The U.S. and Irish Credit Crises: Similarities and ... · – Low cost of funding (Eurocurrency)...

The U.S. and Irish Credit Crises:Similarities and DifferencesSimilarities and Differences

Thomas FlavinNUI MaynoothNUI Maynooth

Irish Financial CrisisIrish Financial Crisis

• Ireland has experienced a severe financialIreland has experienced a severe financial crisis

• Our leading financial institutions had to be• Our leading financial institutions had to be saved from extinctionC i i h ill d t th l• Crisis has spilled over to the real economy and the Irish recession is most severe

d d iamong advanced economies

05/11/2009 Presentation at the CenFIS conference on Regulating Systemic Risk 2

Financial Equity Index growth relative to TotalFinancial Equity Index growth relative to Total Market

2 5

3

3.5

1.5

2

2.5

IRLUS

0.5

1

0

02/0

1/19

95

02/0

7/19

95

02/0

1/19

96

02/0

7/19

96

02/0

1/19

97

02/0

7/19

97

02/0

1/19

98

02/0

7/19

98

02/0

1/19

99

02/0

7/19

99

02/0

1/20

00

02/0

7/20

00

02/0

1/20

01

02/0

7/20

01

02/0

1/20

02

02/0

7/20

02

02/0

1/20

03

02/0

7/20

03

02/0

1/20

04

02/0

7/20

04

02/0

1/20

05

02/0

7/20

05

02/0

1/20

06

02/0

7/20

06

02/0

1/20

07

02/0

7/20

07

02/0

1/20

08

02/0

7/20

08

02/0

1/20

09

02/0

7/20

09


0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Motivation of this studyMotivation of this study

• Ireland – victim of global crisis or author ofIreland victim of global crisis or author of its own downfall?

• “We are exposed to the harsh winds that are blowing in the Anglo-American worldare blowing in the Anglo American world at present”. Minister for Finance, Brian Lenihan, June 08Minister for Finance, Brian Lenihan, June 08

• Was it that simple or was there more?05/11/2009 Presentation at the CenFIS conference on Regulating Systemic Risk 4

Was it that simple or was there more?

Economic BackgroundEconomic Background

• The Irish economy became the great ragsThe Irish economy became the great rags to riches story over the period 1994 –20062006. – Average annual economic growth of approx

7%7%– achieved full employment at about 4% – increases in standards of living– increases in standards of living – population increased by about 20% to 4.2m.


Timing of the CrisisTiming of the Crisis

• Irish Financial Crisis started later than inIrish Financial Crisis started later than in the US

• Irish house prices began to slow down• Irish house prices began to slow down from March 2007 but mainly due to uncertainty about future tax policyuncertainty about future tax policy

• Economy grew strongly during 2007 and it d th t fi i l t h dappeared that our financial sector had

avoided the worst of the crisis


Common Root causeCommon Root cause

• As in the US the root cause of the IrishAs in the US, the root cause of the Irish crisis lay within a financial sector that was over-exposed to the property sectorover exposed to the property sector – In Ireland, major problems lay in lending for

property development and constructionproperty development and construction • Bank funding mis-match

International Euribor borrowing funding long– International Euribor borrowing funding long-term property development loans


Irish House Price Series

€500,000

€600,000

Second‐hand ‐Dublin

New ‐ Dublin

€300,000

€400,000

New Dublin

Second‐hand ‐ whole country

New ‐ whole country

€100,000

€200,000

€0

€100,000

1970 1975 1980 1985 1990 1995 2000 2005 2010


Irish v US House Prices 1996-2009

350

400

450

200

250

300

50

100

150

0

May

-96

Sep

-96

Jan-

97

May

-97

Sep

-97

Jan-

98

May

-98

Sep

-98

Jan-

99M

ay-9

9

Sep

-99

Jan-

00

May

-00

Sep

-00

Jan-

01

May

-01

Sep

-01

Jan-

02

May

-02

Sep

-02

Jan-

03M

ay-0

3

Sep

-03

Jan-

04M

ay-0

4

Sep

-04

Jan-

05

May

-05

Sep

-05

Jan-

06

May

-06

Sep

-06

Jan-

07M

ay-0

7

Sep

-07

Jan-

08M

ay-0

8

Sep

-08

Jan-

09

May

-09

CA NY USA IRE


Where did it all go wrong?Where did it all go wrong?

• “We drank too deeply from the nationalWe drank too deeply from the national cup of, I suppose, confidence . . . The national mood of self-confidence brewednational mood of self confidence brewed itself up into overdrive.”

AIB chairman Dermot Gleeson May 2009– AIB chairman, Dermot Gleeson, May 2009


Role of the financial sectorRole of the financial sector

• Financial InnovationFinancial Innovation– Little securitization– Banks typically retained loans on balanceBanks typically retained loans on balance

sheet– Originate & hold NOT Originate & distribute

• Declining standards applied to lending– Low cost of funding (Eurocurrency)– Battle for market share – Huge increase in credit extended


Mortgages on Balance Sheets ofCredit Institutions in Ireland

€120 bn

€140 bn

Credit Institutions in Ireland

€80 bn

€100 bn

€20 bn

€40 bn

€60 bn

€0 bn

€20 bn

Mar‐02 Mar‐03 Mar‐04 Mar‐05 Mar‐06 Mar‐07 Mar‐08 Mar‐09 Mar‐10


Breakdown of Mortgages by Loan‐to‐Value

80%

90%

100%

50%

60%

70% >=100%

<99%

<95%

10%

20%

30%

40% <90%

<80%

<70%

0%

10%

2004 2005 2006 2007


Breakdown of Mortgages by Loan Maturity

80%

90%

100%

40%

50%

60%

70%> 35 years

< 35 years

< 30 years

10%

20%

30%

40%< 25 years

< 20 years

0%

2004 2005 2006 2007


Undiversified Loan BookUndiversified Loan Book

• Woods (2007) shows that as a proportionWoods (2007) shows that as a proportion of lending to the private sector, property-related lending grew from 38% in 2001 torelated lending grew from 38% in 2001 to over 62% in 2007.

• Increasing proportion to Commercial• Increasing proportion to Commercial property where income yields were very low relative to other Euro zone countrieslow relative to other Euro zone countries


The role of the EuroThe role of the Euro

• Ireland signalled their intention to join theIreland signalled their intention to join the Euro project at the earliest opportunity

• As date of single currency approaches• As date of single currency approaches, nominal rates fallTh h t i d f E l t h• Throughout period of Euro, real rates have been very low as Irish inflation outstripped th t f E tthat of Euro partners


Mortgage Rates: Nominal and Real

12

14

16

8

10

12

Nominal

4

6

Nominal

Real

-2

0

2

Jan-

85

Jan-

86

Jan-

87

Jan-

88

Jan-

89

Jan-

90

Jan-

91

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08


Role of GovernmentRole of Government

• Encouraged people to invest in propertyEncouraged people to invest in property through a series of tax-incentive schemes

Hotels– Hotels– Rural regeneration

F il t l t• Failure to regulate– Importance of stamp duty to public finance– Cronyism– ‘Bureaucratic gambling’


Manifestation of the CrisisManifestation of the Crisis

• In late September 2008, Irish financialIn late September 2008, Irish financial sector and government have to acknowledge severity of the crisisg y

• Freezing of Interbank lending markets after Lehman Brothers collapsep

• At least one bank unable to roll-over their foreign borrowingsg g

• The crisis then moves to a Resolution phase


p

Resolution PhaseResolution Phase

• The government provided a blanketThe government provided a blanket guarantee to the depositors and all creditors of six domestic bankscreditors of six domestic banks

• Government feared that contagious effects due to the concentrated nature of Irishdue to the concentrated nature of Irish bank could create systemic risk


Resolution PhaseResolution Phase

• Government promise a recapitalizationGovernment promise a recapitalization programme

Jan 09: Nationalization of Anglo Irish Bank– Jan 09: Nationalization of Anglo Irish Bank– Feb 09: €7bn injection for BOI and AIB

E t bli h N ti l A t M t• Establish National Asset Management Agency (NAMA)

(B d) A h h– (Bad) Asset purchase scheme• No fiscal stimulus package


Euro Membership in the CrisisEuro Membership in the Crisis

• Avoided a currency attackAvoided a currency attack• ECB has been an important provider of

liquidity to Irish banksliquidity to Irish banks


SummarySummary

Causes of the Crises US IrelandSecuritization X

ff i l f k diEffective closure of market trading XDecline in Lending standardsE ditEasy creditLack of diversification ?I ti l bIrrational exuberanceGovernment Policies


ConclusionConclusion

• Although the US credit crisis precipitated it,Although the US credit crisis precipitated it, the Irish crisis is identifiably separate

• Many common features but these are often• Many common features but these are often arrived at by differing routesGl b l t h t d I i h i i b t• Global events hastened Irish crisis but fundamental weaknesses already existed

• Resolution of crisis has common elements but important differences


The U.S. and Irish Credit Crises: Similarities and ... · – Low cost of funding (Eurocurrency)...

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