by Frank Schnittger
Sat Oct 4th, 2008 at 10:34:04 AM EST
The Irish Government is reported to be seeking up to 1 Billion per annum from the Irish banks whose deposits it has guaranteed against loss. This contrasts with the $700 Billion the US Government will be paying banks for their most toxic assets. So who got the better deal?
The answer to this question partly depends on how much of the $700 Billion the US Government can recover from the mortgages it buys, but much more importantly depends on whether the Irish Government is ever called on to pay out on those guarantees should one or more of the Irish Banks become insolvent. Given that those guarantees could rise to 500 Billion - almost three times Ireland's GDP - it is clear than Ireland itself could end up defaulting on Sovereign Debt if a doomsday scenario were to unfold.
Bailing out failing banks with taxpayers money is always going to be unpopular - especially if those banks are seen to have indulged in imprudent investment or to have fueled the property boom which has resulted in so many people being mortgaged to the hilt in order to buy a home. The outcome for both the US and Irish Government responses depend on property markets ultimately recovering sufficiently to restore the value of underlying assets and the remaining banks to solvency. For both Governments it is an unprecedented direct involvement in their economies and turns their citizens into involuntary investors into their country's future economic well being.
It is not capitalism as we know it, but is it socialism or a completely new form of direct state participation in the risks and rewards of economic activity? What is the balance of risk and reward should things turn out well, or if things were to go distinctly pear shaped in the future?
If things were to turn out well and the economy and property prices recover, the Irish Government's move could well be hailed as a stroke of genius (in Ireland, at least). Not only does it safeguard the immediate future of the Irish banking sector (and arguably gives it an unfair competitive advantage against non-Irish banks), but the 1 Billion in fees extracted from the banks could go some way towards plugging the 7 Billion hole which has just appeared in the Government's finances.
Relations with our European partners will no doubt have been damaged, however, perhaps more so than any rejection of Lisbon could ever have done. It could be argued that extracting 1 Billion from the Banks each year - if seen as a reasonable commercial price for the deposit guarantee - mitigates the competitive advantage those banks will have vis a s vis their European counterparts who are not backed by such a state guarantee. This will be small consolation to those European banks who see their deposit base drifting to Irish banks precisely at the time they need it most, and it remains to be seen what view the EU Commission will take on deposit guarantee in terms of the prohibition on state aids to private enterprise.
It may also be the case that other countries besides Greece will follow Ireland's lead on deposit guarantees, in which case any competitive advantage will diminish and the arguments against it will become increasingly moot. But there is no doubt that Ireland's action has significantly "upped the ante" for its EU partners, and they may not thank Ireland for that. Nevertheless, the fact that Sarkozy has invited just Germany, Britain and Italy to his summit underlines the fact that a coordinated quick EU response was never going to happen - and the concerns of smaller members such as Ireland were never going to be a primary consideration. The fact that Ireland acted unilaterally is therefore as much a reflection of the EU's lack of preparedness for such an emergency than a lack of community spirit per se.
But what happens if things go significantly awry in Ireland, some banks go to the wall nevertheless, and the Government is required to pay up on a large proportion of the deposits it has guaranteed? First of all, Ireland's public finances are currently still in reasonably good shape - with the debt/GDP ration down to 25% (compared to c. 90% for Greece) and Ireland has also invested c. 20 Billion (or over 10% of GDP) in a National Pension Reserve Fund to provide for future pension liabilities. The collapse in the value of underlying assets would need to be pretty massive to drive Ireland Debt back towards the 100% mark it nearly reached in the 1980's. But nevertheless there is a real risk of national insolvency or a dramatic reduction in living standards which would accentuate the problems by driving property price down still further.
Risk is an inevitable and unavoidable part of life, but never have the citizens of a state been so directly exposed as citizens, rather than as employees, pensioners or investors. Nevertheless I have an intuitive preference for guaranteeing depositors capital rather than bailing out the banks and their most imprudent and toxic investment decisions. Let the banks continue to manage the consequence of their investment and lending decisions - this will have a direct effect on their profits, dividends, and management bonuses in due course. Some will do doubt be taken over by others, but hopeful the business of providing credit to individuals, and capital to businesses will recover.
Governments can and must take a much longer term view than individual businesses and some problems are simply not amenable to a quick fix. The state provides an essential function in providing an environment where economic activity can function, and it is no harm that it is more directly recognised and rewarded for that. The scams of monoline insurers who never had adequate financial reserves to meet their obligations must never be repeated and neither can we simply socialise the losses every time something goes seriously wrong.
The management and shareholders of Irish banks will pay a price, and that is absolutely right. We may haggle over what price is reasonable or economically optimal, but a useful principle has been established. Free markets are only free because Governments enable them to operate within legal, regulatory, and fiscal frameworks. It is time taxpayers got a bigger cut of the action, because it is they who carry the risks when things go seriously wrong.