This week I had planned to finish up the traditional neighborhood versus suburban development discussion we've been hashing over here all month. I spent an inordinate amount of time last week tending to my primary obligation -- my family -- and had to spend the weekend getting caught up on everything I'd missed. I don't want to short change this topic so I'm putting it off slightly. Check back later in the week.

In the meantime, I wanted to share a video exchange between a reporter and an ECB official regarding Ireland and it's obligations to pay back bondholders. This needs a little bit of setup, and for that I'm going to turn to Michael Lewis, knowledge I picked up from his book Boomerang: Travels in the New Third World, and a piece he wrote on Ireland in Vanity Fair

The first paragraph of the Vanity Fair piece sets the table perfectly:

When I flew to Dublin in early November, the Irish government was busy helping the Irish people come to terms with their loss. It had been two years since a handful of Irish politicians and bankers decided to guarantee all the debts of the country’s biggest banks, but the people were only now getting their minds around what that meant for them. The numbers were breathtaking. A single bank, Anglo Irish, which, two years before, the Irish government had claimed was merely suffering from a “liquidity problem,” faced losses of up to 34 billion euros. To get some sense of how “34 billion euros” sounds to Irish ears, an American thinking in dollars needs to multiply it by roughly one hundred: $3.4 trillion. And that was for a single bank. As the sum total of loans made by Anglo Irish, most of it to Irish property developers, was only 72 billion euros, the bank had lost nearly half of every dollar it invested.

He describes in Boomerang exactly what happened. As the cheap credit was flowing, banks in Ireland took on enormous amounts of borrowed money to loan out, largely to Irish citizens who themselves were getting rich in housing and real estate development. When the artificial housing bubble burst and property values started to decline, these banks went from being illiquid (lacking cash to fund operations) to being insolvent (having more debt than assets) very quickly.

To understand what happened next, it is important to understand who these Irish banks owed money to. Much like our banks here in the United States, the money they were playing with was private money. Shareholders (of which the country of Ireland was a significant one), investors, pension funds, etc... In other words; private investors. Some were senior bondholders that would be paid first and some were subordinate, meaning they were the first to take losses.

And losses they should have taken. But they didn't. Unlike their neighbors in Iceland, which let their banks fail and re-established a reality-based banking system, the Irish government bailed out their banks. All of them. Nobody took losses, even those with subdominant (very risky) debt. All of these massive liabilities -- something like 35% of GDP -- became the government's.

And where did the government get the money? They are in the Euro and so, unlike the United States, they can't simply print the money to essentially tax everyone by diminishing the currency's purchasing power. The Irish government had to borrow the money from the banks. Not Irish banks -- that would have been absolutely ridiculous -- but from German banks, French banks, etc... 

This shell game was done to "save" the financial system. Interesting thing happened though. After turnng the private debt into public debt by borrowing from the private sector, the financial system promptly turned on Ireland. Since the country now had such high debt levels, they were a higher risk for default. A higher risk for default means a higher interest rate and higher borrowing costs. Higher borrowing costs makes them a higher risk for default. And on and on and on.

To be protected from default, Ireland needed a bailout. They needed the International Monetary Fund (IMF) and the European Central Bank (ECB) to come in and buy their debt from the private sector, thus removing the private sector and making a high percentage of the resulting debt public. This stabilized interest rates.

Now that things are stable, the Irish people can go about the decades long process of austerity and stagnation necessary to service this enormous debt. What started with crazy lending by a handful of Irish banks has become the indentured servitude of the Irish people to German banks and the European Union, the latter an institution that was supposed to help create prosperity in Ireland.

I guess it is the kind of prosperity you get from a credit card binge at Walmart. The cheap junk all breaks before the bill is even paid off and the only ones truly richer are the Walmart execs and the Chinese.

Now here's the video I started with. What you are going to see is an Irish report named Vincent Browne ask ECB official Klaus Masuch (country of origin unknown to me, but the undertone of nationalism creeps in the conversation ever so slightly). His question: Explain to the average Irish citizen why this debt should be paid, why Ireland shouldn't just default.

Incidentally, this isn't a question just for taxi drivers and curmudgeon reporters but one that is being asked at the highest levels of finance.

And it isn't a question that is ultimately going to be asked only in Ireland either.

One other thing to point out here. The cheap money high started when Ireland began using the Euro in 2002. Check out the following graph of Irish GDP. Project out the pre-2002 growth trend and compare it to what actually happened. I'm not suggesting that is a rigorous economic analysis, but one has to ask how much of the underlying bubble has yet to burst. Who knows -- I certainly don't -- but it is clear that the system has been divorced from sound economics for some time. 

The brilliance of Jared Diamond's incredible book Collapse: How societies Choose to Fail or Succeed, is how he studies complex systems by examining natural experiments in history to identify commonalities and trends. Michael Lewis has done for national finance what Jared Diamond did for anthropology. His verdict for larger systems that continue the present course is no less damning.


If you find this material interesting and would like to know more about how to apply this thinking to your community, join us at the Strong Towns Network, a social enterprise for those working to implement a Strong Towns approach.