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Thursday, 18th April 2024
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Editorial Back  
Comments from the editor
Oil and wheat will be key

In the midst of the “biggest crisis to hit international banking in 30 years” there is a reassuring simplicity to the pattern of events as they have played out in the past year – although ‘reassuring’ might not quite be the first thing that will occur to anyone who is exposed to over-leveraged assets, particularly property-related assets right now.

Ireland’s international finance sector has been first hand witness to the credit crisis. Now the first major domestic manifestation has occurred - ISTC. Like most other funding crises its root lies in a maturity mismatch. The current ‘heart attack’ in the capital markets is leading to a temporary withdrawal of liquidity in critical maturity related assets, and market conditions are testing the solvency/capitalisation of institutions. There is a period of trial and error going on in what are OTC markets, and the winners will be those who are best capitalised.

This process of trial and error will take time. It has been aptly likened to a play in five acts. First there has to be the write offs, so the end of this year is critical for the biggest players and movers at the top of this pyramid - the global investment banks - Prince, and O’Neal the first dramatis personae. Then there will be the mono lines, and the CLO/SIV/CDO investors, and managers, where Act 2 is staged out. Act 3, will see us return to the original source - the retail mortgage markets. The fact that an Irish credit union has been drawn in is illustrative of how it can rumble through the Irish market.

There are big implications for Ireland; there already has been a first round cut of 20 per cent - 25 per cent in Irish residential property related prices, and there will be a second round - likely not as much, but probably a further 15 per cent.

Irish growth and employment became over-dependent on property in the past five years. The disengagement from this needs to be managed - this should begin in the forthcoming Budget - we have become uncompetitive because of property - now we need budget measures to work on this - public salary and political salary increases are needed like a hole in the head right now. A cut in stamp duty would reintroduce needed mobility onto the jobs market. Spending needs to be curbed, as the panel of leading economists argued in the last issue of Finance, and an increase in income taxes or PRSI would be totally inappropriate.

Meanwhile, there is a credit crisis to manage, by the Central Bank and the Regulator. The good news is they are getting it right. The emphasis is on prudential regulation. That will get Ireland through; better still, it will stand to Ireland’s credit as a centre of good regulation.

London is the biggest financial centre in the world, Dublin is 15th, according to a recent study by the City of London itself. London now is looking decidedly second rate when it comes to domestic financial regulation, thanks in no small part to the handing of the Northern Rock bailout. By contrast, and no small credit is due to Trichet and his colleagues, the ECB has played this credit crisis better even than its US counterpart. Ireland’s Regulator is part of the Euro system - and the benefits of this have already been seen in the (cooperative) handling of cases to date, such as the German conduit problems of the autumn.

In a word, the system is deleveraging. It will all return to normal (albeit with many lessons learnt) when that process is complete. When will that be?

Most likely when the fundamental economic causes of the problem resolve - when proper balance is restored to the price of money relative to the price of tangible goods (most importantly house prices). Central bankers will end the upswing in interest rates that began in January 2005 when they are happy that inflation has been turned down - in the markets that will be when the (still intact at the time of writing) upward trends in the price of wheat and oil are broken. When oil and wheat, the two staples of life, top out - the next upturn can begin.

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