The [Irish] government responded to this with what is now regarded – rather disconcertingly – as “standard” policies. They guaranteed all the liabilities of banks and then began injecting government funds. The government is now starting a new phase – it is planning to buy the most worthless assets from banks and pay them government bonds in return. Ministers have also promised to recapitalize banks than need more capital. The ultimate result of this exercise is obvious: one way or another, the government will have converted the liabilities of private banks into debts of the sovereign (i.e., Irish taxpayers).
The government is gambling that GDP growth will recover to over 4% per year starting 2012 — and they still plan further major expenditure cutting and revenue increasing measures each year until 2013, in order to bring the deficit back to 3% of GDP by that date. The latest round of bank bailouts (swapping bad debts for government bonds) dramatically exacerbates the fiscal problem. The government will in essence be issuing 1/3 of GDP in government debts for distressed bank assets which may have no intrinsic value. The government debt/GDP ratio of Ireland will be over 100% by end 2011 once we include this debt.
Ireland had more prudent choices. They could have avoided taking on private bank debts by forcing the creditors of these banks to share the burden – and this is now what some sensible voices within the main opposition party have called for. However, a strong lobby of real estate developers, the investors who bought the bank bonds, and politicians with links to the failed developments (and their bankers), have managed to ensure that taxpayers rather than creditors will pay. The government plan is – with good reason – highly unpopular, but the coalition of interests in its favor it strong enough to ensure that it will proceed.
Baseline Scenario, Kwak and Johnson, definitely one to subscribe to.