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David McWilliams: ECB is happy to let Irish banks go bust by stealth

Did you know that AIB defaulted on Monday? It did, and the people who internationally govern this type of thing announced yesterday that AIB is technically in default. AIB decided -- rightly -- not to pay some of its many billions of bonds. It began the process of burning the bondholders. Now, were we not told that if the banks defaulted then the sky would fall in? Wasn't that the establishment line?

It's not me who says AIB has defaulted, it is the following list of banks: Bank of America/Merrill Lynch; Barclays, Credit Suisse; Deutsche Bank; AG Goldman Sachs; JPMorgan Chase Bank; NA Morgan Stanley; UBS; BNP Paribas; Societe Generale; Citadel Investment Group LLC; DE Shaw Group; BlackRock; BlueMountain Capital and Rabobank International.

All these international investment banks that make up an august body called the International Swaps and Derivatives Association deemed officially that AIB has defaulted.

Now I don't really care what happens to these bankers, but I do remember that they had said that if AIB or any of the Irish banks defaulted on anything, the world would cave in. So has it? Weren't you told that by now the ATMs would not have any money in them?

Yesterday morning, I approached an ATM in Dalkey at the local AIB expecting to see lines and lines of frantic depositors queueing up to get their money out.

I was terrified as I put in my card because these usual suspects who come on telly and sound as if they know something warned that at the first hint of a default there would be no money in the hole in the wall. Now granted, these were the same lads who said we'd have a soft landing and who reassured us that the banks were "well capitalised".

But let's cut them some slack, people make mistakes; surely they were right this time about a bank default and the ATMs? They wouldn't just be making it up and scaring people again, would they? Surely they couldn't be talking through their posteriors one more time? Have they no shame?

But lo and behold, the money came out of the machine as it has always done. So AIB defaulted the day before and nothing actually happened. Nothing at all changed. Surely the bankers are not codding us again? If they are, more fool us!

It is beginning to look like that. For example, think about what happened last week. Michael Noonan -- for the first time from an Irish Finance Minister -- said that he would burn the senior bondholders of Anglo and Irish Nationwide. We had been told that the slightest hint of burning the "senior" bondholders -- the holy of holies in the strict hierarchy of creditors -- would signal financial Armageddon. But guess what? Nothing happened!

So here we have the Finance Minister of a wobbly eurozone member country saying he will default on senior bondholders and nothing happens. Isn't this a complete reversal of the original Department of Finance/ banking establishment view?

Why do we continue to listen to those who warn that the default on bank bonds -- particularly ones that have been guaranteed like those of Anglo and INBS -- would lead to chaos?

How much more evidence do we need before we conclude that the Irish financial establishment, like the Bourbons, has "learned nothing and forgotten nothing"? And like any crumbling orthodoxy the establishment deploys tactics such as fear and scaremongering rather than logic to bolster its outdated position.

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Let's get something straight at this stage because we are obviously now going into the "defaulting" stage of this financial cycle. The only way the ATMs would run out of money is if the ECB decided to break the Irish banking system. But with nothing to replace it, the ECB won't take such a step.

So the only way the Irish ATMs would stop functioning is if the Irish Central Bank, acting as the ECB's vassal in Ireland, decided to prompt financial panic by refusing to exchange Irish bank assets for money.

Just so you know, the way a stylised banking system works is a follows: The bank lends you money, let's say €300,000 to buy a house. This is an "asset" to the bank because it generates interest on the loan from you and thus generates income. The more of these loans the bank makes, the more profit it makes.

It has therefore in its vaults a promise from you that you will pay it. As long as you redeem this promise, this is "as good as money". The bank then goes with this promise from you, commonly known as a mortgage, to the Central Bank, it hands in this mortgage and in return, the Central Bank gives the bank real cash for which the banks pays a small amount of interest. It then puts this cash in the ATM and lends it to you at a higher rate of interest.

So in order for there to be no money in the ATMs as the scaremongers claim, the ECB has to have the balls to react to a bank default on bondholders by breaking this crucial banking circle.

This would mean the ECB refusing to give the bank money or refusing to let the Irish Central Bank give the retail bank money at the discount window.

Now in normal times it should do this because the Central Bank has no business giving more money to a bank that can't pay its debts to its creditors. Because if it does this it would be propping up a bank that is bankrupt and there is no way to distinguish between banks that are good and banks that are bad if the Central Bank doesn't do that basic job. But these are not normal times.

As a consequence yesterday, faced with a default by AIB, the ECB did nothing. Following Mr Noonan's threat to burn the senior bondholders, did the ECB cut off the Irish banks from the repo market? No it didn't. Did the market sell off Irish government bonds in the wake of Mr Noonan's musings? No it didn't. Why?

Because the market already knows that the Irish banks are bust. The market knows that they have become re-cycling vehicles for the Irish Government, which is simply upholding the ECB's will that an Irish bank doesn't declare itself bust, because that would look bad for the euro. So the ECB is now allowing the Irish banks to go bust by stealth rather than by diktat.

They won't cut off cash at the ATMs because they don't have the balls to do it. And therefore, we are condemned to a decade of zombie banks, breastfeeding a zombie economy. That is what this means for you.

Far better to bring this nonsense to a head and give us some hope in the future. The way to do this is to introduce new licences, kill the old banks and allow new ones to come in, unencumbered by the last 10 years.

You can't have a recovery without a banking system and you can't have a banking system which is bust and limps along from one crisis to another.

The Irish banks will now begin to default bit by bit and Irish depositors will wake up to this and react by doing what the ECB doesn't have the courage to do -- they might just continue to take their money out. Now that would be a real crisis.

David McWilliams has set up a new economics consultancy http://economicsclinic.ie/