The Irish banking system remains a problem whilst institutionalised inflation is hurting the UK

At the end of last week when optimists might have been hoping for some signs of at least  a settling down of the current Euro zone crisis we saw several events which raised its profile yet again. The meeting of Euro zone ministers on the 16th and 17th of December had come and gone without any great disputes but also without any particular new plan. It has been quite some time now since we were first promised a new plan or European Stability Mechanism from 2013. The problem is that we get a new version of it almost every week! Each new version is badged as the solution only to disappear and be replaced by a new one leaving behind an increasing problem of credibility. One obvious problem of grand plans which start in 2013 is what happens in the meantime? Investors posing this question have sometimes not liked the answer and accordingly (loose) talk by Euro zone ministers and officials has contributed to an escalation of this stage of the crisis. I am reminded of the poster campaign in the UK in the Second World War which said “loose talk costs lives”. This time its money rather than lives.

The Ratings Agencies

Over the weekend a comment on here addressed the ratings agencies and I thought I would make my position clear on them. They are conceptually bankrupt organisations which failed in their purpose. Unfortunately a feature of the post credit crunch era is that we have not been good at clearing out failures. So to add to zombie banks we have zombie ratings agencies. We do not have any plan for an improvement as I feel the idea of governments forming them is one example of something which could even make things worse. Could you imagine the Greek ratings agency of say 2 years ago when all her statistics were being dissembled? Or going forwards any ratings agency and the enormous pressure it would come under rating the debt of its own sovereign? An European Union wide one would have the problem of the fact that the organisation setting it up has been unable to get its own accounts past its auditor for 16 years.

Unless anyone has a better idea I would propose simply scrapping them. I doubt the world would end as the financial industry if pressed is often quite innovative.

The European Central Bank and Ireland

We shall receive news later today as to how much money the European Central Bank had to spend in an effort to support the Irish government bond market last week (it is also supporting Portugal and Greece) under its Securities Markets Programme. I wrote on Friday about the planned increase in its capital to address the losses it must be holding on this book. Although as this has been misrepresented in the mainstream media let me make the actual position clear. Some extra money is due on the 29th of December but even then it will have less paid-up capital than many have claimed its capital to be now! Also the next two tranches will be paid one year and two years later so are not much use now. If you are at the ECB you are probably a little edgy on this subject and maybe a little embarrassed. After all it is hard to lecture banks about capital inadequacy with a straight face if you have the same problem.

Just to add to the conceptual issues facing the ECB it is not happy with the details in the bailout deal for Ireland and here is an example from its letter on this subject which summarises its generic view.

The Section needs to clarify this, in particular since the published Bill does not contain an Article 60 which appeared in a previous version of the draft law and which usefully stated that‘nothing in this Act affects any function, right, or entitlement of the [Central] Bank or the European Central Bank’.

You would have thought that all this would have been sorted out. If you remember I first called for Ireland to call for international aid in mid-September so there was plenty of time to prepare paperwork. It would appear however that basic competence is not a Euro zone strength. The problem for the ECB is that it is offering an enormous amount of liquidity to the Irish Banking system and in return for that it receives collateral.

As we stand the most recent data show Irish banks are receiving some 136 billion Euros of liquidity assistance  from the ECB  and a further 45 billion  Euros in emergency liquidity assistance from the Irish central bank which is of course another name for the ECB. No wonder the ECB is worried about collateral rules….

The Bank of England offers a credit line to the ECB

The Bank of England and European Central Bank (ECB) are today announcing a temporary reciprocal swap agreement (swap line). This precautionary measure would enable the ECB to provide sterling liquidity to its counterparties. If requested, the Bank of England will provide the ECB with sterling in exchange for euro up to a limit of £10bn. The agreement expires on 30th September 2011.

I have to confess this arrangement came as something of a surprise. If you look at the liquidity support provided to Ireland by the ECB and add it to IMF/EU/ECB the aid package you can see that an enormous amount of support is being given to what is in effect a very small economy in relative terms. Yet they need a swap line with the Bank of England? If it was me I would only announce such a thing as I was about to use it so I will be monitoring the status of this swap line closely.

The International Monetary Fund

If you were thinking that enough minds seemed to be occupied with Ireland from the news above you would be wrong. The IMF has compiled a staff paper on the subject and it is by no means sugar-coated. Let me give you two excerpts which give plenty of food for thought.

Ireland has faced intense economic and financial pressures in recent months. At the root of its problems is a critically weakened banking sector that has yet to be restored to health and stands at the center of a dynamic that dampens economic recovery while creating pressures on an already serious fiscal challenge.
High program risks reflect uncertain bank losses, a difficult debt outlook despite an unprecedented fiscal adjustment, unclear growth prospects, continued market focus on peripheral Europe countries, and an impending general election. 


The issue of uncertain bank losses in Ireland is something I have often written about as a barrier to a solution to her problems. Let me explain why this is important.At this moment in time.

1. If we look at commercial property loans then the Irish bad bank called NAMA is dealing with some of these but this begs the question what about the rest?

2.The Irish banking sector also made loans to companies which must have been affected by the downturn.

3 Residential mortgage lending must have been affected by what has happened and will be affected further as time goes by. What about other personal lending on the books of Irish banks?

4. There remains talk of derivative losses sitting on the books of the Irish banks and this needs to be addressed apart from having echoes of AIG/Lehman Bros from 2008.

So much remains to be done and there is still a danger that problems will mount for Ireland and hinder her recovery. Indeed the IMF was worried about potential contagion for itself from this. But then if you use an organisation designed to deal with balance of payments problems ( Ireland has a surplus on her latest figures)  for fiscal problems you shouldn’t be surprised if you hit trouble.

International Problems: contagion?

Theses issues tend to spread and it was the turn of Lloyds Bank via its ownership of Bank of Scotland to declare increased loss provision for Ireland on Friday. Also I notice that Danske Bank announced that it expected bad debts to remain high in 2011 at its National Irish Bank subsidiary. I am sure it is not a coincidence that both countries gave bilateral loans to Ireland as part of the aid package. Put another way its looks as though they were attempting to defend their own banking sectors.

Reviewing events remind me yet again of why I was against the bilateral loan given to Ireland. Firstly the Irish banking sector is by no means fixed and secondly we have given her the money on terms she cannot afford. I do not expect for us to see all of it back.

UK Inflationary trends

One of the problems that the UK faces is that there are quite a few institutions in our economy who faced with problems simply raise prices. These are usually ones which face little or no competition in their main market. In other words with a monopoly or some extent of a monopolistic position. Many of these have been in evidence over the recent period where our inflation rate has been higher than the level one might have expected coming out of a severe recession.

Well now add to the list the Post Office. Next April a first class stamp will rise by 5 pence or 12.2% to 46 pence and a second class stamp will rise by 4 pence or 12.5% to 36 pence. So rather than concentrate on the economics text books with their cost push and demand pull versions of inflation in the UK we have institutionalised inflation as a sub-case.

I was asked over the weekend if consumers and individuals are having more than their share of the burden placed on them in this phase of our economic life. If you add in the effect of inflation (which you can consider as a tax by another name) then the answer is plainly yes.


15 thoughts on “The Irish banking system remains a problem whilst institutionalised inflation is hurting the UK

  1. Shaun, you mention-“You would have thought that all this would have been sorted out.”
    and you were wondering why Ireland asked for help so early when it was funded till next year.

  2. shaun,

    with all this inflation “baked in” so to speak you would’ve thought the BoE would up interest rates to dampen it.

    but it won’t will it? finacial stability means the banks need the housing market to stay afloat. If rates rise and cause defaults then the bansk realise losses – large ones

    therefore the “deflationary ” pressures Mervin is talking about is the housing market – nothing else!


  3. “They are conceptually bankrupt organisations which failed in their purpose. Unfortunately a feature of the post credit crunch era is that we have not been good at clearing out failures.” How true, Shaun, how true; not only of the rating agencies I fear; including most of the banks Eh? And now the latter are clearly determined to pay out £billions in bonuses again, despite the threats of reprisal from government?

    Is macro bank insolvencies MkII now in sight?

    • Hi Drf
      The problem with zombie banks is you are never entirely sure what the effects are. What I mean is that it is possible to construct a list of them but that the effects should they implode or explode are much much harder to figure out. We learnt this back with AIG and Lehmans. However the concept of dead men walking is a policy error in my view as they will be making new contracts and so on leading to them being ever more entangled in the system.
      Back when I was following Japan in the early 90s their banking system was safe we were told down to 24k on the Nikkei then 22k then 20k then 18k and so on…. It would have been better to clear it up at the beginning and yet we havent learned from that. Hence the payment of bonuses etc. and the political posturing which I have to confess is becoming tiresome as if you want to do something about it then two years plus is plenty of time.
      So if it were me I would prefer a few bank insolvencies now to try to prevent more in the future……

  4. Mervin King has already stated in one of the wikileaks cables that the crisis is now one of systemic banking insolvency. Can you explain in clear and lucid terms the difference between liquidity and insolvency and their consequences?

    • Hi Bruce and welcome to my blog.
      One difference is timing as liquidity is something which affects you now. For example a liquidity crisis would be now or next week. Whereas insolvency is usually much slower moving in that for example with Greece earlier in the year then the 3 year rescue plan was likely to leave it insolvent. Also liquidity is a question of cashflow. For a bank I do not just mean the notes and coins in its tills and vaults but also its readily accessible assets and deposits at the Bank of England. These days they tend not to hold a lot of this which is why a run on a bank can affect it quite quickly. Insolvency by contrast is a matter of profit and loss. Essentially if you make losses and if you keep doing that you will run out of capital.

      From a central bank these have a different perspective as it can always deal with liquidity problems by simply creating money and bailing it out. This doesnt mean that it thinks this is right merely that it can and in general should. However solvency is much harder as if it takes over this role then there will be a bill to pay for taxpayers.

  5. Shaun hi

    This is the first occasion on which I’ve commented on the blog which I do find fascinating as ever. I speak not as a eurosceptic, but as one with a European family (in more than one country), and a business concentrated in other European countries.

    I have been against the Euro since its inception, but at present must confess that I see it difficult to survive unless Germany and other countries effectively guarantee the other countries liabilities, – both sovereign and banking.

    I was also interested in the recent FT article, dealing with the 3 questions, – will countries default, – will the ECB establish a means of dealing with the propblems, and thirdly will the euro survive. The answers were, ‘almost certainly’, ‘probably not’ and ‘perhaps’…..hardly inspiring.

    Without wishing to be alarmist, in this event, I fear the effect on the UK would be enormous, and is by far the biggest threat in the next few years.

    Whilst I do appreciate from German friends that there is far more willingness in Germany to ‘help Europe’, than is generally recognised in this country, am I being alarmist, – would you agree with my concerns, – and am I being realistic in saying that it is difficult to see how the Euro can survive in its present form without some sort of blanket guarantee?

    I would be very interested in your views…as ever. Thanks for interesting blogs.

    • Hi Robert and welcome
      As to your questions then yes I believe that countries in the Euro zone will have to default on their finances to some degree and the longer this interregnum carries on then the more will be sucked into this. As to question 2 I differ slightly in that as a cental bank it is not the ECB’s role to sort this out and this is one of the ways things have gone wrong. In the end it is a political question as to whether Europe is willing to pay the price for past mistakes. So far there is very little sign of any agreement. Will the Euro survive? It might but it could easily be a different Euro to the one we have now. Or there could be a Euro but with different nations.

      For it to work the they need to address these two areas in some form.But these would prevent future problems more than solve current ones
      1. Fiscal Policy
      2. Regional Policy

      • Shaun hi again.

        Thanks for the reply. But in the circunstances you mention (which I agree with), the impact on the UK economy would surely be extremely significant. As such, whilst there have been articles in (for example) the Economist/FT on the generality of the Eurozone, there has been virtually nothing on the effects on the UK economy/banking sector if there was some sort of breakdown. Also by the Government or parliament.

        My children say I’m being alarmist……..

        Regards and Happy Christmas

        Robert H

        • Hi Robert
          I feel that in the UK we will be subject to both inflationary and deflationary trends in 2011. The inflationary trends mostly follow what has been happening in 2010 but places such as Ireland and other strugggling parts of Europe will impact on us. For example of the Irish bad bank NAMA some 27% of the assets put in it were in the UK. So I feel that our banks will have pressures on them still and am constantly amazed by the talk of floating them off and making a profit as there are scenarios where such actions could be a severe case of miss-selling.
          So I am very cautious about our banks and accordingly expect them to be cautious about any lending in 2011. I wrote an article elsewhere about the Bank of England withdrawing its Special Liquidity Scheme and think that the way it is doing this is a mistake and will add to issues in 2011. Please do not take this as investment advice as this is my opinion only but I still feel that the full truth about UK banks has not been revealed.
          So as I say in my article about Hungary it is a time for central banks to be on their toes and if necessary to reverse moves quickly in what will be a volatile and mixed year. I feel that here the MPC should have taken my advice at the end of 2009 and raised UK interest rates but going into 2011 I feel that it may be necessary to act in either direction and maybe even both……

  6. I take your point about government agencies being in charge of government ratings and think of statistics. Maybe a way round that is to ask other governments to do the ratings on a 3 yr cycle. For example, Australians may do Germany and vice versa. It is sort of based on George Bernard Shaw’s idea that no country should be ruled by its own countrymen. On the other hand not having rating agencies about at all seems like a wonderful idea.

  7. Hi Shaun, credit rating agency assessments are hard-wired in to legislation and regulations. They create an environment where people get lazy about making their own full assessments. Central banks, for example, make great use of their aasessments on collateral standards and the like. They also create a herding of behaviour. I am sceptical about transferring their role, however, to supra governmental authorities. Who will hold them to account? Will central banks enjoy the responsibility of making their own assessments?

  8. My (exceedingly humble) opinion is that by summer, both Portugal and Spain will reach their moment of truth and require a bailout. Portugal’s will be the same as Greece and Ireland’s.. IMF/SMP help for the Portugese government; the Portugese people will begin to suffer deflation’s iron grip. Where this gets most interesting is when Spain’s Ten Year Bond reaches seven percent. I highly doubt the Spanish people, with their 20% unemployment, will tolerate much more “austerity” without some serious unrest.

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