Opinion

Felix Salmon

Why Ireland is bailing out foreign banks

By Felix Salmon
September 27, 2010

Robert Peston has a theory for why Ireland can’t bail in the sophisticated institutions which lent untold billions to the country’s beleaguered banks:

Take a look at the latest figures from the central bankers’ bank, the Bank for International Settlements, on just the exposure of overseas banks to Ireland (in other words, credit provided by pension funds, hedge funds and wealthy individuals would be on top of this).

Total foreign bank exposure to Ireland’s economy is $844bn, or five times the value of Ireland’s GDP or economic output. Of that, German and UK banks are Ireland’s biggest creditors, with €206bn and €224bn of exposure respectively.

To put it another way, German and British banks on their own have each extended credit to Ireland greater than Irish GDP. Which doesn’t sound altogether prudent, does it?

As for direct bank-to-bank lending, overseas banks have provided Ireland’s banks with €169bn of loans, which is also greater than Irish GDP.

Here’s the point: an economy as open and as dependent on foreign finance as Ireland’s cannot afford to alienate its creditors. If those overseas lenders asked for their money back now, Ireland’s recent fall back into a modest economic contraction could spiral into dark deep prolonged recession or even depression.

The implicit assumption here is that if the Irish government took away its backstop of Irish banks’ debts, there would be a mad dash for the exits, all of the banks’ creditors would refuse, overnight, to roll over any of their debts and the resultant liquidity crisis would make the Lehman collapse look positively modest.

It’s like there’s a whole new level to the famous adage: if you owe the bank $10 million, then you have a problem. If you owe the bank $10 billion, then the bank has a problem. But if you owe the banks $844 billion, then now the problem is back on you again, since at any time the banks can turn you into Iceland overnight.

I think the fear here is a very realistic one. In an ideal world, of course, the banks would understand the need for burdens to be shared and would also understand that staying invested in a healthy Ireland, even with a modest haircut on their original investment, is a much better outcome for all concerned than a mad panic and sovereign default with the debt of Irish banks falling in value to pennies on the dollar.

But we don’t live in an ideal world and the collective-action problems here are all but insurmountable: at the first whiff of a haircut, everybody’s going to want to be the first to bail out entirely. Ireland’s technocratic elite seems to understand that and so it’s unhappily bailing out its foreign lenders at 100 cents on the euro, even the government continues to slash spending domestically. It’s not fair, everybody knows that. But it might be unavoidable.

Comments
3 comments so far | RSS Comments RSS

Where is Ireland getting the money to bail out those foreign lenders? In US it is future taxpayers. Will this actually work out in a world of rising population and increased energy prices?

We have tried extend and pretend since about 1998 (or 1976) and it hasn’t been working out.

Posted by walt9316 | Report as abusive
 

It’s ok in the medium term, I guess; those of us able to make an easy living elsewhere just leave the country, and wonder why the pitchforks aren’t out on the streets from afar. Sucks for the people left behind, though.

Posted by BarryKelly | Report as abusive
 

An old joke, with a new ending.

Q. What’s the richest country in the world?
A. Ireland.
Q. Why?
A. Because its capital is dublin’ every day!
Q. So’s its debt.

Posted by Christofurio | Report as abusive
 

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