September 16, 2013
This week, let’s consider the probability of another banking crisis. Mortgage defaults – both owner-occupier and buy-to-lets – could overwhelm the banks’ fragile capital buffers, meaning the banks will need more capital in the next few years. Because the Irish state is bust and has no capital to give, this new capital can only come from two places. The first source is the European institutions (or the taxpayers of the richer countries). The second source is the depositor in the Irish banks.
What happens if the taxpayers of other countries don’t feel like giving the Irish banks cash?
In such an event (which is quite likely) the capital will have to come from a smash and grab exercise on Irish deposits. This is exactly what happened in Cyprus earlier this year. The precedent is there in black and white. More significantly, it is a precedent hatched and copper-bottomed during the Irish presidency of the EU. We can hardly orchestrate a depositor raid from Dublin on Cypriots and then cry foul if the rest of the EU suggest that this is exactly what we have to do to ourselves in the event of a new banking crisis.
There is another solution to a new banking crisis. It is to leave the euro, beef up our own Central Bank and ask it to inject new Irish punts into the banks to avoid a deposit raid.
For many, this would be a step too far. But it is only a step too far if we can avoid having to make the choice.
If faced with the prospect of robbing deposits to keep the banks afloat or reverting to our own currency, what’s the likely choice of politicians who want to be re-elected?
It might not come to this. Germany may bail us out. But there has to be a reasonable doubt about this outcome.
Given that “bail-ins” (robbing deposits from today’s voters) are the new bailouts (lumbering future voters potentially with more debt), a deposit seizure looks possible.
However, the future is brighter if we get strong economic growth over the next few years which raises people’s incomes, reduces their debt-to-income ratios and, in turn, reduces the levels of mortgage defaults. But who knows whether this will happen?
One thing is sure: the present policies followed by this administration, overseen by the ECB and the Troika, are highly unlikely to create the environment where people like me – who employ others – are encouraged to employ more workers.
Let’s now examine the macro-economic policies of Ireland with a view to assessing whether they will facilitate growth. Second, let’s see whether growth will be sufficient to prevent another mortgage driven banking crisis. Third, let’s consider the options in the event of another banking crisis and finally, let’s examine what choice is likely to be made by democratic politicians who want to be re-elected.
How many times over the past few years have you heard the battle for the survival of the Irish economy referred to as a “war”? It is probably a fair description of the ongoing fight for competitiveness in an increasingly globalised world where everyone is in competition with each other, all the time, everywhere.
But while it may be a fair description of what is going on in the global economy, surely a country wouldn’t enter into such a battle with no artillery. Yet this is what Ireland is trying to do. The main two macroeconomic weapons open to a sovereign country that intends to grow are: (A) monetary policy – the power to raise and reduce the interest and exchange rate; and (B) fiscal policy – the latitude to raise taxes or expenditures and vice versa when you deem it necessary.
It is clearly understood that a country in recession should reduce its currency and interest rates, and should borrow when the economy is weak and pay back when the economy is strong.
These weapons are what are commonly understood to be the heavy artillery of economic policy, essential if an economy is to have a hope in this global struggle. In addition, if there are huge debts and a broken banking system, the country should have its own central bank where it can “park” the debts at no cost until it is strong enough to consider paying them back.
But Ireland has given away both monetary and fiscal policy and we don’t have an independent central bank. We have no weapons. We are turning up to a gunfight with a penknife and expecting to win.
Now we all hope that the economy will grow, but hope is not a strategy and it tends to leave us with just that, hope.
With no economic tools, how do we expect the economy to grow? Well we could hang on the coat-tails of others, but with our major trading partners growing fitfully at best, there is no prospect of an export surge sufficient to drive general incomes up or general unemployment down.
And if we don’t grow, arrears will rise and so too will defaults on mortgage books. Let’s just look briefly at the numbers.
According to the Central Bank, by the end of June this year, there were 770,610 owner-occupier mortgage accounts to the value of €109.1 billion in the country. The total value of those who were more than 90 days in arrears was €18.6 billion. This is 16.6 per cent. There were also 148,529 buy-to-let mortgages in the country with a total value of €30.6 billion. Of this, 30,326, or 20.4 per cent of the total, were in arrears of more than 90 days. This is more than €6 billion.
Thus the banks have more than €24 billion of mortgages “in trouble”, and no doubt more to come as we work through the mortgage solution process in the months ahead. Not all of this money will be lost, but a significant amount will. Yet only €9.5 billion has been provisioned to cover this. So where will the rest of the capital come from?
Maybe the Germans will feel generous and pay for this, but on recent evidence, that particular parachute might not open. In this case, the money will have to come from you, the depositor in the Irish banks. Or it could come from the totally logical next step of reinstating the Irish punt, allowing the Irish Central Bank to inject the capital in punts and that part of the crisis at least, would be over. The likely fall in the punt would also make Irish industry, agriculture and above all the multinational sector with Irish labour inputs phenomenally competitive.
The next banking crisis, itself a product of too much debt, not enough growth and insufficient capital, is likely to cause another banking crisis. The government knows this, which is why it secured another €10 billion loan the other week from the Troika. But that new loan is simply borrowing from tomorrow to pay for yesterday and it does nothing to improve the growth and competitiveness position of the economy.
Big choices lie ahead for the political system. And if it is the choice between robbing ordinary people’s deposits to pay for the banks or reinstating a sovereign currency, the choice will not be that easy to make.