The Irish Economy

This post draws attention to two recent examples of best current practice for dealing with a problem bank that is not indispensable to the economy.

Key lessons: no need for capital injections if the bank is not going to survive; no protection for unguaranteed subordinated debt holders.  In a nutshell, the problem bank is wound up; the guaranteed depositors transferred to a strong bank.

While it is now clear that Lehman Brothers was too large and complex a bank to be wound up, this is not true of many other banks. Indeed, even since Lehmans a number of quite large banks have been intervened.  The cases of Washington Mutual and Bradford and Bingley are instructive for any authorities faced with a problem bank whose continued operation is not vital to the economy.

These banks were seen by the authorities as having no viable future, and as not being indispensible to the economy.  Their continuing business was transferred to other banks.  Government only injected sufficient funds to cover insured depositors: no new capital was needed as the rump banks were gradually being wound up.  Holders of uninsured and unguaranteed subordinated debt and preference shares faced heavy losses (they had been earning higher interest in recognition of default risk).

More detail:

On September 25th, 2008, Washington Mutual, one of the largest banks in the US, was intervened by Federal Authorities.  Its insured deposits and mortgage book was sold to the bigger bank JP Morgan Chase.  Retail customers were able to continue access their accounts the following morning and in the same old branches, but now owned by JPM.  Little or nothing was left to pay WaMu’s $22.6bn in unsecured debt, let alone the shareholders.  See: www.fdic.gov/bank/individual/failed/wamu.html

On September 29th, 2008, Bradford and Bingley, a large UK mortgage lender, was intervened by the British Authorities.  All of the deposits were transferred to Abbey National and depositors had continued access to their funds through the B&B branches, now operated by Abbey.  Mortgage holders continued to make debt service payments to B&B, now owned by the Government.  Subordinated debt holders will lose much of their investment.  See: www.hm-treasury.gov.uk/press_97_08.htm

The Financial Times this morning carries the story of Sean FitzPatrick’s departure from Anglo Irish Bank. The article provides links to the “AIB Statement” and “AIB Chairman’s Statement.” There’s a reason the media in this country use Anglo as shorthand for Anglo Irish Bank.

Carmen Reinhart and Ken Rogoff have released a new cross-country empirical study “Banking Crises: An Equal Opportunity Menace“.   Their analysis shows that the average fiscal impact of a banking crisis is to increase the level of public debt by 86 percent, such that the public debt nearly doubles.  They also show that the typical duration of a housing bust is 4-6 years.

Such cross-country averages are useful benchmarks and it is useful to think about the reasons why the current Irish crisis might deviate from such patterns.

Update: Reinhart and Rogoff have also just released a much shorter companion paper “The Aftermath of Financial Crises”  [to be presented at the January AEA meetings in San Francisco].

The Irish government’s economic recovery plan can be found here. This report has a wide-ranging agenda.

For university-based economists, the following section is especially interesting, since it may represent an important shift in the government’s approach to funding research:

“The creation of more concentrated research-intensive excellence will enhance the country’s reputation internationally and its ability to attract top-level researchers and will underline Ireland’s intentions in terms of the development of the Smart Economy.  It will also enhance the international exposure of Irish
universities and institutes of technology.” (page 75)

A busy day for CSO releases.   The quarterly national accounts are published here, while the BOP data are here. In addition, the CSO released the 2006-2007 data for services trade, which can found here.

A striking feature of the data is the wide divergence between GNP and GDP for Ireland, with the most worrying data point being the 0.9 percent decline in GNP during the 3rd quarter (corresponding to an approximately 3.6 percent contraction at an annualised rate).   The widening of the current account deficit, despite the slowdown, signals the external competitiveness problem.