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Authors: Brian Lucey
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double-digit current account surpluses in order to deflate the current debt overhang in the Irish economy, the above historical record is not encouraging. Growing out of debt is unlikely to be a sustainable strategy for Irish economy.
The traditional tool-box for dealing with balance sheet recessions includes:
Growth-supporting external demand
Availability of cheap investment financing from abroad
Devaluation-driven improved cost competitiveness
Deep and swift institutional reforms
Significant excess capacity for absorption of FDI
Hardly any of the above tools are available to Ireland today.
From this vantage point, restructuring of Irish debts appears to be no longer a policy choice, but a policy necessity. The only remaining question, therefore, is how such restructuring can be configured to minimise adverse effects on the Irish economy.
Given the analysis above, it is clear that the options available to Ireland are:
Option 1: Restructure official government debt, which is expected to peak at circa 116 per cent of GDP in 2013â2014
Option 2: Restructure banking sector debts, especially those that represent quasi-governmental liabilities, such as the promissory notes to the Irish Bank Resolution Corporation (IBRC, formerly Anglo Irish Bank), amounting to under â¬30 billion
Option 3: Restructure household debt
Option 4: Restructure private corporate debt
Option 4 can be ruled out from the start as it will constitute a market-distorting support for incumbent enterprises. In addition, corporate debt restructuring can be dealt with through both normal liquidation and receivership processes. Furthermore, absent independent monetary policy capacity, restructuring corporate debts in a systemic fashion will have the most adverse impact on the banking sector balance sheets and will lead to significant debt transfers from the private sector to the Exchequer. It is perhaps revealing to note that the Irish governmentâs approach to resolving the banking crisis to date, exemplified by NAMA, attempted exactly this type of restructuring with NAMA purchasing only business loans related to land, development and property investments.
Option 1, while attractive from the fiscal short-term sustainability point of view, carries substantial costs for any Exchequer that is running deep (greater than 1â2 per cent) structural deficits. The requirement for securing external funding to finance gradual adjustments to fiscal deficits means that this option is de facto shut for Ireland.
This suggests that the only two options open for Ireland are Options 2 and 3: restructuring of some banking sector debts and some household debts. The two options are not only feasible, they are actually complementary. This complementarity implies an overall reduced cost of undertaking such restructuring and is driven by the fact that much of the household debt in Ireland is held on domestic banksâ balance sheets. Further complementarity is implied by the fact that some of the banking sector debts are directly linked to the government debt â via the promissory notes and NAMA bonds which have been used as collateral for borrowings from the Central Bank of Ireland and the ECB. In other words, restructuring banking sector debts by reducing sector liabilities to external lenders will free resources to draw down some of the assets written against the households and the Exchequer.
The upside to such a drawdown is to reduce the probability of future defaults by the households and to bring loan-to-value (LTV) ratios closer to the level where any foreclosures that might still arise will be carried out at no loss to both the banks and the households. Core benefits, however, are much broader. Restructuring current household debt levels will reduce the overall rates of mortgage default and will simultaneously compensate households for the greater burden of recent banks bailouts and public debt increases.
Mortgages arrears and pressures on household
The traditional tool-box for dealing with balance sheet recessions includes:
Growth-supporting external demand
Availability of cheap investment financing from abroad
Devaluation-driven improved cost competitiveness
Deep and swift institutional reforms
Significant excess capacity for absorption of FDI
Hardly any of the above tools are available to Ireland today.
From this vantage point, restructuring of Irish debts appears to be no longer a policy choice, but a policy necessity. The only remaining question, therefore, is how such restructuring can be configured to minimise adverse effects on the Irish economy.
Given the analysis above, it is clear that the options available to Ireland are:
Option 1: Restructure official government debt, which is expected to peak at circa 116 per cent of GDP in 2013â2014
Option 2: Restructure banking sector debts, especially those that represent quasi-governmental liabilities, such as the promissory notes to the Irish Bank Resolution Corporation (IBRC, formerly Anglo Irish Bank), amounting to under â¬30 billion
Option 3: Restructure household debt
Option 4: Restructure private corporate debt
Option 4 can be ruled out from the start as it will constitute a market-distorting support for incumbent enterprises. In addition, corporate debt restructuring can be dealt with through both normal liquidation and receivership processes. Furthermore, absent independent monetary policy capacity, restructuring corporate debts in a systemic fashion will have the most adverse impact on the banking sector balance sheets and will lead to significant debt transfers from the private sector to the Exchequer. It is perhaps revealing to note that the Irish governmentâs approach to resolving the banking crisis to date, exemplified by NAMA, attempted exactly this type of restructuring with NAMA purchasing only business loans related to land, development and property investments.
Option 1, while attractive from the fiscal short-term sustainability point of view, carries substantial costs for any Exchequer that is running deep (greater than 1â2 per cent) structural deficits. The requirement for securing external funding to finance gradual adjustments to fiscal deficits means that this option is de facto shut for Ireland.
This suggests that the only two options open for Ireland are Options 2 and 3: restructuring of some banking sector debts and some household debts. The two options are not only feasible, they are actually complementary. This complementarity implies an overall reduced cost of undertaking such restructuring and is driven by the fact that much of the household debt in Ireland is held on domestic banksâ balance sheets. Further complementarity is implied by the fact that some of the banking sector debts are directly linked to the government debt â via the promissory notes and NAMA bonds which have been used as collateral for borrowings from the Central Bank of Ireland and the ECB. In other words, restructuring banking sector debts by reducing sector liabilities to external lenders will free resources to draw down some of the assets written against the households and the Exchequer.
The upside to such a drawdown is to reduce the probability of future defaults by the households and to bring loan-to-value (LTV) ratios closer to the level where any foreclosures that might still arise will be carried out at no loss to both the banks and the households. Core benefits, however, are much broader. Restructuring current household debt levels will reduce the overall rates of mortgage default and will simultaneously compensate households for the greater burden of recent banks bailouts and public debt increases.
Mortgages arrears and pressures on household
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