Monday, September 13, 2010

Economics 13/9/10: FT's belated recognition of Irish realities

In today's FT (here), Wolfgang Munchau clearly states that (emphasis is mine): "...Irish banking sector is insolvent, and there are questions about the capacity of the Irish state to absorb those losses. ...two years have passed [since the crisis acknowledgement by the state] and nothing has been resolved.

…As we saw last week, this strategy [of shoving bad loans under the rug via Nama and quasi-recapitalizations] came badly unstuck in Ireland. The Irish government massively underestimated the scale of the problem in its banking sector. On my own back-of-the-envelope calculations, the cost of a financial sector bail-out may exceed 30 per cent of Irish gross domestic product, if you make realistic assumptions about bad debt write-offs and apply a conservative trajectory for future economic growth.

[Note: this blog has previously (here), on a number of occasions estimated the overall impact of the net losses realized by the banks to Irish taxpayers will be in the region of €62-75 billion, inclusive of Nama. Based on the Department of Finance own figures, this can be expected to amount to 38.5-46.6% of Ireland’s 2010 GDP or 48-58.1% of our GNP. Either range of numbers is significantly in excess of Munchau’s back-of-the-envelope estimate.

However, even at 30% of annual GDP, the expected hit on this economy from the banking sector debacle is simply insurmountable.

No economy on earth can be expected to withstand a 30% contraction in its GDP over two-three years, while still running a 7-8% of GDP structural deficit in every one of these years. The insolvency of Irish banks recognized by Munchau, therefore, automatically implies the insolvency of our economy, unless the banks are isolated from the rest of our economy by a removal of the blanket guarantee on the bondholders, while retaining a guarantee on depositors.]

Munchau goes on to say that: “We know from economic history that countries enter into longish phases of stagnation after a financial crisis.

[My estimates based on the IMF and OECD models of fiscal and financial crisis imply that Ireland can expect at least another 33 quarters of continued crisis pressures in Exchequer finances, house prices and asset markets, as well as a permanent decline in the potential rate of economic growth to below 1.5%]

Ireland suffered an extreme crisis. In the light of what we know, the safe assumption to make for Ireland – and Greece – is that there will not be much nominal growth in the next five years. If you make that assumption, you realise Greece will almost certainly not be in a position to repay its debts. While Ireland’s situation is marginally better, there are justified doubts about the country’s long-term solvency.”

[The above are not some idle words. They are, as I mentioned early, fully in line with the existent econometric models of crises based on historical experiences in the advanced economies in the past.]

Per Munchau: “….In Ireland, the cure would consist of nationalisation and wiping out the bondholders of Irish banks through bond-to-equity conversions.”

[Needless to say, since April 2008 I am on the record – in the press, media, on this blog, in public meetings and private briefings to the policymakers – these are exactly the first steps that need to be taken in order to begin – note, just to begin – the process of restoring order to our banking system. Irony has it – on a number of occasions, I have written to the Financial Times precisely about these issues, raised by Mr Munchau, with, needless to say, not a peep back from the broadsheet offices].

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