by Mike Soden
If a fairytale ending to the current financial crisis is preferable then perhaps Hans Christian Andersen might take a better shot at writing this episode. Unfortunately, it is clear that no solutions can come without pain for every sector of our society. Another suggestion would be that the working week be increased to 5.5 days. Everyone in the country would be expected to increase their working week by some 10 per cent with no corresponding increase in wages or salary. The economic benefits of this action would be substantial. It would automatically increase production, reduce our cost base and very quickly get us on the road to recovery. However, the social implications would be substantial and the effects on quality of life would be harsh. While many will argue against increasing the working week on these grounds (and the EU might well have something to say about it too), it may be the single best way to demonstrate to ourselves and the rest of the world that we can take difficult decisions to protect and preserve our economy.
The Government has made it clear that its preferred method for recovery is to get the balance sheets of the banks cleansed and, through this, enable the banks to put more liquidity into the market. If the banks can manage to start putting liquidity into the market then one of the outcomes would be a controlled infusion of inflation into the system, in cooperation with guidance from the Central Bank. If this was managed in the right way we would see a steady increase in asset prices. For those who have been caught in the negative equity trap, this would be an avenue that would lead to an easing of the implied constraints therein. It should not happen overnight but be controlled over a three- to five-year period. This slow but perceptible increase in the price of assets would inject an air of hope and possibly renewed confidence into the economy. I cannot stress enough the need for control in the adoption of an inflation-driven recovery, for the consequences of uncontrolled inflation would be catastrophic.
If one of the key imperatives for the country is to reduce or erase the Government’s liabilities, in turn achieving an improvement in the country’s sovereign debt rating, then the sale of the cleansed banks to international investors must be a consideration. Perhaps getting the banks into a ‘ready for sale’ state should be considered in preparation for the possibility of new capital being injected into the banks or some major financial entities wishing to expand their European footprint into Ireland. However, giving up control of domestic banking would have negative effects, as the case of New Zealand demonstrates (discussed in Chapter 7). After twenty years New Zealand’s four major banks remain in foreign ownership. Since the late 1980s, the income per capita in New Zealand has been close to the bottom quartile of the OECD (Organisation for Economic Co-operation and Development) ladder. Giving up control of our banks may carry too high a price. One other option on the banking horizon might be a once-off offer to customers to exchange retail deposit interest for warrants or shares in the banks, which would be a voluntary commitment.
The old banking model is broken and a new one needs to be developed. The two major banks have an uphill battle over the foreseeable future and, with the sale of some of their best-performing assets to strengthen their capital bases, large dependable cash flows will have been eliminated, leaving both institutions dependent upon the Irish market to repair their balance sheets. If both banks are now going to focus on Ireland then investors must wonder when they’ll see capital growth, dividends and earnings per share return to acceptable levels. The future for these banks is about survival for the next few years. Due to the enormity of the problems in the commercial property sector there has been little focus on the potential losses of the SME sector by investment analysts. Mounting provisions will be required to offset the losses from the growth in insolvencies that were up 27 per cent on the 2009 figure for the first half of 2010; the year 2009 saw insolvencies increase by 80 per cent up on 2008.50
Looking over the financial landscape of Ireland as it appears today, I am saddened (others may simply be outraged) when I observe the destruction of the national financial services system.
Do the boards of the banks know what caused the downfall of their institutions and, if so, have steps been taken to avoid a recurrence? It is fair to say that the Irish banks were reckless in their credit management and, worse still, they were nowhere near prepared for the liquidity crisis that has occurred. I have no doubt as to the level of incompetency that has prevailed at management level within the banks.
The ongoing discussion on fairness and who in reality has to pay for the mistakes of executive bankers and politicians has led to the very political system being questioned. Have the political parties in the country adjusted to the changes in our society? Will the current crisis be the catalyst for political parties changing their policies for a new and better society? If the mainstream political parties in Ireland are seen to be failing the electorate, might this create a void into which more marginal, and perhaps less desirable, political parties will step? What are the alternatives to the current system? What, in effect, would be a ‘better society’?
On a recent visit to Russia I learned about the changes that occurred in both the political and social environment over the past twenty years. Perestroika (restructuring) and glasnost (openness) were the two principal pillars of change. The centralised Soviet Union was dissolved in 1991 to make way for a loose confederation of states. The adoption of capitalism was painful in the early days. Private ownership was established through the passing of property that was once part of a collective to individual ownership. The history of callous decision making in Russia continued in the period of transition from socialism to capitalism, with the weak and poor paying the price for change. Only the strong would survive and this was the order of the day.51
Extraordinarily, today, the majority of Russians would acknowledge that almost all in their community are better off under the present system than they could remember being under the old Soviet system.52 A once proud socialist state now competes at the highest levels of capitalism with its own model of private ownership and open markets. The local observer would comment that it might not have been the easiest of transitions but no major structural reform to a society comes easily. Are we as a nation evolving in the opposite direction to the Russians in our search for a fairer society? Before dismissing capitalism out of hand, perhaps those supporting socialism should take time out to experience a country where it is practised, or where it had been practised.
Any Irish political party would be tested today to come up with a political doctrine to reflect the values of the country and the mood that currently prevails. However, I believe that we need go no further than France to find a set of principles that would be, broadly speaking, acceptable to the Irish electorate: Liberté, Egalité, Fraternité. These principles had their origins in the French Revolution and were more formally adopted into French society at the end of the nineteenth century. But what does this motto represent that our Constitution doesn’t?
Liberté – in France the general interpretation of Liberté consists of being able to do anything that does not harm others. Thus, the exercise of the natural rights of every man and woman has no bounds other than those that guarantee all other members of society the enjoyment of these same rights.53
Egalité – the law must be the same for all, whether it protects or punishes. All citizens should be equally eligible for high offices, public positions and employment according to their ability, virtues or talents, without other distinction.54 This definition faces cronyism head-on and looks to a meritocracy as a preferred right.
Fraternité or brotherhood refers to moral obligations rather than rights, links rather than statutes, harmony rather than contract and community rather than individuality.55
As time passes and we begin to see an end to the crisis, we should reflect on what benefits we have taken out of this conundrum. If we simply address each problem as it arises without looking for positive outcomes for our society as a whole then we will do an injustice to ourselves through wasting an opportunity for
change and progress.
Ireland needs a socio-political facelift that reflects a society that changed greatly in the face of economic blessings and has since experienced the jolt of an economic crisis. The Government has given to the electorate with one hand and are now forced to take back with the other, which is destroying trust and confidence, essential for a united approach to our recovery. Whatever risks need to be taken and managed, perhaps it would be opportune for all of us – Government, bankers, developers, public servants and private sector workers – to take on board the principles of Liberté, Egalité and Fraternité.
APPENDIX
Figure 1: Lending to the Private Sector and Deposits of Irish
Banks as a Percentage of GNP, 1992 to 2009
Source: Morgan Kelly, ‘The Irish Credit Bubble’, p. 7.
Figure 2: Average Irish Economy-Wide Wage
Source:
Table 1: Overview of Exposures to Portugal, Italy, Greece and Spain (‘the PIGS’), December 2009
Adjusted
Exposure (USD’bn) Total
EU
Banks Austria Belgium France Germany Ireland Italy Nether
lands Portugal Spain Sweden Switzer
land UK
Greece 152.6 6.1 7.3 22.7 41.7 8.3 8.2 11.5 1.2 1.2 1.0 62.6 12.0
Portugal 144.2 2.6 8.6 33.7 42.6 5.6 6.7 11.8 0.0 0.4 0.5 3.6 24.5
Spain 582.4 6.5 30.2 155.9 102.6 29.2 28.4 116.7 15.6 0.0 5.6 13.2 60.8
Italy 582.6 13.4 45.4 152.7 103.2 45.4 0.0 75.4 5.3 35.1 3.5 20.7 73.5
Total 1461.7 30.6 100.7 305.1 440.0 86.5 43.4 214.5 22.3 39.8 10.5 100.1 170.9
Figures from the Bank for International Settlements (BIS), adjusted by Morgan Stanley International Research to include such claims as subsidiaries and other corporate loans.
GLOSSARY
AAA rating The best-known scale for measuring debt quality is that used by Standard & Poor’s which uses AAA for the highest rated debts and AA, A, BBB and so on for debt of descending credit quality.
Bank holding
company A company that controls one or more banks.
Basis point A unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument; it usually refers to changes in interest rates and bond yields.
Bond A certificate of public or private debt that is bought and sold.
Bond rating A rating company’s evaluation of the probability that a particular bond issue will default.
Bull market A financial market in which prices of securities are rising or expected to rise.
Capital ratio The percentage of a bank’s capital to its riskweighted assets.
Collateralized
debt obligation
(CDO) A type of structured asset-backed security, the value and payments of which are derived from a portfolio of fixed-income underlying assets.
Credit default
swap (CDS) A swap designed to transfer the credit exposure of fixed-income products bet ween parties.
Debt-to-GDP
ratio This is commonly used to assess a government’s finances by dividing government debt by GDP. Another way of using it is to divide total debt by GDP in order to establish a nation’s finance as a whole.
Deleveraging A process that is employed by financial institutions, businesses and governments to reduce the amount of financial leverage currently in place.
Derivatives Financial products that derive their value from another commodity, security or other financial instrument. Also called ‘swaps’.
Due diligence An investigation of a potential investment, involving reasonable care to ensure all matters are in order before entering into the transaction.
Equity The value of a business or property above any mortgage or liability.
Forward contract A non-standardised agreement bet ween two parties to buy or sell an asset at a cert ain future time at a price settled on today.
GDP Gross domestic product: the total market values of goods and services produced within a nation’s borders during a given period.
GNP Gross national product: the total market values of goods and services produced by a nation within a given time period, plus income earned by its citizens abroad, minus income earned by foreigners in the country.
Hedge funds Private investment partnerships open to institutions and individuals. These funds pursue returns through a number of alternative investment strategies, often not allowed in mutual funds or other funds.
Hedging A strategy designed to reduce investment risk by buying or selling commodity futures as a protection against loss due to price fluctuation.
Investment bank A financial institution that assists corporations and governments in raising capital by acting as the agent in the issuance of securities.
Leverage The use of credit to enhance one’s speculative capacity.
Liquidity Assets that are easily convertible into cash.
Loan-to-deposit
ratio Ratio that assesses a bank’s liquidity by dividing the bank’s total loans by its total deposits.
Loan-to-value
ratio Assessment ratio that lenders use before approving a mortgage. The ratio considers the mortgage amount against the value of the property.
Market maker
(jobber) A broker-dealer company that accepts the risk of holding a certain num ber of shares of a particular security in order to facilitate trading in that security.
Marking to
market Settling or reconciling changes in the value of futures contracts (agreements to buy or sell assets) on a daily basis.
Private equity
fund A pooled investment vehicle used for making investments in various equity (and to a lesser extent debt) securities according to an investment strategy associated with private equity.
Retail bank A financial institution that deals with consumers directly, rather than with corporations or other banks.
SME Small and medium enterprise: business whose turnover and number of staff are below certain limits.
Structured investment
vehicle
(SIV) A type of structured credit product, popular until the crash of 2008.
Subprime debt Debt that results from a particularly risky category of consumer loans; typically sold in a separate market from prime loans.
Swaps See ‘derivatives’.
TARP Troubled Asset Relief Program: set up by the US Government to purchase assets and equity from financial institutions to strengthen its financial sector after the crisis of 2008.
NOTES
1. Morgan Kelly (2009), ‘The Irish Credit Bubble’, University College Dublin (UCD) Centre for Economic Research Working Paper Series, UCD School of Economics.
2. Construction Industry Federation (CIF), internal paper.
3. From a personal interview.
4. Kevin Cashman (2003), ‘Awakening Authenticity’, Executive Excellence, May, available at
5. Figures taken from
6. Ibid.
7. Ibid.
8. Hank Paulson (2010), On the Brink: Inside the Race to Stop the Collapse of the Global Financial System, London: Headline Publishing Group.
9. Andrew Ross Sorkin (2009), Too Big to Fail: Inside the Battle to Save Wall Street, London: Allen Lane.
10. See note 8.
11. Paulson, On the Brink, pp. 439–440.
12. Entities are seen as ‘too big to fail’ if they are so essential to a macro-economy that their failure would be disastrous to the economy.
13. The eight financial institutions were Bear Stearns, IndyMac, Fannie Mae, Freddie Mac, Lehman Brothers, AIG, Washington Mutual and Wachovia.
14.
/> 15.
16. Transparency International Ireland (2010), ‘Alternative to Silence: Whistleblower Protection in Ireland’, p. 5.
17. Report of the Company Law Review Group 2007, available at
18. See Deaglán de Bréadún, ‘Support for Whistleblower Protection’, Irish Times, 18 May 2010.
19.
20. See
21. Figures from
22.
23. Joe Mulholland and Finbarr Bradley (2009), Ireland’s Economic Crisis – Time to Act (Essays from the MacGill Summer School, 2009), Dublin: Carysfort Press.
24. Davy ‘Weekly Book’.
25. My own observations of the market.
26. ‘Opening Statement to the Joint Committee on Finance and the Public Service’, available at
27. Figure from CIF, internal paper.
28. Ibid.
29. Ibid.
30. Ibid.
31. Ibid.
32. SIC (2010), information from press conference held on 12 April and an internal report.
33. From consultation with Peter Thodey.
34. Morgan Kelly, ‘The Irish Credit Bubble’, p. 7. See also Figure 1 in the Appendix.
35. Danske Bank (2008), ‘Lessons from Swedish Bank Crisis Management’, 30 September.
36. Ibid.
37. My own estimate.
38.
39. Shareholder’s Register.
40. Wriston repeated this story at a lunch I was privileged to attend.
41. Figures from
42. Ibid.
