Open Dissent

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Open Dissent Page 9

by Mike Soden


  The following expression may well reflect an underlying ethos that prevails in our society: ‘It is better to do nothing at all than it is to make a mistake.’ This attitude must be avoided at all costs. The economic engine of the country will be driven by risk takers in conjunction with the banks that will provide the much needed liquidity. It is important that we all appreciate the financial term ‘deleveraging’. This term, which is used extensively when referring to financial bubbles, is the signpost to recovery. Deleveraging is the process by which financial institutions, investors and home owners reduce the relative size of their assets and reduce their debts with the proceeds. The process involves an implied acceptable ratio of debt to the level of assets held.

  Companies and banks often take on excessive amounts of debt to finance growth. However, this leverage substantially increases a firm’s risk profile because, if the leverage does not foster growth as planned, the risk can become too much for the borrower to bear. When this occurs, all the firm can do is deleverage by paying off debt. This deleveraging is viewed by savvy investors as a warning sign.

  Deleveraging applies to individuals as well as to companies. The problems arise when households have to sell off assets at a loss to repay their outstanding debts. Individuals should be cautious to ensure that through this process they do not become bankrupt. Negative equity in a home can be dealt with if the owner has a cash flow, other assets and the ability to stay in their home or rent it at a viable amount to cover monthly repayments.

  From a national perspective, the deleveraging process is essential to take the excess out of bubbles, but it is not a quick fix. Different sectors in the community, be they homeowners, banks, insurance companies, investors or the Government, have to absorb the losses associated with deleveraging as assets fall to their new market level. In the past, some big pension funds and insurance companies were so badly affected by property bubbles in the UK and US that it took between ten and fifteen years to create new interest in the property sector. The lesson is that it takes time to allow the effect of deleveraging to work its way through the system. A healthy property sector requires a confident and well-managed financial system.

  Whatever the new normal will be, it is going to be influenced strongly by the global economy’s growth rate. As an open economy, we are influenced by the exchange rates and growth in the principal markets of the UK, Europe and the US. Much hope will be placed in the export market to pull us out of our demise, but we remain hostages to renewed growth in the US, the UK and Europe.

  The first euro−US dollar exchange transaction was executed between National Australia Bank and Fairfax Publishing on 1 January 1999 in Sydney, Australia. The deal was transacted at €1:$1.1740. I was fortunate enough to make the first ever trade at 4.30 a.m. (Sydney time). It was a great occasion and was televised globally on Bloomberg TV from the trading floor of National Australia Bank. I was asked if the rate struck would be held for long or if there would there be a strengthening of the euro. My reply then, as it is now, was that I intentionally do not bet against the US dollar for any extended period of time. If one looks back at the price of that first trade and observes the volatility of these currencies over the past eleven years, it is remarkable to note how the swings have gone, with €1 trading at between US$1.59 and US$0.82 over the eleven-year period from 1999, giving a spread in excess of 80 per cent. The volatility has been enormous. Due to the sovereign debt crisis it appears that the exchange rate is moving back to the original level. The markets, as we all know, are as much an art as a science, and history has proven that what goes up in the foreign exchange markets invariably comes down.

  Minister for Finance Brian Lenihan, in a paper given at the MacGill Summer School 2009, made the statement that there was only one possible path to recovery and there were three elements to it.23 First, we must have sustainable public finances; second, we must regain our competitiveness through boosting our employment and creating real jobs; and, third, we must repair our banking system. If Ireland wants to pay its way in the world and get on as a country then all these elements must be addressed.

  As we have managed to catch the wave of commercial and economic progress over the past forty years, the time and circumstances are opportune for a move towards the smart economy. The national competition for the best proposals to help turn around the economy and create jobs, ‘Your Country, Your Call’, is taking this challenge on by providing an attractive platform for creative ideas to come forward. The winning schemes will receive capital for their national application. Building on the inherent technological skills of the Irish workforce, we can attract businesses from around the world while at the same time accommodating the entrepreneurial character who wishes to build internet-based activities from their home. Young people should be encouraged to venture out with their creative ideas and be assisted in raising capital through government- and bank-structured schemes. The tried and tested marketing programmes of the IDA and Enterprise Ireland have proven successful at attracting new businesses to Ireland with a high demand for the technically skilled. The skill base within these agencies is of the highest professional standard and has assisted many Irish companies with international growth aspirations to pursue them. The IDA and Enterprise Ireland have what is required to ignite the national recovery plan.

  The principal element of a smart economy is an educated workforce. We continue to produce an abundance of well-educated, intelligent, innovative technologists, engineers, doctors and so on, but the temptation to emigrate is enormous for these people. The number of skilled people seeking opportunities in the UK, Canada, the US and Australia is growing every month and, while not yet at the levels of the early 1970s or late 1980s, the trend is clear. Major organisations that do not consciously make the home alternative attractive for graduates are contributing to the current brain drain. It is a very complex set of circumstances but we must stretch to retain our best people and, if this is not viable, we should not lose contact with them. Those who go abroad do so to get experience and improve their skill bases and could return home to provide a valuable labour pool for the country in the future.

  The losses financially and materially due to the crisis may well be offset by gains that are on a different scale. If, for whatever reason, we find ourselves with time on our hands, perhaps this is one of the positive side effects of the crisis. Time, during the halcyon days, was in short supply, whether it was for one’s family or oneself. Perhaps the pressure brought about by economic stress in the household is in some way reduced by improved social relationships with family and friends. The virtue of caring is strongly linked to our heritage and cannot be described in financial terms, but it is an extremely strong currency that will outlast a euro in any denomination. Perhaps this quality will be the attraction for those Irish emigrants considering a return to Ireland.

  Keeping in mind that we have many objectives in the recovery phase, not least of which is basic economic growth, the demand for an experienced and skilled workforce will be paramount in the creation of the next generation of sustainable businesses. We must become best in class at whatever sectors of this smart, knowledge-based society we choose to develop. As we have proven over the years, we can compete in many fields of endeavour but we must strive to become best of breed internationally.

  As discussed in Chapter 4, individual and business wealth creation is key to our recovery. In order to produce the right conditions for this to happen, the Government and the banks should focus on three things: get people out of debt, get them investing and get them back in business.

  Unfortunately, recent events make it seem that we will stretch as far as we can in order to save an entity that has created a national crisis but we are less able to accommodate the weaknesses of individuals and families. If the draconian measures that existed under the old regime, which the Caroline McCann case proved influential in changing, were applied against major debtors in the current crisis, the outcry for retribution would have been satisfied. Howeve
r, this law would never have been applicable to the class of major borrower who could threaten banks with failure in the event of their default. Individuals and companies that have raised billions and now declare inability to repay can rightfully claim contributory negligence on the lenders’ behalf and will possibly walk away leaving the taxpayer with the bill.

  In the event someone leaves an organisation for any reason connected to alleged wrongdoing, the institution is recognised as the owner of all files and computers. Giving people months to depart reeks of weakness and indecision, which can easily play into the hands of offenders. A higher level of diligence must be required from the Director of Corporate Enforcement, and if the laws have to be changed so action can be taken, then so be it.

  One can be sure that the same level of leniency is not available under law to unfortunate investors who go bankrupt. In the event of defaults in business, consideration must be given to the bankruptcy laws in Ireland. At the moment, not only is the stigma attached to bankruptcy severe, but the punishment of a twelve-year recovery period is excessive in respect to default. We must align ourselves to whatever best practice is in Europe; it might not be more difficult than examining the bankruptcy laws in the UK. In a nutshell, the term that a bankrupt serves in the UK is one year before they can go back into business and have their credit record cleared. A term of twelve years exists for bankrupts here. It appears that the laws in Ireland view a bankrupt in line with a criminal. If people fail in business and in turn fail to repay their creditors, should they be burdened with such a horrendous stigma from which they are unlikely to ever recover? The penalty of bankruptcy is out of proportion to the damage. Will a variation of the action in the Caroline McCann case be witnessed over the next year or so to prevent the stigma of bankruptcy condemning some to twelve years of exclusion from business?

  Should debtors get a life sentence for misfortune, greed or poor judgment? There are endless cases of negative equity and these are visible in all sectors of the community. Is there any room in the recovery equation for an amnesty or forgiveness for part of the outstanding debt? Should a generation be relegated to a life of penury and insecurity? Lenience on the part of the creditors will possibly hinder the efforts of the regulators to have the banks recapitalised at levels consistent with best practice.

  It is in the interests of the state that measures are taken to alleviate some of the stresses and burdens that are weighing down the families whose biggest crime was that they wanted to be wealthy and secure. Homeownership needs to be facilitated. The law should be changed so that the home cannot be repossessed in the event of a failure to pay debts in another area. The home is the cornerstone of society and it should be protected from the greed, weakness or foolishness of borrowers and lenders alike.

  The owners of the banks come in various guises, from major institutional players to retail investors, to those whose few hundred shares mean as much or more to them as the big institutional holdings of fund managers. A great deal of trust and loyalty has been lost among this constituent. The financial losses have accumulated for each category of investor and many are left wondering if they are ever going to get anything back on the shares they hold. Will the value of the shares go to zero through nationalisation or, by some great financial miracle, will they recover to €2, €5 or €10?

  It has to be understood that the major shareholders in the Irish banks who were badly burnt during this crisis are unlikely ever to reinvest in the old banks. This unfortunately arises as the major investors will put their surplus funds where they deem the opportunities to be greater and the risk a lot lower. These people never saw the banks from the perspective of networks and employees but in terms of financial investments that would generate capital gains and dividends. Often these investors would look at the annual reports and would value the performance of the Irish institutions compared to the other best-performing banks in Europe. Our banks had something more than just a domestic network: they had created a financial legacy from hundreds of years of banking practice. Good banking practice. But over time they have matured into international banks that have grown organically or acquired new businesses in wholesale banking, capital markets, fund management and insurance. The investors were able to put values on the diversified sources of cash flows, which meant, from an analyst’s perspective, that, even if one activity failed, three or four others would perform profitably. On those occasions when all cylinders were working in unison, the profits were substantial and the return on equity and dividends was praiseworthy.

  The big investors take what might be described as a helicopter view of our banks from the perspective of investment. From that same vantage point today, looking down on the remains of these once venerable institutions, they see little life in the future unless some very hard decisions are taken about the management and strategy going forward. This is now in the hands of the Government and the EU.

  While there is no doubt that the trust and confidence of shareholders and investors in the banks have been seriously shaken, the relationship between the banks’ customers and local branches, the flagships of our financial infrastructure in every city, town and village in the country, have also taken a hard knock. This situation is dangerous for the whole banking system and the local branches need to work to re-establish the trust that once was inviolable.

  In the middle of this financial crisis we appear to have lost sight of the ‘old’ shareholders. In the Irish banking context these shareholders were either domestic or international and were made up of private and institutional investors. At least that was until the Government was forced to step in, initially becoming a preference shareholder and subsequently, through conversion, becoming an ordinary shareholder. The market capitalisation of the banks was in aggregate close to €60 billion before the crisis occurred. More than 150,000 individual shareholders held billions between them, either directly or through funds. The value of the combined shareholdings in the banks today is less than 5 per cent of what they were at the peak.24

  We can often forget that these 150,000 were family members, businessmen, farmers, professionals and pensioners. As the market value of shares started to evaporate, tens of thousands of individuals from all walks of life were hurt financially. The nest eggs that had been put aside for the rainy day had all but disappeared. Education funds for children, fees for nursing homes, cash for the new car or holidays, or just savings for a rainy day were no longer within easy reach. Worse still, the insecurity caused by this crisis has knocked the confidence out of this key sector of our community. Savers who were unlikely to be a burden on the state are now thrust into the social welfare system that they prided themselves on being able to avoid through good planning. Is consideration given to this cadre of savers in the context of them losing more than money? They have no reason to question their own self-respect or judgment; they did their piece for society and the system has let them down.

  In many ways losing one’s security brings on stress for the ordinary family that may manifest itself in frightening ways. This brings up the questions of the size of the holes in the pension funds and what can be done to fill them. Many of the Irish pension funds would have held substantial amounts in Irish equities. During the past three years some 70 per cent of the market value was written off. The Irish stock market index has fallen from a peak of 10,400 to below 2,700 over the past two-and-a-half years.25

  Over recent years, a number of Irish corporations have gone to the wall, leaving their pension schemes underfunded. The trustees who were responsible for the investment of the pension funds in corporations were charged with the responsibility of taking an arm’s length approach to ensure no conflicts of interest occurred that would jeopardise their predetermined investment strategy. There are many categories of funds, ranging from personal to company to institutionalised funds. Simple investment strategies were often developed where the pension funds had overriding principles of security before growth; if growth was essential then the preferred risk profil
e of the investment had to be stated. Speculative funds in pension funds generally represented a very small percentage of the total to be invested. Entertaining speculative opportunities, however small, tended to be under the condition that there would be only modest losses in the event of a failure.

  One of the single biggest problems for Irish pension funds is the conflict that can arise when the trustees are encouraged to invest some percentage of their funds in their employer’s company. The support given to one’s company through investment in some part of the pension fund is laudable and, in good times, rewarding for all. Having influence in the company as a shareholder and not just as an employee allows for greater commitment to the vision of the organisation. Whatever percentage is deemed appropriate from the perspective of the maximum exposure by the company’s pension fund in the company, be it 1 per cent to perhaps a maximum of 10 per cent, should be predetermined. The benefits of so investing must be analysed and judged in the context of a possible major downturn in the economy or the company. On those occasions when the trustees meet with the owners or senior management of the company, employees may be faced with the dilemma that more money out of the staff pension fund is required to be invested in the company. The conflict is terrible and the decision to invest more of the employees’ pensions into their employer’s business has to be taken very seriously. Depending on the make-up of the trustees, whether they include employees, pensioners, auditors, the company secretary or perhaps some senior executive of the company, the conflict begins to simmer. If further pension funds are required to be invested in the company, the purpose for the additional resources must be explained clearly to employees. The explanation may well be couched in positive terms, reflecting the growth of the company; on the other hand, there may be veiled threats as to potential job losses if the investment does not take place.

 

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