The scenario has a familiar ring. A country goes on a credit binge. Borrowers in large numbers receive approval for home mortgages and other loans that they can’t afford to repay. A sharp upswing in defaults and foreclosures of these now-securitized loans helps trigger a world financial crisis. And a frantic government bails out investors to prevent a depression and defuse political chaos. That’s Ireland we’re talking about.
By now almost everyone glued to financial news outlets knows that the Republic of Ireland, population 4.5 million, is set to receive a whopping emergency loan bailout worth 67.5 billion euros (US$89.4 billion). Irish lawmakers, by a close margin, voted on December 15 to accept the terms of the package. Two-thirds of that sum will come from the European Union (EU), fresh from staving off collapse in Greece a half-year earlier; the other third will come from the Washington, D.C.-based International Monetary Fund (IMF). The average interest rate is 5.8 percent. Lurking somewhere in all this are lessons for America, no stranger lately to bailouts either.
The rescue of the weakest links in the 16-nation euro zone, led by an increasingly recalcitrant Germany, likely will “work” – for now. But in bringing short-term stability, they also raise the risk of a more intractable crisis down the road. For if recipient nations of this largesse cannot pay back their loans – not inconceivable – they either must raise taxes to intolerable levels (triggering a capital flight and, paradoxically, foregone tax revenues), cut basic public services to the bone or ask other nations for help once more. Ireland’s crisis mirrors that of Europe.
This is a far cry from a half-decade ago. Ireland, if one recalls, was a veritable “Celtic tiger,” showing the world how to run an economy. U.S. information technology companies, including Cisco, IBM, Intel and Microsoft, lured by the country’s low 12.5 percent corporate tax rate, literate English-speaking labor force and membership in the World Trade Organization, located plants and back offices there. Domestic enterprises also grew, and not just export-oriented mainstays like Waterford, Guinness and Barry’s Tea, but also RTE, Magnet Entertainment and IONA Technologies. Many Irish who had migrated abroad during the Eighties in search of work – New York City was an especially common destination – came home. If people didn’t come to Ireland to work, they came to play. Offering lush countryside, quaint urbanity, and cultural creativity (e.g., “Riverdance,” Enya), Ireland became a magnet for tourists and their dollars. Annual GDP growth during 1994-2007 averaged around 6.5 percent. And by the end of that period, Ireland had about 30,000 euro millionaires.
A by-product of this growth and accompanying optimism was a desire to buy a home – and not just any home, but single-family dwellings that rivaled those in some of America’s best neighborhoods. The banking and real estate industries were happy to accommodate the rush, and then some. And anticipating indefinitely rising prices, homebuyers were happy to pay a premium. During 1994-2007 house prices in Ireland rose by more than 500 percent, setting in motion a debt bomb that finally detonated in 2008.
Exacerbating the collapse was rapid public sector growth. Flush with potential tax revenues, many Irish officials believed they could afford the expenditures. When recession hit with full force, government couldn’t adjust. By the close of 2009, public debt represented 57.7 percent of GDP, a figure only half that of Greece, but alarming all the same.
The Irish debt crisis, in short, has morphed into a general crisis. The country is looking at a cumulative debt of $2.25 trillion, more than a dozen times its 2009 Gross Domestic Product of $172.5 billion. That comes to more than $530,000 per capita. GDP is down by around 10 percent from 2008. House prices have tumbled by as much as 70 percent in some communities – talk about “underwater” real estate! The national unemployment rate, only 4.6 percent in 2007, rose rapidly during 2008-09 and has hovered around 13.5 percent these past several months. Unemployment claims rose from 267,200 in November 2008 to 466,900 in August 2010. Direct foreign investment dried up. Ireland became the first European Union nation to enter a recession, as defined by the EU Central Statistics Office. And banks, increasingly unable to collect from strapped borrowers, have fast approached insolvency. To add to the indignity, the nation’s suicide rate has increased 25 percent in the past year.
The Conference Board, a Manhattan-based global nonprofit business research organization, aptly summarized the situation: “The luck of the Irish has run out.”
Indeed, it has. And Ireland turned to foreign sources for a reversal of fortune. A month ago, following tense meetings, the European Union and the IMF agreed to save the day. The rescue protects mainly foreign investors, assuring timely payments of around $60 billion in Irish senior bank bonds. But if bondholders won’t be forced to take a loss (at least for the next few years), Ireland is learning the meaning of the word “austerity.” To repay its $89.4 billion loan package, the Irish government must set aside: $43.1 billion to cover budget deficits over the next four years; hold $33.1 billion in reserve for commercial banks; and hold another $13.2 billion in reserve for state banks. In addition, the government will have to contribute $23.2 billion in cash reserves and pension funds to cover current expenditures, thus pushing the true cost of the bailout to beyond $110 billion. Moreover, it must reduce its budget deficit from the current 32 percent of GDP (the highest in postwar European history) to 3 percent by 2015.
The detritus of bad lending decisions is being felt politically. On November 27 more than 100,000 Irish took to the streets of downtown Dublin to protest the international bailout and mandated austerity. “We should be more like the French and get onto the streets more often,” said contractor Mick Wallace, who has had to lay off about 100 construction workers. A beleaguered Prime Minister Brian Cowen already has announced that he will step down early next year.
The pain is especially acute for those who have lost their homes, put buying plans on hold, or build homes for a living. Ireland is now home to at least 600 vacant, often unfinished residential developments known as “ghost estates.” The homes aren’t being sold because they can’t be sold. As the real estate boom was a product of an artificially-generated credit boom, the pool of creditworthy buyers in the recession has diminished sharply. And in a manner not unlike our own Troubled Asset Relief Program (TARP), Ireland earlier this year set up its National Asset Management Agency to remove about 80 million euros (US$104.2 billion) worth of bad assets from the country’s banks. As it is, fearful depositors have pulled out billions of dollars in recent months. And only days ago, Moody’s dropped Ireland’s credit rating to just three steps above junk-bond status.
Germany, the richest EU nation, understandably is a reluctant business partner. On one hand, led by Chancellor Angela Merkel, the Germans have made known their distaste for bailing out member nations. On the other hand, their assets are heavily tied up in weaker countries. German banks currently hold a combined $515 billion in debt owed by the so-called “PIGS” – Portugal, Ireland, Greece and Spain (the U.S. share is $133 billion). If heavily-indebted Spain, with more than 45 million people, needs a bailout, a full-scale panic may ensue. The Germans are going along with the bailout if only to preserve the illusion of EU stability.
It’s not as if the Irish are happy with their predicament. An editorial in the Irish Times (November 18) inveighed, “Having obtained our political independence from Britain to be the masters of our own affairs, we have now surrendered our sovereignty to the European Commission, the European Central Bank, and the International Monetary Fund.” And Gerry Mullin, a car dealer in Monaghan, laments: “Jesus Christ, we’re the laughingstock of the world. We’re back into a fine mess, we are. Look. You got the IMF coming now.”
If the bailout is eroding Irish self-reliance and pride, not everyone is planning on sticking around for the conclusion. Tara Keegan, 26, a Dubliner with a master’s degree, puts it this way: “For me, England is the next step, but people are going to Canada, Australia, everywhere you can get work.” She’s apparently in good company. Some 13,400 Irish nationals moved overseas in fiscal 2008, a figure that jumped to 27,700 this past year. The Union of Students of Ireland estimates that more than 75,000 recent college graduates will emigrate over the next five years. “People aren’t leaving because they want to; there isn’t much choice,” notes the London-bound Daniel Philbin-Bowman, a student at Dublin’s Trinity College. “The country needs to be rebuilt.” Responds his professor, Elaine Byrne: “But who will rebuild it if all of you are leaving?”
It’s a paradox, all right. And we Americans, luckily, aren’t remotely at the point where we have to resolve it. Yet our fate, like it or not, is tied to that of Ireland. There are a number of reasons why the U.S. can’t escape.
First, some $30 billion of the Irish bailout is coming from the International Monetary Fund. And since our own government currently covers 17 percent of IMF expenses, U.S. taxpayers are on the hook for about $5 billion. The IMF isn’t hesitant about calling for additional bailouts worldwide either. Its October 2010 Global Financial Stability Report (“Sovereigns, Funding, and Systemic Liquidity”) recommended that governments inject fresh equity into banks and prop up funding structures through further emergency support. “Nearly $4 trillion of bank debt will need to be rolled over in the next 24 months,” noted the report. By implication, America will have to do its part.
Second, U.S. institutional investors hold about $25 billion in Irish assets, according to the Basel, Switzerland-based Bank for International Settlements, which serves as a clearinghouse for central banks around the world. That comes to around 15 percent of the $170 billion invested in Irish banks by foreign lenders overall. Should Ireland default, our banks either will have to write off the losses or receive a bailout, whether foreign or domestic.
Third, and most ominously, bailouts in all countries are self-perpetuating. That is, by providing large-scale relief for short-sighted or reckless financial behavior, donors enable the very behavior that led to the rescue in the first place. Here in America, the $700 billion TARP loan program and $787 billion in “stimulus” spending have not closed a widening national deficit. Why should Ireland be immune to this logic? A bailout by its nature rescues the beneficiary, but also raises expectations of another bailout. In Europe, this is especially ominous, since bailouts occur between countries as well as within them. Just as Greece’s international $144.6 billion bailout paved the way for the rescue of Ireland, the Irish bailout in turn has heightened the widely-rumored possibility that Portugal and Spain will get their own EU-IMF aid package. The more Ireland needs money, the more America will be asked to provide it.
Lawmakers in the U.S., to their credit, grasp what is at stake. Back in May, in the immediate wake of the Greek fiasco, the Senate, led by John Cornyn, R-Tex., unanimously approved a measure requiring that the U.S. representative to the IMF certify the financial capability of recipient nations whose government debt exceeds GDP. The provision, now part of the Dodd-Frank banking reform law, thus far has been symbolic because the Obama administration believes it impedes its jurisdiction over foreign policy.
As for Ireland, its best course of action is to reject outside aid. This can be done without inviting economic collapse. The example of Iceland is instructive. This far less populous island nation in the Atlantic recently experienced a mortgage-driven banking meltdown every bit as traumatic as Ireland’s. Yet it rejected outside aid. The result: The Icelandic economy did not crash. In fact, GDP grew by 1.2 percent in Third Quarter 2010.
Ireland is a highly resilient nation. It knows all about war, political chaos and famine. It can survive a banking and fiscal crisis. Tourists will continue to come. Some even may settle. The pubs will remain open. “Rescuing” the Irish by undermining its self-discipline and sovereignty raises rather than diminishes the likelihood of Round Two.
Bailouts are seductive. It’s hard to say “no” to one when offered. But Ireland should turn down the money to assure its people that it is serious about getting its house in order. We in America should apply the same lesson to ourselves.