November 29, 2009
The default of Dubai World – announced on Thanksgiving Day, when most Americans were on holiday – showed us what the second leg of this great crisis was all about.
The financial markets’ reaction indicated that many believed that, rather than being an isolated incident, this default in Dubai – for so long, the poster boy of globalisation – might be the beginning of a new domino effect of defaults all around the exposed parts of the world.
I say ‘exposed’ parts of the world because a new trend is developing, as the ramifications of the great 2008 crash become more evident. We are moving into a phase where the relative position of companies and countries is being closely looked at.
In the crisis, a ‘blanket’ rescue operation was mounted – the good and the bad were treated with equal generosity. The world’s central banks, because they were worried about systemic risk – which is a complicated way of saying ‘‘the bad boys will drag down the good boys’’ – treated everyone the same. Money was printed and thrown at everyone, everywhere, in the hope that the system would not seize up.
Now that the system has been saved – or at least looks more robust than many imagined possible this time last year – it is time to become more discriminating. Financial history reveals that all economic crises go through various stages.
Typically, there are periods of calm, when people think the worst is over and then, wham, something else happens, triggering another decline. In the discriminating as opposed to the blanket phase, investors consider who is really delinquent and who can be salvaged.
This time around, the discriminating phase has been made all the more acute by the fact that the central banks – and the ECB in particular – have warned the fragile banks that the taps will be turned off soon.
The realisation of this in Greece last week caused a huge sell-off in the stock market there. No one seems to have reminded us that the Irish banks are much more dependent on the ECB’s daily largesse than the Greeks.
It is ridiculous to think that countries and companies carrying huge debts, borrowed in the good times, will be able to pay them all. There are a few hard rules of economics, one of which is that debts that can’t be paid won’t be paid. The sooner the creditors realise this, the better for everyone.
All over the world, borrowers are doing deals with lenders to restructure debts. Many major companies – Independent News & Media is an Irish example – have done debt/equity swaps with creditors, giving them shares instead of cash, thus ensuring that the company, its creditors and existing shareholders live to fight another day.
This is what adults do in a crisis: they make the best deal possible. Only fanatics carry on as if nothing has happened, promising to honour all debts and never to renegotiate. So when we hear our government suggesting that our crippled taxpayers can pay all the debts incurred by our bankers, the world knows we are spoofing.
This type of behaviour scares people, and leads to capital flight. When capital leaves a country, it doesn’t come back until there is an event that signals that the game has changed and the boil has been lanced.
One event would be a change in the management at the top of the banks. It is hard to overestimate the damage that has been done by the failure to appoint outsiders to the top positions of our banks.
I was chatting to a serious investor from New York the other day who despaired of the situation. Two years into the problem, we have no new management and the only outsider in the Irish banking scene is the new boss of Anglo, who was brought in after nationalisation.
Next year, there is likely to be a significant re-rating of countries and companies.
What the Dubai default indicates is that the bond market was asleep. It didn’t see this coming. Dubai, like Ireland, went on a binge over the past ten years, using other people’s money to build whatever and wherever it could. Now Dubai can’t pay it back.
Let’s just do some back of the envelope calculations for Ireland to see whether we are hurtling down the Dubai route. How much money do we owe and how will the financial markets regard us next year – particularly after the Dubai default?
Let’s start with the banks. Last year, they borrowed â‚¬135billion abroad to fund their lending here. With ECB help in the past year, flogging a few assets, the figure probably stands at about â‚¬120 billion. Government debt, according to the National Treasury Management Agency, stands at â‚¬73 billion.
Together that is â‚¬208 billion; being generous we can call it â‚¬200 billion. Averaging interest at 5 per cent means the interest payment on this is â‚¬10 billion per annum. In the past few months, when millions seem to have slipped into billions, and nobody can grasp how big the number is, let’s just remind ourselves that â‚¬10 billion is enough to build nine Luas lines in our cities or enough to give every worker in the country a pay rise of â‚¬90 a week.
Remember this â‚¬10 billion is just the interest to be paid every year. The principal may have to be repaid eventually too.
But the people repaying this â‚¬10 billion each year are also the people paying interest on their own debts, because private sector debt stands at â‚¬378 billion.
Again, allowing 5 per cent interest (but it is probably higher in most cases), this leads to annual interest payments of â‚¬18.9 billion – 17 Luas lines and â‚¬170.10 per worker in the economy per week. Presuming that the interest payments on the private debt are covering the banks’ debt, we can add the â‚¬378 billion of private sector debts to the national debt of â‚¬73 billion and now add Nama loans of â‚¬54 billion just for good measure.
This gives us a total debt of â‚¬505 billion Once again, allowing for 5 per cent interest, we get total interest payments that have to be generated from Ireland every year of â‚¬25.1 billion per annum. That’s how much cash will leave the country in interest payments on loans next year.
This means that the first â‚¬225 earned by every worker every week in this country will be earned simply to pay the huge debts. Now what are we going to do about this? With these figures, default is obviously on the horizon.
Should we renegotiate now or allow the thing to blow up like Dubai? I can’t answer this, but it’s interesting to see what the Bible has to say. The Bible reveals that debt cycles, defaults and debtors getting into trouble are stories that are as old as the hills. In Deuteronomy, chapter 15, verses 1 and 2, the Bible says: “At the end of every seven years thou shalt make a release . . . Every creditor that lendeth unto his neighbour shall release it; he shall not exact it of his neighbour or of his brother because it is called the Lord’s release.”
At least if we do ’fess up and begin to renegotiate our debts, we might have the consolation of knowing that God is on our side.