Three weeks ago, German Chancellor Angela Merkel said, “We won’t allow only the taxpayers to bear all the costs of a future crisis.” Her statement was obvious, correct, and a huge mistake. Immediately Ireland plunged into turmoil—with investors pulling their money out, fearing they would take the hit should Irish banks fail. Irish bond prices fell, yields shot up.
Ireland should have been safe, at least for a while. Its government is currently fully funded, that is to say it doesn’t need to refinance any of its debt until mid 2011. That is why for weeks the Irish government rejected the idea that it needed a bailout.
But as bondholders continued to flee Irish debt and depositors fled Irish banks, Prime Minister Brian Cowen was forced to accept a more than 80 billion euro credit line from the IMF and the European Central Bank (ECB). In return, Ireland will have to cut costs and raise taxes, imposing the typical austerity package debtor nations are accustomed to when they beg for IMF money. The Irish are not happy. Confronted by high-level defections from his ruling coalition, Cowen has had to dissolve his government and call for new elections. Unions and their allies plan to take to the streets this Saturday to protest against the austerity package.
The situation in Ireland allows us to examine one of the key questions of the financial crisis: who ultimately will pay for our thirty-year debt fuelled binge? So far, government reaction to the ongoing financial crises has been to shift the cost of imprudent lending from investors to the public. The bailouts in America, Ireland and Greece have protected the bondholders, their dangerous debts absorbed by the taxpayers. Governments claim, with reason, that to do otherwise would be to destroy confidence in the stability of the financial system and to make a bad situation much worse.
But in a democracy, we are not ruled by philosopher-kings. The public in Ireland and Greece may not take kindly to higher taxes, lower wages and slower growth imposed by international institutions aiming to get foreign firms their money back. Default may begin to look attractive.
Remember the aphorism: “If you owe a bank thousands, you have a…