Wednesday, December 1, 2010

Question Authority

In the midst of reading a blizzard of news reports about the bailout of the Irish banks (and, by extension, the euro zone), I came across this article about TARP.

As we all remember, the Troubled Asset Relief Program (TARP) was supposed to be a major financial sinkhole for the government. Pundits from Wall Street to academia declared that the proposed $700 billion program would only scratch the surface of the needs to bail out the banking system.

Well, they were right about $700 billion being the wrong number - but they were wildly wrong when it came to the ultimate cost of the program.

Here's an excerpt from an article in the Los Angeles Times:

The projected cost of the $700-billion financial bailout fund — initially feared to be a huge hit to taxpayers — continues to drop, with the nonpartisan Congressional Budget Office estimating Monday that losses would amount to just $25 billion.

That's a sharp drop from the CBO's last estimate, in August, of a $66-billion loss for the Troubled Asset Relief Program, known as TARP. Going back to March, the budget office estimated that the program would cost taxpayers $109 billion.

Estimate of TARP losses falls to $25 billion -

Which brings me back to Ireland.

A couple of years ago, when Washington was being blasted for their fiscal policies, the government of Ireland was being praised as being a model of fiscal probity. Budgets were balanced through a combination of tax increases and service reductions, and even former Fed chairman Paul Volcker gave a speech praising the Irish.

And now look where we are.

Frankly I am not totally clear on how and why everything went so badly for the Irish, so I have been turning to one of my favorite columnists, Ambrose Evans-Pritchard of the London Telegraph. Here's an explanation from his column yesterday:

Patrick Honohan, the World Bank veteran brought in to clean house at the Irish Central Bank, wrote the definitive paper on the causes of this disaster from his perch at Trinity College Dublin in early 2009.

Entitled “What Went Wrong In Ireland?”, it recounts how the genuine tiger economy lost its way after the launch of the euro, and because of the euro.

“Real interest rates from 1998 to 2007 averaged -1pc [compared with plus 7pc in the early 1990s],” he said.

A (positive) interest shock of this magnitude in a vibrant fast-growing economy was bound to stoke a massive credit and property bubble.

Eurozone membership certainly contributed to the property boom, and to the deteriorating drift in wage competitiveness. To be sure, all of these imbalances and misalignments could have happened outside EMU, but the policy antennae had not been retuned in Ireland. Warning signs were muted. Lacking these prompts, Irish policy-makers neglected the basics of public finance.”

“Lengthy success lulled policy makers into a false sense of security. Captured by hubris, they neglected to ensure the basics, allowing a rogue bank’s reckless expansionism,” he wrote.

The lessons from all of this continue to unfold, but it is worth remembering that even the most knowledgeable among us can be wrong. We should all invest accordingly.