Dublin Opinion

Today in the Irish Times we have two perspectives on the legislation being brought through the Dail last night to resolve the crisis in Irish banking, one by politicial correspondent Stephen Collins and the other by Morgan Kelly, Professor of Economics at UCD who has already written about the potential problems in Irish banking system due to excessive lending to property developers. Stephen Collin account is more of a descriptive piece rather than analysis, as it reports on the mood and the comments made by TDs during the debates in the Dail. However, the piece still contains implicit conclusions about the situation.

If the legislation works then people will never know the scale of the potential calamity that has been avoided by Brian Lenihan’s decisive intervention.

On Monday night he faced the stark choice of letting one Irish bank go down, with incalculable consequences for the entire banking industry, or implementing his guarantee scheme.

“People will never know”? Contrast this with Morgan Kelly’s opinion.

Not only does the Government guarantee of bank borrowing fail to solve the underlying problem of bad loans; it faces the Irish taxpayer with a real risk of enormous losses.

By insuring the borrowing of banks with toxic assets, the Government has taken up where the collapsed American insurer AIG left off. It was by guaranteeing to cover any losses to institutions that lent to client banks, what was called monoline insurance, that the world’s largest insurance company went bankrupt. The particular risk that the Government now faces is that Irish banks will package toxic loans as asset-backed securities and sell them off with a Government guarantee, passing on their losses to the Irish taxpayer.

So was this the only option open to Lenihan? We are told that banks would have started to collapse but we actually know nothing. Again, Morgan Kelly has a different opinion:

The Irish Government should have done what the Swedes did in 1991. The Swedish government stepped in and, in return for banks’ admitting the scale of their losses and firing the senior managers that had caused their problems, provided capital in return for a share of ownership.

As the Swedish economy recovered, the government was able to sell off its share in the banks, with the result that the Swedish taxpayer lost nothing on the bailout. In Finland, by contrast, the government denied that there was any problem until their banking system had collapsed and was then forced into a ruinously expensive bailout. The Government should have offered new capital to four of the institutions, and left the others, where the real problems lie, to fend for themselves.

Emphasis mine.

What Collins’ piece fails to mention, and what doesn’t seem to be appreciated in the Dail is that this legislation is hiding a considerable level of bad debt in the banking system and is avoiding the reason why that bad debt was allowed to accumulate in the first place.

Morgan Kelly again, highlighting what precipitated the crisis in the first place:

What precipitated the crisis on Monday was that foreign banks stopped lending to them. What we need to understand is what caused foreign banks to stop lending to Irish banks while they kept lending to most other banks in Europe. Once we understand the answer to this question we will understand how inept and potentially dangerous the Government’s attempted bailout really is.

The reason that foreign banks started to shun Irish banks is that international investors have gradually become aware of the scale and recklessness of Irish bank lending to builders and property speculators. Irish banks are currently owed €110 billion by builders and developers. Of every €100 that Irish residents have deposited in banks, €60 has been lent for property speculation.

There was another point made in Collin’s piece that I think is worth highlighting:

The furious reaction of the British authorities to the competitive implications of the measure cut little ice, although the mood in the Dáil certainly favoured the extension of the scheme to the two foreign-owned banks with a long history of involvement in the Irish market.

The UK Treasury, in denouncing the move said that at least they worked with the EU commission in the bail out of Branford and Bingley, while EU competition commissioner, pleaded with governments “not to act unilaterally“. At some point an EU fund might be put in place, but the Irish action avoids not only the liability falling to the banks or their shareholders, but it also allows them to continue to hide the bad debt and base their business on the false value of their assets. And that false value is what brought us to this situation in the first place. When it becomes known, however, people will surely know about the consequences of Brian Lenihan’s decision on Monday. After all, we’ll have to pay for it.