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News : Irish Last Updated: Apr 24, 2009 - 5:31:05 PM

Irish Economy: Ireland is faced with new challenges as the US financial sector faces retrenchment and transformation
By Michael Hennigan, Founder and Editor of Finfacts
Sep 20, 2008 - 11:36:43 AM

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US Treasury Secretary Paulson outlined a comprehensive approach to relieving the stresses on financial institutions and markets Friday. "Right now, our focus is restoring the strength of our financial system so it can again finance economic growth. The financial security of all Americans – their retirement savings, their home values, their ability to borrow for college, and the opportunities for more and higher-paying jobs – depends on our ability to restore our financial institutions to a sound footing," said Paulson.

Paulson put a price tag of $700 billion on the bailout but others say that it could exceed $1 trillion.

Irish Economy: Ireland is faced with new challenges as the US financial sector faces retrenchment and transformation. The economy has benefited enormously from both the huge growth of the US high tech and financial sectors since 1990. In the aftermath of a dramatic week for American finance, which will remain semi-socialised for the foreseeable future, the longterm consequences for the Irish economy, that is dependent on American firms for 90% of its exports, should at least alert Irish policymakers to challenges ahead, that marketing spoof from politicians and State enterprise agencies, will not provide credible solutions for.

The financial crisis has been termed the worst since the 1930's and in the grim year of 1932, the renowned British economist John Maynard Keynes, when on a visit to Washington, was asked how long did he expect the Depression to last. "The last one was called the Dark Ages," he jokingly replied."And it lasted 400 years!"

Keynes seminal work, The General Theory of Employment, Interest and Money, was a few years ahead but he had established his reputation with The Economic Consequences of the Peace (1919). Keynes had been a member of the British delegation at Versailles and saw that the vengeful peace, would have baleful economic consequences for both victors and vanquished. America was a creditor of both sides and in 1933, Keynes in his open letter to President Roosevelt said: "You have made yourself the Trustee for those in every country who seek to mend the evils of our condition by reasoned experiment within the framework of the existing social system. If you fail, rational change will be gravely prejudiced throughout the world, leaving orthodoxy and revolution to fight it out."

The wild gyrations on world markets this week, illustrate the continuing economic pre-eminence of American economic power. Ireland is not alone in being a dependent of Uncle Sam.

Since the onset of the credit crisis in August 2007, the name of Ken Lay, the founder of the Texan energy trader Enron, has crossed my mind more than once. Enron collapsed in 2002 under a weight of debt and accounting fraud involving a network of off-balance sheet vehicles. In recent times, we have become accustomed to an alphabet soup mix of finance industry off-balance sheet and on-balance sheet vehicles and Robert Rubin, Obama adviser, former Clinton Administration Treasury Secretary and Citgroup executive/board member confessed, to Fortune Magazine that until the mortgage storms broke over his head in the summer of 2007, he was unfamiliar with the kinds of complex mortgage structures with which Citi's own balance sheet was packed - and that was just the on-balance sheet assets.

June 16, 1933:Washington, DC- President Franklin D. Roosevelt affixes his signature to the Glass-Steagall Bank Reform Act--deposit insurance measure, one of the last bits of legislation put through before Congress adjourned, at the end of the famous first 100 days of the Administration. Behind the President (l-r) are: Sen. Allen Barkley; Sen. Thomas Gore; Sen. Carter Glass; Comptroller of Currency J.F.T. Connors; Sen. William G. McAdoo; Rep. Henry S. Steagall; Senator Duncan U. Fletcher; Rep. Alan Goldsborough; and Rep. Robert Luce.

In addition to deposit insurance, this second Glass-Steagall Act, separated investment banking and commercial banking, which is why Morgan Stanley and JP Morgan are two different firms. The Act was repealed in 1999.

Commercial banks were seen as having taken on too much risk in share trading, with depositors' money, up to the October 1929 Crash. © Bettmann/CORBIS

Rubin who earned $17.3 million at Citi in 2006, was not aware of the detail of $55 billion of collateralized debt obligations (CDOs) and other subprime-related securities on the group's balance sheet

"The answer is very simple," he said. "It didn't go on under my nose."

Warren Buffet, the billionaire investor, who lives in the same house in Omaha, Nebraska, since 1958, wrote in 2003 that credit default swaps and other derivative products were "weapons of mass destruction."

We reported this week that at the end of 2002, the notional value (the value of the underlying assets) of the entire credit-default swaps market was just $2.19 trillion and about $144 billion a decade ago, but at the end of 2007, had rocketed to $62.17 trillion, according to the International Swaps and Derivatives Association.

As with the chain linking a subprime mortgage issued to a resident of Reno, Nevada and a municipality in northern Norway, the level of interconnectedness of CDS contracts is now what could be termed a known unknown.

The Wall Street Journal said that  as of June 30, an AIG unit had written credit-default swaps on more than $446 billion in credit assets, including mortgage securities, corporate loans and complex structured products.

Finfacts Reports:
US Treasury and Federal Reserve to propose sweeping plan to stem the worst financial crisis since the 1930's
IMF says worst of the financial crisis may still lie ahead; Storm can be weathered without a damaging global recession; Recovery to be only gradual
US Securities and Exchange Commission to issue temporary ban on short-selling; Irish and UK regulators announce bans to protect financial stocks from shorting
The Credit Crisis: Denial, delusion and the "defunct" American economist who foresaw the dénouement
Panic on Wall Street: Barometers of stress hit World War II levels; Fears grow about credit-default swaps on more than $62 trillion in debt (Thursday report - - See why Warren Buffett termed credit default swaps and derivatives "weapons of mass destruction" in 2003.)
Analysis: Irish Economy - Cowen and the 100 days' milestone - a Political Pygmy amongst the Oireachtas Lilliputians
Irish Services Strategy Group Report: Political whitewash ignores overwhelming dominance of foreign-owned firms in Irish service exports thereby neutering strategy for Irish firms
IBEC and understanding the world East of Suez
Whitaker Tribute Conference: International academic says Ireland’s economic institutions “seem inherently quite vulnerable to corruption, special pleading, ‘jobs for the boys’ and other such undesirable distortions"
The Irish Mind and the Knowledge Economy: Should we bank everything on fuzzy leprechaunic political dreams?
Irish investors were the second biggest net investors in commercial property across Europe in 2007
Foreign-owned firms were responsible for 90.2% of Irish exports in 2006 - including both merchandise goods and internationally traded services
International house price comparison index for 2007 ranks Dublin, Ireland and Beverly Hills, California for world's most expensive comparable management level family homes
Irish full-time employment in manufacturing and internationally traded services fell 10,297 in the period 2000-2007 while the total workforce expanded by 605,000

Nicholas Kristof wrote in the New York Times this week that Richard Fuld, the longtime chief of Lehman Brothers took home nearly half-a-billion dollars in total compensation between 1993 and 2007.

Last year, Fuld earned about $45 million, according to the calculations of Equilar, an executive pay research company. That amounts to roughly $17,000 an hour to obliterate a firm.

Fuld was a hired hand like many more of the modern day plutocrats, Stan O'Neal who doomed Merrill Lynch, walked away with a cool $161 million.

The "rainmakers" earn huge bonuses selling toxic products that they don't have to repay when they are exposed as duds, while the lives of many colleagues have been ruined.

The top earning US hedge fund manager John Paulson earned a record $3.7 billion in 2007 to top Alpha Magazine's annual ranking of the 50 most highly paid hedge fund managers. The Paulson & Co. head overtook George Soros and James Simons, who ranked second and third, at $2.9 billion and $2.8 billion, respectively. The top 25 on the list earned an average $892 million, up from $532 million in 2006.

That alas, was just part of the greatest credit bubble in history.

Financials as a percentage of S&P 500 market capitalisation rose from 8% in 1990 to almost 25% at the height of the housing boom and in recent years, the cut of the Fed's federal funds rate to 1% facilitated the out-of-control asset boom.

With Washington calling the shots in the foreseeable future, the industry will surely shrink as the global economy gradually recovers from the downturn.

Dublin's International Financial Services Centre(IFSC), which has 22,000 employed, has benefited from the boom but should expect collateral damage.

Dell Computer, Ireland's largest merchandise exporter, is expected to close its manufacturing plant in Limerick with the loss of up to 3,000 jobs and an ailing British economy remains the main market for exports from Irish-owned firms.

Chris Giles, Financial Times Economics Correspondent, wrote on Thursday: "If all the news was not gloomy enough, signs are increasing that something bigger is going on than a cyclical downturn. The fear is that recent rapid growth was a temporary purple patch and the underlying potential of the economy is weaker than thought. While inflation was low and stable and the economy was growing quickly - at a rate close to 3 per cent a year in the past decade - domestic costs and inflation were nevertheless rising, far above the 2 per cent inflation target. Strong sterling, weak import prices and favourable headwinds from globalisation, including an immigration boom, allowed the economy to grow fast without inflation taking off.

But those days appear over. Sterling's decline and the end of cheap imports seem to have reduced the rate of growth that is consistent with stable inflation. This change is reflected in economic forecasts, such as those from the Bank and the CBI employers' organisation, which show that a year of stagnation is required to eliminate inflation and that the subsequent pick-up will be lukewarm.

If true, the consequences will be profound. For many households, the level of debt they have taken out will be too high if their incomes grow more slowly than they had hoped. For the government, the effect will come through a permanent deterioration in public finances.

Yesterday's government borrowing figures showed revenues struggling against still strong public spending. On estimates from the Institute for Fiscal Studies, public borrowing is likely to overshoot government forecasts by almost £30bn, putting the deficit at 4 per cent of national income in 2010-11."

In coming years, a nice earner for the Irish Exchequer is likely to come under attack.

The US Treasury has requested a renegotiation of a taxation agreement in respect of Irish-based US multinationals.

Companies such as Microsoft and Pfizer route revenues from other overseas units to avail of the low corporate tax rate of 12.5%.

In November 2005, The Wall Street Journal wrote that "a law firm's office on a quiet downtown street [in Dublin, Ireland ] houses an obscure subsidiary of Microsoft Corp. that helps the computer giant shave at least $500 million from its annual tax bill. The four-year-old subsidiary, Round Island One Ltd., has a thin roster of employees but controls more than $16 billion in Microsoft assets. Virtually unknown in Ireland, on paper it has quickly become one of the country's biggest companies, with gross profits of nearly $9 billion in 2004."

Flat Island Company made a profit of $802.4 million in 2004 on sales of $2 billion, but paid no tax. It issues licences for software in Europe, the Middle East and Africa.

Recent data on these companies isn't available as Microsoft has converted them to unlimited companies and is allowed to keep the results private.

There is much hope that service exports will sustain Ireland's economy but at official level, it's considered good marketing not to distinguish between the overwhelming dominance of US firms and the small number of indigenous exporters.

The Minister for Enterprise, Trade and Employment, is responsible for industrial and service sector policy. It has been almost 14 years since a politician with business experience, has held the portfolio. 

The current incumbent was a social worker and she was preceded by two former schoolteachers and a lecturer.

There are currently 4 ministers in the Department.

The Senior minister has the important job i.e for public relations purposes, of making jobs announcements on behalf of American firms. The other 3 ministers spend most of their time, making speeches at conferences.

After spending 8.2 billion of Exchequer funds, the goal is that: "Ireland by 2013 will be internationally renowned for the excellence of its research, and will be to the forefront in generating and using new knowledge for economic and social progress, within an innovation driven culture."

Nobody knows what the criteria are for the exalted state. Forfás the science policy advisory agency, isn't even tracking the commercialisation of university patents.

In the 15 years of the Celtic Tiger, the personal windfalls from the boom, went to commercial property investment.

Irish investment of €13.9 billion was put into European property deals last year. In contrast, the Irish business sector does not even get a total of €200 million in venture capital investment.

The depressing aspect of policymaking, is that the managers at the State enterprise agencies appear to be cheerleaders for political marketing spoof.

How can credible policies be developed if marketing spoof that obfuscates reality, goes unchallenged?

During the boom, only a handful of Irish firms, made an impact internationally while US firms were overwhelmingly responsible for the diversification of exports from a historic dependence on the UK market.

In simple terms, whose interests are served when Microsoft exports from Ireland are claimed as an "Irish" success in the Chinese market?

Now that the boom is over, spoof certainly doesn't help the Irish economy.

The term "tectonic shifts" was liberally used this week.

There will be no worthwhile reform in governance, the public service, sheltered areas of the private sector and the land rezoning system that adds to poor competitiveness.

Neither is there a silver bullet for the export sector.

However, the "it will be awright on the day" approach, is hardly the best response to the rapidly changing international environment.

Finally, it is a striking fact, that after the self-congratulation of a 15-year boom, Ireland is likely more dependent on its future prosperity on American firms, than any other developed country. The travails of companies like Dell, AIG and Pfizer will continue to have a particular potency in Ireland and investors with surplus cash will put it in commercial property investment overseas.

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