Is Ireland fated to be another Iceland?

[MikeWB]

Is Ireland fated to be another Iceland?
As Taoiseach Brian Cowen announces tough measures for the economy, Landon Thomas of the New York Times speaks to a financial expert who predicts that the country could be on course for a catastrophic collapse
Landon Thomas
The Observer, Sunday 1 March 2009
Article history
What separates Ireland from Iceland? According to a local joke, the letter C. According to Morgan Kelly, about six months.

The stunning fall of Iceland late last year and the spreading contagion of the financial crisis have ignited fears - fanned by bloggers, analysts and a small group of outspoken economists like Kelly - that Ireland, another small, open economy plagued by deficits and an outsize banking industry with incalculable losses, may suffer a similar fate.

Known in this country as Dr Doom, Kelly, whose eyes burn with the intensity of his prophecy, calls himself the Nouriel Roubini of Ireland - a nod to the now world-recognised economist at New York University who was one of a handful of experts who predicted the credit collapse.

"We have gone from the Celtic Tiger to Bob the Builder - this place is vaporising," Kelly said as he sipped coffee in a Dublin cafe. An economist at University College in Dublin who specialises in medieval demographics, Kelly began sounding the alarm of a coming housing market crash in late 2006, the peak of the property boom.

Now he expects the economy to contract by 20%. And his latest prediction - to which he attaches a 25% probability - is that Ireland will default, and that Anglo Irish Bank, the recently nationalised bank that has become a reviled symbol of rampant lending and corruption, has not only underestimated its loan losses but has a swelling book of derivatives contracts gone bad.

The result, he warns, could be bank losses at Anglo Irish and other banks that supersede the Irish government's promise to guarantee all liabilities in the banking sector. What would follow would be a run on the banks, inability of the government to finance its 12% budget deficit, and ultimately a bailout by the European union.

"That is the optimistic scenario," Kelly said, arguing that his worst fear is a collective economic failure of several countries in eastern Europe, along with Ireland and those on the southern periphery of the eurozone - Greece, Italy, Spain and Portugal - that would be beyond the capacity of any government or group of governments to stem.

"It's not about the property developers and the banks any more - it is about the survival of Ireland," he said.

In many ways, the "blood-dimmed tide" that Kelly fears resembles more an apocalyptic fancy of William Butler Yeats than rigorous economic thinking. Kelly's view is in the distinct minority in Ireland - but so was Roubini's in the United States. Among the fraternity of economists in Dublin, Kelly's perspective is seen not only as outlandish when compared with the facts, but bordering on the irresponsible.

"People are talking aloud about what-if scenarios as if they are real," said Gerard O'Neill, an economist and consultant in Dublin whose research has shown that the more the Irish public is exposed to such negative views, the less it spends - a classic example of John Maynard Keynes's paradox of thrift.

"This talk of disaster is so one-sided and irresponsible," O'Neill added. "It is bad for Ireland."

O'Neill and other economists like Patrick Honohan, a former economist at the World Bank who teaches at Trinity College Dublin, argue that Ireland will never go the way of Iceland, because Ireland's public debt is a manageable 40% of gross domestic product.

The banking sector, more than 200% of national income, does not even approach that of Iceland, they add, which was about 10 times the size of its economy.

Honohan said that at worst, bank losses will compose about 20% of national income. "Are we another Iceland? No. The numbers just are not big enough," he said.

It is a view shared by the government, though Mary Coughlan, who as deputy prime minister oversees trade and industry, acknowledged in an interview that there was a need to "reinstate our record internationally".

As for the worst-case assumptions, she shook her head, citing fiscal measures and the continuing bank clean-up. "We will not be another Iceland," she said.

Still, as the slump deepens, it is becoming evident that the controversy surrounding Anglo Irish - and the broader threat it may pose to the Irish economy - is putting intense pressure on the government. Last week police raided the bank's offices as part of an investigation into a murky web of insider dealings and undisclosed loans that has infuriated the public. Once a sleepy domestic bank, Anglo Irish became one of the biggest property lenders in Europe, its loan book growing at more than 30% a year.

And now Dublin - where gossip travels quickly - is consumed with speculation that the government is not adequately investigating a brewing scandal over more than €400m (£355m) that Anglo Irish lent to a "golden circle" of property developers to support its sinking stock price.

And last week even the country's police force took to the street. "There was corruption in Enron and Madoff and they took them all away in handcuffs," said Brian Finn, 50, an officer from the town of Drogheda. "But in this country they don't even touch the crooks."

Coughlan said that the inquiry into Anglo Irish is still continuing. "People want heads on plates," she said. "But we have to be careful. We are a democracy, after all."

© 2009 The New York Times Company