While Ireland’s finances, mostly those of its financial institutions, are slowly getting worse and worse, the question arises: Who lent that much money to those institutions? It takes two to tango, and putting blame on one dancer after the performance stalled would certainly be unfair.
Sadly, the German Landesbanken are among the biggest creditors of Irish financial institutions. The reason for this is reported by the Irish Times. I would call this the last Hurrah of the Landesbanken:
The last big potential trigger for change in the sector was ignored – and contributed to the banks’ current plight. The Landesbanken used to rely on funding themselves cheaply with the help of guarantees from their state owners. When the EU ordered an end to such practices by 2005, many Landesbanken used a last flurry of cheap debt to invest heavily in foreign commercial property, subprime debt and other structured securities – with disastrous consequences.
On a side note: remember those stress tests that the Landesbanken passed? This policy instrument should have lost all credibility. As with monetary policy, expectations matter a lot, but if you are unable to use your instrument in a way that at least seems compatible with reality, you will lose your reputation.
If increasing confidence was the idea behind these stress tests, then a rise in confidence was traded against a fall in confidence now. Or, better, a rise in uncertainty, since while this is happening rules will be made up along the way. There is no euro zone resolution mechanism for this kind of scenario (a so-called SDRM – sovereign debt restructuring mechanism). It wasn’t supposed to happen. That doesn’t mean though that nothing could be done, as Nouriel Roubini rightly pointed out:
The current debate on a European SDRM is ... a red herring. The reason the EU has so far decided to provide emergency financing to Greece and Ireland is not because it lacks a legal mechanism for orderly restructuring; it is rather because of concerns about systemic contagion. But an orderly restructuring via exchange offers is the best way to reduce this risk. The sooner the EU admits this, the sooner Europe can put its financial house back in order.