Ireland in the ditch

The glowing land of paddies
rushing around on the black blood of guiness
gyrating to the everlasting tune of the harp with distinction earned eons ago
as indefatigable and defiant expressions of honour and freedom

a proud people steeped in faith and hope
successfully battling one adversery after another
be they human or ignorance
carving a niche with global attention

rescuing herself no less with hemoglobic blood
from the hands of that mortal enemy across the channel
foretold to hamstring her on end
until constellations favour a divided victory

attacking independence with gusto
amidst fatigue and suffocating embrace of a distorted goodwill
dragging along internally as emigration solidifies
as a green promontory at the edge of europe

with a fringy attitude and growing confidence
ireland measured up in stature
confused between ancient and modern
vaccilating between openness and hoarding hedious baggages

until its investment in the new world finally showed up
combining forces and processes for the emergence of Celtic tiger
unfolding a new pride and honour
riding the waves of economic stability and final emancipation

sustained for over two decades and attracted the best
living high life and celebrating deserved booty
saying little and boosting opportunities
setting up chain reaction of cataclysmic bastion of change

no doubt confidence ran in the head
and gradually bleed the heart to great disease
until avarice and abuse consumed citzen and state
now ireland is now in a ditch naked and desolate

can you imagine her dissolved pride as IMF stood at the door
total dishonour that other capitals indict her treasury
under a bloated taoiseach
as hardwon pride and confidence collapsed quickly to pieces and ignormity

Guardian Commenter: afrogeografa

Here’s the Real Story Behind the Bailout of Ireland

CNBC – By John Carney

…So why would the Eurocrats demand a bailout of Ireland when Ireland insisted it didn’t need one?

The first reason is that much of Ireland’s debt—both its sovereign debt and the debt of its banks—is held by many of Europe’s largest financial institutions. The continued downward pressure on the market value of Ireland’s debt was causing balance sheet issues for these banks.

Many of Europe’s banks had written credit default swaps on Irish debt, which was draining cash. Finally, the banks were finding it increasingly expensive to borrow against Irish debt—that is, other banks would not lend money in exchange for Irish debt as collateral, except at steep discounts—creating the potential for a credit crunch.

It’s likely that the European Central Bank has large exposures to Irish debt. The ECB has been quietly buying European sovereign debt since May—although it won’t say exactly what debt it is buying. The purpose of the purchases is to stabilize the debt market and provide liquidity to the economies of Europe.

The stabilization effort, at least, appears to have failed. Further purchases of sovereign debt in a renewed stabilization effort threaten to become inflationary—essentially the ECB monetizing sovereign debt in Europe. An official bailout may be an attempt to ward off monetization and inflation.

Which means that this is not so much a bailout of Ireland—it’s a bailout of Ireland’s counterparties. That is to say, it’s a bit like Europe’s version of AIG: a backdoor bailout of invisible financial players who failed to manage their exposure to a shaky borrower…

Non-capital Liabilities Of Irish banks

The Irish Credit Bubble

By Morgan Kelly

Economist – University College, Dublin

During the 1990s, rising employment resulting from improved competitiveness caused Ireland to experience rapid economic growth. As Ireland converged to average levels of Western European income around 2000 it might have been expected that growth would fall to normal European levels. Instead growth continued at high rates until late 2007, since when it has turned sharply negative.

The proximate cause of the boom and bust in Ireland since 2000 is well known: construction. Ireland went from getting 4–6 per cent of its national income from house building in the 1990s—the usual level for a developed economy—to 15 per cent at the peak of the bubble in 2006–07, with another 6 per cent coming from other construction. This construction boom led to an employment boom which drove wages in all sectors of the economy to uncompetitive levels; and generated the tax revenues that funded substantial rises in government spending.

However, driving the construction boom was a less recognised boom, in bank lending. As Figure 1 shows, in 1997, Irish bank lending to the non-financial private sector was only 60 per cent of GNP, compared with 80 per cent in most Eurozone economies and the UK. The international credit boom then saw these economies experience a rapid rise in bank lending, with loans increasing to 100 per cent of GDP on average by 2008.

Figure 1

Bank lending to households and non-financial firms as a percentage of GDP for
Eurozone economies and the UK, 1997 and 2008

These rises were dwarfed, however, by Ireland, where bank lending grew to 200 per cent of national income by 2008. Irish banks were lending forty per cent more in real terms to property developers alone in 2008 than they had been lending to everyone in Ireland in 2000, and seventy-five per cent more as mortgages.

This more than tripling of credit relative to GNP in 11 years created profound distortions in the Irish economy. The most visible impact was on house prices. We show below that the rise in Irish house prices has little to do with falling interest rates and rising population, and is almost completely explained by increased mortgage lending. In 1995 the average first time buyer took out a mortgage equal to three years’ average earnings, and the average house (new or secondhand, in Dublin or elsewhere) cost 4 years’ average earnings.

By the bubble peak in late 2006, the average first time buyer mortgage had risen to 8 times average earnings, and the average new house now cost 10 times average earnings, while the average Dublin secondhand house cost 17 times average earnings. These rises in mortgages and house prices became mutually reinforcing, with larger mortgages driving house prices higher; while rising house prices made banks willing to grant larger mortgages.

As the price of new houses rose faster than the cost of building them, investment in housing rose. Ireland went from completing around 30,000 units in 1995 to 80,000 in 2007: one new housing unit for every 20 households.

Like any bubble, the rise of Irish property prices contained the seeds of its own collapse. Property bubbles grow as long as buyers are willing to borrow increasingly large amounts in the expectation that prices will continue to rise. This process inevitably hits a limit where borrowers become reluctant to take on what start to appear as impossibly large levels of debt, and the self-reinforcing spiral of borrowing and prices starts to work in reverse.

In Ireland buyers started to become nervous sooner than most observers imagine: the number and average size of mortgages approved (to all categories of borrower: first time buyers, movers, and investors) peaked in the third quarter of 2006. By the middle of 2007 the Irish construction industry was in clear trouble, with unsold units beginning to accumulate.

This property slowdown was bad news for the Irish banking system which had lent heavily to builders and developers to finance projects and to make speculative land purchases. Share prices of Irish banks fell steadily from March 2007, with the crisis coming to a head in late September 2008 with a run in wholesale markets on the joint-second largest Irish bank Anglo Irish. After aggressive denials that the banking system faced any difficulties, the Irish government has been forced to respond with a sequence of increasingly desperate and expensive improvised measures.

It guaranteed all deposits and senior debt in the six Irish banks in September 2008; was forced to nationalise Anglo Irish in January 2009; invested €3.5 Bn in preference shares in the two large retail banks AIB and Bank of Ireland in February 2009; and established a National Asset Management Agency (NAMA) to buy non-performing development loans from banks in November 2009.

It is currently proposed that NAMA buy loans with a face value of €70 Bn for €55 Bn. However, even assuming that the government’s forecasts of interest costs and the recovery of property prices—which appear to lie in the upper tail of optimism—prove correct, the situation of the Irish banking system will remain difficult.

The business model of the Irish banks for the last decade was to borrow heavily in wholesale markets to lend to developers and house buyers. The collapse of this model leaves them with three, inter-related problems.

1. Large losses on loans to builders and developers.

2. Heavy reliance on wholesale funding.

3. The likelihood of considerable defaults on mortgages.

While NAMA is intended to repair, for now, the damage to the asset side of Irish bank balance sheets from developer loans, their liability side appears unsustainable. The aggressive expansion of Irish bank lending was funded mostly in international wholesale markets, where Irish banks were able to borrow at low rates. From being almost entirely funded by domestic deposits in 1997, by 2008 over half of Irish bank lending was funded by wholesale borrowers through bonds and inter-bank borrowing. This well of easy credit has now run dry.

In the words of Bank of England Governor Mervyn King: “But the age of innocence—when banks lent to each other unsecured for three months or longer at only a slight premium to expected policy rates—will not quickly, or ever, return.”4 As foreign lenders have become nervous of Irish banks, their place has increasingly been taken by borrowing from the European Central Bank and short-term borrowing in the inter-bank market. Payments from NAMA will allow Irish banks to reduce their borrowing by a trivial amount.

Without continued government guarantees of their borrowing and, more problematically, continued ECB forbearance, the operations of the Irish banks do not appear viable. Borrowing in wholesale markets at 5.6 per cent5 to fund mortgages yielding 3.5 per cent is not a sustainable activity, and Irish banks face no choice but to shrink their balance sheets by repaying debt and returning to their earlier state of being funded mostly by deposits. It appears likely that the leverage of the Irish economy will return to normal international levels, with bank lending in the region of 80–100 per cent of GNP, back where it was in the late 1990s.

While the stock of credit to the Irish economy will contract by at least half, when we remember that loans equivalent to 80 per cent of GNP are tied up in mortgages (most of them of recent origin with terms of 35 years or more), the flow of new lending will contract even more sharply. It follows that property prices that were inflated by bank lending will drop steeply.

Should lending criteria return to their late 1990s standards, our results indicate that the prices of new houses and commercial property will return to an equilibrium two thirds below their peak levels, with larger falls possible for secondhand property. This means that, supposing residential prices have already fallen 40 per cent from peak, prices still have to fall by about half from their present levels. Were prices then to grow in line with real incomes, at around 2 per cent per year, it will take about 50 years for real prices to return to their 2006 peaks.

The third problem of the Irish banks is their mortgages. Recent US experience highlights two factors that rapidly increase the likelihood of mortgage default: falling house prices, and, most importantly, unemployment. Both have become realities for many Irish borrowers in the last year. In September 2009, 14.4 per cent of US mortgages were at least one payment past due or in foreclosure; while in Florida, whose investor fuelled housing bubble closely resembles the Irish one, the figure is 25%.6 Dealing with the financial and, more importantly, human cost of widespread mortgage defaults will be the next, and far more challenging, step of the Irish banking crisis.

By pushing itself close to, and quite possibly beyond, the limits of its fiscal capacity, the Irish state has succeeded in rescuing Irish banks from their losses on developer loans. Despite this, these banks remain as zombies entirely reliant on continued Irish government guarantees and ECB forbearance, and committed solely to reducing their own debts.

While bank capital levels are, probably, adequate for the markedly smaller scale of their future lending, we will see below that even fairly modest losses on their mortgage portfolios will be sufficient to wipe out most or all of that capital. Having exhausted its resources in rescuing the Irish banks from the first wave of developer losses, the Irish state can do nothing but watch as the second wave of mortgage defaults sweeps in and drowns them.

In other words, it is starting to appear that the Irish banking system is too big to save. As mortgage losses crystallise, the Irish government’s ill conceived project of insulating bank bond-holders from any losses on their investments is sliding beyond the means of its taxpayers.

The mounting losses of its banking system are facing the Irish state with a stark choice. It can attempt a NAMA II for mortgage losses that will end in a bond market strike or a sovereign default. Or it can, probably with the assistance of the IMF and EU, organise a resolution that shares property losses with bank creditors through a partial debt for equity swap. It is easy for governments everywhere to forget that their states are not wholly controlled subsidiaries of their banks but separate entities; and a resolution that transfers bank losses from the Irish taxpayer to bank bond holders will leave Ireland with a low level of debt that, even after several years of deficits, it can easily afford…]

Lending to the private sector and deposits of Irish banks as a percentage of GNP, 1992 to 2009

Conclusions

In the last decade, the Irish economy has experienced an unusually large credit bubble. Lending as a fraction of GNP increased from 60% in 1997, to over 200% in 2008, twice the level of other industrialized economies.

In the aftermath of this bubble, the Irish banking system faces three inter-related problems. The first is that it has made large losses on loans to property developers. The second is that it has large wholesale liabilities to international bond holders and, increasingly, to the European Central Bank. The final problem is that it faces likely further large losses on mortgages and business loans.

The Irish government’s policy response has been solely to address the first problem of losses on developer loans by establishing a state institution to buy these loans. However, by ignoring the second problem of the large wholesale liabilities of the Irish banks, this project will inevitably end in expensive failure.

As Irish banks are forced to repay this wholesale borrowing and to shrink their balance sheets to normal international levels, the sharply diminished supply of credit will lead inevitably to continued sharp falls in property prices. These falls in property prices will result in severe losses for the Irish taxpayer on the ill-conceived NAMA project.

Despite having pushed the Irish state close to, and quite possibly beyond, the limits of its fiscal capacity with the NAMA scheme, the Irish banks remain as zombies whose only priority is to reduce their debt, and who face complete destruction from mortgage losses.

The issue therefore is not whether the Irish bank bailout will restore the Irish banks so that they can function as independent commercial entities: it cannot. Rather it is whether the Irish government’s commitments to bank bond holders when added to its existing spending commitments, will overwhelm the fiscal capacity of the Irish state, forcing outside entities such as the IMF and EU to intervene and impose a resolution on the Irish banking system.

Download Discussion Paper (PDF)(28 Pages)

Morgan Kelly is a Professor of Economics at University College Dublin. Kelly predicted in 2007 that property prices were going to crash by 60% based on empirical evidence of past property crashes. Kelly has garnered praise from fellow economists for his prediction of the collapse of the property market and for opposing the Government’s banking policy.

Kelly was implicitly criticized by former Irish Tasoiseach, Bertie Ahern in July 2007 for his articles predicting a property crash; “Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide because frankly the only thing that motivates me is being able to actively change something.” Ahern subsequently apologized for the remark.

Related Links:

Bloomberg: Ireland Is Second Euro Nation to Seek Aid as Banks Wobble

Reuters: Analysis: Irish EU bailout may not stop Portugal follow-up

CNBC:  In Bailouts, Spain Will Be ‘the Biggie’: Strategist

WSJ: Europe Races to Aid Ireland

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