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economix.blogs.nytimes.com/2010/05/20/irish-miracle-or-mirage/
Irish Miracle – Or mirage?
Peter Boone and Simon Johnson
Economix
New York Times
Friday 21 May 2010

(Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. He is also a principal in Salute Capital Management Ltd. Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”)

With the European Central Bank announcing that it has bought more than $20 billion of mostly high-risk euro-zone government debt in one week, its new strategy is crystal clear: We will take the risk from bank balance sheets and give it to the central bank, and we expect Portugal-Ireland-Italy-Greece-Spain to cut fiscal spending sharply and pull themselves out of this mess through austerity.

But the bank’s head, Jean-Claude Trichet, faces a potential major issue: the task assigned to the profligate nations could be impossible. Some of these nations may be stuck in a downward debt spiral that makes greater economic decline ever more likely…

… reland’s politicians, rather than facing up to their problems, are making things ever worse. Simply put, the Irish miracle was a mirage driven by clever use of tax-haven rules and a huge credit boom that permitted real estate prices and construction to grow quickly before declining ever more rapidly. The biggest banks grew to have assets twice the size of official G.D.P. when they essentially failed in 2008. The government has now made a fateful choice: rather than make creditors pay some part of the losses, it is taking the bank debt onto the national balance sheet, effectively ballooning its already large sovereign debt. Irish taxpayers are set to be left with the risk of very large payments to make on someone else’s real estate deals gone bad.

There is no simple escape, but if the government hopes to avoid a sovereign default, the one overriding priority should be to stop bailing out the banks. Instead, the government should wind down existing banks in a “bad bank,” while moving their deposit base and profitable businesses into new, well-capitalized banks that can function without a taxpayer burden. This will be messy, but it is far better than a sovereign default.

Second, the Irish must take the tough fiscal steps that will be required under any circumstances. The International Monetary Fund and the European Union have made clear that funding is available to Ireland – so the government should use this to bridge the tough journey of fiscal cuts ahead.

Finally, the Irish need to consider seriously whether being in the euro zone is worth the cost. The adjustment to this awful situation would be far easier outside the euro zone – even though leaving the zone might have adverse repercussions for other nations. Once again, a comprehensive program with European Union and I.M.F. support might make this the least worse option.
Given the depths of Ireland’s problems, it is no wonder the markets are looking with skepticism at the announced bailout package for the entire euro zone provided by the European Union and the International Monetary Fund. Policy makers are still not dealing with the core problems of each nation in the euro zone. With the debt hangovers remaining, who will want to invest in Europe’s periphery, and so how can Greece, let alone Ireland, grow? One thing we can be sure of: Europe’s political leaders are doomed to be spending much more time at emergency meetings in Brussels over the coming months and years.