Wool/Eyes?
December 12, 2010 1:35 PM Subscribe
What would actually have happened if the Irish Government had not taken on the banks' debt?
Since the GFC we have been hearing the same mantra all around the world: banks are "too big to fail" and therefore public money should be used to prop them up, bail them out or underwrite them.
On the surface this, begrudgingly, makes sense. However, philosophically it irks me that banks and large financial institutions are capitalists when they are making mega-profits yet turn into socialists when their debt levels climb through the roof (usually through their own rashness or incompetence).
What would actually happen if the Irish* banks were left to fail (ie if the Govt hadn't taken on their debt)? Are they really too big to fail in a country like Ireland or Greece? What would happen to the average person on the street with a modest savings account and perhaps a home loan? Ditto retirees, ditto businesses and so on....
*Any examples that are relevant would be great really.
Since the GFC we have been hearing the same mantra all around the world: banks are "too big to fail" and therefore public money should be used to prop them up, bail them out or underwrite them.
On the surface this, begrudgingly, makes sense. However, philosophically it irks me that banks and large financial institutions are capitalists when they are making mega-profits yet turn into socialists when their debt levels climb through the roof (usually through their own rashness or incompetence).
What would actually happen if the Irish* banks were left to fail (ie if the Govt hadn't taken on their debt)? Are they really too big to fail in a country like Ireland or Greece? What would happen to the average person on the street with a modest savings account and perhaps a home loan? Ditto retirees, ditto businesses and so on....
*Any examples that are relevant would be great really.
Anyone who invested in Irish bonds would not get paid. Ireland would be forced to go off the euro and print their own money. There would be general upheaval for awhile but they would survive.
posted by blargerz at 2:02 PM on December 12, 2010
posted by blargerz at 2:02 PM on December 12, 2010
The best contemporaneous counter-example is Iceland. Krugman has had a lot to say on this topic (particularly comparisons between Iceland and Ireland). The short version is that Iceland did pretty much the opposite of what Ireland is doing - and seems to be faring a good bit better.
posted by Conrad Cornelius o'Donald o'Dell at 2:03 PM on December 12, 2010 [2 favorites]
posted by Conrad Cornelius o'Donald o'Dell at 2:03 PM on December 12, 2010 [2 favorites]
Anyone who invested in Irish bonds would not get paid.
I disagree with this assessment, and would be interested to hear the reasoning behind it.
posted by pompomtom at 3:08 PM on December 12, 2010
I disagree with this assessment, and would be interested to hear the reasoning behind it.
posted by pompomtom at 3:08 PM on December 12, 2010
Also, it would have knock-on effects in other countries (probably different to Iceland). Ireland is in the Euro so it would affect people's investments in other Euro countries. Also, the Irish banking system is closely connected to the British banking system so it would have a knock-on effect in the UK.
(Not that that should necessarily bother the Irish, but still...)
posted by plonkee at 3:31 PM on December 12, 2010
(Not that that should necessarily bother the Irish, but still...)
posted by plonkee at 3:31 PM on December 12, 2010
The short version is that Iceland did pretty much the opposite of what Ireland is doing - and seems to be faring a good bit better.
misleading - Ireland doesn't have the option of devaluing like Iceland does. Krugman's point is that austerity doesn't work - either you spend your way out (potentially defaulting on sovereign debt) , or you drop out of the Euro and devalue the Irish pound. But then you have the issue of still having your debts denominated in Euros so you are still sort of fucked.
posted by JPD at 4:42 PM on December 12, 2010
misleading - Ireland doesn't have the option of devaluing like Iceland does. Krugman's point is that austerity doesn't work - either you spend your way out (potentially defaulting on sovereign debt) , or you drop out of the Euro and devalue the Irish pound. But then you have the issue of still having your debts denominated in Euros so you are still sort of fucked.
posted by JPD at 4:42 PM on December 12, 2010
From watching what happened in the USA, the problem is that the people and companies and computers who make up the money markets just go insane. Faced with getting 99 cents on the dollar instead of 100, because of a bank bankruptcy in what was supposed to be a safe place to park money, everyone acts like martians are invading at the same time as WW3 has started and wine has turned into water, and that's what destroys everything. The system launches into a self-accelerating spiral.
posted by -harlequin- at 5:56 PM on December 12, 2010
posted by -harlequin- at 5:56 PM on December 12, 2010
As harlequin says, a lot of it is psychological. Banking is one of the bedrocks of any money-based system, and people get weird when it goes badly.
Look at a completely uninsured, unregulated old-school bank failure. The owners (shareholders) lose all their money right off the bat. Anyone they sold bonds to loses their money. They try to sell off the debts (loans) they own, but they get pennies on the dollar. *Maybe* the people with cash accounts in the bank get back most of their money. Everyone whose job depends on the bank loses their livelihood.
All those years of growing, building and becoming part of the local economy simply evaporates. The velocity of money in that local economy slows down. People have less and they are afraid to do anything with it besides stuff it into mattresses. Other banks get closer to insolvency because there is just less money around, not to mention people going nuts and pulling cash out.
Meanwhile, there is less money available for others to borrow. The interest rates go up to try and balance out the supply versus demand of borrowing. Fewer homes bought and sold, prices drop. Businesses that depended on a temporary loan here and there to maintain cash flow can't afford them any more. Some go out of business, others lay people off or raise prices.
Eventually, things start to stabilize and the businesses that are creating value start to outnumber the forces destroying value and things start to grow and prosper again. This takes years, if it ever happens. While that is happening, prosperity is destroyed.
And this doesn't even get started on all the people who lost significant chunks of their savings because they were invested in the bank. All those people start to need money and try to get jobs in an economy that can't even support the jobless it already had.
Now imagine what happens if a second bank had failed, or a larger bank had failed. Double all that trouble, and maybe quadruple the psychological craziness. Now imagine the biggest bank in the country.
(Consider AIG. They had all this trouble AND they were unable to pay out on insurance they owed to other entities. So all those other entities fail, or come dangerously close.)
Now there is moral hazard in doing bailouts. But hopefully that hazard is counteracted by better regulations that prevent that from happening again. The "fat cats" still lose pretty hard, but we aren't taking all those other people down with them.
There is a tipping point. That is possibly unknowable. An economy can absorb some failure, but beyond that tipping point, the failure compounds and almost lights a fuse that leads to an economic tire fire.
posted by gjc at 6:56 PM on December 12, 2010 [1 favorite]
Look at a completely uninsured, unregulated old-school bank failure. The owners (shareholders) lose all their money right off the bat. Anyone they sold bonds to loses their money. They try to sell off the debts (loans) they own, but they get pennies on the dollar. *Maybe* the people with cash accounts in the bank get back most of their money. Everyone whose job depends on the bank loses their livelihood.
All those years of growing, building and becoming part of the local economy simply evaporates. The velocity of money in that local economy slows down. People have less and they are afraid to do anything with it besides stuff it into mattresses. Other banks get closer to insolvency because there is just less money around, not to mention people going nuts and pulling cash out.
Meanwhile, there is less money available for others to borrow. The interest rates go up to try and balance out the supply versus demand of borrowing. Fewer homes bought and sold, prices drop. Businesses that depended on a temporary loan here and there to maintain cash flow can't afford them any more. Some go out of business, others lay people off or raise prices.
Eventually, things start to stabilize and the businesses that are creating value start to outnumber the forces destroying value and things start to grow and prosper again. This takes years, if it ever happens. While that is happening, prosperity is destroyed.
And this doesn't even get started on all the people who lost significant chunks of their savings because they were invested in the bank. All those people start to need money and try to get jobs in an economy that can't even support the jobless it already had.
Now imagine what happens if a second bank had failed, or a larger bank had failed. Double all that trouble, and maybe quadruple the psychological craziness. Now imagine the biggest bank in the country.
(Consider AIG. They had all this trouble AND they were unable to pay out on insurance they owed to other entities. So all those other entities fail, or come dangerously close.)
Now there is moral hazard in doing bailouts. But hopefully that hazard is counteracted by better regulations that prevent that from happening again. The "fat cats" still lose pretty hard, but we aren't taking all those other people down with them.
There is a tipping point. That is possibly unknowable. An economy can absorb some failure, but beyond that tipping point, the failure compounds and almost lights a fuse that leads to an economic tire fire.
posted by gjc at 6:56 PM on December 12, 2010 [1 favorite]
What would actually happen if the Irish* banks were left to fail (ie if the Govt hadn't taken on their debt)? Are they really too big to fail in a country like Ireland or Greece?This wasn't the only option. The Irish government could have taken over the banks and decided which debts of the banks to honor with taxpayer money on the basis of the impact on the Irish economy, sort of how the FDIC currently works in the US to cover personal savings in bank accounts of failed banks.
The same thing could have happened in the US, too. The US government could have just kept taking over the institutions which failed as a result of the AIG collapse, etc. and honored the economically important commitments of those institutions with taxpayer money. Instead they decided to honor politically important commitments by providing far more taxpayer money to temporarily prop those institutions up. It's not going to end well.
posted by Coventry at 7:45 PM on December 12, 2010 [2 favorites]
The FDIC is not funded with taxpayer money, but through an insurance premium paid by covered banks. As far as I know, the taxpayer hasn't been on the hook for anything yet. When the FDIC closes down a bank, they sell the assets immediately to another bank and liquidate the rest, and cover whatever the difference is. They have very strict criteria for closing down a bank, they don't wait until it is too late. The FDIC doesn't "decide" which accounts to cover on a case by case basis, all deposits are guaranteed up to $250,000.
Instead they decided to honor politically important commitments by providing far more taxpayer money to temporarily prop those institutions up. It's not going to end well.
Actually, we are on our way to coming close to breaking even. "Originally expected to cost the U.S. taxpayers $356 billion, the most recent final net estimate of the cost, as of October 5, 2010, will be close to $30 billion, including expected returns from interest in AIG." I think we got more than $30 billion in confidence (or in stemming the tide of confidence) back for our trouble. Hell, we spend that much every 20 days on defense.
posted by gjc at 9:08 PM on December 12, 2010
Instead they decided to honor politically important commitments by providing far more taxpayer money to temporarily prop those institutions up. It's not going to end well.
Actually, we are on our way to coming close to breaking even. "Originally expected to cost the U.S. taxpayers $356 billion, the most recent final net estimate of the cost, as of October 5, 2010, will be close to $30 billion, including expected returns from interest in AIG." I think we got more than $30 billion in confidence (or in stemming the tide of confidence) back for our trouble. Hell, we spend that much every 20 days on defense.
posted by gjc at 9:08 PM on December 12, 2010
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I'm not sure what Ireland has that's equivalent to FDIC, but if the Government offered any depository insurance, then it's possible that they would have had to throw tons of money at these banks just to cover that. After all, if the government doesn't step in, then bank runs are inevitable.
The failure of multiple large banks, especially if it's all the major banks in a country, would also hugely constrict the flow of credit going to everybody. Expensive credit means businesses can't afford to invest/expand or even continuing operating.
And a bunch of other stuff would happen too.
posted by Geppp at 1:58 PM on December 12, 2010