October 12, 2009
Last Wednesday night at the Historical Society in Trinity College Dublin – the Hist, as it’s known – Professor Joe Stiglitz, winner of the Nobel Prize in economics and former chief economist of the World Bank, gave a stirring speech about the impact of globalisation on the poor.
Sitting in the debating room where Douglas Hyde, Oscar Wilde and many other brilliant Irish and international orators have held forth, I thought to myself that this setting was a far cry from the first time I met Stiglitz. Then he was a mere professor of economics and known only to the economics world for the elegance of his mathematical models.
Back in 1991, Stiglitz was invited by the Irish Economics Association to give a talk in Carrickmacross. His interest in Ireland was heightened by the fact that his daughter chose to go to Trinity. After the talk, Stiglitz, dressed in jeans and runners, said that he would like to visit the North.
So we drove to Crossmaglen, where the Columbia professor downed a few pints in a bar just off the main square, chatting away to the publican who would probably not have seen a more incongruous visitor in his bar since Robert Nairac walked through the door.
Stiglitz has come a long way since the smiling New Yorker raised his glass in Crossmaglen. The conversation was then drowned out by the constant clatter of Chinook helicopters hovering around the British Army base right above the metal IRA sculpture of the Republican phoenix on the main square.
Today Ireland has changed, though the professor hasn’t changed that much. He is still forthright but charming and, during an interview after the speech, he spoke to me at length about current Irish economic policy.
When asked whether he would implement a Nama-style bailout for the banks, he responded: ‘‘No, this is the kind of highway robbery which we see happening all over the world, with guns pointing at the heads of the political leaders and the bankers claiming the sky will fall down and the economy will be devastated unless they get this money.”
He went on to compare the employment of mass fear as the single justification for bank bailouts with the same weapon of mass fear that was deployed by President George W Bush after 9/11.
‘‘It was invoked to justify anything the president wanted to do, such as the Iraq invasion,” Stiglitz said. ‘‘Well, the bankers now use 15/9 [September 15, 2008 was the day Lehman Bros went bankrupt] as the new weapon of choice to force politicians into the huge bailouts, which will bring us enormous debts on our balance sheets with no real assets on the other side. But the bankers will be saved. When we gave them the money, the bankers said ‘don’t worry, you will get your money back’, but no one believes that now.”
When asked if letting the banks go would be the end of the world, which is the default position of Ireland’s current government and banking and economic establishment, Stiglitz laughed.
‘‘This is nonsense,” he said. ‘‘Countries which allow banks to go under by following the ordinary rules of capitalism have done fine. The US has let 100 banks go this year alone, as did Sweden and Norway in their crises. In the US, it’s just the big, politically-powerful banks that have not been allowed to go down, for political reasons.
‘‘The important thing to remember about financial markets is that they are forward-looking, but what they do remember is the size of your national debt.
If you spend money in bailing out banks without taking all the equity, you will end up having a huge national debt, a liability with no assets to show for it. Now that will scare off investors in the future.
“[In Ireland], this bank bailout is a simple transfer from taxpayers to bondholders, and it will saddle generations to come. The only thing that might give you solace is that, as chief economist of the World Bank, we see this type of thing happening in banana republics all over the world. Whenever a banking crisis happens, the financial sector uses the turmoil as a mechanism to transfer wealth from the general population to themselves. I’ve been very disappointed to see that it has happened, not only in banana republics, but in advanced industrialised countries.”
Digest these words and their implication for us. Here we have a Nobel prize winner for economics, a former chief economist of the World Bank, the head of former US president Bill Clinton’s Council of Economic Advisers who presided over the US’s sustainable boom of the 1990s – when it grew while, at the same time, paying off its debts.
He is comparing Nama and what is happening in Ireland – a country with which he is very familiar – to a smash and grab banana republic exercise.
The extent of this robbery can be seen if we look at the real cost of our bank bailout.
When you borrow for your house, the mortgage you pay off is much greater than the principal because you pay compound interest.
So for your house to be worth the investment after you pay everything off, it just doesn’t have to be worth what you paid for it in principal, but it has to be worth what you paid for it in its entirety, including interest. The cost to you of buying that house is also the ‘opportunity cost’ of what else you could have done with all the money.
With these basic economic principles in mind, let’s look at the likely cost of Nama and the opportunity cost of Nama, given what else we could do with the money we are about to borrow to buy land that nobody wants.
We need to get an idea of the likely costs over a ten-year cycle. At the moment, interest rates are historically low, but that will not always be the case. So let’s look at market interest rates and the current rate of inflation as real figures.
On Irish interest rates, the latest long term bond issue was a 15-year â‚¬7 billion bond. The press release last Tuesday, October 6, gives the yield at 5.472 per cent.
So, the â‚¬54 billion we are throwing into the banks, if invested at that rate would earn â‚¬38 billion over ten years. Therefore, not counting inflation, the opportunity cost of Nama is â‚¬38 billion. If we had loaned to our own government, we the people would get back â‚¬38 billion and gain a social dividend from the roads, schools and technology invested. Not with Nama.
But, of course, we don’t have â‚¬54 billion to invest; we have to borrow it all. In any calculation, we should also look at the rate of inflation, to try to get an idea of the ‘real’ cost. At the moment, the Consumer Price Index (CPI) is falling and, without some inflation coming along soon, we will be in big trouble.
The current CPI, which was announced last Thursday, is minus 6.5 per cent. Prices and wages are falling, which drives up the cost of borrowing, because you have to take more of your income to pay off the debts. So the ‘real’ cost (the interest rate minus the rate of inflation) of a 5.472 per cent interest rate is actually a jaw dropping 11.972 per cent.
If the figures were to be repeated for the next 12 months, property would have to increase in value by nearly 12 per cent just to keep the real cost of Nama neutral. The idea of property prices rising while inflation is falling is something even Brian Lenihan, our Minister for Finance – who dismissed Professor Stiglitz during the week – would find hard to sell.
I don’t know about you, but I’m with Professor Stiglitz on this one.