Total Pageviews

Wednesday, 8 July 2015

Truths, partial truths and myths: Inside the Irish ‘bailout’

Alexandra Zeitz (Global Economic Governance Programme, University of Oxford)

Speaker: Patrick Honohan, Governor, Central Bank of Ireland
Chair: David Vines, Balliol College, University of Oxford

For a second year in a row, Ireland will be the fastest growing economy in Europe in 2015. Unemployment remains in the double digits and public debt is high at 115% of GDP, but the country’s recovery from its banking-cum-sovereign debt crisis in 2008 has been remarkable.

It was an honor for PEFM to host Patrick Honohan, Governor of the Central Bank of Ireland in May to hear the story of both the crisis and the ‘bailout’ from the inside.

The recovery package Ireland received from its international creditors remains contentious, its legacy hotly debated in Ireland and across Europe, since Ireland offers possible lessons for the contemporary Greek experience. Governor Honohan waded directly into the debate, structuring his remarks around the truths, partial truths and myths of the Irish bailout.

Did the government’s decision to guarantee Ireland’s banks cripple the Irish economy and directly lead to austerity?

In September 2008, the Irish government issued a broad state guarantee for all Irish banks for a year. The decision remains controversial, with critics claiming that the blanket bank guarantee was responsible plunging the country into recession as sovereign borrowing costs soared, ultimately prompting the international recovery programme and a harsh period of austerity.

The guarantee certainly prompted the debt crisis, Governor Honohan agreed, as an alarming 31% deficit called attention to Ireland’s fiscal situation. And yet Honohan still branded this view a myth. Internal adjustment was provoked not only by the fiscal burden of the bank guarantee, but also because government funding sources in the years leading up to the crisis had become very vulnerable to downturns.

In the boom years, there was an increasing shift towards sources of government revenue that would dry up in a downturn: capital gains tax, corporate tax and stamp duty. Particularly as the housing market crashed, stamp duty collections collapsed. As revenue contracted, so too did government spending.

Did the troika’s ‘bailout’ drive the economy into recession?

Honohan also branded this view a myth. The €67.5 billion programme that Ireland agreed with the IMF, the European Central Bank (ECB) and European Commission was domestically controversial, with some seeing policies forced on the country by outsiders with economic leverage.

Honohan has admitted that elements of the package, especially the high interest rate initially charged for the IMF loans. Yet he insists that the ‘bailout’ was critical to Ireland’s recovery, even if its success was never guaranteed. The programme ensured that the recession was not even worse, Honohan says, and points out that Ireland’s economic performance has closely tracked the trajectory predicted by the troika’s models.

There was a risk of the troika demanding reforms unrelated to the recovery loans. But Honohan says that the Irish negotiating team managed to head off that threat. Since debt restructuring was off the table, the troika’s policy demands for adjustment were limited. Instead, says Honohan, adjustment was a matter of “arithmetic,” of the Irish government deciding where and how to cut from the budget.

Did the Troika insist that senior bank creditors could not be ‘bailed in’ as part of the restructuring of banks?

This, Honohan pointed out, is true. The troika would not countenance a bail-in of senior bank creditors in the restructuring of Ireland’s banks. This proposal, soon popularly dubbed ‘burn the bondholders’ sowed dissent among Ireland’s official creditors.

As Ajai Chopra revealed in his PEFM presentation in March, several senior IMF staff were supportive of a haircut on bank debt. The bail-in of subordinated debt significantly lowered the cost of bank recapitalization, and imposing haircuts on senior debt would have greatly reduced the burden on the government of recapitalizing the country’s banks.

But the European bodies were very nervous about contagion effects. Losses imposed on bondholders could have provoked widespread instability across the European banking system, so they reasoned.

Honohan stresses that though senior IMF figures may now be vocally speaking out about their original support for the bail-in of bank debt, IMF leadership also refused to agree to a bail-in and the troika presented a joint front on the proposal.

Did the IMF make a loan to Ireland even though it believed it was unsustainable?

This was another fact of Ireland’s ‘bailout’. In 2010, the IMF introduced the concept of a ‘systemic risk exception’ to allow lending that could adversely affect a country’s debt sustainability in cases where the loan is deemed to help prevent contagion and spillover effects.

Just a few short months after this exception was introduced, it was also applied to the loan package extended to Ireland. IMF staff assessments of the programme for Ireland concluded that it risked debt unsustainability. But Irish banks were central to the European banking system, and the risk that crisis would seep into other markets was great.

The Irish recovery turned out remarkably well, as becomes dramatically clear when Ireland’s experience is compared to that of Greece. And yet, Honohan says borrowing countries should be wary of the systemic risk exception. Accepting a loan that is acknowledged to be at risk of overburdening the state can, in itself, be destabilizing, as the Greek experience testifies.

Ireland’s case also reveals that countries may have little choice. Irish authorities worried about the debt burden of troika loans, but accepted them anyway in order to cushion the blow of austerity. Luckily, bank stress tests revealed that the banks were less badly capitalized than expected, and the bail-in of subordinated debt also reduced the costs of bank capitalization for the government. A further, and unanticipated, blessing came as market interest rates were driven near zero by the ECB’s quantitative easing and the interest rates on IMF and EU loans, linked to market rates, came down.

Reflecting on the Irish experience, Honohan drew conclusions for Europe. The Irish ‘bailout’ reveals the striking institutional gaps remaining in Europe, which has become more than a currency union, but less than a fiscal union, he said. The severe, divisive and asymmetric shock that Europe has been through has strained shared sovereignty. But it should prompt further institutional development, so as to better respond to ongoing and future crises.

No comments:

Post a Comment