Ireland may be the first troubled eurozone country to go back to borrow money in the financial markets as it exits the bailout phase which started when it had to be rescued by the European Commission, the ECB and the IMF in 2010. To get here it had to suffer the humiliation of being transformed from a model of excellent economic management to a much less flattering example of gross business and political mismanagement.

I remember the days at the turn of the millennium when the Celtic Tiger model was used as a case study of how a modern economy should be managed. Dublin was the Mecca for strategists from small countries, including Malta, that were aiming to join the EU. The way that Ireland was managed in the last two decades has now become a template of how not to manage an economy.

My favourite book this summer was The Fall of the Celtic Tiger by the Irish economists Donal Donovan and Antoin Murphy. This book is written in a style that makes it easy for most people, including those who are not familiar with the world of finance, to understand how the Celtic Tiger was killed by gross mismanagement at the political and business level.

The book starts with a clear explanation of how the Celtic Tiger was born in the 1990s: “By the year 2000, Ireland witnessed an enviable golden macroeconomic scorecard: continued high growth, low unemployment a budgetary surplus and a low and falling debt to GDP ratio.”

The two factors that influenced this admirable performance were the high-tech revolution centred in Silicon Valley in California, and the growing Europeanisation of the Irish economy. Ireland attracted high-tech direct foreign investment mainly from the US, thanks to the attractive fiscal incentives that it offered and the high quality of the Irish educational system. Ireland literally moved from the agricultural “donkey-and-cart economy to a post-modern high-tech economy without experiencing the intervening phase of industrialisation”.

The sudden prosperity experienced in the 1990s quickly created the right environment for an asset bubble. History shows how the extent to which bubbles can develop and, when they burst, cause in many cases the collapse of financial systems and massive macroeconomic disorder. Donovan and Murphy have no doubt as to who was responsible for the fall of the Celtic Tiger: the banks; the regulators; and the Irish government who helped to blow the property market bubble.

Irish regulators were completely inept at understanding and reacting to the dangerous practices that banks were adopting to boost their profits

The Irish property market went through two phases before it collapsed in 2008. Between 2002 and 2008, the market saw the first downturn when the dot-com phenomenon collapsed, and the 9/11 incident shocked the global economy at a time when confidence was already collapsing. The Irish government attempted to revive the faltering property market by granting fiscal incentives to developers. Irish banks massively increased their lending to the property sector following the model of the Anglo-Irish Bank that was generally considered as a best practice bank at the time.

Donovan and Murphy give us a very good explanation of what distinguishes good from bad bank lending. To do this they quote Hyman Minsky, the Keynesian professor of economics at Washington University, St Louis. Minsky categorised three types of bank financing regimes: (i) hedge; (ii) speculative and (iii) Ponzi. Hedge financing happens when the borrower’s cash flow is sufficient to cover interest and capital repayments.

But in a period of “excessive exuberance” banks often move to a more risky lending regime: under a speculative regime, “borrowers only cover their interest payments and there is a general expectation that asset prices are likely to rise – but not interest rates – so that borrowers will be able to rollover their debt without difficulty”.

When speculative lending creates an apparent increase in prosperity banks are often tempted to introduce a third lending regime: Ponzi financing. This is the riskiest form of lending. When banks lend because asset prices are rising, even though the borrowers’ cash flow is insufficient to cover either interest or capital repayments, it is only a question of time before the bubble bursts and pushes the economy in a highly unstable direction.

The Fall of the Celtic Tiger goes to some length to describe how the Irish regulators were completely inept at understanding and reacting to the dangerous practices that banks were adopting to boost their profits.

A mixture of incompetence and complacency on the part of regulators, government ministers and bank leaders accelerated the inevitable downfall that killed the Celtic tiger.

johncassarwhite@yahoo.com

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