It is hugely ironic that President Sarkozy called last week for Ireland’s corporate tax rate to be increased, as some sort of quid pro quo of the EU-IMF loan to Ireland. It is ironic, because it completely misses the point of who’s doing who a favour. Let’s leave aside, for the moment, the fact that the rate is a huge revenue raiser, that such things are a sovereign right and that Ireland is not being picked on for its low rate but for the fact that its rate is clear. (Other countries in the EU have effective rates than go lower than Ireland’s, depending on the FDI deal being dangled.)
One could certainly understand Mr. Sarkozy’s pronouncements if France and the other EU member states were gifting Ireland a large amount of money – some give and take would be expected. But what has happened is something designed to be a win-win for France, Germany and other EU states. Not only do their banks – the bondholders of the Irish banks – get off scot-free, while Irish taxpayers foot the bill, they as European governments earn a tidy little profit from the interest rate differential, middlemen between the markets and Ireland. In that context, the irony is the general perception that European taxpayers are helping to bailout Irish banks, while it is in fact Irish taxpayers helping to bailout European banks.
The “I Didn’t Do It” School of Thought
The Great Financial Crisis has given birth to two excuses: “I didn’t know what I was borrowing” and “I didn’t know what I was lending”. Ultimately, both cannot be true: in an economy with the rule of law, if neither the borrower nor the lender is responsible for their actions, something has gone wrong. So we know that at least one and possibly both of those arguments has to fall.
As more and more homes go “under water” into negative equity, it is easy to feel sympathy for the argument “I didn’t know what I was borrowing”. Given that they are the professionals, banks have at least in some sense a duty of care entering into a transaction, in the same way a doctor or solicitor has. This is in fact the thinking behind newbeginning.ie, which has been founded to help people who were clearly failed in the duty of care they were owed.
However, it’s not as simple as that. There were certainly, for example, public servants who felt as though they were forced into buying a two-bedroom apartment 80 miles from Dublin because they thought they’d never own their own home. But there were others who, looking around and seeing construction workers take home €100,000 a year, thought the whole thing was madness and avoided buying till it all blew over. A bank’s duty of care can be a convenient cloak under which to hide an abdication of personal responsibility.
What about the lenders to the Irish banks, the bondholders? The first rule of lending is that there is some risk of not being paid back in full. Despite this, the bondholders’ argument, when it has surfaced, has been that money was lent in good faith and borrowers were trusted to only take as much as they could manage sustainably. This is the “I didn’t know what I was lending” argument: why should they – as lenders – have to take a hit due to someone else’s mistake?
This only makes sense if Irish borrowers were so irresponsible as to undermine any responsibility the lenders had. Indeed, given that wealth is often destroyed and lenders have to take a hit, they would have to be so wilfully irresponsible that the Irish taxpayer had to step in to plug the holes created.
The Folly of the Irish?
So perhaps Irish households were silly? Perhaps they were so silly that not only does the “I didn’t know what I was borrowing” argument not stack up, but we can actually give 100% credence to the “I didn’t know what I was lending” argument by bondholders to Irish banks – i.e. European and US banks – and let them off on their merry way unharmed.
It’s pretty clear from even a cursory glance at the statistics that while Irish households may have been silly, Irish households were no more in the thrall of credit than other “more qualified” sectors of Irish society. The business sector in Ireland – people with business plans, shareholders and financial advisors – borrowed almost penny for penny the same amount as households did: while outstanding debt for households in Ireland rose from €57bn in 2003 to €153bn in late 2007, business debt rose from €47bn to €157bn in the same period. So, it’s clear from the statistics that it was not just Irish households.
Not only that, Irish households were no more in the thrall of credit than households in other countries. For example, as the graph below shows, in 2007, residential mortgage debt in Ireland was 75% of GDP, compared to 85% or more in the UK, Denmark and the Netherlands. Instead, Ireland must be viewed as a microcosm – perhaps an extreme one, but one nonetheless – of the global financial environment over the last ten years. As all bubbles eventually do, the seemingly unending flow of money made it harder and harder to ignore the allure of cheap credit.
The Meat of the Sandwich
Irish banks – now owned by the Irish taxpayer – are in the middle of a sandwich. On the one hand, they have Irish households saying: “I didn’t know what I was borrowing.” On the other hand, they have international bondholders saying: “I didn’t know what I was lending.” Of course, Irish banks themselves could have tried to use either of those excuses up or down the line… but everyone knows that Irish banks have got to live with the consequences of their actions.
So will Irish households: the vast majority of Ireland’s mortgage debt will have to be – and will be – repaid. So this all comes down to whether anyone honestly believes 100% in the argument “I didn’t know what I was lending” on the part of bondholders – whether anyone honestly believes that while Irish banks and Irish households have to live with the consequences of their actions, international bondholders don’t.
This is not a call for default in knee-jerk reaction to austerity. Ireland needs austerity to bring its public finances back into line. The Irish Exchequer lived for many years precariously and in recent years well beyond its means and that is something all major political parties are committed to resolving in the coming years. The Irish taxpayer has to live with the consequences of its actions.
Similarly, bondholders must live with the consequences of their actions. That is the argument here. There are other arguments. Normally, I’m a number cruncher and there are plenty of analysts who think bank bondholders would be far better off taking an orderly restructuring of the debt than taking their chances down the line when Irish debt is 150% of GNP. But the argument here is a moral one.
I am just about old enough to remember ads in the Irish newspapers in the 1980s with 17% interest rates. With all that’s happened in the last generation, it can be easy to forget that Ireland is not a country used to low interest rates. When it got them, for better or for worse, it assumed that plain sailing and easy credit was what it was like to be in a low and stable interest rate environment. Ireland got it wrong and will have to its price. And so did – and should – the people who lent to Ireland.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.