On 28 November 2010, a deal was reached between the Irish government, the ECB, the IMF and other individual governments to bail out Ireland. The deal involved an €85bn package to bail out the collapsing Irish banks. Not all of the money went directly to the banks and the Irish government did set aside some of the loan. However, some of this money will now be required by four key lenders in Ireland, after a stress test by a group of independent experts found that the Republic of Ireland’s banks need another €24bn (that’s £21.2bn) to survive the continuing financial crisis. Allied Irish Banks require €13.5bn, Bank of Ireland €5.2bn, Irish Life €4bn and EBS a meager €1.5bn. The governor of the central bank, Professor Patrick Honohan said:
‘The new requirements are needed to restore market confidence, and ensure banks have enough capital to meet even the markets’ darkest estimates.’
The stress test focused on an assumption of a ‘cumulative collapse’ in property prices by 62%, together with rising unemployment. Following this, the Irish Finance Minister announced the government’s intention to take a majority stake in all of the major lenders. The Irish banks have been told they need to reduce the net loans on their balance sheets by some €71bn (£63bn) by the end of 2013. This process of deleveraging is likely to generate further losses, as many loans and assets will be sold for less than their true value. The causes of this ongoing financial crisis can still be traced back to the weakness within the Irish economy and more specifically to mortgage accounts being in arrears following the property market bubble that burst. A key question will be whether this second bail-out is sufficient to restore much needed confidence in the economy and particularly in the banking sector. The articles below consider this ongoing crisis.
Irish hope it is second time lucky for bail-out Telegraph, Harry Wilson (1/4/11)
Irish Bank needs extra €24bn euros to survive BBC News (31/3/11)
Ireland forced into new £21bn bailout by debt crisis Guardian, Larry Elliott and Jill Treanor (31/3/11)
The hole in Ireland’s banks is £21bn BBC News Blogs: Peston’s Picks, Robert Peston (31/3/11)
ECB has given Ireland serious commitment Reuters (1/4/11)
Ireland banking crisis: is the worst really over? Guardian: Ireland Business Blog, Lisa O’Carroll (1/4/11)
Ireland: a dead cert for default Guardian, Larry Elliott (1/4/11)
Timeline: Ireland’s string of bank bailouts Reuters (31/3/11)
Questions
- What is the process of deleveraging? Why is likely to lead to more losses for Ireland’s banks?
- What are the causes of the financial crisis in Ireland? How do they differ from financial crises around the world?
- What are the arguments for and against bailing out the Irish banks?
- Will this second bailout halt the possible contagion to other Eurozone and EU members?
- If this second bailout proves insufficient, should there be further intervention in the Irish economy?
Life must be very hard for bankers in the UK. Not only are they being partly blamed for the current financial crisis, but they may now have to survive on just their salary. Imagine trying to have a happy Christmas when you’ve only earned £200,000 over the past year: it really will be a cold and hard Christmas for them. Unless of course, the government does call the bluff of the RBS directors who have threatened to quit if an estimated £1.5bn bonus pool for staff at the investment arm of the bank is blocked. Let’s not forget that RBS is largely owned by the public: 70% or an investment of £53.5bn. It’s our taxes that will be used to pay these bonuses giving 20,000 RBS bankers a salary that is at least 3 times greater than the national average.
RBS directors have threatened a mass walkout if the government does withhold the ‘competitive bonus package’. Given that many blame bank directors for plunging us into the credit crunch, some may laugh at their argument that if the bonus package is withheld, then ‘top talent will leave the bank’. However, it is a serious threat: pay out or we leave and you’ll see the profitability of the bank decline, making it less likely that taxpayers will see a ‘return’ on their investment. RBS needs to make profits to repay the taxpayer, but is the taxpayer willing to pay out? RBS directors argue that if its bankers do not receive bonuses, then RBS will lose out in recruiting the best talent. Why would a banker choose to work for a bank that doesn’t pay out bonuses?
Lord Mandelson said: “I understand the point that RBS directors are expressing – they say they have to remain competitive in the market in recruiting senior executives, and this is why it’s important that all the banks are equally restrained, and RBS is not singled out.” One solution here would be a one-off windfall tax on bonuses, or even a permanently higher rate of tax (a ‘supertax’) on bonuses.
Over the past year or so, not a day has gone by when banks are not in the news and the next few days look to be no exception. This is another issue that affects everyone, so read the articles below and make up your mind! The government has an important decision to make, especially given than it’s the taxpayers who will decide on the next government.
‘Bankers need to join the real world’ minister says BBC News (3/12/09)
UK seeks to calm fears of RBS walk-out over bonuses Reuters, (3/12/09)
RBS chief Stephen Hester set to walkout over bonus row Scotsman, Nathalie Thomas (3/12/09)
RBS directors threaten to quit over bonuses Big On News (3/12/09)
Thousands of Bankers paid £1m in bonuses Sky News (3/11/09)
Barclays bankers to get 150pc pay rise Telegraph, Jonathan Sibun and Philip Aldrick (3/12/09)
PM reacts to RBS Director’s threat ITN (3/12/09)
Banks criticise plans for windfall tax on bonuses BBC News (7/12/09)
Will biffing bankers also biff Britain? BBC News, Peston’s Picks, Robert Peston (3/12/09)
Roger Bootle: Bank reform hasn’t gone far enough (video) BBC News (25/12/09)
Questions
- How are wages determined in the labour market? Use a diagram to illustrate this.
- Why do bankers receive such a high salary? (Think about elasticity.)
- What are the main arguments for paying out bonuses to bankers?
- If bonuses were blocked, and the RBS directors did walk out, what do you think would be the likely repercussions? Who would suffer?
- One argument for paying bonuses is that bankers need an incentive. Excluding monetary benefits, are there any other methods that could be used to increase their productivity?
- When we consider the labour market, we look at economic power. Who do you think has the power in this case and what do you think will be the outcome?
Northern Rock seems to have had a fixed place in the news for the past year or so. Unfortunately, the advertising it’s been getting hasn’t been positive. The usual picture was one of a Northern Rock branch and a few hundred people queuing outside, ready to withdraw their savings.
In the financial crisis, the banking sector has been at the forefront of economic policy and billions of pounds of public money have been invested in banks simply to keep them afloat and encourage them to keep lending. But now the government, in a measure approved by the European Commission, is considering selliing part of Northern Rock, by splitting it into a ‘good bank’, which will be returned to the private sector, and a ‘bad bank’, which will have to remain nationalised. This bad bank would gradually run down its assets and eventually be liquidated. Similar plans are being considered for the part-nationalised Royal Bank of Scotland and Lloyds Banking Group.
Northern Rock’s loan book will be cut from £100bn pre-crisis to just £20bn to ensure that a bank which enjoyed state support should not have “an unfair competitive advantage”. Savers with Northern Rock will find themselves in the ‘good’ bank, while mortgage customers with arrears and those who are regarded as risky, will be seen as ‘bad’ bank clients.
The buyers of these banks remain unknown. Tesco was considered to be a possible buyer of Northern Rock but has pulled out, with plans to build a new full-service bank itself. Established banks, such as Barclays, will not be allowed to make a purchase and the FSA has stated that standards will not be dropped to allow new competitors to enter the market, especially given that much of the banking crisis is due to poor standards and insufficient regulation. National Australia Bank, the owners of Yorkshire and Clydesdale, is a possible buyer, as too is Virgin Money, even though it would require new finance and possibly new partners. Some potential bidders may be ruled out by competition considerations. So let the games begin!
The following articles look at the banking situation and the possible developments.
Where Gordon Brown feared to tread, Kroes is ready to trample Telegraph, Alistair Osborne (28/10/09)
Lloyds eyes capital raising plans BBC News (29/10/09)
Tesco rules out Northern Rock takeover Guardian, Julia Finch (28/10/09)
EU approves Northern Rock split BBC News (28/10/09)
The Business Podcast: The break-up of Northern Rock Guardian (28/10/09)
Lloyds Banking share price could scupper offer SME Web, Roberta Murray (29/10/09)
Roll up, roll up, for the great bank sell off Independent, Richard Northedge (8/11/09)
Treasury says Northern Rock may lose savers as Government pulls out The Times, Francis Elliott and Suzy Jagger (5/11/09)
Union fears for 25,000 jobs as EU insists Lloyds and RBS must shed branches Guardian, Jill Treanor (3/11/09)
Decision time for Lloyds shareholders BBC News, Money Talk, Justin Urquhart Stewart (11/11/09)
The Business podcast: The break-up of Northern Rock Guardian (28/10/09)
Details of the European Commission ruling on the restructuring of Northern Rock can be found at:
State aid: Commission approves restructuring package for Northern Rock
Questions
- What started all the trouble at Northern Rock?
- What are the arguments (a) for and (b) against the break up of Northern Rock and the other banks that received state aid? Do you think the right decision has been made?
- The BBC News article ‘Lloyds eyes capital raising plans’ refers to 43% of Lloyds being owned by the tax payer. What does this mean and how has it happened?
- Why do you think Tesco has decided not to put in a bid to take over Northern Rock?
- Consider the potential bidders for these new ‘good’ and ‘bad’ banks. In each case, consider the (a) advantages and (b) disadvantages. Then, explain the type of take-over or merger this would be and whether there could be any competition considerations.
- One of the aims of recent developments in the banking sector is to increase competition. Why is this so important and how will it affect consumers and businesses?
Elinor Ostrom and Oliver Williamson shared the 2009 Nobel Prize for Economics (and a prize of $1.4m) on Monday for their work on how economic transactions operate outside markets in common spaces and within companies. Their work includes topics such as the free-rider problem and how this can lead to a sub-optimal over-consumption of a resource. Their work also considers economic governance and how this has led to the increasing popularity of outsourcing for companies.
Despite the prestige of a Nobel Prize, there have been suggestions that a Nobel Prize in Economics should not have been awarded this year, given the inability of economists to predict the financial crisis and mixed opinions about how to prevent another one in the future. What do you think?
US duo wins Nobel for economics Financial Times, Chris Giles (12/10/09)
Two Americans win Nobel economics prize MSNBC, Associated Press (14/10/09)
What this year’s Nobel Prize in Economics says about the Nobel Prize in Economics The New York Times, Steven Levitt (12/10/09)
Humbling year for bickering economists Financial Times, Alan Beattie (11/10/09)
Questions
- What is market failure and how does the free-rider problem fit in?
- Do you think economists were at fault for not foreseeing the financial crisis?
- Do you think that the research of Elinor Ostrom and Oliver Williamson was deserving of the Nobel Prize and how important is their research in the context of economic theory?
In 2008, as the economy was on the verge of recession, the UK Prime Minister said that we would ‘spend our way out of it’ despite rising levels of public-sector debt. In recent weeks, however, the focus has been much more on tackling the debt, which has now increased to over £800 billion (58% of GDP) – it was £500 billion at the end of 2006 (37% of GDP).
Although the current level of general government debt in the UK as a proportion of GDP is still one of the lowest of the G8 countries, it is rising the fastest. In other words, the general government deficit as a proportion of GDP is the highest (see Table A8 in IMF World Economic Outlook, Statistical Appendix A). The IMF’s forecasts suggest that, by 2014, government debt could be as much as 92% of GDP – the highest since World War II – and lower only than Japan (144%) and Italy (126%) of the G8 countries (although the USA, Germany and France are forecast by then each to have government debt over 80% of GDP).
Gordon Brown has said that public spending will have to be cut back once the recession is over, mainly by cutting out waste in the public sector. Conservatives too are looking to make substantial cuts in public expenditure if they come to office next year and have talked of an era of austerity.
But will such cuts be too little too late? Has government spending on saving the banks and trying to boost the economy by cutting VAT actually damaged our recovery prospects and are the British people going to be the ones to suffer? Or should the fiscal stimulus be retained for some time yet to prevent a lurch back into recession? The following articles look at the public debt situation, which poses some interesting policy questions, especially with the Party Conferences!
£805,000,000,000: UK’s monstrous debt The Mirror (19/9/09)
Osborne gambles with cut plans BBC News (6/10/09)
Governments will have legal obligation to reduce UK’s debt Telegraph (28/9/09)
We’ll spend our way out of recession Independent (20/10/08)
Public sector borrowing soaring BBC News (18/9/09)
Govt spending cuts ‘could help pound’ Just the Flight (21/9/09)
Deficit danger worries Cameron BBC News (4/10/09)
Public debt hits £800 billion – the highest on record Times Online (19/9/09)
Pay freeze ‘to protect UK services’ The Mirror (6/10/09)
This recession demands that we employ logic and spend our way out of it Telegraph (11/1/09)
Cuts and pay freezes ‘just the beginning’, Tories admit Telegraph (7/10/09)
Robert Stheeman: So what’s worrying the banker in charge of our £1trn debt? Independent (8/10/09)
Has Darling or Osborne the best plan for cutting the deficit? Observer (11/10/09)
This public-spending squeeze will be much tighter than people expect Independent on Sunday (11/10/09)
Tax and spending squeeze will keep Bank rate low Sunday Times (11/10/09)
UK rates ‘to stay low for years’ BBC News (11/10/09)
Questions
- According to economic theory, how does increasing government spending or reducing taxation aim to boost the economy?
- What do we mean by a budget deficit or budget surplus? How does a budget deficit differ from national debt?
- What is the ‘golden rule’ for fiscal policy? Discuss the advantages and disadvantages of such a rule-based approach to fiscal policy.
- What are the advantages and disadvantages of a policy of ‘spending our way out of a recession?’
- With spending cuts looming, many will be affected. How will cuts in government spending affect the UK’s ability to recover from the recession? Will you be affected and, if so, how?
- Last year £85.5 billion was spent by the government on bailing out banks. Do you think this was money well spent, or is it the main cause of the current spending cuts that could see the recession worsen?