V. STAFF APPRAISAL
43. The Irish economy is in the midst of an unprecedented economic correction. The
stress exceeds that being faced currently by any other advanced economy and matches
episodes of the most severe economic distress in post-World War II history. Banks face
extensive losses and double-digit fiscal deficits over the next three years will imply a run up
in public debt. The short-term dislocations come on top of a sharp decline in potential
growth, implying a modest pace of recovery.
44. The risks remain significant. Market sentiment has improved and Irish sovereign
spreads have come down from their highs. The reduction in public sector wages has been
accompanied by a decline in private wages, which if sustained would help competitiveness in
the medium term. But the recent research is clear. Financial crises generate deeper and more
prolonged downturns, and more so if the crisis is globally synchronized. In a weakened Irish
economy, adverse global economic and financial events would be disruptive.
45. On the two fronts that matter most, the authorities have moved in the right
direction. Most recently, the proposed establishment of NAMA offers the prospect of
extracting distressed assets from the banks, a precondition for their return to healthy
functionality. They have also laid out a multi-year plan to contain the fiscal deficit.
46. But the task ahead is formidable and determined execution of these initiatives
will be needed. The challenge is severe because unwinding the large macroeconomic
imbalances entails difficult policy trade-offs, which, in turn, are associated with considerable
political sensitivities. Communicating clear objectives, allowing for contingencies, and
creating benchmarks for transparent assessment will help maintain political legitimacy.
47. With regard to NAMA, risk-sharing structures should be considered to address
the well-known pricing problem. The pricing of distressed assets is complex and can slow
down the transfer of assets from the troubled bank. Risk-sharing can potentially create better
incentives for managing the bad assets. And they also guard against the risk that the taxpayer
does not bear a disproportionate burden of the costs cleaning up the banks.
48. It is particularly important to incorporate flexibility in NAMA’s design. While an
early focus on removing property-development loans from the financial system may be
appropriate, the economic downturn will cause impairment of other asset classes as the latest
trends are already indicating. The option of relieving banks of those additional assets within a
year or so will continue the process of “cleaning” up the banks. Absent that option, banks
may remain hobbled.
49. Where a bank has been rendered economically insolvent, the only real option
would be its temporary nationalization. In that case, NAMA would continue to act in its
capacity as an agency managing bad assets. An advantage would be that prices at which these assets are transferred would become less of an issue. Nationalization could also be used as a
step towards mergers and, hence, sectoral restructuring. But it would be necessary to ensure
that the banks are operated transparently, with commercial objectives, and that they receive
the same regulatory and supervisory treatment as private banks. Finally, a clear exit strategy
to return the banks to private operation would be needed.
50. Accompanying these immediate crisis management tasks are several supportive
crisis prevention measures. These can and should be guided by evolving European Union
guidelines. However, inevitably, they will need to be tailored to domestic circumstances.
• A broader tool kit would allow for more speedy resolution of banks. This would be
supported by the authorities’ ongoing enhancements of the deposit protection
program.
• The supervisory challenges include intensification of surveillance for systemic risks
beyond the six guaranteed banks, further safeguards against related-party lending, and
continued development of a macro-prudential regulatory and supervisory process.
51. The authorities have laid out an ambitious fiscal consolidation plan.While the
initial reliance on increases in personal income tax rates was appropriate to minimize the
contractionary effect of the consolidation, a greater focus on reductions in current
expenditure will be needed in the coming years.
52. Steps should be taken to sustain the execution of the planned fiscal
consolidation. The following principles could be used as a guide:
• More targeting of the vulnerable (as proposed for child benefits) and greater reliance
on incentives for efficient use of public resources.
• Further ratcheting down of the public pay structure and employment levels.
• Broadening the tax base.
• A fiscal rule, backed by a medium-term expenditure plan that details the intended
measures over the full horizon.
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Originally Posted by Captain Con O'Sullivan
