The government has spent more than it can afford on Anglo, a bank of no value, so when a proper bank comes begging, there will be nothing left to give

Writing on a bus can always be a bit tricky, particularly on a dodgy stretch of road outside Charleville. But, bumps apart, the 12.30 Citylink bus from Galway to Cork is making good time, and the fact that all these buses have free wi-fi means it’s far preferable to the hassle of driving.

Traffic doesn’t faze you and you end up chatting to neighbours and watching the beautiful countryside – unfortunately blighted by ghost estates – as it flies by outside on a beautiful late summer’s day.

The bus is jammed, mainly with students. These people are the future of our country. I couldn’t help wondering, as I listened to the news about the latest losses in Anglo Irish Bank – another €8.2 billion racked up in the first six months of this year alone —what would happen to this bus service if we applied the basic rules of capitalism to Anglo. Would the Galway-to-Cork bus service stop if we called the creditors of Anglo into a room and said: ‘‘Sorry, we cannot pay you for your mistakes’’?

Would a repudiation of Anglo’s debts make a jot of difference to the day-to-day reality of life in our country? If the answer is no, then the right course of action would be to do an adult deal with the creditors. And what if closing down Anglo now and forcing the creditors to take whatever a liquidator instructs would actually make life better here?

What if forcing the bondholders of Anglo to become shareholders in Alan Dukes’ new business bank signalled the beginning of the end of Ireland’s banking crisis?

The government’s current stance is that Anglo and the Irish state are one and the same thing. By extension, defaulting on the bondholders would be tantamount to a default on Irish sovereign debt. This is what is terrifying the markets. The signal from them is clearly that we should go in the opposite direction: cut Anglo off from the state and let it go. Yes, this change of policy will demand difficult negotiations with everyone, including the European Central Bank (ECB), but that is what being grown up is all about.

Jean-Claude Trichet, governor of the ECB, is also wrong when he says that Anglo is an Irish problem- and he knows this. He is bluffing. Anglo and the rest of the Irish banks borrowed from other European banks, so the counterparties of all these trades are banks on Trichet’s watch.

The problem for Trichet is that his ‘‘you are on your own’’ stance – which might sound tough – is actually very childish from a serious central banker, as it brings the prospect of a sovereign debt crisis closer. By suggesting that Anglo and Ireland are the same legal entity – which they clearly are not – the state is contaminating itself.

The amazing thing about the government’s stance is that it is prepared to risk the financing of the entire country for the sake of this notion.

Quite apart from the Anglo fiasco, there is the little problem of AIB. Paying full whack for Anglo might mean that the state will have no money left for AIB, when AIB comes looking for cash in a few months.

Think about what is now happening in the country Figures published last week by the Financial Regulator show some pretty stark realities in the mortgage market. In the second quarter, 4,117 more mortgages fell into arrears, bringing the total number to 36,438.By value, e 7 billion-worth of mortgages are now in arrears. This is 5.9 per cent of the total outstanding mortgage debt in the country.

The banks have no way of recovering this money. The entirely political decision not to allow banks to foreclose on delinquent mortgage holders means the banks have no way of recovering their losses. Their only hope is that the delinquent borrowers will sort out their finances (presumably by getting a new, well-paid job) and be able to pay their arrears. With unemployment up again this month, we can discount that idea.

Thus, the banks will have to raise more capital to cover their mounting losses. But, hang on: they already need to raise more capital to pay for the writedowns on their Nama-bound loans. AIB is still going on about raising €7.4 billion by December by selling some overseas assets. It is now September and, while talks are being held with some interested parties, nothing has yet been concluded. If it hasn’t managed to get the money together by the regulator’s cut-off date in December, it will most likely have to turn to the government for funds.

But AIB (or any other bank that comes knocking for more capital) could be in for a shock. The cupboard may well be bare by December – all available funds having been written off in Anglo.

If it doesn’t happen in December, it may be next March or next June or whenever. But it will happen because, as long as unemployment is high, mortgage delinquency will continue to rise; and as long as delinquency continues to rise, the banks will continue to need more capital.

Add to this the fall in savings, as people use their nest eggs to survive the recession (household savings are down €2.5 billion since January) and the banks will also be coming under pressure on the funding side.

Adding to the problems is the likelihood of the ECB rolling back on its generous liquidity operations in 2011.And, as if things weren’t bad enough, there are also going to be rises in ECB interest rates at some stage. Last week the ECB raised its growth forecasts for the EU, a precursor to a rate rise if there ever was one (remember, the ECB looks at Germany, not Ireland, when setting rates).

For the bankers, the next couple of years are going to very difficult, and it is the exchequer that has promised to help them through it. That is the same exchequer that spent €12.1 billion more than it earned in the eight months to the end of August this year, an overspend of €1.5 billion per month. Where is the room in that account for further bailouts for the banks? The answer is simple. There isn’t any.

The government might be faced with the choice between Anglo or AIB before a full-blown debt crisis. One bank is a black hole and of no value at all. AIB, in contrast, is systemically important.

I can guarantee some of the students on this bus have accounts with AIB. If the government is prepared to risk AIB for Anglo, the lunatics are clearly on the loose and running the asylum.

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