State bailout far from being the commercial deal Cowen claims it is
Published 01/10/2008 | 00:00
The government's decision to unconditionally guarantee Irish bank deposits and inter-bank loans exposes the taxpayer to potentially huge risks. With property prices still falling, it is likely that the government's deposit guarantee will be called upon sooner rather than later.
Between them, the Irish banks owe their depositors, other banks and bondholders almost €400bn. That's more than twice the value of our total annual economic output and 10 times the total national debt.
Presenting the guarantee scheme to the Dail yesterday, Taoiseach Brian Cowen portrayed it as a commercial arrangement, with the banks paying a market-determined fee to guarantee deposits and wholesale funding.
It is, of course, nothing of the sort. Before the government's dramatic move yesterday, Irish banks were paying between 2.5pc and 5.5pc over Euroibor for wholesale funding. If the guarantee scheme were to reflect market reality, then the banks should be paying somewhere between 2.5pc and 5.5pc of the amount guaranteed, from €10bn to €22bn a year, to the government.
Will the government charge the banks anywhere near this amount for the guarantee? Will it what?
Even a €10bn premium would more than wipe out the profits of the Irish banking system. This isn't an arms-length commercial transaction, but the first stage in what is likely to be a protracted bailout of the banks, whose balance sheets have been stretched to breaking point and beyond by the collapse in Irish property prices.
Total property-related lending by the Irish banks now stands at a towering €240bn. Even a 10pc writedown in the value of this lending would wipe out more than half the reserves of the Irish banks.
The biggest risk posed by yesterday's move is what bankers call "moral hazard". With the government's unconditional guarantee of all deposits and inter-bank funding having eliminated the danger of a "run" on a bank by nervous depositors, what is there to stop financial institutions lending irresponsibly in the knowledge that the state will pick up the tab?
To take a hypothetical example, Bank A has been approached by Developer B to lend him money to fund a property development scheme. Up to yesterday, Bank A, experiencing difficulty attracting money from depositors and other banks, and sceptical about the merits of the scheme, was reluctant to lend Developer B the money.
Now, with the government having unconditionally guaranteed all deposits and inter-bank funding with Irish-owned banks, Bank A is awash with funds once again.
So will Bank A now lend Developer B, with whom it has a long relationship, the money he is seeking, rather than stick with its earlier reservations?
While this is no doubt an extreme example, it will be almost impossible for the government to avoid being dragged further and further into the day-to-day running of the banks as it seeks to prevent them from abusing the guarantee.
The guarantee scheme will almost certainly turn into the financial equivalent of a tar baby: the more desperately the government seeks to escape from its clutches, the more enmeshed it will become.
With more than one of the banks covered by the guarantee likely to experience problems in the near future as the true state of property loan books emerges, it will be difficult, if not impossible, for the government to maintain the fiction that yesterday's guarantee is no more than a temporary little arrangement. Far more likely is that it will be the start of a long drawn-out process that will last for many years and cost the taxpayer tens of billions of euro.