August 31, 2008
As the banks sit tight to protect their developer mates, the Central Bank needs to move fast and decisively.
How can a tiny country in a huge monetary union experience a credit crunch? How is such a nonsensical dilemma possible?
This is a question worth posing because the present credit crunch in Ireland is totally unnecessary. It is a function of laziness and a lack of courage by our Central Bank.
Many hundreds of businesses will go bust and many thousands of people will lose their jobs unnecessarily because the Central Bank will not step up to the plate and act. In the US, the Fed is trying to turn things around, yet here, our Central Bank is behaving like a rabbit in the headlights.
The problem in Ireland is monetary in nature and only the monetary authority – the Central Bank – can solve it. It’s a wonder that Brian Cowen tolerates such inactivity from the only institution in the state that can do anything about the present economic crisis.
Let us begin by talking about the European Monetary Union (EMU). The EMU gave us a free lunch. We got the ATM card and the pin number of the pool of savings that resided in Germany. The Germans have been saving for years and, by joining the euro, we could access their savings. Why do you think Irish interest rates came down from 12 per cent to 4 per cent in the late 1990s? It was because, in financial terms, the Irish became German. We gave up our own autonomy for something much more appealing – other people’s money.
The implication was that we would never again want for credit. Because we were so small, we could dip into this huge savings pool to finance our growing economy. In contrast, before the EMU, we had to depend on our own savings to finance our expenditure. Back then, if we spent too much, the national current account would go into deficit.
This would trigger a chain of events. The first warning sign would occur in the Irish currency: its value would fall if the current account deficit got too big as people, expecting a devaluation, tried to get their money into another safer currency, selling punts in the process. To protect the currency, the Central Bank would raise interest rates and this would choke off the excess demand that drove the current account into deficit in the first place. Hey presto, the system righted itself. In so doing, it sent a signal to all of us that there was only so much cash we could spend.
Fast forward ten years and we had no such constraints. We could spend as much German cash as we wanted. Unfortunately, we blew this golden opportunity on bricks and mortar, but our recklessness does not change the logic of the EMU. We still have access to all this money. Furthermore, with interest rates adjusted for inflation now in negative territory, it pays to borrow.
So why is there a credit crunch? The credit crunch exists because, first, we have seen through the scam that was the housing boom and, secondly, the banks are finding it hard to get cash and they have tightened their belts. These two moves set in train the next phase of the credit crunch: the bad debt cycle.
Because Ireland turned itself into one giant pyramid scheme, many purchases were mortgaged against other previous purchases, and all this borrowing was legitimised by the ludicrous valuations given to property. Once property collapsed, the deck of cards came down around it.
Now we have the truly shameful spectacle of the banks protecting their developer mates, while they wait for some government-sponsored bail out. As long as the banks play this silly game of hide-and-seek with their shareholders’ capital – short-changing their shareholders to protect their clients – we will not get over this predicament.
Worse still, imagine that the government is being lobbied to cough up taxpayers’ money in order to hoodwink first-time buyers into the market to bail out millionaire – and, in some cases, billionaire – developers. This is a classic example of socialising losses in the bad times and privatising profits in good times. This is cronyism of the highest order. If the present government accedes to this gombeenism, we might as well turn off the lights.
However, there is a better way forward, which allows us to recapitalise the banks. It would not cost us a penny. Ireland needs ample liquidity to be available to promising non-property related ventures. This will allow us rapidly to switch our emphasis from domestic demand to exports.
Difficult as it is to admit, the banks – which caused the problem – are the single most efficient redistributors of capital and they will need to be part of the solution. In addition, like dogs, they are licensed. The banking licence, like a driving licence, is governed by rules and regulations – break those rules and you lose your licence.
The Central Bank could now show leadership. First, it could institute a massive sale-and-repurchase operation with the banks. The Central Bank could swap the banks’ huge property liabilities at a massive discount that would prevent the Central Bank from exposing itself to downside risk.
In return, the Central Bank would give the banks liquidity to lend. The stipulation is that this new cash must not go to property investment and that strict guidelines be imposed limiting the amount of cash that can be invested in property.
In terms of re-injecting confidence, some of the liquidity could be used to give developers a break in terms of the conditions of their mega-loans, which they clearly can’t repay. However, as they would have been already forced to take a serious discount on their property ‘‘assets’’, the banks would be compelled to share some of the pain with the developers. (After all, they did lend in the first place.)
The main attraction of the scheme is that, by swapping property loans for real cash that could be used for productive investment, Ireland could salvage something from the property boom. We could make good some of our bad behaviour by using property as a financial pulley to lift real industries and companies that are producing real things and adding value.
The beauty of the EMU is that the money isn’t ours. We would be using euro to fund this swap operation, and thus wouldn’t have to put our hands in our own pockets. As it was in the beginning, the cash is German. So we, the Irish taxpayer wouldn’t use a shilling.
At the moment in the US, the Federal Reserve is engaging in a similar operation: governor Ben Bernanke has dramatically increased the Fed’s role in providing liquidity to the system. His critics suggest that all these new dollars will contribute to US inflation.
This might be true. But in the Irish case, as all the recycled cash would be euros, our inflation rate wouldn’t change. Who said we can’t still dine out on a monetary free lunch?
All this takes is a bit of vision from the bankers on Dame Street. If they can’t see this, possibly the Minister for Finance, their boss, should force their hands. Monetary union is a two-way street. While we can’t affect our interest rates, we can engineer liquidity.
The EMU allowed us to be on the offensive in the upswing; it also allows us to be defensive in the downturn. All we have to do is change the tactics – not the strategy. Remember, it’s the Germans’ cash anyway, so we’ve nothing to lose.