Thursday 18 November 2010

Ireland - What Went Wrong?

Ireland, or more precisely, the travails of the Irish economy are once again the subject of newspaper headlines and much panicking by politicians and the markets.  Even our nasty Coalition seems willing to cough up billions to help the Irish.   Why all this fuss and bother?  
As regards the timing of this stage in a long running crisis, it seems that the precipatating factors lie outwith Ireland.  In particular what has been said and done in Germany and the USA have brought on the current crisis.  However, it seems very clear that the cause of the crisis facing Ireland is all of the making of the Irish themselves.  Not all Irish people of course.  As usual some are much more guilty than others.
So, what did happen in Ireland?   Here Brian Lucey, an Irish financial comentator and former economist at Ireland’s Central Bank, outlines the key factors in the collapse of the Irish economy.  “The core cause of the problems lies in a monstrous credit-fuelled property bubble which started in the early 2000s and really roared in the middle years of the decade.
This was fuelled by a toxic combination; abundant cheap international liquidity coupled with a low interest rate (Ireland having joined the EMU) and a foolish procyclical fiscal stance by the government which released a wave of cash which in turn nicely intersected with the Irish love of property.

The results were an unmitigated disaster. Reliance, as a percentage of all funding, by the Irish banks on ordinary deposits from Irish residents shrunk by half in the 2000-2008 period, with the slack being taken up by foreign bank deposits and bond issuance. At the same time the banks nearly doubled in size.

This money was disproportionally lent out to property and property-related investments. Lending to the private sector as a percentage of national income rose from about parity in 1998 to nearly 300% in 2009, with mortgage lending rising seven-fold in the 1997-2008 period and lending to property development rising 11-fold.”
So far this is not too dissimilar from what was going on in other countries. What seems to have made the situation in Ireland so much worse was the government’s decision in 2008 to guarantee the total liabilities of the banking system, then estimated at some €440bn.  Now this was something that no other government had done or has done.  It was more importantly, a guarantee that the Irish government was in no position to honour, then or now.
As the extent of the liabilities of the various Irish banks began to emerge the government was forced into effectively nationalizing the banks.  As the banks are in essence insolvent this means that the Irish state, or to be more precise, the Irish taxpayer is now responsible for the private debt of private banks.  So much for the discipline of the market!
How did all this come to pass?  Here we get into the tricky and murky waters of Irish politics and the cosy, perhaps incestuous relationship between the upper echelons of the political and business communities.  At any rate the Fianna Fail government was only too willing to bail out their friends in the banking system and pass the buck on to the poor taxpayer.
Of course in order to bail out the banks the government has had itself to borrow vast sums of money, thus landing the government with a massive deficit.  To help make this deficit more manageable the government has also introduced a series of austerity budgets which have cut public services and public sector pay.  All to no avail.  The much vaunted, or should that be mythical? private sector has so far been pretty conspicuous by its absence.  With a depressed EU and the USA still mired in its own economic woes, there is little prospect of increased demand for Irish products.
However the banks' debts still have to be covered.  Hence the current spot of bother.  The reality is that though this is presented as a liquidity crisis, it is in reality a solvency crisis.  The Irish banks are insolvent and there is no way that the Irish economy can grow sufficiently fast to pay off these debts.  But why are the EU and the UK only too willing to offer substantial loans to help Ireland?  Why not just let the Irish clear up their own mess?  The reason is simple - too many EU and UK banks too deep into the Irish mess.  It is estimated that UK bank exposures to Ireland could be as much as £139bn.  If Ireland were to declare its banks insolvent then this would lead to great losses to these UK banks and to another financial crash in the UK and in parts of the EU.  So much better if you can persuade, or should that be bully, the Irish taxpayer into bearing the burden.  Though for how long is anyone’s guess
Things are particularly bad in Ireland right now.  Though it is only a matter of degree.  And the key mystery remains.  How is it that all these highly paid, highly respected people who got us into this mess - the bankers, the top civil servants at the treasury and the central banks and the politicians - how come they are all still there in their still lucrative posts.  To paraphrase Winston  Churchill, rarely have so few made such a goddam mess for the rest of us -  and got away with it. 

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