Felix Salmon

Ireland’s lessons for Spain

Felix Salmon
Feb 4, 2011 15:21 UTC

It almost goes without saying, but you have to read Michael Lewis’s tour de force on Ireland in Vanity Fair. It’s long — over 13,000 words — and it’s beautifully written, giving both a big-picture perspective on the Irish economic boom and bust, and a credible account of the fateful meeting at which the Irish government decided that it should go ahead and guarantee the debts of all Irish banks. That move was the single worst decision among all the policymaker actions over the course of the global financial crisis, and Lewis is right to be astonished at how meekly the Irish population has accepted its devastating consequences.

Ireland was unfortunately yet predictably being run, at the time of the crisis, by the business-friendly Fianna Fáil party, full of lawyers and other pillars of the establishment with a tendency to make decisions on a narrow, legalistic basis. The government paid Merrill Lynch €7 million, at the height of the crisis, for a seven-page report saying that “all of the Irish banks are profitable and well capitalised” and that the government guarantee would therefore cost nothing. The result was an immediate overnight windfall for anybody invested in Irish bank debt:

The bondholders didn’t even expect to be made whole by the Irish government. Not long ago I spoke with a former senior Merrill Lynch bond trader who, on September 29, 2008, owned a pile of bonds in one of the Irish banks. He’d already tried to sell them back to the bank for 50 cents on the dollar—that is, he’d offered to take a huge loss, just to get out of them. On the morning of September 30 he awakened to find his bonds worth 100 cents on the dollar. The Irish government had guaranteed them! He couldn’t believe his luck.

Lewis does a great job of presenting the back-story to the way in which the Irish government chose Merrill to be its CYA mechanism: Merrill was the bank which had recently bowdlerized a prescient report from its own analyst, Philip Ingram, which had cast doubt on the quality of the assets at Irish banks. It was unthinkable that Merrill would be honest with the government, and it wasn’t.

Ireland’s bank-debt guarantee was a bit like AIG’s CDO guarantees, only much, much worse. The CDO guarantees were issued when the CDOs were trading at 100 cents on the dollar, and AIG stopped writing them in 2006. The bank-debt guarantee was issued as markets were plunging, at the end of September 2008, after Lehman Brothers had already gone bust. AIG genuinely believed, when it was writing its guarantees, that there was a negligible chance that any of them would result in payouts. Ireland, by contrast, knew full well that its banks were in trouble — the guarantee was a bit like offering free health insurance to someone who’s just been rushed to the emergency room, on the grounds that a Merrill Lynch report says the patient is in fine fettle.

Lewis makes another important point, too: substantially all those bonds which Ireland guaranteed have now been paid off, in full, at par, using money from the European Central Bank. There is no longer a pool of government-guaranteed bank bonds alongside another pool of government debt; everything is now pure government debt, and as a result Ireland is mired in a fiscal crisis from which there is no way out.

All of which is an important cautionary tale for Spain, which needs to work out what to do with its undercapitalized cajas. A blanket guarantee of caja debt wouldn’t be as disastrous as the Irish guarantee, but it’s still a bad idea. On the other hand, letting them go bust doesn’t seem very attractive either. The ideal solution, as Mohamed El-Erian says today, would be to somehow recapitalize them with private money — but there’s understandably little appetite in the private sector to come up with the tens of billions of euros needed to do that. And forcibly merging the cajas doesn’t help much either: as the cliché has it, you can’t tie two rocks together and hope that they’ll float.

The best-case scenario, for me, would be one in which some or all caja debt was turned into equity. Ireland should mark the end of the era of bank bailouts: given the fiscal straits of the European periphery, it’s time to draw a line in the sand. Ireland has avoided riots and chaos, and its upcoming political transition looks as though it’s going to go smoothly. But that’s no evidence that what it did was in any way a good idea.


The Irish citizenry was no less meek about their situation than the American citizenry.

The American government made the same incredibly bad decision to guarantee debt that the Irish government made and we have suffered similar consequences.

Both Obama and McCain voted to bailout the banks, so we couldn’t punish one party or the other for their misdeed.

The Republicans are proud to do the banks’ bidding, the Democrats are just as subservient, but less public about it.

So what options are left to the citizens of Ireland, America? Revolution? Murder? Terrorism?

I’m not ready to go that far, but I voted against Obama and McCain, I moved my banking from Wells Fargo to a credit union and I pay cash for things a lot more than I used to.

I’d like to see something like what happened in Tunisia and Egypt happen right here in America. I even went so far as to sign up for Twitter just in case something gets going; I’d like to be a part of it.

Only instead of demanding a different leader, we should simply demand: Justice!

Posted by breezinthru | Report as abusive

Is Ireland’s problem a Basel problem?

Felix Salmon
Nov 24, 2010 14:34 UTC

Does the Ireland crisis bespeak a major weakness in the Basel capital-adequacy regime? Simon Nixon thinks so: the fact that investors won’t lend to Bank of Ireland, he says, “highlights a major weakness of the Basel capital rules that European banks operate under.”

This is an interesting idea: Ireland’s problem is a banking problem, banking problems are Basel problems, and therefore it stands to reason that Ireland’s problem might be a Basel problem. But if you look more closely at Nixon’s reasoning, his thesis ends up falling apart.

Nixon lays the blame at the feet of Basel’s well-known weakness: the fact that it concentrates on risk-weighted assets rather than total assets. And he implies that there might be large national differences when it comes to the ratio of risk-weighted assets to total assets, while conceding that thesis ” is impossible to prove from regulatory disclosures.”

But there are three huge things missing from Nixon’s piece. First, he takes just one bank from each of four different countries (Santander in Spain, BNP Paribas in France, Barclays in the UK, and Deutsche Bank in Germany) to illustrate national differences. He would be much more interesting, and much more compelling, if he presented a couple more datapoints in each country, to help give readers a better idea of whether French banks in general tend to have a higher ratio of risk-weighted assets to total assets than German banks in general, or whether we’re just looking at idiosyncratic differences between BNP Paribas and Deutsche Bank.

Second, Nixon thinks that the credibility problem in Ireland is a function of the way that the banks’ risk-weighted assets are calculated. He’s right that the market is skeptical that Bank of Ireland really has a core Tier 1 ratio of 8%. And he’s right that risk-weighted assets are a key part of that calculation, and can throw it off. Essentially, the ratio is (A-L)/R, where A is total assets, L is total liabilities, and R is risk-weighted assets. If R is artificially low, then that makes the ratio artificially high.

But the fact is that it’s not the denominator here that the markets are worried about. Instead, it’s the numerator. The key problematic number is A, Bank of Ireland’s total assets. Many of those assets are Irish commercial real-estate loans for which there’s essentially no buyer right now except for the Irish government. And a huge proportion of the rest are Irish residential mortgages, which might be performing for the time being but which would surely sell for much less than par if the bank tried to sell them on the open market.

Any mark-to-market valuation of BoI’s assets, then, would almost certainly show the bank to be insolvent. (This is not news: it’s true of all banks in all crises.) And the reason that the market won’t lend to BoI is that it fears the bank is insolvent. And that has nothing to do with its risk weightings at all: it doesn’t matter what the denominator is, if the numerator is negative.

Finally, Nixon nowhere mentions any Irish ratios of risk-weighted assets to total assets! The very heart of his thesis would seem to be that Basel understated the riskiness of Irish banks by coming up with an unreasonably low number for their risk-weighted assets. Yet Nixon doesn’t tell us what Bank of Ireland’s ratios were, in comparison to those other European banks, and he doesn’t give ratios for any other Irish banks, either.

I suspect this is more than just an oversight. In general, banks reduce their ratio of risk-weighted assets to total assets in one of three ways. They can be heavily involved in investment banking, where loans tend to be taken out in the repo market and are fully collateralized; they can be heavily invested in structured products with triple-A credit ratings; or they can be heavily exposed to OECD sovereign credits. Ireland’s banks, by contrast, were more old-fashioned than that: they just loaded up on property loans, which tend to carry a full risk weighting. There are clearly lots of things wrong with Ireland’s banks, but I doubt that artificially reduced risk weighting was one of them. Certainly Nixon adduces no evidence that it was.

Is Ireland’s problem a Basel problem, then? I don’t think so—or if it is, then we’d need to see a lot more numbers first before Nixon came close to making his case. I understand that the Heard column has space constraints and specializes in short, punchy analysis, but this piece is so short as to be pretty much useless. At the very least, Heard should allow its writers to put extra material online, showing their work, as it were, to back up the conclusions in the printed paper.


“In general, banks reduce their ratio of risk-weighted assets to total assets in one of three ways. They can be heavily involved in investment banking, where loans tend to be taken out in the repo market and are fully collateralized; they can be heavily invested in structured products with triple-A credit ratings; or they can be heavily exposed to OECD sovereign credits.”

What. On. Earth. Are. You. Talking. About?

You’ve never worked in a bank, I presume?

Posted by drewiepe | Report as abusive

The underwhelming Irish bailout

Felix Salmon
Nov 22, 2010 04:26 UTC

Color me underwhelmed by the Irish bailout. By all accounts it’s going to be less than €100 billion — probably in the €80 billion to €90 billion range — and that sum has to cover the country’s entire borrowing needs for the next three years. The NYT has a breakdown:

While a precise breakdown was not given, analysts and people involved in the talks said that about 15 billion euros was likely to go to backstop the banks. As much as 60 billion euros would go to Ireland’s annual budget deficit of 19 billion euros for the next three years.

That leaves a few billion euros left over for one-off expenses and emergencies — but I worry that Ireland’s banks are going to need a lot more than €15 billion. The banking system is on its knees and it has roughly half a trillion euros in assets. The black hole in commercial real-estate alone — over and above the €50 billion or so that the Irish government has already shelled out — is estimated at somewhere in the €20 billion to €25 billion range and that’s before you even start thinking about residential mortgages:

Where the first round of the banking crisis centred on a few dozen large developers, the next round will involve hundreds of thousands of families with mortgages. Between negotiated repayment reductions and defaults, at least 100,000 mortgages (one in eight) are already under water, and things have barely started.

Banks have been relying on two dams to block the torrent of defaults – house prices and social stigma – but both have started to crumble alarmingly.

When a residential property bubble as big as Ireland’s bursts, there will be always enormous bank losses. But because those losses haven’t materialized yet, everybody in Ireland and the EU is sticking their heads in the sand, pretending that they’re never going to arrive at all.

The best-case scenario, then, is that the EU bailout will kick the Irish can three years down the road. But in implementing the plan, Ireland’s banks will effectively be nationalized and any future mortgage losses will have to come straight out of these bailout funds. Which aren’t remotely sufficient for such a task. If the spike on mortgage defaults comes sooner rather than later, this particular bailout package could prove to be very short-lived indeed.


Well done Felix. How anyone could be bullish on the Euro with all this mismanagement and incompetence at the national level is beyond me.

Posted by Gotthardbahn | Report as abusive

Should Ireland default and devalue?

Felix Salmon
Nov 19, 2010 18:24 UTC

Mohamed El-Erian weighs in on Ireland today, and is blunt:

What is most desirable is not feasible given the path Europe is embarked on; and, to make things even more complicated, what appears feasible to Europe is not necessarily desirable. As a result, Ireland finds itself stuck in an unstable muddled-middle.

What seems probable in Ireland is a Greece-style bailout. It’s a debt-go-round, basically: the sovereign takes on the bad debts of its banks, becoming less creditworthy itself in the process; and then the EU takes on the debts of the sovereign. Writes El-Erian:

While seemingly exceptional to many, this approach constitutes the path of least resistance. In fact, it is the most feasible. But we should not confuse feasibility with desirability.

At its roots, the approach addresses liquidity but not solvency. It adds to the debt overhang rather than reducing it. And it uses the socially-painful method of income and growth compression as the principal way to promote international competitiveness over time.

This approach hasn’t worked in Greece, which still has sky-high borrowing costs and which is no more internationally competitive now than it was during the bailout. And it’s unlikely to work in Ireland, either.

So what might work? Default and devaluation, basically:

In a wider policy debate, debt restructuring would be considered as a possible pre-emptive option rather than a disorderly inevitability; thought would be given to the possibility of the weakest Euro-zone members taking a type of sabbatical from the club and rejoining on a stronger and more sustainable basis.

These options are still unthinkable politically. But as El-Erian says, the longer they’re put off, the worse the consequences for European growth in general, and the higher the likelihood that the crisis will engulf the entire eurozone. Right now, says, El-Erian, “given the undeniable strength of core Euro-zone countries, anchored by a fiscally sound and economically robust Germany,” it’s possible to structure a default and devaluation in such a way that the country concerned emerges in a strong fiscal position and with a healthy growth outlook. But the longer we wait, the harder that becomes.

I do think that it would be grossly unfair should the lenders to Ireland’s insolvent banks find themselves getting bailed out by Irish and EU taxpayers at 100 cents on the dollar. Is a sovereign debt restructuring the only way to avoid that? I’m not sure. And it’s also politically all but impossible to build a mechanism into the eurozone allowing countries to exit and re-enter again at a more competitive level, now that the currency union has been deliberately designed without that possibility in place.

Essentially, what El-Erian is calling for requires a level of political unity within the eurozone which has rarely existed historically and which certainly doesn’t exit now. Which is why, as he says, “the region as a whole will lose out in terms of both what is desirable and what is feasible.”


Honestly, unless individual sovereignty is abolished (which will never happen without riots and war) and a single government rules all of Europe with a single budget (another fairy tale that will never come true), the concept of a single currency is simply unworkable.

So, perhaps the Euro should disintegrate and let individual countries have their old currencies back. The bail outs cannot continue forever. While payments and trade have clearly been easier under the Euro, who honestly ever believed a single currency would ever work without control of individual EU nations’ budgets? Would France dictate the annual budgets for Italy? Should Germany tell Greece their annual budget is too large? Of course not. So why then should Germany bail out anyone, simply because she has managed her balance sheets properly?

Let’s face it – the modern notion of a single currency working without complete control of all of annual budgets is simply ridiculous.

Posted by JoeyDawson | Report as abusive

Learning from Ireland

Felix Salmon
Nov 10, 2010 14:52 UTC

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.


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

Wall Street’s trolls

Felix Salmon
Oct 3, 2010 23:03 UTC

There are anonymous commenters on blogs like mine, and then there are the elite and sophisticated investors invited to join a conference call with Ireland’s finance minister. Which group would you think is better behaved? Silly question, really. It’s not even close:

Mr Lenihan had been speaking for less than two minutes on Friday before a mistake by Citigroup meant that the bank’s clients were all able to be heard on the line.

Between 200 and 500 investors are understood to have been on the call, and as they realized their lines were not muted many began to heckle Mr Lenihan.

Some traders began making what one banker on the call described as “chimp sounds”, while another cried out “dive, dive”. A third man said “short Ireland” before adding “why not short Citi too?”

As the call descended into chaos, with one participant heard to say “this is the worst conference call ever”, Citigroup officials shut down the line.

This says a lot about the effects of anonymity on public behavior, and about the manners of Wall Street types, and about the regard in which the markets hold both Ireland and Citigroup.

But I think it also says something about the way in which even rich and sophisticated investors feel as though they don’t have a voice and aren’t being heard. Remember that the Tea Party started with a rant on CNBC. This is a sign of the times, I think: this kind of fiasco wouldn’t have taken place pre-crisis.

Update: The Irish Times pushes back on this story, quoting spokesmen from the National Treasury Management Agency and the Department of Finance saying that the heckling never happened, and that the Telegraph was sold a line by holders of Anglo Irish Bank’s subordinated debt. The Irish spokespeople might well be right, but so far no one has managed to produce a transcript or recording of the call, which would presumably clear things up.


“Sophisticated investors” – are they the ones that do or do not need government bailouts to stay solvent? I keep forgetting.

Posted by ErnieD | Report as abusive