I didn’t expect to be asking this question again (I thought about it a lot a quarter century ago), but how much Government debt do contributors believe the Irish economy can support? A lot more than it has at present, of course.
But I raise the point now because Morgan seems sure in his latest newspaper article (not as incendiary as the previous one). It’s OK, he says, if the Banks have “bad debt” of only €10-20 billion; not OK if this number goes up to €50-60 billion.
OK, by “bad debt” I presume he means prospective loan losses. And I suppose he also may be ignoring the fact that the banks still have upwards of €20 billion of book equity capital to burn through before the Government starts taking the hit — but let’s ignore such details.
The interesting point is that the difference between his low figure and his high figure is only 22% of forecast GDP for 2009. Can we be so sure that one figure is affordable, and the other not?
Seems to me that the taxation collapse, and the resulting surge in the deficit on normal operations, is at least as big an issue in terms of a sustainable debt path as the prospective banking losses, large though these are.
9 replies on “Ireland’s borrowing capacity”
Good post, Patrick.
Your conclusion is surely right. Indeed, I would go further and say that the surge in the deficit on normal operations is a much bigger issue in relation to debt sustainability than prospective banking losses. What is critical here is the distinction between a once-off increase and a recurring accretion. In the event that the Exchequer took a banking-related hit at the very top of Morgan Kelly’s range, the impact on the debt-GDP ratio would be of the order of 33% points. This is a big hit by any standards, but it is equivalent to less than three years’ budget deficits at the current run rate (this year’s deficit looks headed for at least 11% of GDP, and its not difficult to construct scenarios in which it’s a good deal higher, even after the latest adjustment package).
Whatever debt burden the Irish economy can bear, we are approaching it too quickly for comfort, whatever the scale of bank losses.
Irelands borrowing capacity is no longer the sole remit of Ireland. As predicted, our Euro zone partners have decided enough is enough! Our capacity to borrow was based on an assumption that the government knew what they were doing.
Our borrowing capacity is limited by our perceived ability to repay our debts. By by our soaring cost of insurance – CDS’s, by our shrinking economy, our soaring unemployment and now finally by the capping that is going to be put on our voracious borrowing requirement. The European Central Bank have now intimated that they will no longer stand idly by and watch as our deficit goes from 11% of GDP to 13% of GDP and onwards and upwards.
The ECB are not going to let Mr. Cowen explode borrowing requirements because he was, and is, unable to make the Public Sector take its long overdue medicine. The medicine will now include job cuts and reform of the Public Sector to including the ludicrous pension schemes, along with at least 30% cuts to salaries, 20% cuts to social welfare and probably cuts even to the minimum wage levels which are amongst the highest in Europe. fortunately, there will be no sacred cows.
When the financial regulator decided to ask the legal “experts” advising Anglo Irish Bank for their help, their advise and their opinions on their own dodgy share dealing practise it heralded the end of even a pretence at regulation of the financial institutions. It proved, if proof was needed, that we were running on empty.
The regulator is gone with his golden hand shake of 400k and pension of over 120k a year. A reward for failure. The ECB has now seen enough from tomorrow on Mr. Cowen and Mr. Lenihan will no longer be allowed to make it up as they go along. Welcome to our new borrowing capacity reality.
There’s an interesting post at American blog site http://econlog.econlib.org/ (see http://econlog.econlib.org/archives/2009/02/one-two_punch_o.html), pointing to a post at another American blog site Marginal Revolution (http://www.marginalrevolution.com/marginalrevolution/2009/02/coming-to-terms-with-bank-nationalization.html).
Anyway: the first post notes that “mark-to-market regs can lead regulators to say that balance sheets are insolvent even in the extreme case that all borrowers are paying their regular payments”.
There have also been critiques of regulations such as Basel II that they will increase voltatility by being “pro-cyclical (see for example Charles Goodhart’s presentation at http://www.case.com.pl/plik–23627967.pdf, where he states “Basel II plus mark-to-market a procyclical doomsday machine.”)
Just how inappropriate are banking regulations – are they causing the entire banking problem or making it much much worse than it has to be ?
Mark-to-market accounting rules (rather then old historic cost accounting) can certainly make bank capital more pro-cyclical. Professor Shin in the Econ dept at Princeton has a few papers on this. Bankers (in US and Europe) are using this idea to argue for a suspension of mark-to-market, but this would merely be a forbearance strategy.
The idea that the bankers highlight is that when you have markets that are extremely illiquid you can get liquidity pricing in the short terms and prices deviate (below of course) the fundamental values of these structured debt instruments. In this case, marking-to-market would force you to value your asset at the “wrong” amount since the market prices is “wrong” — if you are going to hold the asset to maturity. But, all the accounting rules (US and International) already allow banks to move from “mark-to-market” to “mark-to-model” (a valuation model) when markets are deemed illiquid and, effectively, dysfunctional — as is the case now. These rules feed into the regulatory capital rules. So, banks are forced to book too big losses — just at the worst point in the credit cycle.
While this pro-cyclicality issue is real, at the end of the day, bankers made bad investment decisions. So, a lot of this criticism seems to me at least to be a case of “blaming the messenger.” The SEC did a study of fair value (i.e., mark-to-market) accounting in the fall to see if it contributed to bank failures in the US in 2008. http://www.sec.gov/spotlight/fairvalue.htm They concluded that these types of rules did not play a central role in bank failures in the US.
This specific debate does not affect Irish banks. Irish banks probably do not have much holding of securitized debt instruments, so they would not be doing much mark-to-market accounting. On the other hand, losses on regular old loans also tend to be pro-cyclical: credit losses are bunched in time, which will affect Irish banks. But, again, this just reflects bad investment decisions.
Michael Taft has probably produced the most cogent discussion of the impact of the banking crisis on government bond yields: http://notesonthefront.typepad.com/politicaleconomy/2009/02/you-do-not-get-it-you-are-stupid-do-not-demonstrate-do-not-remonstrate-you-are-interfering-in-thing-you-do-not-understa.html
@Robert Browne: What impact do you think “at least 30% cuts to salaries, 20% cuts to social welfare” would have on our GDP and tax revenues? Do you think these reduction may result in the need for more borrowing as the economy slumps further?
@Patrick and Jim
One quibble: For the run/speculative attack scenario, it is not just the uncertain loan losses that matter, but also the total stock of bank liabilities (and its maturity structure). I agree that losses even at the upper end of the range you discuss could be manageable. In that case, the continuing flow deficit is likely to indeed be a bigger problem than the starting stock of government debt. Coming clean on the bank balance sheets asap is critical.
@ robert browne.
Medicine, when used, should be discriminate and based on an accurate diagnosis. An acknowledgement of personal medical history is particularly relevant: allergies to penicillin have been known to have near fatal consequences, when ignored.
Likewise, the medicine may be administered through lifestyle changes: for example dietary or exercise regimes. If a patient presents the symptoms of a bullimic or anorexic, you don´t tell her to go exercise even more and eat even less. However, if someone is obese and suffering from gallstones and gout, diabetes and blood pressure, well then those lifestyle changes might just fit the bill.
You see you and I might just agree with each other that there are sacred cows, but for me the sacred cows are overlarge – bloated infact – few in number, and with access to the corridors of power. All the other cows to my mind look lean, and getting leaner what with those sacred cows chewing on their pasture.
As Patrick has now returned to a question that he hoped (?) to have left behind him 25 years ago, what measures would he (and other citizens who want to live and work here) propose to ensure that he does not have to answer the same question yet again in 25 years time? This is political economy, with an emphasis on the political – in the sense how power is acquired and what it is used for in this society of 4m+ people on an island, off an island off the western of a land mass. To ensure that Patrick has a calm old age, must we now address – How are we to govern ourselves? How are we to allocate our resources so that we can live productively, prosperously and peacefully? How are we create and manage those resources? How can we do this in ways that are open, transparent and accountable? At least the economists have focused on resources under the control of government, both now and over the years. Other similarly well-informed groups continue in the mode of what the late Prof. John Kelly described ”Ireland’s political and official rulers have largely behaved like a crew of maintenance engineers, just keeping a lot of old British structures and plant ticking over… The challenge is to evolve structures –within which the people can be drawn to individual and community responsibility for their own development.” What Howard Kilroy (once Governor of the Bank of Ireland) said of accountants, his own profession, seems apt “They back confidently into the future with their eyes fixed firmly on the past”
George Soros is suggesting a European bond market in today’s FT: