What happened to the global economy and what we can do about it
with 10 comments
By Peter Boone and Simon Johnson
As Greece acts in an intransigent manner, refusing to act decisively despite deep fiscal difficulties, the financial markets look on Ireland all the more favorably. Ireland is seen as the poster child for prudent fiscal adjustment among the weaker eurozone countries.
The Irish economy is in serious trouble. Irish GDP declined 7.3% as of third quarter 2009 compared with third quarter 2008. Exports were down 9% year-on-year in December. House prices continue to fall. While stuck in the eurozone, Ireland's exchange rate cannot move relative to its major trading partners "“ it thus cannot improve competitiveness without drastic private sector wage cuts. Yet investors are so pleased with the country that its bond yields imply just a one percent greater annual chance of default than Germany over the next five years.
Ireland’s perceived "success" is partly due to its draconian fiscal cuts. The government has cut take home pay of public sector workers by roughly 20% since 2008 through lower wages, higher taxes, and increased pension payments. As the head of the National Treasury Management Agency John Corrigan proudly advised the Greeks (and everyone else): “You have to talk the talk and walk the walk”.
So is Ireland truly a model for Greece and other potential problems in Europe and elsewhere? Definitely not "“ but it does provide a cautionary tale regarding what could go wrong for all of us.
Ireland’s difficulties arose because of a massive property boom financed by cheap credit from Irish banks. Irelands’ three main banks built up 2.5 times the GDP in loans and investments by 2008; these are big banks (relative to the economy) that pushed the frontier in terms of reckless lending. The banks got the upside and then came the global crash in fall 2008: property prices fell over 50%, construction and development stopped, and people started defaulting on loans. Today roughly 1/3 of the loans on the balance sheets of banks are non-performing or “under surveillance”; that's an astonishing 80 percent of GDP, in terms of potentially bad debts.
The government responded to this with what is now regarded "“ rather disconcertingly "“ as "standard" policies. They guaranteed all the liabilities of banks and then began injecting government funds. The government is now starting a new phase "“ it is planning to buy the most worthless assets from banks and pay them government bonds in return. Ministers have also promised to recapitalize banks than need more capital. The ultimate result of this exercise is obvious: one way or another, the government will have converted the liabilities of private banks into debts of the sovereign (i.e., Irish taxpayers).
Ireland, until 2009, seemed like a fiscally prudent nation. Successive governments had paid down the national debt to such an extent that total debt to GDP was only 25% at end 2008 "“ among industrialized countries, this was one of the lowest.
But the Irish state was also carrying a large off-balance sheet liability, in the form of three huge banks that were seriously out of control. When the crash came, the scale and nature of the bank bailouts meant that all this changed. Even with their now famous public wage cuts, the government budget deficit will be an eye-popping 12.5% of GDP in 2010.
The government is gambling that GDP growth will recover to over 4% per year starting 2012 — and they still plan further major expenditure cutting and revenue increasing measures each year until 2013, in order to bring the deficit back to 3% of GDP by that date. The latest round of bank bailouts (swapping bad debts for government bonds) dramatically exacerbates the fiscal problem. The government will in essence be issuing 1/3 of GDP in government debts for distressed bank assets which may have no intrinsic value. The government debt/GDP ratio of Ireland will be over 100% by end 2011 once we include this debt.
Ireland had more prudent choices. They could have avoided taking on private bank debts by forcing the creditors of these banks to share the burden "“ and this is now what some sensible voices within the main opposition party have called for. However, a strong lobby of real estate developers, the investors who bought the bank bonds, and politicians with links to the failed developments (and their bankers), have managed to ensure that taxpayers rather than creditors will pay. The government plan is "“ with good reason "“ highly unpopular, but the coalition of interests in its favor it strong enough to ensure that it will proceed.
Investors may wish to remain pleased today with Ireland, but Ireland’s “austerity” – reflecting an unwillingness to make creditors pay for their past mistakes – hardly seems a good lesson for Greece, the eurozone, or anyone else.
Countries "“ like the US – with large banks that are prone to reckless risk taking should limit the size of those banks relative to the economy and force them to hold a lot more capital. If you thought the "too big to fail" issues of 2008-09 were bad in the US, wait until our biggest banks become even bigger "“ today the big six banks in the US have assets over 60 percent of GDP; there is no reason why they won't increase towards Irish scale.
When Irish-type banks fail, you have a dramatic and unpleasant choice. Either takeover the banks' debts "“ and create a very real burden on taxpayers and a drag on growth. Or restructure these debts "“ forcing creditors to take a hit. If the banks are bigger, more powerful politically, and better connected in the corridors of power, you will find the creditors' potential losses more fully shifted onto the shoulders of taxpayers.
An edited version of this post appeared this morning on the NYT’s Economix; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.
Written by Simon Johnson
March 18, 2010 at 7:58 am
Posted in Commentary
Tagged with Ireland, too big to save
“Either takeover the banks' debts "“ and create a very real burden on taxpayers and a drag on growth. Or restructure these debts "“ forcing creditors to take a hit. If the banks are bigger, more powerful politically, and better connected in the corridors of power, you will find the creditors' potential losses more fully shifted onto the shoulders of taxpayers.”
Agree, and yes…. way too big to be saved (and way early in the morning) but if like Greece, taking half steps forward right now, questions of when and how will be answered promptly and in good faith – I know that to be a fact :-) The “Doop Loop” doesn’t have to be inevitable "“ the way out of this crisis is happening, even as we speak"¦..
Beth
March 18, 2010 at 9:16 am
Mr. Boone and Mr. Johnson wrote:
Could The US Become Another Ireland?
(AP) "“ 2 hours ago
“Top Irish ex-banker arrested over alleged fraud”
http://tinyurl.com/yj73d4s
We’re off to a good start.
Rickk
March 18, 2010 at 9:34 am
The US Government can still print Dollars and channel them thru Fannie Mae and Freddie Mac to lend to the private banks. That’s how the newly printed dollars get accounted in the government’s balance sheet. Ireland or any Euro Zone country for that matter, can’t go around printing Euros at will and use any of its own banks to incorporate those in their balance sheets.
Sailendra Das
March 18, 2010 at 10:50 am
Spot on.
Pragmatic realism. The Irish Citizenry has been sacrificed at the altar of the Irish upper_echelon Kleptocracy (dominant policical party, well connected builders/developers, reckless bankers, ideological free-marketeering influential cliques, supine regulators). The Irish response provides definitive and highly supportive evidence that dominant elites will do all to preserve their power, status and wealth at the expense of the lower orders – and get away with it – any equation you like stat sig *** Being praised internationally for it in fact …….. and in terms of Corporate Governance – there is no real change at the top on all the relevant boards of directors ……. the reckless Insiders who got Ireland in to this mess are still in position in over 95% of cases.
David O'Donnell
March 18, 2010 at 11:13 am
It has been said that Ireland’s banks and Government sell to the same limited subset of the international bond market. Therefore, the logic goes, if Ireland defaulted on senior bank debt it would suffer the same as if it has a de facto sovereign default, and indeed sovereign default would become likely.
Furthermore, even if Ireland wanted to force losses on senior bondholders, Ireland did not have a bank resolution mechanism to achieve this. Therefore, there was a risk that the entire banking sector would collapse or be nationalised lumbering the state with the debts in any event.
What do you make of these arguments?
Zhou
March 18, 2010 at 11:28 am
The Irish case is difficult due to the Govt guarantee of all liabilities and therefore they cannot force any losses on bondholders or be faced with a legal challenge.
Being realistic the money (upwards of â?¬50Bn) that is being spent setting up NAMA to bail out the Kleptocracy (- defined by David above) would be much better spent setting up a new fresh state run bank that would lend to business, upgrade of infrastructure (read broadband, R&D etc) rather than handing a bail out to the idiots that ran us into the ground. The ordinary tax payer will be paying back this money for generations. Let the Gov Guarantee lapse, wipe out the shareholder of the banks and hand the banks to the creditors, set up a new state bank and invest as above. This is the only way the country will ever get out of the hole we’re in. NAMA will ruin us all!
john
March 18, 2010 at 11:56 am
At the end "too big too fail" will be the major reason to cause the sovereign debt crisis in US without doubt. Now "too big too fail" create the over risk taking in too big banks and the manipulation in the market will cause the mispricing and the large price swing will cause the crisis in banking sectors. Surely if "too big too fail" still stay, the government will be responsible the huge debts and the sovereign debt crisis will happen in US and every country having “too big too fail”. I am not sure is there anyone trying to solve this problem?
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