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News : Irish Last Updated: Dec 19th, 2007 - 13:17:15

European credit markets back at crisis level; Subdued Irish economic growth likely to last beyond 2008: Minister says lack of Irish public sector reform "is a joke"
By Michael Hennigan, Editor and Founder of Finfacts
Nov 26, 2007, 06:03

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Lucas Papademos Vice President and Jean-Claude Trichet President, of the European Central Bank

Hopes that the credit crisis that hit European markets in early August had abated, were dashed last week when interest rates on short-term lending in money markets returned to levels reached in August and areas that had escaped impact such as the €2 trillion market for covered bonds, an equivalent of the US mortgage-backed-securities market, that had been viewed as among the safest, were also affected.

Banks are reported to be building up cash reserves as insurance against potential losses on securities backed by subprime home loans, many of which still are held in off-balance-sheet investment funds, known as conduits and structured investment vehicles (SIVs), for which the banks could be forced to take responsibility.

In London, the London interbank offered rate, or Libor, rose sharply last week. The three-month US dollar rate reached 5.04% Friday, up from 4.87% on Nov. 13th. The three-month Euribor rate was 4.6975% on Friday, up more than 0.1 percentage point from a week earlier - the biggest rise since August.

The Wall Street Journal says that in an unusual sign of stress, banks are offering to pay well above publicly quoted interest rates for short-term loans. In the Euro commercial-paper market, where banks and companies issue IOUs to investors such as money-market funds, some banks are willing to pay as much as 0.2 percentage point more than Libor, according to a person familiar with the market. Still, the market contracted by $41 billion in the first three weeks of November as investors shied away, according to Capital Market Daily.

The Journal says that in recent days, investor anxiety has spread to the market for covered bonds, which had been the last remaining option for many European banks looking to tap capital markets. The market has long been a major source of financing for public-sector banks and mortgage lenders throughout Europe, including troubled United Kingdom mortgage lender Northern Rock PLC. The market emerged from the summer's credit turmoil relatively unscathed because it was seen as ultrasafe: Covered bonds must meet stringent requirements for the quality of loans backing them and must carry further guarantees from issuers.

Last Friday, the European Central Bank announced that it would provide fresh emergency injections of liquidity to the inter-bank markets, from this week.

Lawrence Summers, former US Treasury secretary, writing in Monday’s Financial Times, says: “The odds now favour a US recession that slows growth significantly on a global basis.”

Prof Summers writes: Several streams of data indicate how much more serious the situation is than was clear a few months ago. First, forward-looking indicators suggest that the housing sector may be in free-fall from what felt like the basement levels of a few months ago. Single family home construction may be down over the next year by as much as half from previous peak levels. There are forecasts implied by at least one property derivatives market indicating that nationwide house prices could fall from their previous peaks by as much as 25 per cent over the next several years.

Two weeks ago, China said that its exporters would be devastated by a US downturn.

Goldman Sachs said last week that US house prices have 13 to 14 per cent more to fall, or 35 to 40 per cent in the case of California.

Peter Sutherland SC, Chairman of BP and of Goldman Sachs International

The current global financial crisis could cause "considerable trauma" for the whole of 2008 because its causes are not yet fully understood, BP Chairman Peter Sutherland has warned.

Speaking on Irish television channel TV3's The Political Party on Sunday, Sutherland, who is also chairman of Goldman Sachs International, sid it would certainly continue through the first half of the year.

"The problem is everyone says that we can rely on growth in China and India, but China exports most of its products to the United States so if the US is in a recession, this is a problem."

The full background to the crisis is not yet fully understood and has not fully played out in regard to providing credit and liquidity to institutions, "so I think it is a dangerous period for the world", Sutherland said.

The US economy is "in a mess", with the result that the dollar is weakening and the euro is strengthening.

The former EU competition commissioner said that the situation makes it more difficult for Ireland to sell in dollar-dominated markets, while productivity becomes a major issue for multinational operations based in Ireland.

The International Monetary Fund meeting in Washington last month and other gatherings since of central bank governors were terribly depressing, he said, "because people didn't understand the extent of the problem".

"So I think it is a dangerous period for the world," Sutherland said.

Michael McCabe, who is head of portfolio specialists with Bank of Ireland Asset Management, wrote in the Irish Times last week:  The major concern is with the potential economic spill-over from the still unfolding US subprime collapse which, because of securitisation and globalisation, has had ramifications all over the world. This is a serious problem, but weren't the US Savings & Loans crisis, the 1987 stock market crash, the Gulf War stock market collapse and the bursting of the TMT bubble also serious crises? We will always face crises but those crises are not terminal. With the right policy responses from central banks, crises can be managed and overcome. At this point there is no reason to doubt that a few interest rate cuts won't address this subprime crisis.

Even the maestro himself, former Federal Reserve Chairman Alan Greenspan who is blamed by some for the fallout from the period of easy money when the federal funds rate fell to 1%, has cast doubt on the return to that strategy, which operated against a backdrop of Chinese goods price deflation, falling commodity prices and the surge of an additional billion people to the globalised workforce, following the collapse of communism in Europe and the development of capitalism in China.

The European Central Bank will not tolerate increasing inflation in the Eurozone, ECB Executive Board member Jürgen Stark said in an interview Sunday, but he termed the current rise in prices "temporary".

"The risks for price stability have grown, especially due to higher oil and food prices," Stark told the Welt am Sonntag newspaper.

Irish Economy

The forecasts for Irish economic growth in 2008, range from about 2% up to 4% with Goodbody Stockbrokers' Dermot O'Leary at the lower end and Bank of Ireland's Dan McLauglin heading the optimists.

Even the pessimists see an upturn in 2009 as the trough in housing output will result a speedy recovery. However, that may well be wishful thinking.

McLaughlin and IIB Bank's Austin Hughes who both called a peak in the ECB's key interest rate at 3.5% in 2006, are now forecasting a cut in the central bank's key rate of 4% to 3.5% by mid-2008.

Even if a severe impending recession in Europe prompts the ECB to reverse course, it is unlikely to swiftly change the dynamics of the severe housing slump for sometime as its impact is likely to have more severe spillover effects than expected.

Davy welcomed news on Friday that house prices fell 1.3% month on month (mom) and 4.7% year-on-year (yoy) in October. Economist Rossa White said that vendors, who for so long held out for the kind of prices seen in summer 2006, are now getting realistic. Individual vendors have to sell their home eventually if they have decided to move and so the ask has dropped. White said, in contrast, new home prices have been static. This is one of the key problems in the market. Developers have refused to drop prices. Yet prospective home-buyers can't or won't pay as much as in 2006, so sales have been awful.

Figures released by the Department of Finance show that the monthly sale of second hand houses has slumped by more than 50% this year. Last January, 5,375 second hand houses were sold, bringing in €127m in stamp duty to the Department of Finance.

But by October house sales had fallen to a low of just 2,662 sales and a 50% cut in revenue to €68.5m.

Fine Gael TD Richard Bruton noted that these figures "collapsed the government's claim that we were experiencing a soft landing".

Minister for Finance Brian Cowen told Bruton in response to a parliamentary question on the estimate of the taxes raised from housing in each year since 2002 that: In 2002, the residential stamp duty net receipts were €349 million and the VAT estimates were €1,436 million. In 2003, the residential stamp duty net receipts were €528 million and the VAT estimates were €1,874 million. In 2004, the residential stamp duty net receipts were €752 million and the VAT estimates were €2,327 million. In 2005, the residential stamp duty net receipts were €945 million and the VAT estimates were €2,841 million. In 2006, the residential stamp duty net receipts were €1,311 million and the VAT estimates were €3,247 million. The residential stamp duty net receipts for 2007, to the end of October, were €902 million and the full-year VAT estimates are €3,501 million.

According to an Irish Times report on Thursday, there are an estimated 10,000 empty new apartments in Dublin.

In the same report, Dermot O'Leary, economist from Goodbody Stockbrokers, is reported as saying that the stock level of unsold homes in Ireland "has risen steadily".

There are now 42,000 second-hand homes for sale - equivalent to a 12-month supply of housing stock, he says. Some regions are more affected than others, according to O'Leary.

One in 15 properties is on the market in both counties Cavan and Roscommon, he said.

Dublin comes in at the very bottom of the list with only one in a 100 properties for sale in the capital at present.

The impact of the housing slump, coincident with the cut in the growth of current public spending from a 12% rate to 8% and a difficult international environment for exporters is likely to have an impact beyond 2008 and could well usher in at least three years of sub-par growth.

Irish employment in internationally traded goods and services was down 11,000 in 2006 compared with 2000. During the same period, the workforce grew by 430,000. Domestic demand has been the main driver of employment in the current decade.

Nine months after ISEQ record highs, Irish shares likely to underperform other markets for sometime

Pramit Ghose, Managing Partner at Bloxham Stockbrokers, wrote in the Irish Times on Saturday that the Irish stock market has suffered from the spillover from the US to Europe of this banking crisis, as the availability and cost of interbank funding has tightened sharply. Allied to a weak housing market, the short sellers have had a field day, causing the third worst year since the Irish stock market commenced in 1782. Only 1974 (-47 per cent) and 1826 (-37 per cent) were worse.

Ghose says it seems incredible that the ISEQ is down some 30% in 2007 so far, while the Dow is up 3% and the FTSE 100 flat. Can things in Ireland really be that bad he asks?

Reality hurts, he says- we have to assume some slowdown in 2008 Irish earnings as the economy slows - but today's valuation of Irish banks at roughly five to six times next year's earnings assume a major and prolonged recession is imminent. The last year that we had negative GDP growth was 1983, when unemployment and inflation boasted double digit numbers.

Bargain basement valuations matter little when there are more sellers than buyers. Market participants are scared by the scale and speed of the sell-off in Ireland, particularly this month, and are reluctant to purchase more Irish shares. What will turn things around?

Ghose says that maybe a takeover bid for one of our larger companies - they are vulnerable at today's valuation levels. Maybe, as we expect, rate cuts from the Bank of England and the European Central Bank (ECB) next spring (or earlier), as a global recession threatens. Or maybe, simply, the short-sellers bank their profits from the ISEQ, and move on to a new game.

On any sane probability curve, the risk of not making money on Irish shares at today's level is small; we just don't know how long it will take or how much more downside there is, and thus advocate a staggered investment strategy over the next few months. We will, however, look back in a couple of years' time and wonder why we were so reluctant to buy Irish shares today!

An finally...in relation to the political leaders who took credit for the Celtic Tiger boom but lacked both the vision and courage to reform archaic governance and public sector systems, one of the four ministers in the Department of Enterprise, Trade and Employment has had the courage to call a spade a spade and it is not the senior minister/schoolteacher Micheál Martin, who is more at home with superlatives about graduates and the fantasy of a "world-class" knowledge economy in just over 5 year's time.

Minister of State John McGuinness warned on Saturday that the Irish public service is failing to perform, is affected by scandalous restrictive work practices and must face a root-and-branch reform.

"There is a growing feeling in this country that, with a few notable exceptions, public service systems are not doing their job," he told an Institute of Chartered Accountants in Ireland conference in Wicklow.

Acknowledging the thousands of "good, honest, impartial and diligent" public servants, McGuinness said "they are working within a system that has had its day. The world has moved on, and the public service must move with it.

"Public service reform is the elephant in the room that no one looks at for fear that Liberty Hall will fall on top of them. Well, the public is looking at it. Business leaders are looking at it.

"Liberty Hall does not have to fall, but it should pay attention."

John McGuinness TD, Minister for Trade and Commerce - one of 4 ministers in the Department of Enterprise, Trade and Employment. Ireland with a population of 4.1 million has 35 ministers.

The Minister for Trade and Commerce told the Druids' Glen conference that the "systems are not serving the people who are working in them either. They are destroying the morale, and creating organisational apathy, supported by scandalous restrictive practices."

Public sector unions had achieved "extremely good pay and conditions". However, they should now, "for the good of their members, for the wellbeing of the economy", and in co-operation with the Government and others, help to convert the public service into "a vibrant, modern, efficient, accountable contributor in the drive to keep Ireland moving forward".

"I am not looking for a loss of job or any weakening of union power. I am calling for job enhancement, excitement and the creation of a can-do spirit which will convince our business leaders and the public generally that the State is working for them, rather than against them.

"I am calling for unions to help create this new order because it is in everyone's interests that they do so. Everyone in this room knows that the existing state of affairs cannot continue.

"It is a joke. You cannot run a high-powered economic engine on flat bureaucratic tyres," McGuinness said.

"Look at what is happening. It is not acceptable that the changing of a light-bulb should nearly close a hospital.

"It is not acceptable that public servants cannot transfer easily from a department or State body, where perhaps there is not a demand, to another where people are needed."

Criticising the payments of bonuses to public service managers, McGuinness said: "it is not acceptable that bonus payments are handed out so liberally.

"In the private sector workers get paid bonuses only when exceptional profits are made. It is said that there is no profit in the public sector. But there is: in the goodwill, the support and approval of the public.

"By that measure alone, I doubt if there would be a long queue for bonuses. Public servants seeking parity with the private sector must surely accept that they just can't take the good bits.

"That applies to politicians, too. That is why the benchmarking process should be reviewed by an independent group drawn from the private sector," McGuinness said.

© Copyright 2007 by Finfacts.com

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