Ireland's warning for America

The losses inflicted by the vainglorious Irish bankers are staggering. Overnight, the Irish government estimated that the total cost of bailing out the Irish banks had risen to a sickening €45 billion ($AUD 63 billion), writes Karen Maley.

The crippling cost of bank bail-outs will push the country’s budget deficit to 32% of GDP this year, or more than ten times the official eurozone limit. As a result, the Irish government will be forced to introduce even tougher budget cut-backs in December, even though the economy is struggling.

In the boom years, Ireland’s banks enjoyed spectacular growth, and surging profits as they funded massive speculation. They’re now left with balance sheets bloated by bad residential and commercial property loans And the country is saddled with huge tracts of unwanted properties, many half-finished, along with gaping budget deficits.

Since the banking bailouts were first announced, the cost of rescuing the banks has risen steadily. Initial estimates were that banks would face haircuts of around 30% on the loans they transferred to the National Asset Management Agency. But the banks are facing losses as high as 70% on some of their remaining loans — leaving them with gaping capital shortfalls.

As a result, the Irish government overnight said it would pump an extra $AUD 16.9 billion into the banks. The worst offender, the now-nationalised Anglo Irish Bank, received an extra $AUD 9 billion. But markets were slightly surprised by the extra $AUD 4.2 billion for Allied Irish Bank — which will leave the Irish government owning up to 92.5% of the bank – and the extra $AUD 3.7 billion for Irish Nationwide Building Society.

Ireland’s finance minister, Brian Lenihan, was hopeful that this latest round of bailouts would bring “closure and finality” to Ireland’s banking woes.

Ireland has at least faced up to the consequences of the reckless lending, unlike the United States. The Obama administration has adopted a muddle-through,approach, hoping that a recovery in housing prices might mean that the big US banks can avoid recognising crippling property losses.

But the failure of US house prices to pick up, despite near zero interest rates, has left the big US banks facing huge problems. Some estimate that one-third of all US households have negative equity — where the size of the mortgage is greater than the value of their house. An estimated one in five households is now at risk of foreclosure.

Leading US bank analyst, Chris Whalen, co-founder of Institutional Risk Analytics, has warned that the banks are struggling to cope with the mountain of problem home loans and delinquent commercial property loans. Whalen estimates that the big US banks have restructured less than a quarter of their delinquent commercial and residential real estate loans, and the backlog of problem loans is growing.

This is eroding bank profitability, because they are no longer collecting interest on a huge chunk of their loan book. At the same time, they also face higher administration and legal costs as they deal with the problem property loans.

Banks nursing huge portfolios of problem loans become reluctant to make new loans, which chokes off economic activity.

Ultimately, Whalen warns, the US government will have to bow to the inevitable and restructure some of the major US banks. At that point the US banking system will have to recognise hundreds of billions of dollars in losses from the deflation of the US mortgage bubble.

If Whalen is right, Ireland is a template of what lies ahead for the US.

*This article originally appeared on Business Spectator