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Ireland’s “Black Thursday” – cost of financial bailout rises to €50 billion
6 October 2010
Last week’s announcement by finance minister Brian Lenihan, estimating the final cost of the financial bailout, was the latest attempt by the Irish Government to assuage market fears over the size of liabilities it has taken on and the capacity of the state to bear them. Increasing bank losses and the accompanying increase in state borrowing required to fund their rescue has raised serious doubts over Ireland’s solvency. Such doubts have grown significantly in the wake of the record looses posted by Anglo Irish, and are reflected in the increasing borrowing costs for the Irish state. By putting a final figure on cost the bailout Lenihan hopes to convince the markets that Ireland’s financial crisis is manageable.
The Irish Government and the Central Bank now estimate that the cost of the financial bailout to the state will be €45 billion. This could rise as high as €50 billion in a worst-case scenario in which bank losses continue and the property market fails to recover. The biggest element of the bailout is the mounting cost of the nationalised Anglo Irish Bank. This is now estimated to be €29.3 billion, but could go as high as €34.3 billion if there is no recovery in the property market. The cost of Anglo Irish has risen to this level from €1.5 billion in December 2008 to €22 billion last March and €25 billion in August. It is equivalent to a staggering 21 per cent of Irish GDP, more than the entire bill for sorting the Japanese banking crisis of 1997 and almost twice the cost of the Finnish crisis in the early 1990s. While the costs associated with Anglo Irish are the biggest component of the bailout, it is not the only institution that requires further state support. The cost of recapitalising Irish Nationwide Building Society (INBS) has doubled to €5.4 billion. Ireland's second biggest bank, Allied Irish Banks, is to be effectively nationalised, with the National Pension Reserve Fund injecting up to €7.2bn and the state taking control of 80 per cent of its shares.
The Government had hoped to keep this year’s budget deficit to around 12 per cent of GDP. But the extra cost of fresh capital for Anglo and INBS will raise that to 32 per cent of GDP, increasing public debt to 98.6 per cent of GDP. It is estimated that Ireland’s total debt may exceed 115 per cent of GDP before it stabilises. Such a figure would require the state to find around €10bn a year to cover the interest on the national debt. If you add together all the capital provided to Ireland's banks by various arms of the state, support to those banks in the form of capital injections is around 30 per cent of GDP. A further 25 per cent of GDP can be added to this if the costs of NAMA (which through a technicality are off balance sheet) are included. Overall, more than half of Ireland’s GDP has been devoted to keeping its banks afloat.
The increasing cost of the financail bailout has been reflected in the rising costs of borrowing for the Irish state. At the end of September the yield on its ten-year government bonds neared 7 per cent, a record spread of 4.7 points above those of Germany. Such high interest rates, combined with an increasing level of overall indebtedness, are unsustainable. This has raised the prospect of Ireland being forced to borrow from the European Financial Stability Facility (EFSF), the €440 billion fund established in June for struggling euro-zone countries. Such a move would significantly enhance the role of the EU in the running of Ireland’s economy. This would not be a sudden shift, but rather the culmination of a process that has continued throughout the period of the financial crisis. The EU’s support has been vital to the efforts of the Irish Government to bailout its banks. This was clearly the case in the establishment of NAMA, the nationalisation of Anglo Irish and the various rounds of re-capitalisation. All these initiatives, as do the latest proposals from Irish Government, have required the endorsement of the EU. There is also a political aspect to such support. It was highlighted in the wake the Black Thursday announcement when Olli Rehn, the European commissioner for economic and monetary affairs, suggested higher taxes were a likely part of the solution. This was taken as a reference to Ireland’s low corporation tax, and an indication that the EU would no longer tolerate this competitive advantage the Irish state holds over other members.
Will it work?
The claims for the Black Thursday announcement are that it will resolve the banking crisis, reassure the markets, reduce the cost of state borrowing and provide a basis for economic recovery. However, the same claims were made for all the other once and for all solutions announced over the past two years, from the liabilities guarantee and the nationalisation of Anglo Irish to the establishment of NAMA and recapitalisation. Today the guarantee should, according to the original plan, have lapsed with the banks in a position to operate without sate support. Yet two years on the Irish banking system is still chronically weak, and the guarantee, which has turned out to be the most expensive element of the financial bailout, is still in place.
The Irish Government may have put an estimate on the final cost of the bailout, but is no reason to believe that this will turn out to be accurate. The previous estimates, which started as low as €4bn, massively underestimated the cost. The current €50bn figure while large, and supposedly allowing for a lot of “headroom”, could also fall short of the eventual total. Its calculation rests upon a number of assumptions that are uncertain. Firstly, there is the definition of what constitutes a worst-case scenario. The Government says this would be a fall in commercial property prices by 65 per cent with no subsequent increase this decade. Yet this point has already been reached - the discount on the latest tranche of loans being transferred to NAMA is 67 per cent. As the value of the assets on which the bank loans are based have fallen by more than 65 per cent, future losses of the banks will be greater than expected.
The worst case scenario also assumes there will be no further shocks to the banking system. This ignores the fact that Irish banks have consistently failed to disclose the true extent of their debts. Also, by concentrating on the problems arising out of commercial property loans, it ignores other problems faced by the banks. One of these is the growing problem around mortgage arrears. Recent data from the Central Bank shows that of the €118bn in mortgages outstanding, €6.95bn are more than 90 days in arrears, with €4.8bn of those more than six months behind. The continuing contraction of the economy and accompanying rise in unemployment will see the number of mortgages in arrears increase. While actual defaults may have been at a lower level than expected through this financial crisis, delays in payment still mean a loss of revenue for the banks. A rise in arrears and eventual defaults will add to the losses of the banks and thereby the costs of state support.
Secondly, the conditions in the financial markets are likely to remain tough for Ireland. The Irish government currently pays an interest rate on 10-year bonds of well over 6 per cent. Factoring in the affects of deflation in the Irish economy, of stagnating prices, falling wages and dramatic falls in asset prices, suggest a greater “real” debt and long term interest rates that are approaching double-digits. Having the European Financial Stability Facility as a lender of last resort is not going to help with this. The EFSF may offer finance when others do not, but the rates will not be any more favourable than current market rates
Thirdly, and most importantly, the estimates for growth in the Irish economy, on which so much else rests, continue to be over optimistic. They underestimate the effects of the financial crisis on growth. History shows that it takes a long time for economies to return to “normal” after a big financial crisis. Given that the crisis in Ireland has been one of the biggest ever recorded, a more likely scenario, than the rapid recovery projected by the Irish Government, would be a prolonged period of stagnation. This would see mass emigration, further falls in property prices, a fall in tax revenues, more public spending cuts and more problems in the banking sector. Even if such a worst case scenario isn’t realised Ireland will still face difficulties. These stem from its ability to manage its huge national debt. In the best case scenario, on which the Government’s calculations are based, the economy grows at 4 per cent a year and debt costs don’t rise above 5 per cent. This would allow for a stabilisation of the state’s debt to GDP ratio at around 120 per cent of GDP by 2015. If growth were 3 per cent, or average borrowing 6 per cent then debt stabilises at 125 per cent of GDP. Marginal changes to the rate of growth and/or the cost of borrowing can make a significance difference to the state’s overall level of indebtedness. With the Irish economy continuing to contract and borrowing costs running at 6.4 per cent, the state’s debt to GDP ratio is likely to be significantly higher than that produced in the two examples above. Unless, either of these measurements improves debt will grow at rate and to a level where a default will be unavoidable. Ireland is a vicious cycle of economic contraction, banking losses, falling tax revenues and increasing indebtedness that is taking the state towards bankruptcy.
One of the most significant aspects of the “Black Thursday” announcement was the muted reaction of opposition parties. Beyond the usual rhetoric about Fianna Fail incompetence, there was no indication that they would do anything differently. There is no sense of urgency to replace the current government any time soon, at least until the next budget has been passed. It has been suggested that the opposition parties are happy for the Government to continue with its austerity programme, so as many unpopular measures as possible are in place before they come to office. Labour’s Pat Rabbitte has indicated that it would stick with any long-term budget plan that had been endorsed by the EU. Agreeing in substance with the course set by the current Government all he could offer was to “tweak things here and there”. The unanimity across the political parties is revealed in the boast by the governor of the central bank, Patrick Honohan, that Ireland could manage its financial crisis because “there’s a political elite determined to manage it”. This elite also includes the trade union leaderships. They have played a major role in support of the financial bailout and imposing the measures designed to make Irish workers pay for it. Their response to the “Black Thursday” announcement didn’t even rise to the level of empty rhetoric. After their litany of betrayals all that is left is a shameful silence.
The consequences of “Black Thursday” will be an intensification of the austerity drive. The plan for a minimum of €3bn worth of cuts in the upcoming budget has been revised upwards. It is expected that there will be cuts of up to €4.5bn in December’s budget and total "adjustments" in excess of €10bn over the next four years. These are to be achieved through a combination of spending cuts and tax rises. Options being considered include the introduction of a property tax and water charges; a further cut in public sector pay through redundancies and reductions in pensions; further cuts in capital projects and the scraping of key infrastructure projects such as the Dublin Metro; the widening of the tax net to include many lower paid workers; restrictions on tax credits to the over 65s; and further cuts in the social welfare budget. We already know there will be cuts of €1bn-plus in health and education for 2011 alone. There is also speculation that the Croke Park agreement on maintaining the wage rates of public sector workers will be reneged on. Only last year union leaders were hailing the trade off between working conditions and wage rates as a success, now even this rotten deal can’t hold.
The Black Thursday announcement is no more
likely to be a final resolution of the banking crisis than all the previous
once and for all solutions advanced over the past two years.
The reality is that cost of the financial bailout and the price that workers
must pay for it is rising and will continue to rise. That will
not end with a change of Government or the intervention of the EU.
All these forces agree that banks and their bondholders must be saved,
and that the Irish people must be bled white if necessary to achieve this.
The only way this will be brought to a halt and the bleeding staunched
is when those forces pushing it are met with the countervailing force of
working class resistance. As time progresses, and the crisis
deepens, the task of socialist and trade union activists to help build
such a resistance becomes ever more urgent.
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