FOR some reason, the issue of debt forgiveness, which has been discussed for years, seems to be back on the table as if it is something new. It is not new. Debt forgiveness, debt write-offs, debt restructuring — whatever term you want to use — always happens after a credit-driven growth mirage. The reason is simple. In the boom, too much credit was given to people who had no prospect of paying the stuff back and now they can’t pay it back. So, as the saying goes, “can’t pay, won’t pay”.
In order to think about this, let us consider a person who still has a job, but who is in the generation that were unlucky enough to come into the housing market in the boom. We are talking broadly about people who were born in the mid-1970s to mid-1980s — 600,000 people.
If you are one of them and borrowed lots of money to buy a house in the years up to 2008, how are you going to pay it all back on the same terms? Now the house is worth possibly 50pc less than you paid and as there is no market, because the very banks that lent you the money are bust and have no new money to lend to anyone, so this 50pc drop might be simply notional and the actual drop may be higher.
Your wealth has been decimated and there is no prospect of it rising again in the next 10 years. Meanwhile, your income has fallen because taxes have not only risen but are due to rise again and again. Worse still, your taxes have risen to bail out the very banks that gave you the ludicrous loan in the first place.
Therefore, you have no wealth, just an enormous debt and interest rates are likely to rise rather than fall in the years ahead (according to the ECB). Your income has fallen and your taxes, direct and indirect have risen. The only way you can pay the mortgage is if you spend less on something else. So you stop buying things you used to buy.
But you are not alone. There are thousands of people in your position, buying less in order to pay off the mortgage, which is now enormous relative to the value of the house. Therefore, aggregate demand in the economy falls like a stone.
This obviously affects the rate at which the Government can raise revenue because if people are not spending, there is a taxation problem.
What does the State do when faced with this and the strict budget targets stipulated by the IMF/EU? It needs to raise taxes somewhere else or cut spending somewhere else. So it makes large cuts in spending, which again reduces total demand in the economy, making the demand problem even worse.
In normal economics, this all should be no problem. If some people spend less and save more because they spent too much in the past and saved too little, the money they now save will be used by other people who will borrow the saving to spend on new investment.
This smooth transfer of cash from one section of society to the next presupposes that the banking system is functioning. But in Ireland, it is not.
The banks are now largely safe-deposit boxes for the ECB. This gradual disappearance of money from the system is called “deleveraging”.
The banks, having blown the balance sheet of the country by their recklessness, are no longer trusted by anybody.
But now something odd that might be called “the law of unintended consequences” occurs. In order to make sure that they don’t go mad again, the new regulator raises the amount of capital the banks need to discipline them. The banks now have to keep much more capital on their books. All the while, the banks have also to pay back the money they lent because Irish bankers ran out of our savings in 2005 and started to borrow to keep their bonuses.
Now we have come full circle; whereas we had too little regulation in the boom, we might have too much now.
Clearly, it is human nature for the regulator to demand higher standards from the banks, but at this stage in the cycle — with people saving not spending — tighter regulation makes the overall situation worse. This process of much tighter regulation reduces the banks’ willingness to lend.
There is an added reason why, arguably, generally tighter regulation at this stage in the cycle could be a retrograde step.
If the regulation is seen as too tight because the old banks screwed up, this very regulation may repel new banks from coming into the game. What Ireland needs now is not a few equity investors in Bank of Ireland, it needs a new balance sheet, new capital and a new source of financing. This can only come from fresh capital, which can only come from a new bank or banks. But if there is too much regulation, these new banks might stay away.
ANOTHER aspect of the deleveraging process is that the old banks hold on to deposits like they are gold. Deposits are the cheapest and most stable form of capital a bank has and so now they are king. All our banks need to attract more deposits. This leads to a deposit war as they push up deposit rates to get cash. Ultimately, they don’t lend.
All the above basic economics means that the “normal” laws of economics don’t apply in Ireland. The banking bottleneck is preventing saving being recycled. Therefore, the more the generation who got shafted in the boom pay back their mortgages — despite their balance sheet being decimated — the less money they have to spend on something else and the more the tax base shrinks. If the money they save gets stuck in the banks and doesn’t find its way to people who would like to use this money profitably, the economy will shrink more.
Thus, coming back to debt forgiveness, restructuring or whatever you are having yourself, the arguments are less to do with morality, moral hazard or bailing out the profligate and more to do with how demand and employment are generated.
For many these issues are contentious and some might say, why should this generation get special treatment? But bear in mind that big policy changes always have a generational aspect to them because of the way wealth is created and at what stage in life it is created. For example, the generation older than me received a massive once-off transfer of wealth when we joined the euro. They had saved in the old, soft currency, the punt, which was a “serial devaluer”, yet, as if by magic, they got all those savings in a “weak” currency redenominated in the “hard” euro currency. Did we hear much from them about the “fairness” of this once-off windfall?
Debt restructuring is going to happen; it is just a matter of when — not because it is right or wrong, but because that’s how the economy works.