Monday, 22 November 2010
The Irish bail-out teaches us a lesson about EU
The bail-out package for Ireland is the story of a pre-announced disaster. First the Irish allowed their economy to become a hedge fund, allowing the banks to grow their balances to levels disproportionate with the size of the economy – just like Iceland. Just like Iceland, the Celtic Tiger dreamt of having invented a new economic model of debt-fuelled hyper growth. They had not.
At the same time, they decided to attract foreign direct investments by lowering tax rates to levels that have been a thorn in the side of larger EU countries. As the crisis struck, they made a colossal mistake by guaranteeing all deposits in the Irish banks. As the scale of the losses in the banks began to become clear, it dawned upon most observers able to do simple sums that honouring that guarantee would lead to budget cuts so severe that social unrest could be the consequence.
The reaction from the corporate and financial sector was predictable. Yields on Irish government debt soared and companies withdrew billions form the Irish banks. As the cost of refinancing government debt increased, it became clear that the real cost of servicing the debt would surpass the growth rate of the Irish economy, catching the Republic in a debt trap.
The situation was compounded by German Chancellor Merkel’s untimely – but essentially correct – remark that when things go badly, it is not only the borrowers that should be punished. The lenders should also take a haircut if they had not assessed the quality of the borrower properly, which should be the responsibility of any lender. That remark gave a further push to the borrowing costs, and may seen in retrospect have been the event that finally pushed the Irish over the edge. They would have gone there anyway, but it might have taken longer time.
Now that the Irish have formally asked the EU and the IMF for a “contingent loan”, i.e. an overdraft facility, we are told that granting the facility was in order to protect the Euro zone. Maybe it would be a good idea to remember that German and French banks hold large swathes of Irish debt, and would obviously have been badly hit in case of an Irish default. They are now saved from that ignominy.
All of this is just another episode in the ongoing saga of greed, incompetence, and cynicism that is the story of the European debt crisis. At every twist in the road, Moral Hazard becomes more engrained and acceptable as a business concept.
If there is any lesson to be learned from the Greek and the Irish bailout, it is that EU is slowly waking up to the fact that the common currency was launched for political reasons essentially without the support of rules and institutions required to secure the survival of the Euro zone.
In the weeks before the bailout it became clear that some of the wrangling had more to do with the future of the EU than with Ireland. Germany (again) suggested that the EU should be given far more power to control and influence the budgets of the individual member countries. This would mean a transfer of sovereignty to the EU commission and France would have none of that.
The differing positions could well be understood on the basis of economic logic. Germany has no problems transferring economic decision power to the commission, knowing full well, that the German economic strength will continue to give the Federal Republic a strong say in Europe’s fiscal affairs.
France, on the other hand, has for ages used German economic strength to project her own global aspirations. Obviously, the new assertiveness of Germany is a threat to that position, and France will for that reason resist any transfer of economic decision power to the Commission.
For now, France won the battle. Germany backed down and accepted that the procedure for dealing with bail-outs will continue to be led by politicians instead of bureaucrats. But make no mistake. The Germans are getting sharper and more precise than we are used to. In the words of German finance minister Schäuble, pretending that things can continue like they have worked in the past decade, implies a lot of wishful thinking. When Ireland has faded from the headlines, the issue of making the Eurozone work will be the most important for the future of the EU.