September 24, 2008
Once upon a time, in a village, a man showed up and told the villagers that he would buy monkeys at â‚¬10 each. The villagers, aware that the area had plenty of monkeys, went to the forest and started hunting them. The man bought hundreds of monkeys at â‚¬10 each, and the villagers began to slow their efforts.
The man then said he’d pay â‚¬20 for each monkey, and the villagers went hunting again, redoubling their efforts. Soon the monkeys became hard to find, and the villagers began to give up the search. The offer went up to â‚¬25, but the number of remaining monkeys was so small that interest in the hunt petered out. The man then announced he would pay â‚¬50 for each monkey, but since he had to go to a big city on business, his assistant would handle the payments.
While the man was away, the assistant told the villagers, “Look at all these caged monkeys the man bought from you. I can sell them to you for â‚¬35 each, and when he returns he will pay you â‚¬50.
The smart villagers took all their money, others borrowed to take advantage of the offer and bought all monkeys from the assistant. The assistant said he was headed to the city to bring the man back.
They saw neither the man nor the assistant ever again, just hundreds of monkeys all over the place.
This little story outlines what happened in Ireland with our housing and stock markets. We believed the hype, got greedy and thought to ourselves that we could all make money for nothing. We borrowed accordingly and now are stuck with the consequences. Worse still, we borrowed so heavily to buy houses that it is unlikely Irish house prices will, at least in the next decade, reach levels seen in 2006/7. The place now is full of land and houses — like the villagers’ monkeys — that no-one wants nor is willing to pay for.
While this will affect all of us — particularly the younger generation who were duped into buying these expensive houses — the true barometer of our financial calamity is the enfeebled Irish banking system, which needs time.
The problem is time is exactly what we do not have. Events in the past 24 hours are not reassuring. Pessimists would take a look at today’s financial markets and suggest that we are edging closer to meltdown.
Yesterday, the ‘New York Times’ put it succinctly: “The cavalry have arrived, but no-one knows what they are supposed to do”. The cavalry in question is the putative $700bn bailout of the US banks by the Bush administration. The reaction to the plan has been one of horror. RTE reported yesterday that the markets sold off because of fears that the bill wouldn’t be passed. This is not correct. The markets have been frightened by the prospect of the rescue package going through.
Let’s leave the US for a moment and return home where we see that shares in our banks fell in response to Finance Minister Brian Lenihan’s â‚¬100,000 deposit guarantee scheme. Rather than enhancing confidence in the banks, the move is being seen by investors as admitting that there is a problem at the epicentre of the banking system, but not doing enough to solve it. A full guarantee covering all deposits would have been, and still could be, a much more comprehensive option.
Up to last Friday night, Mr Lenihan and his predecessor Brian Cowen were saying that there is no problem in the Irish banking system. Now, with the deposit guarantee scheme, they are implicitly telling us there’s a big problem. If it’s a big problem, let’s do something big to rectify it.
This difficulty is not going to go away. The Irish banks are like mini-versions of the American banks. The difference is one of degree. In America, the debts of the banking system are there for all to see. So when the property market fell, the value of the bank’s exposure to property fell, too. This is called mark-to-market valuations. And it means that the value of any portfolio is assessed against the price at which you could sell those assets in the marketplace today.
In Ireland, the banks are refusing to mark to market their portfolios and exposure to property, so they are pretending to themselves and their auditors that the land they have on their books is still worth the price it was bought for. But this is nonsense. If Irish banks were to value their assets against the price they could get today, they wouldn’t be far away from the fate of their American counterparts.
Both systems are up to their necks in bad debts in the property market. They have no outside funding available to them (except from the ECB) and, most egregiously, no-one appears to be able to tell the truth about the extent of the carnage on their balance sheets. So we got the pathetic bluff from Anglo Irish Bank last week that it was considering taking over Irish Nationwide. Not only do two bad balance sheets not make a good one, but the idea that we can be duped by a bank which is pretending to be a “buyer” when in fact it hasn’t the means, is indicative of an industry that hasn’t woken up to reality.
The blueprint for Irish banks now looks increasingly like Japan in the 1990s. In 1989 the Japanese property market peaked. By late 1992, property prices in central Tokyo had fallen by 60pc from the highs.
Many people in Japan expected the government to shoulder the risk of the banks and thus bad banks were offered a lifeline. It took at least half a decade from the peak for the banks to admit the extent of the problems. This was because the Central Bank in Japan sought to protect, at all costs, the banks and the developers who had become close to the political system in the boom. So instead of marking down loans and starting again with a new sense of purpose, Japan experienced a tortuous period of obfuscation and bluffs, which eventually shattered public confidence.
We need to learn the lessons of this. We can’t afford to do what the US is proposing and set up a similar toxic fund to bail out the Irish banks’ property debts. We don’t have the cash.
However, there is something we can do. By giving a full deposit guarantee now, the State could re-energise creditors’ — both big and small — confidence in our banks. In fact, given what is happening all over the world, a comprehensive guarantee would prompt foreigners to lodge their money in Irish banks. As a member of EMU with the lowest State-debt-to-GDP ratio, Ireland would be ideally placed to offer itself as a financial port in this international storm.