Investors sit tight until stability returns
The latest developments with Lehman brothers, AIG, Fannie Mae, and Freddie Mac are absolutely mind blowing in terms of their significance and magnitude and should convince any doubters about just how calamitous the sub-prime crisis is. Things are happening in markets today that nobody would have believed possible 18 months ago, particularly the manner in which the free market US administration is now bailing out some financial institutions on a daily basis.
The capitalist system has created a huge crisis that threatens the stability of the whole global financial and economic system. It does suggest that unfettered free markets do not always deliver the best outcomes and that the regulators cannot be trusted to regulate anything in an even-handed and prudent manner. How US banks were allowed engage is such irresponsible lending behaviour and how the rating agencies facilitated the packaging of useless mortgages into investment products is hard to figure out.
There is now considerable rumour and speculation about the health of the Irish financial system. Unless one could get access to the loan books of the institutions, it is hard to make any meaningful judgement. What we do know is that thankfully Irish financial institutions did not get a chance to immerse themselves in the subprime lending culture that prevailed in US banking. However, the obvious vulnerability to the system is the exposure on the mortgage side to sharply falling house prices, and on the developer side to developers who have paid high prices for land banks. These land banks cannot now be developed due to a combination of tight credit availability and an inability to sell the building product even if it were developed. It is hard to say how financially vulnerable these developers are, but if they started to fall it would create quite a hole in the balance sheets of the exposed banks. This obviously does create a certain vulnerability, which will have to be monitored carefully.
There is certainly a possibility that at the end of the global crisis we may have a different configuration in Irish banking. That might be no bad thing. Meanwhile, savers need to be re-assured by the banks themselves and the regulator that their savings are safe. Confidence in the system is vitally important, and the vibes I am picking up from many people would suggest that confidence is very fragile at the moment.
For investors, it is an absolutely horrible and very uncertain environment. It is not at all clear where money should be directed at the moment. Global equity markets are in serious difficulty, the Irish equity market has literally collapsed, domestic property prices are still falling, and many foreign property markets are looking distinctly sick.
Cash is obviously king at a time like this. When markets are falling, opportunities always present themselves, but it is just a question of trying to pick the bottom of the cycle, which is never easy to do. At some stage equity and property levels will present themselves which will look very attractive in hindsight.
However, we are not likely to have reached that stage yet. For investors who can, the advice has to be to sit on cash until more stability returns to the system. That will take a while longer, based on all available evidence. The word crisis in Chinese means both a threat and an opportunity.
Jim Power, chief economist, Friends First
