When the 'cure' only serves to prolong the disease
THE BOTTOM LINE:The German word Verschlimmbesserung could well be applied to what Ireland and the rest of the euro zone is going through right now. The noun means a supposed improvement that, in fact, makes a situation worse.
The austerity being imposed across Europe is intended to resolve the crisis; instead it is exacerbating it. Economic growth is required to lift countries out of this crisis, yet the measures designed to save us are killing off prospects of growth.
The very public disagreement between IMF managing director Christine Lagarde and the head of the euro’s political power group, Luxembourg’s prime minister Jean-Claude Juncker, over how best to tackle the latest risk of a Greek default is a depressing illustration that there is still no unity on how to resolve this crisis.
The massive shrinking of the Irish banking sector required as a condition of the State’s financial resurrection is a perfect example of Verschlimmbesserung.
The problem is compounded by the fact that it is not just the State-rescued banks that are shrinking: right across what was an over-banked sector, foreign lenders are retrenching and dumping Irish loans.
Central Bank chief economist Lars Frisell warned this week that Ireland faced a “lost decade” much like Japan’s if the Irish banks cannot lend to viable businesses while shedding non-viable loans.
What was designed to improve Ireland’s predicament is, in fact, hampering our growth prospects. It’s trying to hammer a large round peg into a tiny square hole.
Take the face value of loans across the banking sector, including the loan books in wind-down at Nama, Bank of Scotland Ireland and the former Anglo Irish Bank, and you are talking about more than €100 billion of Irish loans marked to go. The bulk of these relate to property.
But these assets cannot magically vanish; they must find a home on someone’s balance sheet somewhere.
When you consider that a normal commercial property market in Ireland involves new lending of between €1 billion and €2 billion a year, that is a colossal amount of debt to be refinanced on to the books of other financial institutions.
In the absence of heavily discounted sales of loan books to attract fresh outside capital into the State, it would take more than 50 years to refinance these assets through the last-standing Irish banks.
Selling or dumping assets into a market with little fresh finance available only makes that market even more fragile, and who exactly would want to buy assets in a market that is getting ever more fragile?
Lloyds has packaged up more than €2 billion of delinquent property loans in a portfolio called Pittlane and a transaction is expected to be concluded very shortly. The scale of the problem can be seen in the discount being applied to the loans; prospective buyers say the loans will sell for about 10 to 15 cent in the euro.
The usual international buyers of distressed debt have been circling amid the Irish banking drought but most are only swooping to feed on the juiciest parts of the Irish property carcass. There are slim pickings across much of the market.
If there is some improvement to be found in this situation, it’s in the change of approach that new owners of loans take with borrowers. Negotiating a debt writedown with a lender who bought the loan for 50 cent in the euro is far easier than with the original lender who advanced it at 100 cent in the euro. In a perverse way, it is only after the loan is sold that a pragmatic approach can be taken with a borrower when the loan’s new owner has accepted the reality of a market that the previous owner refused to accept.
Given the tight costs these distressed debt investors operate on, their preference is to work with borrowers on a new repayment schedule or towards a sale of the underlying property. Most recognise that personal guarantees, worthless when they were given, have no value now and they are more likely to remove the Sword of Damocles over debtors.
Given the kind of loans sought by buyers, debt relief will be more easily agreed on commercial than on residential property so homeowners will continue to cope with the go-slow approach of banks gripped by a fear of moral hazard.
The “extend-and-pretend” strategy is in nobody’s interest but, in a market saturated with debt and unwanted property assets and with few buyers and little fresh equity, forcing through “improvements” will leave us far worse off in the long-run.