Cheap Credit Continues to Bite the Economy

Todays Sunday Independent splashes a big call for Brian Cowen to return to work in light of the bad economic data/stories of the past two weeks. And they have a point, that data has been bad. Yet, for two reasons Brian Cowen’s return is unlikely to sort it out to any other degree that provide someone to direct ire at. These are that the seeds for our current decline were sown by cheap credit and the record of the FF ministers is not too much intervention.

There is a saying around, those who predict bear markets only have to be correct once those who predict bull markets gotta be right all the time. Those like Marc Coleman have a need to be correct at every juncture considering what they are predicting/hoping for while the likes of McWilliams, Lee and the newly converted economists at the big banks only need to be right once. Richard Curran for example has been credited with precipitating that decline in the property market that is now resulting in talk of circa 35,000 job losses.

Yet Curran in his predictions of a housing bust was doing little more than outlining indicators and making an extrapolation. Yet the work of Curran, Lee and others had been built on examining underlying trends on the economy and they only required vindication once on talk of a downturn in the economy.

The decline in the housing market and the decline in the stock market are related in far more serious a fashion than worries about the the decline in construction. What maintained such a buoyant housing market, with prices which were mad and unaffordable to many was the availability of affordable loans thanks to cheap credit.

The cheap credit made the prices just about manageable. As the interest rates crept up, there was no avoiding the argument that the government and stamp duty were slowing down the market, when in fact the clear element that appears to be at play in affordability.

The real estate agents and other might have had some arguments in their favour but it is the decline of the ISEQ in losing 8 billion Euro in valuation last week and over 9% of its value year to date, that points up the influence of cheap credit. Low interest rates were able to fuel consumer spending like never before thanks to the de facto loans of credit cards as well as the loans used to purchase cars and houses.

Alan Greenspan began the move when head of the Treasury following 9/11 and came in for a degree of criticism for it. Yet our own Central Bank here in Europe, thanks to its focus on inflation in the primary economies of France and Germany, also had a similar impact on our own fair isle. We enjoyed some of the cheapest credit possible.

Cheap credit had the knock on effect of generating a bubble in property prices as it became easier to leverage spending, the other areas of consumer spending were equally buoyed up by the free flow of money through credit cards, cheap financing deals and other elements. As Conor has argued, the credit-led mortage boom had a huge knock on effect throughout the economy. We had the paradox of difficult inflation with little or no significant movement on interest rates. What McWilliams terms the era of cheap credit has been with us a long time, with folk discussing it in earnest as a problem almost since Greenspan embarked on the policy. Government response to the issue has been to let sleeping dogs lie and continue to allow the economy to funnel along on the back of high consumption and cheap credit. The role of construction in economic growth and job creation has been an issue around for a long time, we have known that a contraction in house building considered inevitable in light of the level of building supply and demand.

In a similar fashion to costruction foreclosures the banks and lenders are moving on the ISEQ too as those who decided to use CFDs and other leveraged purchases to buy stocks on the back of low interest rates are now forced to settle debts. Granted the ISEQ is less a picture of middle Ireland than a housing slowdown but it is a reflection on free flowing money. The rise in interest rates, the consequent tightening of money around the place begins to pull in the extreme edges of the exuberance of cheap credit.

Policy makers have been told quite regularly that the effects of cheap credit, visible in reliance on construction and consumption is worrying and potentially problematic. Those discussing it only needed to be right eventually and it looks like that eventually is upon us.

The problem is more pronounced than simple distinct issues of construction, employment, inflation, costs, spending, jitters on stocks etc. Its a connected series of issues which arise from the era of cheap credit beginning to unwind. Government have had some pointers to this coming down the line, they haven’t acted before and there is little they can do now at short notice so why bring Brian home?

This brings me to the second point, what would Brian do in the event of his arrival on these shores? With talk of impending wind-ups in construction firms, banks and accountants putting together teams to deal with receiverships in the sector and a fall in asset values. Any number of moves open to Cowen would have involved a variety of short and medium terms interventions in markets and lending policies. Cowen’s stated policy was as little intervention as possible during the cacophony of diversion generated by stamp duty earlier in the year.

Many interests would have derided market intervention to deal with sub-prime lenders (a matter still on the table and likely to garner more headlines if foreclosures rise alongside interest rates). The ESRI and others have talked of a need to rebalance the economy and its growth model, rebalance means regulation and control.

This is not something that Fianna Fail find easy to do in situations, owing to their own interested parties, their partners in government and the general slowness with which cabinet moves on issues of importance. Moves to a service and knowledge economy seem unlikely to cover a slowdown and higher unemployment rate straight away as Marc Coleman noted this morning, indigenous industry has not been able to share the burden of growth with multinational FDI.

Issues abound upon which moves have been slow and steady but insufficient to head off the problems of a bubble in property prices, thanks to cheap credit which is beginning to destabilise the economic picture.

Yet, the ESRI remind us, we have resons to be positive. There are demographic and other issues which run in our favour. Yet this are potentials and require strong leadership from all sides, government, business and workers, public and private sector alike. Yet Brian coming home early is unlikely to change anything short term. It seems that the short term fate is pretty certain at present, declines in housing/construction. Higher unemployment, higher interest rates and short term difficulty. It seems that economic planning will once again take on the same time frame as the electoral cycle.