Noose Closing on Ireland

We indicated yesterday that the Irish government had been in the process of trying to steer an inevitable rescue operation towards salvaging its bloated, cancerous banking system rather than a government bailout, which would not only further reduce national sovereignty but also saddle Erin with debt that could not be restructured. Stratfor describes how the Irish crisis is indeed a banking crisis (hat tip reader Valissa):

The Irish banking system is in extreme distress with the Irish government fearing that it may need to inject another 20 billion euros ($27 billion) on top of the 60 billion euros it has already used to recapitalize the sector. But unlike the debt situation in Southern Europe — and especially Greece — Ireland’s worst abuses are private in banking, not public in state spending. This is not the (Greek) story of a state that lived on loans to maintain a standard of living it could not afford. Instead, this is the story of an overall well-managed system whose banks are guilty of overexuberance. So where the Greeks begged for a bailout earlier this year and then railed (and continue to rail) against the budget cuts they are being forced to abide by to maintain the intravenous drip of euros, the Irish are already nearly two years into a self-imposed austerity, all without any serious protests or strikes.

Stock markets rallied around the world on the assumption that the Irish will be forced to accept a IMF-EU-UK rescue. And while odds favor that outcome, there are still some serious points of friction.

In particular, outside observers took to heart the remarks of central bank governor Patrick Honohan, that he anticipated that negotiations with the bailout delegation, set to commence today, would result in a tens-of-billion-euro loan deal. But per the Irish Times, the government took issue with his remarks:

[Brian] Cowen indicated that the Government did not share Prof Honohan’s views on the figure or a deal, saying his comments were premature ahead of negotiations.

“The governor gave his view. He is entitled to give his view. I am entitled to give the view about the decision the Government will take when the necessary discussions are over,” he said.

However, Minister for Finance Brian Lenihan later told the Dáil that the Government could accept an aid package for the banks after the talks with the IMF.

He said the establishment of a contingency fund would be a “very desirable outcome” but said no final decisions had been made.

It was possible that the funds would be made available but not drawn down, he added.

In a subsequent interview on RTÉ television, Mr Lenihan accepted that the external assistance from the EU would “have to be funnelled through the State” but denied the IMF would be directing the budget and four-year plan.

Note that the Irish government is still holding out for a banking-system-only bailout, even if the funds are channeled through the government. Since I am not aware of any IMF bailout being done on this format, it’s likely to be a sticking point if the Irish refuse to back down (recall that the government itself is under no immediate funding pressure; they have six months before they need to go to market, which is an eternity in crisis-land).

The other major bone of contention is Ireland’s super-low corporation tax, which served as a significant incentive for multinationals to set up shop in Ireland. The Germans and French are insistent that it be increased to balance the budget. The Irish objections here are plausible, particularly since the low rates are a cornerstone of their national strategy (do you want 12.5%, the current corporate tax rate, of a decent sized number or 25% of a vastly smaller number?). The Irish have made it clear that they are non-negotiable on this point, and as keenly as the rest of the eurozone would like to beat Ireland back into line, I doubt they’d be willing to risk negotiations failing over this issue.

What has been remarkable about this whole saga is that these rescues continue to be presented as sovereign bailouts, when in fact the real objective is to keep the European financial system from imploding. A Financial Times editorial described what is really at stake:

There is something absurd about pressuring Ireland to borrow money from Europe in order to calm markets enough to lower yields for Spain and Portugal, whose refinancing needs are more acute..

But the most urgent problem is not the solvency of the Irish state; it is the solvency of the Irish banking system….If Irish banks collapse – and if one falls it will not fall alone – it may well trigger bank failures across a continent that remains full of institutions whose earlier stress tests were remarkably stressless…

Saving the banking system, however, is not the same as bailing out extant institutions; nor should taxpayers give up even more of their blood to the walking dead. Yet this is what Ireland is being asked to do – borrow money from the EFSF to raise the banks’ equity. Doing so would be an insult to the Irish people (whose incomes will be mortgaged to pay the loan back) and a gratuitous one at that: it defies logic to claim that adding to Dublin’s debt will seduce markets back to Irish sovereign bonds.

So Ireland – and Europe – must confront the prospect of an inevitable string of bank restructurings. Giving away more capital now will weaken states’ ability to deal with the problem when there is no more time to be bought….

Europe does not yet seem willing to give up a diabolical bargain that has core states lend to peripheral ones so that they can support their banks, all to save financial institutions in the core from losses. This game of bail-outs on the sly cannot be sustained for much longer.

It has hit the point that the banks’ refusal to remedy their behavior is facilitating continued looting, as the scale of bloated big bank operations and financial firm pay have changed. Financiers like to tout their industry as Darwinian, yet they have failed to learn a key lesson from nature: successful parasites do not kill their hosts.

Originally published at naked capitalism and reproduced here with permission.