If the two biggest American mortgage banks can go bust and be bailed out by the US government, could the same happen here? When the US government intervened to save Freddie Mac and Fanny Mae on Monday, it put the world on notice. We are now in a new era where our banks are the single biggest weakness in the economy and the State (meaning the taxpayer) will be expected to save them.
The developments in America have serious implications for Ireland. If anything, our property boom was more ridiculous than that of the US. So the obvious question now is whether one of our banks might go bust. It could happen, but is it probable? We don’t know; but if it wasn’t a possibility, why has the share price of Irish banks fallen 60pc in the past year?
The reason share prices have collapsed is that investors are afraid their money will disappear. Like the rest of us, they don’t believe the banks’ management. They have lost faith in the business model and they are not going to risk their money. Internationally, some senior managers of banks have been exposed as frauds, who seemed to be totally out of touch with what was going on in the banks they were supposed to be running.
They constantly underestimated the losses they were facing and when they did finally acknowledge malpractice (well after shareholders lost their shirts), it was too late. Now no one believes anything stated by banks.
As Bill Gross, of Pimco — one of the biggest investors in the US — said recently, the question today for investors is not “return on capital”, it is “return of capital”. So if the professionals are worried about the Irish banks, shouldn’t you be too?
We are in a new epoch, where it is necessary to think the unthinkable. It is only by questioning the spin, hype and lies of vested interests that we can arrive at something close to the truth.
At the moment the vested interests are circling the wagons and dismissing any concerns about the viability of Irish banks as wild speculation. They did the same three or four years ago when a few questioned the sustainability of the housing boom. Back then, those of us who said that the housing market would collapse were ridiculed and branded traitors, extremists and unpatriotic.
It is important to appreciate that what was branded extreme last year is now mainstream. Consensus-thinking has moved dramatically. It is now commonplace to hear ‘experts’, who last year were saying that the Irish fundamentals were strong, now claiming that we are in for a protracted recession.
The lesson of the past year is that the experts actually “know nothing” and therefore, you have to trust your own instinct and analysis. It’s your money after all, and if it disappears no one will cry for you.
So with that in mind, let us analyse the Irish banks. At the moment, for some reason best known to themselves, the experts are telling us that the banks are in decent shape. Last Saturday, I mentioned the possible weakness of the banks during ‘Saturday View’ on RTE1 radio. The Minister for Finance reacted to this reasonable concern by saying such talk was “dangerous”. Now I can understand the minister’s position, but suggesting that questioning the establishment is dangerous means that we have not learnt anything. Years ago, questioning the housing mania was also described as dangerous. When the establishment tries to muzzle questioning, you know we are in three monkeys territory — hear no evil, see no evil, speak no evil.
But back in the real world, we know that the banks are tightening their belts. They are not lending. The Central Bank’s monthly figures on total lending in the economy show that bank lending has fallen off a cliff. So what are the implications of this macro trend for individual banks?
Banks work in a very simple way. Typically, for every €1m in capital they have, they can lend out €10m. The profit is the difference in the cost of capital and money they borrow to lend and the interest rate they charge. If a bank is paying 4pc for your money and charging 8pc, it is making 4pc times €10m — a gross profit of €400,000. That is a whopping 40pc return on invested capital.
Of course, they have to be able to take some losses. If they had a €500,000 loan go bad, that would have eaten up all their profits and dipped into their capital. Now they would only have €900,000 in capital. That means the bank could only make €9m in loans. Either the bank will have to raise more capital from investors or reduce its loan portfolio, in addition to writing off the bad loan.
It’s easy to see how bad loans and defaults can rapidly turn a ‘strong’ bank into a ‘weak’ one. To keep lending, the bank has to go back and ask its investors for more money. However, as share prices have been falling, investors are reticent to lend to the banks.
In tandem, as house prices fall further, and unemployment rises, the bad debts in the banks will increase exponentially.
Thus, the bank in a downturn is caught between a rapidly deteriorating balance sheet and an inability to raise money. The bank still has to pay out interest on its deposits, but if it’s not earning interest on loans because they are being reneged on, it can’t pay deposits without raising more money from shareholders.
Like so many aspects of finance, the game is a confidence trick. If that confidence evaporates, as it has done in the US, depositors naturally get worried.
To make matters worse in Ireland, we know that at the height of the boom, the Irish banks were borrowing close to 50pc of their financing needs, not from depositors like you and me, but from overseas investors.
These loans have to be paid back too. Therefore, as the economy slides, the Irish depositor is in competition with the foreign investor as to who will get their money back first. This is when the crisis becomes a reality.
Who can say that over the next two years, this will not happen in Ireland? If it happened in the US this week, only a monkey can rule out the same here.
David where do we put our savings if they are not safe in the banks…Help!!
Lets all rush to the bank and withdraw everything!
John, under european regulation, your savings are ‘safe’ up to €20,000 whatever happens your bank. If you have decided to invest in banks shares, there will be no protection for you. Unlikely as it is for an major Irish bank to collapse, it is unthinkable for the Irish government/central bank to allow it to happen. Fannie and Freddie are just the latest in a growing list of bank bail-outs. Northern Rock in the UK, and more recently Roskilde in Denmark have also been saved when the chips were down. So, if it’s needed, it will happen here. We may not… Read more »
how much does the state guarantee in a bank account if a bank goes tits up ?
in the UK they up’d it to 35,000 last october in light of northern rock
I am just guessing that there could be runs on BoI/AIB in the near future
Hi David, Yes, the Fannie Mae and Freddie Mac bailouts show to some extent how bad things have become in the US system. We must remember however that both of of these similar institutions were de-facto governmental backed anyway, so fundamentally, nothing has really changed, apart from the fact that this move is yet another admittance/measure of how bad things have become in the US. > If anything, our property boom was more ridiculous than that of the US. Yes, but also perhaps No. Each market has its nuances and a lot depends on who the loans were given to,… Read more »
Dave, where would you recommend people should emigrate to?.Western Canada, Northern Australia?.The dopey euro was the undoing of the Irish economy, interest rates that were zero in real terms and now an overvalued currency against sterling.Watch out Cowen’s about!.
My main concern is that liquidity for production has dried up…not just in Ireland, but for a lot of the world. IDA’s favourite fallback to US MNCs who are all suffering from this and this leads to lowered demand from hard pressed customers (due to lowered employment prospects). So really, irrespective of how well the banks survive here, the bulk of their customers will be having more and more problems in the coming months and this is THE PRIMARY ISSUE that needs addressing. People drive an economy – not banks. Furthermore, if people are out of work for more than… Read more »
@David McWilliams Parry:
How about emigrating to a Failed State?
http://www.fundforpeace.org/web/index.php?option=com_content&task=view&id=229&Itemid=366
Little exposure to sub-prime in the top 10, no ties with Fannie or Freddie (if we avoid nos. 2 and 8), inflation making good old barter necessary again, you can grow fruit and veg all year round in most of them, what are we waiting for?
And guess who comes in at No. 174?
Ah, but that was in 2007!
Just saw on CNN that Lehmann Bros losses for year to date is almost 4 billion and its investment division will be sold……..needless to say for a song and who knows to whom! I am no economist but this is worrying…..if the major banks in the US are sinking both private and semi-state entities surely this has global implications……..Jim Rogers of George Soros ilk hails that all bank should be left tank………if only to face the recession head-on thus ensuring a swifter though a painful recovery in the medium term.
Excellent point Phillip, we really need a strong leader who can guide us through these challenging times, but I for one would have little faith in the current leadership…raising taxes is not going to help us out of this mess….this will just damage our economy further . We need to slash the public service budget and invest in innovation and energy saving technologies…but this couse of action while simple to achieve will not be taken because of the lack of foresight of our leader.Who will revert to the old worn strategy of raising taxes and reducing the spending on vulnerable… Read more »
Excellent article David. But then Paul suggested “Lets all rush to the bank and withdraw everything!” Let’s just picture that scene and its consequences. Scribbled notes taped to all the ATM machines ‘Out of order’. Bank doors locked. Angry depositors milling about outside. Rush to the supermarkets for cashback. “Sorry, tills are low and we need our money for change.” Offer to pay with credit card. “Sorry, cash only today–pin machines are down.” “But the banks are closed and I need baby food for little Twinkie.” “Can’t give credit–it’s against company policy.–Try Lidl.” Crisis escalates. Filling stations closed. Food stores… Read more »
David another honest article to a degree as I would not say you really think the same could happen to us within the next two years.It will take less than that time frame What is happening now in America is building up momentum at a quite extraordinary pace. We had Bern Sterns back in March, Fannie and Freddie last week now Wachovia their fourth biggest lender is in serious trouble along with Lehman Brothers so we are seeing a domino effect or the financial equivalent of the perfect storm within the US markets as right across the board over there… Read more »
@Brendan W
If some Saudi Outfit buys one or more of the banks then the “management” (I use that term loosely) will be outa there faster than a speeding bullet with their familial nest-eggs safely tucked away and living in Portugal laughing at the eegit oil money that bailed them out of a really nasty mess. They wont be out ploughing in the rain anyway.
On a more agricultural note, it isn’t a good idea to be ploughing in the rain.
Ger
Brendan W said: “And I would love to see the Saudis taking over one of our Banks and putting it’s management out in the rain to plough the fields for them”. Interesting suggestion that would probably influence many Irish to become muslims. Islamic banks are precluded from charging interest from those of the muslim faith. This used to be the case amongst christians and jews too, (with muslims, also “people of the book”) as usury was strongly condemned in their common ethical source, the old testament: 25 If you lend money to any of My people who are poor among… Read more »
Back in the ’30s, the DMark was devalued due to having no control over money supply. Central banks now carry out that regulatory function – without question. When this mess blows over, central banks will be in charge of credit supply. Maybe the Muslims were aware of this all along – they invented the basis for our maths today – pity most of us are only waking up to using it now – and that’s to record history rather than predict a major probem unfolding.
@ Malcom And if thou sell aught unto thy neighbour, or buy of thy neighbour’s hand, ye shall not wrong one another. Leviticus verse 14. What a great economical thinker this man was too. Maybe now that you are studying the Old Books , it might strike you as to what is really going on within our western banking system , This war on Global Terrorism is perhaps just a smoke screen to kill all these Muslims who don’t charge interest on their brothers loans. And I wonder what would happen if you went into the Bank’s of Ireland and… Read more »
I have been following the writings of one Lyndon Larouche now for quite a number of years when I was first introduced to some of his material at a conference in Berkly. Larouche describes himself as a Physical Economist of the American System of Economics in the tradition of Alexander Hamilton, Henry Carey, Abraham Lincoln, John Kenneth Galbraith, FDR and JFK. At first I thought him a crank but in light of recent developments I have now come to revere him, and when you read Larouche you can’t help but feel that he is definitely onto something. About forty years… Read more »
Is there censorship on this post?
Unlike a bubble built on cash, this one was built on borrowing. When a cash-built bubble bursts, there’s always a little something left in the ‘kitty’. When a bubble built on borrowing bursts there’s just a big air-hole into which the debts and the negative-equities tumble. This is what the banks are now holding as ‘assets’ in their vaults. The banks that we were all dealing with this year appear to be exactly the same banks we all dealt with last year. But they’re not. They’ve spent all our money … by a factor of ten … and they’ve lost… Read more »
If investors are selling their bank shares, where are they putting the money they receive?? Surely not into the deposit accounts of the same banks that they have lost confidence in??
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
Thomas Jefferson (1743 – 1826), Letter to the Secretary of the Treasury Albert Gallatin (1802)
@Longlivetherepublics, ‘Is There censorship here’? , while I do not claim to represent Mr McWilliams or to be his webmaster, I say maybe your problem was with loading or a poor broadband connection. On previous posts it is only when you get too personal when you will be blocked out.
I think Skin’s point is a very important one. Not so much about where the investors are putting their cash, but rather that they are cashing in their shares. The current level of investor risk-aversion, while understandable, is, in my opinion, one of the most damaging long-term effects of the credit crisis. Venture capitalists have always been a rare breed on this side of the Atlantic, but without them the innovative solutions we will need to grow our way out of the coming (current?) recession will fall by the wayside, stifled by a lack of funding. I know it is… Read more »
@woodsey: You say “(The banks have) spent all our money … by a factor of ten … and they’ve lost it.” I used to think a bank was like the heart of our system, the veins (deposits) bringing in the blood, and the arteries (loans) pumping the blood out. DMcW’s articles and posters like you have made me realise this analogy is false, as the supply of blood in the banking system is not finite like our own; or at least much more seems to be travelling down the arteries than back down the veins. In fact you make it… Read more »
The problems that these banks are having such as Lehman’s, is just another aspect of the property/asset bubble and the credit binge that fuelled it. Lehman is having to write the value of its assets (mainly commercial property vehicles) down to ‘market values’. That was the main factor in their recent quarterly loss. The assets value is lower than they were and hence a loss. The bank has lost business elsewhere as people have been treating it with caution and moving their business elsewhere in case it should go bang wallop. Its a negaive circle and things just get worse.… Read more »
Are we overreacting ?- we know that the American Banking System lost its way over the last decade, but surely in our case, the powers that be are more than capable of doing a risk analysis and acting on it – if not, then the Universities should be closed down. If Napoleon was able to do it two hundred years ago, surely our lot at the Central Bank are up to the task. If we’re going to get out of this crisis, then only positive thinking should be encouraged, based of course on some foundation solid or otherwise and this… Read more »
Hi Please don’t post “test” comments on this site. It is annoying, particularly for those who get email updates when new comments are posted. There are a number of anti-spam comment filters on the site. Not all posts are listed automatically, some are held for manual review which I try to do every day or so. On any given day spammers submit 100-200 spam comments so this is necessary. It is rare though that posts are held for review. I can appreciate it can be annoying if you want to post a hasty rebuttal, but the alternative is dozens of… Read more »
I have been following the writings of one Lyndon Larouche now for quite a number of years when I was first introduced to some of his material at a conference in Berkly. Larouche describes himself as a Physical Economist of the American System of Economics in the tradition of Alexander Hamilton, Henry Carey, Abraham Lincoln, John Kenneth Galbraith, FDR and JFK. At first I thought him a crank but in light of recent developments I have now come to revere him, and when you read Larouche you can’t help but feel that he is definitely onto something. About forty years… Read more »
My apologies Webmaster. Its just that I had a post with four links and it did not automatically go through
at first under the name ‘the fixer’, so I had to determine how many links would be allowed to go through without a manual review.
@Newname – I just read an article about Hewlett Packard’s R&D findings about people’s use of the web. Guess what, people only use a few sites – ever! and only have a small circle of friends. Being able to access the whole world of information with all the associated garbage and some good bits is just a drag. We are all little villagers who like to feel special even in a small way. The Ithaca concept merely reflects this and maybe all that is happening is a global correction where people are just going home and deciding to work for… Read more »
MK said: “Trust in cash and money hasnt broken down completely nor will it unless things get a lot lot worse. We are far from that situation at the moment.” – No we’re not. People are just waking up to the frightening reality of their long-term commitments. Let’s look at the average Pauric, who five years ago signed up for a 100% bank loan to buy a flat costing €100,000 at fixed rate of 5%. His friendly bank manager said that housing was rising at 10% a year and that would probably continue for as long as the Celtic Tiger… Read more »
@mishko: ‘… the veins (deposits) bringing in the blood, and the arteries (loans) pumping the blood out.’? Yep, it used to be that way. But that was back in 1908. Finance became way too clever for that. Nowadays financial regulators allow banks to spend €100 for every €8 they take in. ‘Take in’ can mean the sum of assets, deposits and loan repayments. Loan repayments are a BIG part of the banks’ income stream. For every €8 of loan repayment income the banks can ‘spend’ €100. This ‘spend’ includes €100 loans based on their €8, and the asset you’re offering… Read more »
Have a look over at thepropertypin and search for “What Happened in Japan When the Bubble Crashed in the 1990s?”
http://www.thepropertypin.com/viewtopic.php?f=19&t=12424
It’s the second great depression and we are following the same pattern as the 1930s
Malcolm McClure not meaning to offend your religious sensitivities, but the Old Testament of the Bible was written before Central Banks discovered how to inflate currencies. As Ben Bernanke said “we have the tecnology” (i.e. the Printing Presses). People require interest to make up for the losses incurred by reckless central bankers, and the politicians who are continually appointing them. Regarding rescuing the Irish Banks. This is a complete waste of taxpayers money, just to save national pride. Absolutely disgraceful. Bear in mind that both Bank of Ireland and Allied Irish Banks shareholdings are over 40% owned by American institutions.… Read more »
The bail out of the Freddies was inevitable -but of course totally wrong. Nevertheless it has probably staved off a global monetary crisis.It has solved some of the problems for banks such as our own B of I and AIB etc.The next step to “bail out” the irish banks is to help the builders off load their unsold stock.if the builders can be saved-the banks will be saved.! We are told the government will bring in steps to resolve this shortly.They include a massive buy out of new housing units for everybody, from the unemployed -to the low waged families… Read more »
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Mr Cowan said (today) re housing:
“The Government will help those who want to buy a home but are experiencing problems obtaining credit, but will avoid anything that would artificially inflate house prices.”
Is that a classic oxymoron?
Should he have (honestly) said:
“The government will move heaven and earth, to ensure that the builders continue to prosper”