Impoverishing a generation is a high price to pay

WHEN finally written up, the management of Ireland’s banking crisis will become a classic case study.

No one knows how deep it will run or how much it will cost. More importantly, no one knows if we can afford to pay back all that’s been borrowed by banks to fund the credit boom.

Officially, it’s said to be affordable, but at what cost to society? International precedents are useful if only to understand the sheer scale of the inevitable costs to society of banking crisis.

Since 1945, numerous national banking crises have caused deep and prolonged recessions. On average, real property prices declined by 35% over a six-year period, economic output declined by 9% and unemployment rose by 7% with equity values collapsing by 50%.

What’s more, public debt rose by 86%. Only a portion was spent on banking bailout costs. Most of the money was spent on Government economic recovery programmes. These are average figures – Ireland’s experience is already a lot worse.

The modern bad bank option was first developed in the US during the 1980s Savings & Loans crisis when rogue bankers brought the house down.

The Americans used a resolution regime to take over the banks, sell off the good bits and close errant institutions, with the taxpayer picking up the bill for recovering bad loans. Today, vast tracts of land with ghost housing estates stand in silent witness to the greed that drove American S&Ls to the wall.

Later still, Norway, Sweden and Finland, faced with an imploding property bubble, took differing approaches. Sweden nationalised two of its big seven banks, splitting them into a good bank and a bad bank.

Norway refused to capitalise its main banks until they had forced their bond holders to bear losses.

Both countries ended up owning banks, which when reprivatised paid most of the taxpayers’ money back.

Both states retained strategic shareholdings in the rescued banks.

Comparisons with the US, Swedish and Norwegian experiences are relevant here only to understand the two generic options – nationalise first and use a bad bank to wind out bad loans or first let private banks take the hit and then recapitalise them.

The sheer relative size of Irish banks’ exposure to property lending and absence of a bank resolution regime, which would have allowed for the ordered take over of troubled banks, left the state with a dilemma.

The banks are too big to fail and too big to bail out. It’s an unresolved dilemma that elsewhere has led states to default on guarantees provided to banks.

The term “zombie bank” was coined for banks starved of capital unable to generate new loans off their shattered balance sheets. The very same has happened here. Not only are the big banks in serious trouble, but all banks, including credit unions, are facing a second round of bad debts as consumer and business loans sour. NAMA is only designed to cover losses on €90bn of loans; what of losses on €180bn consumer loans and billions owed by small business owners?

Higher regulatory capital requirements announced yesterday will force banks to shrink their balance sheets, allocate capital to low-risk investments, eschew lending and increase prices to rebuild capital.

NAMA should have been a side show to the main event – the creation of a good banking system that works. But nothing is being done to build good banks and can’t be until boom time losses are fully recognised and written off.

Other countries have allowed banks to fail and have survived. It is not the end of the world to draw a line in the sand and decide that citizens will not be impoverished for a generation even if economically affordable.

Anglo Irish Bank’s questionable status as a “systemically important” bank is finally being defined in its write-off bill. And the full extent of systemic risk inherent within the domestic financial service system was exposed yesterday through the Quinn Insurance administration. As an insurer’s solvency is as important as banking capital, the state may have to provide capital to a systemically important general insurer.

Far from being over, the banking crisis is deepening.

At what point can we figure out what we can realistically afford to pay and write off the rest?