ANALYSIS:OVER THE last few months, our policymakers' attention has been focused on debt and recapitalisation of the banking sector. Meanwhile, the other elephant in the room waits to be noticed. Hundreds of thousands of households face (at best) static mortgage and consumer credit repayments, against emerging negative equity and falls in real after-tax incomes. Tens of thousands of enterprises feel the weight of unsustainable debt.
The absence of a policy response regarding non-financial institutions is a serious impediment to current and future economic growth and a potential source for social instability.
Staring into the headlights of the banking sector crisis, policymakers and social partners seem to have forgotten the main engine of Irish domestic growth since 2002-2003 – households and non-financial companies.
Proposals circulating at the partnership talks contain at best only peripheral ideas on repairing the real (non-financial) side of our economy. Yet the magnitude of the debt problem facing these core sectors is simply staggering and dwarfs that of the banks.
According to the latest figures from the International Monetary Fund and the Bank for International Settlements, total gross indebtedness of Irish residents, that is the State, the banks and the non-financial personal and corporate sector, stood at a gargantuan €1,671 billion at the end of 2008. This is over eight times national income, and compares to a mere €504 billion at the end of 2002 and €970 billion at the end of 2005. The greater part of the rise in this debt arises not from the State – its debt merely doubled from €27 billion in the fourth quarter of 2005 to €51.2 billion by the third quarter of 2008 (or €77.1 billion if the monetary authority liabilities are added) – but from the private sector.
The debt owed by the private sector rose from €876 billion to €1,594 billion over the period. Much of this represents real borrowings by Irish people and companies. As of September 2008, €591.2 billion in debt securities was outstanding by non-financial domestic companies – up from €473.6 billion in December 2006. Overall foreign claims on the Irish economy stood at a gargantuan seven times our national income. In absolute terms, this mountain of debt is one-sixth of the USA’s and greater than that owed by Japan.
On any reasonable metric, Irish households and indigenous companies are the most indebted in the entire EU. Put more starkly, when it comes to overall solvency prospects for Irish consumers and small and medium enterprises, we are ranking dead last across Europe.
Using IMF data and factoring in our liabilities arising from foreign direct investment, Ireland’s total personal and corporate indebtedness, net of borrowings by international and domestic financial institutions based here and public sector debt, stood at €790.8 billion (more than five times our GNP) at the end of 2008.
A further worry is the structure of this borrowing. Again from IMF data , as of June 2008, Irish borrowers had outstanding €69 billion in domestic and €194 billion of international debt securities with a remaining maturity of 12 months or less, implying that the Irish corporate and personal economy faced a total debt payment bill of some €263 billion in July 2008-July 2009 alone. Of this €65 billion is maturing corporate debt. Adding in interest payments, this implies that the Irish corporate and personal sector faces finding close to €300 billion in total redemptions over that period. That is a real credit crunch. Such a burden can only lead to increased bankruptcies, and we already see this feeding through.
In 2008 Irish companies were nearly five times more likely to go bankrupt than they were in 2002. Latest figures show that some 21 per cent of Irish companies have negative balance sheet net worth, with total company assets having fallen below company liabilities. The corporate economy as a whole is technically insolvent, but not necessarily bankrupt if, and it is a big if, it can generate enough cashflow to keep servicing the debt.
This year will also see personal bankruptcies increase. Meanwhile, we do not have a well-structured personal bankruptcy code, which inevitably results in the poorest and the newly unemployed running the risk not only of massive perennial indebtedness but imprisonment for non-payment. Increases in personal bankruptcies and repossessions cases hitting Irish courts are the effect of housing over-inflation and borrowing overstretch over the last half decade.
As it takes on average 18+ months for cases to be brought to courts, 2009 will see the first rise in the numbers of home repossession orders and personal bankruptcy hearings arising from the beginning of the housing collapse in 2007. 2010 and 2011 will see further increases in the numbers of people losing their homes and good credit standing. Good credit ratings are vital, especially for those on lower incomes, if they are not to fall into the hands of moneylenders.
If we are to work this debt mountain down then three things need to happen. We need to stop inflating it – this requires a rapid return to prudence in both lending and borrowing; we need to earn more – which will be difficult in 2009-10 as the economy contracts and tax increases; and we need to ensure that the tax system is structured in such a way as not to divert savings, investment, expenditure and borrowing out of real productive investment.
We must also ensure that taxpayers’ funds used for bank recapitalisation deliver an added benefit of helping to deleverage Irish household balance sheets. One example is to recapitalise via a voucher-type approach. This would involve the State issuing shares to the banks, which would then be used for recapitalisation. These would be transferred directly to Irish households, improving their long-term financial positions and in future generating capital gains receipts for the exchequer.
To prevent short-termism and the re-inflation of the credit bubble these would have to be held for a defined period of time; no personal lending which used them directly or indirectly as collateral would be possible.
A further problem is that this private debt can, in part, easily end up as public debt. That part of the private sector indebtedness outstanding to the Irish banking sector is covered by the Government guarantee. In addition, as corporate and personal defaults grow, so too grows the hole which the bank recapitalisation is intended to fill. Both, ultimately, end up increasing State liabilities and the cost of State borrowing. This in turn results in a need for further deflation via reduced State expenditure and increased taxes and charges, weakening still the non-financial sector. A malign cycle emerges. To counter this, a swift and early action is required to restore Irish households’ confidence in our future and their own ability to withstand the crisis. However, to date swift action has not been a hallmark of this Government. It remains to be seen if any action will be take.
Brian Lucey is associate professor of finance at the school of business studies in Trinity College Dublin; Constantin Gurdgiev is a research associate in the department of economics in Trinity College Dublin