banks, where a recession in a major asset sector - e.g. property - will have a disproportionate effect on banks' liquidity.

    What can we do about it?

    Money is a commodity - it may be our medium of exchange, but it has a price - the interest rate - and a value - i.e. what it will buy.

    As the price of money is now zero, how long will it be before its value falls too?

    And in a market economy the price of anything can rise or fall - chronically over-issued currencies only have a value because it is in the interests of those issuing them, holding them or trading in them that they retain value.

    This is a "king" with no clothes situation - in the end those at the back of the crowd are going to start whispering to each other and in the end the game will be up.

    The market will clear - but in doing so there will be longlasting and probably permanent damage done to human society. The alternative is for governments to take major steps to reforge the system into something sustainable - and to break with the idea that free markets work - they clearly don't.

    Drastic reductions in public spending only exacerbate the problem by hammering down demand, which in turn leads to the economy contracting - do this hard enough in a short time and you have all the ingredients for an Ireland-style property meltdown that will tip banks over the edge.

  • Comment number 17.

    Stephanie, Good title for this blog but "the problem" is not going to be shared but mirrored in all of our economies. I cannot agree with JfromH suggestion in joining a vunerable relatively new currency which we would have little control of. Far better that we deflate our indebtedness along with the value of sterling and juggle for the next few years with a negative economy. We (GB) have some serious public and private debts that can be ironed out by erosion and these will wilt away along with the value of our assets even though they will be appear to be holding their own by being priced against a falling currency. Perhaps the BoE is right in advising us to spend our cash. What use is it locked away for a rainy day when it's true value is falling. I cannot see any benefit in transfering GBPs into Euros as its worth looks odds-on to suffering erosion too.
    Joe / Sean / Jose / Jean-Paul / Gustav... public are not going to respond too favourably to bailing out the greedy and incompetent people who encouraged this financial meltdown with their indulgences, dogmas and fantasies. Austerity here we come!
    A house is worth a house nothing more nothing less. Good hard working people are worth a lot more but will they spend they hard earned cash on taxes for the benefit of the few as opposed to helping each other out of this mess. We shall see sooner rather than later.

  • Comment number 18.

    Can someone tell me whether the following assertion is true or has any truth within it?

    If 10% of the top earning people in the UK were levied an extra 10% tax, for just one year only, the yield for the treasury would be equal to more than 300% (three hundred) of the current national deficit.

    If this is true, I am more than a little curious to know why 90% of us are having to loose rather more than 10% (for some 100%) of our income, social services and benefits for years to come.

    (Janehop)

  • Comment number 19.

    10. At 4:31pm on 30 Sep 2010, John_from_Hendon wrote:

    *************

    I really do not see anything to be gained by joining the euro; just look at the financial straight jacket that envelopes most of the countries, PIIGS in particular. There is a very minor upside, reduced cost of trading, downside is bankruptcy. I see no choice other than to stay independent as we now are. [BTW, I am not a little englander].

  • Comment number 20.

    "bonfire of the creditors"

    What delicious imagery!

    The Icelanders have`nt starved have they?


  • Comment number 21.

    Janehop

    If you want a mass exodus of some of the most hard working, talented, and economically vital people this country has to offer then imposing an extra 10% tax is certainly the way to go. The 50% tax rate on those earning over 150,000 is unlikely to raise a penny in additional revenue (according to the IFS).

    In any case we're all in it together so only fair that the burden is shared. Most of the tax changes that have been implemented favour those less well of (e.g. raising the tax threshhold) at the expense of the better off (increase in capital gains to name but one).

  • Comment number 22.

    Ireland are in a mess because of Europe, the Euro is doomed, and the quicker we leave the EU AND return to English Law the better. Our legal system was built as a buffer against an overmighty state, European law was built to bolster almighty states. Europe and the EU are chains to bind us with, let us get out now.


  • Comment number 23.

    Having invested £75K with AI 2 years ago under the guise, at that time of FCCS protection, I am looking forward to 11th November and a return of my money. No more Ireland for me.

  • Comment number 24.

    How can Ireland be broke? Its capital is always Dublin

  • Comment number 25.

    Trichete should be in jail.

    I am buying EUO.

    Next year the defaults will happen.

  • Comment number 26.

    I, some time ago had the privilege of having dinner with the then Taoiseach. He joked with me saying "The Irish are all just thieves, liars and horse traders and then there are the bad ones".

  • Comment number 27.

    Just walk away from the debts that were not of your own making.

    It will put a stop to foolish lending practice.

    The markets will cope with it. That is how capitalism works.

  • Comment number 28.

    There is a great deal of bank bashing going on at the moment and to a certain extent they deserve it. Irresponsible lending practices and obsession with personal bonus's earned on deals that many knew to be rather dodgy and not in the long term interest of the shareholders. But what of the folk receiving this money? Joe public was very happy to take the 125% mortgages, obtained on a false deceleration of income and buy themselves a new car or property they couldn't afford. New boats, foreign holidays - the list is endless and all on the money forced upon the helpless individuals by the nasty banks. Needless to say they weren't thought so nasty then when everyone thought they could make a killing on property. No it was collective greed that got us into this mess and we all should shoulder the blame - not just the banks.

  • Comment number 29.

    @BluesBerry

    "Greece was wrong to even think about going to the IMF which is heavily American-influenced and takes far too much control of internal economic policies."

    Indeed Greece was wrong.

    Though the IMF (and world bank) isn't "heavily American-influenced" it *is* American, the pair are their international finance bully boys sent in to enslave countries with debt and change policies to favour the US.

 

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