A glimpse over the rim of Ireland’s financial inferno…

Excellent piece in today’s Irish Times on the Irish bank deal from Morgan Kelly, who gives us a quick view of what it might look like when if the Irish state tips towards a state of state bankcrupcy [can that happen? – Ed]. Oh, yes. You don’t go to court, if the country defaults government will have to pay for nearly everthing itself on a dwindling tax take, government bondholders (ie pension funds and ordinary citizens) will all be f*&%ed, regardless of what the Supreme Court might have to say about it… [So how come the Republic’s in such peril? – Ed]… Well, it might not be… Morgan takes up the story below the fold…

…imagine that you are a bank manager and somebody that we will call Brian (not his real name) comes in looking for a loan.

Brian’s income is €30,000 and he would like to borrow €20,000 to cover living expenses. This sounds like a lot in these nervous times but, because Brian is not carrying much debt, you think you might lend to him.

However, Brian then lets it slip that, because his income is falling sharply, he will need to borrow at least as much each year for the foreseeable future. He also admits that, late one night and for what seemed like good reasons at the time, he somehow agreed to insure the gambling losses of some “banks”.

Brian has no idea how large these losses might be, but is starting to fear that they might be substantial. At this stage, you realise that Brian is on a trajectory into bankruptcy and show him the door.

The devil in this case lies not in Ireland’s public debt, but in the government’s foolish audicious cunning plan to guarantee the losses of the Irish banks:

The Government has not updated its estimate of losses since Brian Lenihan’s boast that the liability guarantee was “the cheapest bailout in the world so far”, an assurance that already ranks in the annals of supreme political irony alongside Neville Chamberlain’s “peace in our time”.

According to Kelly, the equation is brutally simple:

The ability of the State to continue funding itself ultimately depends on the size of these bad debts. If they are of the order of €10ր20 billion, we will survive. If they are of the order of €50-€60 billion, we are sunk.

And how did we get here? Lax regulation is not just an Irish disease. Right across the western world, the banks and international financial houses lobbied for it hard, sometimes making sub rosa threats to political parties and leaders that they would redirect their resources elsewhere without a lowering of base standards.

According to Fintan O’Toole, Ireland under Fianna Fail bought the line hook line and sinker:

At the IFSC annual lunch in December 2005, Micheál Martin noted the “unhappiness in the business sector at the degree and extent of obligations imposed by directors’ compliance statement obligations” and boasted that he was changing these regulations to ensure the law would be “less prescriptive about the methods a company uses to review its compliance procedures, and in not requiring review of the compliance statement by an external auditor”.

There was a concerted campaign to silence calls for tighter regulation. Charlie McCreevy urged the Financial Regulator: “Don’t try to protect everyone from every possible accident . . . And leave industry with the space to breathe and investors with the freedom to learn from their mistakes.” He actually boasted of how “Many of us in this room are from the generations that had the luck to grow up before governments got working and lawyers got rich on regulating our lives. We were part of the ‘unregulated generation’ – the generation that has produced some of the best risk-takers, problem-solvers and inventors.”

In effect, Fianna Fail took a gamble on the goodwill of the financial services industry. Last October it went in deep, before it knew just how deep a hole their mates in the banks had dug for them and the whole public sector. Back then Noel Whelan probably reflected government expectations that:

…if the insurance given to the banking system is not called upon, the Government finances will turn a substantial profit from the levy charged for the guarantee. Even if difficulties arise and some of the guarantee scheme is drawn down, the Government is determined that those costs will be borne by the wider banking sector rather than the taxpayer.

That was clearly very wide of the mark. The government seems to have mixed bad with good without asking the tough questions. Hardly surprising since the banks had all gotten used to being in the bully place. Morgan Kelly sees the worst looming:

To see what would happen to Ireland if foreign lenders suddenly pull the plug, we only need to look at what happened in Latvia last December. We would be forced to seek an international bailout, with the International Monetary Fund and European Union playing bad cop and good cop. We could expect cuts of one-quarter to one-third in public sector wages and social welfare benefits, and draconian tax rises to bring the deficit back to around 5 per cent of national income in two years.

There is actually a worse scenario where international bond markets suffer a general panic, like 1998. Not only does Ireland gets torpedoed, but also Portugal, Italy, Greece, Spain and Austria. The IMF and EU simply would not have the resources to bail out so many economies and we would be entirely on our own.

In circumstances where the Government could not even pay public sector salaries, the bank guarantee would immediately become worthless and we would see an uncontrollable run on all the Irish banks.

This won’t be like previous recessions. If the stimulus packages elsewhere don’t work (the Republic has already committed its future earnings to covering the banks come what may…), we are heading for a very painful reversal of the globalisation process. Unlike the 1980s, there is simply no place to escape to. As my colleague at River Path, David Steven noted in Tokyo recently: “be ready for the backlash – people are angry and rightfully so, but that may well lead us down some populist blind alleys.”

In which case, what Ireland needs right now is an opposition with a steady eye and a steady nerve.

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