Credibility of Central Bank at risk
After less than two weeks, it is clear that Fianna Fáil is holding the Sword of Damocles over the Government, and stands ready to bring it down with devastating force at the opportune time.
The danger is that, in the meantime, it, and other parties in opposition, will seek to put forward legislative proposals that will have populist appeal and may deliver popular results in the short-term, but create longer-term problems.
Even if the Government does not approve of the legislation, there is not a lot it can do about it, if the majority in the Dail supports it. This is not a recipe for sensible policymaking.
This week, Fianna Fáil brought forward legislation to the Dáil that will give the Central Bank power to force the commercial banks to cut variable mortgage rates.
The other political groupings support this legislation, and, despite the justifiable reservations of the Government, there is not a lot it can do to prevent it.
Such a proposal has obvious popular appeal, given that average variable mortgage rates in Ireland stand at 3.6%, compared to around 2% in the eurozone. The question is why the Irish banks are earning such margins.
The obvious answer is because they can. However, the less obvious answer is that the banks have a lot of tracker mortgages on their books, which are loss-making.
With a tracker mortgage, the bank enters into a legal contract with the mortgage holder to charge a certain margin over the European Central Bank’s base rate.
Unfortunately, these were very popular up to 2007 and there is now a very negative legacy. The ECB base rate currently stands at zero and most holders are now paying a rate of between 0.5% and 1%.
Given that the average cost of funding for banks is now, at best, around 1%, these tracker mortgages are loss-making, but there is not a lot the banks can do about a legally-binding contract.
Hence, the wider margins on variable-rate mortgages are, to some extent, being used to subsidise the loss-making tracker mortgages, as the banks seek to rebuild profitability and their balance sheets.
The question is if the political system should be used to undermine the independence of the Central Bank of Ireland for what is obviously a populist political motive.
One of the first things that Tony Blair did, when elected British Prime Minister in 1997, was to give the Bank of England operational independence and free it from the whims of its political masters.
The boom-bust characteristics of the economy, up to that time, have been largely eradicated, notwithstanding the impact of the global shock in 2007.
For any central bank, and for monetary policy in general, independence is crucial to credibility.
Once the politicians start to interfere at a micro level, that credibility risks being damaged, and, once damaged, it is hard to restore.
I heard one Fianna Fáil TD, on radio, arguing that these extra powers for the Central Bank would enhance competition in the market.
I fail to see how this could possibly be so. What the Irish banking market requires is more completion from at home and/abroad.
Theory would suggest that if super-normal profits were being earned in a particular market segment, then competitors would enter that market and eventually compete away those super-normal profits.
This is exactly what happened when Bank of Scotland entered the Irish mortgage market in 1999.
With government intervention of the type proposed, such competition would be less likely to materialise.
Furthermore, for any potential purchaser of AIB, such micro-intervention could act as a deterrent.
By forcing the banks to cut variable rates, it is likely that the supply of new loans to first-time buyers will be damaged.
There will, inevitably, be significant opportunity costs, if the Central Bank were to exercise its proposed new powers by insisting that banks cut variable rates for their existing mortgage-holders.
The other point to note is that the Central Bank does not want these new powers.
