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.
Now there is an idea. But the banks would need to look like one of those dressage ponies. Because a bit like FF they tend to play in all the pools, and they are certain to drain from one to the other.
Points for :- ———– – Nice quick hit to asset values – Immediate return to credit flow – Losses correctly borne by those who should bear – shoddy lenders and asset holders Challenges- ————- – Traditionally banks look for collateral when lending – i.e. property – If business investment loans become the credit growth vehicle – then banks will charge a premium for unsecuritised loans Overall ——– I would like to see David include investment in private medical, infrastructure and education investment in his definition of “exports” / business. This would have an exponential effect of reducing the requirement for… Read more »
I have to say I am mightly confused about this so-called ‘credit crunch’. Fair enough, I dont run a business so I cant call it one way or another about lending from banks, but from a personal perspective the banks are still offering huge blood-sucking mortgages to many who would like one. Perhaps they have disshelved the 100% mortgage, but big deal, 95%, or 90% mortgages on over-inflated property prices still points to wreckless lending – I thought there was supposed to be a liquidity problem?
The mega devs and the banks will weasel out of this whilst the heavily mortgaged punters have a forty year mortgage sentence.
Is this to be the actual price of economic correction?
Interesting idea david ( as always) – it’s interesting to see the policy responses from the Federal reserve and compare them to our own central bank. The Fed has pumped the banking system with liquidity and also saved a few banks in the process and are also looking at ways of preventing this whole debacle from happening again in the future. So they are acting in a tactical and strategic way. and our central bank ? – Mr. Hurley and all the other overpaid administrators are as usual doing……..yep you got it, they’re doing nowt. No policy repsonses to the… Read more »
Fascinating piece, David. Do you think you could explain?
> 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.
I don’t understand how this part would work. By “huge property liabilities” do you mean foreclosures on their books or the banks’ own property portfolio?
What would the German’s opinion of this be? Could we blame them if they took a very dim view of your shyster scheme .. and some time down the road, decide to look after ‘numero uno’ ?
Nice one David. And we are probably small enough to get away with it. We just need a few DMcWs in the CBank and Gov and we’re sorted. We now will ask banks to move from exchanging money for appreciating securities and charging interest to being venture capitalists – working the 20:1 success rule and taking a share in the buiz – was that not something that did in Japan. As company shares climbed, so did Banks own value and the rest is history – at first very very very good for about 20 years and now stagnation for the… Read more »
“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.” David, this article is a great suggestion and if ‘implemented’ could promote Ireland to be the ‘leader’ in financing businesses selling ‘products and services’ into international markets. No point in having all these new commercial properties if we don’t have a demand from ‘productive’ businesses. There are risks the ‘liquidity’ will be used to just buy more properties. Also it would be hard to change many lenders appetite for property backed loans, as they… Read more »
David’s scheme would only pay dividents for the moribund economy if the banks and the builders were forced- as part of the Central Bank cash top up-to place their unsellable properties on sale immediately, at revised highly realistic prices.i.e.at least 40% off the current asking prices. This is unlikely to happen and such a scheme/bailout as David proposes -like the American government’s Freddie Mac bale out some years past- would only postpone the day of reckoning for irish banks and developers, unless the price fall was a strict condition of the whole deal. The American taxpayer now pays twice, for… Read more »
I very much question the idea of giving large developers a break. We have the capacity to build 90000 units a year yet we only need a third of this.The construction sector is too bloated. If we keep credit flowing into these developers the market will not restructure. Insolvent companies should shed workers and loose their market share, have their assets should be liquidated etc… Only the better developers should emerge at the other end of all this. If we keep a load of developers on life support, it will discourage investment and healthy firms from entering the market. I… Read more »
Can the big Irish developers really not repay the mega-loans? They’re investing big bucks outside the EU in places like Russia and China. And how would they be affected by (or better how could they be made to contribute to) your idea, David?
I am confused… According to last Saturday’s ITimes, mortgage growth is at lowest in 21 years of 964Millon for July 08. Did I read that right? Level of Credit card debt is 1.3bn! exceeding the new spend of 1.2bn…clearly, money is flowing. Debt is down in June by over 1% Private sector credit up by nearly 1% by 3.3bn! Total lending to non-Gov residents is nearly 400Bn…Annual growth rate in lending declined to 4.6 in 2Q08 for construction sector…it is still growing by 4.6%…not falling. So Construction is actually expanding in spite of all the talk – maybe not in… Read more »
Again David you have raised some valid points here, unfortunately our Current incumbents in charge while they like taking their trips to the USA they never open their eyes to what is going on. As for our Central Bank making a decisive move , well all you have to do is look at it’s board of directors to get your answers. Ireland politically today with the level of cronyism within the corridors of power they are only interested in lining their own pockets we are no better than Romain twenty years ago ,instead of looking at Our Country as a… Read more »
Hi David, Well, the Central Bank may seem to be inactive to a certain degree, but it is, along with the ECB, providing windows of liquidity. The problem that many of the banks have is that the loans that they have already given out are falling in terms of the assets that are backing them up. Yes, we all know this. That is ‘okay’, if the loaners can keep repaying the loans back but due to property activity slowdown (commercial and residential across many markets in the EU, US, etc), keeping those payments up is proving difficult. Many loaners have… Read more »
David, Interesting article, you are to be applauded for trying to find a solution to the current liquidity impass. But (isn’t there always one) I do wonder how practical, or necessary, the suggested stipulation that the newly introduced cash must not go to property investment is. The current property market decline is part of the economic cycle that effect all ‘free’ market commodities. A first year economic student could have predicted the current problems, but short-termism amongst the ‘power-that-be’ allowed the bubble to inflate beyond sustainable levels. So if they easy money is gone, for the time being, from the… Read more »
could everybody please stop using the phrase ” first year economic student could have ……..” its getting old ..
David: I have always been rather skeptical of the theory you advanced in ‘The Pope’s Children’ that Irish mortgage debt was being financed with Real Money saved by elderly and industrious Germans. An alternative interpretation is a bit more complicated so please bear with me. It suggests that the banks sliced and diced the mortgage repayment streams, then compressed them, like canned spam, into Bonds that could be rated Aaa. That’s where the fun started. Cautious types who purchased these bonds also bought Credit Default Swap derivatives that insured them against default on their bonds. And here’s the ugly truth.… Read more »
Sorry if my choice of phrase caused offence or affronted you.
I shall endeavour in future to avoid it, and instead at all times use my father’s rather more vernacular ‘A dog with a mallet up it’s ar** could have…..’
Hope this helps to alleviate your concerns.
Lorcan Roche Kelly
The european Central bank has too much power; with the current climate, I’m not sure they will be able to put any plans in place to combat a continent that has a mountain of problems on its doorsteps…….. not to mention financial.
Ireland is in way too much debt compared to the likes of France, Germany and Britian who are only just swimming above the deep end & carrying alot of heavy baggage.
The Great Depression occured when the US was in a Surplus, god only knows what is in stall for us.
David has made a freudian slip. What he calls “property liabilities” are actually classed as assets on the banks’ balance sheets. They are only looking like liabilities because they have slipped so much in value. I feel that David may be wrong in suggesting that there is too little liquidity in the Irish banking system. It may seem like it, but that is because we have grown used to an abundance of cheap and easy credit over the last ten years. Compared with how it was in Ireland in the 1980s it is now extremely easy to obtain credit. The… Read more »
How much of this ‘credit crunch’ is really a crunch. As Philip has noted, there is still year on year GROWTH in lending. Growth in mortgages is at a 21 year low, not actual value – even compared with 2007, there is growth. What has happened is that some people have realised that property cannot always be an appreciating asset and that residential buildings have been overvalued. Factories are laying off people in Ireland because people can employed more cheaply in Poland, Romania, China, Bangladesh etc. Part of the reason for that is because of inflated public services (requiring more… Read more »
Liquidity has been pumped in to the system – by the ECB. Around Christmas it amounted to â‚¬400b. In fact, the ECB was better prepared than the Fed, who had to invent an alphabet soup of programs to extend the authority to provide that liquidity in the US. The problem they all find is that they can’t force the lenders to lend – much of that funding has gone either in to the blackhole that many banks have on their balance sheets or in to commodities. Now the ECB is calling in to question the worth of many assets that… Read more »
Given that it is possible for a government to encourage bank lending to companies, via a loan guarantee scheme, for example, the next question is what would happen? My immediate response is to put my head in my hands and weep at the rip-offs that would occur. With the banks being actively encouraged by the government to lend, companies that were just enough more than paper to get a loan, would spring up like a desert after a once-in-10-year rain. So many would disappear as quickly. Venture funding is very difficult. VCs are often seen as the enemy, by start-ups,… Read more »
Hi I think Lorcan, Philip and Fergal make good posts. By and large the economy is heading for minimal growth (1-1.5%) for the year, it could possibly retract but this is widely expected as a short-term or at least until mid 2010. The construction industry is, as with property prices, going through a ‘correction’. But surely this is a good thing!?!?! Commentators, including David, have been chanting the unsustainability of the growth in the construction industry for years – and he/they were correct in doing so. But we are now where we are, and I for one think it is… Read more »
Malcolm> derivatives which now amount worldwide to $62 Trillion This is a critical and missing piece of information from most people’s radars. Its the elephant in the room, to borrow a phrase, but for many/all it is an invisible elephant, the exact size of which we do not know. The global financial system is based on debt. Debt that will in some time be paid off. We live for now, and generations will pay for it in the future if we dont. I have two fears with the global model of increasing debt. The 1st is that trust may at… Read more »
So there is a credit crunch and there isn’t one, it depends on how you look at it. Malcom and MK, you are after making me feel more than a little uneasy. Can we compare this derivatives wheeze to mad cow disease which resulted from feeding animals with the carcasses of their dead relatives? Luckily Armageddon was avoided (so far) and let’s hope for the best here too. No wonder nobody was keeping these lads in check when nobody knew what was going on. I’m not quite sure whether I should be pleased or disappointed. Is that how you’re supposed… Read more »
MK & Malcolm McClure, I think you guys have hit it on the head. The current “crunch” is just a current play is what is essentially a trust system. The ECB, Fed etc all depend on it. This hassle we are experiencing now is really about people loosing trust. Whether this minor tear in the fabric of the global financial systems evolves into a major rip really depends on how the rest of the world will respond over the coming year. Metaphors abound here. Then Fergal comes in and for me underlines what is really happening…too many people’s job security… Read more »
Philip > Maybe some innovation in Economics is needed. Innovation during a crisis is fraught with dangers. But we find ourselves in a situation where Friedman’s economic ideas, as implemented, are failing. So where do we turn? Band-aid solutions, like those being implemented by Ben Bernanke in the Fed, are short-termist both in their thinking and effects. They are implemented to protect the current system, and as such are limited by the system. As Philip says, since the end of the gold standard, all international trade is completed on trust. Our currencies are ‘Fiat’ money. It’s is only worth what… Read more »
We’re on the verge of a systemic banking crisis. Lets be frank. The options are very simple. Either you nationalise the banks now or you nationalise the mortgages, When you have a systemic financial crisis, there is always a government bailout.
“Red”Joe HigginsÂ´s assessment of it all back in the Dail, before he lost his seat , was not too far off the mark.
Global debt, the majority of which is actually gambling debt accumulated through speculation on questionable financial instruments like cds’s, is several orders of magnitude beyond global GDP which is about 50 trillion. In all practicality this debt can never be payed. The global financial system is bankrupt and dead. Trying to revive it by the printing of paper money by central bankers only serves to create hyper inflation, destroy wages and savings and undermine the currencies. The only real solution is a bankruptcy reorganization on an international scale in which the gambling debts are written and the useful ones are… Read more »
Real interest rates are in negative territory already but banks are not lending as freely and people are not prepared to borrow as much as before. The Greenspan “put” worked a charm in a benign inflationary environment but it appears that the game is up. Advocating for the preservation of over inflated asset prices is reminiscent of the price controls of the 30’s. These unwise market manipulations turned a recession into a depression then. What happened to the Reganomic free market fervour of the eighties. Seems like it is was not all it seemed, perhaps it was not as free… Read more »
I am inclined to agree with “JohnnieG” While the Euro is a common currency,the average housewife can not do her shopping every day in a French or German, or Austrian branch of Lidl or Aldi where she would find savings at the checkout of about 40% on her irish bill. Even these supermarkets have to pass on irish costs in an inflation riddled economy. Then again Fianna Fail never learned the new economic concept of a common currency situation. Their tax Revenues, remember, thrive on rising prices-and wages.! Its a kind of dog chasing its own tail situation, and if… Read more »
David, I have not heard you criticise your friends in the central bank yet? Surely the head of Irish central bank must take some blame? He gets paid more than Bernanke , Trichet and Darling despite have little or no power or responsibility, doesnt have to set rates or fight currency speculators. The central bank too late rose reserve ratios when house prices had already started to fall, why didnt the implement credit restrictions earlier. Please address this question for me.
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