Transcript Euro Membership & Bank Stability Friends Or Foes? Lessons From

Euro Membership & Bank Stability
Friends Or Foes?
Lessons From Ireland
Patrick Honohan
Professor, Department of Economics
and
Institute for International Integration Studies
Trinity College Dublin
Prepared for the 15th Dubrovnik Economic Conference, 26-27 June, 2009
The question
• Ireland was doing exceptionally well before joining EMU
• Then everything started to go wrong
• Especially the credit boom, fuelled by easy money – low
interest, no FX risk
• And Ireland has ended up with [one of] the worst busts in
the global crisis
• So is there something specially risky about euro
membership for banking?
18
16
Unemployment rate
14
12
10
8
6
4
2
0
60
65
70
75
80
85
90
95
00
05
Employment in nonAg as % Population
50
45
40
35
30
25
20
15
10
5
0
1961
1971
1986
1991
2001
2007
Net migration 1930-2007 (000s)
80
60
40
20
0
-20
-40
-60
-80
30
40
50
60
70
80
90
00
Growth in living standards
8
7
% per annum
6
5
GNP/Pop
GNDI Adj ToT/Pop
Personal Cons/Pop
4
3
2
1
0
-1
75/70 80/75
85/80
90/85 95/90
00/95 06/00
After 2000 – shift to
property/construction bubble
Biggest price bubble: driven by a “new era” myth (Shiller)
Supported by sense that Tiger was unstoppable
Rationalized by sharp drop in interest rates with €
By 2004 prices exceeded any equilibrium model
And not just price: construction
2006: 15% of houses empty
% labour force in construction jumps from 7% to 13%
Funded by bank borrowing from abroad
LTVs rise and rise
A rogue bank grows from 3% to 18% of market
destabilizing others
Real interest rates 1983-2007
deflated by 4-quarter future inflation
20
15
10
5
0
-5
83
85
87
89
91
93
95
97
99
01
03
05
07
Irish Real New House Prices 1970-2008
4
Index, 1970=1
3.5
3
2.5
2
1.5
1
0.5
1970
1980
1990
2000
2010
Employment in construction
as % of total employment, 1990-2008 (April)
14
13
12
11
10
9
8
7
6
5
90
95
00
05
Net international position of Irish credit institutions
1999q1-2009q1
70
60
% GDP
50
40
30
20
10
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
LTV rates -- first time buyers
LTV rates -- all loans
100%
100%
90%
90%
80%
80%
70%
100% LTV
95-99% LTV
60%
95-99% LTV
91-95% LTV
50%
70%
100% LTV
60%
50%
81-90% LTV
40%
71-80% LTV
30%
<70% LTV
91-95% LTV
81-90% LTV
40%
71-80% LTV
30%
<70% LTV
20%
20%
10%
10%
0%
0%
2004
2005
2006
2007
2004
2005
2006
Ireland: Mortgage loans by initial loan-to-value ratio 2004-7
2007
100
80
60
90
Total assets real
growth rate %
70
Total assets (RHS,
€bn)
50
40
30
10
20
-10
0
-30
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Allied Irish Banks AIB Growth 1999-2008
200
90
200
Total assets real growth rate %
180
Total assets (RHS, €bn)
160
80
70
180
160
60
50
140
120
40
100
30
20
80
60
40
20
60
50
140
40
30
100
120
80
20
10
60
%
%
80
70
Bank of Ireland Growth 1999-2008
€ billion
90
90
80
70
60
50
40
30
20
10
0
0
-10
40
10
0
20
-10
-20
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
€ billion
Total assets (RHS,
€bn)
120
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
€ billion
Total assets real
growth rate %
%
90
80
70
60
50
40
30
20
10
0
Irish Life and Permanent Growth 1999-2008
€ billion
%
Anglo Irish Bank Growth 1999-2008
Total assets (RHS,
€bn)
%
50
18
90
16
80
14
70
12
60
10
30
8
10
-10
-30
30
4
20
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
25
Total assets (RHS,
€bn)
20
15
40
6
2
Total assets real
growth rate %
50
%
70
Total assets real
growth rate %
€ billion
90
10
10
5
0
-10
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Growth rates of Irish banks, 1999-2008
€ billion
Educational BS Growth 2001-2008
Irish Nationwide BS Growth 1999-2008
The collapse and after -- banks
3rd bank fails in September 2008—others fear run
Govt gives extensive guarantee believing problem just caused by
unjustified international lender concerns -- liquidity
Management abuses revealed
(small beer but reputationally damaging)
3rd bank nationalized (Jan 15th 2009)
Foreign borrowing not rolled over
replaced with central bank lending
AMC announced
Irish Credit Institutions Borrowing from Central Bank
140
120
€ billion
100
80
60
40
20
0
End 2006
End 2007
End 2008
The collapse and after – rest of
economy
Govt revenue collapses (had become super-dependent on property—
related and other boom-dependent sources
Fiscal prospects (including bank rescue costs) cause Govt borrowing
spreads to balloon out to 284 bps (end-March)
Tough fiscal response cuts public sector pay, but deficit for 2009 still 11
%
GDP fall peak-to-trough expected to be 15% (9% fall this year)
Ireland: Credit supply and demand, Jan 2003-Apr 2009
(Change
previous
Ireland: Credit Supply and
Demand --from
Enterprises
(Change from previous quarter)
Enterprises
Credit
demand & Supply -- House purchase
quarter; Ireland:
“3” = no
change)
(change from previous quarter)
Households
4
4
More demand,
easier supply
More demand,
easier supply
3.5
3.5
3
3
2.5
2.5
Supply (standards)
2
Demand
1.5
1
2003Jan
Supply (standards)
2
2007Jan
Less demand,
tighter supply
1.5
Less demand,
tighter supply
2005Jan
Demand
2009Jan
1
2003Jan
2005Jan
2007Jan
2009Jan
Irish bank prime lending rates 2007-2009
6
5
%
4
3
2
Irish Prime highest
Irish Prime lowest
1
0
2007Jan
ECB
2008Jan
2009Jan
Proof by contradiction:
Other countries
In
Out
Ireland
Latvia
crisis
Portugal
no crisis
Fixed peg - crisis
Iceland
Not pegged - crisis
Latvia
The myth
Post-socialist convergence, EU membership, EMU glidepath
2005-7: GDP growth @ 11%; house price growth @ 60%
Incredible facts
Double-digit inflation despite 15-year currency peg
90% FX-denominated loans
Supporting actors
Foreign banks (60%)
The crash:
One bank failed, largest bank (Swedbank) says 14% loss rate
Rescue package about 30% GDP
GDP falling faster than anywhere else
Iceland
The myth
Nothing to do with euro
Belief in industrial/financial conglomerate model
Incredible facts
Banking sector liabilities c.10 times GDP
1/3 to 2/3 of balance sheet outside Iceland
Supporting actors
EEA single banking passport
Political/business nexus
The crash:
All three big banks failed and nationalized
Deposit insurance scheme fails
FX market suspended, currency collapse
GDP falls 10% this year but may bounce back faster
Rescue package > 100% GDP
Portugal
No “new era” myth
Incredible facts
Small boom after euro membership (attributed to post
euro-entry optimism and low interest rates
Shallow recession 2002-3
Subsequent continued stagnation – no convergence in
living standards
Conclusion:
€ neither necessary nor sufficient
Euro did have a causal role in Ireland story
Low interest rates
Context for unremarked huge bank borrowing
But background of global credit bubble was a fertile environment for
“new era” myths
Lulled regulators worldwide into false security
Latvia, Iceland and others “caught” their own indigenous myths
If it hadn’t been euro, it might have been something else
Any big environment change is risky – even if it promises stability
Financial markets did not punish excesses as in the past
And policy antennae had not been retuned (also on wages)
That is a mistake that will not be made again