News Colm McCarthy

Friday 19 September 2014

There is no certainty the markets will fund our future borrowing

Why were alternatives to plunging the nation into long-term penury not pursued, asks Colm McCarthy

Published 23/06/2013 | 05:00

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WHY DID YOU DO IT? Former finance minister Brian Lenihan in 2010 with then UK chancellor Alistair Darling. In his memoir, 'Back From The Brink', Mr Darling told of his surprise on hearing of the Irish decision of September 30, 2008, to give a blanket guarantee to the banks.
WHY DID YOU DO IT? Former finance minister Brian Lenihan in 2010 with then UK chancellor Alistair Darling. In his memoir, 'Back From The Brink', Mr Darling told of his surprise on hearing of the Irish decision of September 30, 2008, to give a blanket guarantee to the banks.

Starting in late 2008 when the financial crisis finally erupted in Ireland, government spokes-persons have persistently stuck to the line that economic turnaround is imminent, and that when it comes the problems with the banks and with the public finances will become more manageable. No evidence in support of this rosy prognosis is available, but happily none is required, since it is a profession of faith.

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Since the beginning of May, European policy-makers have been reminded that the broader eurozone financial crisis is also far from over. The cost of government borrowing in Spain and Italy, both too-big-to-fail eurozone members, has been rising again, and the likelihood of a further dramatic intervention to save the euro has been rising with it. Spain and Italy are not in EU/IMF rescue programmes and must meet their substantial financing needs in the markets. The yield on Spanish 10-year bonds reached 4.91 per cent on Friday, up from just over four per cent early in May. Orange lights will begin to flash if this number breaches five per cent.

Four countries are in bailout – Greece, Ireland, Portugal and Cyprus. Greece will struggle to avoid a further debt default (the IMF has admitted the initial Greek 'rescue' of May 2010 was botched), while bond yields in Portugal have jumped again towards unsustainable levels. The mistakes in Greece have been repeated, with some novel twists, in Cyprus. If the planned Irish exit from bailout at year's end is jeopardised, the star pupil in bailout class will have flunked the exam.

Europe's banking system remains under-capitalised, and there has been no concrete progress towards the kind of banking union necessary to sustain the common currency. There are straws to grasp at, notably the decision to leave open the possible uses of the eurozone rescue fund, the ESM, for refinancing banks. It could still be used to fund the legacy liabilities of zombie banks currently resting on the balance sheets of zombie treasuries. But there has been no agreement on ending decisively the doom-loop connecting bust banks to bust states. Official policy is to reassure markets through a confident complacency and to see out September's election in Germany before facing the music. The markets could calm down again, but another interruption to the vacation plans of eurozone politicians in July and August is entirely possible.

In Ireland there is evidence that the government parties, halfway through the maximum Dail term, are beginning to suffer pre-election nerves. There have been backbencher defections as well as discordant voices in the senior ranks, with ministers making solo runs on impossible relaxations of budgetary constraints. These have included proposals to reduce income tax, to expand the public capital programme and to further increase the minimum wage. The number of Dail deputies fearful of losing their seats is rising, and support among TDs for the retention of the 60 safety hammocks in the Seanad needs to be understood against this background.

Friday's data on mortgage arrears was not reassuring. Despite the further reduction in the interest rate on tracker mortgages (most mortgages from the peak bubble years are trackers), there is no sign that the volume of arrears has peaked. It is an open question whether the banks have adequate capital to absorb future loan losses from mortgages and the SME sector.

The Government continues to borrow at the rate of €1bn per month, and no relaxation of budgetary policy is feasible between now and the general election. From next January, all of Ireland's considerable financing needs will have to be met through borrowing in the markets. Loose talk about stimulus packages designed for domestic consumption will be interpreted as a weakening of government commitment to getting the finances in order. Add in the lack of evidence thus far of any broad-based economic recovery and there can be no certainty that Irish borrowing needs from 2014 onwards will be met by the markets. Contingency plans for some form of continued financing from the EU and IMF are doubtless under discussion, and they may well be required.

In their letter published in last week's Sunday Independent, Professors Donal Donovan and Antoin Murphy took issue with my criticisms of their recent book, The Fall of the Celtic Tiger. They raise three main points. The first is their judgement that the government's decision on September 30, 2008, to guarantee virtually all of the liabilities of the Irish banking system was correct in the circumstances. They acknowledge particularly the government's (mistaken) perception that the banks were solvent, though illiquid. Many people, including the opposition Fine Gael and Sinn Fein parties, supported the government's action at the time.

No economic policy action can retrospectively be condoned merely because the authorities perceived no alternatives at the time. Policy actions need to be judged on their consequences. The Irish banks failed anyway and the State itself went bust. That there were alternative courses of action available is evident from the wide range of less-costly policies, short of a comprehensive guarantee, pursued in other countries. In his memoir, Back From The Brink, then UK Chancellor of the Exchequer Alistair Darling recounted his surprised reaction to the Irish move: "It meant the Irish Government was effectively underwriting its banks in a way no other country in the world had done." He continued: "I knew full well that if the Irish Government's bluff was called they would be bankrupt. It was a promise on which they could never deliver."

Mr Darling's reaction, shared by many economists and commentators in Ireland, has proven to have been the correct one, but the TINA (There Is No Alternative) defence is at least arguable. Central Bank governor Patrick Honohan for one did not accept it in his report to the Minister for Finance. He wrote: ". . . the extent of the cover provided . . . can, even without benefit of hindsight, be criticised inasmuch as it complicated and narrowed the eventual resolution options for the failing institutions and increased the State's potential share of the losses".

Professors Donovan and Murphy, remarkably in my view, go on to contend that, even if the government had understood fully the insolvency of the banks, they would have been correct nonetheless to have guaranteed (virtually) all of their liabilities, to the tune of three times the national income. In this contention, the professors have the field to themselves.

Even those involved in the decision of September 30, 2008, have offered ignorance of the true state of affairs in the banks as the principal explanation for the action taken. The government could hardly have concealed its knowledge of bank insolvency from potential lenders, private or official, without risking culpability in securities fraud. Nor could it have survived politically – try this: "We have discovered that the banks are utterly bust and we are guaranteeing all of their liabilities." The belief that the banks were sound remained government dogma for many months following the guarantee ("the world's cheapest bailout") and the full admission of bank insolvency was delayed until the early months of 2011.

The final contention in the Donovan/Murphy letter is as follows: "McCarthy's statement that there has been no comprehensive official inquiry into the banking crisis is incorrect. There have been two such inquiries, the Honohan inquiry and the Nyberg commission." The operative term here is "comprehensive". If Professors Donovan and Murphy regard both the inquiries they name as comprehensive, they are at odds with the authors of the two reports, both of whom draw attention to the limits of their investigations. Anyway, there have been three official inquiries, the third being the Regling/Watson report.

Regular readers of this column will know that I have found all three documents useful in different ways, but none of them is comprehensive (or claims to be, in fairness to their authors). An example of a comprehensive report into the collapse of a bank would be the Valukas report on Lehman Brothers, or the report on HBOS prepared by the UK's parliamentary commission on banking standards.

That there has been no comparable inquiry into the Irish banking collapse, one of the biggest banking crashes that has ever occurred anywhere, is a continuing scandal. Every single Irish bank went under and had to be rescued. The State itself lost access to credit for the first time since its foundation. The desire to understand what happened is not just idle curiosity.

Irish Independent

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