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Central Bank boss Patrick Honohan

Morgan Kelly: the professor who tells the truth

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Central Bank boss Patrick Honohan

Central Bank Governor Patrick Honohan.
Talk about having your weekend ruined!  Like thousands of people all over Ireland last Saturday morning I opened my Irish Times to find another Weapon of Mass Destruction from the economist Morgan Kelly. 

Ireland, according to Kelly in his latest full page missile/missive, is in mortal danger of becoming an economic dead duck. 

Now if anyone else was saying this -- especially one of the economists here who write in our papers every week -- we might pass over it.  But Kelly, who is professor of economics at UCD, Ireland's largest university, is different. 

He writes an article about once a year, and only for The Irish Times.  He is the guy who predicted the crash in Ireland years ago before it happened and, when the boom began to falter, accurately forecast just how severe the collapse would be.

He was laughed at by his colleagues at the time and ridiculed by politicians.  But he was right.  In fact he was so accurate in his predictions of doom that he has now become something of a seer in Ireland.  

As I said, he only writes a piece about once a year and he rarely gives TV or radio interviews.  So when a new article by him appears, it is seized on like the words of a prophet. 

His latest article, which appeared without any advance publicity, dominated the news here over the weekend. 

There must have been people all over Ireland last Saturday morning, like me, who wished they had had their breakfast before starting it. 

Because believe me, when you finish reading it you feel sick instead of hungry.  (You can find the full text on the Irish Times website, where it is Number 1 on their most popular story menu. Have your breakfast first!) 

Part of the reason that Kelly is so widely read is that he is absolutely fearless.  He says exactly what he thinks, he doesn't care if he upsets powerful people here in the process and this latest article is further proof of that. 

Plus he happens to be a more entertaining writer than any economist has a right to be!

The headline on this latest article was “Ireland's future depends on breaking free from bailout.”  Other people (including yours truly) have been saying the same thing for some time. 

But Kelly's analysis of why we need to do it is more perceptive, more detailed and more convincing than anything else that has been written here on the issue. And it is far more direct. 

"Ireland is facing economic ruin," Kelly writes, unless we break free from the bailout deal and take drastic action to save ourselves.  You can't be clearer than that. 

He likens the new government's policy to one of "lying on the ground with a begging bowl and hoping that someone takes pity on us.”  He says the last government was "spineless," and that former Finance Minister

Brian Lenihan's original decision to give a blanket guarantee to the Irish banks in September 2008 was a serious mistake.

But Kelly reserves his real fire for what came after that.  "The real error was in sticking with the guarantee long after it had become clear that the bank losses were insupportable," he says.

We all know now that the banks either covered up or did not grasp the full extent of their losses back then, and that Lenihan was misled about the scale of the problem.  But as time went on, the depth of the black hole became increasingly clear.  And instead of confronting it, we tried to hide it under the carpet.

By then it had become clear that Lenihan had made a big mistake, and that the hole in the banks which we had guaranteed to fill was big enough to drag the state down as well. 

"The ideal time to have reversed the bank guarantee was a few months later when Patrick Honohan was appointed governor of the Central Bank and assumed de facto control of the Irish economy," Kelly says. 
Instead of forcing bond holders in the Irish banks to swap bonds for shares, Honohan carried on as before, insisting that the losses were "manageable."  

"Honohan's miscalculation of the bank losses has turned out to be the costliest mistake ever made by an Irish person," Kelly writes.

The Irish government continued to borrow vast amounts of money to give to the banks so they could pay back the foreign bondholders and banks that had gambled on the Irish property boom. But the markets were wise to this foolishness, and towards the end of last year they simply stopped lending to us because they didn't think Ireland would ever be able to pay back the debt. 

After that, we were completely dependent on the European Central Bank (ECB). The game was up.

Kelly also accuses Honohan of siding with the ECB against his own minister for finance who he "deftly sliced off at the ankles" when he (Honohan) went on radio last November and insisted that Ireland would need a bailout of "tens of billions."  

This intervention came at a critical time when Lenihan was hanging tough and was resisting the bailout that the EU was attempting to force on Ireland to protect the rest of the Euro zone.

At the time, Lenihan was in a position to exploit a "strong negotiating position" to get a haircut for bank debt, according to Kelly.  But the other EU finance ministers wanted us to accept a national bailout to stop panic spreading to Spain and Portugal.

Honohan "also played for the opposing team" as a member of the council of the ECB, Kelly writes.  And
Honohan's intervention was a key influence in forcing us to accept the ECB line that we needed a national bailout, that there would be no haircuts of bank debt and that the Irish bank losses should be repaid by Irish taxpayers following the bailout of the state.

Kelly also has an interesting insight into the role played by the U.S. in the critical decisions that were taken when Lenihan and the Irish government were in negotiation with the EU-IMF.

"The IMF, which believes that lenders should pay for their stupidity before it has to reach into its pocket, presented the Irish with a plan to haircut €30 billion of unguaranteed bonds by two-thirds on average," Kelly writes. 

"The deal was torpedoed from an unexpected direction. At a conference call with the G7 finance ministers, the haircut was vetoed by U.S. Treasury Secretary Timothy Geithner who, as his payment of $13 billion from government-owned AIG to Goldman Sachs showed, believes that bankers take priority over taxpayers.

"The only one to speak up for the Irish was U.K. Chancellor George Osborne but Geithner, as always, got his way. An instructive, if painful, lesson in the extent of U.S. soft power, and in who our friends really are," Kelly writes.

"The negotiations went downhill from there. On one side was the European Central Bank, unabashedly representing Ireland's creditors and insisting on full repayment of bank bonds. On the other was the IMF, arguing that Irish taxpayers would be doing well to balance their government's books, let alone repay the losses of private banks."

As we all know, the Irish caved in and took the bailout ... and the government used most of the money to repay the bank debt in full, thereby reducing us to the state we are in where we can't borrow on the markets. 

All this detail, fascinating though it is, is just billions down the toilet. We are where we are ... and what we need to do now, according to Kelly, is take drastic action unless we want to default, go bankrupt and collapse. 

What Kelly proposes is a two-part solution beginning with walking away from the bailout.   Part one involves us telling the EU and anyone else we owe that this debt has been swapped for equity and that they are now the proud owners of the Irish banks. 

This means, of course, that our pipeline of funding from the EU would be shut off, which is where part two comes in.  We would immediately reduce government spending by about one-third to balance our budget.  We would have no choice because we would be unable to borrow. 

Kelly writes, "The ECB can then learn the basic economic truth that if you lend €160 billion to insolvent banks backed by an insolvent state, you are no longer a creditor: you are the owner. At some stage the ECB can take out an eraser and, where ‘emergency loan’ is written in the accounts of Irish banks, write ‘capital’ instead. When it chooses to do so is its problem, not ours.

"At a stroke, the Irish government can halve its debt to a survivable €110 billion. The ECB can do nothing to the Irish banks in retaliation without triggering a catastrophic panic in Spain and across the rest of Europe.  The only way Europe can respond is by cutting off funding to the government.

"So the second strand of national survival is to bring the government budget immediately into balance … Cutting government borrowing to zero immediately is not painless, but it is the only way of disentangling ourselves from the loan sharks who are intent on making an example of us.

“By bringing our budget immediately into balance, we focus attention on the fact that Ireland's problems stem almost entirely from the activities of six privately owned banks, while freeing ourselves to walk away from these poisonous institutions.

"Just as importantly, it sends a signal to the rest of the world that Ireland ... is back and means business."
So that's Kelly's solution.  Several papers have taken to calling him the maverick professor or the radical professor. 

But there's nothing radical or maverick about what he's saying.  In fact he's more a conservative and a realist than anything else. 

The truth is there is no alternative other than a long and painful slide into bankruptcy, which will come at some point in the near future when the debt burden overwhelms us and the EU pulls the plug. 

On the present trend, we're going we're going to be around €250 billion in debt within a few years. Cutting back a few billion a year to balance our budget in four years' time is not going to help much, despite all the pain it will cause.

Which is why it makes sense to go for the nuclear option immediately, and why many people here agree with Kelly's “radical” solution. 

So alarmed were the government and the Department of Finance at the huge coverage given to Kelly's article over the weekend that Taoiseach (Prime Minister) Enda Kenny, the department and senior politicians all made statements rubbishing it. You know he has to be making sense when all those boys are out together to shoot him down. 

The Department of Finance pulled no punches.  State pensions, child benefit and the wages of 300,000 public sector workers would be slashed by one-third if we abandoned the EU-IMF bailout deal, it said. 

Which of course is alarmist rubbish.  It's true that government spending would have to be cut by as much as one-third if we don't raise taxes.  But there is so much waste and overpayment in government spending that the correction should be possible without going near sensitive areas like old age pensions if we raise taxes a little.

As for child benefit, it should have been means tested years ago. And as for the wages of state workers, the Central Statistics Office here in March of this year released figures showing that Irish state workers earn an average of €912 a week compared with state workers in the U.K. who earn an average of €634 a week, and compared with Irish private sector workers (the real economy) where people earned an average €625 a week. 

And don't start me about all those directors and managers and consultants and PR minders, and all the rest of the vast overpaid top layer on the state payroll both directly in the state service and in semi-state organizations.  And all the doctors and lawyers and all the rest of the professionals who make a fortune supplying overpriced services to the state and raising the cost of living for the rest of us.  

We can make the cuts and still afford pensions and welfare for those who really need it.  We can shed all the rest of the Celtic Tiger fat. 

Kelly is right.  We should just get on with it and tell the ECB guys to take a hike.

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