I’ve avoided talking about Ireland’s debt situation ‘til now – it makes my blood boil to think about it! It’s v difficult to comment or analyze when you’re starting from a point that should never have been reached…
Where to begin..? Well, nearly every day I get a nagging feeling, try to ignore it and finally (with a start) wonder if I was off sick the day the Irish government explained EXACTLY why they took on tens of billions of bank debts/losses?! And I never got the note either! Plenty of friends, relatives and colleagues ask me to explain this mystery, and to my embarrassment I just can’t! Now I just tell them what I think they want to hear…
Please help me. Why?!?
Crony Capitalism? In light of the absurd excesses, corruption and stupidity in the boom years, yeah I could almost believe that. The three best (worst?) explanations I’ve heard are:
i) A major portion bank liabilities were already guaranteed by the state and/or in Ireland bank debt is ranked equally with bank deposits so if you burned bondholders you’d also have to burn depositors equally. This is absurd! Let’s take the minor point first – what example in history can you cite where depositors got equally burnt? Depositors are your voters! They’re always going to be the last you will hit in a crisis – I’d venture to say that one of the safest domestic financial assets in any economy will always be local currency bank retail deposits. (I believe this strongly enough that, for example, I simply couldn’t sleep any longer until I switched my US brokerage a/c balance sweep from a money market fund to a bank deposit).
Now the major point – who makes the laws? The government! Why can’t you default on sovereign debt? Because it’s government guaranteed..?!? C’mon, anything goes in a financial crisis, and there’s plenty of history to warn investors (if rising yields/falling prices are not enough warning…) what can occur, and what can change, overnight. Of course the government could have burnt (senior) bondholders 100%, and preserved depositors, if they so wished.
ii) A default on bank debt, government guaranteed or otherwise, is unthinkable and would shut off access to the international financial markets for Ireland FOREVER..! Yeah, right! History’s littered with serial defaulters, and memories are much shorter than one thinks. This is just as true for individual defaulters as it is for sovereign defaulters. Nobody really cares – just offer me a piece of paper, a rating and a yield and if I’m finally feeling happy again I’ll buy it!
Then there‘s the other aspect, who would you rather lend to? A defaulter with debt metrics that, as a result, are perhaps now back in good shape, or an honest Joe country who has no chance of paying you back? (MMI’s been writing about rights issues: Bit of a different angle, but I believe rights issues present a similar issue. I’d hate to be shareholder who’s penalized/diluted by a rights issue…but the day after I’m often the happy new shareholder investing in a financially stronger company).
Let’s put it another way, who would you prefer to lend to: a) That affable, but somewhat dodgy, guy you met down the pub recently who’ll definitely have plenty of money to repay you, if you ever see him again!, or b) Your local salt-of-the-earth parish priest who’s 100% dependable…but will never actually be able to repay you (err, due to a looming civil liability case…)? Yes, character matters (esp. with company management), but sometimes it makes f**k all difference in the end.
It really comes down to culture. Why have so few Irish people handed in their house keys to the bank? Culture. Not the case in America – in fact, people now gleefully look forward to enjoying a spending spree during a likely 18 month rent-free holiday before they get foreclosed on. But I bet the culture would change very quickly if this trend gained any momentum in Ireland – the media companies may be lap-dogs, but what bleeding heart journalist is going to portray your average mortgage defaulter as a villain?! I’m not sure I’ll ever see this trend develop – but why on earth would people prefer to suffer, and commit to spending the next 10-15 years paying for a f**king gaping ‘hole’ in their house?
I don’t get it. Is there something wrong with me? I swear if I owed somebody a single Euro, I wouldn’t sleep right ‘til I repaid it. But I don’t consider a mortgage to be a moral obligation, it’s a bloody business transaction! The bank controls everything – they set the rate, the fees, the covenants, the LTV etc. (and if/when they lose their head on these, that’s their problem) and they take a charge on your bloody house. (Jesus, they even thought they had the right to screw people out of their tracker mortgages!). The banks take the reward, so they need to be aware of the risk also – I get to give you back the house if it makes financial sense for me. After all, once I choose a particular bank to sign up with, this is the one piece of control/power that I can ever realistically exercise. And, of course, bank debt falls into the same category – bond investors should be old enough and smart enough to realize this.
iii) Now we’re getting to the crux of it: The EU, ECB and Geithner (the IMF were apparently ambiguous) were resolutely opposed to any haircut on bank debt to avoid market contagion and to avoid writedowns on foreign bank holdings of this debt. And the Irish government cravenly gave in to their demands, sorry their instructions. Sure, maybe you could argue it’s for the greater good?
Nope, not at all, kicking the can down the road would be more accurate… Every government and central bank response to, and rescue of the market from, each bubble in the past dozen years has only delayed the resulting crash and/or simultaneously created the next (bigger) bubble. The tech bubble crash at the turn of the century triggered an easing that directly created the housing bubble in the middle of the last decade, which then crashed, but the subsequent easing deferred the crash of the credit bubble until 2007/08. And, of course, the response to the credit crunch, and further (ongoing) action in relation to the current Eurozone crisis, are sowing the seeds for the next great bubble and crash…
Yes, sure, we’d all like to be good chaps, rowing in together… But desperate times demand desperate measures. The knock-on effect of an Irish default could well be terrible in a European context, or even globally, but bluffing works both ways..! If the consequences were so dire, why didn’t the Irish government stand firm and demand much more in return for no default, instead of ending up looking like a shoeless urchin holding out the begging bowl?! Why on earth should a small nation of people like the Irish suffer for the sake of the whole world (and for a lot longer than three days and three nights…um, plus an afternoon)? The duty of any government is to put the long term financial future of its people first – taking on bank debt was obviously not a contributor to this financial future. And I say that because bank debt may be the straw that breaks the camel’s back.
Ireland’s been here before – poor revenues, and bloated spending. The Debt/GDP ratio reached 111% in 1987, and Ireland recovered from it – so everybody knows it can be done, but not everybody remembers the pain and stagnation that was involved. Now, the same problem is looming – forget bank debt etc., the fiscal situation would look pretty grim anyway. Philip O’Sullivan had a great post about this the other day. That’s certainly enough to tackle now, and in the next few years, but no the government f**kwits had to sink the nation into a situation where predictions of a Debt/GDP peak of 120%, 130%, even 140% seem equally valid.
So, that’s where things stand now…
What’s next? Well, the devaluation scenario could be the classic, and pathetic, outcome – no, of course I don’t actually mean currency devaluation, but the scenario where the nation suffers, suffers, suffers and then the government finally cracks, far too late…and almost immediately everybody wonders why they didn’t do it sooner!? They might even end up singing in the bathtub, like Norman Lamont! Good end result perhaps, but what a way to get there, euchh.
More likely, Ireland will just have to stagger on in their current endeavours. Very admirable in terms of some of the pruning that was so obviously needed, but a miserable prospect when one realizes that ‘success’ will probably be completely dependent on uncontrollable factors in the end. Such as the level of the Euro, European/global GDP growth, further attacks on Ireland’s low tax rate (yes, they are coming), the level of emigration etc. And then, of course, there’s possible Eurozone developments – I’ll talk about that again on a separate occasion. If any of these go in the wrong direction, the game’s over.
Then again, perhaps we can all enter a world of 200%+ Debt/GDP ratios..? The Irish government was pretty famous for their junketeering – I’m all for eliminating this wasteful excess, but perhaps we should earmark a special expense line in the next budget to ensure some nice junkets to Japan – let them share their secrets..!