If fiscal sloppiness is not Ireland’s problem, then what’s the solution?

So much of yesterday was spent examining the government’s four year plan to get spending and tax in line with each other. It’s both a gamble and as Brian points out a malleable tool. Joan Burton’s main criticisms of it last evening were that it didn’t include Labour’s plan for a strategic investment bank (to be part funded by the national pension fund).

But since the biggest impulse to rein down debt within three years is coming from the outside (mainly the German’s presuming the fiscal straightjacket the prescribed for Greece will just jolly well have to do Ireland too, nothing about this plan is likely to be permanent. Especially in consideration of the fact that the ECB are still only playing the game according to Plan A.

But in the FT, Martin Wolf thinks Ireland has an opportunity to escape a German fiscal straightjacket. He begins by noting,  that Irish public indebtedness is a consequence, not a cause of the crisis. He draws from the analysis of Paul De Grauwe at Leuven University:

…the proposed mechanism is based on the view that the sovereign debt crisis in the eurozone is the result of irresponsible behaviour of governments that exploited the implicit bail-out guarantee while private investors had no incentive to discipline these governments.

This interpretation of the source of the debt crisis in the eurozone has become popular mainly because it fits the Greek crisis well. It cannot, however, explain the debt crisis involving the other eurozone countries, where the root cause of the debt problems is to be found in the unsustainable debt accumulation of the private sectors.

As if to illustrate:

Ireland and Spain, two of the countries with the severest government debt problems today, experienced the strongest declines of their government debt ratios prior to the crisis. These are also the countries where the private debt accumulation was the strongest.

It had nothing to do with irresponsible governments that failed to be disciplined by financial markets. The reverse is the truth. Financial markets were undisciplined and governments took their responsibility when they saved them.

He believes the ECB’s strategy is merely inviting speculators to shoot the cash fish swimming in the EFSF barrel:

When governments solemnly declare that in times of payment difficulties they will devalue the government bonds (that’s what a haircut means), this will introduce the speculative dynamics in the eurozone that destroyed the ERM. Once investors expect payment difficulties of a particular government, they will sell the bonds, thereby raising the interest rate on these bonds. This is exactly what speculators in the ERM did when they expected a devaluation of the currency: they sold the currency.

Last word to Martin Wolf who points out that for all the self flagellation (or FF flagellation) amongst the media and political class in Dublin, this is (as Lenihan has been insisting from the start) a private sector debt crisis of much wider provenance than poor wee Ireland:

The crisis is a huge challenge for Ireland, which should surely convert unsecured bank debt into equity rather than force its citizens to bail out all the improvident lenders. But the Irish case also shows that the German view of how the eurozone should work is mistaken: fiscal sloppiness is not the main problem and fiscal retrenchment and debt restructuring are not the sole solutions. One cannot learn from history if one does not understand it. [Emphasis added]

For all the argument going on in Dublin today over the four year plan, that’s not one being pushed by any political party.

  • I’m no economist and I may be missing something here, but surely it’s the case that we don’t *know* if Ireland would have been fiscally imprudent under normal circumstances because it’s not *been* in normal circumstances in recent years?

    Isn’t it the case that the combination of lax regulation and irresponsibility in the banks has meant that the country has been able to tax and spend ‘responsibly’ without pushing too many of the pressure-points the electorate might object to?

    (This is all a question rather than a statement mind!)

  • Mack

    Ambrose Evans Pritchard in The Telegraph

    Opposition leaders have not clarified how they will handle the issue [senior debt in the Irish banks]. However, it is becoming ever harder to explain to the Irish people why they should suffer austerity in order to ensure that foreign holders of damaged Irish bank debt should lose nothing. The country’s Labour Party already favours burden-sharing. The concern is that once Ireland cracks on senior debt, the dam will break across Europe.

    The big problem are the costs of fixing Irish bank insolvency (in order to bail out big European banks – see http://www.businessinsider.com/banks-exposed-ireland-2010-11 ) and the cost of replacing the liquidity functions the ECB are withdrawing.

    The protection of the Eurosystem banks is a European issue not an Irish issue. If European leaders wake up to that we might see a resolution to this problem and save the Euro. If not? Ireland simply can’t afford to take on the debt levels being spoken off, at anywhere near market interest rates…

  • Mack
  • JR

    It seems to all boil back down to the debt based economy system. When a bank only needs 20,000 to lend you 100,000 it seems to me there is a fundimental problem.

    I heard an economist make the point that even the 7bn the british government is lending to Ireland is ultimately just zeros created on a computer screen.

    The big problem with money created from nothing is that eventually it has to go back to nothing.

  • John Ó Néill

    In general, I’d been trying to keep an eye on the language being used in the centre-left press in Europe (the likes of the Guardian, Le Monde, Süddeutsche Zeitung etc). They have all been explicit (to some degree) in calling this a bank ‘bailout’ rather than a government ‘bailout’. Deutsche Bank has been routinely fingered as an ultimate beneficiary of this, too, alongside significant regulatory failure. They have also given some recognition to the fact that this is simply pushing private bank debt onto the taxpayer.
    In the Republic, only Vincent Browne’s TV3 show has routinely been including panels whose analysis seems to match the wider European observations (which is worrying, in terms of the standard of public discourse, since he is being dismissed as a sensationalist and alarmist).
    I think a rift between the centre-left and the euro project is a wider angle worth following in the medium term. If the eurozone becomes regarded as a German exo-currency (the old commercial tokens spring to mind) which it undoubtedly will if the convergence of private and public sector debts (but not responsibilities) continues. For the first time, in a long time, a significant left-right divide may re-emerge over all of this.

  • Anon

    The government’s failure was in the proper regulation of the banks. Obviously there was no interest rate lever to pull, but that didn’t precluse any action by the Central Bank in reining in excessive lending, and fiscal polic could have directed against the property bubble relatively easily. Mental capture by right wing ideology, incentive to turn a blind eye and rake in the tax revenue and a bit of crony capitalism are all significant holes. The government does not get off scott free.

    He’s right in that all the talk of stricter stability and growth pact requirements and peer reviewing budgets would not have prevented the problem. And I think he’s right that allowing haircuts is inviting speculative attacks.

  • Mack

    You are right the government are highly culpable. As is the Irish regulator – but it also worth pointing out that the regulator’s powers were somewhat limited anyway as European banks operating throughout Europe are regulated by the home country regulator. I.e. British banks in Ireland are regulated by the British regulator, Dutch banks by the Dutch. That means that if one (external) regulator permits lax activities the pressure increases on the home regulator to also allow it. Especially in a small country where the foreign banks operating there are larger (they could engage in lax practices simply to take market share from native banks).

    This is still a European problem though, and not one simply to be dealt with at Ireland’s expense..

  • Mack

    Krugman on Ireland & Iceland

    What’s going on here? In a nutshell, Ireland has been orthodox and responsible — guaranteeing all debts, engaging in savage austerity to try to pay for the cost of those guarantees, and, of course, staying on the euro. Iceland has been heterodox: capital controls, large devaluation, and a lot of debt restructuring — notice that wonderful line from the IMF, above, about how “private sector bankruptcies have led to a marked decline in external debt”. Bankrupting yourself to recovery! Seriously.

    And guess what: heterodoxy is working a whole lot better than orthodoxy.


  • DC

    First of all markets are necessary, secondly I’m no economist either.

    But, what financial markets produced this time round was a lot of credit which wasn’t necessarily needed in fact as Paul says it was irresponsible – the markets did so because they could; financial markets created decades worth of credit which was then produced, or actually compressed and released over 7 years – spewed out over 7 years or so, too much credit which could not be sustained and repaid inside national economies at the rate at which the markets and banks wanted it repaid. Toxic credit.

    This was largely possible because of *financial innovation* – debt hedging, splitting and splicing and repackaging, traded and re-traded – stretching credit limits out by sharing debt globally across interconnected financial markets, which should have been regulated much better so that credit levels were kept in line with what the nation could repay. Bit like limiting one person to one credit card, rather than give the person 5 credit cards and ignoring the fact he/she is on min wage.

    The money markets, rather than wait around till the natural economy catches up to repay all this compressed credit, it wants it all back over 4-5 years – speedily repaid – off the back of taxpayers, who were not all involved in this credit/property game.

    And as Paul above says, yes the government did have lax regulation and government did tax bank turnover and spend/invest it nationally, trouble is – that tax take was less than the systemic failure and balance sheet shortfall. That’s why the taxpayer is called on and austerity programmes are called for.

    I reckon a lot of patience is needed along with slow burn repayments – to be repaid in part by banks, in part out of proper economic growth in a manner that doesn’t cause distress to the vulnerable in society using public sector cuts – min wage cuts etc; repayments should be private sector-based; rather than frontloaded onto the taxpayer today and bounced into repaying most of it over 4-5 years hardcore austerity style.

    If economic growth doesn’t live up to expectations then attempt to debt write-downs.

  • DC

    And American as well.

  • John Ó Néill

    DC – it just struck me – that makes it sound like there is a fairly obvious problem – a large financial sector employing lots of people looking for things to trade and make money out of. Maybe the bigger story is that the financial sector needs to be beaten down in size so it stops trying to feed far too many mouths (none of whom would exactly be on minimum wage) by inventing new ways to make profit off other people’s money?

  • DC

    Yes which is why banks are resisting this, particularly in Britain.

  • John Ó Néill

    Hmmm. And going all the way back to Lehmans etc, the simple solution is to ban a range of financial products so they can’t be traded.
    The usual suspects will scream that the market is god when it clearly isn’t – if it was any other industry it would have been allowed to go to the wall and stay there as something that was of its time but that time had now passed…

  • DC

    Do haircuts, bond holders can freak, make sure the governments do not enforce any repayments using legislation. Nothing can then be done.

    In a simple world, Britain could have let Northern Rock fall and failed to enforce mortgage repayments and allowed the property to fall into the laps of the people for free! No Northern Rock, no repayments needed, no police calling at your door for repayments/repossession/courts – no toxic debt problem, no societal costs, no bother.

    Hurrah for Merkel! Hurrah!

  • Mack

    You can still blow monstrous bubbles without using complex derivatives. Just look at the Irish credit bubble. All straightforward lending.

  • DC

    Trouble with Lehman’s was thev v wealthy got out of *the game* simply because they didn’t want to take big hits, so the government had to get into their game and pump up the system with taxpayers money to sort out the liquidity problem; trick is to have another v similar game on the go I think.

    Just like when generating electricity and power, take Kilroot power station in NI which is coal fired, it has an oil-fired back up station close at hand in case of fatal network/grid failure. I wonder if there had been a viable public sector banking system or small network of such banks in parallel could deposits have been transferred over and protected that way, and have a form of core, essential capitalism operated out of that infrastructure?

    Government was caught with its pants down: the too big to fail scenarios then played out.

  • Anon

    That is utter madness and a straight race to the bottom. I still think the Irish Government and Regulator could have made life very uncomfortable for the foreign banks regardless.

    I read a suggestion that the ECB could have placed differential reserve requirements on different countries and the US ran a similar system with the states between the wars. I can’t find the link now though. It seems sensible.

    I initially thought Ireland could tough thsi out and it would improve competitiveness long term. But no, it’s just a black hole. The bond holders need to share some pain, or ireland should default, leave the Euro and force this onto them.

  • Johnny Boy

    Bail outs, four year plans; it’s all just treating symptoms, not addressing the cause. Unfortunately the root of the problem is human nature, and how do you fix that?

  • Billy Pilgrim

    Greed is not human nature. It’s just a bad habit for which human beings have wildly varying propensities. We should not structure our economy around the principle that greed is beneficial to the economy, let alone to society. We fix it by making and enforcing laws that give priority to the well-being of society. For these laws to be effective they must recognise that greed is like arsenic: a small amount can be a tonic, but anything more than a small amount is poison.

  • Johnny Boy

    The problem is that when the electorate are enjoying the boom times, they aren’t going to vote for politicians who are going to legislate
    egulate in a way that curtails the rate of growth.

  • DC

    That’s why you have regulators who good politicians should whisper in the ear of to make those necessary changes.

  • joeCanuck

    What’s the Solution?
    Easy, bring Bertie back, give him whatever money is left in the Treasury and send him off to the racetrack.

  • DC

    Apparently he has been spotted in the Dail or in the bar there – he received a genuine hearty cheer on arrival. I kid you not.

  • aquifer

    Ah yes the solution. Private investors tend to trust governments less than they trust private individuals situated in a territory with functioningl private property laws. i.e. Government bonds may be more expensive than money invested into private lending. The individuals have a strong interest in not going bust and so will probably repay their loans, or pay enough back before going under.

    Sell a bust bank with branches to bigger chinese or arab ones and get some fresh money into the system.