With Ireland in the grip of an economic meltdown and intense nationalization it is easy to slip into the lull of “economic bailout is the only way” but if we look back in recent history Iceland went through what was once perceived as the worst economic crisis in history and is now coming out the other side stronger than when they went in. So how did they do it, the simple answer is they let the banks fail, agreed not to bail out investors and then devalued their currency to take advantage of the status of being a “low cost country”. In effect Iceland created a simple arbitrage situation and in effect created the crisis to lure in investors with an attractive opportunity. Iceland has turned to face the monster that they had created and went straight through it. This actually led the way to solve their woes through a plan that did not involve adding excessive debt and eroding the financial future of the country through paying interest on a long term loan.
This is a brilliant example of not trading tomorrow for today, something that Ireland is signing up for through the acceptance of EU funds to ease their current short term suffering. As the third world expands and narrows the gap between the “haves” and the “have-nots” the idea of cheap labor and a new frontier will shrink as the standard of living rises and education leads to knowledge work being not just the domain of established developed economies. Iceland’s strategy is a great move for Ireland to begin a new push toward recruiting firms into the country though devaluing their currency similar to a “loss leader” in a supermarket, luring potential investment into the country and then hooking them into doing business through their competitive advantages.
The alternative is to trade tomorrow for today, and face the possibility of a slower economic recovery that erodes the bottom line 5.7% at a time. This means that for generations to come Ireland may be crawling out of the mountain of debt that the current administration has burdened future generations with. An economic recovery will be slower than expected and will also have the businesses struggling for scraps that are left after the EU and the IMF take their shares off the top similar to the garnishment of wages, leaving only enough to make life that much harder to dig yourself out. A country should not trade tomorrow for today, because inevitably there will always be another day, and you will have to face it one way or another.
With so many people talking from so many different angles on the Irish banking and financial industry it is hard to tell what all the hype means. This becomes increasingly important going into a year in which some feel the housing market is nearing the bottom of the curve and cash is being injected into the Irish economy like an intravenous drip. With the EU going all in on the heels of Greece’s bailout early this year Ireland is under increasing pressure to cut their deficient to around 3% in the coming years. The question that this raises though is the same for every domestic household in every corner of the world… where is the money going to come from? I every household, in every country you really only have two options to balance the budget, spend less or earn more.
For Ireland this becomes a balancing act of protecting the precious income that comes in from foreign entities attracted by lower than average corporate taxes and protecting the very population that threatens to offer a change of government as early as this March. To complicate this the EU is going to discontinue funding in 2013, leaving Ireland to fix its own capital issues and raise its own money (most notably at a higher and higher rate at each successive bail out from each lender). It has been mentioned more than once that this is not a unique problem, as several monetary funds have been created and there is an expected 24 billion dollars ready to be shelled out to cover short term lending issues. But like any household, where is the money coming from, and who are we going to have to ask when the funds run dry? Many have mentioned that the existence of these “bail out” funds encourages credit heavy wild lending that sets a country up for failure knowing that there is a safety net in the event that they cannot pay.
But where does the bailout end, who must be the “father figure” that exercises financial responsibility that provides a stable base for those that should be taking risks. A business should be allowed to take appropriate risks through access to secure capital. The underlying bank should be taking less risk to assure that they can be a bedrock for the appropriate businesses that can drive the economic engine. If the EU stops providing the fiscally responsible access to capital and the national banks have not more discretion than a start-up then what happens when the money runs out? As a company grows , so does a government and the higher levels of the organization have a responsibility to provide for those at the lower levels to go after the big gains.
This week European ministers reached an agreement to provide a failing Irish banking economy with a huge eighty five billion euro bailout. While it was unanimously agreed upon by the 
ministers of the Eurozone, it was far from a good natured unanimous vote, with UK Chancellor George Osborne agreeing to loan only if they are excluded from all future bail out agreements as of 2013. This sort of tenuous relationship points to the stress caused by another bail-out coming in the heels of Greece’s bailout earlier. Everything from the interest rate charged to the use of the Euros were criticized and compared relative to the bailout of Greece in early 2010. The Eurozone has a right however to be upset, as the use of the Euros was largely left undefined and “up in the air”.
Only 10 billion of the borrowed funds are required for “recapitalization”, when a majority of the issue facing the banks is a lack of solvency that is directly impacting the access to capital and that in turn is making it difficult for businesses to hire or make any real meaningful long term expansion plans. These plans will be key if the Irish business economy is going to make its substantial rebound without raising its coveted 12.5% corporate tax rate. This tax rate is closely ties into the recovery plans to utilize foreign companies to support an export driven strategy to move the country forward.
In addition to the 10 billion mentioned above there is an ambiguous “debt mechanism” that requires the EU to avoid the use of the rescue fund that is set to run out in 2013. However what was lost and make this ambiguous is that there are no real plans to define the “how” the measures are actually going to work. The general rule however is that the mechanism should force losses on private investors "only on a case by case basis", exactly what that means remains to be seen. It has been mentioned that it will look similar to Iceland’s approach to let banks fail and investors fall, only to come back after the currency is devalued stronger than before. It is interesting however that if the banks are publicly owned then the losses associated with economic downturn should be passé on to those who were not minding the store closely enough. This will be compounded by the required austerity plan that will cut public services for those unemployed at the greatest time of crisis. The requirement for the bailout is the requirement that the government reduce its excessive debt by 2015 to less than 3%.
With the Irish government now holding 93% of AIB (Allied Irish Bank) it appears as if the entire banking system has been take under the protectionist wing of the Irish government and the bad debts that contributed to the lack of capitalization have been shuffled off the an organization called NAMA that will “revise” them and “rework” them until they are profitable and can pay back the Irish tax payer.
The more looming question however is whether or not government intervention will actually work for the banking sector, and what this means for SMEs in Ireland. The government is an extension of the taxpayer, the taxpayer is therefore the owner of the government (theoretically), and the taxpayer is the one who signed up to a mortgage they could not afford because they lacked the financial literacy to understand that an interest only loan is highly volatile given the historical rates. Isn’t this in effect similar to giving the inmate the key to their own cell?
Banks will inevitably have to write off a majority of the bad uncollected debt, and unfortunately that amount is not figured into the repayment of the taxpayer, plus out of that amount comes the administrative expense for the “department” that has to oversee the process and physically handle the collections and the restructuring. In a nutshell this is eroding the bottom line and throwing good taxpayer money after bad debts. This is very similar to rework in a manufacturing operation and as a result the end amount is rarely worth the effort. Secondly the government will take the banks and with hold their ability to issue stock shares pending the payback of the bailout funds, and these payback funds will come at the expense of the taxpayers that the government was trying to protect in the first place. They will be leveraged through additional fees and charges to make up for the lost revenue of their mortgage holdings.
In short the nationalization of the banking sector is not the correct method through which to leverage reform. The real reform comes through diversification of a bank’s investments and the line of sight into what truly they are invested in. Things like derivatives become more and more ambiguous as we stack the foundation of an asset on another, and then still another. True reform will come through the investment in SME’s which can be molded through relationships and flexible credit terms dependent on real and relevant factors. Much like tried and true business rules throughout the ages, if you cannot define what you do, then it is not really a product or service, and the derivatives based on layers of ambiguity should have investors scratching their heads and wonder what they are buying, and in the case of bank nationalization, who they are buying it from.
