Saturday 24 March 2018

Demonstrators' analysis of the bank bailout is deeply flawed

Eithne Keating from the Ballyhea protest group with a petition against bank bailouts before marching to Leinster House, Dublin in September, 2012.
Eithne Keating from the Ballyhea protest group with a petition against bank bailouts before marching to Leinster House, Dublin in September, 2012.
Dan O'Brien

Dan O'Brien

LAST Tuesday marked the third anniversary of the start of weekly demonstrations against the socialisation of bank losses in the north Cork town of Ballyhea.

It is easy to understand the protesters' commitment to their cause given the enormity of what has taken place.

The direct cost to taxpayers of the collapse has been, by some measures, the highest relative to the size of the economy in world financial history.

Even if, in a best-case scenario, tens of billions of euro can be recouped from the sale of the State's stakes in the pillar banks, the total cost of the bailout will still be one of the biggest ever.

The Ballyhea protesters argue that the underlying cause of the crash was a badly designed euro and a central bank in Frankfurt that did not do its job. They believe that when the consequences of these failures manifested in a banking collapse, the powers that be in the eurozone forced weak Irish governments to socialise the costs. On the basis of this analysis, they argue that justice demands other European countries repay the Irish state the approximately €65bn spent on the bank bailout.

There is nothing I would like more than to agree with this position. If the Ballyhea protesters' analysis was correct, taxpayers and citizens would have a real hope that a significant chunk of the State's total debt – now standing at over €200bn – would disappear. This would cut the huge annual interest bill, bring closer the day when public debt returns to manageable levels and reduce the risk of default if the economy were to falter again.

But agreeing with that analysis, however popular it might be, would be dishonest because the protesters' analysis it is almost completely flawed from start to finish.

The starting point is the euro and its design. At this juncture, it is hard to avoid the conclusion that the creation of the single currency was a mistake. It has proved to be the perfect transmission mechanism for financial crisis and caused profoundly deep divisions among the states and peoples of Europe. It may yet prove that a project designed primarily to bring Europeans together ends up doing precisely the opposite.

But that does not mean that the euro caused the current crisis. The origins of the crisis are to be found in the wider Western financial system which ran out of control from 2002 (almost a half decade after the launch of the euro).

Until the megabubble exploded in 2008, financiers ramped up the channelling of huge amounts of money to the most unlikely places with little or no consideration for the risks involved. The countries into which the international financial system poured most money (measured by balance of payments deficits expressed as a percentage of GDP) were non-euro countries. Iceland, Latvia, Estonia, Bulgaria, Romania, Moldova, Albania and Georgia all recorded bigger balance-of-payments deficits than any of the euro-area countries.

Far too much money flowed into Ireland in the 2002-07 period, and this cash was central to the inflating of a massive property bubble, but attributing that to the euro when so many non-euro countries experienced even larger inflows and similar booms and busts is plainly wrong.

Another variant of the argument that attributes the Irish bubble to the euro relates to interest rates. They did decline a lot in the run-up to the launch of the single currency in 1999 and interest rates do, of course, influence economic activity. But they do not determine everything.

Like Ireland, Italy and Portugal experienced big falls in interest rates when they adopted the euro in 1999, yet their economies stagnated continuously after the turn of the century and they had no construction or property booms.

If the sudden availability of cheap money was the cause of the Irish bubble, why did Italy and Portugal not also overheat when their interest rates fell by as much or more than Irish rates?

What about the role of the ECB?

The bank has made plenty of errors in its 15 years in existence – it is insufficiently accountable to elected representatives and it has specific questions to answer in relation to Ireland's bailout – but it is wrong to blame it for failing to regulate the eurozone financial system before the crash.

That is because the countries which signed up to the euro and designed its institutions wanted to keep regulatory powers in national capitals rather than transferring them to Frankfurt. It is not credible to blame an institution for not exercising powers it never had in the first place.

Perhaps the most contentious aspect of the banking debacle is who decided that the costs of the banking collapse should be socialised. The Ballyhea protesters say that foreigners forced Irish governments to ensure that Irish taxpayers repaid all investors in the domestic banks.

There is some limited truth in this charge. In 2010 and 2011, the Fianna Fail-led government, and later the current administration, believed that there would be limited collateral damage for the Irish economy if it let investors take the pain for their bad investments in the two defunct banks.

Approximately €5bn worth of unsecured senior bonds was involved. The ECB made it clear to both administrations that it believed allowing a default would pose a risk to the wider eurozone and left both governments with little choice but to use taxpayers' money to repay the bondholders.

But what of the other €60bn that was pumped into the banks? The most important decisions that led to that vast cost being incurred were taken by an Irish government – rightly or wrongly – doing what it believed to be in Ireland's best interests.

The liability guarantee of late 2008, the nationalisation of Anglo Irish Bank in early 2009 and the issuance of €30bn in promissory notes in the spring of 2010 were the big decisions that socialised the costs of the banking crisis. Despite the claims of the Ballyhea protesters, there is not a shred of evidence that those decisions were forced on the then government by foreigners.

The socialising of massive private losses is a huge injustice. But often injustice happens not because of the malign motives of those involved, but for other reasons. In this case its root cause was the blindness of financiers to the risks they were taking, the failure of regulators to control clear excesses by bankers and the insistence of the government during the bubble that there was no chance of a hard landing. When the hardest of landings came, there were only bad choices and the then government was left to try to pick the least bad among them.

The Ballyhea protesters have been dignified and committed to their cause. But their analysis is flawed and the prospect of other taxpayers in Europe (many of whom have paid for bailing out their own banks) gifting Ireland €65bn is next to zero.

The Government should level with people on this and explicitly refocus its diplomatic effort towards the €5bn imposed by the ECB and, even more importantly, securing cast-iron guarantees that any further recapitalisation costs will be Europeanised.

Blaming others for all our woes did little for this country over decades. Doing it again would be equally fruitless.

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