February 9, 2011
IT is quite surreal to see the opening days of the campaign have been dominated by arguments about whether party leaders will appear on TV programmes.
This doesn’t seem to be the sort of thing that will determine the future of the country. Arguably, the next seven weeks will shape what kind of country we are going to live in. I say next seven weeks because although the election is crucial, it is not the end of the project. The EU summit four weeks after the election is likely to be just as important for us. This summit could be the battleground between European countries like Ireland, Spain, Portugal and Greece — the debtor nations — and Germany and France, the creditor nations.
The script is being written. The conversation is being set and the parameters of the debate are being framed. The problem for Ireland and Europe — a continent deeply divided between creditor and debtor nations — is that the pen is in the hands of the creditors, who have as their key objectives the protection of their banks.
What is going on at the moment is nothing more than a titanic struggle between the interests of the citizens of Europe and the interests of the finance industry in Europe.
It is one the citizens must win. Otherwise Europe will be turned from a democracy — where, broadly speaking, economic policy is framed with the interests of the average citizen in mind — to a bankocracy, where economic policy is driven exclusively by the interests of the banks.
Germany and France want to introduce a common corporate tax rate and rules about government spending. They are trying to make Europe look more and more like Germany. But these are the concerns of creditor countries, with old populations who are in the business of wealth preservation. Countries like this need slow steady growth and low or no inflation — both designed to make savers richer.
This is all very well if you are owed money.
In contrast, if you owe money these policies will make your predicament untenable. Ireland owes money, lots of money. If we sign up to these rules we will simply ensure that the economy implodes under the strain of low inflation and enormous debt payments. In its simplest form, once your total debts reach 100pc of your income, which is the case in Ireland with the bank debt soldered on to the country’s debt, your economy has to grow at a rate faster than the rate of interest for you to keep your head above water.
But the EU rate of interest at 5.7pc is well above the growth rate that our economy can muster. So the debt dynamics of such a situation imply that the debt will explode.
What does this mean for us as a nation? It means that we are well on the way towards a sovereign default, where the debt mountain simply gets too big and we do an Argentina and default in chaos. When this happens, the credibility of Ireland as a place to do business evaporates and multinationals will not consider us a safe place. Equally, and maybe more significantly, as the situation deteriorates, the locals will pull their cash out of the banking system, ahead of an expected default.
So the new government has to face this with the utmost urgency.
What can we do? Are we going to do nothing and hope for the cavalry to emerge over the horizon? Are we going to risk everything for the bankrupt banks, which are not even functioning as providers of credit to the system? Is there an alternative way out?
Let’s look at some numbers. The total unsecured bank debt of the banks in Ireland is â‚¬21.4bn — â‚¬15.4bn senior and â‚¬6bn subordinated.
We can take the Anglo and the INBS debt out of that equation, as those banks are being wound up at the moment and presumably the bondholders will have to wait in line and pick up the scraps.
That gives us senior debt of â‚¬11,623m and unsecured debt of â‚¬5,743m.
Savings on this would be quite easy. First, wipe out the subordinated debt thus saving â‚¬5.7bn. This is what happens to subordinated debt in a crisis: it goes.
THE senior debt that remains (about â‚¬5bn each for AIB and BoI) can then be restructured. Those senior creditors should be offered a debt for equity swap. This will allow them to take over large portions of the ownership of the banks and these former creditors, who are now owners, will have an interest in the recovery of the relevant bank.
But won’t this cause panic?
Well no, not at all. In fact, the opposite is the case: not doing anything causes panic. Last weekend we got an example from Denmark of what happens.
A small Danish bank called Amagerbanken was put into administration by the Danish financial authorities on Saturday. The bank had assets of â‚¬2bn and liabilities of â‚¬3.3bn. Instead of the Danish government making up the difference, they are forcing losses on senior bondholders of 41pc.
The Danish authorities said to the bondholders: ‘You invested in the bank, so you can share the assets amongst yourselves, don’t come crying to us when there is a shortfall.’
And guess what? Did the sky fall down? No. The Danish banking system hasn’t collapsed. In fact, Danish 10-year bonds — the bellwether for risk in a country — hardly moved. They were at 3.3pc on Friday and they are still 3.3pc today. Nobody cared. Capitalism works.
Unfortunately for us, the Danes are not in the euro. They chose to stay out and keep their currency in 2001. This means they do not come under the diktat of Germany and France.
However, the Danes have shown us that when you do the right thing — let capitalism work — the market moves on. The losers take losses and get on with it. That’s how it works.
The new government needs to go to Europe and make this case for us. It’s not a choice but an imperative. Forget the TV debates, this is what the election is all about.
David McWilliams will teach a new economics diploma at the Independent Colleges Dublin beginning next Monday.