Lessons from Ireland's spectacular fall

Dennis Morrison, Contributor

Ireland, the miracle economy of the 1990s, is teetering on the brink of sovereign default as its banking system is being overtaken by a full-blown crisis that has international investors on the alert. As a result, the people of the 'Emerald Isle' are about to be hit by another round of pay cuts, layoffs, and other public-spending controls, as well as tax hikes as the price of securing international support to prevent a catastrophe.

In a still fragile global economic environment, there are concerns that the Irish problems could reignite the uncertainties that pushed the United States and European recovery off course when the Greek debt crisis erupted earlier this year.

After Ireland was transformed from the poor man of Northern Europe to a per capita GDP almost equal to that of the United States (US) by the early 2000s, Irish banks hyperinflated a commercial and residential housing bubble that went bust in 2008. Despite the massive sums that the government has pumped into the financial system since 2008, the largest banks are going under as investors and depositors take flight. With signs that the debt turmoil could spread to other countries of peripheral Europe - Spain and Portugal - the International Monetary Fund (IMF) and the European Union (EU) are mounting a US$114-billion bailout to be used by Ireland to undertake a full-scale rescue of its banks.

Accepting bailout

After resisting pressure for it to seek help from the EU, the government is now forced to accept this bailout if it is to meet the cost of the bank rescue which, it is estimated, will push its budget deficit to an unprecedented 32 per cent of GDP for the current fiscal year. But the magnitude of the cross-border exposures of European banks is so great it is feared that Ireland's banking crisis could undermine the entire European banking system, cause almost incomprehensible losses, and push the region into a double-dip recession.

So nervous are the global financial markets that despite the news of the IMF-EU emergency, rescue package, and an austerity plan to restructure Ireland's public finances, the euro has been losing value as investors seek refuge in the US dollar. The fear of contagion has been fed by the exposure of the failure of EU banking regulation that allowed banks to make massive unsecured loans, including loans to fraudulent borrowers throughout Europe.

It was in this context that Ireland's banks, operating under weak supervision, went wild and crazy, borrowed cheaply, and pumped loans into houses and construction projects that fuelled the bubble.

German banks are thought to be the most heavily exposed to large unrecognised losses on debt not only in Ireland, but in the other countries of the PIIGS group - Portugal, Italy, Greece and Spain - whose fiscal-deficit problems are the most extreme in Europe. But systemically important banks in France and Belgium are also enmeshed in the debt crisis as are banks in The Netherlands, Luxembourg, and Austria. Keen observers of the crisis in Ireland believe that the failure of Irish banks is largely related to "accounting-control fraud" that was facilitated by deregulation and 'desupervision' of the financial system in the boom years.

'Criminogenic' environment

They further argue that the poor handling of the crisis has compounded the problems. In what has been described as the strongly 'criminogenic' environment existing in Ireland - with the special links between the leading business elites, the political classes and the regulators - the government has acted to protect its cronies by guaranteeing virtually all debts of the failed banks. This environment is said to also exist elsewhere in Europe, hence the heightened uncertainty about the crisis spreading to other countries.

Accounting-control fraud is regarded as the leading cause of severe financial crises, and this factor, together with repressive interest rates and lax supervision contributed to the costly meltdown in Jamaica's financial system in the 1990s. Major overhaul of the laws and regulations was undertaken, and tighter control of the system has kept us away from the current problems. But the recent alternative-investment schemes remind us of the risks that remain.

Ireland's spectacular fall from the heights of economic success to austerity has already set off the unravelling of the social-partnership framework that was credited with setting the conditions for the country's turbo-charged growth in the 1990s and the first half of the 2000s. As it now faces the sharp cutbacks in its social-welfare state and the burdens of the bailout of financial elite, the political parties are divided and workers are agitated. It is important that we try to understand how this reversal of fortunes came about, and the lessons of the crisis. Like the Americans, the enquiry into our financial-sector crisis should cover issues of regulation and the practices of the institutions, and not just economic policy.

In the current disturbed state of the European and wider international capital markets, it is not clear how countries seeking to raise money are going to fare. If Ireland, with higher ratings, is having a tough time, how will Jamaica's anticipated return to the markets turn out?

Dennis Morrison is an economist. Feedback may be sent to columns@gleanerjm.com.