Central Bank must finally show leadership in the face of crisis

The crisis in Ireland is monetary, and the bank has to assess what needs to be done and tell the truth.

This weekend, Rupert Murdoch was door-stepped by a bunch of journalists. Speaking off the cuff into a sea of microphone heads, the veteran media mogul summed up, with clarity and directness, what he saw as the problem facing the world economy.

He said that the average western family was affected by rising food and fuel prices, eroding their monthly income, at a time when their wages couldn’t rise because of the competitive pressures from China and India.

Succinctly and with little fuss, Murdoch concluded that, as a result, he was extremely ‘‘bearish’’ for our prospects over the next few years. He pointed out that 100 million people a year clawing their way out of poverty around the globe, meant that the demand for food, shelter and energy would continue to rise, putting huge price pressures on western families for the foreseeable future.

In a nutshell, Murdoch summed up the Malthusian dilemma that the world faces: the more people wanting to use resources, the more expensive those resources become. We have seen this played out in our rate of inflation, which hit 5 per cent last month. These pressures are not new and, in fact, they have been building over the past few years.

However, in an effort to avoid the inevitable, Ireland and many other countries postponed the day of reckoning by borrowing other people’s money where we could get our hands on it.

One of the basic rules of economics is that, if we want to increase our income in the face of rising costs, we all have to increase our productivity, implying that we have to work harder or smarter. Over the long term, there is no substitute for this.

We in Ireland thought that we had invented away around this inevitability by borrowing against inflated houses. We put our hearts and souls into this scam, becoming one of the most indebted nations on earth in the process. We realised that our income couldn’t sustain our lifestyle so, instead of reining in, we splurged.

The main architects of this shaky edifice were the Irish banks, and its structural engineer was the Central Bank.

But the problem with borrowing is that there always has to be a lender to lend to keep the entire structure from crumbling. The willingness of a lender to lend is predicated on the lender having cash to lend.

This cash comes from us paying back promptly while those others, who are not involved in the pyramid scheme, lend to the banks in the secure knowledge that they will be paid back at a higher rate than they can get elsewhere. Unfortunately, that final part of the equation began to unravel late last year.

What began as a trickle has become a torrent. Now the prospect of bad debts shunting on from one exposed sector to another is upon us. We have seen this in the US, where defaults in the mortgage market gradually gave way to defaults on credit cards, car and holiday loans, plus the various ‘buy now, pay later’ scams orchestrated by sellers of all sorts. Many commentators suggest that the situation is not as bad in Ireland as it is in the US. This is absolutely not true.

In the ten years from1996 to 2006, Irish residential mortgage debt rose by 522 per cent per capita; in the US, the same debt rose by 103 per cent. In terms of new debt, we are five times more exposed than our American cousins. The same shunting bad debt cycle will happen in Ireland, make no mistake about it.

The crisis is so significant in the US that the Bush administration is worried about the solvency of America’s two huge mortgage companies, known as Freddie Mac and Fannie Mae. This would have been unthinkable only a few weeks ago.

As the New York Times put it last Friday: ‘‘Fannie Mae and Freddie Mac are so big – they own or guarantee roughly half of the nation’s $12 trillion mortgage market – that the thought that they might falter once seemed unimaginable.” Well, unfortunately, the time has come to think the unthinkable.

Rupert Murdoch believes that this time has come, so does George Soros and the myriad of market players who have been selling Irish banks stocks in the past days and weeks. Put simply, the game is up and no one really knows where fair value for the Irish banks is or what toxic waste is now piling up on their balance sheets.

This is why the news last Friday that the Central Bank of Ireland gave Irish banks the thumbs up, while not surprising, is depressing. The Central Bank and the Financial Regulator have a vested interest in saying that Irish banks are fine, because it was they who presided over the scam.

During the boom, for month after month, the Central Bank produced figures telling us that credit growth was roaring ahead. At the same time, it was saying that it was happy that Irish banks were not in breach of mortgage guidelines. To return to a phrase used in last week’s column: ‘‘Don’t piss down my back and tell me it’s raining.”

The canard of Irish finance is that the very institution that has most to lose by saying we have a problem in the banking system is the one asked to assess whether there is a problem. Of course such an institution was going to say that everything was fine, in the same way it failed to blow the whistle on the banks’ role in actively defrauding the state during the Dirt scandal in the 1980s and 1990s.Did anyone resign over that lamentable story? In the boys’ club that is Irish banking, no one does anything so honourable.

As is the way in democracies, all the fingers are now pointing at Brian Cowen, but when you examine the Irish story, you see that the politicians were let down by their first line of defence – the Central Bank. The crisis in Ireland is monetary in nature and the people who were charged with overseeing this are working in Dame Street, not Kildare Street.

What we need now is someone with the clarity of Murdoch to assess what needs to be done and to tell the truth. In the US, the Fed chief, Ben Bernanke, orchestrated the takeover of Bear Stearns by JP Morgan to prevent further systemic problems. Should someone in power be looking at doing something similar here?

The markets need actions – not words – from financial guardians.

Take, for example, Irish Life and Permanent, Ireland’s largest mortgage provider. An analysis by Davy stockbrokers suggested the financial markets were placing a negative valuation on its mortgage business, with its value on the market reflecting its life assurance business. Other lenders are also feeling the heat.

Now if you believe that there will be some recovery in Ireland and that most of us will payback these debts at some stage, then when the banks finally concede that they do need fresh capital, someone will be willing to invest in the banking system.

Why is the Central Bank not following the Fed’s example and looking at brokering possible deals involving the Irish banks – and maybe consortiums of international banks? This would achieve two objectives: it would inject fresh capital and stability into the banking sector and it would send out a signal that we are in responsible hands, with those in power thinking about the future.

When it’s clear that the dilemma as outlined by Murdoch implies falling living standards for the next few years, the country needs its institutions to be strong, to show leadership and to reveal a modicum of integrity in the face of adversity.

Instead, when the dogs on the street know that the banks – the very heart of the capitalist economy – are in trouble, we get self-regarding platitudes aimed at protecting those responsible.