One of the diagnoses of why the Great Depression was so bad is that countries engaged in “competitive devaluation” — weakening their exchange rates to make exports cheaper, but when all try to do this, no one gains, and confidence runs out.Â One wonders today if Ireland has created a new version of this risk with the dramatic government announcement that it is providing a public guarantee to all liabilities of banks with their HQs in the Republic of Ireland.Â That means every debt that these banksÂ have to anyone: to their depositors, interbank lenders, and bondholders.Â
This sweeping guarantee far exceeds that of deposit insurance, and means that any wholesale lending to the Irish banks — the part of the banking system that is nearly stalled at the moment — is now secured by the Irish taxpayer.Â But foreign banks operating in Ireland, including Ulster Bank (owned by RBS), Rabobank (Dutch), and Postbank (part owned by, er, Fortis) are not covered.Â Any wholesale lender to these banks now has a strong incentive to switch to one of the six Irish HQ’d banks to get the guarantee.Â
And it’s still not clear whether the liabilities of UK subsidiaries of Irish banks are also included in the scheme, which would put Alistair Darling in a severe pickle about whether to offer a similar guarantee.Â When Darling offered a similar guarantee to Bradford & Bingley, it was only in conjunction with selling the deposit business and taking the rest of B&B into immediate public ownership to be wound down.
Now would the world be better or worse off if every country moved to similarly guarantee all liabilities of banks?Â In the short-term, perhaps better off, since interbank lending could proceed on a more confident basis.Â But the precedent would be atrocious.Â Those liabilities are matched to assets, and the cost to the taxpayer of any payout would depend on loan quality.Â Which ultimately means that a responsible government would have to engage in tight oversight of lending decisions.Â Which is sort of like running a bank.Â Isn’t this a business that governments were supposed to be getting out of?
It’s also bad timing for Charlie McCreevy and the European Commission, who will announce tomorrow their proposals for a more pan-EU system of banking regulation within the constraint of the primary of national regulators.Â Ireland seems to have announced its new guarantee without any consultation with the UK or the Commission, the latter who still have to judge, inter alia, whether the system discriminates against non-Irish banks (on its face, it does).Â Â There’s no direct connection between the banking crisis and Lisbon, but other finance ministers might see this as another example of Ireland’s go-it-alone approach toÂ the functioning of the EU institutions.