The U.S. and Irish Credit Crises: Their Distinctive Differences and Common Features Post author By Philip Lane Post date March 5, 2010 Gregory Connor, Thomas Flavin and Brian Kelly write on this topic in Irish Economy Note No. 10. Categories In Banking Crisis Tags credit crises 14 Comments on The U.S. and Irish Credit Crises: Their Distinctive Differences and Common Features ← The Latest from Iceland! → Academic freedom 14 replies on “The U.S. and Irish Credit Crises: Their Distinctive Differences and Common Features” You miss, I think, a few symptomatic similarities of booms that deserver deeper coverage than the irrational exhuberance tag. The first is the greed and stupidity phenomenon (or perhaps that greed-induced stupidity?). This is where otherwise rational entities swallow the most outlandish claims for future profitability because of their greed. The greed takes a number of manifestations – for politicians re-election, for punters early retirement perhaps or beating the joneses, for companies share prices (for a number of reasons). So governments overlook structural deficits because they can have giveaway budgets, or they invent reasons why the FIRE economy can work, or listen to nuts who tell them that BOP doesn’t matter &c. All sorts of outlandish theory becomes accepted as the norm and straight-line economics rules. Indeed, everyone is an ‘expert’ or ‘leading’… Conspicuous consumption becomes de rigeur – bling und tat the order of the day whether it is truffle omelettes, hummers, D&G bling or wall-to-wall chinese tat. Houses take on the air of cathedrals, whether of taste or excess it doesn’t matter as long as it is expensive and imported. People cease to make stuff and start to speculate on the price of trading stuff. So the size and range of consumption imports explodes. Credit growth you cover well, but there is still room to talk about the ease of revolving credit. You can get credit for anything, it seems – houses, cars, electrical goods. If you can’t get credit for it, you can get store cards or credit cards. All with teaser rates and shocking full-price ones. I also think this bit is mistaken: “In March 2000, Fannie Mae announced its American Dream Commitment: an aggressive corporate strategy to purchase $2 trillion in mortgage loans for poor and minority households over the following ten years.” Nobody has lost any money on Fannie Mae, Freddie Mac, of FHFA securitised mortgages. The US government has made the implicit guarantee pretty much explicit. Fannie Mae is soaking up the losses. It is the sub-prime lending of the commercial banks, that the ADC program was designed to keep consumers away from that has caused the problem. The O&D model is what broke, not the GSE model. The GSE model has been broken for years… I would also argue that much of the lending that has been taking place in Ireland by the main lenders would be considered sub-prime in almost any other country: Parental deposits and guarantees Loans for deposit, stamp and fees 100+% mortgages (or 100% mortgages with an attached personal loan) Rent a room considerations Self-certification Widespread use of interest only, teaser rates, extended terms (up to 40 years!) All these are indicative, as sub-prime in the US was, of a one-way bet on rising prices such that they only made sense if the borrower could sell or refinance at another teaser rate in the future. All that was missing from Ireland was large scale securitisation and even that was evident in some of the covered bond issuance, Wolfhound and Emerald for instance. PS It is a good read though! Sorry if I sound very critical. Thanks for the link Philip. I still think that the IE blog could conduct a series of threads such as this one, in which commentators could deposit their own piece of ‘social memory of the crisis as it un-folded. As I explained earlier, on another thread, I was probably too busy at the time, to pay much attention. But if everyone here could deposit a small personal memory, a single paragraph perhaps of the time of 2008, maybe the university students at UCD or somewhere, could compile it into a nice web page or something – as a sort of ‘project’ for them? Here is mine: I will be honest, as an arm chair economist, in late 2008, the only strange thing in my world – apart from getting fired – was to see all of the re-releases of books by Kenneth Galbraith, Joe Stiglitz, Paul Krugman, George Soros, Alan Greenspan (with added chapters) and just about every so called expert. The funny thing is, I must be one of the few anoraks in Dublin city, who had read a lot of those books prior to late 2008. But then, all the old editions started flying off the shelves, literally. It was like a Beatles or Doors revival, except for economics books! Maybe the students in economics departments from various universities could tackle the crisis of 2008, from a different slant, and come up with different time lines to track events? As I suggested to KW earlier, the crisis of 2008, is something that will be discussed in academic departments for a long time to come. Perhaps IE blog could be used to capture some of that social/financial memory? A bit like the way, Vietnam war was the first to enter the minds of people through television, maybe 2008 financial crisis, could be captured in some way through the blog/up-load medium? BOH. Thank you Philip, this looks interesting on first glance. That said, I am shocked to find not a single mention of Minsky in the paper. For me, his analytical framework of financial stability leading over time to excess lending which eventually leads the system to deep instability is the core dynamic operating in both situations, driving the parallel credit bubbles and subsequent crashes. The methods of financing and the question of whether loans made were securitized (amongst other factors) obviously differed between the two markets but the core dynamic is for me essentially similar. My question is was this exclusion a conscious choice on the part of the authors or has the Minsky framework passed Irish commentators by? There are some great resources available on the net now about Minsky – particularly at the Levy Institute. A greater understanding of Minsky will be essential to guiding financial regulation and economic policy if we are to avoid the same scale of financial crises occurring in the future. Here are a few obvious pointers: A very readable and clear account of Minsky dynamics by McCulley of PIMCO http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/2009/Global+Central+Bank+Focus+May+2009+Shadow+Banking+and+Minsky+McCulley.htm Money Manager Capitalism and the Global Financial Crisis http://www.levy.org/vdoc.aspx?docid=1199 I think that Issac’s paragraph here: http://www.irisheconomy.ie/index.php/2010/03/05/empty-houses/#comment-38692 Was a very poignant paragraph, which solidifies a kind of image about Ireland’s second Celtic Tiger phase, which should be recorded somehow in the annals of social memory. BOH. Conor Brady, editor of The Irish Times from 1986 to 2002, reports on the ‘Covering the Crisis’ recent two-day seminar organised in Brussels by the European Journalism Centre. http://www.irishtimes.com/newspaper/opinion/2010/0306/1224265703246.html @ BO’H: This current ‘financial’ crisis has had a long gestation – possibly 3 decades. For whatever reasons it was artfully concealed from most, but at least 12 commentators ‘saw’ through the fog and were writing about the coming calamity as early as 2000, though most started in earnest in 2002/2003. I would have difficulty ascribing ‘blame’ to acdemic economists – they might not have had a clear understanding of the underlying financial chicanery. The massive increase in credit and accompanying debt is the predicament – and I have not seen any connection between GDP and the negative affect of accumulating debt on GDP in the undergrad economics texts. It may well be there – its just not obvious. I was alerted to the problem of accumulating debt back in 2005 – quite by accident, and took some ‘evasive’ action. At the time family and friends thought I had lost it! They’re a tad wiser and quieter now. The title above is a little odd. Its a debt predicament surely, not a credit crisis. Cheers. B Peter @ Brian Woods, Have you downloaded and read this paper? I got through a few pages this morning. Linked by GK on the ‘Slide 11’ thread. http://online.wsj.com/public/resources/documents/crisisqa0210.pdf On the subject of dealing with a financial crisis…… It just doesn’t stack up to me that Iraq is getting a $3.6 bn loan from the IMF to ‘rebuild its battered infrastructure’. Previous loans came with conditions about removing subsidies (why am I suddenly thinking IMF and South America/Poland/etc. ?) so no doubt this one will have strings attached too. It’s that how war works these days? You go in and smack the living daylights out of a country then arrange for them to take loans to repair the damage? I guess they will just have to take oil if they can’t stump up cash for the interest…… What a shame Bank of Ireland doesn’t have any oil. A very good essay! I particularly like the rejection of the superficial symptoms and the analysis of the more fundamental factors. A good start for others to progress, perhaps? You mention that some coordination occurred, (my words) that was “somewhat surprising”. Well done. Obviously, you still crave academic acceptance and need to pursue careers, unlike me, a retired civil servant. So you could not say that much of this was predicted, and as a result, many of TPTB decided to ensure that the bubble in each case, was as large as possible, by overparticipation. The destruction of the middle class is sinister as it enables revolution. The “somewhat surprising” co-ordination therefore smacks of organization and optimization. Across much of the world, a world that has never been so well connected before. The likely sweep to power of “left” leaning governments was also predictable and is in train. I just wonder what has been planned for the survivors? Setting us at odds with the “rich” should be easy enough, but to what end? The expulsion from Russia of a lot of the intellectual supporters of communism in the nineties, meant that the US got to play host. Their loss may be the greatest. Similar to that of Ireland. Joseph The Marshall plan seems to have stopped the two wars phenomenon, that was a result of reparations imposed by the victors. Most therefore applaud the gifts of aid to enable war torn countries to recover. Or do you want all aid to flow to Ireland? Things will get very bad here, but there is considerably worse……. Brian Peter Woods Spot on! The obscuration is vital otherwise we would not get the squeeze at all…… Mick Costigan Yes, but really, you aren’t actually shocked are you? All the feds men make sure nothing ever gets out about their tricks. If they did, the game would be up. I still think that squeeze and release is only so potent due to the greed of the dupes. You cannot con an honest (ungreedy) man, actually. So, on balance, I no longer complain that the truth should be put out there. Let the stupid, greedy and impulsive learn themselves or perish? Austrian school and Minsky are black holes as far as economics is concerned. They will be buried by the time the next bubble comes around! Yoganmahew The greed business is the “hidden hand” that causes rational (wo)men to overwork in order to satisfy some perceived but unreal need. Look at the lilies in the field and the birds of the air, they toil not neither do they spin. We have a system that forces many of the innocent to suffer for the folly of others. Is that a crime? Quite deliberately, it is not! On the low ECB rate, how much different would the situation have been with a UK rate of 3.5%-4.5% coinciding with the ECB rate of 2%? There would have been no shortage of foreign funds from the carry trade to boost bank lending. Fiscal policy would have been as reckless, with the punt, and the central bank would not have been independent. The fairytale of Ireland’s economic miracle also spurred US interest and the Irish banks were majority owned overseas – – 65% in the case of AIB. 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