If your country’s banking system is about to fail should you rescue it or let it collapse?
Iceland’s banking system fell into a crisis before most. The government let it fall. Now some people are saying that was the best way to handle it. Rip the Band-Aid off quickly and get it over with. Let the insolvent banks go under, suffer the consequences, and start rebuilding.
The alternative is to try to keep sticking 2 x 4s under the rickety banks to keep them running at all costs. Take money from the government (which really means the people) and plow it into private banks that hand out big bonuses to their managers and traders.
The Atlantic has a great writeup on the Irish real estate bust and the resulting banking crisis. It illustrates the banks’ incredible irresponsibility in loaning out money that would never be repaid, followed by a bailout that’s going to take generations of the Irish to pay for. Why are ordinary people bailing out banks and bondholders?
The Irish banks, like the big American banks, managed to persuade a lot of people that they were so intertwined with their economy that their failure would bring down a lot of other things, too. But they weren’t, at least not all of them. Anglo Irish Bank had only six branches in Ireland, no A.T.M.’s, and no organic relationship with Irish business except the property developers. It lent money to people to buy land and build: that’s practically all it did. It did this mainly with money it had borrowed from foreigners. It was not, by nature, systemic. It became so only when its losses were made everyone’s.
In any case, if the Irish wanted to save their banks, why not guarantee just the deposits? There’s a big difference between depositors and bondholders: depositors can flee. The immediate danger to the banks was that savers who had put money into them would take their money out, and the banks would be without funds. The investors who owned the roughly 80 billion euros of Irish bank bonds, on the other hand, were stuck. They couldn’t take their money out of the bank. And their 80 billion euros very nearly exactly covered the eventual losses inside the Irish banks. These private bondholders didn’t have any right to be made whole by the Irish government. The bondholders didn’t even expect to be made whole by the Irish government. Not long ago I spoke with a former senior Merrill Lynch bond trader who, on September 29, 2008, owned a pile of bonds in one of the Irish banks. He’d already tried to sell them back to the bank for 50 cents on the dollar-that is, he’d offered to take a huge loss, just to get out of them. On the morning of September 30 he awakened to find his bonds worth 100 cents on the dollar. The Irish government had guaranteed them! He couldn’t believe his luck. Across the financial markets this episode repeated itself. People who had made a private bet that went bad, and didn’t expect to be repaid in full, were handed their money back-from the Irish taxpayer.
In retrospect, now that the Irish bank losses are known to be world-historically huge, the decision to cover them appears not merely odd but suicidal. A handful of Irish bankers incurred debts they could never repay, of something like 100 billion euros. They may have had no idea what they were doing, but they did it all the same. Their debts were private-owed by them to investors around the world-and still the Irish people have undertaken to repay them as if they were obligations of the state. For two years they have labored under this impossible burden with scarcely a peep of protest. What’s more, all of the policy decisions since September 29, 2008, have set the hook more firmly inside the mouths of the Irish public. In January 2009 the Irish government nationalized Anglo Irish and its 34-billion-euro (and mounting) losses. In late 2009 they created the Irish version of the tarp program, but, unlike the U.S. government (which ended up buying stakes in the banks), they actually followed through on the plan and are in the process of buying 70 billion euros of crappy assets from the Irish banks.
- Irish Central Bank Printing 51 Billion Euros
- Hungary, Bulgaria, Poland, Ireland, France, Bolivia Seize Private Pensions
- Economist: Ireland real estate will fall 80% from peak
- What caused the global housing bubble?