Ireland's €50 billion banking black hole

So now we know the extent of the bad news. The official figure for the cost of the bailout of the Irish banks will be a staggering €50 billion.

Last Thursday -- dubbed Black Thursday by the Irish media -- Minister for Finance Brian Lenihan revealed the awful truth to the Dail (Irish parliament).

We had known in advance that it was going to be really bad -- in fact I gave the €50 billion figure in this column last week -- but to hear it spelled out in stark detail by Lenihan in the Dail was genuinely shocking.
For once the media were not exaggerating. It was without question the darkest day for Ireland since the Irish state won its independence.

In fact the appalling vista that has now opened up before us is a very real threat to that hard won independence. It’s that serious.

It may be the International Monetary Fund (IMF) instead of the British the next time, but control of our economy could slip from our grasp in the next few years if we do not deal with this debt crisis effectively.

The amount of money involved is almost unbelievable for a country this size. The biggest black hole is in one of our smallest banks, Anglo Irish, which borrowed billions on the money markets during the boom to lend on as property and development loans. That single bank, which was once a minor player here, will now cost the Irish taxpayer between €29 and €34 billion. This will be money down the drain because there is little hope of getting any of it back. Totally bust, Anglo Irish Bank has been taken over by the state and is being wound down. Another minor financial institution here called Irish Nationwide Building Society, a small savings and loan that also played the property game, is now going to cost us well over €5 billion. But the biggest shock of all last Thursday was the news that Ireland’s biggest bank, Allied Irish Bank (AIB), needs so much additional capital that it is also being taken over by the state. Since the crisis emerged two years ago AIB has already been recapitalized heavily by the state. Lately it has been selling off parts of the business (like its Polish banking operation) in a desperate attempt to raise enough funds to avoid having to get even more capital from the state which would result in majority state ownership.

But the hole in its capital was too great, thanks to the billions in bad property loans it dished out during the boom, and it simply ran out of time.

So AIB, for years the biggest banking group in Ireland with enormous wealth and power, is now on the way into state ownership. Its top management, only recently appointed after the first crisis, are on the way out. We have known for the past year or so that the effective nationalization of AIB was a possibility, but to hear last Thursday that this was really happening was still a major shock. It’s hard for us to take in the reality.

So spare a thought for all those educated Eastern European immigrants who got jobs here in the Irish banks during the boom and must now be wondering what is going on -- they moved to get away from communism and they end up working for the state again!

When the cost of rescuing all the banks is added up, we get a figure of €50 billion. That’s fifty thousand million euro, mainly blown on bad property loans to Irish developers and speculators who rode the boom at home and abroad. You remember what the guys selling foreign property investments used to say -- there’s the price for local buyers, the price for international buyers … and the price for the Irish! The bitter truth behind that joke has now emerged, and no one is laughing. The €50 billion figure was calculated by the new Irish financial regulator, a man with real credibility who tells it like it is. Mind you, it’s still only an estimate, but it’s the most realistic estimate possible, based on casting a cold eye over the loan books of the banks and the amounts they will get back for their property loans. The regulator has taken into account the very severe discounts applied to the property loan portfolios which have been taken off the books of the banks by the National Asset Management Agency (NAMA), the state body set up to work out the loans over a long period, perhaps a decade or more. Both the financial regulator and NAMA take the view that there will be no recovery in the property market here for years, perhaps 10 years or more. A lot of land bought for development that will now never happen has been marked down to a fraction of its loan value, one-20th or less.

The same applies to speculative commercial property and unfinished residential property in over-developed rural towns. In some cases the value has been written down to zero.

This process has created the huge hole in the Irish banks, and it’s a mess of gigantic proportions because almost all of it was done with money borrowed from the markets. But the €50 billion our banks owe to the money markets is not our only problem. At the same time that this has been happening our economy has crashed, and with it the amount of tax revenue the government gets in. So the Irish state has been running enormous budget deficits and building up a mountain of debt as a result. It’s a double whammy and it explains why we can’t default on most of the money the Irish banks owe to the markets. That’s what a lot of people here are now advocating … tell the bondholders to get lost, they took the risk, let them swing. The trouble is that if we burn all the bondholders who lent the money to the banks, the state won’t be able to go on borrowing the billions we need to get every year to keep the country functioning. In fact, horrendous though the ***50 billion bank debt is going to be for Irish taxpayers, it’s not our biggest problem. Cutting our budget deficit is going to mean even more pain.

By the time we get our deficit under control (it’s running at around €20 billion euro a year which is over one-third of government spending) the accumulated debt will be two or three times as big a problem as the €50 billion hole in the banks.

When the economy here was booming, the government spent money like it was going out of style. That was possible because a huge amount of tax revenue flowed in as the property sector boomed. But when the property bubble burst a couple of years ago, the revenue river turned into a small stream. The problem is that by then we had vastly expanded state spending on services, the state payroll, the number of state workers, welfare payment levels and so on. Cutting back is going to be very painful because this extra spending is now seen as normal, even essential. But cutting back on what the state spends has to be done -- and done fast -- or we will go belly up and the IMF will have to come in to rescue us, like happened in Greece recently. Getting the budget deficit down will be even harder now because we have the added burden of the interest we have to pay on the €50 billion for the banks. So instead of cutting €3 billion off the deficit in the budget this December, Lenihan said last Thursday that it will have to be considerably more than that. To get the money to keep going we have had to agree a program of budget deficit reductions with the European Union which will see our deficit cut to 3% of GDP by the end of 2014.

Sticking to that program will be essential if we are to be able to borrow money at less than the penal rates we were asked for a week ago, when the markets wanted almost a 7% annual return on Irish government 10 year bonds.

The bond price has eased a little since then, but it shows that the international markets regard us as a serious risk. The only way to alter that is to implement the cutbacks program to get our national finances back into line. To do this is going to take a series of draconian annual budgets the like of which has never been seen here before. Nothing can be ruled out of the cutbacks, not pay and pensions for state workers, not welfare payments, not child benefit payments, not any of the emotive sacred cows that so far have been untouchable.
As we have said here before, the Irish government has not run out of compassion, it has run out of money. So it has to be done.

Last Thursday Lenihan made it clear that next December’s budget would go even further than the proposed €3 billion in cuts. He also said that at the start of November he would be outlining a four-year program of deficit reductions showing the annual steps to get us down to our 3% deficit target by 2014. It won’t be just cutbacks in spending. There will also be a widening of the tax net, with property taxes and water charges expected. By raising taxes and lowering spending, the deficit will be reduced over the next four years. When the markets see that we’re serious, the pressure will start to come off Ireland. But it’s going to be very difficult to do without our society tearing itself apart. Meanwhile, the property speculators, bankers, failed regulators and weak politicians who have brought Ireland to its knees are still free and walking around. Is it any wonder people here are so angry?

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