June 9, 2010

Sinking in sea of bad debt despite a €440bn lifebuoy

Posted in Banks · 143 comments ·

Almost two years ago to the day, on June 22, 2008, this column wrote the following:

“Ireland is now going into the early stages of a classic bad debt cycle. While many are still talking about the credit crunch, the crunch is only a mild forerunner of the greater challenge. When one bad debt begets another, the financial system falls victim to a contagious spread of bad or unpaid debts. This is a bad debt cycle.”

Yesterday this bad debt cycle reached the end game. The eurozone announced a government fund of €440bn, which will act as a guarantee for sovereign debt issuances by eurozone countries.

Think about this: we have arrived at the illogical position where the eurozone governments are guaranteeing their own debt, before it is even issued. So they don’t trust themselves!

Let’s look at how the bad debt cycle has developed for Ireland since that article was penned 24 months ago.

The Irish banks were lending so much that they ran out of sufficient deposits sometime in 2004 and they needed to find money elsewhere to stuff into the economy. They found it abroad.

As a result, Irish banks have a funding shortfall of €200bn (difference between loans outstanding and customer deposits). This needs to be funded from international markets.

Karl Whelan over at the excellent Irisheconomy.ie website has figures that say €73.4bn of this needs to be rolled over in the next four months. This is a huge amount and it is far from clear who will finance this.

Meanwhile back at the banks, the property market crash means they are not getting paid back the money they loaned out. So Irish banks are seen as a large risk to international investors. As a consequence, the banks do not have access to the money markets to roll over their loans.

This sequence of events was clear back in summer 2008 and this was the logic of the guarantee issued in September 2008.

The upside of the guarantee was that it prevented a chaotic run on the banks; the downside back then was always that the Government might be tempted to extend it. My understanding at the time was that if it was introduced it would be introduced with a fixed shelf-life and not be extended. Time will tell on that.

If it is extended, the banks will drag the country down, pure and simple.

The reason the guarantee must be allowed lapse as originally envisaged is that the tactic has now reached the limit of its use. The guarantee was a stopgap to get over the panic in October 2008. In the 20 months since then, the banks have not being able to sort out their funding problems. This means either the banks are unwilling to sort out the problem, which is a damning indictment of their management, or they are unable to, which means they are bust.

Either way, the guarantee was their last chance, and they have blown it. But rather than pay for their incompetence, they have been rewarded by the Government with NAMA, which is nothing more than a bank bailout paid for by the citizen.

Because the banks have not dealt with their funding problem, but have prevaricated, the guarantee has bled into our sovereign debt. Because the markets now think the guarantee will be extended and they see that NAMA has put the actual cost of the banks recklessness on the taxpayer, the markets are worried about whether the State (i.e. you and me) can pay for all this.

The guarantee of the Irish bank debts was always a bluff — it was not a policy. There is no way, either financially (or politically) that Ireland could come good on it if it was ever called on. It was about buying time to sort out the banks, not about giving the banks time to run rings around the State. So now it should be let lapse, because a bad debt cycle only ends in one way, and it’s not pretty.

Ireland, of course does not operate in a vacuum. Debt problems in other EU countries have also meant that sovereign funding costs have risen across the peripheral EU states.

In fact for the EU, the Irish banking problem, which was a critical concern last year, has been superseded by a great eurozone debt crisis. As the Greek crisis unfolded, the whole of the periphery of the EU has experienced a massive credit crunch.

The bad debt cycle has driven the credit crunch and the credit crunch has driven the bad debts. Initially, the lack of credit makes the bad debts worse and then the bad debts themselves exacerbate the credit crunch.

In the end there is only one buyer in town of all this junk, the European Central Bank. So, for the banks that can’t access the markets, the ECB has stepped in to give them finance in the short term.

This might hold for the moment, but it does mean that the fate of Irish banks is well out of Ireland’s hands. If the EU does withdraw its liquidity operations, then the Irish banks will have nowhere left to turn. The ECB is not called the ‘lender of last resort’ for nothing.

Similarly for Ireland, the EU has now set up a SPV under the European Stabilisation Mechanism that will provide funding of up to €440bn to any state or states in trouble. Of course, this SPV is underwritten (guaranteed) by the same eurozone countries that it has been set up to protect.

So, nearly exactly two years after the opening quote above on bad debt cycles, we are in a position where the ECB is keeping our banks afloat, and the Eurozone countries are keeping each other afloat through mutual guarantees. And the underlying problem, which is the same as the problem 24 months ago, is still there. Too much bad debt.

David McWilliams performs ‘Outsiders’ at the Peacock previewing tonight and running until July 3. www.abbeytheatre.ie

  1. Tull McAdoo

    Cowen will do nothing about anything because he has been moulded and shaped since birth to think and act along certain ways in defence of Fianna Fail, Catholic Church, Banks, and all the other institutions that have gotten a free ride on the back of Irish people since the foundation of the State.
    Cowen for those of ye not in the know went to the Franciscan School in Clara, run by the Monks. Most of these Fcukers are now in jail or just out of jail or should be in jail for sexual abuse as well as other crimes. He then went to the Religious School in Roscrea with the same shower of so and so’s. Anyway to cut a long story short suffice to say that Cowen has been indoctrinated into this whole culture that is the Cancer at the heart of Ireland. Cowen sees himself as the new Lemass, bollocks I say, He is just another gobshite that has been brought up to continue the status quo.
    Cowen will save FF…then the Banks….then the Catholic Church….. Blasphemy my Arse, this is all abut fcuking money, control and power as it always is with these people. OUT OUT OUT.

    • Deco

      Cowen is just the local political magnate. I don’t think he is a bad person. In fact he is loaded with good intentions. And he has intelligence, despite the liquid lubrication given to the brain cells.

      The problem is that in our hour of need he is a bit of a let down. And we need to compensate for him, because the tree huggers are happy to have him there.

    • wills


      Is this outta the article in the *Sunday times* entitled *nightmare on dame street* you post is mentioning.

      • Tull McAdoo

        Do you have a link for that Wills, hardcopy of most papers only availeable when I go into the City tomorrow, thanks. ;-)

  2. Deco

    David – I have just read your article in the Business Post. You are correct. There is a need for a long term statistical analysis to determine if a country is having a bubble. And then there is anecdotal evidence (the nonsense comeing from Bertie Ahern should have set off alarm bells).

    In fact your suggestion has relevance for all economic systems, particularly those with a recent past of property speculation.

    Of course any economic policy framework that is cautious in tone is a detestable burden to a range of vested interests and opportunists who benefit from such excesses in the first place. We should always expect kickback.

    An interesting quote on the radio earlier from Business lecturer Tom Foley in DCU. He said that there was a serious flaw in both the regulatory bodies and in the banks, that the tendency of subordinates speaking up was readily quoshed. This is extremely true.

    This again goes back to the problem concerning the “Irish contemporary concept of management” having been found out to be completely wanting. Contrary to what we hear from the media, this is probably worse in the private sector than in the public sector.

    So there we have ground zero, we need to redefine “management”. And it should be a term that is completely free of authority. It should be derived from personal autonomy, human respect, and intelligent allocation of resources. It should not be based on authoritarian centric dogmas, the “manufacturing of consent”, lies, deceit, conceit, nepotism, or meglamania.

    Something radically different is required. It has been done before. It was done in Japan after the Second World War.

    • Deco

      Excellent commentary from top man in HP Irl, also in the S B Post – concerning the employment issue and training. We need to get real. And we need to mean business – not BS.

    • Tull McAdoo

      Yes Deco but this model or philosophy of Management is coming from the Smurfitt Business School, St. Patricks Maynooth for the Taliban,and so on. Built by the major stakeholders in the status quo. Ireland is always dragged kicking and screaming into modernity, with these fools acting as the biggest anchor.

      • Tull McAdoo

        P.S. Fianna Fail will agree to nothing unless all their people are in place to benifit from whatever . That is their modus operendi, as it always has been. I could write a book about Cowen and his ilk. Watching from afar all my life.

  3. Re Daniel McDonnell, Sunday Independent, 13/06, ‘Anglo can be wound up without the sky falling in’, let me make some comments to add to his article.

    ‘If you were to shut it down overnight, with the guarantee, the Government would have to immediately find between €65bn – €75bn to pay depositors.

    This is simply not possible, the Government say.’

    Examine this for a moment. I’ll use two scenarios. The first with the guarantee; the second, lets say guarantee ends October next.

    OK, the First scenario: Move €50bn deposits into AIB, €25bn over to BOI. Get IMF to support the move with a €75bn bond issue. Permit these banks to issue
    long term government index bonds to the value of €75bn at a good yield for investors. It is very possible with IMF reforms in place, with the cleanup of our banks and financial system, that up to and further than 50% of the issue can be raised from the markets with the help of good marketing from the NTMA. Say €38bn is raised. This can immediately be used to buy back 50% of loans outstanding to the IMF. Creative management of the debt can bring opportunities and a good result with creative solutions that can improve on suggestions such as one along above lines.

    Second scenario:
    Guarantee ends and deposits no longer secured. Transfer deposits as above. Negotiate write down of debt in accordance with a deep dive stress test of all deposits. Negotiate with depositors. Issue government index bonds as a possible buyout option for depositors. Use the leveredge of a debt for equity swap and shares issue to turn deposits into promissory notes that can be handled in the manner of a credit default swap insurance.

    There are many scenarios one could use to mange the wind down of Anglo. here’s too little focus on scenarios such as above, too little emphasis on how the detail of a wind down on Anglo can be achieved. Its not enough to plead lack of transparency, information from Anglo on the state of its books.

    Its time we got in some professional bank busters to give good advice on the wind down of Anglo.

    Anglo is of systemic importance to Ireland Inc. Keeping it open signals corruption, mismanagement,incompetence rules roost in Ireland Inc.

    Closing Anglo means we’ve learned the lesson the polluter pays, Ireland Inc can clean up its mess and get back to better business asap.

    • Of course you’d have to stress test the quangos vis a vis political patronage, forcing the civil service to do work they should be doin without political patronage anyhow, about 80% cull, e.g keep Irish Film Board, fire the cronies time. Then cull the number of TD’s approx 25% – 50%. Cull their salaries upwards of 25%, Taoiseach’s by 50%. No more expenses. Copy Stockholm, build a TD hostel and they can stay/work there while in Dublin. No more travelling expenses rubbish, buy their own cars/petrol. There’s a couple of ideas to begin with! Major reform of financial laws required. Drumm/Seanie et al on call for a full independent inquiry. Time to put in place a political system built to serve taxpayers not one to serve cronies and bankers.

  4. I was enjoying a convivial drink with an 85 year old the other evening. He had served in the Guards years ago. He’s a clever man and a great reader \ Thinker.
    His summation of all this lack of regulation and squander;

    “A little power is a dangerous thing in a Nation of Crooks”

    Sad but unfortunately true.

    • furrylugs – I am reading the History of Kerry and somewhat the more one reads it the more similar the patterns are with todays economic world.I discovered how south Kerry and north Kerry separated – the Geraldines ( old English ) in the north and the Mc Cathys ( old Irish ) in the South .Nothing seems to change after all .

  5. Philip

    I have a solution.

    People of Ireland “Stall all mortage repayments until an election is called”. Give it about 3 months.

  6. Phillip – Will it be a compound or a new substance?

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