| Managing a burst financial bubble |
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| Joe Carr says that Ireland’s reasonably robust financial services sector gives it a sound base for moving ahead in the coming years |
We are now 12 months into a series of crises which have engulfed capital markets and threatened the world economy. These events have at heart a cause (or more precisely, a number of causes, including: bad credit management, the use of financial technologies to transfer poorly judged risks, over-reliance on an unchallenged ratings system and, in places, ineffective oversight) and effect, the most serious of which is perhaps an erosion of confidence in the financial services sector among industry participants, consumers and enterprises.
In the short term a key question is the length of time it will take for trust to be reborn in the financial sector. The existence of this intangible is essential not only to the reopening of normal market activity, but also to the ability of the banking sector to continue to provide the global economy with the liquidity that is its life-blood. In my view, confidence can be restored by the banking sector if it embraces an investor demand for a renewed level of simplicity and transparency in transactions (something which was lost in the heady days before the first sub-prime losses) and by bankers being brave in supporting lending to strong business propositions, rather than surrendering to a knee-jerk reaction to restrict all activity.
The financial sector faces another serious challenge, one which is currently being given serious consideration by the Fed - how to manage a bubble? Recent policy, shaped by Alan Greenspan, takes bubbles as given, inevitable, and until they burst, unmanageable. The thinking is reportedly now moving in the direction of developing a more anticipatory approach by monetary authorities. If this happens it will represent a fundamental shift in philosophy towards the thinking of the late American economist Hyman Minsky, who emphasised the inherent instability of financial systems and the need for public authorities to counter this tendency, rather than wait for inevitable bubbles to burst.
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Facing up to responsibility
This is a considerable challenge and one that faces all participants in the financial services sector. If it behoves governments to better regulate and supervise the innate tendency of ‘free’ financial markets to oscillate between the exuberantly irrational and the ‘black dog’ of financial recession, it also requires the financial services industry to support and assist them in this project in a meaningful way.
?Asset bubbles are not a natural phenomenon, they are a function of individual and corporate behaviours. The financial sector needs to face up to its responsibility to manage these events, enhancing the sustainability and in the long term, profitability of institutions. Good governance and clear financial reporting are obvious elements in this regard. I believe that good governance is not exclusively the preserve of audit committees, auditors and back office teams, industry leaders also need to seriously consider the balance of reward systems with the risk positions that institutions take and look to build a longer term view into
those systems.
The last short-term unknown is the question of how long it will take for affected businesses (and by extension markets and economies) to get back on a growth track. A study of previous bubbles shows that the aftermath can continue for quite some time. I think it likely in this case that we will continue to feel the effects for a period of up to three years from now. We need to plan prudently for the development of the financial sector against this backdrop.
I believe we should also acknowledge that volatile and difficult times provide opportunities to some; downward cycles always end with the beginning of another positive cycle.
Planning for a challenge
In the medium to longer term the prospects for the Irish Financial Services sector appear to be more robust. Inherent in the ESRI medium term review 2008-2015 is a clear challenge: if we are to achieve the kind of employment levels predicted, we will need to continue to place ourselves in the forefront of innovation and excellence in the financial services sector. This will need to happen on a scale far greater than currently and as a consequence of such scale, we are likely to make ourselves the subject of competition from the bigger European economies with expertise in this area. I believe however that this is a challenge which the Irish Financial Services sector should continue to pursue in a careful and planned way. Our financial services sector has been shown to be reasonably robust by comparison with that in some other countries and I believe this gives us a sound base for moving ahead in the coming years. |
Joe Carr is managing partner at Mazars.
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| Article appeared in the August 2008 issue.
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