Picture owned by u07ch.
My piece in the Wednesday Irish Daily Mail:

So as it turns out, gloomy economists aren’t the only ones who think the Irish government might have to bail out a bank. The Moody’s rating agency has built in the assumption of a rescue [in the unlikely event one is needed, which it is not at present - thank you Financial Regulator for the reminder] into its rating of Irish Life & Permanent - it’s why the bank’s credit rating hasn’t totally cratered.

And the good news is that today’s financial weather featured a clearing to scattered showers of traders jumping from windows, which is an improvement.

Richard Delevan

Yesterday was a bad day for Irish banks, but it could have been worse.

I’m not talking about the late recoveries that saw the ISEQ, heavily laden with Irish financial stocks, trim its losses from 5% to 3.5%. Traders in London and New York noting Dublin’s dramatic early drop – even lower than other European stock markets – could have returned to the story late in the afternoon and seen it magnified by the sudden financial collapse of one of Ireland’s Masters of the Universe, the property developers who have been the celebrated of the last few years. And much, much worse, the government could have hinted that if an Irish bank did go to the wall it would do nothing.

Most of the recent worries about Irish banks has focused on the things that most of us can see and touch: residential mortgages, house prices, and jobs. House prices started slowing their rate of increase about 18 months ago, then they plateaued, and now they are headed downward. At around the same time we saw the first stirrings of what we now call the global credit crunch, which now makes it harder – or impossible – for banks to top up the money they have on deposit in savings with money they borrow from other banks. And the darkened economic picture means that more people will lose their jobs, meaning that more will be unable to meet their mortgages – and those mortgages may cost more than the house they’re paying for is now worth. That’s negative equity – a concept that doesn’t really matter a damn if you’re an ordinary punter with one house, until you find yourself in circumstances, like losing your job, where you suddenly are forced to sell that house.

These are issues that the Bank of Ireland tried to reassure investors about when the bank held its annual general meeting yesterday. The bank’s executives, when they weren’t fending off questions about the chief executive’s €4m pay packet, were letting us know that their residential mortgage portfolio was not showing the signs of weakness many were worried about. None of their 100% mortgage customers were in trouble. Only one house was repossessed this year by the bank. Things were fundamentally sound.

Those concerns – about this ‘perfect storm’ of an Irish property bubble deflating, the Irish economy in recession, and the global credit cruch – were also at the heart of two other signs of weakened confidence in Irish banks. The credit rating firms Moody’s and Standard & Poors (S&P) both issued reports that lowered the outlook for major Irish banks. S&P lowered its outlook for AIB and Bank of Ireland from “positive” to “stable” and for Anglo Irish Bank from “stable” to “negative”. And both S&P and Moody’s lowered the credit rating for Irish Life & Permanent (IL&P).

The reason for the downgrades, in order of severity from IL&P, Anglo Irish Bank, Babk of Ireland and AIB, is their relative reliance on “wholesale funding” – those bank-to-bank global money markets hit by the ‘credit crunch’. The more reliant a bank is on other banks in order to get the cash it uses to make loans for homes, commercial property or business expansion, the more likely – in the opinion of the ratings agencies – to suffer in the coming months.

Northern Rock, the British bank that had to be bailed out by taxpayers, is the poster child for this problem. To a far, far greater extent than any Irish bank, Northern Rock relied on those money markets to get the cash to lend for mortgages. When those markets seized up, so did Northern Rock.

Which makes people nervous about any bank that relies on those markets as a source for funds.

Northern Rock, with its images of long queues symbolising the first bank run in a western country in living memory and the first in Britain for 150 years, still leaves people asking whether it could happen here in Ireland. Could a bank go to the wall? What would happen if one of the banks collapsed?

Such talk is incendiary, and openly speculating that an Irish bank could go bust landed UCD economist Morgan Kelly into hot water earlier this year. But such predictable reactions tend to miss the point.

In fact, buried in the report from Moody’s but spotted by Goodbody analyst Eamonn Hughes was some good news for IL&P. Moody’s left its rating on IL&P at the same level, which was regarded as a surprise. And there was a hint at an explanation:

“We note with interest that one of the factors underpinning the current rating is the commentary at the end of the statement that the Aa3 rating reflects Moodys view that ‘given IL&P’s importance to the Irish banking system, the probability of potential systemic support being extended to IL&P in the case of need is very high’.”

To translate, Moody’s is betting that IL&P is too big, too important to fail. Just like Northern Rock, or America’s “Bear Stearns”, or the Japanese and Finnish banks in the 1990s, or the American savings and loan institutions in the 1980s. The consequences of a failure would be too great for the financial system as a whole to bear, so government would be left with no choice but to use taxpayer money to fund a bailout.

And they’re almost certainly right. If it came down to it, it is inconceivable that Brian Cowen would not instruct the Central Bank to perform its role as “lender of last resort” to provide whatever support was necessary to preserve the integrity of the financial system. The free market is not a suicide pact.

But there are two other points worth noting here. First, contrary to all of the hysterical reaction by vested interests when Morgan Kelly raised the spectre of an Irish bank imploding, such an event is not “unthinkable”. It is sufficiently in the realm of the possible to merit consideration by responsible, professional assessors of risk at Moody’s. Their presumption about the government’s response kept IL&P’s bad week from being catastrophic.

If the government is forced to make a bailout of one bank, our tax money shouldn’t be used to fix the mistakes of others without something in return. That something should be reforms of the banking sector itself.

The first is that the chief executive of any bank which receives taxpayer support should be permitted to earn no more than the top grade of an Irish civil servant – considerably less than the Bank of Ireland chief executive’s €4m.

The second should be to to shift the market towards more stable, long-term fixed rate mortgages, which will reduce the uncertainty so many face every time the European Central Bank does something to interest rates.

Third, we need to weed out the incentives towards investments in property, instead of investments in Irish companies that will create jobs and exports.

None of this here is of course the ultimate nightmare scenario, where more than one bank finds itself in difficulty at the same time. In an event where a lot of Masters of the Universe decide that the highly-leveraged property deals they have been spinning aren’t going to pan out, and suddenly the 28% of money owed to Irish banks by property-related interests looks in jeopardy, that’s not an impossibility.

That week would make this week look like the good old days.

ends