German solution seems irresistible to Irish people but not to the State


BUSINESS OPINION:Why is the Government against accessing the European Financial Stability Fund?

IRELAND, WE are led to believe, is a source of endless fascination, no little bafflement and some affection for the Germans. Right now they must be wondering why their chancellor, Angela Merkel, is being blamed for our latest crisis by the Taoiseach when she appears far more in tune with the Irish national mood than he does.

At a very fundamental level, all the German chancellor wants to do is change the rules of global finance so that the investors who lend money to feckless governments and banks must share the cost when things go wrong and thus be incentivised to act more responsibly. It’s a sentiment that pretty much everyone in Ireland would support.

Her proposals have an added populist attraction in Ireland as, inter alia, they would involve the burning of bank bondholders, the cause célèbreof much of the economic commentariat. This is because it is hard to see how Ireland could restructure its own debt – the nub of Merkel’s plan – without also restructuring the debts of the almost completely nationalised banking system.

Merkel must also wonder why the Government and the financial establishment are so opposed to her plan when accessing the European Financial Stability Fund is arguably the best way of getting funds for yet another bank bailout, but this time one that might directly benefit the electorate.

It is looking more likely by the day that the Government will have to – and indeed should – put more capital in the banks. One reason is that if the more pessimistic assessments of the mortgage market – as epitomised by the views of UCD’s Morgan Kelly – are proved well-founded then the bank’s current capital buffers will not suffice.

If Kelly is proved wrong – and let’s hope he is – it may still be necessary to put more money into the banks to win the confidence of investors. The trend is towards overcapitalisation and Patrick Honohan, the Central Bank governor, acknowledged this point last week.

But from the public’s point of view, the tangible benefit of putting more money into the banks is that it would allow them engage in the sort of widespread private debt restructuring that looks set to be the next big policy dilemma.

The report of the Government working group on mortgage arrears and private debt is due any day now. It is expected to recommend various measures aimed at easing the burden on heavily indebted individuals to prevent them being a drag on recovery. Its recommendations will no doubt be constrained by the reality that the banks have very little money available to facilitate any substantive moves in this regard.

Views diverge as to whether there really is a need for some radical action in this area, but two things are certain; the banks don’t have the money for it; and the bond market will not look kindly on the Government if it tries to borrow more money to put into the banks.

From this point of view, the European Financial Stability Fund is starting to look irresistible. Not only do you get to burn the bond holders, you may even be able to help people out of negative equity! “What’s not for these Irish to like?” Merkel can legitimately ask. “Nothing” is the answer most of us would give.

So why is it then that we have a situation where the German chancellor and most Irish people seem to want one thing and our Government and the financial establishment want the other?

The answer is that, unfortunately, we must live with the immediate consequences of what is a laudable effort to reverse the balance of power between the financial system and sovereign governments. It is admirable – and indeed necessary – because the overriding lesson of the global financial crisis has been that governments have found themselves servants of the financial markets rather than the other way around. But while we would all like to get to the sun-lit uplands envisioned by Merkel, Ireland unfortunately might not survive the journey.

As we have seen, the mere prospect that the successor to the European Financial Stability Fund – which runs out in 2013 – would involve sovereign debt restructuring has pushed the cost of Irish debt to levels that would bankrupt Ireland.

Even if we were to pre-emptively tap the fund in the hope of avoiding any post-2013 conditions – which seems to be the evolving German position – the risk that we might still be reliant on it post-2013 will weigh on Irish bonds. Likewise, the Irish banks have been hammered. Deposits have flowed out because of a loss of confidence in the State and no one will lend to them apart from the ECB for fear of default.

Faced with this immediate problem, the Government feels it has little option but to oppose Merkel and try and avoid turning to the European Financial Stability Fund.

Changing the way the world works is the prerogative of big nations and rich nations. But until the rules change, small countries like Ireland must play by them. The number one rule is that countries that want to borrow money cannot default on their debts.

If Merkel really wants to make Ireland the front line of some sort of existential struggle between the concept of the sovereign state and the omnipotence of financial markets, she needs to do a better job of showing us how we will survive the process.

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