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State Capitalism and its consequences

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.

European bank rescue plan in tatters amid savings stampede - Times Online

The latest chapter in the story of this piecemeal approach to stabilising the banking system began on Monday evening, when a group of Ireland's most senior bankers trooped into Government Buildings in Dublin.

It had been a terrible day in markets worldwide and a catastrophic one locally. One bank, Anglo Irish, had seen its shares plummet by 46 per cent. There were rumours of large depositors demanding their money, including one German customer wanting an immediate €1.5billion. Then came the horrendous news that Congress had rejected the US bailout plan.

The shaken Irish bankers were grave as they poured out their story to the Taoiseach, Brian Cowen, and the Finance Minister, Brian Lenihan. Liquidity was drying up, they said, other banks were refusing to lend to them except for the shortest periods. According to one source: "They basically said, `Look, tomorrow two of our banks won't survive'."

Thus began the hatching of the explosive plan for a guarantee of all Irish bank deposits. Irish officials worked through the night to cobble together a credible plan.

There was no time to consult other governments, the European Commission or even the European Central Bank. A guarantee had to be in place before ordinary bank branches opened on Tuesday. At 4.15am the plan was completed. The promise would apply to six home-grown banks, and to no one else.

A couple of hours later Alistair Darling rose from his slumbers to be told the bad news. The Chancellor had for once had a full night's sleep, having spent most of the weekend stitching together the Bradford & Bingley deal.

Mr Darling immediately spoke by phone to Mr Lenihan. Why hadn't he been told? Why was there no consultation with other EU states? Mr Lehinan explained that there had been no time.

Vote McCain for war without gain
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sat Oct 4th, 2008 at 11:47:04 AM EST
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 it reminds me most of is feudal lords raising war taxes to fund their military adventurism. If things go well, the people get to pay and the rulers get to benefit. If things go pear-shaped, the people get to pay and face a distinct risk of having their livelihoods destroyed, while the rulers are ransomed with the money the people got to pay.

Of course, today what's being imposed on the public is a risk, not a straight-up cost, and the additional penalty levied on the public if things go bad is that their pensions get burned, not that their village gets burned. But the underlying mechanism appears to be the same.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Oct 4th, 2008 at 01:59:04 PM EST
Wonder when "the people" wake up and DO something about it?  Ever?

They tried to assimilate me. They failed.
by THE Twank (yatta blah blah @ blah.com) on Sat Oct 4th, 2008 at 07:57:47 PM EST
[ Parent ]
Before "the people" will do something, "the people" must suffer. So far, for all the fear mongering, there's not a lot of actual suffering going on at the level of "the people". Cause and effect, and all that.

$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Sun Oct 5th, 2008 at 11:40:25 PM EST
[ Parent ]

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