Something has got to give
The ever-mounting cost of the bank bailout raises serious questions about our continuing membership of the euro. Something has got to give, writes Dan White
13 April 2010
Even for those of us who had been insisting that the government was massively under-estimating the cost of bailing out the banks, the series of announcements on 30 March still came as a shock. When all of the numbers are added up it now seems as if the there will be little if any change out of €86bn by the time the banking mess has been cleaned up.
Even worse, apart from whatever smidgeon of private capital can be raised by Bank of Ireland and AIB, the vast bulk of this €86bn is going to have to come from the taxpayer.
When in September 2008 the government unconditionally guaranteed all of the deposits and most of the bonds of the Irish-owned banks, those of us who were concerned that we had opened a Pandora’s box were assured that this was the cheapest bank bailout of any developed country.
Within weeks this had been exposed for the conceit that it was when the government was forced to announce its plans to recapitalise AIB, Bank of Ireland and Anglo in December 2008. The following month, stripped of its remaining credibility following the discovery of concealed loans to its chairman Sean FitzPatrick, Anglo was nationalised.
This was followed shortly afterwards by the government injecting €3.5bn of fresh capital into both AIB and Bank of Ireland and €4bn into Anglo. So much for cheap bank bailouts.
Removing toxic assets
The 2009 recapitalisations merely bought time for the banks. Clearly something had to be done to remove the toxic assets, mainly non-performing loans to builders and property developers, from the balance sheets of the Irish banks.
That something was NAMA, the plans for which were originally announced in the April 2009 emergency budget. Getting the state’s “bad bank” up and running has proved to be a protracted process. We had to wait until September 2009 for Brian Lenihan to give details of the total of bad loans, book value of €77bn, which the banks were transferring to NAMA and the average discount to be applied when NAMA purchased these loans, 30%.
The 30% average “haircut” proposed by Brian Lenihan last September was widely criticised as being far too generous to the banks. As the evidence of the true extent of the collapse in property values flowed in from the Commercial Court, it quickly became clear that a much higher discount would have to be applied.
When Liam Carroll’s property empire collapsed last summer the Commercial Court was told that, despite owing more than €1.2bn, his assets would fetch a mere €300m in a fire sale. Then there was the site outside Athlone that had been valued at €31m as recently as 2006 but was now worth a mere €600,000.
A good haircut for all
These developments were reflected in the 30 March announcements. While the volume of bad loans, a total book value of €81bn, being transferred to NAMA has risen only marginally, the average haircut, assuming the same write-down is applied to all of the loans transferred to NAMA as was levied on the first tranche of €16bn at the end of March, has risen steeply to 47%.
This means that the €23bn of loan losses implied by Brian Lenihan’s announcement last September has now risen to €38bn. As a result estimates of the extra capital required by the banks have had to be revised drastically upwards with AIB needing €7.4bn, Bank of Ireland €2.6bn, Irish Nationwide Building Society €2.6bn and the ESB €875m.
However, it was the escalating capital requirements of Anglo which fairly took the breath away. It needs a further €8.3bn straight away with the probability of a further €10bn capital injection down the road.
When last year’s €11bn is added, this means that the Irish banks will gobble up almost €43bn of fresh capital.
And that’s barely the half of it. Even after the discounts have been applied NAMA will be paying the banks €43bn for their bad loans. In other words, the net cost of bailing out the Irish banks is now standing at a minimum of €86bn. With the exception of whatever capital Bank of Ireland and AIB can raise from private investors and asset sales, the vast bulk of this extra capital, at least €80bn, will have to come from the state.
Overseas bond investors won’t be fooled
While the government argues that the cost of bailing out the banks stands somehow apart from the national debt, which is also growing rapidly, overseas bond investors won’t be fooled.
At the end of December the, official, national debt stood at €75bn, up from €50bn 12 months previously. Even if the government manages to stick to its budget targets the national debt will reach about €95bn by the end of this year and €110bn by the end of 2011. Add in the likely cost to the taxpayer of bailing out the banks and we are looking at an effective national debt of about €190bn by the end of next year.
Economy still shrinking
At the same time as the national debt, both official and unofficial, is soaring, the economy is shrinking at a pace not seen since the Great Depression of the 1930s. Economists now expect the economy to contract by over 15% in real terms over the three years to the end of 2010.
But it’s even worse than that. As in the 1930s prices are also falling. When falling prices are taken into account the contraction in the economy has been even more severe with the Central Bank estimating that GNP, the only meaningful barometer of Irish economic activity will fall from €161bn in 2007 to just €126m this year, a reduction of 22%.
This combination of a shrinking economy and an escalating national debt is potentially disastrous. Even if there is some modest growth in 2011 Irish GNP is unlikely to exceed €130bn next year. With the real national debt likely to hit €190bn that translates into a debt/GNP ratio 146%, as bad as anything we experienced in the 1980s.
However, unlike in the 1980s when private sector debt levels were relatively modest, Irish private sector credit is still likely to top €300bn even after the banks’ bad loans have been transferred to NAMA.
Add it all up and you are looking at total indebtedness, public and private, of almost half a trillion euro. How does an economy of just €130m support such a debt mountain?
It almost certainly can’t.
The obvious course of action for most countries faced with such a debt burden is to resort to the printing presses and allow the internal level (prices) and external level (the exchange rate) of the currency to fall. This is what the British have effectively done. Five years of 20% annual inflation would reduce the real value of our debts by 60% in real terms.
Unfortunately our membership of the euro currently rules out such a policy. Which almost certainly means that we will be forced out of the single currency. When German Chancellor Angela Merkel suggested changing eurozone rules to allow for the expulsion of errant members everyone assumed that she was talking about Greece.
Who knows? Maybe she was talking about Ireland instead.