The fake wealth of a nation

From kathleen barrington: 18 April 2010

By Kathleen Barrington

I remember the moment in July 2006 when Bank of Ireland reported that Ireland was the second wealthiest of the top eight OECD nations, ahead of Britain, the US, Italy, France, Germany and Canada.
The reason I remember it so clearly is that my husband read the story on the French teletext service while we were on holiday in France.
The story of the rise of the poor Irish to take their place among the wealthy nations of the world made international headlines, because Ireland had, until then, still lingered in the European imagination as one of the poorest countries in the European Union.
The following day, a shopkeeper asked me where I came from. When I told her I was Irish, she immediately inquired how we had come to be one of the richest countries in the world. She recalled having read about the Troubles in the North and the Great Famine, and seemed delighted to hear that those days were behind us.
I wasn’t playing up the ‘‘Ah sure, we’re now all rich as Croesus’’ angle, because I doubted it was true. I didn’t want to sound boastful, and I certainly didn’t want shopkeepers charging a ‘Paddy premium’ next time we walked in the door.
The report, which had generated such positive global headlines, was the first Wealth of Nations report published by Bank of Ireland.
It claimed that the average wealth per person in Ireland was about €150,000. It also boasted that there were now 30,000 millionaires in Ireland, where a millionaire was measured by total assets excluding the principal private residence.
‘‘Much of the wealth had been created through gains in property investment and through a willingness to borrow to invest further,” said Mark Cunningham, head of Bank of Ireland Private Banking, at the time. ‘‘It has been entrepreneurial and more risk-orientated than many other developed countries where inheritance features more prominently.”
Pat O’Sullivan, senior economist at Bank of Ireland, played down the fact that debt as a percentage of disposable income had increased to 140 per cent of disposable income, saying that ‘‘neither the absolute level of borrowing nor the level of borrowing relative to overall wealth are ahead of international norms’’.
In short, the bankers dismissed the idea that our wealth was a mere illusion built on the rocky foundation of borrowed money.
So, for anyone who had swallowed the spin, it came as a shock to find in September 2006 that international credit rating agency Fitch had lumped us in the sin bin alongside Azerbaijan, Russia, South Africa and Iceland when it came to the riskiness of our banking system.
The Insider noted at the time that ‘‘the comparison with Iceland, in particular, should be enough to send a shiver down the spines of even the most bullish Irish investors’’, as it was Fitch’s verdict on the state of Iceland’s finances that had sent the formerly booming economy into meltdown earlier in 2006.
While Fitch did attach certain caveats to its report, which may have dulled its impact, it nevertheless stated clearly that its Macro Prudential Indicator (MPI) highlighted ‘‘the existence and severity of a set of macroeconomic circumstances that has been shown to anticipate a majority of past episodes of banking system distress and in some cases full-blown systemic crises’’.
There were three possible scores here, and Ireland scored a three, the worst of the ratings assigned by Fitch. The rating meant the country’s banking system faced ‘‘a high level of vulnerability to potential systemic stress’’.
Fitch pointed out that system crises typically occurred some years after the first early warning signs were apparent. It said the role of the indicator was to highlight potential systemic stress up to three years ahead.
In the event, the Irish banking system collapsed just two years later in September 2008, when the taxpayer had to intervene to guarantee €400 billion worth of bank liabilities, while it has since had to step up to recapitalise the banks at a cost of billions
The crisis, which Fitch had foreseen as a distinct possibility, is now widely believed to have arisen as a result of a combination of reckless lending to the property sector and the drying up of global credit markets triggered by the international credit crunch.
Some analysts were already telling The Insider in September 2006 that an earlier February report from Fitch may have contributed to at least some of the underperformance in Irish shares in the first half of the year, when Ireland had first been relegated alongside Iceland. This suggested that some of the world’s savvier investors were heeding the Fitch warnings.
So it was interesting to note last week that the Special Investigation Commission report into the collapse of Iceland’s banking system referred to Fitch’s February Bank Systemic Risk report as one of a number of reports which the Icelandic bankers and authorities failed to heed.
The commission drew attention to the fact that the February report had stated that ‘‘the credit boom in Iceland gives most cause for concern’’. It noted that Fitch had averred that if the credit cycle turned and equity and property prices fell sharply, banks would suffer a deterioration in loan quality with an adverse impact on financial performance.
The commission concluded that the proximate cause of the Icelandic banks’ demise in October 2008 was their inability to access funds in wholesale debt markets.
This was a problem shared by many major financial institutions in the wake of Lehman Brothers’ collapse. However, the Icelandic banks were particularly vulnerable to such a market disruption because of issues first raised by outside analysts in early 2006.
‘‘Even with such clear warnings, the banks had not managed or communicated their situations very effectively to world financial markets,” it said.
‘‘The sub-prime financial crisis surely added pressure on the banks, particularly after Lehman Brothers failed in mid-September 2008.
‘‘However, the banks had ignored repeated warnings that their size and rapid expansion exposed them to great risks. It seems likely that they would have come to grief eventually, even without a worldwide financial crisis.”
It would be interesting to establish whether the February and September 2006 Fitch reports were known to the Central Bank, the Financial Regulator, the Department of Finance, the banks and the government, and what action the authorities and banks took after digesting the content of those reports.
One thing is sure, though: the Fitch report didn’t stop Bank of Ireland producing a second Wealth of Nations report on July 30, 2007. By then, Bank of Ireland was telling us that there were 33,000 millionaires in Ireland, an increase of 10 per cent on the previous year following another year of ‘robust growth’ in household debt.
At the time the report was published, household debt had increased to 178 per cent of disposable income, but the bank was still arguing that ‘‘the overall level of assets clearly supports this level of debt’’.
I still have a copy of the report sitting on my shelf. It is printed on high-quality paper and bound in a deep red cover on which the words ‘The Wealth of the Nation’ are embossed in gold writing – a testament to the hubris of another era.