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David McWilliams: We must face reality - and end bank guarantee

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'Define reality, face into it and do something about it' -- Jack Welch, CEO, GE

In 2001, I worked for Jack Welch, the legendary CEO of GE. He was on a book tour and I was his MC -- asking the questions at events and teasing out ideas and experiences from the gnarled titan of corporate America. Welch was the hardest taskmaster I have every worked for, but it was worth every minute, every harsh word, every cold stare.

When we weren't on stage, we chatted about all sorts of things and he was almost grandfatherly in these quieter moments. He was particularly keen to emphasise that crises define the person, the institution, the country.

He constantly referred to the fact that the crisis wasn't the issue, rather how you react to the crisis and the fact that all of us experience crisis -- whether in our business, social or personal lives. He told me that the most important thing to do was define exactly what the "reality" is -- not as you'd like it to be, but as it is. Once you have defined reality, then he said you must face into it and meet the challenge by doing something about it. Ultimately, all crises pass; we all get through to the far side and, in most cases, the far side is a less intimidating place than we first expected.

However, the key is to define reality. Welch explained to me that if you don't define the crisis, others will define it for you and then you play catch up and are on a hiding to nothing.

Think of our reality. Our reality is that our country is almost bankrupt and we will be unable to pay our bills. In practical terms, this is best evidenced by bond yields on Irish debt moving up to 6.99pc yesterday, a fraction shy of 7pc. Once bond yields hit 7pc, it's curtains because the psychological impact of going above 7pc is that we are in Greek territory and there's nothing to stop yields going higher.

The official reaction to this -- rather than defining reality -- has been to try to pin the blame on commentators and, worse still, to come out with the platitude that we have enough money already -- at least to last us to next March. To say we have borrowed enough money to last us till next year is like two drunks at closing time when one lad says, "Don't worry the night's not over yet, I have a bag of cans stashed in the kitchen and a bottle of vodka behind the sofa". Sorted so.

Reality is not being defined. The reality is that the Irish Government's credibility is being contaminated by the banks. Today the guarantee should -- according to the original plan -- have lapsed and the banks should be left to deal with their own mess. The reason the guarantee was granted two years ago was to avoid a run on the banks in the chaos of autumn 2008. Then, once that was prevented, the Government could have seen which banks it was going to save and which it was going to let go. Clearly this would have involved using the clock ticking down to the end of the guarantee as an incentive for the creditors to come to the table and do a deal with the State. But instead of using the guarantee as a bargaining chip, it was used as a blanket bailout.

The reality of the Irish banking system was not defined and now the bond markets have defined it for us. Looking at the numbers, it is easy to see why we can't pay the debts of the banks and any effort to do so will lead to the IMF marching through the door.

Let's look at the reality. What I want to focus on here is the issue of re-mortgaging, equity release and the deluge of cash borrowed against houses, which made us feel richer but which was ultimately wasted. This is the reality and this is why we will default, because the money is gone. The internal default is what drives the external default, not the other way around. The ability of the Government to pay its debts is only the amalgamated ability of us to pay our debts. The "Irish sovereign", as it is so grandly termed, is only the agglomeration of us.

The amount of outstanding mortgage debt at the start of January 2004 was €54.6bn. It is now €118bn. So mortgage lending went up by close to 120pc in five years.

It could be argued that there are many more houses in Ireland since the beginning of 2004, so maybe those numbers are not as bad as they seem -- because at least we have houses on the other side of the balance sheet.

But this is not the case, because on the other side of the balance sheet are cars, second houses, fields, fancy kitchens, flat-screen TVs and holidays on the Algarve. This is what we borrowed for and we used our houses as a large ATM machine, and the banks eagerly facilitated.

At the beginning of 2004, 16pc of our housing stock (by value) was mortgaged; by mid-2010 that number stood at 39pc.

It is important to remember the majority of houses in the State are not mortgaged, or have very small mortgages on them. So a huge amount of the mortgage debt and the re-mortgaging is centred on a certain part of the population, which is likely to be young couples -- the backbone of the society and the generation supposed to drag us out of the pit.

Their plight is now evident. Recent Central Bank data shows that of the €118bn in mortgages outstanding, €6.95bn are more than 90 days in arrears, with €4.8bn of those more than six months behind.

For these people in arrears (there are 36,620 of them) there is no way out, as property price falls mean that they cannot sell their property to relieve their debts (negative equity) and they cannot earn more money to pay off their debts (due to the economic collapse). Essentially, when these people most need money, they can't get it.

So the financial markets are looking at the internal situation and concluding that -- unlike the Greeks who had a government borrowing problem that became a banking crisis -- we have a bank borrowing problem which has become a government problem. If the guarantee was lifted today, a huge part of the State's burden would be lifted.

But that would mean defining reality and our leaders couldn't do that.

David McWilliams has devised and will teach a new diploma in economics entitled 'Economics Without Boundaries'. Enrolling now. www.independentcolleges.ie

Irish Independent