Irish banks bail-out: the UK’s role in a rescue bid

But Irish Prime Minister Brian Cowen stressed his country isn’t being pushed around. He said: “There has been no dictation to anybody. What we’re involved in here is working with colleagues in respect of currency problems and euro area problems that are affecting Ireland and other countries, and particularly affecting Ireland.”

A joint IMF and European Commission team will travel to Ireland this week. The Irish government has already announced a plan to slash 15bn euros from the country’s budget over four years.

Earlier today, just before talks in Brussels, the Chancellor George Osborne said that it was in Britain’s national interest to see stability restored in Ireland, which is responsible for 7 per cent of UK exports.

“We are going to do what’s in Britain’s national interest. Ireland is our closest neighbour and it is in Britain’s national interest that the Irish economy is successful and we have a stable banking system,” he said.

“So Britain stands ready to support Ireland in the steps that it needs to take to bring about that stability.”

How a bailout could work

The way the UK could help the Irish government would be to be a loan guarantor for the UK’s 13 per cent portion of a 60bn euros pot which Ireland could draw on should it need to. This cash comes from the EU budget of which the UK is a contributor and should Ireland default on such a loan, the UK as guarantor would be responsible for paying back the money to the EU.

The Treasury told Channel 4 News this would have no impact on UK public finances and that any suggestion suggesting the government would also help out by keeping lines of credit open for UK banks which have exposure to Irish markets was pure speculation.

Silvia Ardagna, senior European economist, Bank of America Merrill Lynch Global Research agreed: “I don’t think people’s lives would change if Ireland seek external aid from the IMF and EU but we do need to see more clarity about the Irish banks’ health.”

Neighbourly help 
Britain is taking the surprising step of offering to help its struggling neighbour but Ireland has to come knocking first, writes Economics editor Faisal Islam

"Ireland is our closest neighbour and it's in Britain's national interest that the Irish economy is successful and we have a stable banking system, so Britain stands ready to support Ireland in the steps that it needs to take to bring about that stability."

No decision has been made, because ultimately the trigger would need to be pulled by Dublin to activate any help. That process begins tomorrow, when the same IMF EU troika that is inspecting Greece, visits Dublin for a quick assessment of the Irish banking problem. But the UK Treasury is positioning itself as Dublin's friend. It is taking its cues from Ireland, rather than the ECB-inspired efforts to force feed a rescue on the Emerald Isle.

Read more about this on Faisal Islam's blog: Ireland debt - Osborne ponders bail-out

Warning

As far back as 2006 the current Chancellor (then Shadow Chancellor) was congratulating Ireland on its financial success story. In an article he wrote for The Times at the beginning of 2006, George Osborne said: “A generation ago, the very idea that a British politician would go to Ireland to see how to run an economy would have been laughable.

“The Irish Republic was seen as Britain’s poor and troubled country cousin, a rural backwater on the edge of Europe. Today things are different. Ireland stands as a shining example of the art of the possible in long-term economic policymaking, and that is why I am in Dublin: to listen and to learn.”

Yet only one year later, as formerly booming house prices were stabilising, a respected Irish economist from University College Dublin noticed the historic precedents for such booms to inevitably turn into equally sizeable crashes and wondered what could be the impact in Ireland.

In a paper about the potential for the flourishing property market to collapse, Professor Morgan Kelly said: “Looking at nearly 40 booms and busts in OECD economies since 1970, we find that the size of the initial boom is a strong predictor of the size and duration of the subsequent bust.

“Typically, real house prices give up 70 per cent of what they gained in a boom during the bust that follows. This is a remarkably robust relationship, holding across very different OECD housing markets over more than 30 years.

“Were this relationship to hold for Ireland, it would predict a fall in real house prices of around 40 to 60 per cent, over a period of 8 or 9 years. Assuming an inflation rate of 4 per cent, this would translate into an annual fall of average selling prices of around 5 per cent.”

The root of the current problem is the uncertainty about the health of the banking system which the 2000 – 2006 property boom prompted. As happened in the UK, US and Spain credit was pretty freely available and much was invested into housing. Once the housing boom subsided, property owners were left with debts on houses bought at the top of a property bubble, worth less than they paid for them.

Professor Kelly noted that this and not external economic factors such as a rise in interest rates, had precipitated a collapse: “It is interesting to note that the collapse of housing booms in several US cities in the last few months was not triggered by any economic slowdown, or increase in mortgage interest rates (while US short rates have risen, long rates, on which mortgages there depend, have not), but by the feeling that houses had come to cost more than they were worth.”

The decline in the price of Irish property coupled with the freezing of the international lending market meant that Irish banks had difficulty servicing their routine daily operations.

Current situation

The combination of this, the threat by the Irish opposition not to pass the country’s budget on 7 December as well as strong words from Germany’s Chancellor Angela Merkel – who wants private investors to shoulder some of the costs of bank bail-outs rather than taxpayers – has increased pressure on Ireland to address the issue of exactly how robust is the health of its banks.

Silvia Ardagna of Bank of America Merrill Lynch Global Research believes that Ireland has some breathing space: “The Irish government has already issued bonds so it has enough cash at present which has bought it time. It can now use the next few months to try to pass the 2011 budget, hope market confidence turns less negative and be able to finance itself at rates lower than the one we have seen in these last days.”

But she warned that some fundamental issues need to be addressed to restore international economic confidence in Ireland.

“If I were an investor I think what I would want to see happen is one budget to be passed on 7 December as well as more clarity on the health of the Irish banking situation which I don’t think is there at present.”