Monday, December 6, 2010

Ireland's so-called "bailout"

What's happening now is a variation on what I complained about previously (in my unpublished letter to the Irish Times, posted here). Rather than using the "we all partied" line (and what a gem that is - the line now is this crap about the state running out of money, having no alternative etc., with Fianna Fail taking some culpability for some mistakes somewhere in the distant past (but sure the others would've done the same anyway), and ultimately we should be grateful to our Euro "partners" for bailing us out of this fine mess we've gotten ourselves into.

This is all a web of lies, deception etc. The only reason markets stopped lending to Ireland in the last few weeks is because of the bank debt that has been nationalised. WE CANT AFFORD TO REPAY THIS. The markets know this. Our banks have been shut out of international markets - because their losses on property etc. have been rising beyond any "worst case scenarios" previously envisaged, and because they had become entirely reliant on money from the ECB (this is its role remember: CB = lender of last resort to the financial system, so let's not feel too grateful/ashamed for requiring this facility either). Then the markets got really spooked when Merkel started talking about making bondholders share the pain without giving any details.

So Ireland was pressured into taking the bailout in an attempt to "stuff" the banks with cash (over-capitalise them is what Gov Honohan called it) and convince markets this was the end of it so they would start lending to our banks again. The whole point was to avoid "contagion" to the other Euro countries in trouble. This hasn't worked. Big surprise. The bit about using this money to fund the Irish state is a total sideshow.

We do need to make a big "fiscal correction" over the next few years, but that is totally doable.

So, yes I believe we do have an alternative. As David McWilliams has been saying, what we need is a new "bank resolution" law (I don't think any such legislation currently exists in Ireland, so creating an entirely new one should be straightforward). The law would simply state that in Ireland, when a bank becomes insolvent (the Irish CB could be allowed to decide when this is so) that bank's bondholders must share the burden. Specifically we would create a debt-equity swap mechanism. Bondholders who are owed money by an insolvent bank will have their debt converted into equity (or shares in the bank). The bank doesn't disappear. In fact the bank is now significantly healthier as it has rid itself of debt. Depositors would have to be protected by some sort of insurance. (The Irish government already guarantees anything up to EUR100k. I'm not sure if we would need European cooperation to guarantee bigger deposits.)

The bit about all the medium sized firms imploding in such a scenario is probably exaggerated. Our banking system wouldn't disappear over night. As it is, small firms are having a really hard time getting credit because whatever money goes into the banks is being used to pay down their debts and/or build up these extra capital requirements that are supposed to make them look like good banks again.

So the banks' bondholders would suffer losses. But they expect this, because it will become European law in 2013. Anyway, even if we piss off some investors, so what?! Would the markets ever lend to Ireland again? Of course they would. The 'markets' are not a single entity with some sort of institutional memory. They are made up of lots of different investors all over the world. Investors do not generally hold grudges. They make decisions based on future prospects of risk/return. Even if some of the specific individuals that get burned in this scenario did decide to take it personally and never lend to Ireland again it wouldn't matter. Ireland is small. So are our funding needs by international standards. There are plenty of more investor fish in the sea, so to speak.

An Irish state that is rid of its bank debt obligations would represent a very attractive investment (especially at the kind of rates we are paying for this so-called "bailout"). We will still have low taxes by European standards (even after we get our fiscal house in order). We have a young, well educated workforce. We have a hugely successful manufacturing and internationally-traded services sector, with highly profitable divisions of some of the world's biggest companies based here. We have a lot going for us. Yes this course of action involves some reputational damage, but would that really be worse than the reputational damage already done by fiscal and economic mis-management? And the reputational damage of having to be "bailed out"?? Distinguishing between the Irish state and the Irish banks might actually be a good way to begin restoring our damaged reputation overseas. Anyway, a damaged reputation (and some bruised egos) is a lower price to pay than the costs associated with this bailout and our continued commitment to pay for whatever losses are accrued by our reckless banks.

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