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The Irish aren't rioting over austerity—yet

Ireland should be burning. High unemployment, plummeting real estate values, the recession and the sense that the government is part of the problem would seem to be enough to trigger social unrest. Now add in the mullet-brained insistence on foisting the cost of Ireland's epic banking collapse onto the taxpayers, mortgaging their future for years, maybe decades.

Financial crises have triggered social unrest in many countries in the past, ranging from strikes and demonstrations to riots. Almost 30 people died in riots in Argentina in December, 2001, when the government restricted bank accounts in an attempt to stop a run by depositors. The country then defaulted on its debt and ended its peso's 1-to-1 parity link with the U.S. dollar.

In May of last year, rallies against Greece's deep-cut austerity plan turned ugly when a firebomb killed three workers in an Athens bank. The city has been paralyzed by several protests since then. More recently, in London and Rome, dozens of students and police were injured in protests against education cutbacks.

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Dublin saw some demonstrations late last year, but they were rather civilized compared to the strife elsewhere in Europe. That will almost certainly change, however. If anyone is justified in feeling wronged, it is the Irish, because the poor bastards are being forced to pick up the tab for their bankers' gambling losses.

Ireland is having not so much an economic crisis as a financial one. The country's banks were among the most loosely regulated financial institutions on the planet in the early 2000s, and they went on a massive real estate lending spree. The annual value of house building soared from a historic norm of about 5% of national income to close to 15% in 2006 and 2007. Morgan Kelly, the University College Dublin economist who predicted the Irish real estate crunch, said last year that "the Irish decided that competitiveness no longer mattered, and that the road to riches lay in selling houses to each other."

The banks threw gasoline onto the fire. The value of all bank loans outstanding expanded to 200% of national income by 2008. Near the peak of the market, Irish banks were lending 40% more in real terms to property developers than they were lending to all clients in 2000. In 2007, Ireland was building half as many homes as all of Britain, which has 14 times the population. Typically, loans made to developers were made without collateral.

The bubble burst in 2007. Property prices in many areas are down by more than a third since the peak. That deterioration will continue, because an estimated one in eight households has negative home equity—the value of the house is lower than the value of the mortgage against it.

The insanity of unrestrained lending to the housing market was matched by unrestrained guarantees to the lenders—the equivalent of rewarding a heroin addict with more heroin. The Irish government guaranteed most of the bonds issued by banks and, in 2008, it committed €40 billion to buying dud loans. The government is also investing about €45 billion to recapitalize the banks. A big chunk of the €67.5 billion in bailout money Ireland is receiving from the European Union and the International Monetary Fund in December will be used to prop up the so-called zombie banks—ones that are essentially worthless but still carry on business with government support.

The cost of the bank rescues more than doubled Ireland's 2010 budget deficit to 32% of GDP, according to European Commission estimates, compared to 9.6% for Greece. The ratio of Ireland's total public debt to GDP soared to almost 100% from 65% a year earlier. Thanks to the battered banks, the ratio is expected to reach about 115% by the end of 2012.

Ireland doesn't have its own currency (it uses the euro), so it can't devalue its way out of the mess. Instead, it must resort to a grim mix of wage deflation, higher taxes and public spending cuts. As the Irish get poorer, their relative debt burden grows—all for the sake of the banks.

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There is, of course, a solution: Send the senior debt holders to the barbershop. Haircuts on their holdings could save Irish taxpayers an estimated €15 billion, giving the country a chance to emerge from the debt swamp years earlier. It's cruel to impose the banks' losses on taxpayers in order to repay the senior debt holders in full. Capitalism isn't supposed to work that way. Greece looks like it may go through a national default to slice its public debt, as Argentina did a decade ago.

Will the Irish government do the right thing for its citizens and whack the bondholders? Probably not. The bank and investor lobbyists are powerful, and Dublin won't want to risk legal challenges it might not win. Other EU governments will put pressure on Ireland to leave the bonds intact, for fear that haircuts would anger investors and raise borrowing costs for their countries.

Yet if Ireland's debt is economically unsustainable, it's also politically unsustainable. A populist uprising seems inevitable and it could easily spread to other debt-choked countries whose bond investors are getting an easy ride. If 2010 was the year of the debt crisis, 2011 could be the year of the social crisis.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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