This day marked the transfer of the first loans to NAMA, and consequently further promises of capital injection for the banks. In transferring impaired loans from bankrupt banks to a national vehicle, NAMA, the Irish state has assumed the liabilities of failed private enterprises. The scale of those liabilities is staggering. Having finally been forced to acknowledge some of their losses on loans transferred to NAMA and remaining capital requirements, the cost of the bank bailout is at last being revealed.

Anglo Irish Bank alone is likely to cost the exchequer €20bn in recapitalisations, in addition to the losses NAMA will suffer on its transferred loan book. Expect similar losses from each of AIB and BOI, who while only slightly less reckless lenders than Anglo, have far larger loan books. Overall then, the total bill will be way north of €50bn. I estimate at least €80bn, not including interest payments on the increased national debt. That is 65% of GNP just to keep 3 businesses open.

Clearly this is a debt that cannot and will not be repayed. Whatever the government’s intentions to honour its debt, it cannot wish into existence the means to repay such a massive amount of money. Ireland is bust, its banks bankrupt, its citizens jobless, and its government has just made the largest financial commitment in history!

The NAMA scheme will drain vital resources from the economy. Real growth has no prospect of returning while this financial monster sucks money out of the economy. The scheme, though it should never have started, will continue until it is finally obvious to everyone involved that there is no way it can proceed. Only when Ireland is on its knees, a hollowed-out replica of the 1980s with not a cent left in the country will our heads of state finally concede that the game is up and default. It might be 10 years from now, but it will happen. Debts that cannot be repayed are not.

In the meantime the deception continues. Welcome to the decade of pointless suffering.

Free market economics is about trade; It is the freedom to buy or sell any product or service for profit. Through this system the most desired goods are made available at the lowest cost.

Capitalism is about capital; It is about investment and property. It is the freedom to invest or to own without interference or responsibility. It is the ability to accumulate wealth through ownership.

If the free market is about generating a profit through trade, then capitalism is about accumulating wealth through those profits. Capitalism typically requires, and benefits, a free market system. A free market is required in so far as it is the most effective mechanism for generating profits for accumulation. The free market is benefited by capitalism in its investment of profit and property as working capital for businesses.

Leading the supposed recovery is China, the only major economy to not only avoid recession but achieve very high levels of growth (approaching +10% GDP) during the economic crisis. China’s growth is vital to all. Its market is large enough that its momentum could pull other major economies out of their downward spiral. However, a closer look at how China achieved its recent growth spurt reveals that it cannot last.

In response to the global financial crisis, the Communist government of China delivered the world’s largest stimulus package: a massive programme of infrastructure building and credit availability. In one sense it worked; China went to work building and investing all over the country at faster than ever levels. But it was the nature of the investment that failed.

As always happens when a central bank makes credit too cheap, malinvestments abounded. Speculative money flooded into the Chinese property market and house prices exploded, doubling and tripling in a single year. China built cities it didn’t need, set record prices for apartments, and queued around the block to buy residential property off plans. It all sounds so familiar. China today looks like Ireland did in 2004.

Much is made of China’s unique economic strength. Of its demographics and burgeoning middle class. Of its rise to become the world’s largest exporter and third largest economy, and of its inexorable rise to becoming a global superpower. I have been to China and I agree, it is dazzling in scale. Overwhelming in its industrial capacity. And remarkable in its rate of progress. One day I am sure it will take its place as the world’s largest economy. But it must still deal with economic gravity. This time it is not different. China’s property bubble will burst.

When it does the world is in for a shock. China will experience its own credit crisis and its banks will be devastated. The global economy will lose its primary source of upward momentum, and will sink back into recession. Far from saving the world economy, China will lead it into the second downward leg of the Great Recession. And next time around, we’re going to be running out of miracle economies to save us.

The one thing I will refrain from doing is timing the bursting of the Chinese property bubble. Though its implosion is certain, its date is much harder to predict. As we have learned from experience at home asset bubbles can continue for far longer than reason would predict, especially when those controlling the levers have a vested interest in it continuing. The Chinese property bubble, already at deluded heights, could burst next month or it could take years. I suspect there is still much more capacity for borrowing among the Chinese population, and their appetite for credit does not appear to be waning. But as we have seen before, the longer it goes on, the worse the eventual fallout will be.

Icelandic citizens have been on the hook for €4 billion since the British and Dutch governments bailed out savers following the failure of Icebank in 2008. Britain and the Netherlands choose to guarantee deposits in the Icelandic bank operating in their countries. Now they want their money back and think the citizens of Iceland rather than the banks’ owners should be responsible for it.

€4 billion is a vast sum for Iceland’s small economy, amounting to around 30% of GDP or €10,000 per head of population. The people of Iceland have justifiably questioned why they should be personally liable for such large debts amassed by a private enterprise. Acting in opposition to government approval of the debt repayment, 25% of Icelanders signed a petition which was delivered to their president. He has called for a referendum before will sign the bill into law [3].

Iceland’s creditors have reacted angrily, threatening frosty relationships and even to block Iceland’s EU accession unless the debt is made good [1], [2]. One wonders how far they might go if a majority of Icelanders reject the bill. Wars have been fought over less, but presumably non-military tactics would be employed, or at least an alternative justification found.

It is time that big creditors everywhere realise their money has been lost through successive financial bubbles and come to terms with it, rather than trying to wring it out of small fish without the means to pay. Iceland’s stand is a brave and lonely one. Perhaps they will be supported or even joined by other debtor nations soon, whether willingly or not.

The Anglo Money Pit

The Minister of Finance, Brian Lenihan, has achieved budget cuts of €4 billion by reducing public sector pay, welfare, and capital investment. The unions and opposition are livid, and widespread industrial action is likely. This is indeed a severe belt-tightening exercise for the country.

It is right then that we should ask for whom are we tightening our belts; For what benefit do we cut the pay of our teachers and nurses and live more frugally? Is it, as the government suggests, to close the budget deficit or restore competitiveness to the economy. Is it somehow to reduce unemployment?

No, the deficit is still running at over €20 billion per year; The improvement to competitiveness from a leaner public service is offset by the tax increases of the previous two budgets; And there are no provisions in the 2010 budget that offer higher employment.

The answer, uncomfortably, is that the entire €4 billion saved in this most austere of budgets will pay only for the recapitalisation of Anglo Irish Bank this year. And I say this year because more money will be needed next year.

This then is the cost of saving our financial system; A back-breaking budget for every broken bank. And lets not forget that we have 3 broken banks under effective nationalization, each one of which will suck in a large part of our output every year for years to come. And that is even before we add the cost of NAMA.

This is too great a burden for our little nation to bear.

I predicted that following the nationalization of Anglo Irish Bank late last year, the other Irish banks would soon run out of funding and would have to be nationalized. This would scare funding away from the Irish government’s bond market, and the state would be forced into default. The EU and ECB, I predicted, would quickly swoop in to restore funding and refloat the Irish state.

In point of fact, the ECB acted even faster than I had expected, intervening early to prevent a default in its Eurozone community.
And the Irish government, though it must have briefly contemplated the idea, chose to avoid further nationalization and do all it could to keep the remaining Irish banks in private hands. None of which however, limits the impairment of the banks or the exposure of the Irish taxpayer to that black hole.

While the steps have been rearranged, with intervention coming earlier to avoid nationalization and default, the problems remain in our banking sector. And the shuffling of deckchairs has only prolonged the timeline of the collapse.

The Irish taxpayer remains, as predicted, on the hook for the malinvestments of the country’s financial establishment. And, as predicted, aid, such as it is, is coming from the EU through the ECB. But to what end is all this frantic financial support? The ‘aid’ received from the ECB is not as I had suggested it might be, a gift, but only a further loan. The ECB appears prepared to keep lending money to the Irish government and banks indefinitely so as to indefinitely postpone default. But what good is that to the Irish taxpayer? Such ‘assistance’ keeps the zombie banking system from dying at the expense of the living citizens, who have to service this ever-increasing debt pile.

The Irish government’s current plan is to bundle all the liabilities of our failed developers and bankers into the NAMA agency and pass them, along with our ever-growing national debt onto the country’s taxpayers; Who already have the highest personal indebtedness in the world to shoulder. The ECB is happy to facilitate this transfer of liabilities because it keeps the banks open for business. It is not after all, the European Citizen’s Bureau; It is the European Central Bank and the reputation and viability of the European banking sector is its only concern.

How then do the Irish people avoid being turned into, as David McWilliams puts it, “a large debt-servicing machine”? There is but one way. We must drop the charade and admit that we are in over our heads. We have borrowed far more than we can ever hope to repay. And, as no one is willing to gift us the money we must be allowed to default.

The best and most humane thing that the Irish government, the EU, and the International community can do for the people of Ireland now is to allow them to fail. To concede to our creditors that we cannot repay them; To liquidate our banking system and property assets, retrieving from them for their creditors what little value remains; And to begin anew. With a fresh, new banking system lending unimpaired to new businesses unshackled from the mistakes of their forebears, Ireland can recover. But if it stays on its present course, it can only sink deeper into penury.

Ireland’s problem, as described in earlier posts, is an unmanageable debt burden. While government debt is relatively low for now, private sector debt (mortgages, car loans, credit card debt, etc.) is somewhere north of 180% of GDP. This gives Ireland the highest level of personal indebtedness in the world. In an economy contracting at an alarming pace, we have no chance of being able to pay it all back.

Debt default will visit Ireland in a big way. But the nature of that default will not reflect the current ownership of the debt. Instead of allowing private debtors to individually default as their personal finances wane, the debt will be assumed by the state and repayed/defaulted against collectively. This will happen through state nationalization of the banks, through which all private credit is extended.

Once the state owns the banks, it will be on the hook for the losses on all the private loans, in addition to its own public debt. In this way, the public debt that funded schools and postmen will be merged with loans for BTL apartments and pie-in-the-sky skyscraper developments.

Every taxpayer in Ireland, whether they directly participated in the housing bubble or not, will soon be on the hook for the losses of those who played a fool’s game and lost.

Crippled from the fallout of a massive housing bust, Ireland is wobbling towards default. A rocketing soverign deficit and the world’s highest levels of per capita private debt mean Ireland’s ability to service its debt is becoming increasingly precarious. But what implications does this have for the wider economic bloc of which Ireland is a part?

Sovereign default is a traumatic event even for unattached nations like Russia in the 90s or Iceland in 2008. It has dramatic implications for that country’s currency and its future ability to borrow. In most cases the defaulting country will absorb the shock, stumble, but eventually carry on. It will wear the badge of a defaultor for a time and its creditors will be more cautious in their future dealings with it.

Can Ireland be allowed to default like this? Ireland is a member of the Eurozone, the 16 nation EU single currency zone. As such its debt obligations affect the standing of the shared currency. A failed member state, even a small one like Ireland, could badly damage the credibility of the currency. Which begs the question of whether the EU could allow a Eurozone member to default? Larger Eurozone members would have to consider coming to Ireland’s aid to avert damage to their own currency. This is the reason why Ireland’s bailout will come from Europe, with Germany reluctantly cleaning up Ireland’s mess.

Ireland’s economy is only 1/50th of the overall Eurozone’s, and could easily be picked up by other members. But the systemic threat comes from the fact that Ireland is not alone among Eurozone members in courting default. Ireland’s position may be the worst, but Greece, Portugal, Spain and Italy all have problems that place them at higher than normal risk of default. Were Ireland to be rescued, these other states may also demand rescue. And that is a bill that the EU cannot easily shoulder.

Such an event could greatly alter the structure of the EU. Consider the following crisis scenario from FT Deutschland; Substitute if you wish Ireland for Greece in the opening act, who the CDS market now rates a higher risk of defaulting.

But that does not mean that a breakdown of the euro area is inconceivable under all scenarios. Let us start with the hypothetical scenario of a Greek payment default. If the German finance minister, as I would expect, were to insist pedantically to apply the no-bail out clause, the crisis could, within hours, spill over to Portugal, Ireland, Spain and Italy, where bond spreads would be shooting up. Hedge funds will suddenly have discovered a good opportunity to make up for previous losses. Finance instruments such as Credit Default Swaps (CDS) are imminently suited to this type of speculation: If you stock up with Portuguese or Italian CDS during one of the panic runs, you stand to make very large profits. This in turn accelerates the domino effect of the crisis, and market interest rates will go up to double-digit rates all over southern Europe. The EU will hold an emergency summit at which it becomes clear that it is too late for a general bailout. This would have worked in the case of Greece or Ireland. But Italy and Spain are simply too big.

The summit would summon experts who tell the prime ministers that there are only two alternatives. Either the euro-area is dissolved with immediate effect. Or, one creates an imminent fiscal union, starting with single the European issuance of all future debt, and the transformation of all existing debt into a single European bond. The member countries would lose the sovereignty over budgetary politics. The finance ministers would receive their daily marching orders from Brussels. This would, of course, require a whole new EU Treaty, which the prime minister would have to agree on almost in real time.

I am not sure how Germany’s political leadership would jump when confronted with such a stark choice. Jean Quatremer, the Brussels correspondent of the French newspaper “Libération”, asked on his blog on Tuesday whether Germany is still a European country? The political instincts of Angela Merkel and Peer Steinbrück have been clearly anti-European during this entire crisis. They have prevented any real economic coordination with persistent reference to the national interest.

Ireland’s calamity has been so great that it must be recused before it threatens the entire European project. What price the EU will extract for its rescue, and how it will change both Ireland and the EU remain to be seen.

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.