Revealed: the great Irish bail-in

Financial repression is a term popularised by the economists Ken Rogoff andCarmen Reinhardt, well known for their extensive research into what happens after a debt crisis.

The eminent professors got into a spot of bother when other researchers tried to replicate their results - there was an ugly spat over the forecast that big trouble invariably hits an economy once a 90 per cent debt/GDP threshold is breached.

An elementary spreadsheet error didn’t help and interest drifted away. This was a shame – lots of good ideas and insights got lost in the controversy, not least the observation that, historically, governments everywhere invariably deal with legacy debt problems with financial repression of one form or another.

The most obvious, and quite normal, way for debt to be magically disappeared is to default. This was the dreary debate over bailing in the bondholders.

Here, bail-in is just another way of saying repress: the bondholders don’t get their money back. As we know, that wasn’t to be.

The use of the phrase bail in is not just a euphemism for default – sometimes, bondholders are forced to swap their bonds into equities. But the euphemisms can proliferate in a confusing way.

In Cyprus, for example, we observed the bail-in of some ordinary depositors who were forced to take losses on uninsured bank deposits, usually those in excess of €100,000 – some depositors became creditors rather than share holders, hoping for a claim on any potential asset recoveries. In the ugly jargon surrounding these matters in the Cyprus case the bail-in was more of a haircut.

All pretty normal stuff for non-financial bankruptcies: as Reinhardt & Rogoff observed, it is always about monetary repression of one kind or another.

Governments used to repress their bondholders with inflation. This was a miracle cure for debt overhangs and always worked a treat. Well, nearly always – hyperinflation certainly wiped out, completely, the bondholders but had one or two other nasty side effects. In any event, in Europe the legacy of German inflation experiences of the inter-war years means that the usual way of imposing losses on bondholders, creeping inflation, is no longer an option.

Although obvious now, this was never discussed around the time of the Euro’s creation: a zero inflation world has lots of implications, few of them positive.

So, repression has to take other forms, particularly in those countries that habitually have turned to inflation to sort out previous messes. Ireland, for instance, has regularly inflated past debt problems away: what options do we have now, what other forms might repression take?

We start from the proposition that somebody has to be repressed. If it isn’t the bondholders it has to be someone else. So, we inevitably start with the taxpayer. Actually, several generations of taxpayers. In a sense, we have all been bailed in. But the cute policy maker wouldn’t stop there. He would ask a very simple question: where is the money?

There are three pots of wealth in Ireland which, when added up, comprises almost the entire stock of personal sector wealth: houses, pension funds and bank deposits. Our policy maker looking for bail-in candidates might be tempted to look at all three. But in the spirit of the creeping inflation tax that he used to use, he will try to act under the radar.

Pension funds are an easy target: pensions bore and terrify people in equal amounts, so nobody under 55 ever thinks about them. So a temporary levy can be put on pension funds, since hardly anybody will notice. Levy always sounds slightly kinder tan tax – less permanent anyway. Bail-in number one achieved.

Property is trickier to tax but it would help if we could blame somebody else, like the IMF or ECB, for imposing it and wrap it nonsense about funding local authorities. That’s our second bail-in.

The third bail-in candidate, the bank depositor, is too difficult to contemplate.

The thought of Cyprus-style haircuts is an appalling vista. Only one, extremely fanciful, possibility presents itself. The government now owns the banks that own the domestic property market. Nama owns the commercial property market. What if we can persuade the bank depositors, particularly the larger ones, to buy property, preferably over-priced property? Turn those big cash depositors into cash buyers of real estate? Property prices quickly get bid back up; we can off-load the loans and the real estate back into the private sector at good, if not over-the-top, prices. Bail in number three.

Financial repression? Done.