A scare at lunch-time

Morgan Kelly’s most recent horror novel research paper available online – The Irish Credit Bubble.

A taster –

By pushing itself close to, and quite possibly beyond, the limits of its fiscal capacity, the Irish state has succeeded in rescuing Irish banks from their losses on developer loans. Despite this, these banks remain as zombies entirely reliant on continued Irish government guarantees and ECB forbearance, and committed solely to reducing their own debts.

While bank capital levels are, probably, adequate for the markedly smaller scale of their future lending, we will see below that even fairly modest losses on their mortgage portfolios will be sufficient to wipe out most or all of that capital. Having exhausted its resources in rescuing the Irish banks from the first wave of developer losses, the Irish state can do nothing but watch as the second wave of mortgage defaults sweeps in and drowns them.

In other words, it is starting to appear that the Irish banking system is too big to save. As mortgage losses crystallise, the Irish government’s ill conceived project of insulating bank bond-holders from any losses on their investments is sliding beyond the means of its taxpayers.

The mounting losses of its banking system are facing the Irish state with a stark choice. It can attempt a NAMA II for mortgage losses that will end in a bond market strike or a sovereign default. Or it can, probably with the assistance of the IMF and EU, organise a resolution that shares property losses with bank creditors through a partial debt for equity swap. It is easy for governments everywhere to forget that their states are not wholly controlled subsidiaries of their banks but separate entities; and a resolution that transfers bank losses from the Irish taxpayer to bank bond holders will leave Ireland with a low level of debt that, even after several years of deficits, it can easily afford

Hat Tip Irish Economy.He correctly identifies the Banking Guarantee as a major source of our current problems..

Although the crisis had been building for 18 months, the government and financial regulators appear to have been taken entirely by surprise. At a late night meeting with banks, the Irish government committed itself to the unusual step of guaranteeing all existing senior debt
of Irish banks (among European economies, only Denmark subsequently did this) as well as deposits. In addition, as well as guaranteeing the two large retail banks (AIB and Bank of Ireland) and two smaller mortgage lenders; for reasons that have never become clear the
Irish government agreed to guarantee two specialist property development lenders (Anglo-Irish Bank and Irish Nationwide Building Society) despite already well known deficiencies in their corporate governance.

The most likely rationale for the Irish government’s actions is that it still believed that the liquidity problems of the Irish banks merely reflected market nervousness in the wake of the Lehmann collapse, and not justified concerns about the solvency of these institutions

So the Irish government was caught on the hop, but what about David McWilliams? One of the consistent voices of restraint throughout the boom, and one of the architects of the guarantee?

  • Drumlins Rock

    wow, just read the paper, that is scarey stuff, and although heavy reading makes sense, basically the banks are screwed, and the question is do the bring the government down with them?

  • The Raven

    “end in a bond market strike or a sovereign default”

    Layman’s terms – what does that mean?

  • wild turkey

    ‘The most likely rationale for the Irish government’s actions is that it still believed that the liquidity problems of the Irish banks merely reflected market nervousness in the wake of the Lehmann collapse, and not justified concerns about the solvency of these institutions’

    the above should be revised to read

    ‘The most likely rationale for the Irish government’s actions is that that the banking and political elite of ireland are in bed with each other. they felt this was a mature and satisfying relationship. indeed they mutually took moral solace from the apparent practice of the hierarchy of the irish roman church in so far as they weren’t actually fucking each other… only the unsuspecting innocent; be it the taxpayer or those of a young age (defined as less than 36). in anycase, the winners would not be expected to either pay the bill or take responsibility for the losers who had been fucked’.

    before the gombeen trolls go apeshit over the above, please consider the link below

    http://www.irishtimes.com/newspaper/ireland/2009/1223/1224261161039.html

    Irish Nationwide Building Society , McCreevy??? My, what a coincidence.

    Fuck this. It is Christmas time. Snowy and Cold.

    In fact, so snowy and cold, that my 9 year old son has assured me, ‘ forget santa and the reindeer. it is so cold you might see an irish politician with his hand in his own pocket’

    … on balance, we will stay with Santa. He has credibility and does his own heavy lifting.

    Nollaig Shona Daoibh

  • wild turkey

    “end in a bond market strike or a sovereign default”
    Layman’s terms – what does that mean?

    Raven
    If things go the wall and Ireland cannot service its national debt it means the bankers and the government, and all the associated ‘social partners’ fucked up. Fucked up big time

    We (and future generations) pay the price. In economics this is known as a cross generational transfer and has some bearing on the price of debt, and hence, the rate of interest on that debt.

    In return, and assuming the govt is not re-elected once more (economics is built upon heroic “simplifying assumptions”) they get a gold plated pension and residence in a non-extradible third world country of their choice.

    Call it Mangele land. it is claimed that they never ceased serving communion there

    Then again, Fianna Fail and its associated zipper lickers in the private and trade union sectors might re-brand and present themselves as ‘Ouch Mor’

  • Scaramoosh

    In due course it is almost a certainty that Ireland and Greece will be bailed out by the IMF. They cannot afford to leave the Euro; their interest rates would shoot up to 10% and above.

  • Drumlins Rock

    what is the general picture in the Eurozone, I know the big 2 (france & germany) are relatively strong, and ireland and greece are still on the brink, spain, portugal and italy arent great either, but are they near as bad as the other 2? and what about the rest, scaramoosh is probably right in that ireland wont get away with an internal fix, but how the EU deals with it will depend on what else is happening across the continent.
    Was just thinking the other day much of the seeds of the boom were sown 20 yrs ago at the fall of the Berlin wall, everything is part of one big picture, finance, politics, religion, sport, culture, but a central theme often develops, I think the days when cities were judged by the number of cranes you could count are gone for a while.

  • Nic01

    Im no economist, but it seems plausible. I heard a couple of big “if”s in there, though.
    Principally I’m trying to square the circle on the tidal wave of mortgage defaults. According to the Amarach research that Mick posted, only a relatively small percentage of the country is actually affected, since more than half the population already own their house outright and most of the rest have reasonable mortage levels (ie taken out before the madness of the mid noughties).

    So, while there will be defaults and sure it may break the major Irish banks, you know what? Screw them. I don’t have much time for McWilliams usually but I’m with him that the banks should be let fail and should have been let fail from the start. In an open market, there are plenty of foreign banks with better risk management willing to take up the slack.

    And save the country €20bn in the process.

  • cynic

    ““end in a bond market strike or a sovereign default”

    Layman’s terms – what does that mean?”

    Raven

    1 no-one will lend money to Ireland

    2 Ireland goes bust and is bailed out by IMF who then insist on austerity budgets and take payment back over time. Expect recovery to take perhaps 10 years

  • Mack

    Cynic –

    I think in this case Morgan Kelly is suggesting that the IMF would insist on bank bond holders shouldering the burden of the banks insolvency rather than the Irish taxpayer. This is an altogether more benign solution for Ireland

    Or it can, probably with the assistance of the IMF and EU, organise a resolution that shares property losses with bank creditors through a partial debt for equity swap. It is easy for governments everywhere to forget that their states are not wholly controlled subsidiaries of their banks but separate entities; and a resolution that transfers bank losses from the Irish taxpayer to bank bond holders will leave Ireland with a low level of debt that, even after several years of deficits, it can easily afford

  • I think it is too late to leave the banks to sink or swim. If the government withdraws its guarantee from the banks it would be highly likely to precipitate a panic and collapse. This would not be pretty; almost all payments are done through banks. Think of employees not getting their pay cheques because of the bank collapse, pensioners having their life savings destroyed and the like.

    The bank guarantee was given because the government thought this would be a temporary problem and that given a few years and a calming of the market that it would be possible to remove it and no money would have been spent. Hoping for this is still probably better than any of the more “radical” alternatives. Postponing the day of reckoning until the property market (the main source of collateral) is more healthy seems wise.

    Remember that the Lehman Brothers collapse set off a panicky chain reaction throughout the world. The collapse of the Irish banking sector could have similar effects throughout Europe.

  • Mack

    Aldamir –

    That’s a good point – but surely the full burden shouldn’t fall on the Irish tax payer? (The taxpayer pays via higher interest rates on government bonds today).

    Bond holders should bear some of the brunt (via debt for equity swaps in the banks). Also, surely there is no need to save every Irish bank? Surely some could be wound down in an orderly manner?

    Given the risk to the European banking system, should the cost be shared somewhat among Eurozone economies?