Saturday, October 23, 2010
Ireland counts the rising cost of rescuing its banks

BILL HICKS, a chain-smoking comedian, loved to ridicule the “eternal-life fantasy” of the non-smokers in his audience. “Non-smokers die every day,” he jeered. “And you know what doctors say: ‘If only you smoked we’d have the technology to help you. It’s you people dying from nothing that are screwed.’”
This twisted logic seems now to apply to one of Europe’s most troubled economies. Ireland looks like an abstemious jogger that has suffered a heart attack. The yield on its ten-year government bonds neared 7% on September 29th, a record spread of 4.7 percentage points above those of Germany. Ireland has tried hard to fix its problems. Public-sector wages have been slashed and new taxes raised. The economy is already flexible. As its troubled banks eat up ever more cash, it now seems short of options to return it to health.
Contrast that with Greece’s flabby economy. It acted belatedly to address its troubles, and only then as a condition of a €110 billion ($145 billion) bail-out by the European Union and the IMF. But at least it can now tell a story of how the country’s ambitious reforms will bring it redemption. Greece is on target to cut its deficit to 8% of GDP this year. Spain too can point to a shrinking budget deficit and less stressed banks. Portugal, however, is slipping back: its budget deficit is likely to be bigger than last year, when it was 9.3% of GDP. The opposition is refusing to back the minority government’s 2011 budget (it wants spending cuts, not more taxes), making bond markets nervous.
For now, though, Ireland holds their attention, thanks to growing clarity about the scale of banks’ property-related losses and the amount of public money needed to rescue them. In March Ireland’s central bank said that the country’s three biggest banks must raise €28.4 billion of equity to meet a new requirement of 8% core Tier-1 capital by the end of the year. It said Anglo Irish Bank, a hugely reckless property lender that had been nationalised in January 2009, would alone need €18.3 billion. The reckoning took account of the likely losses from transferring the banks’ worst loans at a discount to NAMA, Ireland’s “bad bank”.






The Irish government injected €8.3 billion of capital into Anglo in the form of a “promissory note”, essentially an IOU. In August the value of the promissory note was bumped up to €18.9 billion, only a bit more than had been indicated in March but enough to make markets fret that bank-rescue costs were still rising (see chart).
On September 30th the bill did indeed increase. The central bank determined that Anglo needed another €6.4 billion in capital, to take account of bigger losses on NAMA assets. It doubled the cost of recapitalising Irish Nationwide Building Society (INBS), a small but troubled state-owned lender, to €5.4 billion. Ireland’s finance ministry said Allied Irish Banks might find only half of the €10.4 billion extra capital it needs by selling assets abroad. The rest will be raised by a rights issue, underwritten by the National Pension Reserve Fund (NPRF), a pot of money set aside to fund future welfare costs. At least Bank of Ireland, the country’s biggest lender, has enough capital to meet its new requirement.
Ireland’s government had hoped to keep this year’s budget deficit to around 12% of GDP. But the extra cost of fresh capital for Anglo and INBS will raise that to 32% of GDP, increasing public debt to 98.6% of GDP. On plausible assumptions Ireland’s gross debt may exceed 115% of GDP before it stabilises. Even that relies on a sustained economic recovery which is far from assured. Figures published on September 23rd showed that Ireland’s GDP fell by 1.2% in the second quarter. Recent data are more encouraging, says Gillian Edgeworth at UniCredit. But there is no sign yet of a convincing pickup in tax revenues.
The government plans a further €3 billion of measures to cut the deficit when it announces its 2011 budget later this year. Some are calling for more drastic action, though that would stiffen the headwinds blowing against a fragile economy. An alternative would be to force some bank losses onto creditors. The blanket guarantee on all bank debt and deposits made by the Irish government in September 2008 has now expired (though a separate scheme for new debt issues is being extended until the end of the year). That creates some limited scope to share the banks’ losses. Ireland’s finance minister, Brian Lenihan, ruled out imposing losses on senior creditors, but said he expected subordinated debtholders to take a hit. One option would be to buy back Anglo’s €2.4 billion of such debt at a heavy discount to its face value. Such a trick has been used to boost Anglo’s capital before.
Ireland hopes that ending the uncertainty about the cost of bank rescues will drive a wedge between itself and the euro zone’s other troubled countries. Being bracketed together does not just scare away risk-averse lenders. Investors seduced by Greece’s 11% yields may wish to hedge their bets by selling the bonds of other euro-zone countries with weak public finances and poor growth prospects.
There is speculation that, if bond yields rise further, Ireland and Portugal might soon be forced to borrow from the European Financial Stability Facility (EFSF), the €440 billion fund established in June for struggling euro-zone countries. That is unlikely. Ireland has already raised enough money to finance this year’s borrowing requirement (it will spread the cost of bank bail-outs over several years) and has a big cash buffer besides. Portugal, too, is not anything like as desperate for cash as Greece was in the spring. But if Ireland were eventually forced to borrow from the EFSF, the fund might find it hard to impose conditions harsher than the ones it has volunteered for already. You cannot ask a non-smoker to give up cigarettes.