The roots of the Irish crisis

December 4, 2010

The Republic of Ireland’s financial crisis, which has caused unemployment to rise from 4.3% in 2006 to 14.1% in October, has deep roots.

The conditions of the European Central Bank (ECB)/International Monetary Fund (IMF) “bailout” package for the Irish government will total €85 billion — at a higher interest rate than that tied to the Greek bailout in May. It is tied to the Irish government carrying out huge government spending cuts, tax rises for workers and wage cuts for public sector employees.

Irish workers are being told to pay for a crisis they did not cause.

The most immediate cause of Ireland’s financial crisis was the collapse of its banks. In January 2009, the Irish government nationalised the Anglo-Irish Bank after it was left exposed to a series of bad debts flowing from the bursting of the Irish property bubble in 2008.

Nancy Macdonald, writing for Macleans.Ca on November 17, said that in 2007, “Ireland’s household debt was at 191 per cent of household income ... A family home in Dublin cost as much as in Beverly Hills. Mortgages worth 10 times average earnings were commonplace.”

When the collapse came, it came spectacularly.

After making an open-ended guarantee of bank deposits and bank borrowings in October 2008, the Irish government sought to recapitalise the major banks by offering loans in an attempt to re-establish liquidity.

Anglo-Irish was the bank most exposed to the property bubble in Ireland. Its loan portfolio had grown from US$4 billion in 1998 to $103 billion in 2008, equivalent to half of the Irish national income, Macdonald said.

In December 2008, fresh scandals revealed that the chairman of Anglo-Irish had borrowed €87 million and kept it off the banks accounts for eight years. This created another huge hole in the bank’s finances.

Rather than allow it to fail, the Irish government took control of the Anglo-Irish bank in January 2009. The cost for the nationalisation of that one bank has been estimated at between €29 billion and €34 billion.

Other leading Irish banks were also exposed to the collapse of the property bubble. In late 2009 the Irish government established a “bad bank”, the National Asset Management Agency, to absorb bad loans from the Irish banks.

The government-owned “bank” bought bad loans from the banks at a discount, effectively nationalising financial risk and guaranteeing the private banks’ profits.

“Already, Dublin has committed to spending US$100 billion — 10 times per head the amount the U.S. spent rescuing its banks,” Macdonald said.

The bank bailout left a massive hole in the Irish government’s budget. And after years spent lowering corporate taxes, the Irish government was left with few means of filling the hole.

It tried to raise capital by issuing bonds to fund the debt, but the market reacted with scorn, forcing the interest rate for 10-year Irish sovereign bonds above 8% by November 17. This made the cost of servicing these bonds for the Irish government overwhelming.

By contrast, 10-year German government bonds paid only 2.5% on December 2, said.

On November 22, the Irish government caved in to European demands and accepted an ECB and IMF bailout. Irish Prime Minister Brian Cowen claimed the deal was the best available.

The November 29 Sydney Morning Herald said Cowen claimed: “Without these loans the necessary tax increases and spending cuts would be far more severe.”

Even before the bailout, Cowen’s government had implemented severe spending cuts — these will now be dramatically deepened. Conditions the Irish government agreed to for the bailout include budget cuts of €12.7 billion over three years, with a guarantee to cut spending even further if the ECB or IMF require it, the December 2 said.

Changes already agreed to include raising the pension age, cuts to welfare spending and the minimum wage, the privatisation of the gas and electricity industries and increases in consumption taxes. Further measures were to be announced in the emergency budget released on December 7.

However, the Irish government has ruled out raising its 12.5% corporate tax rate.

Irish workers will pay for the bailout with stringent cuts to government spending, pensions, public sector wages and jobs. However, much of the money will find its way back to the leading banks of Europe, which are heavily exposed to Irish banks, the November 22 ABC radio PM program said.

The roots of the Irish crisis lay with attempts to attract foreign investment to the country in the 1990s.

In the mid-90s, the corporate tax rate was reduced to 12.5%. This encouraged massive foreign investment and a flood of capital — much of it speculative — into the Irish economy. In 1997, capital gains tax was cut from 40% to 20%, and property tax concessions were introduced.

Alan Kohler said in the November 27 Business Spectator that this “directly led to the explosion in property speculation, which in turn led to the collapse of the Irish banking system”.

By joining the Eurozone in 2002, Ireland committed itself to maintaining Europe-wide interest rates set by the ECB. Prevailing low interest rates in Europe only encouraged the property bubble to grow, as Irish banks made big loans from overseas sources and lent widely to speculative property developers.

Macdonald said: “By 2004, the International Monetary Fund and the Organisation for Economic Co-operation and Development (OECD) had begun flashing warning lights —which grew increasingly ‘redder, and flashier,’ with each passing year.”

By 2007, stamp duty and capital gains taxes made up €6.7 billion of the Irish government’s budget, Kohler said. After the property bubble burst, this fell to €1.6 billion in 2010, leaving a huge shortfall in government revenues. This is despite savage austerity measures already implemented over the past two years.

Theoretically, the cuts in Irish government spending, cuts in the minimum wage and welfare spending will deflate the Irish economy, reducing wages and making exports cheaper. Theoretically, the country will be able to export itself out of difficulty in coming years, and living standards will slowly recover.

However, Mark Weisbrot, writing in the November 19 Guardian, pointed out that “it’s tough to think of examples where it has actually worked”. The austerity that Irish workers are facing over coming years will be very real, but the chances of significant economic recovery may just be pure illusion.

The Irish bailout, with its attendant austerity for Irish workers, is proving not enough to stabilise Europe’s shaky economies. Interest rates for sovereign bonds issued by Spain, Portugal and Italy rose, even after the announcement of the Irish bailout, showing the market is not convinced that the Eurozone has become stable.

Meanwhile, interest rates on Greek bonds have increased to 12%, the November 30 Guardian said — despite that country being bailed out and forced to adopt stringent austerity measures earlier in the year.

And interest rates for Irish sovereign bonds rose to 9.25% on November 30, despite that country already accepting a bailout.

Spain needs to raise €150 billion in 2011 from bond markets, while Italy needs €340 billion euros, the Guardian said. Yet private capital, which funds bond issues, is increasingly unwilling to risk investing in European sovereign bonds at whatever the return.

Further bailouts, with ever stricter austerity measures attached, could be in the offing.

Europe-wide the crisis of European banks is playing itself out as a crisis of the euro as a currency. The only way out of the crisis for the European rich is to make ordinary workers shoulder it.

It’s not yet certain how the crisis may evolve — whether it’s a series of further bailouts or a complete collapse of the euro as a Europe-wide currency. But the price of the crisis has already been set and unless Europe’s workers are able to resist it, they will be made to pay.

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