This week, as financial markets recover their balance somewhat, millions of investors are trying to make sense of the past few weeks. Why did bank shares collapse so much? Can any rebound be sustained and what might be around the next corner?
Before we try to answer these questions, it is important to appreciate that we are probably not out of the woods yet. The volatility in markets implies that one piece of bad news can send shares tumbling. On the other hand, a ray of hope is seized upon as a sign that good times are ahead.
Traders are caught in the constant crossfire, reeling from fear to elation. If we block our ears to this din, it is not hard to see that we are now in a new phase and this might last much longer than many expect.
This phase could be described as the great unwinding. All over the world, leveraged bets that were placed in the past five or six years are being unwound and credit is getting not only tighter but in many cases has disappeared altogether.
Many people have been terrified by the suddenness and the magnitude of the downturn and are seeking a plausible explanation of the crisis that doesn’t involve things we’ve never heard of like CDOs, ABSs, monoline insurers and structured products.
One interesting way of looking at the behaviour of financial markets is through the medium of geology. The Earth’s rigid outer shell, the lithosphere, is broken up into an extraordinary mosaic of oceanic and continental plates.
The financial equivalents of the geological mosaics are the many markets which reflect global economic trends such as the stock markets, the commodity markets, housing markets and foreign exchange markets.
In geology, just underneath the lithosphere, there is another layer — a more fluid, plasticky surface, called the asthenosphere. This is the uppermost layer of the Earth’s boiling core, which bubbles away below. Trends in financial markets and global economics, such as bank lending, house prices and immigration, can be compared to this pressure bubbling away under the surface.
Ultimately, when the pressure in the bowels of the Earth gets too intense, the core bubbles and occasionally, where the lithosphere is thin or cracked, it explodes into violent volcanoes. In financial markets, these violent volcanoes can be seen in banking crises, house price booms and busts, large falls in exchange rates and gyrating stock prices.
Normal day-to-day market fluctuations are like the daily grinding of the Earth’s continental plates. So for example, along the 1,200km San Andreas Fault, the Pacific Plate has been grinding horizontally past the North American Plate for 10 million years at an average rate of about 5cm per year (about the same speed as your fingernails grow).
There are about 10 other main fault lines across the globe, so earthquakes both on land and under the sea are relatively easy to locate, but predicting precisely when they will happen is almost impossible.
The crucial thing is that although we can assess the pressure points, we don’t know for sure exactly when and with what intensity the financial markets will erupt.
In times like this, we are living on a financial San Andreas Fault and everyone is worried that the next tremor will be “the big one”.
This is why, despite the Fed’s extraordinary action last week, things remain uncertain. Every rally is followed by a trough and the financial markets lack direction.
Once we accept this, we can begin to try to answer some fundamental questions. Given the centrality of our banking system to our economy, have our banks been permanently weakened by the past few weeks’ convulsions?
Optimists, citing yesterday’s rally, are claiming that there is a great buying opportunity out there and that Irish banks will recover strongly, touching and surpassing the previous heights.
This view is hard to substantiate because the Irish banks are not really banks per se but, for the purpose of this discussion, they are simply large leveraged bets on the inflated property market.
Last September, I was criticised for describing in ‘The Generation Game’ certain Irish banks as nothing but “leveraged hedge funds, betting on property”.
I stick to this contention and believe that the Irish property market — far from being close to the bottom — has never looked weaker.
The reason for this outlook is simple. As the banks pull up the credit drawbridge to try to (a) convince shareholders that they are being prudent, (b) repair their balance sheets, they begin to see that lending to a falling property market is the quickest way of losing money.
House prices in Ireland will continue to fall this year and next and possibly longer. Remember, banks are not heroes.
They are not in the business of bargain hunting. They don’t sniff around the bottom of a market, hoping to catch a turning point. They are now in the preservation, rather than expansion mode.
The negative impact on the housing market of this credit contraction would be bad enough, but it is made worse by the fact that there are so many unsold houses in Ireland. This enormous oversupply of property will take years to unwind.
However, this is good long-term news for all of us. Ireland needs to wean itself off the housing obsession.
Unfortunately for us, the credit crisis hasn’t so much served to wean us off as suddenly rip the teat away, leaving the soft, pampered, milk-fed economy in shock. This shock will be difficult to take in the short-term but will only strengthen us medium-term.
In the past few years, the housing lobby has hijacked the debate in Ireland, forcing people to think that the economy and the housing market were one and the same thing. They are not.
For the rest of the economy to recover, the over-bearing presence of the housing market has to recede.
This will liberate capital for more productive investments. In a world of trade, no country ever got rich through speculation on a fixed asset like land.
I know it doesn’t seem like that now, but the collapse in Irish bank shares — in some cases by as much as 70pc in a year — is a blessing in disguise.
David, as an talented economist you should know that countris like Ireland have absolutely no chance of being a strong economy. The only reason Irland became what it is, is the fact the EU is able to create false economies. False booms. There is a reason why Ireland was always poor… simply because of its location, weather, and poor in minerals…the only advantage is the English language… every economist and businessman on earth knows this…look at Dubai where the pool water has to be cooled down because it gets too warm to swim in…the sand became gold with oil money…but… Read more »
Irish banks can run to the ECB – hedge funds can’t, unless Ben Bernanke’s new concept of central banking gains ground. There were “high fives” in the credit industry after his Bear Stearns operation and the extension of the discount window – was it Omaha Beach, or more of the same old Dunkirk?
The collapse in Irish bank shares is a blessing. No disguise to it – just a plain, simple blessing.
Don’t feel too sorry for the banks as their share prices fall. They will be the real winners over the next 25 years or so. Imagine the profit on each house they make over that period due to the interest they charge. A lot of people actually feel secure knowing that their house has increased in value by say 20% and this is a false feeling of wealth gain. We have to cop on because even if the average mortgage holder could sell, he has to pay capital gains tax (after a certain period) then there is stamp duty on… Read more »
George you are on to something but you are mistaken to say that the Celtic tiger is not real. You see the Celtic Tiger is actually an Irish Fairy, and like all Fairys they only exist for those who believe. These days the little Irish Celtic Tiger fairy is very unhappy and in fact the last time I saw her she kept wincing with little pains. When I asked what was the matter she said that when ever a little boy or girl or anyone else stops believing in her, it sends a little pain through her heart. It is… Read more »
I think you’re both away with the fairies. George, your view of natural resources is stuck in the 19th century. How come Singapore and Hong Kong are succesful economies? Smart governments running their countries like a business can make the difference. Take a look at Tanzania, a country with virtually every natural resource known to man, yet a basket case economy.
While the banks play all sides of the street and use methods which can only be described as twinky to prop the share price, it was always a matter of time before a reckoning. Transactions between branches of the same bank are counted as bottom line and then reported to head office by both, where head office then trade on both reports. One ball, becomes two. While all banks know this happens, and that specie transfer is no longer done with horse and carriage. When a question like we now have occurs it is no wonder that they get a… Read more »
Geology as analogy: When a volcano erupts under the sea, it can send a devastating tsunami which wreaks untold and unexpected destruction……. Does a rising tide [of debt] lift all boats? Or does it smash them to smithereens when it finally reaches landfall? What happens when the 3 month liquidity life-line from The Fed times out? Who’ll repurchase the worthless debt then? The taxpayer presumably. Having foisted ‘credit welfare’ onto sub-prime, American Capital will have to be bailed out again so another bubble can be inflated. Or maybe this is ‘the big one’? Very interesting analysis of Australia for any… Read more »
VoiceOfReason, I agree with you about smart governments which obviously is not the case here in Ireland…but while you mentioned Singapore and Hong Kong you again forgot the strategic location of those countries as I mentioned before…….what is causing the boom in west of Australia?? their natural resources… if Irish government didn’t tell fairitails to their people then the irish would have planty of money to invest in real business and not in rubish built houses for a 40 years morgage…they wouldn’t have to drive their landrover on third world roads..bring their kids to school containers…share a room with 6… Read more »
David, It’s amazing that a large number of people are still hoping beyond hope that there will be a resurgence in the property market and that the party will continue ad infinitum. The party is well and truly over, but the contamination from the casino economy will take some time to cleanse from peoples minds. The next big one is just around the corner and so why bother with real enterprise when so and so made more from the sale of his house than he ever made from a lifetime of work. It’s going to be difficult to come down… Read more »
Everyone knows the Irish economy has mostly been relying on the profits made by the property market. Other healthy profit makers in Ireland besides property developers, contractors, builders and so on … are publicans! Give the Irish people some houses to buy and some booze to drink! The current economic situation in Ireland resembles the start of a long hangover where people, sedated by alcohol, are wondering what is going on. 15 years of partying with no planning for the future. What a mess! Regarding the housing situation, my partner and I have been looking for a house to buy… Read more »
Once a month, the Permanent TSB/ ESRI publishes its House Price Index report. In my opinion it is highly likely that the average person is not going to have an idea of how the price of his house is performing against the indices that are available. At the early stages of a decline, investors/home-owners will probably assume this decline does not effect there particular home, and will in all likely hood probably pay little if any attention. As prices fall, the many who had intended to sell investment properties may be forced to withdraw from the market, preferring to rent… Read more »
It’s amazing that a large number of people are still hoping beyond hope that there will be a resurgence in the property market and that the party will continue ad infinitum. The party is well and truly over, but the contamination from the casino economy will take some time to cleanse from peoples minds. The next big one is just around the corner and so why bother with real enterprise when so and so made more from the sale of his house than he ever made from a lifetime of work. It’s going to be difficult to come down from… Read more »
Someone here mentioned the other day that someone had mentioned Will Hutton. That was me, twice, and now it’s three as I finally finished his book (The World We’re In) last night. I wouldn’t like to spoil the ending for anyone but it’s pretty much what we are facing right now. But we all knew that anyway didn’t we, despite what they told us (present company excepted). Very persuasive, although I admit I’m easily persuaded. Now, where were we? Ah yes, the banks and the financial system. These are merely a utility and should accordingly be subject to proper regulation… Read more »
“There is a reason why Ireland was always poor… simply because of its location, weather, and poor in minerals…the only advantage is the English language… every economist and businessman on earth knows this” an excellent article david, i have to strongly disagree with george’s article above, many rich countries around the world have alot less natural resources than ireland, holland, britain,germany, in fact most of europe, ireland per capita is actually fairly rich in natural resources, water, agricricultural land, huge coastline and territorial waters, zimbabwe is rich in natural resources yet is now one of the poorest countries in the… Read more »
A reccession is needed to keep our heads on our shoulders, sadly this is a wake up call that should have put us down to earth years ago, instead of now when our own greed became more inflated.
We just have to get back to normal and learn this lesson by being more responsible, people had been living lives they had no hope of sustaining.
It’ll take time but we’ll be OK, this isn’t the famine and we made it out of that.
I like geological analogies, but the shake-up of irish banks is just on the scale of that earthquake in England last month, compared with the San Francisco scale quake that is coming. Data on the five-fold growth of derivatives to $516 trillion in five years comes from the most recent survey by the Bank of International Settlements, the world’s clearinghouse for central banks in Basel, Switzerland. U.S. annual gross domestic product is about $15 trillion U.S. money supply is also about $15 trillion Current proposed U.S. federal budget is $3 trillion U.S. government’s maximum legal debt is $9 trillion U.S.… Read more »
‘Bank shares collapse is a blessing in disguise’, I hope so, as I just want to buy a a 3 bed house in south Dublin city, for under â‚¬300,000. I think it is only time and patience and I can achieve my goal. The past 12 years have been mad, that is â‚¬300,000 for a house should be the normal amount. Our kids won’t be able to afford a house if the prices don’t correct them selves, so if not now, in the future prices will fall as we have a market economy.
As usual, a good analysis, but I wonder why you didn’t mention the new element, that the banks now know that almost anything they do is covered by a bail-out. In a ‘normal’ market economy mistakes of the magnitude of those made by banks in the last few years would led to their demise. In fact only one, Bear Sterns, has gone, in one sense, but in fact has been rescued by being bought out with a Fed guarantee.
As a result I think that banks will continue to act irresponsibly with impunity.
+1 barry, but the only thing that can stop this from happening is the threat of jail for directors/CEO’s
Fair play to the US, Conrad Black and that Enron guy are behind bars…., I hope that bankers concern for their personal liberty will moderate their actions. …. Full steam ahead here though, we’d probably organise a tribunal and pay their costs!!
Not sure I entirely agree with the commentator about the lack of natural resources. I visited that cliffs of moher recently and the scenery along with the new centre were fantastic. I have always thought that with our lack of oil, minerals etc we should carefully develop our tourist resources. The house boom had to end, it was becoming a giant parasite sucking the life out of everything else. Ten years from now will be an interesting time to judge the developers, banks and their political servants who aided their grubby work. Yeats ‘Fumblers in a greasy till’ is looking… Read more »
Natural resources are not that important in the present age, ingenuity and application are far more valuable, as Japan proved a few decades ago. It’s a sham, however, that they fell for the property illusion – the Achilles heel of success – after such a spectacular rise. I was always fascinated by the way they expanded their economy using technology to enable grandparents of rice farmers to work at home. They developed miniature robots for operation in homes for the production small electronic assemblies for the consumer market. Millions of these assembles were required each year by the big companies… Read more »
Ed, your last sentence is almost a text-book definition of economics, why doesen’t somebody tell the government! Don’t forget one of our factors of production ‘labour’ has been detrimental in this equation. Multiple pay rises, union troubles and strikes leading to even more pay rises has pushed up inflation and house prices. Labour IS the demand so with their increased purchasing power they went on a binge for years, the banks took full advantage of it and the rest as they say is history-oops and the present of course, and maybe a miserable future for some!
Whilst the short term for Irish property does not look good as per discussions above, has anybody thought of the effects that global warming is meant to have on humanity? With a scarcity of basic human requirements of food and water, countries geographically positioned like Ireland in 20 years from now will apparently be more desireable places to live from a primative survival perspective.In the long term our houses should be filled with an increased demand. Who fills them is another debate!
“Don’t forget one of our factors of production ‘labour’ has been detrimental in this equation. Multiple pay rises, union troubles and strikes leading to even more pay rises has pushed up inflation and house prices. ” That may have been true in the non-traded sector but for non-unionised workers in the private sector the competition with immigration, and outsourcing has not increased their wages commensurately with house prices. Far from it. Inflation in Ireland is not wage driven. House prices were driven by the herd mentality, and the cheaper credit available, albeit over 40 years. ( And Strikes?) In any… Read more »
Due to over inflated prices on property market created by pure speculation, no one can argue, and a low tax regime on multinational enterprises establishing themselves in Ireland, we eventually reached a stage where all salaries and cost of living are higher than european average, inflation. We are out of sync. Shares are going down, good. Price of property are going down, good. What is next? Easy. Salaries, not good. Either because it will not be possible for companies (providing they stay in Ireland…) to sustain the higher than average Irish salaries, (necessary if you want to survive in a… Read more »
Totally agree with your article David. A little bit (or a lot of pain, depending on how gullible one was) will hone character and make us great again. Its a necessary evil after a binge. George, how can you believe that Ireland lacks in natural mineral resources (it doesn’t, please do your homework more carefully) and how can you state that Ireland has no oil (and gas) resources? It does; and in fact sizeable ones at that. Some further research on the Irish chronology of licencing, finds and current exploration rights of multinationals might correct your opinion George as to… Read more »
If loan sharks don’t get paid back, they beat you up. If banks don’t get paid back, they take your house away from you. I would rather be beaten up than made homeless. What’s my point? Well, I always thought that mortgage lending in Ireland should be better regulated as US officials have proposed:
Hmmm, my house or my knee caps………tough question. In any case John Q. is on the ball here with regard to regulation. First off there is the question of whether the housing market should be regulated since unlike many other commodities there is no alternative (i.e. if the price of pasta rockets you can switch to spuds,…., not so with housing). Surely the boom bust cycle is not a good thing and the people who got in late, often the more productive members of society, are shafted. A second and more general question is should private debt be regulated better.… Read more »