Ireland is Bankrupt. Now Let’s Get Over It

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Goodbody Stockbrokers is predicting a decline in GDP this year of 6% unsettling public finances. Irish Nationwide has been downgraded by Moody’s to one notch above junk. Ireland is bankrupt. More specifically, its financial institutions are bankrupt, its government is bankrupt and, unfortunately, many of its businesses and citizens are bankrupt. But this is not as bad as it sounds. The admission of bankruptcy is the precondition of taking the necessary action which will help the country cope with the continuing economic crisis.

Let’s stop beating around the bush. Let’s look first at the banks. Ireland’s financial institutions are essentially insolvent. They may well be bankrupt right now. If they are not, they will be in several months time. Nobody who counts believes otherwise. This is most graphically evidenced by the fall in their share values to literally pennies. This raises three important questions. When will they go down? Who will take the hit? And what will replace them? The answers to all of these questions are in the grasp of the government. It must resolve to answer them and sooner rather than later.

When will they go down? They need to go down now. Government policy to date has consisted of indecisiveness masquerading as caution and elevated to the level of strategy. The Minister is hoping to muddle through. He is planning to extend the banks just enough government help to keep them going. This was first in the form of guaranteeing their deposits and their debts. Last week a minimal amount of capital was injected into the banks. The first of these options prevented a run on the banks but does nothing to resolve the problem of toxic assets and reluctant lending. Guaranteeing new debts taken on by the banks simply exposes the taxpayer to possible future losses. The promise of guarantees to new bond buyers should be rescinded immediately. Injecting capital may keep the banks alive for a little while longer but it buys the government a stake in a fundamentally dodgy enterprise. It also incentivises the bank managers to buy back the government shares instead of lending. This is to escape the required dividend payments and government oversight of their pay rates, bonuses, and continued employment.

Who will take the hit? Sadly the options so far pursued by the government put the ordinary taxpayer in the crosshairs. Other options under discussion will only make the problem worse. Providing the banks with public insurance against losses is obviously in this category. So too is the much discussed creation of a “bad bank” which will buy the toxic assets of the rest of the banking system. There was even talk by some commentators of using the now nationalised Anglo-Irish bank for this purpose – as if it wasn’t bad enough already.  This option basically visits the past sins of the bankers on the general public. Interestingly, however, it is based on the principle that the only way to get things moving again is to purge the institutions of bad debt. This principle is correct and such a purge is one of the historic functions of economic downturns. Writing down debt allows individuals, businesses and the economy to start over again. The “bad bank” proposal seeks to create a “good” private bank by segregating the bad debt in a public financial institution. But wait a minute. Why not do it the other way around?

What should replace the current banks? We urgently need to create a publicly owned and operated “good bank” similar to that proposed by the Financial Times columnist and academic Willem Buiter. This institution (or institutions if some competition is deemed advisable) would assume the deposits of the existing banks.  These are already guaranteed by the government in any case. The government would then purchase the good assets of the existing banks for the new good bank. Buying good assets has the advantage of paying a price set in the markets. Assets whose ultimate worth is uncertain and hence hard to price would be left with what are now legacy bad banks. The legacy bad banks would still be owned by their shareholders and would owe obligations to their bondholders. These groups would then assume the risk they contracted for in the first place. The legacy bad banks would be prohibited from accepting new deposits but would have the cash from the sale of their good assets as operating capital. One really attractive aspect of this proposal is that the existing management could be left to manage the remaining assets. If these guys (and gals) are as clever as their bonuses indicate perhaps they can dig the legacy banks out. But if not, there’s always the bankruptcy court with the owners, lenders and managers squarely in the gun sights where they belong. With the bankruptcy of the legacy bad banks, the financial system will be in the hands of the government’s good banks. The public will have dodged the bullet.

This is not necessarily a radical proposal. If you are conservative, the new banks can be privatised after a few years, perhaps at a profit for the state. If you’re a social democrat, the new banks can be kept in public hands and run like utilities providing the basic credit infrastructure of the private economy. If you’re a little more radical, the new banks can become the centre of a popular development strategy to cope with extended bad times. This may well be needed as the current downturn is one of the big ones like the Great Depression of the 30’s and the Great Stagflation of the 70’s and early 80’s. For this reason, the government’s Mr. Micawber strategy, muddling through until something turns up, cannot work with the country’s financial system.

Mr. Micawber won’t work with the public finances, either, which brings us to the second big bankrupt, the state. The state has not yet been forced to go cap in hand to the IMF, but to forestall this possibility, it has already defaulted on its previously agreed obligations to public employees. Dressing up a pay cut as a “pension levy” does not change the fact that the government judged itself unable to financially meet its commitments. Whatever about defaulting on its employees, a formal default on the government debt would be disastrous. The only option is to restore balance to the public finances. Some cuts are possible (all the junior ministers, the entire armed forces, and the Senate come to mind) but it was not overspending that brought us to this pass. It was an unsustainable tax structure based on unfairly taxing buyers in the property markets.

Incredibly the government’s response so far has contained no tax element. It is hoping for a recovery before it has to make this hard decision. This won’t happen. New tax revenue must be found immediately. Income tax must be raised across the middle and top of the income distribution with more than one additional tax band. All tax allowances must be placed on a short death watch unless specifically exempted by new legislation. Taxes on property or “rates” have been proposed. If it is right and proper to tax the kind of property an ordinary person might own, their residence, what’s wrong with taxing property across the board? Wealth is much more unevenly distributed than income. It can be moderately and progressively taxed on a yearly basis and more heavily taxed when inherited.

This brings us to the small bankrupts, businesses and individuals. Here our proposed bank reform can help. Good public banks can bridge cash flow problems for solvent businesses by resuming lending, preventing unnecessary bankruptcies. On the other hand, the legacy bad banks can stop pretending to be solvent by pretending their bad loans may still be collectable. Bankrupt business assets can be sold to solvent businesses at attractive prices. Bankrupt entrepreneurs can start over cleansed of debt. Family homes should be protected, but unpayable private debt should be written down in bankruptcy proceedings. Bankrupt individuals may be denied their credit cards, but they can stop paying interest and start buying products and services again.

The old model worked for a while. The Celtic Tiger period brought an increase in Irish prosperity which may not be fully lost in the current downturn. But it created a highly unequal society addicted to unsustainably low taxes, an unsustainable property bubble, and unsustainable debt. This model has come crashing down as we secretly knew it must. The old model cannot be reconstructed, but the crisis may bring the opportunity for the creation of a more sustainable alternative. Another Ireland is possible. We must stop dithering, act decisively and act now.

Terrence McDonough is professor of economics at the National University of Ireland, Galway.

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Terrence McDonough is Professor of Economic in National University of Ireland, Galway.
 

10 Responses

  1. Blueswannabe

    February 22, 2009 10:41 am

    Just wondering but where would the capital for this ‘good bank’ come from? Would the government have to raise/borrow it or could it be legislated under part of the guarantee scheme? Sorry if the answer is blatantly obvious, an economist I am not.

  2. Terry McDonough

    February 22, 2009 12:11 pm

    New Lending would come from new deposits, borrowed money where appropriate and new capitalization by the government. It looks more and more like most of the new lending (if any happens at all) from the existing banks will come from government recapitalization.

  3. Graham Stull

    February 23, 2009 8:03 am

    Excellent article on ‘good banking’ solution for Ireland. The current bank guarantee has to be repealed before any constructive solution to the banking problem can be found, but I think you make this point already.

    On taxing non-real estate wealth, I am much more sceptical. I question it on efficiency and equity grounds – The very rich get off tax free leaving the middle classes to bear the brunt of such taxes.

    Tax on land property, however, cannot be easily evaded. It can be easily made progressive and best of all, it ensures land is brought to its highest and best use. Finally, it is a natural source of funding for local governments (in most countries) and could help ease Central Govt funding requires to local authorities, while forming a cornerstone of LG reform.

  4. mario mangano

    February 27, 2009 6:02 am

    what’s new, Eire has been operating like a banana republic for years, ex PM Bertie Ahern shot thru with a suitcase full of cash couple years ago and as my Irish cousin said, it used to be jus t brown envelopes!!!

  5. Conor McCabe

    February 27, 2009 8:50 am

    Ireland’s not a banana republic. Just a modern capitalist economy where there’s little checks and balances. This aint about personalities. The problem is structural.

  6. Joe Blog

    March 7, 2009 1:28 pm

    It had to happen. The Irish economy and goverment is made up of crooks, the Irish PM is earning more than the US president. Would he not consider taking a salary the same as UK leaders?, Every single goverment minsiter earns more than 100 professional people. what gives them right to take from the rest of the tax payers. The Tax payers are their employers, so why do you let them pay themselves what they like and pay you peanuts, as you to take cuts. As Always The top welthy people of Irealnd, the ones that have made a hash of running the country are paid the most and therefor suffer the least. They have been disempowering everyone who resides there It began with Charlie Haughey, and has resinated through. Brian Cowen couldnt give a F**** about you, your families, your lives, as long as you keep him in governament do a major clean out get teachers, bussiness men, nurses, etc to run your country and get rid of the crooks once and for all.

  7. Mark Donnelly

    May 5, 2009 12:50 pm

    I think Ireland has huge natural potential. Our surrounding ocean and agriculture. We need the goverment to give a boost to our ability to harness our natural resources. We could produce cheaper food and make it available instead of dishing out all our welfare in cash. We could generate cheaper electricity and sell it on the international grid. Most of the government are bullshit artists ,people who have some balls and were lucky enough to get some public speaking experience. They also inherited the right to be politicans because their Daddys and Mammys were in the Dail. The future of everyones family is in the hands of these people.I would not trust 75% of these people.i think a change is on the way but it maybe hampered by the old I vote Fainna Fail because me Granddad did.By the way I think John McGuinness is great.Its nice to see someone speaking their mind.I would vote for him even though he is Fianna Fail.

  8. Conor McCabe

    May 5, 2009 7:23 pm

    Mark, you’re about forty years too late when it comes to Ireland’s natural resources. Most of Ireland’s natural resources were sold off for a pittance from the 1960s onwards by Fianna Fáil at huge personal gain for its leaders. Our oil and gas fields ditto in the 1970s, while now you have a situation whereby the EU gives over €2 billion to Irish food producers to produce dearer food. And where’s the link between cheaper food production and Ireland’s social net?

  9. jack o connell

    May 28, 2009 11:07 pm

    I believe that if we got rid of all de paedophile priests and Fine Failers we would have a better country all round. Ye have no idea what a bunch of idiots is running the country. runnin it into the ground is what there doing.I use to vote fine Fail but I have given up almost.i dont think i will vote in the next election i am not votin Fine Fail but i will be damned if I am votin for anyone else eider.
    all me family have voted for the Failers even though they never accepted the mandate of the people in 1921.

  10. Sue Blogg

    February 5, 2010 2:36 am

    What a mess this country has found itself. Yes we all have taken paycuts which will make us all have to stop spending and live life on the breadline or thereabouts…..but what about the polititions?? Where’s their paycut that will make them wonder where their next pay cheque is coming. All B Cowen is doing is slashing jobs and putting more people on the dole with no production from these people. He’d rather pay people to sit in their home-if they still have one, than have them go out and do a days work. Then the gov have to pay allowances for their homes so how much does this all add up to? Its the children and the sick who are losing out. I am so fed up that there are no normal people able to sit down with the Gov and show them where the money is going….that would be one step. Some people are being forced to work cash in hand while claiming the dole….no tax coming in but gov money going out…..there is soooo much wrong doing going on…why can something serious not be done about it????