Major questions remain over whether Irish bailout will work

 

IRELAND'S BAILOUT: ONE YEAR ON:The bailout stabilised the Irish economy but failed to prevent the crisis in the euro zone, writes DAN O'BRIEN

A YEAR ago Ireland was in the eye of the euro zone debt storm, having become the second of its 17 member countries to be bailed out. Now the situation in Europe is very much worse, with the collapse of the entire euro project having gone from an outcome of low probability to one that is not far off 50:50. By that measure, Ireland’s bailout was a failure.

The pre-emptive EU-International Monetary Fund intervention, which took place despite the opposition of the then Irish government, was designed to ring-fence Ireland so its problems would not spill over to the rest of the euro zone.

In this it failed – something that has been very clear from the reaction of financial markets to the other peripheral countries from the moment the terms of the bailout were unveiled, along with everything else that has happened since, including the rescue of Portugal in the spring.

But if bailing out Ireland did not contain the wider crisis, from a narrower Irish perspective it could be claimed the EU-IMF programme has helped stabilise the economy. Most notable has been the greatly accelerated progress on dealing with the banking fiasco and – if to a lesser extent – the implementation of a huge budgetary adjustment in 2011, without hurling the economy back into recession.

Change to how the problems of the banking system were being addressed was by far the biggest policy shift resulting from the bailout – and the most onerous.

The EU-IMF decided money was to be thrown at the problem in quantities beyond those which any Irish decision makers had countenanced, including the Governor of the Central Bank, Patrick Honohan, who was public in his opposition to this imposed policy. The National Pension Reserve Fund was used for this purpose, as was borrowed money.

Making the package even more onerous on taxpayers has been the steadfast unwillingness of the European Central Bank to allow the burning of any senior bank bondholders.

From a euro area-wide perspective, the ECB believes the damage from any default to the huge and crucial senior bank bond market would be too great, and thus must be avoided.

There is a strong case to be made for avoiding default on this basis, but for the costs of protecting this euro area market to fall entirely on taxpayers in one small country is grossly unfair.

At the very least, bailout funds should have been made available to buy back senior bank bonds in the secondary market. That would have lowered the cost greatly for the Irish taxpayer and avoided the default the ECB fears so much. Ireland’s weak negotiating position and the additional costs for other member states this move would have entailed have thus far prevented this kind of burden-sharing, or any other.

That all of this has happened without a single shred of published documentation setting out the ECB’s reasons for this stance adds insult to injury, and raises even more questions about the transparency and accountability of the Frankfurt institution, in addition to questions surrounding its central role in bouncing Ireland into a pre-emptive bailout last year.

Although everything that has happened subsequently suggests Ireland would have required a bailout by the middle of 2011 at the latest, what is clear now is the scale of the run on the Irish banking system that took place in autumn 2010. Tens of billions of cash on deposit suddenly began to be withdrawn in September 2010, much of it having to be replaced by financial institutions turning to the ECB and the Irish Central Bank for short term lending.

It was this increased exposure that was one of the most alarming developments for the ECB.

The bailout did not halt the haemorrhage of deposits. In the months of December and January, depositors were pulling cash out of the system just as rapidly as they had been doing before the bailout. In the first weeks of this year the bailout was looking decidedly unsuccessful.

But then the rate of deposit outflows began to slow, giving some sign the financial system was stabilising, albeit at a much reduced size. Banks collectively lost one third of their entire deposit base, amounting to a massive €300 billion.

The most recent signs suggest that despite the deepening of the euro zone crisis during the summer, figures for August and September (the last months for which they are available) showed deposits were actually on the rise for the first time in a year.

Further evidence to support the claim the bailout is working comes from developments in the bond market since the summer. The yields on Irish government bonds fell sharply from late July. In what was as important an indicator of improving confidence, Irish yields diverged from those on Portuguese debt, suggesting Ireland was breaking away from other bailed out countries.

But all that said, huge uncertainties remain. It looks doubtful at this juncture whether the Irish State will be able to begin borrowing normally in the markets at the end of 2012, as the bailout envisages. That raises the question of having to request a second bailout, as Greece has been forced to seek.

But a much bigger question is whether the funds for the current bailout, never mind a second one, will keep flowing. If the euro collapses, chaos will reign. Every country will face unprecedented challenges. Governments may not be able to support their own economies, and this includes those which are providing Ireland’s bailout money. If this happens there is no certainty that bailout funds will still be available.

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