Friday, June 28, 2013

After sticking it to Ireland a few years back, EU "fixes" the bank bailout plan

Ireland was the one country in the Eurozone "periphery" that seemed to be bucking the trend (see post). Many had hoped that the nation will be able to withstand the Eurozone recession due to its strong trade balance. Exports were really humming until global growth stalled last year (see post). Ireland's trade balance turned negative again and does not seem to be recovering. Furthermore, domestic demand is now weakening.

Source: Barclays Capital

As a result Ireland's GDP contracted and the nation followed the rest of the Eurozone into a recession - just over 3 years after the Great Recession.

Source: Barclays Capital

Given Ireland's high government debt to GDP ratio (Ireland ranks third in the Eurozone after Greece and Italy), this is bad news. The hope was that the government can manage down its leverage as the GDP grows, but that's not how things turned out.

Source: Tradingeconomics
Unlike most of the other Eurozone nations whose debt to GDP trajectory was much more gradual, Ireland's ratio shot up rapidly in a matter of 4 years.  What makes Ireland somewhat unique in the Eurozone is that this debt spike is directly related to Ireland's bank bailout. The sad part is that Ireland's EU "friends" had a great deal to do with this. Here is why.

In the last couple of days the EU reached an agreement on dealing with failed banks.
The Express: - The European Union has today agreed to force investors and wealthy savers to share the costs of future bank failures, moving closer to drawing a line under years of taxpayer-funded bailouts that have prompted public outrage.

After seven hours of late-night talks, finance ministers from the bloc's 27 countries emerged with a blueprint to close or salvage banks in trouble.

The plan stipulates that shareholders, bondholders and depositors with more than 100,000 euros should share the burden of saving a bank.
If Ireland were allowed to implement anything resembling this provision during the financial crisis, its debt to GDP would never have reached anything close to the current levels.

During the financial crisis a great deal of the unsecured debt of Irish banks was held by the UK's and the Eurozone's banks. And neither the EU nor the ECB wanted to haircut these bonds. In order to "keep the peace" in the EU banking system, these bonds were not written down, forcing the Irish government to make the bondholders whole. It had no resources to do so and was forced to borrow tremendous amounts in order to cover these obligations. As losses on property portfolios inherited by the government mounted, so did the government debt (government guarantee had to cover increasingly larger losses). The austerity drive generated by this high government debt caused unemployment to spike and destroyed domestic demand. It may be a decade or longer before the nation fully recovers. Now that Ireland had paid the high price for covering its banks' obligations, the EU is about to implement the rules to force haircuts on unsecured creditors - something they refused to do for Ireland just a few years ago.

The next post will contain an email from a reader describing some of the ugly facts around the bailout of the Irish banking system.
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