Ireland’s Announcement of a Fifth Bailout Demonstrates that Bailouts Cannot Work

BlackRock Inc., the independent stress-tester of Irish banks, has discovered a €24 bn capital black hole in their balance sheets. For a fifth time, citizens of the Emerald Isle are told that this bailout will be the last.

As reported by the Wall Street Journal on April 1st, the tab will increase from €46 to perhaps €70 bn as a result, or €15,000 per capita.

Even if this were the final bailout, the evidence cited Thursday 31st by the WSJ correspondent David Enrich supports the view that, contrary to the Irish Government’s assertion, the Irish taxpayer will not in fact fund these amounts and sadly Ireland will be unable to avoid a default.

As any professional in the mortgage markets knows, a housing market in which 5.7% of mortgages are delinquent (90 days past due) is on the brink of a price collapse. When I was securitising European mortgage portfolios in supposedly stable conditions before the systemic banking collapse, my team would raise eyebrows if the 90 day figure was a tenth of this level.

This 5.7% figure, and the trend up from 3.6% at the end of 2009, should have been focussed on more closely by the Irish Central Bank. The problem with the stress tests is that they are static in time, as opposed to forward looking, and fail to factor in these expected future price declines.

Irish house prices, as expressed by wage multiples, will decline further as these delinquencies turn into forced sales and Irish citizens put off buying until a price bottom is felt to be reached.

The historian Niall Ferguson queried whether we should compare our big banks to dinosaurs on the verge of extinction in the Financial Times in December 2007,

The big question for our time is: are we on the brink of a “great dying” – one of those mass extinctions of species that have occurred periodically in the history of life on earth, such as the Cretaceous-Tertiary crisis that killed off the dinosaurs?

The answer to this question is yes. And the proof is in the last 3.5 years of major European bank bailouts.

Let us distinguish the 2007-2008 bailouts (Phase 1) from the recent and future bailouts (Phase 2). The importance of the comparison is that Phase 1 bailouts were accompanied by interest rate cuts. Now that we are in Phase 2, Central Banks have no further scope for reductions.

Promoters of Phase 1 bailouts failed to mention at the time the circular effect of the price inflation of bank-credit-dependent assets triggered by the bailout itself. Right after each bailout, house prices tend to rise, especially so because of the interest rate reductions.

Phase 1 supporters also failed to mention the artificial boost to banks’ apparent profit lines directly attributable to the interest rate cuts. Yield curves were shunted downwards and all bank owned assets subject to mark- to-market accounting were boosted in value, triggering the recording of future hoped for cashflows as higher up-front profits under poor accounting rules that exaggerate the apparent financial health of banks. These rules were brought into effect in an environment in which global authorities did not believe that banks could fail en masse.

During Phase 1 taxpayers were assured that economies would recover relatively swiftly and that the need for the bailout was a unique and unforeseeable banking liquidity hiccup which would be fixed by the proposed drastic action.

But the bailout surgery has failed. The drain of lifeblood from economies by way of tax to fund bailouts will be looked back on with amusement by future generations just as we smile when reading in our history books about unnecessary surgical operations performed on medieval patients. Our never-ending bailouts are simply worsening the condition of each national economic patient.

The cuts required to finance various national austerity programmes are provoking civil unrest (UK) destabilizing governments (Portugal), and stifling economic recovery (UK again – Dixons Retail and other “discretionary spend” businesses continued this week to revise downwards their profit forecasts).

Few of the banking big beasts have perished because of the scale of bailouts by Western governments.

These bailouts should now end. As the Irish case demonstrates, they cannot work. Their impacts are trivial and short lived, and their long term costs cannot be absorbed by taxpayers.

7 Comments

  • waramess says:

    Well, at least there is someone who appreciates that a nation already owing over half a million dollars per capita in external debt alone, is in need of something other than a refinancing.

    This article is absolutely right but the mystery is why our own Chancellor is unable to understand it

  • Current says:

    From living in Ireland over this period I can’t remember this ever happening:

    Promoters of Phase 1 bailouts failed to mention at the time the circular effect of the price inflation of bank-credit-dependent assets triggered by the bailout itself. Right after each bailout, house prices tend to rise, especially so because of the interest rate reductions.

    House prices didn’t rise, as far as I know they have been falling since 2008.

    The Irish bailouts didn’t fail because they caused price inflation, they didn’t cause price inflation. Ireland had price deflation for almost all of 2009-2010. Inflation is currently still low.

  • As Politicians have their own aims and ends, the fact they are keep on bailing out or restructuring means that it has got a sense… in their perspective though.
    Yes, all this stuff is proved (and demonstrated by logics) to be useless or even dangerous for the economy, but we can simply read the story also as “Politicians have goals which got nothing to do with their citizens’ economy”. We should then investigate WHY those guys keep on acting that way, as we cannot simply say they are stupid.

  • Gordon Kerr says:

    Addressing “Current”s point above, (refuting mine that Irish house prices were boosted by the interest rate cut during Phase 1). On 4 Dec 2008 the ECB cut rates by 0.75% to 2.5% and this morning the rate was 1%. Irish house prices, like all fixed assets, were indeed boosted by this cut. Unfortunately Irish houses had become so overheated at the time that the boost perhaps manifested itself in a deceleration of decline, rather than a rise in nominal terms. In the UK and elsewhere, in nominal terms prices rose.

    • Current says:

      Yes, house prices were higher than they would have been had the ECB kept rates higher. That helped keep bank balance sheets looking healthy. But, interest rates are still low now, so what has changed?

      In my opinion the big issue in Ireland is the effect the state of the general economy and the effect the bank bailouts have had. To support the bailout the government have raised taxes sharply. That has had the normal depressive effects. During the boom Ireland was highly competitive, it had low personal taxes and low corporation tax. Now it still has low corporation tax, but personal taxes have risen sharply.

      Businesses are worried that the EU will force Ireland to increase corporation tax, but I think personal taxes are more important. When personal taxes rise there are four issues:
      * Rises in taxes cause uncertainty because they indicate more rises are on the way. That increases the demand for money. If money holdings rise then output will fall before prices fall.
      * If welfare rates don’t change then more people will claim welfare rather than working low wage jobs. I’ve seen this happen a lot.
      * If tax rates are low abroad some people will emigrate. Many recent immigrants to Ireland have gone back home.
      * Prices take time to change. As taxes reduce incomes entrepreneurs must reduce their prices to take into account the new realities. This takes time and before it occurs sales and output fall.
      * Because of effects “New Keynesians” often discuss wages and many prices are still too high. Those in work generally haven’t received pay cuts, doing so would be poor industrial relations. As a result businesses can’t easily cut prices. (Though new businesses can hire unemployed workers cheaply and compete on price. This seems to be happening where I live with shops and cafes, though slowly). In time this will be overcome too, but in the interim output it will cause output to fall.

  • Sara Moore says:

    Dear Gordon Kerr
    Please look at my new website, which is going to be linked to Google.
    You will see that excerpts from my book on the website reveal that Germany was not weak but very powerful between 1929 and 1933.
    You can judge for yourself whether she was primarily responsible for the 1929 crash and the Great Depression.
    There are parallels between 1929 and 2008. Indeed I predicted the crash as you will see in my article ‘Germany an emerging superpower – comparisons with the 1930s.’
    I have just written an article for Bill Cash’s European JOurnal called ‘Is Germany trying to grab the City?’ which gives historical parallels showing how dangerous it could be for our own economy to keep bailing ailing euroland economies.
    best wishes Sara Moore

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