August 19, 2007

Crunch time for Ireland Inc

Posted in Celtic Tiger · 12 comments ·

Our reliance on the property market is being cruelly exposed as the global financial crisis gathers pace.

It’s like discovering your husband downloads porn from the internet. You think you know someone and then, wham, reality hits.

It is now becoming clear that we had no idea about the extent of the financial perversity that was going on behind the marble foyers of our august financial institutions.

Reputable banks and hedge funds are now being exposed as little more than out of control ‘one-way-betters’, who were happy to bet the house on, well, other houses.

Worse still, they were doing it all ‘on margin’. This is a financial market term for putting down only 10 per cent of the value of your investment and borrowing the rest.

The problem with this strategy is that the market has to be rising for it to make sense. If the market falls 10 per cent, your entire investment is wiped out and you are under water. This is when the people you borrowed from phone up and ask for the rest of the collateral.

But you don’t have it because you have been bluffing all along. Now your bluff has been called, you have to sell other assets to raise the cash. Imagine this happening to every card player in the game.

A wave of selling then leads to more selling and more margin calls. Gamblers’ bluffs are being called every second of the day as the casino starts to implode. Everyone wants cash, but no one has any.

The IOUs of yesterday are worthless. The market now wants filthy fivers rather than highfaluting financial ‘products’ sold yesterday by snake-oil salesmen in smart Italian suits.

This lightning-quick change in sentiment, which causes an equally urgent demand for cash, is called a credit crunch. In a credit crunch, interest rates rise initially, despite the certainty that the economy – puffed up by all this borrowed money – will turn down.

Central banks, in an effort to settle nerves and bring market interest rates under control, lend money to the very banks that were lending delinquently in the first place and, on Friday, the US Federal Reserve Board, chaired by Ben Bernanke, sparked a rally by cutting the rate at which it extends this money to banks.

But in this environment, the risk is that anxiety leads to fear and the crisis repeats itself all over again. Funds have to sell shares to raise more cash as their ‘oh-so-smart’ leveraged bets fall apart.

It slowly begins to dawn – even on the cheerleaders who publish the stockbroking bilge on a daily basis to hoodwink people – that all is not well.

Selling continues. And more significantly, funds start selling shares in perfectly good companies that have nothing to do with the overvalued global housing market which is at the epicentre of the problem.

However, because the global financial markets are now so intertwined and overstretched, logical panic in one market, like property, leads to contagion in other markets as funds try to raise money to meet ‘margin calls’ elsewhere.

This is what a credit crunch looks like and we are experiencing one in the world’s financial markets at the moment.

How long it will last is anyone’s guess but, with the world’s central banks stepping in, there will be a concerted effort to calm things down, even if it only postpones the next crisis.

The reason it will only postpone rather than solve the problem is that the centre of economic activity is shifting from the US and Europe to Asia. Our manufacturing base is being hollowed out progressively, and we are too drowsy on the anaesthetic of cheap money to notice.

Ireland is an extreme example of this western malaise. We have codded ourselves into thinking that owning a few houses makes us rich and, worse still, we have misdiagnosed this easy money for economic strength. In fact, it is a sign of financial degeneracy.

Like many of the former ‘masters of the universe’ in the world’s hedge funds who have been shown up as smooth-talking gamblers rather than far-sighted investors, Ireland, as house prices fall, is also being cruelly exposed.

We have spent the past five years allowing inflation to wipe out our competitiveness. If you have just come back from holidays on the continent, you will compare prices for things like dinner in a restaurant.

Ireland, as we know, is more expensive than any other country in Europe bar Finland. That is inflation.

If dinner is expensive here, it is because costs are higher here and, what we see in restaurants, we see in all areas of the economy. Ireland has priced itself out of the game.

As a result, our balance of payments deficit is likely to hit 5 per cent of GDP this year, according to the Economic and Social Research Institute (ESRI).Don’t forget that we had a surplus a few years back.

In the past, this process could be masked because trade was not open, and the world economy was not globalised. But not any more. The opening of China has not only made the world cheaper, it has made it faster.

China has grown by 9 per cent on average every year since 1978 – that’s 700 per cent cumulatively. And last year, it overtook the US as the world’s number one place for foreign investment, with outsiders spending $54 billion in the People’s Republic. And it is moving up the value chain at breakneck speed.

The image of China as a low-cost, low-tech producer is false. Its enormous middle-class attests to a sophisticated workforce in open competition with us.

It is estimated the middle-class in China is now about 350 million people – that’s bigger than the population of the EU before the central Europeans joined in 2004.

Last year, China surpassed the US as the biggest market for that all-American car, the Buick. The demand for designer products underscores not just a consumer class, but an upper middle-class of 90 million people, the same size as Germany’s population.

Rather than accept this and try to do something about it, we are in denial, pretending that it is someone else’s problem. However, as the financial markets have shown in the past three weeks, bluffers always get found out.

  1. Restless

    Hi David

    You have written a number of articles outlining the imminent demise of the Irish model of doing business; but the americans have been even less disciplined than we have and it looks as if the FED/ECB will accommodate this adolescent behaviour; a bit like rich parents there does not seem to be anything outside the pale when it comes to bailing out irresponsible maverick activities to keep the markets turning. Although I don’t confuse morality with business acumen there is no penalty to behaving irresponsibly at a macro level and it looks as if greed and self-indulgence in loans or credit is the smart move at a micro level; if enough people get into trouble then the Central banks will bail us out. So, although your articles are interesting, insightful and reflect good practice, they are principles of a by-gone era. The ECB and FED allowed the sale of over-rated repackaged mortgages into the market, no standards expected ie proof of income from mortgage holders and then stalls/reduces interest rates to support this greed machine?

    What does an investor do? Are savings an anacronysm? What are your plans for investing (you mentioned uranium stocks previously). In your opinion; what does the future hold for Ireland ie next 2-3 years?

  2. Glen Quinn

    Whats happening now is exactly identical to the Panic of 1907.

    Were is J Pierpont Morgan when you need him :-)

  3. mark mc

    seems to me that the rules get broken to suit the banking system, who makes these decisions in the central banks? they are not elected by the people but they are the ones who control out lives, our politicans are effectively nothing now. we should have never joined the euro

  4. Neil B

    Can someone clear up for me: have some small German banks been helped out in this credit crunch by state aid? And, if so, how is this legal as I thought state aid was prohibited.

  5. mark mc

    well, the central banks have helped out everybody, the central banks are more of less controled by the governments?

  6. Garry

    it must be very difficult for you not to write a “I told you so” article….

    What will this credit crunch mean? will banks be forced to go back to a limit of 2 1/2 times salary for a mortgage? will you have to sell your first born in order to get a business loan? Or will the prudent people/governments bail out the speculators once again via the central banks and in 6 months time, it’ll be business as usual…

    In a world where the rules get broken to keep the system running, who are the greater fools…. the americans/irish who have taken out the ninja mortgages and lived like hogs for a few years, the banks who have made out like bandits, the chinese who are subsidizing it with very low manafacturing wages, or the people who havent bought into the hype?

  7. Declan

    Mark Mc, I think that you missed the whole point! It is a good thing that the ECB is not controlled by politicians. Our (Ireland’s) potential difficulties are related to poor political decisions and not the ECB. The ECB’s role is very clear, they are responsibile for price stability, from a Eurozone perspective the ECB has done an exceptional job so far.
    If politicians were allowed to tamper with this, price stability would be compromised and the credibility of the EURO would be called into question.
    Remember that our Government has other tools available to manage our economic situation, (ie fiscal policy). Our current bunch of politicians used fiscal policies that fuelled our economy when it should have been cooling the economy!
    We are going to pay the economic price over the next 5 years for this missmanagement.
    Using the excuse of joining the EURO as a scapegoat is weak arguement!

  8. Dan Hayes

    David & Co.:

    Sooner or later (whether in weeks, years, or even decades) the jerry-built pallative measures introduced by the Fed and Central Banks will fail – and shown to be what they always have been: a gigantic Ponzi scheme. Something will ocur (maybe it has already happened) that will occur so fast and furiously that the powers-that-be will be unable to introduce their smoke-and-mirror bromides. Then it will be all over.

    When this happens – a Depression of all Depressions making 1929 looking like an effete tea party, all Hell will break loose. The American prolitariat deprived of their Wal Mart fantasies will revolt! You say it couldn’t happen in America? Think again – in the 1929 Depression this country could have gone any which way. And remember that the American people in the 1930s were a much tougher crew than their progeny. The post-WWII generation have only known essentially continuous prosperity. They will not be willing to accept hard times and they will follow anyone who promises to lead them back to their Gingerbread Castles. It will be the Katrina debacle only on an infinitely larger scale!

    Of course, the Paleoconservatives will have been proven correct (once again). They have been sayhing for quite some time that to base your society solely on Economic Man is pure folly. Agreed.

    And ending on this upbeat note: Cheers.


  9. mark mc

    Declan, yes, i know what the role of the ECB is, but they have baled out the banks/money makets by pumping money in, whose money is this? what other businesses get such treatment when their own incompetence get them in the sh!t?

  10. I watched from afar (in Toronto) for 37years, and close up on visits back to Dublin as the pigs gathered at the trough. Last few times back the greed was palpable. As the saying goes — the bulls will have their day, the bears too will have their day, but the pigs always get slaughtered. Bacon anybody?
    John Ward

  11. ger

    As we all know, the entire basis of this so called crisis, along with all the other crises in capitalism’s history rely man’s most basest of instincts – greed. The arrogance of a few glorified gamblers employed in so called ‘august’ & ‘reputable’ insitutions playing with other people’s money who then get bought out when the monster turns against them by unelected officials in the main central banks, is quite a scenario. The current scenario in the Irish market operates with even more hubris with absurd property prices managed and cultivated by a few and supported by an obsequious government, whose only interest is the short fix, the latest headline and reelection. The Dail is largely a chamber devoid of real leadership and can therefore not be expected to put up a modicum of questioning let alone resistance against the extensive forces of transnational corporate power, yet if Ireland is ever swept away on a global financial meltdown, no doubt these same TDs will continue to pull their 100k+ and talk of belt tightening over candlelit dinners on the Champs de Elysees.
    While I do not wish an economic collapse on the Irish (as it will only be the man at the bottom who will endure the hit and not the elites who always have the comfort of their holdings), I would welcome the real prespective that such a turn in market fortunes would bring to a country (in particular to its media and centres of political power), which is overly intoxicated on its recently ability (due in large part to US multinationals willingness to relocate (short term) and EU structural funds)) to keep its people on its island. As for whether this economic growth has trickled down to those who actually need it most or has been choked off at source by the same few who have manipulated property prices to suit their own needs or indeed whether Ireland is actually a better place to live, or the Irish a nicer people, well, judging by the recent article in the Irish Independent (17/08/07) on the deportation of the Agbonlahor family to Nigeria some serious questions need not only be asked but answered. To quote a virtual Yeatsian cliche Old Ireland maybe ‘dead and gone with O’Leary in the grave’ but what of New Ireland? Sadly, I have little faith in those who ‘fumble in the greasy till and half pence to pence’.

  12. Basil Mc Herb

    Looks like the global feeding trough of low cost credit is becoming an expensive repas. Of course those who have made the commissions (and bought new italian suits and tubes of hair grease/gel etc) will probably end up packaging all the bad debts and come up with some new banking product. What’s that word that rhymes with banker ……hmmmm. Seems like a good description of those same people.

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