State should heed Nobel winners before budget gamble

OPINION:Draconian cuts are supported by those who argued for Nama and the bank guarantee, writes JOHN McMANUS

WHEN IT comes to the economy, Nobel laureates appear to shares the characteristics of buses. As the old line goes: there is never one when you need them and then they all arrive together.

Joe Stiglitz is the latest winner of the Nobel Prize in economics to share his thoughts on the economy. And it is a great pity he was not around 18 months ago because he has tumbled to what may have turned out to be the fatal flaw in going down the National Asset Management Agency (Nama) route for restructuring the banks.

Stiglitz makes his observation in the affidavit he filed in his role as expert witness in the case taken by developer Paddy McKillen to prevent his loans being acquired by Nama.

Most of the affidavit deals with issues such as “diseconomies of scope” that are no doubt germane to the points on which the court will rule. But as part of his affidavit, he runs through his version of what went on here and how Nama came into being.

In a roundabout way, he points out something that really should be blinding obvious, which is that if we knew that Nama would crystalise something in the region of €40 billion of land and development losses at the banks in one year, we might have thought twice about it.

The reason being that finding the €50 billion in fresh capital needed to allow the banks meet these losses and their non-Nama losses has brought us to the brink of national bankruptcy.

There was another way – and one which was adopted in the UK – which was to drip-feed capital into the banks over a number of years as their losses manifested. As a result, the hit to the national finances is spread over a number of years.

Paradoxically, we are doing something similar by the use of promissory notes to recapitalise Anglo and Irish Nationwide, which will see €1.5 billion or so a year go into the banks annually over the next 10 years. Unfortunately, Europe requires us to take the hit for the full amount of the notes in the exchequer accounts in year one. This is what has sent the exchequer deficit into the stratosphere and freaked out the bond markets.

The other aspect of Nama in which Europe has been less than helpful is the area of valuations. European approval of Nama was tied to very tough valuation rules, meaning that the haircuts on the loans transferring into Nama that were expected to be in the region of 20 per cent have ended up being nearer 50 per cent. Initially, the tough line demanded by Europe was seen to be a good thing because it minimised the chance of soft treatment for developers. But it has come back to bite us in the form of a related €50 billion capitalisation for the banks that we can barely afford.

As a result of these two technical “glitches”, Nama has gone from being a sensible and affordable approach to dealing with the banks to being something of a nightmare. Its big selling point was that it forced the banks to take their losses upfront, move on, start lending and encourage recovery. This did not happen.

With hindsight if we had known how bad the losses were and equally importantly how Europe would make us treat the associated recapitalisation in the all-important national accounts, we would have had second thoughts.

It does not follow, however, that if we had gone down an alternative route similar to that adopted by the UK we would be better off. But it is possible we might be facing a more digestible recapitalisation bill and avoided the closure of Anglo and the 90 per cent nationalisation of AIB. This might have bought us some much-needed time in which to try to fix the underlying deficit, rather than being forced into budget cuts of €4-5 billion simply to be allowed to access the debt markets.

But at the same time, the consequences of the Irish banks’ mad lending spree were always going to emerge at some point. It is equally possible the so-called bond market vigilantes might have seen through the ruse and instead of being beaten up for having been so upfront about the cost of the bailout, we could be punished for trying to hide the losses. There have been a few straws in the wind in this regard recently concerning the bailed out UK banks and whether or not they have confronted their problems.

But in any case, we did what we did and reversing out of Nama seems impossible and impractical.

However, it is worth bearing the above in mind as we are about to embark on another massive national gamble, partly as a result of Nama not working out as planned and indeed the gamble before that – the blanket guarantee in September 2008.

The new gamble is that winning back the confidence of the bond markets with an unprecedented draconian showpiece budget, even at the risk of choking growth and tremendous hardship, is preferable to borrowing from the European Union and the IMF.

The arguments is presented for this in the same assured fashion – and by many of the same internal and external actors – that the case for Nama was advanced. And as Nama and the guarantee have shown, things don’t work out the way these people say they will. Perhaps we should talk to a few Nobel laureates first.