We can see it’s still all about the banks in Ireland. This
depositdebt guarantee issue is still the critical one. The Irish Independent is talking about total nationalisation of AIB because of the ‘bank run’ hitting Ireland. And it is a bank run; AIB cannot access credit markets without a government guarantee. Either Ireland lets some banks fail or it steps in and nationalises them.
When I spoke of the bank run, I was thinking of access to credit markets for the likes of AIB or Bank of Ireland. If you recall, it was a lack of credit market access which proved fatal to Northern Rock, then to Bear Stearns and to Lehman Brothers. These were bank runs by non-depository creditors. We have seen ordinary bank runs with Northern Rock, Washington Mutual and Indy Mac, but in today’s world, it is the non-depository run that remains my worry.
But, this quote from a Bloomberg article caught my eye:
Bank of Ireland, the country’s biggest lender by market value, said Nov. 12 it suffered “deposit outflows over a five- to six-week period in late August and early September.” It didn’t provide a figure. The lender lost 10 billion euros ($14 billion) in deposits in the period, Ciaran Callaghan, an analyst at Dublin-based NCB Stockbrokers, estimated today.
‘Forced to Appeal’
Allied Irish Banks Plc had similar outflows since June, the Sunday Times reported yesterday, without saying where it got the information. Catherine Burke, a spokeswoman for the Dublin-based lender, declined to comment on the report.
The five-member ISEQ Financial Index has fallen 98 percent from its peak in February 2007. Bank of Ireland and Allied Irish account for about 80 percent of the benchmark by weighting.
If “evidence of a deposit flight in Ireland” accelerates, “then the prospect of additional support to the banking system could swamp the government’s comfortable cash position,” Paul Mortimer-Lee, London-based global head of market economics at BNP Paribas SA, wrote in a note today. “Equally, if the losses on the banks were to be revised up again, then with banks in a poor position to raise private capital, the government may be forced to appeal to the European Commission for support.”
What Mortimer-Lee is getting at are the rumours of a run on Irish banks. I wouldn’t call these runs yet. But clearly this is the scenario we want to avoid. Mortimer-Lee is talking about depositors though, not just non-depository creditors. That is significant in my view. Europe’s dithering is making this a possibility, though. Ireland had one of the most extreme property bubbles in Europe. And the crash in prices has been equally extreme, with prices falling as much as 50 or 60%. There is no way the Irish banking system can take this kind of punishment. The banks are effectively insolvent – this, despite heroic efforts by the Irish government to strip away the bad assets. The Icelandic problem becomes a question then because the Irish banking system really is too big for the Irish government to credibly backstop. After I realized that the state creditor guarantees made the bank problem a sovereign debt problem, I wrote in November 2008:
It remains to be seen whether there is a sub-current of panic about the fragile Irish banking system that could lead it to Iceland’s fate. In fact, commentators like Wolfgang Munchau have argued that the single currency is a boon to the likes of Ireland because it prevents currency attacks like the one Iceland suffered, leading to its downfall.
However, a run on Irish banks is what would ultimately bring the Irish down. After all, it is the Government bank guarantee which creates the vulnerability. The Irish Government needs to make some contingency planning because an Icelandic fate is not out of the question. It need not worry about a currency run, but a bank run is still possible.
There are two ways to skin a cat.
Panic today is not what it was two years ago but the situation is spiralling out of control as it did with Greece. And I think the mix in Ireland is more toxic than in Greece because of the creditor guarantee. Sitting here and saying that the Irish have all the money in the world until mid-2011 is setting the country up for disaster in the event that creditors or even depositors pull funds.
What are the realistic scenarios here then?
- The Irish get funds from the EFSF and the IMF now rather than waiting. They push ahead with austerity and rescind the bank creditor guarantees while protecting depositor guarantees. In my view, this would satisfy the EU’s desire for fiscal consolidation while making the bank backstop credible. Depositors would know their money is safe.
- The ECB buys up a bunch of Irish sovereign debt to bring yields down while the Irish government denies it needs the money. They push ahead with austerity, which is voted for on Dec 7. I don’t like this scenario. The sovereign gets the ECB backstop. But rates will not come down. The Irish will still be forced into the EFSF and the arms of the IMF anyway and the prospect of bank runs could continue. Deadweight losses are likely. This is a failed strategy.
My understanding is that plans are now to use bailout money to shore up bank capital in Ireland. This is not a good idea at all – and I don’t think the Irish public would support this. Bank creditors need to be cut loose to de-couple the bank and sovereign credit issues. Moreover, the German public doesn’t want any more bailouts. So Chancellor Merkel has to talk tough. This is the reason for talking about a debt restructuring that requires bondholders who buy post-2013 take a haircut under a permanent bailout mechanism. But this also opens up the issue of haircuts for existing bondholders. I don’t see any way around this issue without talking about haircuts in a permanent version of the EFSF. Has this spooked markets? Yes. But, I say get on with it; the bailout is inevitable. Delaying is only going to make large losses in a restructuring that much more likely.