This is an unedited version of my Sunday Times column from June 17, 2012.
The current Government policy, and indeed the entire euro
area crisis ‘management’ is an example of ‘the lesser of two evils’ con game.
The basic set up involves presenting the crisis faced by the euro area or the
Irish economy as a psychological construct, e.g. ‘We have nothing to fear, but
fear itself’. Then present two options for the crisis resolution, similar to
the choice given to Neo by Morpheus in the Matrix. You can take the blue pill,
the surreal world you currently inhabit will continue unabated (the ATMs will
keep working, the banks will be repaired, the economy will turn the corner,
etc) but a cost of complying with the demands of the system (the banks
bondholders and other lenders must be repaid, the EU systemic solutions must be
embraced, confidence in the overall system must continue). Take the red pill,
you go to the Wonderland and see how deep the rabbit-hole (of collapsed banks,
wiped-out savings, destroyed front-line services, vulture-funds circling their
prey, etc) goes.
Unlike in the Matrix, it’s not a strong, cool, confident
Morpheus who’s offering the option, but Agent Smith, aka the Government and its
experts. And, unlike in the Matrix, we are not heroic Neo, but scared humans,
longing for stability and certainty in life. This disproportionality of the
power of the State as the offerer of the false choice, and the powerlessness of
the society assures the outcome – we take the blue pill and go on feeding the
Matrix of European integration, harmonization, and self-validation. The very
fact that the blue pill choice leads to the ever-accelerating crisis and
ultimate demise of the entire system is irrelevant to our judgement. We are in
How I know? I was told this by the Government own
We all agree that our real economic performance is abysmal.
Take unemployment – officially, it rose to 14.8% in Q1 2012, unofficially,
broader measure of unemployment – that including those recognized as being
under-employed – is hovering over 22%.
But to-date, our fiscal performance has been so stellar, we
are ‘exceeding Troika targets’. Right?
Ireland’s Exchequer deficit for the period from January 2012
through May was €6.5 billion or €3.7 billion below the same period last year. This
‘improvement’ in our deficit is due to €1 billion transfer from the banks
customers and taxpayers (via banks holdings of Government bonds) to the Central
Bank of Ireland that was paid out by the Central Bank to the Exchequer. Further
‘improvement’ was gained by the ‘non-payment’ of the €3.1 billion due on the
promissory note, swapping one government debt for another.
Underlying day-to-day Government spending (ex-banks and
interest payments on debt), meanwhile, is up year on year. Tax receipts are
rising, up €1.6 billion, but if we take out the USC charge which represents
reclassified non-tax receipts in the past currently being labelled as tax
revenues, the increase shrinks to €726 million. In the mean time, interest
costs on Irish national debt rose €1.3 billion on same period of 2011, wiping
out all gains in tax revenues the Government has delivered on.
Take that blue pill, now and have a 15% increase on the 2007
levels of budgeted Government spending (protecting ‘frontline services’, like
HSE senior executives payouts in restructuring and advisers salaries), or a red
pill and face Armageddon. Yet, the red pill in this case would lead us to the
realization that the entire charade of our reforms and austerity measures is
nothing more than a false solution that risks making the crisis only worse.
This week, Professor Karmen Reinhart of the Kennedy School
of Government, Harvard University was dispensing red pills of reality at the
Infiniti 2012 conference over in Trinity College, Dublin. Her keynote address
focused on the area she knows better than anyone else in this world – debt
overhangs and the pain of deleveraging in resolving debt crises. The audience
included many central bankers and monetary and fiscal policy experts from
around the world, including even ECB. No one from the Irish Department of
Finance, the NTMA or any branch of the Irish Government, save the Central Bank,
showed up. Blue pills crowd don’t do red pills dispensations.
Professor Reinhart spoke extensively about Europe and,
briefly, about Ireland. In our conversation after the speech, having met senior
Irish Government decision makers, she reiterated that, like the rest of the
euro area, Ireland will have to face up to the massive debt overhang in its
fiscal, corporate and household sectors and restructure its debts or face a
default. In 26 episodes of severe debt crises in the history of the world since
the early-1800s she studied, only three were corrected without some sort of
debt restructuring, and in all three, “the conditions that allowed these countries
to resolve debt overhang problems absent debt restructuring are no longer
present in today’s world”.
Worse than that, Professor Reinhart explicitly recognized
that “Ireland has taken debt overhang to an entirely new, historically
unparalleled, level”. She also pointed out, consistent with this column’s previously
expressed view, that in the Irish case, it is the household debt that “represents
the gravest threat to both short-term stability and long-term sustainability of
the entire economic system”.
Per claims frequently made by the Government that debt
deleveraging is on-going and progressing according to the policymakers’
expectations, Professor Reinhart stated that “in the US, deleveraging process
had only just begun. Despite the fact that house foreclosures and corporate
defaults have been on-going since 2008, the amount of deleveraging currently
completed is not sufficient to erase the build up of debt that took place over
preceding decades. With that, the US is well ahead of Europe and Ireland in
terms of what will have to be achieved in terms of debt reductions.”
Furthermore, “structural differences in personal and corporate insolvency laws
between the US and Europe imply the need for even deeper debt restructuring,
including direct debt forgiveness and writedowns in Europe. And, once again,
Ireland is in the league of its own, compared to the European counterparts on
personal bankruptcy regime.”
But don’t take Professor Reinhart’s and my points of view on
this. Take a look at the forthcoming sixth EU Commission staff report on
Ireland, leaked this week by the German Bundestag. The Troika is about to start
dispensing its own red pills of reality to the Irish Government.
According to leaked report, the IMF and its European
counterparts are becoming seriously concerned with two key failings of our
reforms. The first one is the delay in putting in place measures to address –
on a systemic basis, not in a case-by-case fashion as the Government insists on
doing – the problem of households’ debts. Incidentally, this column has warned
about this failure repeatedly since mid-2011. The second one is the rising risk
that accelerating mortgages defaults pose to banks balancesheets. Again, this
column covered this risk in April this year when we discussed the overall banks
performance for 2011.
From independent analysts, to world-class researchers like
Professor Reinhart, to Troika, red pills of reality are now vastly outnumbering
the blue pills of denial that our Government-aligned experts are keen at
dispensing. The problem is – no one seems to be capable of waking up inside the
Matrix of our doomed policymaking.
To put it to the policymakers face, let me quote Professor
Reinhart one more time: “Europe’s solution to the crisis, focusing on austerity
instead of restructuring household and sovereign debts will only make the
crisis worse. The pain of deleveraging is only starting. …Europe’s hope that
growth can help in addressing the debt crisis is misplaced, both in terms of
historical experiences and in terms of European economic realities.” And for
our home-grown Mr Smiths: “Ireland’s current account surpluses [or exports
growth] are welcomed and will be helpful [in deleveraging] but are not
sufficient to avoid restructuring economy’s debts.” So fasten your seatbelt,
Dorothy, cause Kansas is going bye-bye…
Sources listed in the charts
Few months ago I highlighted in this very space the risks
poised to the Irish banks and Nama from the excessive over-reliance, in the
pre-crisis period on covered bonds and securitization-based funding. The core
issue, relating to these two sources of funding, is the on-going deterioration
of the quality of the collateral pools that have to be maintained to sustain
the bonds covenants. Things are now going from bad to worse, and not only in
Ireland. Per latest Moody’s Investors Service report, across Europe, 79 percent
of all loans packaged into commercial mortgage-backed securities rated by the
agency that came due in Q1 2012 were not repaid on time. Three years ago, the
non-repayment rate was only 35 percent. Per Moody’s, “real estate with
mortgages that match or exceed the value of the property… suffered defaults in
nearly all cases in the first quarter. About a third of borrowers with LTV
ratios of up to 80 percent didn’t pay on time.” If this is the dynamic across
Europe as a whole, what are the comparable numbers for Ireland, one wonders?
And what do these trends imply for the Irish banks and Nama?