Allies in EU needed now more than ever

WORLD VIEW:THE WORD crisis is overworked in these days of financial turmoil. It derives from the Greek krino, to decide. Decisive action is called for by the conditions that give rise to a crisis and this resolves it for good or ill

The Government's decision to cover the Irish banks' deposits and debts for two years certainly fulfils these criteria. Confronted by the expected failure of one or more Irish banks, it underwrote the whole system to the tune of €400 billion, rather than risking illiquidity and collapse.

In the short term this action has worked to head that off. We are now dealing with the anticipated, unintended and unforeseen consequences of the decision taken - and with whether it addresses the correct problem. It is one thing to tackle an illiquidity problem arising from banks' failure to raise funds, quite another if the underlying problem is potential insolvency.

Irish bank assets are highly concentrated on fast fading UK and Irish property - 80 per cent in the case of Anglo Irish Bank's loan book, 71 per cent for Bank of Ireland and 60 per cent at Allied Irish. As values fade computations of assets and liabilities change fast in bank balance sheets, affecting the original calculation of risk. Thus, as the Financial Times's Lex column said on Wednesday, "guarantees can be cheap to give but ruinous to honour".

That is why the terms and conditions applied to the guarantee are so important. In a letter to the FT on Thursday, two leading political science experts on European and global regulation, Walter Mattli and Ngaire Woods of Oxford University, said three things stand out in making it more effective.

Regulators should, first of all, insist on timely information but also "apply swift and severe sanctions" where it is misleading, inaccurate, incomplete or lacking. Secondly, "there must be sustained public pressure that counterbalances the lobbying efforts of the financial sector". This can be supported by healthy and responsibly run banks which lose out as a confidence crisis affects the entire industry. And thirdly, "it is crucial that the new regulation takes place in the sunshine", and is not "left to the 'experts' working in the quiet, insulated corridors of Wall Street, London and Basle. The result has been failure. No surprise."

That puts a special responsibility on political representatives to set the terms of regulatory implementation and adherence. It also imposes a particular responsibility on media to fulfil their role of telling truth to power in the public interest, however unpalatable or ostensibly complex that is. Putting confidence before established fact is self-deceiving.

Morgan Kelly of UCD argued in these pages on Thursday - bearing out Mattli and Woods - that "the following months will see a battle of wits between banks and the Financial Regulator, as banks try to offload bad debts on to the taxpayer and the regulator tries to stop them". He reckons that potential bank losses of €10-20 billion on their bad property loans are at stake in this game. Like Nouriel Roubini in the US, Kelly is on record as foreseeing this credit crisis and has not been thanked for it by more optimistic economist colleagues or ostrich-like special interests.

The international consequences also loom large. Charges of economic nationalism from British sources complaining about unfair capital flight to Ireland are a bit rich, recalling their own self-centred policies.

Despite strong hints from Neelie Kroes, the European Union competition commissioner, that Ireland's action may breach rules against state aids, there has not so far been any concerted EU chorus of disapproval. Rather might Ireland set a precedent, since we were yesterday followed by Greece. Spain has better banking regulation than us, which protected it from this storm, despite a similar housing collapse.

But competitive re-regulation can be as dangerous as competitive devaluation was. The scale of this crisis calls increasingly for a common EU effort to recapitalise the banks through public equity or by mandatory debt-to-equity conversions, whereby banks are compelled by the state to absorb bad debts. Influence in the EU is closely related to inventing common policies from which you can benefit, as we did in 1987-92 with the structural funds.

This matters because the last thing Ireland needs now is to go out on an unnecessary economic limb within the EU, coming on top of the No to the Lisbon Treaty. The definite and mostly negative economic costs and political consequences of that decision are being brought home this autumn. They badly need public attention for an informed debate on whether to revisit the referendum decision. They were not properly represented during or after the campaign.

Voters therefore remain quite unaware of the damage done to Ireland's reputation in Europe and the consequent erosion of good will. In a meeting of influential figures at an EU think tank this week, I found a clear understanding that the Lisbon problem is European as well as Irish; but responsibility to propose a solution is seen primarily as an Irish matter.

Nevertheless there is a growing frustration that if Lisbon is not ratified before next June's European elections their democratic legitimacy and political transparency will be badly damaged. The same applies to the EU's external role as a global actor - a perception shared by Russian and Chinese leaders. Ireland needs allies in such a turbulent economic setting and can ill afford to antagonise them.