The Irish government is in talks to obtain a loan of up to 90 billion Euros from the IMF and the EU. Britain will be contributing £7 billion of this.
When the current British government took office, it made some immediate spending cuts and tax increases amounting to £6 billion. So in a sense all the good work so far in tackling Britain’s own huge deficit has been undone at a stroke.
John Redwood and others have argued that this is not our problem, and we shouldn’t be helping out with these loans.
The government says it hopes to get the loan paid back in due course by the Irish. And I have no reason to doubt that. Ireland is, despite everything, very far from being a basket case, and the promises and contracts made by the Irish government can be relied upon more than most. Therefore lending that £7 billion is not the same as spending it.
Our £7 billion will of course be borrowed from creditors of our own. The British government is simply lending its AAA credit rating to the Irish – acting rather like a parent who acts as guarantor for their child’s mortgage. We will get our money back, and therefore be able to repay our own creditors in turn.
However, that is not really the point. Wolfgang Schauble, Germany’s Finance Minister, let the cat out of the bag by saying
We are not just defending a member state but our common currency.
This Irish deal is not about saving Ireland. It is about saving the Euro. And that, of course, is why John Redwood is so much against it.
The main losers in this deal, obviously, are Irish taxpayers who will ultimately foot the bill for all this borrowing. They should be very angry this morning.
To my mind, what is really bad about this deal is not that it involves Britain in supporting the Euro. What is bad is that it also may be about subsidising the owners of the Irish banks – among them our own basket case bank, Royal Bank of Scotland.
We need to be clear about the difference between insolvency and lack of liquidity. Insolvency means your liabilities exceed your assets – effectively your business has negative capital. If your business is insolvent, then its shares are worthless.
Illiquidity means you can’t find the cash to keep your operations going – even though you may have assets that are easily enough to cover all your liabilities. In that case, if your company can obtain temporary loans to keep it going, it may very well have real value.
If the Irish banks are insolvent, and it appears that they are, then the money Irish taxpayers provide to those banks is a subsidy to the banks’ owners, not a loan or an investment. The true value of those banks’ shares is, right now, nil. But if they are propped up and the shareholders don’t lose everything, then the value of the shares becomes not nil – and the value of the shares will have come directly from the government / taxpayer support.
That represents a real cost to Irish taxpayers. They will be paying the cost in full – all 90 billion Euros of it.
What about the shareholders in the Irish banks, never mind the bondholders? The details of the bailout are not yet clear. But one thing that is crystal clear to me is that if the banks are insolvent then the shareholders, at least, should lose every penny of their investments as part of the deal.
If the Irish banks are insolvent, in other words their liabilities exceed their assets, then the first losses should fall on the shareholders. That’s how share markets work. (I’ve been a victim of that myself in a small way, having owned a small shareholding in a company that went bust – I lost the lot, which is fair enough and a risk you should accept if you buy shares.)
If the Irish bank shareholders don’t lose their investments, then this deal won’t be a deal to save the Irish banks. It will in fact be a direct subsidy from the Irish taxpayers to the shareholders in the Irish banks.
All the world’s politicians are scared witless by the idea of banks going bust. They should try and learn the difference between allowing a bank to go bust as in cease operations, and allowing the bank shareholders to lose everything.
The same kind of thing happened in Britain, after all. Royal Bank of Scotland was propped up by taxpayers – but the shareholders still own 16 percent of it. Perhaps they would argue that their company was lacking liquidity rather than insolvent. In that case, the government should have provided liquidity, through the Bank of England, not almost fully nationalised the bank.
The public probably think that the government getting shares in RBS was the least taxpayers could expect in exchange for the support the government gave. In fact it was a bad deal because shareholders stand in the queue behind lenders in terms of calls on a company’s assets. If RBS was insolvent, it should have been fully 100 percent nationalised and the shareholders should have lost the lot.
The right course of action is clear, depending on the circumstances in each bank:
- If the bank is solvent but is having trouble borrowing the money to fund its operations, then the relevant central bank should provide the funds to keep it afloat in its capacity as lender of last resort.
- If the bank is insolvent then a deal should be done in which the bank shareholders lose everything but the bank stays in operation at least temporarily so that depositors are protected.
Let’s hope the Irish are more canny than Gordon Brown and Alistair Darling were in Britain.