Seeds of crisis, and necessary solutions, lie in euro zone interdependence


WORLD VIEW:We have seen the weaknesses of pooled economic sovereignty – but strengthening it is in Ireland’s interest

‘THE BANKS could bring down Ireland and Ireland could bring down Europe.” So Brian Lenihan summarised the fear expressed by European Council president Herman Van Rompuy. It is a remarkable journey from a national “systemic” financial crisis in 2008 to a euro zone one two years later. The seeds of the second were sown in the first – and so are the necessary solutions. Ireland’s misfortune can be turned to advantage by a clearer understanding of these realities.

At stake is the probability of an entire system breaking down, rather than its individual components. The Government’s decision on the night of September 30th, 2008, to guarantee the entire Irish banking system’s depositors and bondholders to the tune of €440 billion was based on such assumptions. Bank assurances that this was a crisis of liquidity look entirely disingenuous now as it became one of solvency in the next two years.

Had this deeper crisis been better understood, Irish bank bondholders might have been asked to pay as much as taxpayers through restructuring and debt-for-equity swaps. But this was not to be. Ireland Inc, including most of its citizens, parties, media and economists, bought into the credit boom so comprehensively that it became craven to as well as dependent on the finance capital underpinning the boom. For the Government the crisis was indeed systemic economically – and also ideologically and sociologically, threatening the complex of crony capitalism that drove the boom.

Critics who disputed the risk was systemic were told the banks are thoroughly interdependent and hence needed an overall guarantee. Those like Richard Bruton who advocated bondholder haircuts were vilified as threatening future capital flows. Media, regulators and economists were too slow to report on and understand how the property boom was connected to the credit system, as wholesale money flowed from European banks into Ireland after the euro was introduced. Middle-class citizens using it to buy new and second homes were similarly unaware – and uncaring. Now that period’s “me journalism” has been replaced by an anguished “we journalism” lamenting the loss of national sovereignty.

That these financial flows are real indicators, even predictors, of future problems became clearer in the run-up to this latest euro zone convulsion. Figures for June 2010 from the Bank of International Settlements show Ireland’s total $731 billion government, bank and private international debt exposure distributed as follows: Britain $149 billion; Germany $138 billion; US $69 billion; Belgium $54 billion; France $50 billion; Japan $27 billion; Others $244 billion.

It is instructive to track the concerns expressed about Ireland’s liquidity/solvency by George Osborne, Wolfgang Schaüble, Timothy Geithner, Van Rompuy and Christine Lagarde against these figures. Their sheer scale is best appreciated when compared to Spain’s total debt exposure of $876 billion, Greece’s $175 billion and Portugal’s $235 billion. One can readily see from this that the EU’s €750 billion fund agreed in May could (just about) cover a combined crisis in Ireland, Greece and Portugal, but not a threat to Spain as well.

A drying up of international credit and a withdrawal of corporate deposits from Irish banks triggered the EU’s decision to call in the IMF this week. The European Central Bank was exposed to €130 billion at the end of October compared to €95 billion at the beginning of August, 25 per cent of its total. Because of the bank guarantee in 2008 this is seen as public not private debt, a reality spelled out by the Brussels-based economist Daniel Gros: “You and your banks are one thing.”

Sovereign decisions made that so. But as Lenihan also said, having decided to pool economic sovereignty, we become part of the wider whole when it too is threatened systemically by Irish policy mistakes. This EU/IMF intervention definitely reduces sovereignty but does not abolish it. Deftly handled, it can encourage recovery. Undoubtedly it opens up EU bargaining on corporate tax and other issues, but legal and political safeguards are still in place. Thought should turn to how the EU as a whole should handle the crisis and how that would best serve Irish interests.

Ireland and the EU should beware of a short-term solution that would see new funds used only to shore up the banks, leaving others vulnerable.

Another trigger for this crisis was German insistence on bondholders sharing the costs of insolvency, if only after 2013. That is too late. It is time to create an overall EU mechanism for restructuring sovereign debt. This would confront rampant finance capital with the strength of a pooled sovereignty, even if French, German and British banks had to take a hit. The EU has always developed incrementally through crises. This one opens up the need for a deeper fiscal union, more capable of handling such traumas. That too would be in Ireland’s longer-term interest.