Wednesday, November 10, 2010

Irish Times: "Ireland faced a painful choice between imposing a resolution on banks that were too big to save or becoming insolvent, and, for whatever reason, chose the latter."

I keep mentioning the staggering rise in Irish government debt yields. Here is more context on how that country is a disaster, fiscally speaking.

The other crumbling dam against mass mortgage default is house prices. House prices are driven by the size of mortgages that banks give out. That is why, even though Irish banks face long-run funding costs of at least 8 per cent (if they could find anyone to lend to them), they are still giving out mortgages at 5 per cent, to maintain an artificial floor on house prices. Without this trickle of new mortgages, prices would collapse and mass defaults ensue.

However, once Irish banks pass under direct ECB control next year, they will be forced to stop lending in order to shrink their balance sheets back to a level that can be funded from customer deposits. With no new mortgage lending, the housing market will be driven by cash transactions, and prices will collapse accordingly.
By no means is this type of insanity limited to Ireland. Also, this Irish problem is not limited to Ireland because the fates of all sovereigns and financial institutions are tightly intertwined. They all own each others' debt! Hence the denial.

The European sovereign debt crisis smoldered for a while in the spring this year until it exploded and U.S. markets experienced a crash. It has temporarily been swept under the rug.

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