The background was a high-stakes gamble on property that Liam Carroll made with borrowed money, systematically channelled into the black hole known as Zoe Group (the parent company of Vantive Holdings and Morston Investments among others). He had made it big-time during the bubble years but a collapsing property bubble set the stage for a dramatic show-down. An imprudent speculator in many respects, he had the reliable backing of domestic banks, unconcerned for their shareholders but rather more concerned for their political allies and their network of cronies. There was, however, a dissenter in their midst in the form of ACC Bank.

The old “Agricultural Credit Corporation”, privatised in 2002 and bought by Rabobank, had gone astray in the froth of the speculative bubble, along with the rest of the banking sector. They found themselves in the unfortunate situation of having lent a vast sum to a property developer who had gambled away most of their capital through huge losses on speculative property “investments”. Unlike most of their Irish banking peers, ACC Bank have a wary foreign owner to answer to. Rabobank are a triple-A rated bank – a now rare breed of solid global banks – that can boast of a financial stability and a deep capital base they can dip into during leaner times, which is the envy of the global banking sector. It is no wonder that one of their Irish subsidiaries, ACC Bank, with its mounting provisions for loan losses, was proving to be a thorn in their side, and they needed to bring it under control. As a global bank with its headquarters in the Netherlands, Rabobank is reluctant to allow a large part of their Irish loan portfolio to rot away while the Establishment scurries about making deals to protect their own short-term interests.

In contrast, the two biggest lenders to the Zoe Group were far more willing to compromise to avoid liquidating the company. Allied Irish Banks (AIB) is Irish-owned and subject to the pressures of its fellow crony club members. Bank of Scotland (Ireland) is a subsidiary of HBOS and Lloyds TSB which have also proven their lack of aptitude for risk management. Both banks have been rescued from collapse by government bailouts. When Zoe Group finally breached its loan covenants, ACC called time and applied to the courts to liquidate the company. The other banks which had financed Carroll were still in denial about the severity of the problems of Zoe and of the wider property slump in general and focused only on the short-term consequences. Liam Carroll appealed for court protection and, according to an Irish Times article, his justification for this preferential legal treatment of his groups’ €1 billion deficit was a truly remarkable “single page outlining the hope value of his assets and two short sentences explaining the valuations and citing their source“.

Despite the Zoe Group being clearly insolvent and Liam Carroll proving unable to offer any credible plan for long-term survival, the banks were still prepared to support a deal involving examinership (a process akin to Chapter 11 bankruptcy for US readers) and reorganisation to keep Zombie Zoe on life-support – with the exception of ACC Bank. They fought a legal battle to liquidate the remaining value of their loans and were portrayed in the press as agressive.  Finally, on 11 August, the Supreme court dismissed Carroll’s appeal.

Perhaps ACC Bank is playing hard-ball to strengthen their negotiating position and force an offer from the other banks to buy out ACC’s loans on favourable terms in return for relenting on their petition for liquidation. Ironically, their own self interest is also in the interests of the taxpayer. A forced liquidation of Zoe Group companies would ensure that the banks realise the losses on the loans before they become a taxpayer’s liability when they are transferred to NAMA. It must be said, the Establishment, a crony-capitalist club of bankers, developers and politicians (predominantly Fianna Fáil) with vested interests, put up a good fight – as far as the Supreme Court, exhausting all domestic legal remedies. A continuation of legal proceedings and even a hypothetical victory involving the granting of court protection and examinership would have simply delaying the inevitable liquidation the hopelessly insolvent company. Thankfully, the result is a victory for ACC Bank and possibly even a rare victory for the taxpayer.

So, are we to congratulate our Supreme Court for upholding the rule of law for a foreign-owned company just as it would for a domestic one? Well, perhaps. That is the best answer I can give because my suspicions remain that the Supreme Court had their hands tied. Ever since Ireland joined the European Union in 1973, it has been subject to the supremacy of European Community Law which is within the jurisdiction of the European Court of Justice. The Supreme Court judges know that if they had ruled in favour of Liam O’Carroll and against ACC Bank, any appeal to the European Court of Justice would have been overruled. They would have lost much credibility.

Astonishingly, investment bankers now seem to be braving the waters of public fury by striking back at limits imposed on their earnings according to an article in the Financial Times.

It amazes me that these people actually think they are entitled to claim a bonus while their companies are in the process of being bailed out by the taxpayer in an attempt at avoiding financial oblivion. I was obviously naïve in believing that a bonus (in the sense of remuneration) was an additional reward paid to employees if certain goals were achieved or if they performed well according to some measure or benchmark.

Investment bankers and financial traders were paid vast sums simply because of their use of leverage to amplify the result of any financial transaction they made – both positive and negative. Any percentage, however small, of the gains earned by a trade, inevitably amounts to a huge sum when the value of individual trades can reach into the equivalent of hundreds of millions of euros. When a trade goes wrong, however, the bank incurs huge losses thanks to leverage. On what basis can the traders possibly claim to have earned a “bonus” for losing money?

The taxes on bonuses are not fundamentally about seeking revenge on individual traders. The importance of making concessions to public opinion at this critical time should not be under-estimated. This is especially true in countries where the crisis is so severe that no funds are available for fiscal stimulus. The government needs the support of the people to push through tough measures and to raise funds to fight the crisis. A relatively minor penalty on high-earning employees of bailed-out financial insititutions is a small price to pay to garner support.

Yet again, the tactic of using fear to manipulate the decision-makers is used. As reported by the Financial Times, a memo sent by Vikram Pandit, Citigroup’s chief executive tries to imply that a tax on bonuses will cause “talented” people to leave the company and imperil efforts to stabilise the financial system:

“The work we have all done to try to stabilise the financial system and to get this economy moving again would be significantly set back if we lose our talented people because Congress imposes a special tax on financial services employees…”

Well, let them leave! The traders will be fleeing reckless institutions without effective risk control procedures. They will then be at the mercy of the jobs market like anyone else which will hopefully purge some of the incompetence from the system. Don’t forget that the tax on bonuses only applies to banks that have been bailed out by the government. Other, more stable banks that are strong enough to continue without needing government funds would, in my opinion, probably provide a much more controlled environment and would benefit from the “talents” of these traders while minimising risk by controlling their activities.

“Bankers at Deutsche Bank said it could benefit from the proposed legislation by poaching its US rivals’ most talented employees.”

As for the argument that the likes of AIG and Citigroup need these people to restructure their companies – I thoroughly disagree. Speculative traders are not required to unwind risky trades – accountants would do the job perfectly well, even if it means bringing in a government-appointed third party to manage the process. So, call their bluff – cap their salaries and tax their bonuses. Even if they flee, fewer traders would be a small price to pay to win public support for the rescue of the financial system.

Vikram Pandit’s predecessor, Charles O. “Chuck” Prince, III, famously said to the Financial Times in July 2007:

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing…”

A systemically important bank such as Citigroup with an incompetent board that stupidly employed Chuck Prince as CEO, is prime candidate, along with AIG, to be dismembered and have any non-viable units wound-down. AIG and Citigroup, and any other financial organisation that kept “dancing”, are dysfunctional entities that can only increase the threat of systemic risk thanks to their reckless management. Let Schumpeter’s creative destruction kill off the beasts that cannot survive. Their government-assisted survival only serves to weaken and punish other banks that were well-run and increases the tendency towards moral hazard in the long run. An orderly winding-down also avoids the massive disruption of a Lehman-esque bankruptcy. Their extinction would help to create a stronger financial system.

The media in the US seems rather unaware of how mixed the responses to the crisis are in the rest of the world. China announced strong measures which were subsequently understood to be a re-packaging exercise of already budgeted spending. Germany, the economic core of the European Union, has taken a rather conservative approach. France, keen to protect its national champions, offered capital injections to avoid some significant likely bankruptcies. Spain is currently debating whether to significantly increase its budget deficit to stimulate its economy and draw the wrath of the European Commission in the process.

So what is the best approach is to tackle this crisis? It is true that fiscal stimulus is needed to counter a sharp downward swing, but that is a typical counter-cyclical approach. What we are seeing here is the precipitous correction of a huge credit bubble in (mostly) anglo-saxon countries, partly financed by a savings glut in China and elsewhere. Japan has already had to face a similar situation when its asset price bubbles (including Japanese property and the Tokyo stock market) burst in the early 1990’s. Japan entered a prolonged economic stagnation, also known as the “lost decade”, despite huge stimulus measures (although some were ill-conceived). The legacy of that stimulus has led to Japan’s dubious honour of being the world leader in public debt among developed nations- approaching 200% of GDP. Its “lost decade” is now turning into its “lost quarter-century”.

Ireland, although small, presents an interesting case. In a previous post, I addressed the fiscal crisis with regard to Ireland’s public finances. It is accepted wisdom in Ireland that the over-riding priority is to stabilise public finances to maintain the confidence of the markets and to avoid being obliged to seek a bailout. This situation was inevitable due to the huge risky bet – now gone sour – that the country’s banking system collectively placed on the property sector. It is clear that the austerity measures will remove demand, however, Ireland’s economic policy-makers have no choice but to reverse previous policy and harshly cut spending and increase taxes despite the…

… fear of a demand-led collapse if spending were to be cut on a public or private level – thus realising a Keynesian Paradox of Thrift. On the contrary – the collapse is due to de-leveraging of the credit bubble and cannot be stopped. It can only be managed, to moderate its worse effects.

Of course, it will only be possible to determine if this is actually a successful course of action in hindsight, once the crisis has ended. Greece, a small economy with a similar risk profile to Ireland at present (although for different reasons), is taking the opposite approach, as reported by the Sunday Tribune.

Significantly, Greece, whose debt pile is larger than ours, raised €7.5bn last Wednesday from selling long-dated 10-year bonds by paying a huge interest rate. The National Treasury Management Agency here appears unwilling as yet to pay huge premia to raise new money.

They intend to spend their way out of this crisis and they are paying the elevated risk premium on the debt they are currently issuing. Obviously, they will be in  worse shape than Ireland from the point of view of public finances, although it is probable that further bad news from the Irish banks may mean continued fiscal crisis in Ireland and an unavoidable increase in national debt. As is the case with the US, future generations will be burdened with the new debt now accumulating. The Irish approach will mean an even worse recession – approaching levels normally associated with an economic depression, however, it could be argued that the adjustment in Ireland, while difficult, will be swifter and more effective, because it will focus on de-leveraging – the unwinding of the credit bubble.  It remains to be seen which approach will work.

A major flaw, however, is that Fianna Fáil do not lead by example. People on low or middle incomes will resist any cuts unless they feel that all sectors of society are hit and not just them. The privileged should be faced with severe cuts – especially the well paid banking executives and the bank directors that conveniently retired over the last few months with a windfall golden handshake and lucrative pension. Politicians and government ministers should accept particularly heavy cuts to their salary. People who exploit tax-avoidance loopholes should be brought into the fold, and, above all, tax evaders should be prosecuted. If this does not take place, the government will be faced not only with an end to social partnership, but also social unrest on the streets of the capital.

While the pensions levy is only a start, it does send the right signals that the rapidly worsening fiscal problems are being taken seriously and are being responded to. The best case scenario can only be achieved if difficult measures are taken to make a swift adjustment, however, it would still involve a severe economic contraction. If the action taken is inadequate, however, national bankrupcy may be inevitable. A consequential rescue by our European Union partners or the IMF would come with unwelcome strings attached, in addition to even tougher budget cuts and tax increases. A sharp downward adjustment in prices, spending, lifestyles and expectations cannot be avoided – we can only try to manage the adjustment to minimise the pain inflicted.

The high levels of public sector pay and an over-staffed civil service is something from an era of exuberance. During difficult economic times it is a major drain on the exchequer finances. The pensions levy partially addresses this, however, a likely rise in bad debts on the banks’ balance sheets (now guaranteed by the taxpayer) would undo all the efforts so far. More fat needs to be cut. The Health Service Executive springs to mind, however, not a single hospital bed (and corresponding staff & resources) should be cut until all idle middle management, unnecessary expenditure and pointless bureaucracy have been eliminated. Any wasted expenditure identified by the Comptroller and Auditor General should be ruthlessly eliminated.

The spiralling deficit is also due to the collapsing tax take. Ireland has quite a narrow tax base and this is now proving to be a major disadvantage. The tax base should be broadened. Perhaps a property tax (at least on those with two or more properties) would be a first step in the right direction. No longer should property be an untouchable asset class for speculators. As for corporation tax, it would be rather difficult to increase that. Ireland has nurtured a vast swathe of foreign direct investment from US companies that suckle at the nipple of predatory corporate taxation. They are not easily weaned without the risk of capital flight of a more fundamental nature. Our low tax, low public services society has created an unfortunate dependency on fickle foreign investment.

The good news is that, luckily, Ireland entered the crisis with relatively healthy public finances including low government debt, so there is some scope for borrowing to cover the deficit in the short term. The bad news is that it will be very difficult for Ireland to successfully raise the billions needed to the plug the hole in the public finances by selling government bonds. As so many “developed” countries will also be looking to the markets to finance their budget deficits more or less simultaneously, the markets will demand high interest rates to buy the (now relatively risky) Irish bonds. This is why the spending cuts (including public sector pay) will have to be all the more stringent.

I do regret the unjust nature of the cuts such as the pensions levy that uniformly hits all without considering pay levels. It only reinforces the profound inequality that exists in modern Ireland. We should remember, however, that equality is not what Fianna Fáil and their cronies have come to represent. Let them clean up the mess they created – afterall, they know best where the dirt lies. A time will come when the green shoots of recovery finally beckon us to close the chapter on a reckless gold rush and place our trust in new leaders. Hopefully, a more just society will be waiting for us when we re-emerge on the other side – with a different government. For now, however, we must choose the bitter pill that only Fianna Fáil can deliver.

In a sharp exchange, O’Toole accused the government of not pursuing the 1% top of earners who, more than likely, have their wealth hidden in off-shore tax havens. He also highlighted the injust tax system which effectively subsidises landlords (on top of the feeble tenancy rights in Ireland). While this kind of thing is going on, I can understand why public sector workers are not willing to accept the pension levy that the government is pushing through parliament. At a time when the government should be leading by example, they are protecting hidden billions of the rich, the landlords, and possibly themselves too.

The response by Cullen, consious of his audience of thousands of TV viewers, was typical  of the manner in which aloof politicians use free market economic theory, completely out of context, to scare ordinary people into submission. His argument is one that deserves a prize for practically mocking his audience for not having a degree in economics -

“You can’t at one swoop of a pen, remove all incentives that disaffect mobile investment out of this country. You have to compete in a global market for mobile investment.”

O’Toole, of course, made the point that landlords and rent is not derived from mobile investment. I would imagine that the problems associated with tax havens could be addressed with some sensible legislation requiring financial organisations to disclose more information, allowing government departments to share more data, and by encouraging the tax authorities improve their administrative and investigative processes. A bit of background is useful, however, to understand the impact of this statement on an Irish audience….

In the 1980’s, as today, the country was in a financial crisis. The difference was that, at the time, the crisis was due to economic stagnation and lack of developement – unlike the imploding credit and asset price bubble that is taking down the country today. Reforms were put in place to create an attractive corporate environment, the centrepiece of which was a sharp reduction in corporation tax, and an agressive promotion policy to attract foreign direct investment from the United States. Ireland enjoyed an economic boom (which was sustainable until the early 2000’s) thanks largely to low tax. The Irish people understand the power of using the tax system as an economic tool and have accepted this as unquestionable economic doctrine.

In Ireland, politics tend to be rather right wing with the result that the “centre” of Irish politics is comparable to the Democratic Party in the United States, and far to the right of centrist politics in other Western European states. Incumbent politicians in Ireland, having seen how effective George Bush’s “War on Terror” has been in controlling the people of the US, have invented their very own War on Economic Terror based on the right wing, free-market policies of the dominant Irish political parties. This was made possible by exploiting people’s ignorance of the mechanics of the free market and their firm belief in liberating the free market and preventing state intervention. The abuse of economic theory includes invoking fear of a demand-led collapse if spending were to be cut on a public or private level – thus realising a Keynesian Paradox of Thrift. On the contrary – the collapse is due to de-leveraging of the credit bubble and cannot be stopped. It can only be managed, to moderate its worse effects.

As a rational person, I am not in favour of terrorism in a democratic society. I strongly disagree, however, with the way politicians label any person having a suggestion that involves sustainability, economic prudence, tax reform and sensible regulation, as practically being an economic terrorist. There are people that have rather extreme left wing ideologies that would be rather damaging to implement, however, even middle ground – the centre of the economic spectrum – is choked. Until only a few months ago, it was taboo to utter any remark in public that suggested that the house price boom was a bubble and was unsustainable – they were “talking down the market”. Anyone hinting at sensible regulation or sustainable economic policy was branded a socialist or worse. Victims of this treatment included Morgan Kelly (“Dr Doom”), an economist from University College Dublin, and RTE’s Economics Editor, George Lee.

To refer to the quote of Bertie Ahern, Taoiseach (Prime Minister) of Ireland from 1997 until 2008, when he famously complained about people who warned about the consequences of the government’s consumption-based bubble economics:

“Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide“.

I rest my case.

We’ve come to learn, over the past few months, that banks are not typical businesses. They are basically huge conduits for distributing capital from savers and investors to other business that need to borrow in order to grow, for example, by financing the purchase of new equipment or facilities. As they are the trusted ones who manage the lifeblood of modern economies, they are critical to our economic welfare.

Private regulated entities

Western economic policies assume that private entities are more efficient and effective at distributing capital compared to governments or public agencies. While this is probably true, especially if we consider cases from the past, it does not preclude the importance of strict oversight of these businesses. Free market principles may lead us to believe that, as banks are businesses, they should be left to manage their own activities freely – that government intervention is not desirable.

On the contrary;  due to their critical importance to the economy and the systemic risk to it if they fail, intervention is necessary, at least at a regulatory level. If the state obliged to step in and bail out banks in the event of a crisis, the banks bear special responsibilities and should concede to more transparency and restraint.

Shareholder pain

The owners of the banks, its shareholders, gain handsomely during times of economic growth. In a normal, cyclical economic downturn, their gains are reduced in terms of lower dividend payments and lower share prices, however, this would normally recover once the economy recovers. The financial crisis of 2008/2009 is not, however, a typical cyclical economic downturn – see review here. Instead of a downturn and corresponding fall in bank share prices, some banks have collapsed and others are on the brink.

The lack of effective oversight from financial regulators have given banks the freedom to speculate excessive amounts of capital in risky asset classes including various types of derivatives, subprime mortgage-backed securities and collateral debt obligations. The unexpected fall in stock markets means that banks are now suffering from large losses on their balance sheets. Banks are required to maintain certain capital adequacy ratios, and their shrinking capital bases results in non-compliance with these minimum ratios.

To increase their capital, they issue new share either to private investors or the government. Issuing new capital effectively decimates their profits (or more likely increases losses) in the case of an issue of preference shares with high interest rates, or dilutes existing shareholder value by issueing new ordinary shares.

Bank shareholders, therefore, have suffered like a shareholder of any company would. Many of us would not feel any pity for shareholders, however, we are all affected by drops in both public and private pension funds. We are all shareholders in some sense.

Banking casualties

The list of banking casualties of the crisis reads like the who’s who of global finance:

Bankrupt, nationalised or forced into acquisition

Bailed out or at risk of collapse / nationalisation

Also the Icelandic banks Glitnir, Landsbanki, Kaupthing, although relatively small, have the dubious honour of being the main actors in the ongoing crisis in Iceland – the largest suffered by any country in economic history relative to the size of its economy.

Another banking collapse worth mentioning is Anglo Irish Bank in Ireland – primarily a lender to property developers and construction companies. It was nationalised following a staggering fall in their share price and lack of confidence in them by the financial markets. Read more here.

The Privileged Class

The privileged class is not shareholders, but bank directors, board members and top executives who continue (apart from Lehman Brothers) to receive exorbitant salaries. Even in the few cases where these have been cut and bonuses eliminated, they know that the cutbacks are temporary and will continue in the realistic expectation that their fat pay cheques will be restored in the future. Only in a few cases have bank directors, board members and top executives they been dismissed from their positions. This privileged class wins handsomely in good economic times but is not sufficiently penalised in downturns due to the systemic importance of banks and the government’s (understandable) reluctance to allow a major bank to collapse.

Fallout

The double impact of the need to preserve capital and the reluctance to lend to other banks in fear of possible toxic assets that they may hold on their balance sheets has frozen lending throughout the economy. Business need capital for expansion, as mentioned above, so there is medium term impact on economic growth. In many cases, some solid business need access to short term finance for its working capital to fund normal daily operations andsatisfy maturing short-term debt. Suddenly finding that they have no access to capital, companies have responded by cutting back on investment, laying off staff, and, increasingly, by declaring bankrupcy. The economic impact from the financial crisis is massive.

See also an article about where the responsibilty lies here.

The massive level of house construction in Ireland relative to the size of the population (4.5 million) was even greater, relative ot the size of the population, than other countries that experienced property bubbles. It has left Ireland with a huge unsold stock of housing that now lie empty in “ghost” estates. Many Irish property developers are on the brink of bankrupcy which would result in them defaulting on their loans to the banks.

Ireland does not have large, internationally diversified banks such as Santander in Spain. The balance sheets of Irish banks are concentrated one small market and are filled with toxic loans to property developers. The impact on them was, therefore, much more damaging. The smaller banks such as the EBS, Irish Nationwide Building Society, etc. were hit even harder than their bigger counterparts such as Allied Irish Banks, Bank of Ireland and Irish Life & Permanent (which owns PermanentTSB). A notable exception was the collapse of the scandal-ridden Anglo Irish Bank.

Now that the Irish government has nationalised Anglo Irish Bank and guaranteed all deposits (retail, commercial, institutional and inter-bank), covered bonds, senior debt and dated subordinated debt, it is the taxpayer who will suffer the consequences. The ever-increasing estimates of the Irish government budget deficit will appear trivial once the construction industry collapses, home repossessions rocket and the bad debts of of the banks are assumed by the government.

Large investment funds which had stakes in Anglo Irish Bank are considering legal action to recoup their losses from the bank’s owners i.e. the Irish State. There maybe a valid legal basis to take action as reported by the Sunday Tribune:

Dr Deirdre Ahern, law lecturer at Trinity College Dublin, said that a possible breach had taken place of Section 60 of the Companies Act 1963 which, subject to some exceptions, prohibits the giving of financial assistance by a company for the purchase of its own shares unless this has been approved by all shareholders.

“There may also be an issue under the Market Abuse Regulations 2003 and Part 4 of the Investment Funds, Companies and Miscellaneous Provisions Act 2005 which regulate insider dealing and market manipulation and provide for both civil and criminal liability,” she added.

One memorable phrase that was sums up the situation is “economic treason”, used in comments by Senator Dan Boyle and Irish Congress of Trade Unions general secretary David Begg. The political infighting over the controversy about share price manipulation by Anglo Irish Bank comes amidst a property price collapse, a spiralling government budget deficit and a growing fear of default on Irish government sovereign debt which is now rated as riskier than Italy, Greece.

Financial regulators appear to have been to be impotent onlookers in the monetary boom and bust of many developed countries, and not the strong authoritative pillars they were meant to be. Any financial regulator or central bank chairman who are proven to not have acted upon information received about excessive risk taking by the sector under their oversight,  or even if they did not adequately investigate and monitor the sector, should, in my opinion, be held legally responsible.

United States

The monetary expansion of the past decade in the US was substantially aided and condoned by Alan Greenspan, the former chairman of the Federal Reserve. He held the post during 18 years which proved to be enough time to instutionalise a loose monetary policy of low interest rates and cheap capital despite much evidence of successive bubbles in asset prices such as stocks and property. He justified this by his belief in self-correcting markets and an upwards shift in in the level of sustainable economic growth and higher productivity for a variety of reasons such as increased investment by business in computer systems.

In the US, besides Alan Greenspan, another prime candidate is the Securities and Exchange Commission and its former chairman, William H. Donaldson. He introduced rules to substantially reduce the requirements that large investment banks were subject to. He also decided to rely on the computer models of the very banks the SEC were meant to monitor to determine the riskiness of their investments. While his successor, Christopher Cox, introduced many positive reforms, they were not strong enough to undo the damage done by his predecessors or reduce the risk of the leveraged boom in toxic securities that was underway. His subsequent reaction to the beginning of the crisis in September 2008 was relatively ineffective. They were appointed by the former US president George W Bush.

Here’s a video that describes how toxic assets were created. It’s really incredible that the Federal Reserve and Securities and Exchange Commission allowed this kind of thing to go unchecked!

The Crisis of Credit Visualized from Jonathan Jarvis on YouTube.

United Kingdom

The UK duo of the Bank of England and the Financial Services Authority were notably ill-coordinated in their response to the financial crisis. This became evident with their tentative handling of the collapse of Northern Rock and the ineffectiveness of their bank monitoring procedures despite the prior warning signals. The combination of poor regulation, the large size of its financial services sector, and the existance of a property price bubble (almost as extreme as Ireland’s) has resulted in severe strain in the stability of the UK financial system. There were very few controls on banks speculative investments in toxic assets. The pound sterling has suffered major falls against most major currencies.

Switzerland

The Swiss bank, UBS, and the Swiss reinsurer, Swiss Re, seem to have had free reign to invest any amount of capital in any class of assets. As a major global financial institutions based in a relatively small country, they have the potential to be a destabilising force for Switzerland. The recent downturn of the Swiss Franc may prove to be a sign that Switzerland is losing its status as a safe haven in times of international financial turmoil.

Austria, Italy, Belgium

The financial regulatory authorities of Austria, Italy and Belgium did nothing to react to the issuance of large amounts of , euro-denominated debt to borrowers in countries of Central and Eastern Europe. While this is normally benign, if the currencies of the respective countries is hit on financial markets, the debt becomes ever more expensive for the borrowers to service. The borrowers receive income in their own currencies, however, they must repay the debt in euros which is currently strengthing relative to those currencies. The banks at risk include Erste Bank, Raiffeisen Bank, Societe Generale, Unicredit and KBC Bank .

Ireland

A special mention goes to Patrick Neary, until recently Chief  Executive of the Irish Financial Regulator, and his predecessor, Liam O’Reilly, who held the post from November, 2002 until December 2005, along with all the board members of the Central Bank of Ireland from 2002 until 2007. During their terms, there was huge growth in mortgages that were excessive compared to combined salaries of house buyers, in addition to an explosion of speculative lending of banks to property developers and construction companies. Both were substantial factors in one of the most extreme property bubbles in the world and no effective action was taken to restrict these activities. Patrick Neary was recently forced into early retirement – a convenient move by his political appointees.

Bank directors, board members and top executives

Considering the systemic risk of collapsing banks to the entire country’s (and world’s) economy, the possibility of taking legal action should be investigated. Bank directors, board members and top executives have a duty of care to their stakeholders (including the state) which is not compatible with the unreasonable profligacy and risky speculation with depositors’ and investors’ funds that took place. Those who are proven guilty of mismanagment and breach of duty should bear legal responsibility.

People that should be investigated by law enforcement agencies include top management and board members of the following companies: In the United States – AIG, Merrill Lynch, Lehman Brothers, Bear Stearns, Washington Mutual, Countryside and Wachovia. Elsewhere – Anglo Irish Bank and many more. You many think that it is only natural that a commercial organisation, with its shares quoted on the stock market and subject to the whims of shareholders, should aim to maximise profits – except that banks are not normal companies.

Action?

If we are to discourage the kind of behaviour that led us into this mess, the people responsible should be charged with negligence on a national scale.

Governments

The state’s executive, or the government, is usually responsible for appointing the head of the country’s financial regulatory authority. While much blame lies with the government, it must be remembered that it is the people of the country who choose the politicians from whom the government is formed. It is a major disappointment that the people themselves – the electorate – repeatedly voted for the politicians who led us into this crisis. An elected official who becomes comfortable in their position does not tend to actively defend the interests of the people. It becomes too tempting to aim for short term gain to increase chances of re-election at the expense of long term prosperity and well-being.

United States

George W. Bush was voted in twice in succession by the people of the United States. I would not consider him to be the most exemplary of presidents a country could have. His appointees have overseen the spread of subprime lending and the unregulated derivatives market. The US financial system is now in severe distress and its economy is contracting.

Ireland

Fianna Fáil has been main party of coalition goverments of Ireland since 1997, having been repeatedly re-elected, and have, rather forcefully, consolidated conservative politics in Ireland. A prominent member of Fianna Fáil , Bertie Ahern was Minister for Finance and subsequently Taoiseach (Prime Minister) at the time when damaging stimulatory policies were either put in place or extended without adequate checks and balances. In April 2006, at the peak of the property bubble, he made this comment, as reported by Finfacts Ireland:

“Really we should have an examination into why so many people got it so wrong. My view is there’s not a great problem. Really, the bad advice of last year given by so many has maybe made some people make mistakes, that they should have bought last year.”

He and his party have squandered an impressive economic boom that has now faded. Ireland is currently suffering from fears that it may default on its national debt thanks to the effects of a collapse of a huge speculative property bubble.

Following the collapse of the Dot-com bubble in 2001, Alan Greenspan, chairman of the Federal Reserve at the time, dropped interest rates substantially to cushion the impact rather than let the market imbalances correct themselves. This monetary expansion resulted in excess liquidity in the markets that eventually found its way into oil and commodity speculation and, of course, property.

Many countries experienced similtaneous property bubbles over the last decade. Property prices inflation had deviated substantially from its long term corrolation with average earnings. In many cases, such as the extreme property bubble in Ireland, justifications were invented such as demographic trends (temporary and dependant on economic conditions) and the notion that  prices were catching up with European averages (this had no-longer been the case since about 2002).  The eventual bursting of the US property bubble in 2007 exposed the financial system to the fallout of subprime mortgages which had been packaged up and sold on to buyers on the global markets.

Typical risky mortages on offer were characterised by lending an amount more than 100% of the value of the property and even paying a token amount interest thereby increasing the principal over time.  Often, mortgages were granted to people with high financial risk profiles without the means to repay them. Financial institutions such as the US government sponsored enterprises, Fannie Mae and Freddie Mac, investment banks, and other financial institutions packaged up these mortgages and sold them on to buyers on international markets. These securities, referred to as mortgage-backed securities and collateralized debt obligations, were complex and poorly regulated.

The financial crisis of late 2008 had a domino effect on many other countries and markets. It was not responsible for the collapsing property prices elsewhere, as this was only matter of time,  but it was the catalyst that finally burst other bubbles. Property bubbles in the UK, Ireland, Spain and several other countries began to collapse. The substantial levels of personal debt such as car loans and credit card debt, that was typical of Anglo-Saxon countries such as the US, the UK and Ireland, is now becoming a major issue.  The financial crisis of 2008 has turned into a more general economic crisis in 2009 with no end in sight.

Consumption patterns national current accounts

Wide imbalances have manifested themselves due to relative consumption patterns of various countries. The most notable deficits are those of the US (over US$730bn), Spain (over US$140bn) and the UK (over US$100bn). The most notable surpluses are of China (over US$370bn), Germany (over US$250bn), and Japan (over US$210bn). Relative to their small size, Portugal, Greece and Romania have excessive current account deficits.

US consumers have been living beyond their means for quite some time, depending on funding from China in particular. In turn, China, Germany and Japan have weak domestic consumption and depend on the US consumer to purchase their products. The current crisis will cause a reverse of the consumption patterns of US consumers as they try to repay debt and save for uncertain times. Chinese, German and Japanese exporters will suffer from weak overseas demand.

Eurozone adjustment

Another imbalance was the adjustment (still) taking place by European countries that adoped the new single currency – the Euro. While in the long term, eurozone countries have and will continue to benefit enormously from the advantages of the single currency, the initial adjustment was not seriously planned for, especially by countries on the periphery of Europe. Countries such as Ireland and Spain experienced a substantial drop in interest rates which proved to be an enormous monetary simulus. They did not modify their fiscal policy to counter this by increasing taxes or reducing public spending. The surplus capital in those countries drove up asset prices and manifested itself in huge property bubbles. A huge percentage of their economies became dependent on construction. The inevitable bursting of the property bubbles is now causing severe economic contraction.