Monday 19 March 2018

Yawning Exchequer deficit is the problem

The reason our deficit crisis isn't making headlines is because Nama and Greece are providing useful decoys

LAST week, Nama CEO Brendan McDonagh appeared before the Oireachtas Committee on Finance.

It was a well-flagged meeting, but almost all the focus in the media afterwards was either on the past (on what McDonagh himself described as "a troubling picture of poor loan documentation, of assets not properly legally secured and of inadequate stress-testing of borrowers and loans), or the present -- in particular the revelation that just one-third of Nama's first tranche of loans are still performing.

Very little of the focus, however, was on the future. As a critic of the method chosen for rescuing Ireland's financial system and the manner of its implementation until now, for me, McDonagh's appearance has been a cause for cautious optimism.

The Government's decision to burden an already-overstretched Exchequer with even more obligations to rescue the financial sector is essentially a gamble. But it's a gamble where the Government gets to set the price, and the indications are that Nama, under McDonagh, is going to do its best to make sure the Irish taxpayer drives a hard bargain.

The price for the first tranche, for example, suggests that Nama will now pay a total price of somewhere in the region of €43bn -- and not the September figure of €54bn. Given that an absolute worst-case scenario would mean Nama's collateral would be worth about €30bn, already the exposure of the Irish taxpayer looks to have diminished significantly.

What's even more encouraging is the approach Nama seems to be taking. In McDonagh's own words: "Borrowers who continue to meet their contractual obligations have nothing to fear from us, but those who do not can expect Nama to take whatever actions it considers necessary to protect the interests of the taxpayer... The taxpayer can be assured that the price Nama will pay the financial institutions for these loans will reflect the reality (the current market)."

This is particularly important because Nama's remaining tranches, which will comprise land and developments, will be nothing like the first tranche, which was dominated by "associated loans" and investments. Therefore, while headline stats on haircuts and performing loans may turn out to be similar to those for the first tranche, there's certainly no guarantee they will. This is particularly true because of the large swathes of land around the country that were marked for development but have essentially reverted to agricultural land. Similarly, Nama cannot afford to be sentimental about yields on commercial or residential property, where boomtime yields were already low before rents fell by between 25 and 50 per cent.

The more Nama looks out for citizens, however, the more banks are having their capital bases squeezed. While I appreciate current sympathy levels for the banks are justifiably running low, adequately capitalised banks were the point of the exercise. Therefore, the focus for policymakers -- and for their dialogue with taxpayers -- should be a sustainable plan for bank recapitalisation, including nationalisation and wind-down where necessary.

In particular, in relation to Anglo Irish Bank and Irish Nationwide, it is not enough for the Government to just state that the costs of winding them up over 10 years are greater than keeping them alive -- the taxpayers deserve a full explanation of this decision and the methodology behind these calculations.

However, it's important to keep the likely cost of the rescue of our financial system in perspective. An Irish person worrying exclusively about amounts we may lose on Nama and the banks is a bit like a homeowner fretting about a leak in his attic while his house is on fire. Ireland's yawning Exchequer deficit is by far the bigger worry. Yet bizarrely, Nama seems to grab the majority of the headlines domestically. Internationally, the only reason our deficit is not grabbing the headlines is because Greece's is providing a useful decoy.

To put Ireland's two crises in perspective, national debt at the end of 2006 was €36bn. Were an absolute worst-case scenario to happen in property and finance over the coming decade, say a once-off permanent 75 per cent fall in property values combined with all our money injected into the banks coming to nought, the losses to the Irish taxpayer would be about €35bn. (About €15bn in Nama losses and €20bn in wasted capital injections. A best-case scenario would be making a profit on both fronts.)

The figures for Ireland's public-sector deficit are far more troubling. Even a best-case scenario for the Irish Government's cumulative budget deficit over the period 2008-2014 will total about €110bn -- a worst-case Nama/bailout scenario four times over. That's the optimistic figure, based on the Government securing significant cost-saving productivity improvements, especially in health and education, each year until 2014, in return for no more pay cuts. A worst-case scenario -- no more pay cuts, but also no cost savings while economic growth remains anaemic -- would see deficits total about €135bn until 2014 -- and continuing thereafter.

Nama and the bank bailouts may ultimately make the Irish taxpayer a profit, but that would not mean the right decision was made. It is more likely that the gamble will incur a cost. However, the process is under way now and it seems we have the right man in charge. The far bigger worry is Ireland's public-sector deficit. Much of the public-sector anger following the Croke Park agreement showed a firmly held, if entirely incorrect, belief that public-sector wages were being sacrificed at the altar of banks and developers. The Government has only itself to blame for giving its employees that excuse.

Ronan Lyons is an economist with

Sunday Independent

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