Austerity for Lenders

Here is rather shocking data on Ireland’s debt situation from the BIS by way of the BBC:

BBC – Peston’s Picks: Why Ireland can’t afford to punish reckless lenders to its banks

“Total foreign bank exposure to Ireland’s economy is $844bn, or five times the value of Ireland’s GDP or economic output. Of that, German and UK banks are Ireland’s biggest creditors, with €206bn and €224bn of exposure respectively.

To put it another way, German and British banks on their own have each extended credit to Ireland greater than Irish GDP.”

With that in mind, consider that last month Peter Sutherland, former EU commissioner and chairman of Goldman Sachs International stated in a speech that Irish wages are too high. According to the Independent,

“Mr Sutherland highlighted the positive reception abroad to Ireland’s budgetary discipline of recent years. But only before calling for cuts in the upcoming Budget to go further. He said policymakers should look to cut beyond the target of €3bn.

“Ireland’s principal fiscal problem is its large primary deficit (rather than a large outstanding debt level).”

Tackling the deficit was, therefore, the key to the current crisis. In addition to calling for further cuts in the upcoming budget, he launched an attack on salaries, saying that costs in the Irish economy remained far too high.”

If the Irish were to implement Mr. Sutherland’s recommendations, that would increase the difficulty of paying back the obligations to foreign banks described above; due to the reduced cash flow from lower wages.

While Sutherland is correct that at the moment, Ireland’s most pressing problem is the primary deficit that is because the interest cost on the country’s sovereign debt issuance going forward will likely be high. Because of that the country cancelled upcoming debt issuances that had been previously scheduled, having already borrowed enough cash to avoid new issuance in the short term. However, the enormous total external debt is hot on the heels of the short term funding issue; and there is no apparent easy solution to this.

The question that Irish citizens should be asking themselves is why they should endure draconian austerity measures in order to make whole creditors that lent recklessly on projects in Ireland. The approach of political and financial leadership in Europe and the US thus far has been that taxpayers will bear the burden of poor investments in order to make whole banks and their depositors. In other words, one would expect that as Ireland’s foreign bank exposures come due the government will issue sovereign debt to cover those exposures; as the individual debtors will not be able to repay. The sovereign debt would then require significant increased taxation for the foreseeable future to have a chance of being repaid.

A recent survey of business sentiment in Ireland showed that “confidence in the Irish economy is falling despite an apparent stabilisation in certain business sectors”.  An economist associated with the survey commented on the results as follows:

“The lack of confidence in the economy as a whole is the one thing that stands out in the latest survey,” he said.

Overall the survey’s results are fairly similar to the last quarter yet confidence has fallen significantly.

“To us, this is proof that uncertainty has a cost. Businesses are looking at the banking crisis and waiting on the Government’s four-year budgetary plan, as well as the wider concerns about a slowdown in the US and UK, and they simply don’t know what to plan for,” he added.

“Until the Government gives details of the four-year plan, most businesses are likely to hold off on employment or improving their business. They need to know what’s coming down the tracks at them before expending more capital.”

Lack of confidence among business owners will contribute to a very slow recovery in Ireland.

One measure that would likely reduce uncertainty is a wholesale restructuring of Irish debts where foreign lenders recognize the true, much lower values of the cash flows they can expect from having invested in Ireland. The country simply cannot generate the cash flow sufficient to keep current with its obligations as they are currently structured. Sovereign borrowing to cover these obligations only postpones the inevitable crunch, and would add significantly to the total debt through interest due. Ireland is experiencing austerity now regardless of government fiscal changes; its lenders will experience the same, sooner or later.

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