In August 2003 the International Monetary Fund said the following about Ireland
“The spectacular increase in house prices and credit raises the risk that prices may unwind, possibly abruptly”
It went on to say that the increases in house prices were outstripping rents.
One question we must ask ourselves is why this warning, back in 2003, was ignored. For example, why did the Central Bank not insist at that time that lending for property development by Irish Banks not exceed (say) 20% of the deposit base? What account did the ECB take of this IMF warning in monetary policy?
But questions also need to be asked of the Irish Banks themselves, and of the other Banks elsewhere in Europe who lent so much money to the Irish Banks to fuel this “spectacular increase in house prices and credit”.
The IMF Report was a public document. The Banks and the Rating Agencies had thousands of researchers available to them to read all the IMF publications, including this one on Ireland.
Yes, of course, it is true the Irish Authorities who ignored this Report by the IMF have a lot to answer for. But so also do those who lent so much money to the Irish Banks, or who gave favourable credit ratings to them, notwithstanding their exposure to prices that might “unwind abruptly”, in the elegant phrase of the IMF. Were they not asleep at the wheel too? Were they not culpable in making the comfortable assumption that there would be “a soft landing”?
In terms of house prices and property loans, Ireland is undoubtedly the worst case in Europe. But the same people who ignored that risk also ignored other major credit risks like the unsustainable large foreign indebtedness of European States, like Greece.
Put simply, the markets did not do their job until it was too late, and then they panicked.
And it is not as if they were not warned.
The European Commission has published a number of alarming reports about the long term sustainability of public debt in European Countries in light of the ageing of our populations and the consequential increase in the pension and health care costs relative to what could be earned by the diminishing population of working age.
It predicted that, by 2O50, the debt to GDP ratio of many European countries, including this one, would reach between 400% and 500% of GDP, if existing policies were not changed. Again, these Reports were publicly available, but the researchers in the Rating Agencies and the Banks seemed to take little notice of them, and probably still do. The US also faces the same problem, and is doing even less about it than Europe is. That is why we will have sovereign debt problems for many years to come.
These problems are simply too big to be ignored, and too big to be tackled by one country on its own.
I listened to former British Prime Minister Gordon Brown on the radio this week. He said that the European Union needs to tackle all its three problems at once. The deficit in the Banks, the deficit in the Public Finances, and the deficit in competitive growth are all part of the one problem. Gordon Brown suggested that they should be tackled together, rather than separately. He is right.
He also reflected on the fact that what is happening today in the banking sector is simply a reflection of a huge change in the distribution of economic power in the world. Since 2000, we in the West have been sustaining and increasing our living standards through expanding credit, while the Emerging Economies have been gaining an ever increasing share of the production of goods and services.
All that the expansion of credit did was postpone, and thereby make more painful, an inevitable reduction in relative living standards in the West. The financial crisis is just a symptom of a deeper change.
Ironically, it would have been better for us if it had happened earlier. It is better for us that it is happening now, than it would have been in five years time, because if we had continued on our previous path , the cuts would then be even greater.
The 27 Heads of Government of the European Union will meet this week to work out a new mechanism to support members of the Euro Zone that get into difficulty. I hope they will not confine themselves to trying to solve part of the problem. They need, as Gordon Brown has suggested, to look at the problem in its entirety. I suggest that they sit together until they have mapped out a strategy to deal in an integrated way with the problems of sovereign debts, banking contagion, and insufficient competition and growth
Daniel Gros, the Director of the Centre for European Policy Studies, has suggested that there be what he calls “a big bang solution to Euro Zone problems” . He says that the fact that loans of the future European Stability Mechanism (ESM) are to be senior to private credit, will make it difficult for any country, that gets funds from the ESM, to raise money privately as well. This is something that should be re-examined.
Another respected economist, Wolfgang Munchau has argued for what he calls a limited fiscal Union. He says that, to sustain the euro, the Euro Zone needs a system to redistribute money in a way that will ensure that the imbalances, that our now causing such difficulty ,do not build up again. We do not need a Transfer Union, as some in Germany fear, but we do need a eurozone system of mutual insurance, for which we each pay a fair fee.
He argues against increasing the existing EU Budget, which does little to solve Europe’s imbalances. Instead he suggests that responsibility for resolving the problems of systemically important banks should rest at EU, rather than at national, level. Arguably Europe’s banks have lent so much to one another, that this makes sense. He also proposes a system of EU wide short term unemployment insurance, and a European Tax on countries that consistently run overlarge deficit budgets. I believe the EU needs a tax base to recapitalize the ECB.
One can argue against the specifics of some of these proposals. But there is no doubt but that we urgently need comprehensive decisions on the shape of the European Union, a Union that will be capable of sustaining and managing a single currency. Now is the time to take the whole issue on, and make the big decisions, once and for all. Ireland needs to take part in these debates, and not just obsess about our own problems. It is in our vital interest that the project of building a better structure for the euro is a success.
There are some who would give up the effort, and some who would like the euro to fail. I believe they are wrong.
The euro is the centre piece of the EU. It is the guarantor of the single market. It harnesses economics to build a structure ot peace and interdependence in Europe. The breakup of the euro is not a good option, as Gordon Brown has recognised. It would open us to the threat of competitive devaluations within Europe. That is what happened in the 1930s. Europe’s stateswomen and statesmen will not allow that to happen again. We have built a structure of peace in Europe, and we are going to keep it.
Of course one will hear arguments from economists, particularly in the south East of England , that single currencies are unviable because it is impossible to agree an exchange rate that suits everybody in different parts of a large Union. But this ignores the fact that the same argument could also be made within United Kingdom itself.
The exchange rate of sterling that suited the South East of England in the 1980’s did not suit the rest of the UK. A strong pound was good for London and bad for Newcastle. I am sure Scotland might even need a different monetary policy to Wales from time to time. But nobody has suggested that therefore the UK should have had two currencies, one for the South East of England and another for the rest of the UK. The same argument applies within the European Union.
In the euro we have to find other ways, apart from devaluations, to deal with imbalances. After all, if devaluation was such a panacea, why has Italy lost ground to Germany over the last twenty years?
The big decisions, that can only be taken at European level, should be made this week, so that uncertainties are removed, and we can build on our strengths.
Here in Ireland we have a remarkably strong export sector, which includes our financial services industry. We have a legal and professional infrastructure to support our financial services that is second to none. We have unrivalled international links, as I have found in my travels on behalf of IFSC Ireland. We have regulators who have learned lessons, and who know that success comes from dealing with future risks, not from re fighting the last war. We continue to improve our competitiveness, faster than almost any other euro area country. Our corporate tax policy has been vindicated. Now is the time for unity of purpose and clarity of vision. Let us get on with it.
Speech by John Bruton, President of IFSC Ireland and former Taoiseach – At the FSI Annual Dinner at the Shelbourne Hotel on Tuesday the 14th December 2010 at 8pm.