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European Finances Still in taters, Ireland, Spain.... Still on the Brink

Interest-Rates / Eurozone Debt Crisis May 12, 2013 - 03:16 PM GMT

By: Raul_I_Meijer


Ireland was one of the first European countries to get hit by the financial crisis. It decided to bail out its banks at the direct cost of the taxpayer. In 2012, those banks were still overleveraged (and still are today) to the same level as for instance Cyprus, with assets over 800% of GDP. Probably only Iceland has been worse (UK?!). According to IMF/EC, 2012 Irish national debt was 117% of GDP; not a pretty number either. This all as a lead-up to a May 5 article by Dan White in the Irish Independent that TAE's own Nicole Foss sent over recently. But first a little history, for who may be bit shaky on it, just for fun, and to explain how Ireland got to have its present population of 4.5 million people.

The population of Ireland in the 1830's, when it was part of Britain, was around 8.5 million. There are estimates of as much as 10-12 million; in those days counting everyone, even in a census, was an obvious struggle. Ireland then had perhaps 30% of the overall population of the kingdom, a sharp contrast with today.

In 1845, the Great (Potato) Famine hit home. Over the next 5 years, 1 million Irish died of hunger and disease, and 1 million emigrated. And it didn't stop there. Millions more emigrated in the following decades, and the country remained dirt poor, so starvation didn't stop either. Some say Britain liked things that way (religion was always a big factor). Only in the 1916 Great Rising, the -catholic - Republic of Ireland gained independence, while - protestant - Northern Ireland became part of the UK.

Ironically, it was the very same potato that, once it came to Europe from the Americas in the 16th and 17th centuries, allowed for a huge increase in population in Ireland and beyond. The "Old World" didn't have a crop that all by itself people could live on. Now they had one. And then someone imported blight.

Today, the Irish Republic counts 4.5 million citizens, or 4 million less than in 1830. Northern Ireland's 1.8 million make up some of the loss, but the picture is clear: 180 years later, during which time world population rose from just over 1 billion to just under 7 billion, and Britain went from some 20 million to 63 million, Ireland's population still hasn't recovered (will it ever?).

There is the Irish diaspora, however. Approximately 15 times as many people of - often fiercely proud- Irish descent live elsewhere in the world today than live in Ireland. In the US alone there are over 40 million.

So today, we have (the Republic of) Ireland at 4.5 million people. That's useful when looking at debt numbers. Especially since it is just about 70 times less than the US at 315 million. Irish unemployment is 14.1%, youth unemployment 30.3%, both numbers somewhat recovering from deeper pits.

One more thing before we get to the article: it refers to GNP, Gross National Product. Refresher: it's almost the same as GDP, but not exactly. The latter is a measure of the value of goods and services produced in a country, the former is a measure of the value of goods and services produced in a country by its domestic institutions and individuals. For most countries both will be quite similar, but in Ireland, GNP is estimated to be perhaps as much as 25% smaller than GDP.

The reason for this is that Irish tax laws make the country very attractive for foreign companies (there are some 600 American ones alone operating in the Republic). Ergo (simplified): a lot of the revenue generated in GDP leaves the country as profit for mother companies, and doesn't count towards GNP. This makes some voices even claim that recent GDP gains are false signs of a recovery, and that when measured in GNP, there has been no recovery whatsoever. One more detail: Irish property prices have fallen over 50% since 2007.

So there: Ireland's initial cost for the bailout of its banks was €40 billion ($52.4 billion if you use a 1:1.31 exchange rate). In 2011, US "investment manager" BlackRock conducted a stress test that concluded that the four Irish banks still in business, AIB, Bank of Ireland, Permanent TSB and EBS (now part of AIB), would require an extra €24 billion of capital. So that added up to €64 billion ($83.5 billion). In comparative US terms (70 times bigger), that was $5.85 trillion.

And thus we finally get to Dan White, who says the Irish are far from done bailing out. He starts off referring to numbers published by (Danish, thus foreign) Danske Bank Ireland the week before, and takes it from there:

Taxpayer beware! Irish banks need another €30 billion at least

[..] The latest write-offs mean that Dankse will have written off almost €3.6 billion, just over a third of a loan book which had a total peak value of just over €10.5 billion. If that isn't enough to give taxpayers a bad case of the heebie jeebies then nothing will.

For those of us who have followed the crisis from the beginning Dankse has been a useful pointer to future developments at the Irish-owned banks. Unlike its domestic counterparts, who are still in denial about the full extent of their problems, Dankse has been upfront about its loan losses. Where Dankse goes today the Irish-owned banks look set to follow tomorrow. [..]

The BlackRock stress tests concluded that total loan losses at the continuing Irish-owned banks would amount to between €27.5 billion and €40 billion. The biggest single source of these losses would be residential mortgages with BlackRock forecasting losses of between €9.9 billion and €16.9 billion.

The other big generators of losses were forecast to be commercial real estate lending (between €8.1 billion and €10.3 billion) and corporate lending, including SMEs (between €7 billion and €9.5 billion). [SME=small business]

Even on the basis of the banks' own figures it is clear that these projected losses were hopelessly optimistic. According to the most recent AIB results, €8.1 billion of its €39.5 billion Irish mortgage book was more than 90 days in arrears at the end of December 2012.

Over at Bank of Ireland €3.6 billion of its €27.5 billion Irish mortgage book was more than 90 days in in arrears at the end of last year, while €5.5 billion of Permanent TSB's €24.5 billion Irish mortgage book was similarly suspect.

At the end of December 2012 some €38 billion of owner-occupier mortgages and €10.6 billion of buy-to-let mortgages were in arrears, while a further €6.7 billion of owner-occupier and €3.2 billion of buy-to-let mortgages had been restructured but were not in arrears. By value that's the equivalent to over 41% of the total €142 billion stock of outstanding mortgages held by the domestic and foreign-owned banks.

Apply this pro rata to the €91.5 billion of Irish mortgages held by the domestic banks and one is looking at over €37 billion of compromised loans. With property prices having fallen by at least 50% since 2007 it would seem reasonable to provide 50% against these loans, say €18.5 billion.

In addition the Irish-owned banks have at least €50 billion of loss-making tracker mortgages on their books. Some of the foreign-owned banks have been offering to reduce loan balances by between 20% and 25% for tracker customers who are prepared to switch to a variable rate. Even a 20% write-down on trackers would cost the Irish banks another €10 billion.

Throw in a further 20% provision for those mortgages not currently impaired, €11 billion, and the Irish-owned banks are looking at mortgage losses of €39.5 billion, €22.6 billion more than forecast by BlackRock in its "worst case scenario".

And that's barely the half of it.

The Irish-owned banks have €27 billion of SME lending on their books. Last month the Central Bank's director of credit institutions, Fiona Muldoon, revealed that 50% of SME lending was in distress. On the basis of a 50% write-down of the distressed loans and a 20% precautionary write-down of the remainder that translates into a further €9.4 billion of losses, €4.9 billion greater than BlackRock's "worst case scenario".

The Irish-owned banks also still have almost €30 billion of commercial property lending on their balance sheets. Once again one has to ask, just how realistic is BlackRock's "worst case scenario" of €10.38 billion of losses.

By the time one adds losses on other lending, to large corporates, personal loans, credit cards etc. and it is hard to see how the cost of any fresh bank recapitalisation could come in at under €30 billion. That would bring the total cost to the Irish taxpayer of "fixing" our bust banks to almost €100 billion.

Clearly greater love hath no government than that which lays down its citizens for its banks!

Looking through White’s numbers, for instance "Irish-owned banks have at least €50 billion of loss-making tracker mortgages on their books", I'm thinking even he stays on the cautious side, but they're bad enough as is already. The "total €142 billion stock of outstanding mortgages" translates to $186 billion, which in "US Size" (x70) would be over $13 trillion, about on par with the US at $41.350 per capita, but in a country that has no particular history of owning homes. It's not home value, it's mortgages. Not assets, but debt. And prices have already fallen over 50% in Ireland since 2007.

As late as October 2010 Ireland declared itself "fully funded well into 2011", but just one month later, in November 2010, the government asked for a €67.5 billion "bailout" from the EU and the IMF as part of an €85 billion 'program' (the Irish State "funded" €17.5 billion itself). By August 2011 total funding for the six biggest banks by the ECB and the Irish Central Bank came to about €150 billion; at that point the largest of the six, Bank of Ireland, had a market capitalisation of just €2.86 billion.

The question then becomes how Ireland is going to facilitate another €30 billion bank recapitalisation. The government stated this spring it was getting ready to ask for further aid, but EU forces apparently - and curiously - have a completely different take on this. Before Ireland was recently handed a 7-year extension on paying back the loans, the "donors" made clear they not only don't feel like approving extra aid, they want Ireland to exit the bailout scheme and return to the bond markets for funding. As the Irish Times reported on April 12:

Euro zone believes deal will see Ireland exit bailout this year

An imminent deal to postpone Ireland’s bailout repayments will be enough to secure a smooth exit from the EU-IMF programme later this year, according to the chief of the euro zone finance ministers. The position set out by Dutch minister Jeroen Dijsselbloem is in defiance of the Government’s claim for further aid to ease the cost of propping up Allied Irish Banks and Bank of Ireland.

Although the IMF has strongly backed Dublin’s push for the ESM rescue fund to bear historic debts of the two banks, Mr Dijsselbloem indicated in an interview with The Irish Times yesterday that a decision on that front might not be taken for at least another year.

That is well beyond Ireland’s anticipated return to private debt markets at the end of the bailout and means he expects the Government will be able to do without a specific pledge of bank debt relief from the ESM fund.

Asked if the return to market financing would be eased by a definitive commitment of ESM aid, Mr Dijsselbloem insisted that the two issues should be separated. "The access to the markets is relevant right now, and this year, and we will try to help Ireland and Portugal in exiting the programmes," he said.

"The direct recap instrument ESM isn’t available at the moment," he added. "What we can do is to look at the maturities of the EFSF loans and that’s why we are . . . discussing a proposal by the troika on more time for Ireland and Portugal [NB: 7-year extension since granted]. That would greatly help both countries going back to the markets and finding their own funding."

While agreement on whether the ESM can retroactively bear historic debts is anticipated in June, Mr Dijsselbloem said a decision on which countries can use the scheme will only be taken after a common bank supervisor is set up in the middle of next year.

The Government campaign for ESM aid relies on a pledge by euro zone leaders to break the link between bank and sovereign debt, but Germany and like-minded allies, such as the Netherlands and Finland, remain sceptical.

Last week, the IMF reiterated its call for the ESM to take equity stakes in the two Irish pillar banks, arguing that it could play "an invaluable role in marking prospects for recovery and debt sustainability more robust". However, Mr Dijsselbloem said he could not predict whether the retroactive application of the direct recapitalisation instrument would be sanctioned at all.

In other words, there's now a substantial stretch of financial no man's land in Europe. The EU still doesn't have its newest "direct recap" instrument, the ESM Stability Mechanism, ready yet while its predecessor, the EFSF, is still sort of active, though it can't take on any new commitments, and what's - still - being discussed is in what shape EFSF loans can be transferred to the ESM - if they can at all - . Of course a banking union could play a large role in all this, but that looks as far away as ever.

Meanwhile, affording Ireland and Portugal more time to pay back loans appears to be seen in Brussels as some kind of end solution, but how realistic is that? Ireland would need to cough up, what, €10 billion a year over that 7 year period (?!), while, in the short term, ingesting another €30+ billion into its banks. Anyone who doesn't think of Dijsselbloem, Lagarde and Draghi as the next reincarnation of the genius of Albert Einstein might come away with some doubts as to whether this is going to work out.

Nor does this stop at Ireland, of course, or Portugal. Take for instance this loud warning about Spain from everyone's favorite right-wing anti-Europe correspondent for the Telegraph, Jeremy Warner:

Spain is officially insolvent: get your money out while you still can

I'd not noticed this until someone drew my attention to it, but the latest IMF Fiscal Monitor, published last month, comes about as close to declaring Spain insolvent as you are ever likely to see in official analysis of this sort. Of course, it doesn't actually say this outright. The IMF is far too diplomatic for such language.

Let's take the projected budget deficit first. This is expected to decline quite steeply this year to 6.6% of GDP, but that's mainly because the cost of bailing out the banking sector fell substantially on last year's budget. On a like-for-like basis, there has in fact been very little fall in the underlying deficit. And nor on the present policy mix is there ever likely to be, for that's where the deficit is projected to remain until the end of the IMF's forecasting horizon in 2018. Next year, the deficit is expected to be 6.9%, the year after 6.6%, and so on with very little further progress thereafter. [..]

The situation looks even worse on a cyclically adjusted basis. What is sometimes called the "structural deficit", or the bit of government borrowing that doesn't go away even after the economy returns to growth (if indeed it ever does), actually deteriorates from an expected 4.2% of GDP this year to 5.7% in 2018. By 2018, Spain has far and away the worst structural deficit of any advanced economy, including other such well known fiscal basket cases as the UK and the US.

So what happens when you carry on borrowing at that sort of rate, year in, year out? Your overall indebtedness rockets, of course, and that's what's going to happen to Spain, where general government gross debt is forecast to rise from 84.1% of GDP last year to 110.6% in 2018. No other advanced economy has such a dramatically worsening outlook. And the tragedy of it all is that Spain is actually making relatively good progress in addressing the "primary balance", that's the deficit before debt servicing costs.

What's projected to occur is essentially what happens in all bankruptcies. Eventually you have to borrow more just to pay the interest on your existing debt. The fiscal compact requires eurozone countries to reduce their deficits to 3% by the end of this year, though Spain among others was recently granted an extension. But on these numbers, there is no chance ever of achieving this target without further austerity measures, which even if they were attempted would very likely be self defeating. In any case, it seems doubtful an economy where unemployment is already above 25% could take any more. [..] Spain is chasing its tail down into deflationary oblivion.

All this leads to the conclusion that a big Spanish debt restructuring is inevitable. Spanish sovereign bond yields have fallen sharply since the announcement of the European Central Bank's "outright monetary transactions" programme. The ECB has promised to print money without limit to counter the speculators. But in the end, no amount of liquidity can cover up for an underlying problem with solvency.

Europe said that Greece was the first and last such restructuring, but then there was Cyprus. Spain is holding off further recapitalisation of its banks in anticipation of the arrival of Europe's banking union, which it hopes will do the job instead. But if the Cypriot precedent is anything to go by, a heavy price will be demanded by way of recompense. Bank creditors will be widely bailed in. Confiscation of deposits looks all too possible.

I don't advise getting your money out lightly. Indeed, such advise is generally thought grossly irresponsible, for it risks inducing a self reinforcing panic. Yet looking at the IMF projections, it's the only rational thing to do.

Let's cautiously summarize it this way: Europe's finances - still - are in tatters. Ireland and Spain are just two examples. We can come up with similar stories about a handful (or two) of other countries. Perception for now remains that Draghi will do whatever it takes - re: buy buy buy - to rescue anyone and everyone. But that perception rests on the idea that he can, in the first place. Jeremy Warner puts his finger on a sore spot that doesn't get nearly enough attention anymore:"... in the end, no amount of liquidity can cover up for an underlying problem with solvency".

The illusion of central bank omnipotence, be it in setting interest rates or in buying up any and all kinds of paper, will continue until it doesn't; we have our media, our politicians and our own gullibility and wishful thinking to thank for that. In the meantime, though, hardly any of the problems in Europe are truly being solved. Moreover, those that are even attempted will increasingly involve bail-ins as a way of funding bail-outs.

It's just a matter of time until the walls come down, and of course it's ironic that the longer reality can be kept hidden underneath the carpet, the less real it seems. But that's simply a predictable consequence of having short attention spans. And we should be able to look beyond that.

By Raul Ilargi Meijer
Website: (provides unique analysis of economics, finance, politics and social dynamics in the context of Complexity Theory)

© 2013 Copyright Raul I Meijer - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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