September 30, 2009
One thing the Lisbon debate has done is distract us from the juggernaut that is NAMA. In Laois today, speaking to a large group of retailers — who can sense the credit crunch in their bottom lines — the only topic was the banks, the bailout and what is going to be left after NAMA.
The feeling in the room was one of outrage, bordering on disgust, and a palpable sense of powerlessness.
One woman, a big retailer from a decent-sized town, told me that watching events unfold was like watching a drama from prison. Because the electoral cycle is five years long, she felt there was nothing she could do to register her dismay at NAMA. There was just no way of signalling her opposition. She told me she wanted to scream “not in my name” but had lost her voice.
As far as she and others were concerned, Lisbon can come and go, but NAMA is where the big mistake is likely to be made. The retailer said she knew the builders in the town that would be bailed out and the bankers who lent to them and were still taking home good salaries and playing golf in the local club as if nothing happened. All the while, she feared her business would really feel the pinch when interest rates turn. Whatever about having precious little credit now she feared that, once rates began to rise, the position of her and many on the main street like her would become impossible.
Others shared her concern. They were worried about their outstanding loans. Many of these are “interest only” affairs, taken out when times were good and provincial towns were booming. Many retailers expanded their shops dramatically not only to respond to demand and the insatiable appetite of my old friend Breakfast Roll man, but also to try and stave off competition from big multiples like Tesco. This expansion leaves them very exposed to interest-rate moves.
With that in mind, let us have a look at the interest-rate cycle in Europe because, Lisbon or no Lisbon, interest rates in Europe will rise progressively over the next year or two. And this could be enough to push many Irish businesses over the edge.
Before we look at the likely trajectory of rates, let us examine how interest rates work differently in different countries in Europe. In Ireland and in the UK, we finance more or less everything at variable and short-term rates. In Germany, they finance at fixed and long-term rates. This means changes in interest rates have much smaller impacts on consumer demand in Germany than they have in Ireland.
When rates are decreased, we party here and when rates rise fast we suffer dramatically. So, in the past year, as the ECB cut rates significantly, we have have been given a significant breather. Many highly indebted companies are just holding on at the moment because rates are so low.
When the rates turn, however, the precarious position of many of us and our companies will become apparent. And the financial markets will factor this in to their equations.
To understand what is likely to happen, take a look at the chart above. It shows the reaction of the US financial markets in the past 12 months to companies that had lots of debt.
Traditionally, these risky companies are asked to pay a premium to investors of about 2pc over US government bonds. This is to cover the investor for the risk that these companies will default. In other words, because they are more risky than government bonds, indebted companies pay more for their borrowings.
Now look what happened last year. When the liquidity crisis broke, companies dependent on short-term financing looked far weaker than they already were. The graph shows the difference between the interest rate on their borrowings and that paid by the US government. At the peak of the crisis, indebted businesses had to pay 5pc more in interest than was paid on government bonds.
We see a dramatically amplified effect on the interest rates weaker companies had to pay in the graph, which caused many of them to go to the wall. But it is the taking over of the banks rather than the trials of indebted businesses that will worry the markets the most.
Investors will be afraid that the capital position of our banks will be eroded, once more, by new bad debts as interest rates rise — but this time from companies and retailers rather than builders. Crucially, this debt will not be in NAMA. Share prices will fall as bad debts mount, and the State may be compelled to act again. In this scenario, it could nationalise the banks — by injecting more capital — or it could preside over zombie banks with neither confident management or shareholders.
This is the vista we face, Lisbon or no Lisbon, and that worry was written on the faces of the people I met yesterday — who sell us our milk and butter late at night, or are there when we’ve forgotten to make the children’s lunch.