http://economix.blogs.nytimes.com/2010/03/18/will-the-u-s-become-the-next-ireland/
Will the U.S. Become the Next Ireland?
By PETER BOONE AND SIMON JOHNSON
Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. Simon Johnson, a senior fellow at the Peterson Institute for International Economics, is the former chief economist at the International Monetary Fund.
As Greece acts in an intransigent manner, refusing to move decisively despite deep fiscal difficulties, the financial markets look on Ireland all the more favorably. Ireland is seen as the poster child for prudent fiscal adjustment among the weaker euro zone countries.
The Irish economy is in serious trouble. Irish gross domestic product declined 7.3 percent in the third quarter of 2009 compared with the third quarter of 2008. Exports were down 9 percent year on year in December. House prices continue to fall.
While stuck in the euro zone, Ireland’s exchange rate cannot move relative to its major trading partners. Thus, it cannot improve competitiveness without drastic private-sector wage cuts. Yet investors are so pleased with the country that its bond yields imply just a 1 percent greater annual chance of default than Germany over the next five years.
Ireland’s perceived “success” is partly due to its draconian fiscal cuts.
The government has cut take-home pay of public-sector workers by roughly 20 percent since 2008 through lower wages, higher taxes and increased pension payments. As the head of the National Treasury Management Agency, John Corrigan, proudly advised the Greeks (and everyone else), “You have to talk the talk and walk the walk.”
So is Ireland truly a model for Greece and other potential trouble spots in Europe and elsewhere?
Definitely not. But it does provide a cautionary tale regarding what could go wrong for all of us.
Ireland’s difficulties arose because of a vast property boom financed by cheap credit from Irish banks. Ireland’s three main banks built up 2.5 times the country’s G.D.P. in loans and investments by 2008; these are big banks (relative to the economy) that pushed the frontier in terms of reckless lending.
The banks got the upside, and then came the global crash in fall 2008: Property prices fell over 50 percent, construction and development stopped, and people started defaulting on loans. Today roughly one-third of the loans on the balance sheets of banks are non-performing or “under surveillance”; that’s an astonishing 80 percent of gross domestic product, in terms of potentially bad debts.
The government responded to this with what are now regarded — rather disconcertingly — as “standard” policies.
They guaranteed all the liabilities of banks and then began injecting government funds. The government is now starting a new phase: It is planning to buy the most worthless assets from banks and give them government bonds in return. Ministers have also promised to recapitalize banks that need more capital.
The ultimate result of this exercise is obvious: One way or another, the government will have converted the liabilities of private banks into debts of the sovereign (i.e., Irish taxpayers).
Ireland, until 2009, seemed like a fiscally prudent nation. Successive governments had paid down the national debt to such an extent that total-debt-to-G.D.P. was only 25 percent at the end of 2008. Among industrialized countries, this was one of the lowest debt ratios.
But the Irish state was also carrying a large off-balance sheet liability, in the form of three huge banks that were seriously out of control. When the crash came, the scale and nature of the bank bailouts meant that all this changed. Even with the now-famous public wage cuts, the government budget deficit will be an eye-popping 12.5 percent of G.D.P. in 2010.
The government is gambling that annual G.D.P. growth will recover to over 4 percent starting in 2012 — and it still plans further major spending cuts and revenue increases each year until 2013, to bring the deficit back to 3 percent of G.D.P. by that date.
The latest round of bank bailouts (swapping bad debts for government bonds) greatly compounds the fiscal problem. The government will in essence be issuing one-third of G.D.P. in government debts for distressed bank assets that may have no intrinsic value. The government debt-to-G.D.P. ratio of Ireland will be over 100 percent by the end of 2011 once this debt is included.
Ireland had more prudent choices. It could have avoided taking on private bank debts by forcing the creditors of these banks to share the burden — and this is now what some sensible voices within the main opposition party have called for.
But a strong lobby of real-estate developers, the investors who bought the bank bonds, and politicians with links to the failed developments (and their bankers) have managed to ensure that taxpayers rather than creditors will pay. The government plan is — with good reason — highly unpopular, but the coalition of interests in its favor is strong enough to ensure that it will proceed.
Investors may wish to remain pleased today with Ireland, but Ireland’s “austerity” — reflecting an unwillingness to make creditors pay for their past mistakes — hardly seems a good lesson for Greece, the euro zone or anywhere else.
Countries — like the United States — with large banks prone to reckless risk-taking should limit the size of those banks relative to the economy and force them to hold a lot more capital. If you thought the “too big to fail” issues of 2008-9 were bad in the United States, wait until our biggest banks become even bigger.
Today the big six banks in the United States have assets over 60 percent of G.D.P.; there is no reason why they won’t increase toward Irish scale.
When Irish-type banks fail, you have a dramatic and unpleasant choice. Either take over the banks’ debts, which creates a very real burden on taxpayers and a drag on growth, or restructure their debts, which forces creditors to take a hit. If the banks are bigger, more powerful politically and better connected in the corridors of power, you will find the creditors’ potential losses more fully shifted onto the shoulders of taxpayers.
Will the U.S. Become the Next Ireland?
By PETER BOONE AND SIMON JOHNSON
Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. Simon Johnson, a senior fellow at the Peterson Institute for International Economics, is the former chief economist at the International Monetary Fund.
As Greece acts in an intransigent manner, refusing to move decisively despite deep fiscal difficulties, the financial markets look on Ireland all the more favorably. Ireland is seen as the poster child for prudent fiscal adjustment among the weaker euro zone countries.
The Irish economy is in serious trouble. Irish gross domestic product declined 7.3 percent in the third quarter of 2009 compared with the third quarter of 2008. Exports were down 9 percent year on year in December. House prices continue to fall.
While stuck in the euro zone, Ireland’s exchange rate cannot move relative to its major trading partners. Thus, it cannot improve competitiveness without drastic private-sector wage cuts. Yet investors are so pleased with the country that its bond yields imply just a 1 percent greater annual chance of default than Germany over the next five years.
Ireland’s perceived “success” is partly due to its draconian fiscal cuts.
The government has cut take-home pay of public-sector workers by roughly 20 percent since 2008 through lower wages, higher taxes and increased pension payments. As the head of the National Treasury Management Agency, John Corrigan, proudly advised the Greeks (and everyone else), “You have to talk the talk and walk the walk.”
So is Ireland truly a model for Greece and other potential trouble spots in Europe and elsewhere?
Definitely not. But it does provide a cautionary tale regarding what could go wrong for all of us.
Ireland’s difficulties arose because of a vast property boom financed by cheap credit from Irish banks. Ireland’s three main banks built up 2.5 times the country’s G.D.P. in loans and investments by 2008; these are big banks (relative to the economy) that pushed the frontier in terms of reckless lending.
The banks got the upside, and then came the global crash in fall 2008: Property prices fell over 50 percent, construction and development stopped, and people started defaulting on loans. Today roughly one-third of the loans on the balance sheets of banks are non-performing or “under surveillance”; that’s an astonishing 80 percent of gross domestic product, in terms of potentially bad debts.
The government responded to this with what are now regarded — rather disconcertingly — as “standard” policies.
They guaranteed all the liabilities of banks and then began injecting government funds. The government is now starting a new phase: It is planning to buy the most worthless assets from banks and give them government bonds in return. Ministers have also promised to recapitalize banks that need more capital.
The ultimate result of this exercise is obvious: One way or another, the government will have converted the liabilities of private banks into debts of the sovereign (i.e., Irish taxpayers).
Ireland, until 2009, seemed like a fiscally prudent nation. Successive governments had paid down the national debt to such an extent that total-debt-to-G.D.P. was only 25 percent at the end of 2008. Among industrialized countries, this was one of the lowest debt ratios.
But the Irish state was also carrying a large off-balance sheet liability, in the form of three huge banks that were seriously out of control. When the crash came, the scale and nature of the bank bailouts meant that all this changed. Even with the now-famous public wage cuts, the government budget deficit will be an eye-popping 12.5 percent of G.D.P. in 2010.
The government is gambling that annual G.D.P. growth will recover to over 4 percent starting in 2012 — and it still plans further major spending cuts and revenue increases each year until 2013, to bring the deficit back to 3 percent of G.D.P. by that date.
The latest round of bank bailouts (swapping bad debts for government bonds) greatly compounds the fiscal problem. The government will in essence be issuing one-third of G.D.P. in government debts for distressed bank assets that may have no intrinsic value. The government debt-to-G.D.P. ratio of Ireland will be over 100 percent by the end of 2011 once this debt is included.
Ireland had more prudent choices. It could have avoided taking on private bank debts by forcing the creditors of these banks to share the burden — and this is now what some sensible voices within the main opposition party have called for.
But a strong lobby of real-estate developers, the investors who bought the bank bonds, and politicians with links to the failed developments (and their bankers) have managed to ensure that taxpayers rather than creditors will pay. The government plan is — with good reason — highly unpopular, but the coalition of interests in its favor is strong enough to ensure that it will proceed.
Investors may wish to remain pleased today with Ireland, but Ireland’s “austerity” — reflecting an unwillingness to make creditors pay for their past mistakes — hardly seems a good lesson for Greece, the euro zone or anywhere else.
Countries — like the United States — with large banks prone to reckless risk-taking should limit the size of those banks relative to the economy and force them to hold a lot more capital. If you thought the “too big to fail” issues of 2008-9 were bad in the United States, wait until our biggest banks become even bigger.
Today the big six banks in the United States have assets over 60 percent of G.D.P.; there is no reason why they won’t increase toward Irish scale.
When Irish-type banks fail, you have a dramatic and unpleasant choice. Either take over the banks’ debts, which creates a very real burden on taxpayers and a drag on growth, or restructure their debts, which forces creditors to take a hit. If the banks are bigger, more powerful politically and better connected in the corridors of power, you will find the creditors’ potential losses more fully shifted onto the shoulders of taxpayers.