Ireland's Bailout - How Did It Come To This ?

Ireland finally agreed its €85 billion bailout with the EU yesterday – how did it get to this stage?

So this guy goes into a bank in Ireland and says to the manager, “I’m a buy-to-let landlord. Can I have a €1 million to buy 5 more flats to rent?” ‘Of course sir’, says the manager and the money is put into his account.

The landlord then goes to a property exhibition and buys 5 new €200,000 flats off plan, paying the full price over the following 18 months as the flats are built. He’s not raking in any rent at this point of course, funding the interest on the loans from his other rental properties. He’s a bit stretched at this stage but as soon as he rents the flats he’ll be ok.

Another Unsold Development

But …… in the course of those 18 months, Ireland’s property bubble bursts. The flood of new money taken out at cheap eurozone interest rates means there are tens of thousands of new flats being built and nobody can sell them so they are put on the rental market – which doesn’t help our landlord.

He’s now stuck between a financial rock and a hard place – he can’t rent his flats because there are too many available and he can’t sell them even at a lower value (they’re now worth about €150,000 each). So he bites the bullet and hands in the keys to his bank and stops paying the mortgage on his €1 million loan.

The bank now has 5 flats which they didn’t want. They’ve ‘lost’ €1 million but at least they have five flats, which they initially write down in their books to €100,000 each but as the situation worsens, they take the full hit and write them off one year later, to zero. The problem is our guy is one of the smaller borrowers, the average loan taken out for property developers is around €3 million.

Losing an average of €1.5m on each of these loans soon adds up. You only need 56,000 of these bad loans and hey presto, you reach the magic figure of €85,000,000,000 (€85 billion) – the sum the Irish government has just borrowed from the Eurozone.

So who has lost the money?

Our landlord has lost a bit by paying for the mortgage on his €1m without getting any return whatsoever. The bank has lost it’s €1m but it still has 5 flats on its books which eventually they’ll sell, even if it’s only for €50k each. The flat builder was initially laughing as he got his €1m but he’s now got 200 flats on his books which he can’t rent or sell so he goes bust, throwing 300 guys out of work. He also owes the banks €20m.

The banks are down €85 billion so they get a bail out from the government who has borrowed the cash from the European Central Bank and the IMF at high interest rates. The government now own 80% of the banks and have to put up taxes and VAT in order to get their budget balanced. Even our landlord, who didn’t lose that much initially now has to pay more tax and has to try and find a job, but as the government cuts start to bite, employment rises and he cannot get a job. He signs on the dole but after 1 year, his benefits are cut and he ends up living in the one flat he has left on his books.

What goes around comes around.