finances ( and the economy generally ) crippled by local banking excesses that coincided with, but were not in any close way related to, the contemporary excesses related to the us mortgage market. these two cases provide a contrast to the irish one in regard to the impact of bank recapitalisation on the national budget. as mervyn king has remarked, the current crisis has shown the extent to which, no matter how global banks are in life, in death – or near death experiences – they are local ; in this context imposing on the national budget. as has been thoroughly documented by the report of the inquiry there, iceland ’ s banks had made a leap for scale which was not simply based on importing funds that pumped up the local economy. indeed they greatly outgrew the local economy ( which after all is very small, with a national population of less than half a million persons ) and were heavily involved in the financing of international investment ventures of some of their iceland - based customers. when these banks – middle sized in an international comparison – failed, the national authorities regarded the burden of meeting all of their liabilities as being too great to be assumed, and their rescue and restructuring of these entities was partial only, with much of the foreign liabilities not covered, a matter which led to a fraught international negotiation, especially with the authorities in the uk and netherlands. the iceland case probes the limits of the impact that banking system rescues can have on the budget. indeed the general issue of limiting the scope of bailouts has come under increasing international scrutiny with academics and policymakers trying to design viable ways of reducing the number of banks that can be considered too big, too complex, or too interrelated with the rest of the system, to be allowed to fail with losses to uninsured creditors. policies designed to limit the size, remove the complexity, and pre - design an orderly liquidation scheme ( living will ) are all being considered as solutions in this direction. there is much to be said for this line of policy exploration ; especially when it seems that some of the institutions that got into trouble globally have become too complex to be reliably managed. but i have to say that i am not altogether optimistic that there will quickly be a full solution that both preserves the effectiveness and cost efficiencies of modern finance and genuinely removes the need for rescues in all conditions. latvia ’ s reliance on foreign - owned banks points to the opposite end of the budgetary impact of financial

every year. no need, it seemed, for restraint in spending, and so, after years of relatively disciplined government budgeting, there was a relaxation of spending controls – one i will say which was broadly welcomed across most of the political spectrum. alas, that the apparent solidity of the public finances was all a mirage was brutally exposed when global financial confidence collapsed. already the irish boom was well over : house prices were falling and the government deficit widening from early 2007. the global recession did its damage to the budget also through the direct effect on world trade and accordingly on economic activity, given the very open nature of the irish economy. but a more direct effect on the budget was yet to become manifest. the progressive tightening of short - term financial markets during the second half of 2007 and through 2008, peaking in those dramatic weeks after the bankruptcy of lehman brothers, eventually exposed the fact that, not only had the banks fuelled an unsustainable property bubble, but they had not safeguarded their own solvency through adequate collateral and guarantees. the government had little alternative to announcing an extensive guarantee of bank liabilities. this has proved not to be costless, and is imposing a net cost which will place a heavy burden on taxpayers and the users of public services in ireland for several years – though it is manageable and much less than some alarmist commentary had suggested. to be specific, every one of the top eight retail lenders – three of them subsidiaries or branches of well - known international banking groups – are recording loan losses which would eventually eat substantially into their capital were it not for the fact that this is in the process of being replenished. thus the entire banking sector got caught up in an unreal scenario. each firm was looking over its shoulder at the others and reluctant both to miss out on a seemingly profitable growth business and fearful of the shareholders ’ reaction to declining market share. in an ideal world, the prudential regulator would have called a halt, but – as i have recently documented in my detailed report to the minister for finance on the matter – despite some misgivings about the growing exposure, the regulatory apparatus did not fully appreciate the scale and imminence of the risks whether at the systemic or individual bank level and acted only timidly and ineffectually to restrain the lending boom. rather than see the banks limp on, crippled by non - performing loans that would both inhibit their ability to retain depositor funding and discourage any new lending,