September 1, 2011
Government is fighting the wrong war and still losingPosted in Irish Independent · 209 comments ·
When are the powers in this country and internationally going to understand that this economic crisis is a debt crisis and will only be solved when the debtors and the creditors sit down and hammer out a deal with each other? This goes for debt between countries as well as internal debts.
The way to solve a local or global banking crisis is through the medium of “co-responsibility”, where the debtor and the creditor equally share the blame and the cost. One party borrowed too much in the good times and the other lent too much. That’s about the height of it.
The mature and responsible way to solve this problem is to do a deal which involves each party paying.
Contrary to popular belief, this crisis didn’t start in 2008 with the collapse of Lehmans or the collapse of the Irish property market. The debt crisis started in Ireland in the late 1990s and early 2000s when the banks started lending wildly.
The failure of the vast majority of Irish economists and policy makers was not that they didn’t predict the bust, but that they failed to understand what all this credit was doing to the underlying economy.
And unfortunately this thinking remains the establishment view — so rather than looking at the causes of the crisis they are looking at the consequences.
So, for example, the Irish establishment still seems to think that the collapse is the problem rather than seeing that the collapse in house prices is the result of previous lending, and is now also the cause of present indebtedness.
Unlike previous slumps, this is not a recession prompted by a massive oil shock, a war or some enormous technological change, which leaves certain economies stranded in the past. On the contrary, this is a payments crisis, where the lenders can’t accept that they won’t get paid and the borrowers can’t see a way out. So the borrowers stop spending until they get clarity about how much they will have to pay back and the lenders stop lending until they know for certain how much they are going to have to write off. As a result, the economy stalls.
If you doubt this, just look at the news flow in the past 48 hours. At home, retail sales slumped again in July, the banks have reported that they won’t meet their own modest lending targets because people don’t want to borrow and all the while, mortgage arrears all over the country are rising relentlessly.
Internationally, things aren’t much better. The US is losing altitude, as is the UK, markets are falling and even in Asia growth is slowing down.
This is all because there is too much debt.
But rather than focus on this, our politicians are still dealing with this slump as if it can be solved without co-responsibility on debts. Debt forgiveness is part of this co-responsibility agenda, yet even in the past few days we have had Irish politicians who won the election on the platform “not another cent” to the banks, coming out defending the interests of the same banks. They are fighting the last war — and if the last three years has told us anything, it is that it is time to start thinking afresh.
How do you solve a problem of too much debt? You solve it with less debt, not more debt. You never make a balance sheet stronger with more debt, you make it stronger with less debt. This is why we have bankruptcy procedures. In fact, strange as it may sound, bankruptcy is good for business.
In the US when a company is in trouble and its balance sheet is broken, it can go into Chapter 11, where the creditors of the company are told that they will have to take a huge haircut if they want to get any money back. Crucially, the company is saved.
In Ireland we have a similar legal mechanism called “administration”.
The reason we have these mechanisms is that they mean good business. Consider a company that has too much debt and is contracted to pay the debt, but if enforcing that contract will cause the company to fold, then enforcing the contract is reckless for everyone concerned. Therefore, it is financially irresponsible to enforce the contract. This rule is the basis of all business.
However, if you think like a lawyer and not an economist, you are mesmerised by the sanctity of the contract and don’t see that the very contract is now reckless because underlying conditions have changed. So the lawyer will always undermine a business that is in trouble.
The same goes for a household. A household with too much debt that can’t pay its bills will sink if it is forced to pay all its debts, so it must get debt forgiveness. There must be co-responsibility.
We in Ireland have to stop thinking like lawyers and think more like business people when it comes to resolving our debt mountain. Enforcing old debt contracts when the underlying economy has changed dramatically makes things worse not better.
The great economist Galbraith once said: “Faced with the choice between changing our mind and proving that there is no need to do so, almost everyone gets busy with the proof.”
On the issue of solving our debt crisis, we need to change our minds; but understandably, the Irish establishment is busying itself proving to itself that it doesn’t need to change its minds. In the process we are losing time and the crisis gets worse. Very soon we will run out of time.