Coalition’s awful inheritance

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Now that the celebrating is over, the new government has a scary reality to face up to, writes Dan White



16 March 2011

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coalitionThe new coalition government inherits an economic wasteland. With the exchequer still needing to borrow almost €75m every working day and the banking crisis continuing to worsen the outlook is grim and getting grimmer.

Fine Gael and Labour can hardly be blamed for enjoying their general election “victory”. That’s the good news. The bad news is that any enjoyment is likely to be extremely short-lived as the enormity of our problems dawns on the rookie ministers.
As uncertainty about their future prospects mounted, deposits have been pouring out of the Irish banks. The most recent figures from the Central Bank show that the six Irish-owned banks, AIB, Bank of Ireland, Permanent TSB, EBS, Anglo and Irish Nationwide, lost a further €17bn of deposits in January 2011. This brings their total loss of deposits since the beginning of 2010 to a massive €100bn.

The pace of deposit withdrawals from the Irish-owned banks accelerated in the final quarter of 2010 in the run-up to the EU/IMF bailout, with €44bn of deposits, 22% of the total, being withdrawn. Clearly fixing our extremely fragile banking system will be at the top of the incoming government’s agenda.

Living beyond our means

Unfortunately an utterly broke banking system is only one of the extremely serious problems facing the new government. There is also the fact that we as a nation continue to live massively beyond our means.

This year, even after €7bn of tax increases in Brian Lenihan’s four budgets, the government will borrow a projected €17.6bn on our behalf to run the Irish state, almost €75m for every working day. This figure doesn’t include any of the money that will be needed to recapitalise the banks.

If €17.6bn sounds like an awful lot of money it’s because it is. It works out at almost €10,000 for every person still working in this country. Put it another way, the €17.6bn gap between spending and tax revenue means that the government will spend at least €1.50 for every €1.00 it collects in tax revenue this year. That quite clearly is no way to run a railroad, let alone a country.
Why, after all the pain we have had to endure over the past three years, are the public finances still in such disorder?

Could it possibly have anything to do with the fact that Irish weekly welfare payments are almost two-and-a-half times those being paid in either the UK or Germany?

Could it possibly be due to the 96,000 extra public sector employees who have been hired since 1997?

Could it possibly be due to the fact that average hourly public sector pay rates are 47% higher than those in the private sector – a disparity which manifests itself in the utterly bizarre situation of our having the best-paid head of government in the developed world?

Banks still not fixed

Side-by-side with our spendthrift public sector things are going from bad to worse at the banks. The outgoing government sneakily kicked responsibility for injecting a further €10bn of fresh capital into the Irish-owned banks on to its successor. In reality the full bill for fixing the Irish banks, which has already consumed at least €18bn of public funds, excluding the various IOUs which have been issued to Anglo and Irish Nationwide by the state, is likely to leave little change out of €100bn.

Look at the numbers. The total “haircut” on the €71bn of property-based loans which NAMA had purchased from the Irish-owned banks by the end of September 2010 amounted to E44bn or 58%. That implies a total write-down of almost €50bn on the €81bn of bad loans that were originally destined for NAMA.

And remember that the NAMA-bound loans represented less than a fifth of the more than €400bn combined peak loan book of the Irish-owned banks at the end of 2007. Now there are growing signs of distress in the banks’ mortgage books.

Between them the six Irish-owned banks have a total mortgage portfolio of about €100bn. With the latest figures from the Financial Regulator showing that at least 10% of all mortgages are experiencing difficulties and research from the ESRI indicating that close to half of all mortgages are underwater, it should hardly come as any surprise that the Central Bank is now examining the mortgage books of the Irish-owned banks very closely.

Throw in a 50% fall in house prices – with the likelihood of further falls to come, the fact that over half of the banks’ Irish mortgages are loss-making tracker mortgages, widespread job losses and wage cuts, and the stage is set for carnage. By how much will the Irish-owned banks have to write down their mortgage books? Even a 25% writedown, surely conservative under the circumstances, would add a further €25bn to the cost of sorting out the banks.

When this is added to the likely €50bn writedown on the NAMA-bound loans it wouldn’t take much more to bump up the total bad debt figure at the Irish-owned banks to €100bn. Suddenly last September’s widely-derided estimate from ratings agency Standard & Poors, which put the cost of fixing the Irish banking system at €90bn, is looking almost conservative.

Debt default is now inevitable

This combination of fiscal incontinence and bankrupt banks means that some sort of debt default/restructuring is now inevitable. The financial markets are saying as much with ten-year Irish government bonds now trading at just 72% of their redemption value.

No matter how you choose to do the numbers, the picture that emerges is the same: the markets are pricing in a 30% “haircut” on Irish government debt some time over the next five years.

So where do we go from here? Quite clearly some sort of debt restructuring and/or default is now inevitable. However, our European “partners” and other creditors are extremely unlikely to agree to accept severe haircuts while Irish public sector workers and social welfare recipients remain the best-paid in Europe.

Forget the malarkey about the 12.5% corporate tax rate. The real battle will come when Europe insists that we dismantle our lavish public sector and cut the cloth according to our measure. That is something which will be anathema to the comrades of the Labour Party and will stretch the coalition’s bonds to breaking point and possibly beyond. Already one bookie of my acquaintance tells me that he is taking a lot of money on a 2013 general election.

Remember where you read it first.



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