ANALYSIS:The Government should examine other banking solutions – such as that emerging in Germany, writes BERNADETTE ANDREOSSO-O'CALLAGHANand MARTIN MULLINS
THE BANKING crisis poses the question: can the EU financial architecture, and in particular the single market in financial services, provide part of the answer to Ireland’s problem? Those positing solutions to this problem have focused on the way the Swedish government dealt with the financial turbulence of the early 1990s (to use the official wording fashionable at the time).
However, contemporary German responses to Germany’s banking crisis might be worth analysing for the following reasons: first, the German economy is the leading economy in the EU; second, German GDP is expected to contract by an impressive 6 per cent in 2009, or by 7 per cent according to Commerzbank forecasts; third, Germany’s likely preferred solution to the problem of toxic assets differs substantially from what has been suggested elsewhere. The latter reason might offer an insight into how best to deal with the problem of bad debts in Irish banks.
In spite of their many differences, the Irish and German economies may share a common feature, which is the relative size of their toxic loans. According to data leaked from the German federal financial supervisory authority BaFin, and disclosed at the end of April by the Sueddeutsche Zeitung newspaper, toxic assets in German banks could potentially be as high as €816 billion (approximately equivalent to 30 per cent of German GDP).
This is comparable to the theoretical €80 to €90 billion worth of exposure that the Irish banks have to the property sector (representing substantially more than 40 per cent of Irish GDP). The German finance ministry puts the figure of those toxic assets that have to be removed from the balance sheets of German banks at some €180-190 billion. The Irish banking problem is therefore of comparable magnitude to the German one, in relative terms, though the origins are quite distinct.
Some of the proposed solutions to the problem can be summarised as follows:
1: The insurance-based British model;
2: The “central toxic waste dump” model where the proposed National Asset Management Agency (Nama) would feature;
3: The nationalisation model, discarded by the Irish Government, on apparently ideological grounds;
4: The hybrid models of the Swedish type, bearing in mind that once the bad debts were taken out of the Swedish banks and put into the new Agency Securum, created on a temporary basis in 1992, the good Swedish banks were temporarily nationalised.
The German plan is in this hybrid category. Details are just starting to emerge on the German government’s plan to manage the toxic assets on the balance sheets of German banks. The German model implies setting up a network of state guaranteed “waste dumps for financial products”. It would keep its large number of private (partly bad) banks.
The idea is that the risk of asset writedowns would be taken by these banks. In effect, the scheme would be a giant “deep freeze” for German banks’ troubled assets. Crucially, as German finance minister Peer Steinbrück confirmed yesterday, the banks would remain responsible for their toxic assets.
The key difference between this German model and the proposed Nama is that the German plan diverts the burden of adjustment to the banks and to shareholders (as opposed to putting it on the already very much overburdened taxpayer, as does Nama), and therefore minimises risk to the taxpayer.
As has already been reported in these columns, Nama is likely to increase the budgetary deficit and it will lead, through the issuing of Government bonds, to a sharp increase in the national debt.
Interestingly, the German government is determined that a central toxic waste dump, or “freezer”, should not be a burden on the German taxpayer. Consequently, if a state controlled toxic waste dump is not acceptable for a country such as Germany, with infinitely greater resources, why is it that Nama is suitable for the Irish economy? How can Ireland afford such a solution?
Unfortunately, our Government appears to be caught in the headlights of this banking crisis, and is apparently unable to see beyond this aspect of our difficulties. Meanwhile, thousands are losing their jobs each month.
Given the current budgetary situation, it is clear that the Irish Government is faced with a trade-off; it needs to decide whether it wants to use its scarce budgetary resources either for rescuing all Irish banks by creating Nama, (a strategy which, as we have seen in the German case, is beyond the capability of their taxpayers), or for stopping the haemorrhage of jobs in the Irish economy by reversing the trends in the domestic labour market.
Rescuing all Irish banks through Nama is a strategy that might bear some fruit in the long term only, but at a large economic cost. In the short term, this strategy is bound to create more uncertainty in the market, and to depress demand and employment further.
The Economic and Social Research Institute (ESRI) unemployment forecast of 17 per cent for 2010 seems to make a clear case for a national employment recovery plan now, so as to avoid a major socio-economic meltdown.
This implies that a certain portion of the funding that the Government is planning to inject into the banking sector needs to be diverted into the real economy, with priority given to the private business sector so as to stimulate job creation.
Given that the confidence of foreign investors in the Irish economy is at an all time low, it might be judicious to send a strong signal to the EU market, and to invite healthy EU banks either to expand their operations or to set up new branches here.
Healthy European banks, combined with the remaining cleansed Irish banks, in line with the German model, would drive from the market the less viable Irish banks. Such is the damage to the reputation of these institutions that it is difficult to imagine them all functioning well in the market for some time.
Allowing for a stimulus package to revitalise the labour market here would be in line with common and current practice in other small EU and European countries such as Sweden, the Netherlands and Switzerland.
Realistically, such a strategy is only possible if the Irish State diverts resources away from the intended rescue package for our ailing banks, and allows the single market in financial services to do its work. This would give some hope to thousands of Irish people – and go some way to addressing the human tragedy of unemployment.
Bernadette Andreosso-O’Callaghan is Jean Monnet chair of economics at the University of Limerick; Martin Mullins is a lecturer in risk management at UL’s Kemmy Business School