he biggest Irish joke of them all, which underpinned the bank guarantee in the first place: that if we wanted investors to retain confidence in the creditworthiness of the Irish State, we needed to make sure that nobody who invested in our (private sector) banks ever lost a penny?"
The latter decision is the one that sank the country. It was the last great act of hubris of the Celtic Bubble, and was immediately denounced by one of the heroes of the crisis, my old UCD colleague Morgan Kelly. On the night the guarantee was announced, Kelly pointed out that while it was the right policy if the Irish banks were facing a liquidity crisis, it was a terrible policy if they were insolvent, which was in fact the case. As they always do when confronted with someone smarter than them, the Dublin establishment circled the wagons, and Kelly was dismissed as an irresponsible young troublemaker of no consequence. He has been proved right, of course, but the establishment is still at it, making the
same fundamental mistake of thinking that a solvency crisis is just a liquidity crisis. Now, however, the establishment is European as well as Irish, and it is the State rather than the banking sector which is insolvent.
The week started on an optimistic note. The general reaction was one of relief - at last, the Indians had come to sort out the cowboys. (The Indian in question was Ajai Chopra, head of the IMF mission to Dublin; there are no prizes for guessing who were the cowboys.) But the atmosphere soon changed, as it became clear that a substantial portion of the bailout funds would be earmarked, not for vital public services, but for the black hole that is the Irish banking system. At one stage there seemed to be the prospect of some relief for Irish families: the Irish Times was reporting that the EU-IMF team would deliver the loss-sharing with bondholders that our own government had been too craven to insist on. This would have been a good-news story that could have transformed the mood of ordinary people, and proved that the European Union was on their side. That hope was dashed over the weekend.
The finger of blame was clearly pointed by the Minister of Finance, Brian Lenihan, and several of his colleagues: it was the European Central Bank and the Commission who had vetoed the proposal to force some of the bank losses back onto the bondholders. This interpretation is generally accepted in Dublin, although many observers also blame the Irish negotiating team for caving much too easily into pressure from Brussels and Frankfurt. The implication is that the IMF were the good guys: an unusual position for them to find themselves in, perhaps, and one with political implications in a country whose relationship with the European Union has been uneasy in recent years, and which has conserved close ties with the United States. On Monday night, an opposition spokesman made it clear that he would be much happier negotiating with the IMF, who are reasonable people, than with our European partners. The fallout from this will be toxic.
The reaction to the news that Irish taxpayers are to be squeezed while foreign bondholders escape scot-free has been one of outraged disbelief and anger. At the start of last week, it was possible to make the argument that 'burning the bondholders' was irresponsible, since it would inevitably lead to contagion, and the spread of the crisis to Iberia. That argument has at this stage lost all validity, since contagion has happened anyway. Besides, the correct response to the possibility of contagion was never to engage in make-believe, but to extend taxpayer protection to other Eurozone members as required. Swapping debt for equity in a coordinated fashion across Europe would show ordinary people that Europe is on their side; but like the PLO of old, the European Union never misses an opportunity to miss an opportunity.
There's no question that it is morally outrageous for taxpayers who had nothing to do with the overlending to be saddled with the costs, while bondholders who should have watched where they put their money, walk away scot free. Moreover, I cannot but believe that this is creating considerable moral hazard; investing in bank debt starts to look something like investing in the sovereign debt of the country where the bank is.
Who knows what the political consequences of all of this will be? The southern Irish are a conservative lot, and dislike direct confrontation (we leave that to our Northern brethren). This means that political change in normal times is slow; but when it does come, it may come in a rush. If we had a national list system, a Labour-Sinn Fein coalition would be a possibility at this stage. However, our multi-seat constituency system makes it difficult for rising parties to translate support in opinion polls into seats in parliament. Even so, we are about to have a general election, and if Brussels thinks that this deal is not going to be the big issue in that election, then they are even more out of touch than we already think they are. It is no longer even certain that the budget will be passed in December.
Brussels may not have a Plan B, but they had better prepare one nonetheless. Irish citizens may bring down the bailout of foreign bank creditors by voting at the ballot box, but if they do not, they will bring about a default of some kind by voting with their feet. We now face a negative spiral in which austerity causes emigration, which increases the burden of the debt, which ultimately leads to more austerity. We need a game-changer to break the cycle, but what might it be? Since the fundamental problem is that Ireland is insolvent, the smart thing to do is to tackle our debt burden head-on, but the Europeans have vetoed this.
It looks like we may well find out if a bondholder haircut is preferable to austerity. I hope, for many reasons, that this turns out to be the case.