The Bennett Newsletter
Our government somewhat rashly guaranteed South Canterbury finance and assumed considerable, still unknown, liabilities. The policy of guaranteeing deposits was necessary in 2008 because international funding halted and nervous depositors were inclined to rush to safety. Banks were in danger of being overrun.
While Ireland has also propped up its banks at enormous cost to taxpayers, a new run is developing; even though it has yielded to pressure to take out new loans.
Nevertheless, the market continues to hammer bank shares because of the interconnectivity of debt. Debt is the Achilles heel of modern economies. The issue is becoming more pertinent to NZ as S&P have downgraded our credit-rating from stable to negative, and warned of further downgrades.
The Irish have learned, at last, to look the gift horse in the mouth. They know now that the bill will be horrendous and blight a generation with servicing an almost impossible amount of debt. Moreover, the EU has said Ireland would not be able to keep its low corporate tax.
This raises sovereignty issues. How can small states like Ireland and New Zealand protect their interests in a world where powerful states sign them up in treaties and then demand great changes?
The corporate tax rate of 12.5% has been successful for Ireland in attracting multi-nats like Google and Microsoft. Ireland had languished until it joined the EU and set a low rate of corporate tax. Unemployment was 16% despite high emigration. It quickly became a “Celtic Tiger” with massive exports. Unemployment fell to 3-4%, and until 2006, its growth was the fastest in Europe at 7%.
Other Europeans regard the corporation tax as unfair competition. They are reluctant to lend to Ireland when it competes with them to attract job-creating multi-national firms. There is no doubt that Brussels will try to get the tax raised as a condition of the loan.
Those assisting Ireland are not altruistic. They are pursuing very naked self-interest. So determined are the EU and the UK to press a loan, that one must query whether it is in Ireland’s true interest to succumb.
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Digging the grave
To a large extent Ireland dug its own grave. The average family owes 132,00 euro’s to the banks. Houses have fallen 36% form their 2006 peak and unemployment is 14%. Ireland has quickly moved from riches to rags. It was proudly independent but must now obey the European Central Bank.
From 2001 to 2006, the economy became super-charged by a construction boom. Everyone was buying and selling houses it seemed, and developers were great heroes. Banks poured massive doses of credit into the boom and the government never tried to curb its excesses although newspapers had a 50 page real estate section. Ireland's GDP soared from €25billion to €267billion from the 1980’s to 2008.
With the Lehman collapse, property price slips accelerated and shares in financial companies plummeted. On Sept. 29, 2008 that government guaranteed bank debt without knowing the extent of those debts. The Government continued to say they were controlling the global crisis and “everything is fine”. The Irish continued to boast that theirs were the best banks in the world.
The banks were actually reckless in lending without adequate collateral. By 2006, a third of first-time home-buyers had 100% mortgages and two-thirds had 90%. Bank funding was foreign via the domestic banks. It soared to 60% of GDP by 2008. It seemed acceptable to the complacent authorities because Europe's interest rates were so low. European banks now hold US$ 509 bn of Irish obligations.
The crash has left Ireland with a massive national debt. Despite huge fiscal activities like slashing wages and closing down schools, the budget deficit is 32%. This has to be funded by issuing more bonds; Government debt is close to 100% of GDP. Perhaps that would be manageable if interest rates were 3%, but investors demand a premium, and Ireland must offer 9% to get sufficient takers. The government cannot afford to service debt at 9%, hence its call for a loan.
The creditors
Ireland is funded only until June so it had to admit the EU, ECG and the IMF into talks in Dublin. Another run on its banks contributed to the crisis. Fitch said there was “considerable uncertainty” about Irish bank debt and the governments bonds. The EU made it clear its fears contagion spreading to Portugal and Spain. The British also offered loans because its banks, especially the Royal Bank of Scotland, are exposed to US$ 150 bn (7% of UK GDP) on Irish banks and Irish bonds.
But the creditors also worry that each bail-out depletes its €440 bn rescue fund, reducing a war chest that might be needed by others. Moreover, bail-outs add to debt and worsen the core problem of solvency. And each bailout tests the patience of the contributors. Austria balks at helping Greece, and Germans are reluctant lenders to people who showed insufficient discipline.
Change the mould?
The Irish government acted honourably in assuming their banks debts. But the debts are beyond its service capacity. Europe is adding pressure for Ireland to assume more liabilities because it wants the contagion to stop. It is illogical to attempt to fix a solvency problem by borrowing more, especially when there is little hope of being able to service the debt, much less repay it. Moreover the scheme may fail because the market will dump bank shares and sovereign bonds.
There is mounting horror in Germany and Britain of assuming more debt themselves to help the Irish and their own banks which irresponsibly pressed money on Dublin.
Nor should taxpayers be lumbered with impossible debt arising from bankers recklessness. There is no chance that Ireland, Greece, Portugal and Spain can manage their debts. Some kind of managed default is necessary.
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