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The home grown roots of Ireland’s credit crisis Back  
Ireland’s over exuberance with housing credit was signalled in this publication and elsewhere as long ago as the mid 1990s – yet the boom continued, with the worst excesses (and what will be the source of the real long term problems) occurring only in the past four years to end 2006. Back in February 2000, William Slattery, a former deputy head of Banking Supervision in the Central Bank of Ireland published an article which was headlined: ‘Property price fall of 30-50 p.c. possible if credit growth not curbed’. The article caused a considerable stir at the time, and Slattery (subsequently head of Financial Services Ireland, and today chief executive of State Street, which employs some 2,000 people in financial services in the IFSC) spoke about it in various radio and television interviews.
We re-publish that article again in this month’s issue (page 8). It speaks for itself.
At the time Slattery warned of an unsustainable credit boom, which threatened to bring the ratio of private sector credit to what he feared might be 140 p.c. of GNP by 2001.

He has now updated the figures in his 2000 article, and the shocking analysis indicates that the explosive growth of credit in 2004, 2006, 2007 and continuing into this year means that in this short 5-6 year period we will have created as much private indebtedness as we have in the previous history of the state, and that private sector credit at the end of this year will rise to as much as 250 per cent of GNP.

Simply put, the Irish economy is currently twice as indebted as it was when he first flagged the issue as a serious problem in 2000, and this indebtedness occurred very recently (during a six year period, which includes the credit crisis period, which began in June-July 2007).

William Slattery writes:
I would like to pick up on the analysis in the original article and place it in a current context. The article was published in Feb 2000 against the background of very high house price and credit growth realised in 1999 and forecast in 2000. In the event growth in both was very rapid in 2000. With the bursting of the TMT bubble, and latterly, with 9/11 and with ECB rates at 4pc, growth in house prices and credit slowed significantly in 2001. At the end of that year house price growth may have actually been negative and the monetary increase in credit was less in 2001 than 2000, contributing to a significant slowdown in economic growth.
Click for large image...

The ECB cut interest rates quite rapidly in response to the slowdown post TMT and 9/11, to 2pc. This reignited house price and credit growth both of which began togrow rapidly.

Figure 1 illustrates the impact of this, focussing on the five years to end 2008.
Concentrating on credit growth, in 2004 this reached €37bn versus end year GNP of €130bn and outstanding credit at year end of €190bn (145pc of GNP). This latter figure compares to something like 110 pc of GNP at end 1999 when the original article was written and was already higher than comparable figures in Scandinavia when their banking system experienced serious problems at the start of the 1990s. The corresponding figures for 2008 will be something like €40bn, €162bn and €400bn (250pc GNP).

The pattern is clear. Rapid growth in annual credit, peaking at €67bn in 2006, which will decline to €35-€40bn in 2008. Despite the decline in annual credit growth, the stock of credit continues to increase reaching 250% in GNP in 2008, a significant proportion of the percentage increase this year being attributable to the virtual stagnation in GNP.

The fall in annual credit creation (a fall in the order of 17/18pc of GNP between 2006 and 2008) is leading to a sharp decline in economic growth and property prices.

This has further to go unfortunately because credit growth will fall to below €20bn in 2010, possibly by a substantial margin. There will be little nominal GNP growth in 2009 so the stock will continue to grow as a share of GNP to perhaps 265pc. This is way above other countries with Netherlands/Denmark being the next highest comparable economy at around 195%. These are very large figures. For example, I believe it would be difficult to find a historical example of higher credit growth in any other country than Ireland experienced in 2006.

There is only one potential mitigating factor, which is that a significant amount of the credit increase in Ireland may have financed investment abroad. There is no credible publicly available information on this, a situation which should be rectified. While this factor may mitigate the severity of this analysis, I do not believe it will result in a ‘new paradigm-type’ outcome.

I believe it would be difficult to find a historical example of higher credit growth in any other country than Ireland experienced in 2006.

The decline in annual credit creation represents the monetary counterpart to a decline in construction output as a proportion of GNP from 23pc in 2006 to something below 8 pc in 2010. Even 8pc implies substantial private sector construction investment in 2010, but this may be optimistic given the surplus of all types of property which will exist when the current development projects are completed. The reality is that lending of about €40bn in 2008 is still high, set against annual GNP of €160bn and is financing the completion of a huge amount of construction of commercial and residential property most of which will not have an end user in the short term. This will lead to a further sharp drop in prices also.

My real concern is how total private sector credit will revert to a normal stock-even 200pc of GNP. As far as I can see there are only three possible outcomes. Either Ireland remains a significant outlier in credit stock or there will be no growth in lending for a significant number of years or there will be a debt write-off of a significant fraction of GNP.

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