July 13, 2008

Central Bank must finally show leadership in the face of crisis

Posted in Banks · 25 comments ·

The crisis in Ireland is monetary, and the bank has to assess what needs to be done and tell the truth.

This weekend, Rupert Murdoch was door-stepped by a bunch of journalists. Speaking off the cuff into a sea of microphone heads, the veteran media mogul summed up, with clarity and directness, what he saw as the problem facing the world economy.

He said that the average western family was affected by rising food and fuel prices, eroding their monthly income, at a time when their wages couldn’t rise because of the competitive pressures from China and India.

Succinctly and with little fuss, Murdoch concluded that, as a result, he was extremely ‘‘bearish’’ for our prospects over the next few years. He pointed out that 100 million people a year clawing their way out of poverty around the globe, meant that the demand for food, shelter and energy would continue to rise, putting huge price pressures on western families for the foreseeable future.

In a nutshell, Murdoch summed up the Malthusian dilemma that the world faces: the more people wanting to use resources, the more expensive those resources become. We have seen this played out in our rate of inflation, which hit 5 per cent last month. These pressures are not new and, in fact, they have been building over the past few years.

However, in an effort to avoid the inevitable, Ireland and many other countries postponed the day of reckoning by borrowing other people’s money where we could get our hands on it.

One of the basic rules of economics is that, if we want to increase our income in the face of rising costs, we all have to increase our productivity, implying that we have to work harder or smarter. Over the long term, there is no substitute for this.

We in Ireland thought that we had invented away around this inevitability by borrowing against inflated houses. We put our hearts and souls into this scam, becoming one of the most indebted nations on earth in the process. We realised that our income couldn’t sustain our lifestyle so, instead of reining in, we splurged.

The main architects of this shaky edifice were the Irish banks, and its structural engineer was the Central Bank.

But the problem with borrowing is that there always has to be a lender to lend to keep the entire structure from crumbling. The willingness of a lender to lend is predicated on the lender having cash to lend.

This cash comes from us paying back promptly while those others, who are not involved in the pyramid scheme, lend to the banks in the secure knowledge that they will be paid back at a higher rate than they can get elsewhere. Unfortunately, that final part of the equation began to unravel late last year.

What began as a trickle has become a torrent. Now the prospect of bad debts shunting on from one exposed sector to another is upon us. We have seen this in the US, where defaults in the mortgage market gradually gave way to defaults on credit cards, car and holiday loans, plus the various ‘buy now, pay later’ scams orchestrated by sellers of all sorts. Many commentators suggest that the situation is not as bad in Ireland as it is in the US. This is absolutely not true.

In the ten years from1996 to 2006, Irish residential mortgage debt rose by 522 per cent per capita; in the US, the same debt rose by 103 per cent. In terms of new debt, we are five times more exposed than our American cousins. The same shunting bad debt cycle will happen in Ireland, make no mistake about it.

The crisis is so significant in the US that the Bush administration is worried about the solvency of America’s two huge mortgage companies, known as Freddie Mac and Fannie Mae. This would have been unthinkable only a few weeks ago.

As the New York Times put it last Friday: ‘‘Fannie Mae and Freddie Mac are so big – they own or guarantee roughly half of the nation’s $12 trillion mortgage market – that the thought that they might falter once seemed unimaginable.” Well, unfortunately, the time has come to think the unthinkable.

Rupert Murdoch believes that this time has come, so does George Soros and the myriad of market players who have been selling Irish banks stocks in the past days and weeks. Put simply, the game is up and no one really knows where fair value for the Irish banks is or what toxic waste is now piling up on their balance sheets.

This is why the news last Friday that the Central Bank of Ireland gave Irish banks the thumbs up, while not surprising, is depressing. The Central Bank and the Financial Regulator have a vested interest in saying that Irish banks are fine, because it was they who presided over the scam.

During the boom, for month after month, the Central Bank produced figures telling us that credit growth was roaring ahead. At the same time, it was saying that it was happy that Irish banks were not in breach of mortgage guidelines. To return to a phrase used in last week’s column: ‘‘Don’t piss down my back and tell me it’s raining.”

The canard of Irish finance is that the very institution that has most to lose by saying we have a problem in the banking system is the one asked to assess whether there is a problem. Of course such an institution was going to say that everything was fine, in the same way it failed to blow the whistle on the banks’ role in actively defrauding the state during the Dirt scandal in the 1980s and 1990s.Did anyone resign over that lamentable story? In the boys’ club that is Irish banking, no one does anything so honourable.

As is the way in democracies, all the fingers are now pointing at Brian Cowen, but when you examine the Irish story, you see that the politicians were let down by their first line of defence – the Central Bank. The crisis in Ireland is monetary in nature and the people who were charged with overseeing this are working in Dame Street, not Kildare Street.

What we need now is someone with the clarity of Murdoch to assess what needs to be done and to tell the truth. In the US, the Fed chief, Ben Bernanke, orchestrated the takeover of Bear Stearns by JP Morgan to prevent further systemic problems. Should someone in power be looking at doing something similar here?

The markets need actions – not words – from financial guardians.

Take, for example, Irish Life and Permanent, Ireland’s largest mortgage provider. An analysis by Davy stockbrokers suggested the financial markets were placing a negative valuation on its mortgage business, with its value on the market reflecting its life assurance business. Other lenders are also feeling the heat.

Now if you believe that there will be some recovery in Ireland and that most of us will payback these debts at some stage, then when the banks finally concede that they do need fresh capital, someone will be willing to invest in the banking system.

Why is the Central Bank not following the Fed’s example and looking at brokering possible deals involving the Irish banks – and maybe consortiums of international banks? This would achieve two objectives: it would inject fresh capital and stability into the banking sector and it would send out a signal that we are in responsible hands, with those in power thinking about the future.

When it’s clear that the dilemma as outlined by Murdoch implies falling living standards for the next few years, the country needs its institutions to be strong, to show leadership and to reveal a modicum of integrity in the face of adversity.

Instead, when the dogs on the street know that the banks – the very heart of the capitalist economy – are in trouble, we get self-regarding platitudes aimed at protecting those responsible.

  1. Barry

    Good analysis, honest. I would only quibble that you should use such a creature as Murdoch to illustrate the problems. Murdoch is part of the problem, not the solution, his form of capitalism is one of the foundation stones…., over stretched, over borrowed (at one time anyway) and exercising an undue influence….

    Concerning the Central Bank’s support for the Irish banking system, they would say that wouldn’t they? If they say anything else they will send one or more of them under, a view already put forward by Myers…..

    Do you think the situation would or could have been avoided or reduced in effect if one of the banks had been let go under? It seems to me that the unwillingness of the powers that be to let e.g Northern Rock or Bear Stearns go will reinforce the view that bankers can do what they like, the gov will bail them out….

    Bye, Barry

  2. Nagelz

    Who will govern the governors kinda thing.

    We’re only now realising the extent to which hock has funded the past ten years or so.

    Realisition unfortunately doesn’t seem to carry any credence with the beancounters in the Irish banking system.

    Owe the banks 60,000 and you’re in trouble, owe them 600,000 and they’re in trouble would be a reasonably well trotted out adage…….now more than ever it reads true imo.

    The government are muppets with no show, suggest everyone gets a copy of Steinbecks “Grapes Of Wrath” for a view of whats coming

  3. carl smyth

    Can Ireland increase it’s productivity any more?.The internet allows well paid positions’for engineers’ and accountants’ to move offshore and so the what will remain of the private sector will consist of shelf stacking and cleaning jobs.The economy is in a bigger mess than 1986, at least we were a relatively cheap place to do business, hence the birth of the Celtic Tiger.Expect inflation to hit 7% early next year.How do Fianna Fail consistently get away with screwing things up?.

  4. Ed

    “in the same way it failed to blow the whistle on the banks’ role in actively defrauding the state during the Dirt scandal in the 1980s and 1990s.Did anyone resign over that lamentable story? In the boys’ club that is Irish banking, no one does anything so honourable.”

    There was more to that debacle than meets the eye – was it was a question of harnessing greed to save the country? – remember, private savings in Banks were around thirteen billion and the state was bankrupt – exchange controls were in place – you fill in the dots!

  5. Johnny Dunne

    I see the Central bank Governor is in front of the Oireachtas commitee on Finance this Tuesday on the economy / banking situation.

    David, I’m sure many on this blog could list questions to ask him in this ‘public forum’. He has presided over the central bank during our own ‘irrational exuberance’ like Alan Greenspan. Similar to Ben Bernanke in the US he should be held to account – let’s see ???

    Will he mention some options for future of the economy – stay in the euro for a ‘long’ downturn or come out for a ‘short’ shock !

  6. Garry

    Agree 100%. . While shareholders are greedy they aren’t idiots; they can see the bankers are still in denial and hoping things will blow over, or suspect that they are afraid to come clean because the news is so bad. Share prices are down up to 70% whilst everyone is frantically saying things are just hunky dory.

    Lenihan needs remind the bankers
    1) Ireland needs a few banks to loan money and pay depositors. The difference is their margin and we need both to be widely available and as close to the ECB rate as possible.
    2) The names of our banks don’t matter a whole lot provided they are stable, act with integrity and are trusted.
    3) Get on with it. Taxpayer intervention should be something to fear whether you’re a banker, a shareholder or a central banker; not something to make proposals on while at the same time saying everything is grand.

    its time to stop talking shite

  7. Philip

    The country is in denial. People in the street have no idea what the implications are. It’s way over most people’s heads and when the inevitable comes, it’ll just be seen at just one of those things.

    We will not riot and no heads will roll. The guys at the top will just “apologise” or “feel regret” and carry on as though nothing has happened.

    I have no confidence in any of our leaders to give leadership. The Irish lack of trust in the establishment will be reasserted yet again – and life will muddle on. The best thing for your kids is either join the public service (which will have harder than ever exams at first – due to ever higher demand) or emigrate. Back to the 70s and 80s – but with a sense of shame for things lost and knowing what it could have been had some courage and integrity been in place.

    God knows what imaginative fudges we are going to witness in the coming weeks. Here is hoping for some pleasant surprise from the establishment – a few mass firings perhaps to control that current spend? Pulling the plug on a few developers and banks perhaps? Let’s hope they do it soon.

  8. Malcolm McClure

    Just to calm some shattered nerves out there, the Governor of the Central bank said in his annual report just 4 days ago:
    ” While the share prices of Irish banks have fallen, it is important to point out that the direct and indirect exposure of Irish banks to US sub-prime mortgages is negligible, and there is no sign of a material increase in loan arrears. Accordingly, the banking sector here has not experienced the write-down of assets that has required some of their international peers to raise additional capital, thus Irish banks are well capitalised with good asset quality. In line with the results of previous exercises, the preliminary results of our latest macroeconomic stress tests on the banking sector, which are designed to test the financial position of banks in the face of a serious economic downturn suggest that the banking sector’s shock absorption capacity remains strong. This strength is an essential prerequisite for the more challenging times that have arisen,”
    To take up David’s evocative scatology, is he ‘taking the piss’ or ‘pissing into the wind’?

  9. Philip

    Can anyone tell me what would happen if freddy and fannie crumble? My simplistic view is GAME OVER for gatt, world economy as we know it. May as well move to barter. Even the Euro will not stand a chance – you simply cannot remove a 270M people developed economy and simply say Ooops!

  10. MK

    Hi David,

    I, like you, place some blame on the Irish Central Bank for the extent of our property bubble, but I dont blame them entirely. The banks themselves and indeed many countries in the western world were in a credit binge, not only in terms of ‘flipping properties’, but also flipping companies with highly leveraged private equity deals and leveraged hedge funds, etc. The world as we know it, its financial systems, are now highly leveraged. We have borrowed from future generations. That’s grand (for us and our kids) if the worlds population keeps growing indefinitely, but it cant, and resources will at some point be squeezed. The current squeeze on oil is but a mere small example of this.

    The off balance sheet items ‘scare’ me, such as the barely mentioned huge level of derivates which number in the regions of 100 to 150 trillion! These exotic financial ‘tools’ have been used by the markets to further ‘obfuscate’ debt. In essence its like sticking it under the carpet. There should be no such thing as an on-sheet or off-sheet debt. Its an accounting ‘trick’. This is an elephant in the room which is yet to hit. It may do and with disasterous consequences.

    Since we left the ‘gold standard’ in 1974, money is based on trust (more trust), and you can print more of it, a euro costs just 1c. With the levels of debt increasing continually, have we dug ourselves (globally) into a huge debt hole?

    So yes, the Irish Central Bank should have played it better, our Irish Banks should have played it better, but the G word, greed, got the better of the latter. But in a global view, there are many other participants that should have played it better.

    With all this doom and gloom, people may be tempted to ‘give up’. But we will carry on, recessions are recoverable and life will go on, albeit uncomfortable for some. Ironically, Fannie Mae (and its offshoot Freddie Mac) was set-up in 1938 to encourage the US property market back then and to provide liquidity. It was a ‘short-term’ fix that should have been removed from their market a long time ago. Maybe we should have ‘removed’ the Irish Central Bank as well and gave the remit to the ECB. They may have done better.


  11. bertie

    Its partly my fault, here’s the real site about me and what i have done for the country


  12. Mathew

    Hi Guys,

    This is only the start. according to reports in the press 40,000 emigrats would come into ireland for the next 3 years and 65,000 people would leave. The diffrence of 25,000 people would crash the rental market, which in turn would lead investors to sell their properties as they wont be able to pay their mortgages as finding someone to rent a place would be next to impossible. Ireland with a economy which has no manufacturing, negligable exports if you leave IT out of the oicture, dosen’t have a economy that can withstand a downturn like the USA. The worst is yet to begin. The housing market prices would be down to 2001 prices by the end of 2009. Take my word for this.

  13. Roche

    Murdoch is correct is arguing basic supply and demand are significant forces behind current inflation e.g. China, whose seemingly insatiable demand for raw materials is reshaping commodities markets worldwide and straining the systems that move goods on land and sea. Although the majority are bearish right now, the market does present a good oppportunity to get in while prices are low. However, beware of short selling. Any volatility of Freddie Mac & Fannie Mae will add to the economic concerns of the over-borrowed, underprepared, & under-saved. The speculation itself may cause further havoc on the market which is why Bernanke, Dodd, & Paulson are trying to offset media fear mongering. The central bank needs to take a leaf out of Bernanke’s book and be strategically proactive and the government needs to ensure that those behind shady mortgage & lending practices are prosecuted.

  14. shtove

    Do Irish banks really have such little exposure to US mortgage securities? I wonder if we’ve heard the truth about that one yet.

    And reports last week said Anglo, BoI, and AIB are the most heavily exposed lenders to the commercial RE market in the UK. Ooo errr!

    Nationalise the banks! That’s what they did in Sweden. It’s the only way out.

  15. Hi David,

    Saudi Arabia was looking towards American for help again the possible threat from Saddam Hussein. Now Iraqi is no threat and Saudi Arabia is free to flex its oil mussel, and America has no hold over the Saudis. Throw Russia into the mix as they are now a major oil exporter, with the Saudis and America is on the run. Russia lost the cold war battle but my win the war over America in the end. We are all paying for this, our bank and recession problems all stem from our new oil prices which will go over $200 a barrel. What then?

  16. Can of worms

    bertie said,

    on July 14th, 2008 at 2:59 pm

    Its partly my fault, here’s the real site about me and what i have done for the country

    Thats hilarious but Bertie is too busy now to suffer from nightmare about his past.He is off to save the war torn AIDS inflicted continent of Africa from itself and conflict resolve the whole place.
    His true talent-if the only worthwhile one hes got- will be put to good use and he will be reconciled with his God for the hardship which his own people will endure during the looming recession.
    The 300000 Civil Servants he has enriched are already overwhelmed with demands for subsistance money from the hungry hordes at home-maybe he should stay in Ireland and help resolve the internal conflict between those he has made obscenely wealthy and the thousands who are signing on the dole.
    The banks are broke and sitting on billions in land and property assets.The builders have told them-as David indicates-to fu*k off.!
    If the banks took over the derlict half finished housing projects around the country and had a firestorm sale of houses they would at least recover 50% of their losses and start afresh.
    They have no money to lend the buyers which is the real catch 22 problem here but fresh capital could be raised from current shareholders if they were offered the right deal i.e. three more shares at a Euro a share for every one they hold .
    They would have to accept new shareholders directors on the board to stop them repeating the whole debacle over again.!

    on July 14th, 2008 at 2:59 pm

    Its partly my fault, here’s the real site about me and what i have done for the country



  17. liam

    shtove :
    “Nationalise the banks! That’s what they did in Sweden. It’s the only way out.”

    doing that right now will nationalise the losses (taxpayer) after all the privatised gains (dividends etc..) have been taken in the past decade. Let them take the full brunt of market forces (not just the bull market) either fail or be bought by SWF or whatever. keeping it in (NEW) private ownership will at least mean the top brass get more than a slap on the wrist (fired)

  18. MK

    > Nationalise the banks! That’s what they did in Sweden. It’s the only way out.

    No, its far too early to be saving the banks. That only goes to create moral hazard and store up problems for the future. Perhaps AIB and BOI think they are too big to be allowed to fail. Ireland has saved AIB before back in 1984 with ICI to the tune of 400m, paying for their debt/losses essentially and allowing them to continue and profit from it. The money was never returned. We ‘nationalized’ them by saving them yet we didnt accrue any benefits. How dumb is that? That in itself created a moral hazard which is still lurking in our banking system. Perhaps we are too reliant on AIB and BOI, and the ‘new’ players on the street such as Anglo, permanent tsb, Nationwide, etc, have their own problems. As a country strategy, we have to let some banks fail if that’s the way they are going. There will be pain involved but like lancing a boil, its better in the long run.

    What we need to do is put better controls in place, so that our bubble and the over-extension of the banks doesnt happen in the first place!


  19. shtove

    In a nationalisation you wipe out the shareholders and give the bond holders something to alleviate the pain. Then sell back in to the market with an upside for taxpayers – when and if the financial markets recover. Not nice, but what you gonna do?

    Maybe Santander will come along and take the problem off our hands!

    The ICI debacle was Haughey era GUBU.

  20. PP

    The month of June showed a net increase of almost 20,000 in the number of people unemployed – In just one month!

    How many of those people have mortgages?
    It appears that repossessions begin when arrears > €20,000 have arisen.

    How long would it take, on an average mortgage of 300,000, for an unemployed person to develop arrears of €20,000?………..15 months approximately.

    I hope things start to get sorted out before then, but if not, I hope the government will not leap to the rescue of those banks or institutions who repossess the homes of those unfortunates.

  21. As far as I can see now the American Government has bailed those two lenders out and should
    be the first step for the recovery of the American market.
    This could led to the value of property in the states increasing, in certain areas and maybe
    ultimately led to another world property boom..Thus more easy credit…
    Irelands dream…
    But if markets can crash fast can developed markets in theory boom (recover) fast?
    Another pyramid scheme with the US Government on top.
    Would love to hear anyones comments on that wak theory.

  22. Philip

    The snag is that the cheap labour force dries up and productivity remains highest for the latest adopters of manufacturing technology – meaning they hold all the cards in productivity. The old manufacturing giants in the US and UK will never go back./ Too many people stung by the experience and now they are behind. So you stick your loot in reliable bricks and mortar courtesy of cheap credit … and now that inflation and credit increases due to increased demand on oil and food, the old economies simply cannot produce to pay their bills. It’s as simple as that.

    Really, the banks etc are irrelevant. They just manage (pretty badly usually) an information system called money. They produce or make nothing. They merely hold info on your rights to pay.

    The collapse started 15 years ago and was out of control for the last 5 years as we lived off cheap credit instead of productivity. Saving banks is a complete waste of time. Fannie and Freddie are gone and the rest will follow rapidly. When productivity returns (it’ll take years and the lack of knowledagable people and irrelevant training will hamper things a fair bit), things will come back. No sooner.

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