An Irish Experiment

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

Ireland has provided a sneak preview to other countries, neck-deep in bailout debts and deficits, on how things might turn out when the time finally comes to pay the piper. Apparently, the Irish government’s idea of economic bailout envisioned taxpayers purchasing property loans from banks at prices higher than the properties’ market values, but which were also lower than values carried on banks’ books. Certainly, the markets reacted favorably, but this did not necessarily mean that taxpayers would not get stung.

Most nations hesitated to force their banks to admit all the ailments that bothered them and all the troubles they were in, because burying one’s head in the sand sometimes seems like the smartest thing to do. Ireland was no different. The country’s major banks, such as Allied Irish Banks PLC and Bank of Ireland PLC, are still drowning in billions of euros in toxic assets and bad loans. Yet, instead of making the banks face their shareholders and creditors, the Irish government embarked on the path of the least resistance, passing on the bill to the taxpayers.

Of course, the Irish are not the first one to come up with the idea. If you recall, the Troubled Assets Relief Program (TARP) was supposed to take on the toxic assets from banks’ balance sheets so they could start lending again. The Irish have essentially done the same, only they have actually followed through on the original TARP blueprint.

In 2008, pricing the buyout of the U.S. banks’ toxic assets was a matter of much debate. If too high a price was paid, banks would effectively be nationalized with taxpayers’ money. Pay too low a price, and the banks could go under even faster. After trying twice to pass TARP before the Congress, former U.S. Treasury Secretary did a 180 on the original plan and decided to use the $700 billion in TARP funds to buy equity in banks, instead of their toxic assets. Since then, no one squeaked out a word about buying banks’ bad loans and troubled real estate.

In Ireland, however, after Lehman Brothers had failed in September of last year, Irish Finance Minister Brian Lenihan announced the creation of a special government agency for the purpose of “channeling,” literally and metaphorically, the bailout euros, which would buy €77.0 billion worth of troubled assets from five lenders. The deal was that the government itself would cover about 70% of the assets’ carrying value at the time, altogether worth €54.0 billion. And, while that may seem like a substantial haircut, the actual price may have been as much as 15% higher than the assets’ actual price. In other words, the taxpayers have been left on the hook not only for the amount of money lent, but also for the steep premium of at least 15%, having also assumed all the risks that came along with it.

Despite these concerns, the Irish government went boldly on, counting on real estate prices to rise 10% over the next 10 years or so, which would give it enough time to break even. But, as was the case with many government plans before, such expectations did not come to fruition. The days of the Celtic Tiger and soaring real estate prices were long gone. Ireland today is going through the worst recession among Western nations since the Great Depression. Unemployment is at 12% and rising, while the real estate market prognosis is depressing, to say the least. Truth be told, if Ireland were not part of the Euro zone, it would have been reduced to “another Iceland” fiasco faster than you could say “bailout.”

Lessons learned? Plenty, of course. Obviously, it is time to understand that creditors are not the “Untouchables,” that there is nothing sacred about creditors and, if they had agreed to take on excess risk by underwriting suspect loans and if those loans are going under, they should be called on to put their money where their signatures are. There is also recapitalization through debt-for-equity swaps as another viable option. At this point, anything will do that would give taxpayers at least a sporting chance of seeing some of their hard-earned tax dollars back.