Closed BankWe are now in a bad-debt cycle, where a credit crunch is exposing reckless loans that will never be paid back. Make no mistake, millions of euros in loans will never be honoured.

An “Irish” bank has already gone under this week. Merrill Lynch, founded by two Irish Americans — Charles Merrill and Ed Lynch in 1915 — was known as the “Irish Bank” on Wall Street. On Sunday, Merrill Lynch — the bank that had such a network of brokers that when it started selling or buying an asset, it was called the “thundering herd” — ceased to exist. The bank was bought by Bank of America to avoid possible bankruptcy.

Irish Americans have long been associated with Wall Street and financial speculation. In the 1920s, when Merrill Lynch began to prosper, outsiders like the Irish and the Jews, who were not accepted by the WASP establishment, constituted leading cliques of speculators. Irish operators like Charles Mitchell, Mike Meehan, Bernard Smith and, of course, Joe Kennedy, cornered many markets and made fortunes. These men came from nothing and they conformed to the phrase that “he who values not his neck, because he is conscious it is worth nothing, may take the boldest leap”.

Maybe our collective recklessness in the past few years can be put down to something similar. We got access to cheap credit for the first time ever and we went for it. Many companies who have set up here have noted this weakness for speculation as a positive point. When asked, many managers of foreign companies suggest that the Irish willingness to take a risk and to gamble marks us out from some of our more prudent neighbours.

However, like some of the great Irish Wall Street speculators, when assets fall in value, the game changes dramatically. Tragically, Charles Mitchell ended up in jail for tax evasion in 1934, while Mike Meehan was committed to a lunatic asylum in 1936.

While these men fell spectacularly, everywhere in America people’s circumstances changed. Most significantly, in the 1930s, banks failed and failed stunningly. And this brings us to the question on everyone’s lips: what will happen here and what can be done to prevent an implosion of the Irish banking system?

The first myth to dispense with is the idea that Ireland is in some way different. When house prices were going through the roof, practically every economist in Ireland bought (at least publicly) into the canard that Ireland was different. Yarns were spun wholesale, such as we had better population growth, less debt, more immigrants, less houses.

We now know that Ireland is not different. We are the same as every other country. In recent days I have heard commentators suggest that Ireland does not have a subprime crisis and, therefore, have less severe financial problems. This is clearly nonsense.

If you believe lending people money to buy starter homes valued at 14 times the average income is not inviting a financial calamity, then you should stop reading now. If, on the other hand, you believe that we are facing a real crisis, then we must map out what form that crisis will take and how it can be minimised?

We are now in a bad-debt cycle, where a credit crunch is exposing reckless loans that will never be paid back. Make no mistake, millions of euros in loans will never be honoured.

So will an Irish bank go under? If Lehman Brothers can go bust and Merrill Lynch can be swallowed up, there is little doubt this can happen here.

Yesterday, Irish banks lost another huge chunk of their value on stock markets. This is likely to continue over the course of the next few days because the financial markets do not believe the gamble that Hank Paulson, the US treasury secretary, took over Lehman Bros this weekend.

This market reaction is important to appreciate. Mr Paulson thought that by letting Lehman Bros go to the wall he could draw a line in the sand. He gambled that the financial markets would react by thinking: “ok, Lehman was very badly run but that was one bank and now that the authorities are not going to bail banks out, the financial community will have to sort its own act out”.

Had this gamble worked, stock markets would have rallied as the market distinguished between “good” and “bad” banks. Instead, they have all tanked and they are likely to fall yet further. Indeed, next weekend could easily see another huge failure because the markets are now targeting vulnerable giants by the hour.

Residential Mortgage Debt

With that in mind, let’s come back home to the Irish banks. Our banks are no different from US banks. The only issue is one of degree. Very soon, Ireland will be faced with the same crisis as Wall Street. The reason is simple; we are a superannuated version of America. If you look at the numbers, our situation is actually worse.

Check out the chart. It reveals that residential mortgages in Ireland have risen by 522pc in nine years. In the US, the figure is only a 102pc increase, meaning we have got into debt five times faster that the US — where the situation is supposed to be diabolically unique!

Put simply, we are looking into the precipice. However, there is a solution. The first should be a shotgun marriage between two of our banks. For example (and in no particular order as this could be any of them), Bank of Ireland and AIB should be urged to take over one of the smaller banks. The objective of this is the same as the Merrill Lynch takeover — it is to shore up the balance sheet of the weaker banks before everything unravels. This marriage should be forced by the Central Bank to save the system.

At the same time, the Central Bank needs to go around Europe with a “Bank for Sale” sign and entice in a big player to take over one of our bigger banks if necessary.

In addition, and as part of a merger deal, the Central Bank should stop acting macho and provide as much credit to the banking system as it needs. This means that banks have to make public just how much money they need. At the moment, the banks are playing chicken with the market, pretending that they don’t need to go the Central Bank for money.

If we don’t see these moves quickly, there will be serious trouble. It is highly likely that a bank will go bust and the entire financial system could come crashing down. Let’s not wait for this. Let’s not repeat the mistakes of our Irish American cousins. We can act now and do it decisively.

 

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