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Use The Mirror

Michael Hennigan

The Irish Economy Blog www.irisheconomy.ie began in 2008.



In November 2008, Queen Elizabeth reflected a common public reaction when having been given an academic briefing on the origins of the international credit crunch which broke out in August 2007, she wound up the “lesson” by asking why nobody had seen the crisis coming.

The queen had the main aspects of the global financial crisis explained to her by Prof Luis Garicano during the inauguration of a new building at the London School of Economics (LSE). Prof Garicano, director of research at the LSE’s management department, said afterwards: “The Queen asked me: ‘If these things were so large, how come everyone missed them? Why did nobody notice it?’” When Garicano explained that at “every stage, someone was relying on somebody else and everyone thought they were doing the right thing”, she commented: “Awful.”

Last January, Robert Shiller, an economist at Yale, observed that America was in the midst of a boom in popular economics: books, articles, blogs, public lectures, all followed closely by the general public. And this had happened, he wrote, at a time when the general public seemed to have lost faith in professional economists, “because almost all of us failed to predict, or even warn of, the current economic crisis, the biggest since the Great Depression”.

The sudden transformation of the Irish economy from boom to bust has left many bewildered and frightened and has produced a similar boom in the consumption of popular economics by the public. The late Garret FitzGerald was the first Irish economist to write regularly for a general audience through a column in The Irish Times from the 1950s. However, with his passion for statistics, FitzGerald should not be seen as an antecedent to the modern genre of “celebrity economists”, in whose work the emphasis is on opinion rather than fact, inconvenient truths or topics likely to alienate sections of the public audience are avoided, and hugely consequential proposals are floated without detailing the downsides or the process of implementation.

Consider, for example, the almost casual recommendations that Ireland should unilaterally default on its debt or exit from the euro without an agreed withdrawal mechanism. Such courses would be likely to create mayhem, involving collapsed banks, local firms shut off from overseas supplies and an economy which is dependent on foreign firms for 90 per cent of its tradeable exports exposed in a period of profound uncertainty.

It is rare for a people to look in the mirror and accept that they have played some part in a national calamity. Both in politics and in economic commentary it seems more convenient to narrow the focus for blame to politicians in power, bankers and regulators. Reform throughout society is a less digestible concept. Commentators with a grip on the public megaphone are generally in comfortable positions despite the recession and support the status quo. Our society remains a conservative one where, when change occurs it is at a glacial pace and where traditional trade unions appear to have a tacit understanding with wealthier players on the right of the political spectrum to avoid advocacy of change and fundamental reforms. That few journalists in the Irish broadcast media have the knowledge of economics and command of the facts required to challenge spoof is another factor. This was the situation in Ireland during the bubble times and the change in the interval has been marginal.

Two months after the collapse of the US investment bank Lehman Brothers and the issue of the blanket bank guarantee by the Irish state to cover debts as well as deposits, Prof Philip Lane, head of the Department of Economics at Trinity College, launched The Irish Economy Blog (www.irisheconomy.ie). It has since become a popular platform for academics and non-academics to debate current economic issues. Strikingly, the level of interest or non-interest in issues of national importance on the blog appears to mirror that of the Irish public as a whole. For example, in recent posts, the “CSO House Price Index” got nine comments; “Mortgage Arrears” got ten; “Access to Finance” on bank credit eighteen; “Death of Garret FitzGerald thirty-nine” and in March, the Live Register figures prompted only thirty-seven comments. On the other hand, Prof Morgan Kelly’s Irish Times article excited six hundred and nine responses, while an article in late 2010 advocating unilateral default by Prof Brian Lucey got over five hundred comments.

The Irish Economy blog publishes economic facts not commonly available in the general media. However, there are facts and facts.

Paul Krugman, Princeton University economist and New York Times columnist, wrote in 2009: “In a 2007 interview, [conducted in November 2007, eight months after the outbreak of the subprime housing crisis] Eugene Fama, the father of the efficient-market hypothesis, declared that ‘the word bubble drives me nuts’, and went on to explain why we can trust the housing market: ‘Housing markets are less liquid, but people are very careful when they buy houses. It’s typically the biggest investment they’re going to make, so they look around very carefully and they compare prices. The bidding process is very detailed.’”

Facts are very important, and Prof Fama of the University of Chicago was ignoring the then known facts about the subprime mortgage finance crisis and the packaging of junk mortgages by Wall Street banks for sale around the world.

Fact-checking is a hassle which is often avoided by commentators and pundits. Received wisdom, on the other hand, is commonly accepted as fact. Last November, Thomas Friedman, the New York Times columnist, wrote that Anderson Cooper did the country a favour when he expertly deconstructed on his CNN show the bogus rumour promoted by right-wing critics that President Barack Obama’s trip to Asia would cost $200m a day. Friedman wrote:

When widely followed public figures feel free to say anything, without any fact-checking, we have a problem. It becomes impossible for a democracy to think intelligently about big issues ‑ deficit reduction, health care, taxes, energy/climate ‑ let alone act on them. Facts, opinions and fabrications just blend together.

But the carnival barkers that so dominate our public debate today are not going away ‑ and neither is the Internet. All you can hope is that more people will do what Mr. Cooper did ‑ so when the next crazy lie races around the world, people’s first instinct will be to doubt it, not repeat it.

In May 2007, Bank of Ireland chief economist Dr Dan McLaughlin told a conference of housebuilders: “In Ireland there has been a spate of forecasts projecting a slowdown in growth, but in truth most of the current macro-indicators, (including retail sales, industrial production, foreign travel and unemployment) do not suggest any softening in the pace of growth. Consequently, I still expect 6% growth in 2007, easing to 5% in 2008.” McLaughlin added: “Indeed, there are a number of economic viewpoints about the Irish economy which are often voiced but have little in the way of support from the facts. One often hears that growth is unbalanced but a glance at the data from 2001 to 2006 shows average GDP growth of 5.3%, with all components growing in a 4.5%-5.5% range. Others complain that too many resources are being devoted to consumption but consumer spending in Ireland amounts to 46% of GDP which is not only below the eurozone norm (55%) but has fallen steadily for the past forty years. Household savings in Ireland is also relatively high (at around 10% of household disposable income), which is similar to Germany and substantially above the UK (5%) and the US (zero). This also means that many people benefit from a rising rate environment but this view is also rarely heard.”

So, “ ... little in the way of support from the facts”? Academic economists left the public arena to the bank economists and McLaughlin appeared in the broadcast media without fear of challenge from journalists or other economists. The facts he ignored showed that the economy was absolutely unbalanced: annual credit growth was at 30 per cent; reckless bank lending was fuelled by foreign loans: bank debt to foreign banks had been 10 per cent of GDP (gross domestic product) in 2003 and was heading for over 60 per cent in 2007; there was no jobs growth in the exporting sector, while over 400,000 new jobs were created in construction, the public sector, retail and distribution; Ireland in 2007 ‑ a small country reliant on foreign firms for 90 per cent of its tradeable exports ‑ had the most expensive housing in the developed world, with floor areas per person a fifth less than the Western European average.

While only a minority of academic economists may have supported the drift of public policy, the reticence of most of the majority to speak out possibly reflected a reluctance to be seen as controversial. On the Irish Economy blog, there is evidence at times of excessive politeness in discourse between academics. During the bubble, economists at the Economic and Social Research Institute (ESRI) for example shied away from upsetting politicians. Perhaps they viewed challenging bank economists as entering the grubby commercial arena. It is interesting that it was a Canadian, Prof Paul Gorecki, who stood his ground against ministerial and other critics in response to the ESRI report on the Poolbeg incinerator. It might also be pointed out that a critic would have to be prepared to forgo official recognition and handy earners through the extensive insiders’ web of memberships of public boards, commissions, quangos, task forces and review bodies.

Last December, on the second anniversary of the launch of the Irish economy blog, Prof Lane said that visitor traffic fluctuated with the level of interest in the Irish economy: November, the month of the EU-IMF bailout, was a record with 261,000 visitors (567,000 page views). The cumulative total over the two years was 1.89 million visitors (4.67 million page views). Total visits to May 20th this year were at 2.56 million and an average of 3,740 per day; total page views were at 6.17 million and an average of 8,077 per day. There are about thirty contributors, mainly at professor level, who can open threads, but less than a third do so. Engaging with sometimes ignorant anonymous non-academics may not be their cup of tea; some perhaps have little enthusiasm for the web, and, as was common in bubble times, some may have no interest in public commentary. A small number of economists at the Economic and Social Research Institute (ESRI), where there are no students or lectures, make intermittent contributions. (Contributions from the public should perhaps be welcome as academics commonly have a narrow experience of the world, and in particular, where both members of a couple are working, their lives are materially comfortable. Opinion poll pioneer George Gallup understood the correlation between income and an individual’s opinions.)

Irish Times economics editor Dan O’Brien, commenting last October on the annual gathering of Irish economists at Kenmare, wrote that

there was no consideration given to the state of the labour market and the State’s unusually high rate of unemployment.

These issues were not on the programme. They did not come up in discussion, either at the sessions or in the informal chats this writer had with participants. That those who know most about the functioning of labour markets show no interest in the crisis in the Irish labour market is ‑ to be blunt ‑ shameful.

The blog would also seem to indicate that despite the impact on the lives of tens of thousands of people of the economic crash, academics still shy away from challenging the status quo in their own institutions. By way of contrast, minister for education Ruairí Quinn said in his tribute to the late Garret FitzGerald that he had first met him in the 1960s, “when he was a junior lecturer in the economics section and I was a probably fairly obnoxious architectural student in UCD’’. An occupation of UCD had taken place on the grounds that students were dissatisfied with the education they were receiving. “We confronted the university authorities with the inadequacy of their own institution and he supported us in that particular struggle, even though one of his family was intimately involved on the other side,’’ Quinn added. Similar behaviour from today’s Irish insiders would be a surprise.

The subjects which have attracted most attention on the blog have been the establishment of the toxic property loans agency, NAMA, and in recent times, the aftermath of the EU-IMF bailout/support programme. As with the national debate, the search for foreign scapegoats elicits much more enthusiasm than the task of fixing broken systems at home or ending the stranglehold of powerful vested interests. In May this year, an article by Prof Gary O’Callaghan on the ECB’s role in the Irish crisis had this gem: “First, the causes of the crisis include the nefarious activities of a few individuals but are mainly comprised of mistakes by honest people who were lulled into complacency by an incomplete understanding of the new European monetary system.” In fact the Irish Central Bank had publicly declared its impotence in 1997, two years before the launch of the euro, and engaged in futile pleading for restraint from the banking sector as fiscal policy fuelled the boom. In contrast, Spain’s biggest banks survived a huge housing boom because the Spanish central bank insisted on additional “rainy day” ‑ provisioning during the good years and other risk controls. Both countries were in the euro system from the start. O’Callaghan’s thread had one hundred and eighty-three comments. Simply, the argument was that our problems could overwhelmingly be blamed on the euro system and the European Central Bank (ECB).

The first of the two examples of monumental mismanagement that wrecked the lives of tens of thousands of our citizens in a generation happened from 1977. Historian Roy Foster says in his book Luck and the Irish: a brief history of change from 1970‎, that in December 1977, Trinity College professor of economics Martin O’Donoghue, then minister for economic planning and development, promised an “everlasting boom”. In 1978, a public spending-fuelled boom in Ireland resulted in a budget deficit of 17.6 per cent of GDP ‑ a record for developed countries according to the International Monetary Fund (IMF) ‑ for the period 1970-2008. The national debt had tripled by 1982. The second started with payback time against the backdrop of a broken system that resembled Japan’s in terms of cronyism and construction. With regard to blame, lax governance systems in Europe and easy lending were certainly a factor, but the crisis was overwhelmingly made at home.

Ireland now needs to deliver the necessary policy action, Ajai Chopra, the head of the International Monetary Fund’s (IMF) Ireland team said on May 20th. He added that Europe needed to deliver a shared solution and make clear that for countries currently with bailout programmes ‑ Ireland, Greece and Portugal ‑ there will be the right amount of financing on the right terms and for the right duration to foster success. “In other words, the countries cannot do it alone and putting a disproportionate burden of the cost of adjustment on the country may not be economically or politically feasible,” he said. “The resulting uncertainty affects not only these countries but through the high spreads and lack of market access it increases the threat of spillovers and creates downside risks to the broader eurozone. Hence, these costs need to be shared including through additional financing if necessary.”

Since the EU-IMF bailout programme last November, there has been a striking increase in anti-EU sentiment in Ireland, suggesting that, to adapt Parnell, a foreign scapegoat is setting the boundary to the recovery of our nation. The victims’ cross has made a reappearance and we are obsessed with what Europe should do for us while remaining relatively mute on what we should do for ourselves. Yes, there has been a paucity of bold political leadership in Europe. However, in the almost four years since the onset of the international credit crunch, Ireland has managed only a number of baby-steps in the area of overdue structural reform and the citizens in Europe’s well-governed countries have been given no compelling reasons to believe we have fundamentally mended our past profligate ways.

The biggest gripe is that private bank losses have been treated as sovereign debt but there is an inconvenient truth in this story: it was the Irish who, uniquely in the eurozone of then sixteen countries during the financial crisis, socialised bank debt, a move that was contrary to European Union policy at the time. The IMF said in an economics paper in 2009 that of twelve developed countries led by the US, only Ireland and Denmark (outside the eurozone) guaranteed existing bank debt during the financial crisis. Support for the financial industry was as low as 2.5 per cent of GDP in the US; with the exception of Ireland and Denmark, all other countries were at less than 10 per cent of GDP. Denmark’s exposure was 20 per cent of GDP; Ireland was the outlier, with an exposure of 55 per cent.

In October 2007, the Ecofin council of EU finance ministers agreed common principles which stated: “In a crisis situation, primacy will always be given to private sector solutions which as far as possible will build on the financial situation of a banking group as a whole. The management of an ailing institution will be held accountable, shareholders will not be bailed out and creditors and uninsured depositors should expect to face losses.” In February 2008, the Department of Finance warned in a presentation marked “Secret”: “As a matter of public policy to protect the interests of taxpayers any requirement to provide open-ended/legally binding State guarantees which would expose the Exchequer to the risk of very significant costs are not regarded as part of the toolkit for successful crisis management and resolution.”

What is striking about the decision to issue a blanket bank guarantee on the night/early morning of September 29th/30th, 2008, when the unlimited guarantee of bank deposits would have stopped the haemorrhaging of funds from the banks (the banks already had access to central bank emergency liquidity for their wholesale funding), was that there was no official contact with Christine Lagarde, the French finance minister who was head of Ecofin, Jean-Claude Juncker, president of the Eurogroup of eurozone finance ministers or Jean-Claude Trichet, president of the European Central Bank. At this time, the ECB did not have a policy on protecting bond-holders. Within months, Anglo Irish Bank was nationalised and it took almost two more years to quantify its losses. The option that was available to the Obama administration in swiftly restructuring General Motors by offering bond-holders equity in a new GM had been cut off. We had simply surrendered all our chips with one roll of the dice.

 

An extraordinary aspect of the fateful guarantee meeting of September 29th/30th, 2008, was that the chairmen and chief executives of AIB and Bank of Ireland were in Government Buildings for several hours and “Banquo's ghost”, representing the absent Anglo Irish Bank chairman Seán FitzPatrick was also surely there. Earlier on Monday, September 29th, FitzPatrick and David Drumm, the chief executive, had gone to arch rival Bank of Ireland to propose a merger. It was one day to Anglo’s financial year end and a loan of €4.5 billion from Irish Life & Permanent to dress up the year-end figures was contingent on a Central Bank guarantee.

We do not know why FitzPatrick was told to stay away from the guarantee meeting but there must have been constant phone interaction with him. We also do not know what the respective roles of Taoiseach Brian Cowen and the late Brian Lenihan were on the type of guarantee that should be issued. Which of them was the main advocate?

Financial adviser Merrill Lynch had advised against an open-ended guarantee and given the later negative reaction to the guarantee in Europe, it was correctly anticipated that support for it would not have been forthcoming. Providing a lifeline to Anglo was the dominant consideration and the political leaders may still have foolishly believed that it was a liquidity problem rather than a solvency one. However, thirteen months after the onset of the international credit crunch and with the collapse of Lehman Brothers causing ripples across the global economy, there should have been no illusory glimmer of a light at the end of the tunnel for the property market. It does appear that even though the Department of Finance had prepared a draft bill to nationalise Anglo, Fianna Fáil’s leaders just could not accept or take account of the implications of a collapse of the bank that was so synonymous with the Galway Races tent elite. They knew that interest wasn’t even being paid on huge loans by most of the high profile developers. Nevertheless, all debt was guaranteed without apparent consideration of the downside risks. The “cheapest bailout in the world so far” on September 30th, 2008 had by January 16th, 2009 become the biggest bank taxpayer burden in the world, when it was finally decided to nationalise Anglo.

The guarantee took away the pressure for a quick resolution of the banking crisis and as the second anniversary of the issue of the guarantee drew near, the markets lost confidence and the ECB worried about the increasing reliance of Irish banks on its emergency funding mechanism. The ECB vetoed “haircuts” or discounts on senior bank debt during the negotiations of the EU-IMF bailout last November because of fears of spreading instability to other countries. Coupled with the sense of victimhood exploited by opposition politicians in the February general election and the perceived harsh treatment from countries like Germany and France, there has been a rising clamour for debt default.

EU leaders have agreed a permanent bailout mechanism to take effect from mid-2013 and at the insistence of German chancellor Angela Merkel there is a provision for burden-sharing with private creditors or bondholders. The calculation is that the eurozone economy will be in a better shape to handle peripheral country problems by then. The ECB is at loggerheads with political leaders as it feels that it has been forced to assume responsibilities such as purchasing the sovereign bonds of struggling countries, which should be a responsibility of member countries. The central bank has hardened its attitude to restructuring and “haircuts” as it would take a big hit itself.

The peripheral economies together account for only about 5 per cent of eurozone GDP, but Greek, Irish and Portuguese banks account for about €242bn of ECB emergency lending – 55 per cent of that provided to the eurozone financial system. The Financial Times says the ECB stipulation that it provide liquidity only to solvent banks against adequate collateral has been pushed to the limit. Under the securities markets/bond buying programme, the ECB acquired €77 billion in government bonds, almost two-thirds of which are Greek. It also has on its books about €150 billion in other financial assets put up as collateral by Greek banks, much of which is backed by Athens. US bank JPMorgan Chase calculates that, with €81billion in capital and reserves, eurozone central banks could withstand even a 50 per cent “haircut” on Greek bonds. But if writedowns on Portuguese and Irish bonds followed, eurozone governments might be forced to provide billions of euro to rebuild the ECB’s balance sheet.

In contrast to the growing anti-EU hysteria, the appetite for change and reform at home is muted. The ancien regime remains intact; many still expect bubble incomes despite the almost 15 per cent unemployment rate. Blaming Europe and hoping for default appear to be part of the denial process. To cap it all, the celebrity economist who has claimed to be one of the architects of the disastrous bank guarantee is now advocating even more hugely consequential moves, such as quitting the euro and unilateral debt default. Meanwhile, far from the well-off commentators and pundits vying to grab the megaphone to sell outrage to the masses, there are countless small firms who have endured the debt losses from over three thousand collapsed firms in recent years and after a brutal recession are close to tipping point.

When emotion trumps reason, facts and consequences are ignored. Most importantly in the current context, we lose sight of, or conveniently choose to ignore, what we can do to help ourselves. Last November in an op-ed article in The New York Times titled “The Debtor of the Western World”, writer John Banville said there used to be a nice acronym that neatly expressed how the Irish people conceived of themselves: MOPE, that is Most Oppressed People Ever. He wrote: “At first, when the poor beast began to sicken, we Tiger cubs set up a great roaring and ranting. Who is to blame for our sudden travails? We demanded ‑ somebody must be to blame. The bankers? Them, certainly. The politicians? Well, the politicians are always to blame, so nothing new there. The markets, those shadowy entities that seem to operate by whim? Ourselves, perhaps? ‑ now, there was a sobering possibility.”

In conservative Ireland, while the Irish Economy blog may not change frozen mindsets, it is an important resource for mainstream journalists, who can make an exception to the normal professional jealousy and quote a blog source connected with academics. As regards the concept of the wisdom of crowds, by which individual biases may cancel each other out, a new study shows that when researchers tell test participants about their peers’ guesses, the group insight is undermined. James Surowiecki, author of the 2004 bestseller The Wisdom of Crowds, says certain conditions must be met for crowd wisdom to emerge. Members of the crowd should have a variety of opinions, and arrive at those opinions independently. Take those away, and crowd intelligence fails, as evidenced by the Irish bubble.

The enlightened approach of the IMF’s Ajai Chopra is very welcome but crowd intelligence could fail again, whether it’s on the Irish Economy blog or among the rest of the public: we could in effect surrender to the siren voices and delude ourselves that we can avoid reforming failed systems while still making demands in Europe. A Google search for “Irish+reform” sees the Reform Act 1832 heading the results, followed by pages linking to stories on Irish reform schools ‑ hardly symbols of progressivism. It is appropriate that a nineteenth century British act of parliament should head the ranking: in 1986, the late UCD constitutional law professor and Fine Gael TD John Kelly said: “Ireland’s political and official rulers have largely behaved like a crew of maintenance engineers, just keeping a lot of old British structures and plant ticking over .‑. The challenge is to evolve structures ‑ within which the people can be drawn to individual and community responsibility for their own development.”

Staying with the engineering allusion, historian Daniel Boorstin in The Americans: The Democratic Experience, chronicled how the Irish took control of the big American urban areas in the nineteenth century through our mastery of machine politics. Boorstin wrote that when Joyce’s Stephen Dedalus said: “History is a nightmare from which I am trying to awake,” he summed up Irish history. And the United States was to be the place of awakening. A political party, Boorstin argued, is organised for a purpose larger than its own survival. A political machine exists for its own sake; its primary, in a sense its only purpose, is survival. A political party may succeed and make itself obsolete by obtaining the purpose for which it was organised. This is never true of a political machine, for a political machine succeeds only by surviving. The Irish refugee was dominated above all by the need to survive. For the emigrant, in flight from poverty and oppression, American politics had become an end in itself, a business to support him and his fellow clansmen.

The late US senator Daniel Patrick Moynihan wrote in 1961 that New York was perhaps the first great city in history to be ruled by men of the people, not as an isolated or transitory phenomenon, like the Gracchi or the Paris Commune, but as a persisting, established pattern. He wrote of Richard Croker and other leaders of the New York Tammany Hall machine politics system:

The Irish were immensely successful in politics. They ran the city. But the very parochialism and bureaucracy that enabled them to succeed in local politics prevented them from doing much else ... In a sense, the Irish didn’t know what to do with power once they got it. The Irish leaders did for the Protestant establishment what it could not do for itself, and could not do without. But the Irish just didn’t know what to do with their opportunity. They never thought of politics as an instrument of social change ‑ their kind of politics involved the processes of a society that was not changing. Croker alone solved the problem. Having become rich, he did the thing rich people in Ireland did: He bought a manor house in England, bred horses, and won the Derby. The King did not ask him to the Derby dinner.

It seems a familiar story. Fianna Fáil adopted the machine politics model and for a long time has been more adept at the game of politics than governing. It is also evident that the Irish generally are much more energised by the drama of politics than by issues of process, competent management, accountability and reform. Crucially, there has been no Irish tradition of parsimony when it comes to public funds and the horsemen of the Apocalypse have had their inevitable rendezvous with the legions of beggars on horseback. As we struggle for footing in a fast-changing world, we may serve ourselves better by putting the victims’ cross back in the museum and taking a good collective look in the mirror.


Michael Hennigan is founder and editor of the financial website Finfacts www.finfacts.ie.

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