Learning from Ireland

By Felix Salmon
November 10, 2010
the collapse of Ireland's banking system, and with it the country's fiscal leadership.

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I love the way that the WSJ today covers the collapse of Ireland’s banking system, and with it the country’s fiscal leadership. There’s little if any actual news here, but that’s a feature, not a bug: it frees up the WSJ‘s writers and editors to present the big-picture narrative in as clear and compelling a manner as possible, without having to overemphasize some small factoid which they happen to be breaking.

The story reads like one of those epic lyric tragedies of old, where no one ever learns from their mistakes, and errors simply compound endlessly. First, the Irish government, convinced that the country’s banks were suffering from a liquidity crisis rather than a banking crisis, decided to solve that problem in the way that only a government can — with a blanket guarantee of substantially all of the banks’ liabilities.

But of course the banks were fundamentally insolvent, and so began a series of cash drains on the government, each one meant to be the last and final. First there was €1.5 billion for Anglo, and €2 billion each for Bank of Ireland and Allied Irish. Then there was another €7 billion for Allied Irish and Bank of Ireland. Then Anglo’s losses reached €20 billion, with another €48 billion “at risk” of default. And where are we now?

The total capital injected into banks by the government so far: €34 billion, with at least another €12 billion on the way. The bailouts mean Ireland will run a government deficit equal to 32% of its gross domestic product, the highest figure ever in any euro-zone country. Skeptics say a still-sinking property market will next sour residential mortgages, inflating the government tab even more.

Yes, this inconceivably enormous bailout tab—32% of GDP would correspond to an annual deficit of $4.7 trillion here in the U.S., or something over $40,000 per household—has been run up on commercial real-estate losses alone. If and when Ireland’s residential mortgages start defaulting, the country is surely toast.

Bankers, auditors, regulators, politicians—all of them made the same mistake, in Ireland, which was to believe the numbers they were being shown. Numbers are like that: once they’re printed and ratified, they become perceived as hard facts, in the way that merely verbal statements never are. If a politician says “our banks are solvent,” that’s a contentious statement; if PricewaterhouseCoopers comes out with a massively overoptimistic take on the strength of Anglo’s loan book, backing up an official-looking report with lots of numbers and institutional authority, people simply believe them implicitly.

One of the authors of the article, Charles Forelle, has a great accompanying blog entry in which he explains that Ireland’s crisis came out of the blue: it wasn’t a slow-moving train wreck like Portugal. And even with hindsight, it would have been incredibly hard for either the Irish government or the European Union to prevent the build-up of bad loans.

That blanket guarantee of banks’ liabilities, of course, was entirely preventable, and in hindsight a very bad idea. While the banks’ smaller depositors deserve to remain whole, their other lenders should have taken much larger haircuts by now. Instead, they’ve been bailed out by Irish taxpayers, which doesn’t seem fair at all. The Irish government is sovereign, of course: it could always unwind that guarantee if it wanted to. But at this point, it’s too late to do that, since unwinding the guarantee would immediately precipitate a massive run for the exits and a monster sovereign collapse.

One of the key lessons we’ve learned in this crisis is that any time a small country takes pride in its large and profitable international banks, everything is liable to end in tears. Big banks are too big to fail, which means their national governments have to bail them out—but when the banks are as big or bigger than the government in question, such a bailout becomes politically and economically disastrous. My feeling is that no government should ever allow its banks to become too big to bail out, because no government can credibly promise not to bail out such banks should they run into difficulties.

If you look down the Financial Stability Board’s list of the top 30 systemically-important financial institutions, there are definitely a few on there which look like they’re too big for a national bailout. The two big Swiss banks certainly are, and possibly the two big Spanish banks, too; then there’s six insurers as well. I have no idea what can be done about this: no one’s going to blunder in and force UBS and Credit Suisse to break themselves up just because they happen to be based in a small Alpine nation. But the lessons of Iceland and Ireland should wear heavily on any government with an oversized financial sector.


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Clearly the banks should default and restructure. That wealthy creditors should not be hit for their foolish lending as a nation fails is unconscionable.

Banks have failed since the dawn of time. It won’t be the end of the world.

Posted by DanHess | Report as abusive

It’s remarkable how these banking problems, in so many countries, have their roots in real estate. Even now, supposedly intelligent people, with degrees no less, are still convinced that real estate is a can’t-lose investment. What was that line about real estate? ‘They’re not making any more of it’? Yeah, right.

Posted by Gotthardbahn | Report as abusive

One possible alternative: national regulators in country A could refuse to allow banks from country B to operate in country A if country B does not have sufficient resources to back their banks.

So the US would then refuse to allow UBS to operate in the US because it’s clear that Switzerland can’t back UBS in the event that UBS hits the skids.

Perhaps there could be provision for UBS to purchase insurance/guarantees from entities in other, larger countries. Or, perhaps, the solution would be that UBS would simply decamp to another, larger, country — or UBS would have to split, with the “dangerous” parts of its business moving to a bigger country, leaving the asset-management and other bits behind in Switzerland.

Posted by enplaned | Report as abusive

Felix’s last paragraph about financial institutions which are potentially too big for a national bailout is important, but focuses attention on the wrong level of organization. While it is important if any one country’s institution is too big to save, what is more important is if the financial sector at a whole is disproportionately large for the country. In Ireland’s case, each of the distressed banks are potentially saveable on their own, the problem is that the Irish gov’t has to save them all at the same time. The problem isn’t the size of each bank, it’s the size of the banking sector.

In Switzerland’s case, breaking up UBS and Swiss National into six or eight entities might mitigate the risk of a reckless bank CEO. But if Switzerland suffers the same boom-bust cycle that Ireland just saw, it won’t matter one iota if there are 2 banks or 20, as all of those banks will be distressed and in need of rescuing.

Posted by Kosta0101 | Report as abusive

While Ireland may be an especially egregious case of an over-sized banking sector, one wonders about the liabilities of the US financial “industry”.

Fannie and Freddie bleed hundreds of billions slowly and they certainly are sitting on trillions of toxic waste. The same is true with the TBTF banks; the balance sheets have yet to reflect anything close to reality.

Posted by upstater | Report as abusive

According to Forelle’s blog entry, Ireland has 1.5 million households and has ‘hundreds of thousands’ of vacation and investment homes. Sounds to me like one big Ponzi scheme.

Posted by MattF | Report as abusive

The answer dear Felix is GOLD …. it think!

Posted by tonydd | Report as abusive

The answer dear Felix is that, while the ‘Fed’ runs the US of A ….. there is no answer.

Posted by tonydd | Report as abusive

“One of the authors of the article, Charles Forelle, has a great accompanying blog entry in which he explains that Ireland’s crisis came out of the blue.”

Don’t think so, this one has been brewing for years and was pretty apparent for at least half a decade if not more.

Posted by DrEvil | Report as abusive

Dear Mr Salmon,

If you read the following from today’s “Irish Indepenndent” you’d learn how some senior Irish civil servants hid the truth they knew from the Irish people, simple as that. This crisis could have been at least curtailed…if it weren’t for our incompentent government at the Department of Finance who ordered their officials not to tell what the OECD, were telling them, that the boom had already ended, that the bubble had burst. But no, we went on to have another election where they (the Government) were saying everything was dandy, it was more like “Dangly”.

follow the link,

htDrag the underneath link to your browser.tp://www.independent.ie/opinion/ editorial/we-were-denied-the-awful-truth -2415851.html

We were denied the awful truth – Editorial, Opinion – Independent.ie

Posted by IrishGiggle | Report as abusive