A simple public choice theory of the Ireland bailout

In a very good piece, Barry Eichengreen writes:

One can interpret the intransigence of the German government and its EU allies in two ways.

  • First, they understand neither economics nor politics. As Tallyrand said of the Bourbons, “They have learned nothing, and they have forgotten nothing.”
  • Second, policymakers in Germany – and in France and Britain – are scared to death over what Ireland restructuring its bank debt would do to their own banking systems.

My model here is simple.  The Germans fear that if Ireland pulls the plug on the bailout deal, some of the other PBIIGS will meet immediate financial crises, and that spills over onto both German lending banks and Germany as the country holding the eurozone together.  Ireland feels that if it pulls the plug on the bailout deal, the Germans don't lend enough support and a) they lose what's left of their banking system, and b) their next government bond auction goes very, very badly.

I agree with the critics of the current arrangement, but I don't think they're facing up to how bad the alternatives will be (see also Megan).  Predictively speaking, I am betting on Irish electoral resentment to carry the day.  But in the meantime, EU bond purchases are kicking the can down the road.

Comments

Why would Ireland get poor rates on its public debt? If the government lets the banks go into default, rather than assuming their debts and defaulting itself, wouldn't that signal to its creditors that the Irish government's credit is even better because they aren't implicitly guaranteeing private debts?

Ah, come on, don't you think the Fed will step in and bailout the EU zone banks?

After all, it was Barney Frank and Chris Dodd who crammed CRA done the throats of the Irish banks and forced Freddie and Fannie to buy sub-prime mortgages backed by PBIIGS real estate.

If it weren't for Barnie Frank, no bank would ever have made loans to people who could repay the debt, or made loans based on inflated real estate prices.

So, clearly the US needs to step in and make sure Ireland cuts taxes to create jobs, cuts spending to balance the budget, and just force all the fools who recklessly opened checking and savings accounts and retirement pensions with banks controlled by Barney Frank should be forced to take losses.

ps, why isn't anyone talking about booting the Republic of California out of the dollar zone? Why doesn't Texas pull out of the dollar zone and return to the peso so the dollar can be devalued. After all, Texas and California economies are larger than Ireland and Germany.

(I know, Germany is bigger..., but everything economic is clearly in the bizarro zone these days)

BIPIGS?

Predictively speaking, I am betting on Irish electoral resentment to carry the day.

I don't know about when you add "electoral," but otherwise that sentence is a very safe bet.

immediately after a default the states get quite good deal

After the deal the debt service is going to be about 20% of the budget. If revenue is more than 20% lower then they have a problem.

"After the deal the debt service is going to be about 20% of the budget. If revenue is more than 20% lower then they have a problem."

I have probably misunderstood something - if the states "restructures", it - doesn't pay (either all or some part) of the debt. If you default on debt - you don't have debt to service anymore. Or did I get this wrong?

andy,

JMO is pointing out the other half of the equation driving Government behavior, in that the collapse of the Irish banking system is going to rain havoc on the economy, altering the budget and political foundation underpinning the Governments own considerable borrowing requirements. A foreshadow of what was possible, occurred in the weeks leading up to the bailout when multi billion euro outflows began to exit the Ireland. There would be an run on Ireland, not just it's banks.

"leadership involves ruthless truth telling"...........how many great quotes does Keynes have ??

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