November 12, 2006
In the 10th century, the King of England, Ethelred the Unready, faced a crisis. Danish longships threatened rape and pillage all along the east coast of England.
Sensing that his armies would be routed, Ethelred conjured up a scheme: instead of facing the enemy head on, he would persuade the tide not to come in, thereby stopping the invaders before they even set foot on land.
He raised a tax, melted down the proceeds into gold coins called Danegeld (Danish money) and flung the coins into the sea in an effort to buy off the waves.
Needless to say, this unique and innovative solution didn’t do the trick. The Danes arrived and had a field day.
The Danegeld episode reminds me of the efforts of the Central Bank to warn against the excesses of the property market. In the absence of any proper economic tools, such as interest rates, the bank is reduced, like Ethelred, to the rather pathetic spectacle of persuasion with no sanction. Last Wednesday, it issued its financial stability warnings, which sounded like a politically-correct social worker trying to discipline an out-of-control juvenile delinquent.
The report was full of pieties, couched in gentle terms such as ‘‘should’’ and ‘‘could’’ and, like any good-thinking liberal sociologist, the bank was keen to pin the blame for the banks’ financial delinquency on anything but personal behaviour. So the credit mania is now a product of the environment, the social conditions, demography or outside influences. This is the economic equivalent of social theories that blame behaviour on mumbo-jumbo like where you come in the family.
For the arch-persuader – the Central Bank – Ireland’s credit bonanza is the result of a financial broken home where the prudential lessons of the middle-class kitchen table have been forgotten. If we could only get back to basics, it would be alright. And is there a threat of the juvenile going completely off the rails? No, not really, although every sign is screaming calamity.
Let’s cut to the chase. The economy is out of control. We dispensed with all our economic tools when we joined the European Monetary Union (EMU). The resulting deluge of cheap credit has propelled all prices upwards. So wages and inflation have taken off, as Junior Cert theory would attest to. When there’s lots of money around, prices go up; in contrast, when there’s not enough cash in circulation, prices fall.
The reason houses prices have gone up six times faster than wages in the past ten years, is that the supply of labour has responded with all this new cash.
Immigrants have kept wages lower than they would otherwise be, had 400,000 of them not arrived in the past five years.
Although it is not their fault, the result of mass immigration has been to stretch the gap between wages and house prices.
This chasm has been filled by borrowing.
Today, the average house price is close to 14 times the average wage, with the result that private sector debt is 205 per cent of GNP – the highest in the world.
The flip-side of all this debt is huge banking profits. Our banks are money-lenders. The more they lend, the more cash they make. This is why the Irish banks make more per customer in Ireland than any other banks in Europe. Equally, the banks are in a market share fight to the death, so it is not in their interest to lose or turn down business.
This means that the banks set extraordinary volume targets each year for their employees to foist money on us, because they need to keep loan growth going. To do otherwise would see their share price falling, and their shareholders wouldn’t like that.
But who are these secretive shareholders – some shadowy off-shore financial Dr Strangelove? Well, not really.
We, the Irish people who contribute monthly to pension funds are the main shareholders of Irish banks. Irish banks are largely owned by Irish pension funds, so we are caught in a financial brace where cash begets mortgages, which begets profit, which increases share prices, which calls for greater loan growth, which drives the entire cycle one more time.
There is little the Central Bank – the financial social worker – can do in these circumstances. If it had control over interest rates, it could send a shot across the bows of the banking system, raising the cost of money and jolting the system into some semblance of sobriety. It’s all a bit like the ‘‘last call’’ at the pub. At the moment, the Central Bank is like a friend trying to persuade a drunk driver not to drive when drunk, but the friend, though staggering, insists he’s grand. The only course of action is to take the keys off him.
But the Central Bank can’t take our keys, so the chances are we will do something silly.
Another dilemma for the Central Bank is that, like all regulators, it is trying to execute a high-wire act. On the one hand it is trying to rein in the banks with gentle advice; on the other hand, it doesn’t want to frighten the horses by shouting too loudly. The last thing the Central Bank wants is a stampede out of the housing market – as has happened in almost every boom/bust cycle in history.
This would cause one of our big homegrown banks to collapse at worse or be taken over by foreigners for a song, at best.
Foreigners owning one of our banks shouldn’t be a problem for us, but the corporate bloodbath at the executive level is something the cosy cartel that is the upper echelons of the Irish banking system banks – and I include the Central Bank – would be loath to witness.
Likewise, in the great offshore accounts scandal engineered by the banking system against the state, did the Central Bank act as an agent of the state -which is what it is?
Not at all, it acted in the interests of the banking system, not those of the citizenry.
So when we hear the bank’s warnings about the property market, you are hearing a sanitised version of the conversation it is having behind closed doors.
But it matters not a jot, because without control over interest rates, the Central Bank is about as useful against the tsunami of credit crashing down around us, as ancient Ethelred’s Danegeld was against the Danes.