What has led Ireland to the brink of collapse?
At the bottom of this post is an interview that is a comprehensive overview of the politics, economics and history of the sovereign debt crisis in Ireland in 12 short minutes of video. This interview took place during the recent INET conference in Bretton Woods. INET writes:
In this INET interview, Kevin O’Rourke, Professor of Economics at Trinity College Dublin, warns that a socialization of Irish debts will eventually lead to sovereign default, and that amid austerity measures and bank bailouts right-wing populist parties might campaign on anti-European platforms. He also talks about the intellectual advantage of historians in times of crisis.
Let me comprehensively outline my view on the situation and give you a retrospective on the steps leading us to this point before I present the video.
I have been following Ireland along with the US, Spain and Britain as one of the four bursting housing bubble economies since I started this blog. There are other economies that had property bubbles. But Ireland, the US, the UK, and Spain are the four advanced economies that have both seen their bubbles burst and have paid the consequences via banking crises that have sent shockwaves throughout the global economy. It is safe to say, this crisis is far from over given the turmoil we see in the euro zone right now.
As I listened to O’Rourke, I wondered what I had actually written about Ireland as its economy and banking system collapsed. Mentally, I have a picture of my having warned of the crisis, realized that the bank creditor guarantees were a mistake, and then proceeding to argue that Ireland needed to rescind these guarantees if it wanted to avoid sovereign default. But that is just my present framing of what I wrote.
Right now, European politicians are fixated on buying time for their banking system by avoiding any debt restructuring. If my present framing is right, this is not going to work. And it will therefore lead to the kind of right-wing populist radicalism that O’Rourke speaks to in the interview. O’Rourke’s comments about “the intellectual advantage of historians in times of crisis” makes me wonder whether one could have foreseen what has come to pass. They make me wonder as well if I actually have been seeing this picture clearly. So I am about to go back into the archives here for my posts on Ireland to see whether I passed the O’Rourke test.
As I read these posts, I will encapsulate what I find below. Let’s look at the Irish situation in real time in chronological order.
- The first noteworthy post on Ireland that I wrote was called “Ireland votes No on Lisbon Treaty” on how the Irish initially rejected the notion that the European Union should more say over matters in EU member states. I think this is telling in retrospect because it goes to how deep-seated the antipathy for loss of national sovereignty is within the EU and the euro zone.
- Ireland guarantees bank deposits at six banks outlined how Ireland bailed out bank depositors and creditors in late September. If you read this post, you can see that my initial response was positive, as I felt the Irish were following the Swedish script from their 1990s bailout. It was only after I read a post from Willem Buiter from 2 Oct on this issue that I realised what a monumental error the creditor guarantee part was.
- The key factor for Ireland was size. In November 2008, I wrote Iceland: a cautionary tale for small nations which outlined why having a large banking sector could create disruptions. So by the time I wrote Is Ireland the next Iceland? in Nov 2008 I realised that Ireland was in big trouble. My conclusion: “a run on Irish banks is what would ultimately bring the Irish down. After all, it is the Government bank guarantee which creates the vulnerability. The Irish Government needs to make some contingency planning because an Icelandic fate is not out of the question. It need not worry about a currency run, but a bank run is still possible.”
- The last significant 2008 post on Ireland was Irish government unveils plan to recapitalise banks. There was no indication in that post of whether I believed the recap would be successful, just a bland admission that it would be necessary.
If I had to recap 2008, I would say it was clear that Ireland had an outsized banking sector and housing bubble that made it especially vulnerable to crisis. The bank creditor guarantee was almost immediately revealed to be a mistake, the first crucial error leading to potential sovereign default. And I believe the signs of anti-EU sentiment were apparent in 2008, suggesting that sentiment will resurface in greater dimension in 2011 or 2012 given the present political solutions to the sovereign debt crisis.
- My focus early in 2009 was less on Ireland and more on the EU as a whole, especially the linkage between western European banks and Eastern Europe and the Baltics. The most notable piece in that regard was “Do BRICs (and Germans) Eat PIGS?” from Niels Jensen in February 2009 in which Niels argued “The European approach, at least until now, has been to save the banking system at any cost. It is therefore possible that a significant share of the re-financing cost will find its way to the sovereign balance sheets and hence ultimately to the tax payer. This could further destabilise the currency union.” I think this is right, even more so in retrospect. Niels also writes: “if any country were to leave the euro, it would more likely be from a position of strength, and only one country possesses enough strength to pull that off in the current environment. That country is Germany. And, although the euro is not particularly popular in Germany, I believe it is extremely unlikely for Germany to make such a move unilaterally.” That is something we will still have to speculate on.
- Ireland next pops up in July 2009 when I wrote Depressionary bust in Ireland is echoed in California based on the loss of monetary sovereignty in Ireland. It made Ireland more akin to a US state than a sovereign currency issuer. My conclusion was: “The problem is the Impossible Trinity of a fixed exchange rate, independent monetary policy and free movement of capital. You cannot have all three. And California and Ireland both lack the monetary escape hatch. Depression will set in.” And I saw bailouts and emigration as likely, which has turned out to be true. I also mentioned a backdoor currency option, floating the idea of Gold-backed IOUs for Ireland two days later. But that’s just brainstorming. No conventional policy maker would do this unless they were desperate.
- By August 2009, things had deteriorated. Government banking Irish edition. By this time I had lost all faith in the Irish government’s stewardship and the post reflects this. I wrote about the plan: “This is a duplicitous parsing of words that hides a more sinister interpretation of what is happening in Ireland… I translate this as Lenihan implying the government intends to socialize the losses of the Irish banking system despite the looming fiscal problems in the country. In my view, this is the worst outcome of potential policy remedies and the least free-market approach.” I think this is the view that has come to be accepted by everyone now. In re-reading this post, it’s clear I did have hope that Ireland’s recognition of bad debts in another move reminiscent of the Swedes would help them. But, in the end, this nationalisation plan was the second crucial error leading to potential sovereign default.
- By October 2009, I was writing Ireland: Next stop – IMF. “Ireland has made heroic strides in trying to deal with its economic problem after a spectacular property bust. But it is looking increasingly like it will not be enough…There is zero chance the Irish are going to be able you make a fiscal adjustment of 10% of GDP in 3 years in a weak economic environment.”
- Before late November 2009, all of this was academic. Ireland, Greece and Portugal had plenty of time to make the necessary fixes. But the Dubai World crisis led us to the inevitable sovereign debt crisis. It was immediately clear to me that Dubai World was a game changer. In “New Citigroup maven Buiter warns of sovereign debt delusion” I wrote that Willem “Buiter correctly anticipated the potential for collapse in the Icelandic banking system. Since then he has warned other small open countries like Ireland and Dubai not to follow in Iceland’s footsteps in providing sweeping government backstops to bankrupt troubled institutions. This is what he terms the sovereign debt delusion… His most recent blog entry pointed out the relative insignificance of Dubai in the global system but it warns of the potential for sovereign default –especially in the Eurozone.”
- Rounding out the year was “Greece risks financial Armageddon while Ireland makes cuts” in which I wrote: “The Irish government announced draconian spending cuts of 6 billion Euros in order to stave off a debt crisis in the worst modern-day downturn in the nation’s history. Even so, Irish government bond yields have been rising relative to German government bond yields, the benchmark for the Eurozone. Over the past five years the spread had averaged about 40bps. Now it is 170bps. But, the Irish seem to be making the necessary cuts forced on them by lower tax receipts and currency union. The Greek government, on the other hand, is not taking the same tack.” This is when people were still praising Ireland for making he necessary cuts, thinking it could work. The post title is framed that way but I already told you in October that “There is zero chance the Irish are going to be able you make a fiscal adjustment of 10% of GDP in 3 years in a weak economic environment.” “But, the situation in Greece is worse than it is in Ireland. The debt levels are higher. The spread to German bunds (214bps) is higher, and the budget cuts are not yet forthcoming. For signs of stress, I look to Greece before I look to Ireland.”
My recap for 2009 is this: through late summer 2009, Ireland had every opportunity to get the situation with the banks sorted. The Irish government chose to socialise Irish banking losses onto taxpayers and when Dubai World started the sovereign debt crisis, it was game over for the Irish and the Greeks. The Greeks would be first and the Irish would be next.
- All eyes were on Greece in early 2010. They received their bailout and then we turned to Ireland. The first significant 2010 post on Ireland Chart of the day: Exposures to Greece, Ireland, Portugal and Spain showed heavy exposure to Ireland in Germany and the UK.
- In October, I gave some Quick thoughts on Irish sovereign debt crisis. “The biggest parallels I see for Ireland are with Spain. Spain is the perfect example of a country that never should have joined the euro zone. Both countries had budget surpluses in the run-up to the financial crisis. But they both suffered from euro zone rates that were too low during the property bubble.” “What will be necessary is some combination of defaults, bond holder haircuts, internal devaluation, bailouts and money printing with the emphasis on the former yet-to-be taken remedies over the latter quick fixes.”
- Of course, I hadn’t ever given up entirely on Ireland as a sovereign debtor (I still haven’t). So in November 2010, I wrote How the Irish can prevent a bank crisis from becoming sovereign default. “You have a case that should have already headed to the IMF and the EFSF like Greece. When I made the same remark on Tuesday, one commenter suggested this was a bit of stating the obvious. But it’s not. You still have people in the Irish political elite like John Bruton saying the Irish can get by on export growth. Is this a case of denial? After all, Ireland was supposed to be the one that made it as they were willing to face the music and were not profligate like the Greeks. I think, yes, there is a lot of denial and foot dragging here. In my view, the die is cast. What should concern Ireland and Europe is the talk of sovereign default and the potential for contagion. If Ireland is to save itself and prevent contagion, it will have to let bondholders take the hits instead of Irish taxpayers.”
I think I will leave it there for now. Ireland received its bailout soon after. I have a lot more on Ireland in the seven months since then, but the situation is really largely the same.
I see three crucial moments.
- The Irish deposit and creditor guarantee in September 2008. I will note what I said in March regarding the Irish stress tests: “Everyone has patted the Swedes on the back for their successful 1990s bailout and crisis resolution scheme. That scheme was very similar to the present Irish one.” Moreover, “the krona depreciated against the US dollar by some 40%. That’s an enormous move in a 15-month time span. That’s not going to happen in Ireland. In fact, the ECB is talking about raising rates – making the Irish situation worse. Irish residential property losses will increase under that scenario.
There is no way the Irish economy can go through austerity, which lowers consumption demand and economic growth, while paying the 5.8% ‘bailout’ rate of interest it has agreed to without ballooning its debt burden. The Irish are currency users. They have no sovereign currency, so it’s not a matter of printing up a gazillion Irish punts to ease the crisis. The ECB has made it plain that a full scale monetisation route is not going to happen unless we get an existential crisis (likely caused by a Spanish sovereign crisis). Default is the only way to ease this burden. And so the question becomes who will take the losses: Irish taxpayers, foreign bank creditors in Spain, Germany, the UK and France, or sovereign debt creditors. It’s as simple as that.”
- The bank nationalisation plan in August 2009 was the second crucial error leading to potential sovereign default. The Irish government essentially doubled down on tying the Irish banking system up as a liability of the Irish taxpayer. Their duplicitous parsing of words in not calling this a nationalisation warranted them the perpetual enmity of the Irish people. Really, this was critical. Dubai World had not happened and the Irish government had plenty of time to repudiate the creditor guarantees or to stop the taxpayers from footing the bill. They chose not to do so.
- In November 2009, the Dubai World crisis led us to the inevitable sovereign debt crisis. I knew the sovereign debt crisis had begun. However, at the time, I was more concerned about eastern European debtors. But this is what I wrote in real time about The bust in Dubai and exogenous shocks: “the Dubai World events underline the unpredictability of exogenous shocks. All of these potential crisis situations — dollar carry trade unwind, debt crisis in the Baltics, oil price spike, an unexpected surge in interest rates, war in the Middle East — are still there lurking in the background. We don’t see coverage in the press on them everyday, but they are still there”
Thank you for indulging me on my trip down memory lane. Having read my posts, I do think I passed the O’Rourke test and it makes me believe that anyone with enough historical context should be able to see these things before they happen – and adjust accordingly. For whatever reason, our policy makers have failed the O’Rourke test repeatedly and no matter how much they tell you they have it under control, this trip down memory lane should disabuse you of that thought.
Now, here’s Kevin O’Rourke.
P.S. – Also see my post Rising economic nationalism in which I also say that the economic and political choices made in the euro zone right now will eventually lead to a huge resurgence of far right populism.
UPDATE 10 Jun 2011: Today, just hours after I wrote this post, we learned former Irish finance minister Brian Lenihan had died at the age of 52. You may disagree with Lenihan’s decisions but you have to see his commitment and dedication even while he was battling cancer. RIP.