After the Banking guarantee, two problems became immediately
apparent. The first was on the asset side.
The main financial institutions Ireland, through their reckless lending
had accumulated millions of euro worth of ‘bad loans’, which were unlikely to
ever be fully, if at all repaid. These bad loans were mainly used to fund the
now ‘ghost estates’ or other property developments. In addition, many homes
which were defaulting on their mortgage had
gone into negative equity which, coupled with the difficult banks have
in repossessing family homes due to its constitutional protection, led to a
serious strain on the banks balance sheets. To this end, the National Assets
Management Agency, or NAMA was established. This bought the toxic assets from
the bank, albeit at a huge discount, €71.3 billion of these loans for only
€30.3 billion (42%) and thus creating the world’s largest ‘bad bank’. NAMA paid
for these loans with bonds issued by the Irish government, which can be
exchanged for cash on the international markets. Having acquired these bad
loans, NAMA has been free to pursue its debtors and has by many estimates begun
to create a profit, although this is disputed, as there is evidence to suggest
that NAMA failed to account for long term economic value when determining the
worth of the assets.
The other problem facing the banks was on the liability
side. There was a huge deposit flight as a result of the crisis, leading to
very illiquid banks, an issue which was further hampered by the toxic loans.
They were thus forced to rely on government and ECB funding in order to
maintain afloat. Due to the blanket guarantee offered, the bust had a
significant effect on the public finances. Even prior to the crisis, tax
revenue had been too heavily dependent on property transactions, which had now ground
to a halt. In order to reduce the gaping deficit, the government introduced a
widespread programme of austerity.
Of course, the Irish financial crisis did not happen in a vacuum.
Almost every other country in the world experienced a significant downturn in
their economy, and this is particularly true of the Eurozone. Excessive debt,
both in the public and private sector led to a capital flight, and a
reawakening of the markets to sovereign risk, i.e. that governments might
default. The five worst offending nations Portugal, Italy, Ireland, Greece and
Spain were given the rather unattractive moniker PIIGS. Greece, which should
never have been allowed join the single monetary union in the first case, was
the worst example, with its crisis largely due to fiscal profligacy and fraud.
In May 2010, the greek government applied to the Troika; the EU, the ECB and
the IMF for a €120 billion loan in order to pay its debt. However, this did
nothing to reassure international markets about the safety of Irelands debt,
and the banks experienced massive deposit flights. A run on a bank, such as
this was, can destroy even the healthiest of financial institutions and the Irish
banks were positively anaemic.
In the Autumn of 2010, despite the Irish government being
funded a year in advance, yet again more money was needed in order to recapitalise
the government guaranteed banks. With the state effectively shut out of the
international credit markets, they were left with no choice but to sacrifice
economic sovereignty and turn to the Troika. A combined rescue package of up to
€85 billion was agreed, with the Irish government in turn committing to keep
the budget deficit below 3%. The Washington Consensus was imposed; a
liberalisation of the financial system and the removal of capital controls.
Although the bankers have been rightly blamed for their
actions, much of the responsibility must also be borne by the Irish policy
makers. For one, the regulation in place to prevent such a catastrophe was far
too deficient. There is the real sense that Irish lawmakers ensured that they
were not told that which they did not wish to hear, with Patrick Neary, the
financial regulator being a prime example of this. However, the ECB must also
shoulder some of the blame for failing to create a powerful Eurozone wide
financial regulator, similar to that which exists in the UK and USA (although these
two have come under widespread criticism).
Perhaps one of the greatest tragedies of the crisis was that,
for all the talk of the glory days of the Celtic Tiger, very little was made
with it. Public expenditure and investments were made at a level which
incorrectly assumed that there would be no dramatic collapse in government
revenues in a short period- that the business cycle had been tamed and the
Great Moderation had occurred.
A question oft repeated is should the Irish government have
burned the bondholders? To not do so led to an enormous strain and burden on
the Irish taxpayer. Was it because the ECB did not want any bank to follow the
path of Lehman, or because of the cosy relationship between Irish bankers and
their government? Contrasting with Iceland, which allowed its banks to fail and
is now in a much stronger position, and the situation becomes ever more
apparent. There is a gap in governance in the ECB which lies at the heart of
the Euro’s malaise.
The IMF, which believes that lenders should pay for their stupidity
before it has to reach into its pocket, presented the Irish government with a
plan to haircut €30 billion of unguaranteed bonds by two thirds on average.
Lenihan (Minister for Finance) was
overjoyed, according to a source who was there, telling the IMF team ‘You
are Ireland’s Saviour!’. The deal was torpedoed
from an unexpected direction. At a conference call with the G7 ministers, the
haircut was vetoed by US Treasury Secretary Timothy Geithner, who, as his
payment of €13 billion from government owned AIG to Goldman Sachs, believes
that bankers take priority over taxpayers
-Morgan
Kelly
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