Thursday, 30 September 2010

Where did Ireland's money go?

Whenever I see some huge figure for an institution's "losses" I am suspicious. Ireland has now supposedly spent about 55% of its GDP, or €100 billion, to bail out its banks and buy toxic property assets from them.

But they haven't created anything with this money - it hasn't been spent on goods or services. In fact, it's just a transfer. So where is the money now, and has anything of economic value actually been lost?

Partly the story is similar to that in the UK - lots of people who had a property and sold it in 2007 have made a ton of money. Many of the people who bought the properties have now handed the properties - and the debt - over to the government. But at average Irish house prices, that €100 billion is about 500,000 houses - and surely that number of people did not exit the housing market (in a population of 4.4 million). Even if they had, the government has certainly not foreclosed on (or acquired) 100% of the relevant mortgages.

Beneficiaries in this case: homeowners who sold out, or downsized, at the right point in the market.

New houses have also been built. About 90,000 houses a year were built at the peak of the market, and no doubt lots of them remain unsold. In fact, there was an oversupply of about 250,000 houses at the peak of the market in 2007. Certainly a high proportion of those might have ended up in the hands of the government - but again, surely not all of them?

In this case, the beneficiaries are likely to have been builders and construction suppliers, especially in the mid-2000s.

In fact, lots of the debt acquired by the government is likely to be securitisations of existing mortgages and not new build. In these cases, the lenders who historically held the mortgage asset - or traders who have bought and sold it along the way - will have gained at the expense of the new owner, the Irish taxpayer. So some of the money has simply been transferred to the private sector or out of the country.

So there are three sets of people who have benefited from the property boom (some of whom might have been directly bailed out by the government, but most of whom already had their money free and clear). Old homeowners, builders, and the shareholders of banks inside or outside of Ireland who sold mortgage securities at the right time (not those, like Anglo Irish or Allied Irish, who bought them).


Ireland's property boom was fuelled by an expectation that its economy would continue to catch up with - and perhaps overtake - Germany, the Netherlands and the other richer eurozone economies. And on the assumption of continued immigration. Had that continued, Irish property would still have been worth a fortune, and those who borrowed would have been able to sell off the houses, or refinance, and there would be no problem.

And if the European economy can be restarted, and especially if it can be brought back to its previous trend line (so the output gap closes and Ireland returns to its place as a high-growth overflow supply source for EU-wide demand), all the property assets inadvertently acquired by the Irish government might be worth something after all.

So European Central Bank - it's time to step up. Yes, you've provided a few hundred billion of loans against government bonds and bank assets. But you're expecting to get paid back on those.

There's a potential saviour, oddly: if the ECB's loans do go bad, at least the money they've paid for the bonds will go towards creating an extra monetary stimulus to assist European economic recovery. But with the ECB's current attitude, it seems that may be the only way to get one. If the borrowers manage to muddle through and keep paying back what they've borrowed, meaning neither monetary nor fiscal stimulus can operate, then the EU will continue to stagnate.

Either way, if the ECB refuses to print more money, then as Stephanie Flanders says, Ireland's problems will soon land on the shoulders of the rest of the EU. The German government really ought to withdraw its implicit veto on quantitative easing.

Update: One note of interest. The Irish state, as we know, has bailed out its major banks. What they have not done - as far as I can determine - is directly funded those banks, to the full extent of their debts, with public cash. Instead, they have injected a smaller amount of capital, in order to keep the bank (now under public ownership) solvent. The large figures given above primarily consist of implicit promises to pay the banks' debts as they fall due.

Note that this creates a huge temptation, intermediate between actual sovereign default and no default at all. If the Irish government is short of €10 billion at some point next year, it could simply change its policy on bank guarantees and let Anglo Irish default anyway. This could be presented as not a real sovereign default - the Irish state can still pay its bills - but just a decision to step away from its guarantee of the banking system.

Would that be any less bad than a "real" default? I don't know. But the possibility will surely be a huge focal point for risk.

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