The Endgame: What happens next?

Developments in the Irish economy are gathering pace, and we are entering the endgame period of this economic cycle. With so much happening in the economy, lets look forward a few months into the future to see how the endgame is going to play out.

Nationalisation of Anglo Irish Bank

A withdrawal of deposits from Anglo Irish Bank threatened its viability last week. This moved the Minister for Finance, Brian Lenihan, to take the bank under full state control. The nationalisation of this bank, whose €80bn balance sheet faces major impairment, is the impetus for all that follows.

Share Price Collapse

Following the nationalisation of Anglo the share prices of the remaining large Irish banks, AIB and BOI, will collapse to near zero levels. This collapse began Monday 19th January, and will continue until the share prices are so low they threaten the viability of the banks, in the same way as happened to Anglo.

Nationalisation of AIB and BOI

The state will be forced to take control of Ireland’s remaining large banks, AIB, BOI and likely PTSB and NIB. The biggest of these banks differ from Anglo in that they are of genuine systemic importance to Ireland’s economy. But they share Anglo’s fate as becoming vessels of the state and in the manner in which they will be nationalized. The market will demonstrate such a loss of confidence in them by collapsing their share prices that they will be unable to rollover their debt. A run on these banks is unlikely to happen from Irish depositors, who have no other Irish banks to run to, but some substantial deposits may be withdrawn by institutional depositors, as happened with Anglo.

Sovereign Default

On assuming the liabilities and bad debts of Ireland’s toxic banks, the Irish state will also inherit the market’s disdain for them. CDS spreads on Irish sovereign debt will explode and ratings agencies will belatedly downgrade Irish debt. Ireland needs to raise huge amounts of new debt on international money markets in 2009, including €20-25bn for a fiscal shortfall, and a potentially near-unlimited amount to meet bank losses, in addition to bank rollovers which will become the duty of the state.
The markets will have no appetite for this debt, whose scale is preposterous in comparison to the country’s fortunes. Ireland will be unable to meet its debt obligations and will default.

EU and IMF Intervention

With no recourse to normal money markets to raise debt, Ireland will have to accept a loan from a lender of last resort. This will be the EU or ECB in the main, with additional funds coming from the IMF. The EU will accept this burden for the sake of its political and monetary union. It cannot allow one of its members to sink without trace, particularly one inside the Eurozone. A complete collapse of the Irish banking system and sovereign could threaten the European currency. That risk is so great that Brussels (and Frankfurt) will loan, or even gift many billions of Euros to Ireland to refloat the state.
This intervention must carry a price. It will certainly include ratification of Lisbon II at a minimum. It may also include greater control over Irish affairs from Brussels, perhaps no bad thing? And the IMF portion of the loan will be used to demand stripping of the public sector and sale of state assets.

If this sounds unthinkable now, alarmist or even dangerous, consider what was believed unthinkable just 6 months or a year ago. The collapse of Irish house prices and the ISEQ, the spiraling budget deficit, the nationalisation of the high-flying Anglo Irish Bank, all these sacred cows were sacrificed to reality. The endgame, appalling though it is, is irreversible. The damage has been done and our course has been set. And though we may for a while lose our prosperity and even some independence, we should welcome any lines that are thrown us, and be thankful that we were not left to drown alone.

Tags: anglo, banks, crash, default, economics, endgame, imf, ireland, nationalisation