Our political leaders must make the right decisions in the budget or face economic chaos.
At today’s cabinet meeting on the budget, the government must start to face up to the crunch decisions it must make.
Ministers face the most important financial choice taken in the past three decades. If they make the right one, our financial institutions and our economic reputation will be greatly enhanced. If they make the wrong one, there is likely to be pressure on the Irish banks, leading to chaos and, ultimately, political instability.
The discussions on the shape of the October budget are one thing. But the crux of the issue facing us is in the financial sector; it is that our banks have run out of money. This is how my dad would explain what, in financial markets, is grandiosely termed a ‘liquidity problem’.
In addition, there is no point pretending that this problem is limited to ‘weaker’ banks. All Irish banks are in the same boat – the only difference is how critically they are affected.
If the banks go, our economy goes too. All banking systems act like the heart of the economy. Without a strong banking system that pumps credit into every nook and cranny of the economy, activity dries up and the country dives deeper into recession. Recessions lead to depressions when banks are not able to lend and customers and businesses are not able to borrow.
Therefore, it is crucial that the government take the right decision now. Events of the past few days imply that there is no model we can import from anywhere else to help us. The rest of the world is suffering the same plight. Large banks are going under by the day. Thus, if we wait, we will simply suffer more.
We need to come up with an Irish solution to our specific problem – because no one has the antidote to the contagion that is spreading through the global financial markets.
While, in the longer term, Irish banks have bad debts/asset problems due to excessive lending to property, the problem that will drive them to the wall is short-term liquidity. This is what the state must rectify. We have seen from the US that the policymakers are making it up on the fly, hoping that by buying up toxic assets (bad debts), they can insulate the system and buy time.
However, as we can see from the rolling bankruptcies, this is not working – or, at least, only partially so. The challenge for Ireland is to come up with our own rescue model and then export it, rather than wait for some manna to arrive from heaven to solve our banking dilemma.
The only option is to guarantee 100 per cent of all depositors/creditors in the Irish banking system. This guarantee does not extend to shareholders who will have to live with the losses they have suffered. However, it applies to everyone else.
If the minister does this, he will not only staunch any funds outflow, he will show leadership and be seen as someone who is coming up with a solution that can be copied all over the world.
Ireland in the past has done things that no other country has done, to great effect. Think of the zero tax rate on exporters in the 1970s and the 12.5 per cent tax rate on multinationals now.
These were solo initiatives – we didn’t wait for them to work in other countries, and they worked perfectly well here. This proves that we can think for ourselves. Once more, and possibly even more crucially, we need to think for ourselves now. Furthermore, the state could charge the banks a 0.25 per cent fee for the guarantee, thus making about €1.5 billion per year in revenue (0.25 per cent of €500 billion).
If we take second-hand, discredited ideas from abroad, such as a toxic fund or, worse still, nationalising a bank, we will fail. If we fail, our banking system will be imperilled and a generation of Irish people will suffer. A failed banking system is equivalent to a failed state, and Ireland will become an international pariah. No politician can or should survive such a mistake.
The reason nationalising a bank will fail is that it will alert investors – those of us at home and foreigners who are crucial to the banking system – that the Irish banking system is in tatters.
The question then becomes, ‘who’s next?’ This will lead to contagion, and the system unravels.
There is another reason for not nationalising, and it is taxpayers’ money. Once you start using taxpayers’ money, you have to be careful. The lesson from the US in the past week is that using taxpayers’ money is unsuccessful and deeply unfair.
The beauty of guaranteeing deposits is that you use no money – not a penny. Instead, the government is using its sovereign credit as the country with Europe’s lowest debt/GDP level to restore confidence in the system. The civil service view appears to be that such a guarantee would subject Ireland to the risk that people withdraw money, disbelieving the state.
But this would not happen. Some €350 billion of the total €500 billion is held by Irish people, so we won’t move our cash. In addition, the €150 billion owned by foreigners would simply become like an Irish government paper.
The Irish bond market has never been in such demand, and so would this guarantee scheme.
In fact, it is highly likely that money would flow into the Irish banking system from abroad to avail of the guarantee. If you doubt that, look at Northern Rock, which is now receiving deposits from Irish people who are taking their money out of Irish banks.
Why? Because the British government is guaranteeing all Northern Rock’s deposits. Precisely the same would happen here.
Because the international financial system is in tatters, only the government can restore faith. No banks, no fancy footwork from financial whizz kids, no clever use of the bond markets can restore confidence. The market is suffocating and needs clear air passages. This means clear, unambiguous leadership and simple straightforward solutions.
This is the stuff of politics and the type of decision that most politicians would love to be in a position to take. Lenihan should regard the crisis in the banks as an opportunity, not a threat.
Last week he went some of the way. In its press release, the state implicitly guaranteed all deposits when the minister said: ‘‘The government is committed to the stability of our financial system, so that money placed with any Irish credit institution would not be at risk.
‘‘The Irish government wants to protect the whole financial system, secure its stability and ensure that all deposits in Irish financial institutions are safe.”
The key here is ‘‘all deposits’’. If an Irish institution went bust, would depositors with more than €100,000 have the right to hold the government to its ‘‘all deposits’’ description in this press release?
If the crisis leads to any loss of deposits, you can bet the courts will be full of cases against the state.
The minister should simply state explicitly that the deposits are guaranteed and clear up any confusion.
Unfortunately, he is being advised by merchant bankers on the one hand, who are just interested in fees and don’t give a fiddlers about Ireland, and civil servants on the other, who can’t see that nationalising a bank is the biggest policy reversal since TK Whitaker.
He needs to be brave and visionary and see through the limitations of his advisers. Equally, the careers of everyone around that cabinet table will be blighted if the banks go under as a result of any nationalisation plans.
They have collective responsibility. The decisions facing the cabinet are the most momentous any government has had to make in this country for many years. The right one for Ireland is a 100 per cent guarantee of all deposits.
Let’s hope, for all our sakes, that wisdom prevails. The alternative – influenced by vested interests and incomplete advice – is too awful to contemplate. The choice is between a recession, which is already here, and a depression, which might be around the corner. It couldn’t be more simple or more stark.
Greetings! You are absolutely right, David, and I congratulate you on your clear vision. As many who follow economics and politics in this country know, you have been right with your analysis and predictions for a long time. There are not many who share such an impeccable track record. I am in no position to give Brian Lenihan any advise, but if I were, I would tell him to make you an adviser for his department and the government. Ireland would benefit greatly from your clarity of analysis and courage to speak the truth. Keep up the good work! We… Read more »
The real danger is that Lenihan, will not be able to make up his own mind on what to do for the long term benefit of the economy. Ho spent all his life in the realms of Law, and seems rather McCain-like in economic matters. The problem is that he needs advisors for every area of economics and finances. If this government were really serious about the nations finances, they would appoint somebody who knows something about finances in charge. We need somebody in charge of the Finance Ministry who knows how to cut costs and who knows how to… Read more »
Yes above all else we need to be brave enough to think for ourselves. But first we need to hear from the government what they see the problem is. Do they agree “its short-term liquidity.” I’m worried they see the problem “as no first time buyers are taking out 40 year mortgages for some developers 500k apartments”. That is an entirely different if somewhat related issue. When the problem is agreed it can be addressed, but within some general principles, like who pays, who is protected, who isn’t.. Your approach has possibilities, but I would like to see some stick… Read more »
Sorry, but I just don’t see a full deposit guarantee as being the pill to cure all our ills. The €100k scheme covers 90% of depositors and will prevent a run on a bank so that risk has been taken out of the equation. The reasoning for a full guarantee seems to be that it will attract foreign capital…. to the first country in Europe to enter a recession and the one most at risk of a depression? a country with the biggest housing bubble and one of the smallest indigenous industrial bases? with a guarantee from a government that… Read more »
David, Where does an Irish government, already €7 billion in the red (and rising?) get the funds to ‘guarantee’ €500 billion of our disappearing capital? These ‘guarantees’ schemes were always intended to cover the possibility of a single financial entity going bust. They cannot, nor will they, guarantee the whole of the Irish financial system. It is clear that the Irish financial system is presently unable to do any of its previously ‘substantial’ business and that it has been unable to do so since last August, twelve months. It is nursing substantial losses and, whilst all appears smooth on the… Read more »
David said: “The beauty of guaranteeing deposits is that you use no money – not a penny. Instead, the government is using its sovereign credit as the country with Europe’s lowest (after Luxembourg) debt/GDP level to restore confidence in the system.” Irelands GDP in 2007 was about €130 billion, of which construction accounted for about €30 billion. Using an income of 100 to guarantee 600 is rather like a Toyota Prius with a half-flat battery offering to tow a Scania Artic broken down at the roadside. Therefore I agree with Woodsey that it is quite unrealistic to expect the government… Read more »
The problem with an infrastructure spend in this country is that it eventually ends up being a constituency slush fund. A bit like the way the National Lottery ended up paying for golf courses. Before we sign up for any more infrastructure spends, we need to introduce far more openness, accountability and transparency into the entire process. I cannot see this happening. I think that we need to start thinking in terms of sweat instead of other people’s money. Unfortunately the main commentators, from the media and the bank economists seem to have ideas in respect of what to do… Read more »
@Malcolm Mc Clure I agree that that the government should put the time effort into developing the national infrastructure Last year I was at a conference where I heard about the English Building Schools for the Future http://www.teachernet.gov.uk/management/resourcesfinanceandbuilding/bsf/ in essence “Building Schools for the Future (BSF) is the biggest-ever school buildings investment programme. The aim is to rebuild or renew nearly every secondary school in England Building Schools for the Future (BSF) represents a new approach to capital investment. It is bringing together significant investment in buildings and in ICT (Information and Communications Technology) over the coming years to support… Read more »
The US are voting to spend another $700,000,000,000.00 on their bailout and nobody will be able to actually hold or touch what it will buy, though the spend may or may not be sufficient or necessary.. It wont give us a new energy technology, put a man on Mars/start a space colony, educate a generation, create a new invention or food source that we can look back at with awe some day. It will be trousered by bankers in places like the IFSC. This weekend while we in the west are busy bs’ing about the ‘value chain’ and the knowledge… Read more »
The problems with the proposed solution are two fold: first, guaranteeing all deposits would continue to give the banks carte blanche to write whatever type of risky loans they want – using depositors’ money – which is exactly what got us into the mess in the first place. Secondly, it is contrary to EU state aid rules for a government to give that type of helping hand to a particular sector. The EU looks carefully at investor compensation schemes, and a guarantee is within this category. The European Commission would simply not allow this type of state aid and it… Read more »
Surely, the problem with guaranteeing all deposits in private banks, is that it would effectively force the banks to take ever greater risks with the money? Distorting a market in this way, will cause distortions elsewhere. It seems to me that the financial model that we’ve all been living under for the past couple of decades, is knackered. It has proven itself to be simply wrong. It relies on unsustainable, ever increasing, leverage, be it banks, hedge funds, people & houses, ‘high yield’ (aka ‘junk’) bonds and M&A, etc. Wherever you look, you see cleverer and cleverer ways of increasing… Read more »
David > All banking systems act like the heart of the economy. Maybe they are more like the food providers for the economy. We have become used to them dishing up large portions (of credit) to all and sundry. Unfortunately some of what they have been serving us has turned out to be junkfood. Your solution presumes that the problems can be solved, or at least alleviated, by a return of confidence to (and in) the banking sector. While I agree that confidence in the banking sector is very important, I also think that the government probably only has one… Read more »
Hi David, David > State guarantees can avert depression You’ve written about this before where a 100% deposit guarantee is a potential remedy to some of our woes, but I think you are barking up the wrong tree on this occasion. It wont solve a thing. A deposit guarantee is a type of insurance. Any government that provides it, has the banks put in a percentage of their deposits to fund any bad bank. Its like that travel company insurance. It can only have limited funds. Like the travel co insurance, it provides a level of comfort to the customers,… Read more »
The guaranteeing of deposits is a good short term play. But, if you can have depositors rush in so easily, they can rush out just as quickly. The medium to longer term issues in the next couple of years, there will be at least 3 major requirements Reliable and sustainable food sources Reliable and systainable energy sources A cheap to run and use reliable transport/ logistics system By the above, I do not mean the brokerage of these services. I mean businesses (local or foreign) who can provide the above with minimum import requirements. People who are making this stuff… Read more »
MK. This is a deveraging event. This happens when the financial institutions are overleveraged. In this case the most vulnerable financial are the most aggressive,with the most liberal lending policies, and the best incentive scheme for getting their staff to approve risky mortgages. Basically the banks competed with each other and some went harder than others. In fact the banks, a cynic might even argue that the bankers behaved like socialist politicians, in promising to solve all societies problems using other people’s money. And of course in the process this changed the market dynamic, by putting a floor in the… Read more »
> The Spanish banking system is only solvent based on the fact that the ECB are supplying billions of Euros in liquidity Hands up, I havent analysed the situation of the big two Spanish banks in detail so I have no feeling of their precariousness or otherwise. Value wise (marcap), for now, they are still large even with today’s post-Fortis/B&B/Hypo-triggered share price drops. But I do know that the Spanish property market and ancillary activities is going through a huge crash, much bigger than ours has been to date. Whether one or both banks will have to go or be… Read more »
Banks have been falling like skittles this morning. ‘Subprime’ was the word of the year for 2007, anybody want to bet against ‘bailout’ being the word of the year for 2008? Philip > we are entering a period of severe cost push inflation on the basics and it will be every nation for itself. Inflation has been rising quite rapidly for the past year, and due to the credit-crisis distraction little has been done, or said about it. We even got a new word earlier this year (stagflation) to make inflation seem less worrying. There is a chance that the… Read more »
Are we all just getting just a little too obsessed about banks? We ask bankers “What’ll happen if a load of banks go broke” and they answer “the world will end” or something similar. If you asked some senior HSE manager what would happen if we got rid of 50% of HSE staff, they’d probably react in the same way. It rings of the student union “all or nothing” argument: you criticise a law, and the response is “”if we had no laws, society would fall apart, so this law is good”. There’re good banks, banks that haven’t lent recklessly,… Read more »
David,
could be an apt time to revive the Leviathan as forum to discuss whats going on @ the mo
@Stephen Kenny> Totally agree. We are playing number games and it’s consuming itself. The banks are terminally damaged and these bailouts are like trying to resusitate someone pronounced dead. A time comes when you have to bury this and move on. Nobody is thinking outside the box. @Lorcan> Increased inflation would decrease the real value of outstanding debt. The snag is that it assumes we are generating the wealth (thro goods and services) which are appreciating. And therein lies the conundrum….if the banks stop, the money stops flowing and businesses stop trading as they can only complete the one side… Read more »
What I find galling is that the experts who “got into property” are now still giving advice.
I got spooked when the bank wanted to give me money back in ’99. I could have made a heap of cash if I had gone with the flow. But the trouble is that once you’re in you’re in.
Like a frog being slowly boiled you won’t want to get out until its too late and you get scalded.
philip>So, thinking outside the box and conundrums aside, what can we do? I suppose the only option is to ensure that businesses keep going and people’s savings are intact. We need some information system to allow trading of some class of credit information. If the banks in their current guise are clobbered, then what? David states the need to implement a local workaround. Guaranteeing the savings is a good initial ploy…but what else can we do to give us the necessary thinking time to get out of this mess? FDR recognized the same conundrum during the depression concerning the role… Read more »
Philip > Right now, things are happening “out there” very fast indeed. Maybe events will overtake us and Oct2nd will be a day when it’s all purely academic. It will be academic for the banking sector. The government might try to make life easier for the banks, but their future is out of the hands of the department of finance. As you correctly say, the need for a working credit system is paramount. If the banks can’t provide it, then it would be cheaper to create a new system. It would be a hellishly complex undertaking, but it could work.… Read more »
Longlivetherepublics > placed the savings deposits under a freeze but guaranteed the depositors they would eventually get their money back. This act prevented runs on the banks, and allowed them to carry on the business of commercial/retail banking. Freeze deposits? David’s idea does the same thing, only allows access to deposits at the same time. Speaking of FDR, here’s what he had to say about bankers: “Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men. True they have tried, but their efforts have been cast in the… Read more »
The US bail-out bill has failed to make it through congress.
Time to duck and cover.
Least we be dissappointed…http://www.breakingnews.ie/ireland/mhqlsngbeyey/.. talk about deck chairs on the titanic!!
U.S. bailout rejected, 227 nay 207 yea, does this put a different spin on david’s idea, would it now be pointless. This is essentially the end of the world as we know it, the stock market plummets 4% on news. If you can’t convince the house of representatives to spend other peoples tax money then what hope do the banks really have? the good ones might survive the ones with debts will fail. Obviously not very helpful but we have to look at this new reality and accept pensions are now gone. The whole point of the idea was to… Read more »
hang on.
They’re trying a Bertie solution. They didn’t get the right result first time, so they are going to run the vote again.
Who said economics isn’t exciting?
instead of a plaster this bailout failure has thrown salt on the wound, the republicans are trying to blame Nancy Pelosi for it’s failure, but to steal Obama’s thunder, this is a failure of the republicans bankrupt neo-con philosophy over an eight year period. Get ready for a period of bankruptcies and the unthinkable failure of a number of multi-nationals.
Me > Who said economics isn’t exciting?
Of course, I was mistaken. This isn’t economics, it’s politics, as nostramartus points out.
Seems like Humpty Dumpty just fell of the Wall (St).
Lorcan Roche Kelly>Freeze deposits? David’s idea does the same thing, only allows access to deposits at the same time. Its not the same thing. David’s idea is the government making a promise it would find hard to keep in the event of a simultaneous run on all the banks. FDR’s freeze on savings deposits was the government more or less saying, ‘you’ill get your money back, just not today. Meanwhile the bank is still open for business’. Remember this is not some crazy scheme dream t up by one of us armchair economists, the savings deposit freeze was actually implemented… Read more »
Ah watching the American Stock market is better ( almost ) than sex or good golf !. I think it’s rather ironic what’s happening now, for years here in Ireland and to a degree in Europe we all looked towards America and ‘the Dream’…well it turns out to be no more real that the flicks of Hollywood. All you have to do is turn East and look at the Asian and Islamic Banking system they are really on a percentage level not been affected by the system we run under. So since we are such a fickle bunch and such… Read more »
Well now…….tis 00.14 our time and the NZ bourse has opened to a small disaster. I saw poor old Nell McCafferty on RTE’s Q&A being rubbished and all she was trying to say was pure common sense. Richard Bruton had some spark of realism.The prettier version of Harney, Shiny Hanifin, was vacuous. Sarkozy has called a big crinniu. Bush failed in his big crinniu. Everyone of substance is having a crinniu to try and do something. We have Jonathan Bowman. I had a couple of beers tonight with a (very proud) old English hippy domiciled in West Cork who was… Read more »
brendan, if you love the islamic system, then i suggest you go live in a country where there is one. i’ll be surprised if they’ll let a westerner like you in since all the traffic is going the opposite way. by referring to asia, you can include the philippines which has been an economic basketcase longer than ireland ever was. japan has had its banking crisis. if you like singapore’s economics, i suggest you try living there, you may find your civil liberties aren’t quite the same. see if the sultan of brunei can spare you a dime while you… Read more »
David
I think they are finally listening. Well done.
Ger
http://www.rte.ie/news/2008/0930/economy.html
So we are either in the biggest ever reality TV show ,…or are the civil servants starting to visit your site David ?….100% guarantee been announced this morning !…… Now start writing about developing a Nuclear Power industry please
@ Colin ,.. Sure the world isn’t perfect , but I don’t think Biffo would give me a few coins if I asked him either, I do live in hope though that this melt down in Wally Street , will wake us up I hope you have a good day and I hope all viewers here have a good day too. As George Bush once said ‘this internets is a big thing!, ( and man and fish can live together )
I think Colin was on to something there, we handled wealth terribly badly a bit like Indians been given whiskey for their homelands, we didn’t know what to do with it, partied hard now have a hangover with no roof over our heads . Make no mistake though, Fianna Fáil presided over this fiasco and worsened it by kow-towing to the CIF, Parlon and pals for the last 6/7 years. This has beggared a good many young couples who if they decide to stick it out will be left paying mortgages for years on over-priced property. It is conceivable now… Read more »
Well David they took the advice, and if not a good move the only sound one. However, what happens today if or in reality when (a foregone conclusion should think) the money gets pulled from hedge funds. Anyway the rejection of the bailout plan has got to be celebrated in the light of profit before people , (privatize profit, and socialize loss/risk,; government thinking they can just ride roughshod: threaten and intimidate. Anyway, on a lighter note. I love the quote from Allen Mendelowitz member and former chairman of the housing finance board, he said: “we are living in extraordinary… Read more »
Congradulations David.
As I have previously stated, I just hope the timing is right.
I’m watching Bloomberg at the moment and they are talking about Ireland showing political leadership. Who’d have thunk it?
David McWilliams …..we should have you as minister for Finance….it seems they end up doing what you recommend to get themselves out of a mess anyway….no prizes to anyone for naming the six most insolvent institutions in Ireland at this point in time….as Lenihan said….the banks have made mistakes……the health service makes mistakes too…..and they also get covered up…..
Gauranteeing the deposits is the only means of keeping the system solvent….expect to see other countries, especially those in Northern Europe who have the tax systems to support such a measure, follow suit….
Next phase needs to kick in quickly…stop the job haemorrhaging by improving the business climate here. Money needs to start flowing again – away from property.
Hi David, you got your wish with the state guarantee of all irish “owned” bank deposits, (400-500 billion seemingly) – however, this wont make one bit of difference. Its bad debts which are troubling banks, not runs on their deposits. The bad debts are driving down share valuations. Not runs on deposits. What is new however in the overnight announcement is that a new state guarantee “also covers all money borrowed by Irish banks from other financial institutions”. This is new. This hidden gem is a new move and I dont know how many other non-nationalised institutions around Europe have… Read more »
Wall Street will get their bail out. A few bridges to nowhere, and campaign finance “initiatives”, and they could get the compulsory wearing of armbands, and a new national salute, through the two houses. This bailout will only really help Wall Street’s most reckless, since it can do nothing about the effect on the broader economy of the massive deleveraging that is going on, and will have to continue going on. When you look at the details of what Wall Street has done, now they’re coming out, it is so outrageous, it is, quite honestly, hard to believe that it… Read more »
Can someone explain to me, does this guarantee to cover ALL deposits mean that people who have more than 100k on deposit are covered by the government or is this just for inter bank lending?
> Can someone explain to me, does this guarantee to cover ALL deposits mean that people who have more than 100k on deposit are covered by the government or is this just for inter bank lending?
Yes. ALl deposits are covered. It covers deposits over 100k. If you have 2 mill, 10 mill or whatever, you are covered.
—
“Can you kindly tell to me, who owns that head, upon that bed?”
“ah your drunk your drunk on liquidity and still you cannot see …..” :-)
The government is just copying everything David says lately. Makes a change after ignoring him for 5 years!!
Im actually very uncomfortable with the idea of the government being willing to guarantee all money borrowed by Irish banks from other financial institutions !!!!!
brendan, you’re right about nuclear power at least. time for david to write about building them next so that our government will implement it. one for carnsore point and one for malin head, two economic blackspots which did not benefit from the celtic tiger. get prof ed walsh out to thrash it out with the greens. he knows something about nuclear power and enterprise. as for your comment on biffo, he does give plenty of dimes away in the form of dole, children’s allowance, rent supplements, even dimes for bogus asylum seekers (some of which leave islamic countries with islamic… Read more »