Cleverly regulated free market is the new grail
Late last week, following the decision to ban the short selling of Irish shares and amid stories of a takeover of Irish Nationwide by Anglo Irish Bank and of Bank of Ireland by Banco de Santander, markets rallied very strongly.
Unfortunately this week most gains have been given back and sentiment remains fragile. Tuesday was a truly horrendous day, with almost 6% wiped off the value of the market.
A suggestion was made on Tuesday that the heavy selling of Irish bank shares was due to the ban on short selling impacting negatively on the willingness of dealers in equity markets to take long positions in equity markets. The logic underlying this explanation is not at all clear, not least because the ban on short selling in the US and Britain did not have a similar effect.
The explanation for the heavy selling of the Irish market looks much more straightforward. Nationwide rejected Anglo’s approach out of hand and Bank of Ireland denied any knowledge of the takeover.
Markets had taken a view in light of international developments over recent weeks that the Irish financial services market would not be immune to takeover activity and in a strange way that provided a crutch to the market late last week.
When that crutch was removed the selling recommenced. Without such a possibility, international investors have no confidence — or interest — in buying into the Irish bank story and every opportunity to sell is being availed of.
At the same time, domestic fund managers continue to gradually reduce their exposure to the Irish market. This exposure paid handsome dividends up to the start of 2007, but has subsequently done serious damage to investment performance. The weighting of Irish equities in the average managed fund here continues to be reduced and it is hard to imagine any appetite emerging soon.
Investors at home and abroad are concerned about the exposure of Irish banks to falling property values and vulnerable developers and on that basis are steering well clear of the market. These fears are unlikely to be alleviated anytime soon. So for the foreseeable future the Irish market looks set to be dominated by more sellers than buyers.
External developments are not helping sentiment either. Markets are concerned about the US Treasury deal to bail out the US financial system. A deal will be agreed over coming days but there will be a legacy once current problems pass.
US Congress will have to insist on a much greater overseer role in relation to how US banks behave and how staff are paid and incentivised. The current mess cannot be allowed to happen again. This should mean that banks will have to behave in a much more prudent fashion in future and this will dampen potential profitability, which in turn will not please investors seeking strong returns.
The US financial system has created a total mess and this mess was facilitated and driven by inadequate regulation and greedy shareholders seeking so-called “shareholder value” at any cost. Ordinary US taxpayers will now have to pick up the tab and the tab will be outstanding for years to come.
The clear message from all of this is that unfettered free markets do not deliver an efficient outcome any more than a command system would. The appropriate model is somewhere in between, where free market behaviour is continually subjected to scrutiny by a skilled and pro-active regulator, which might not be conducive to maximising shareholder value
The actions of US bankers have given the capitalist system a bad name and we all now have to pay the price.
Jim Power
chief economist
Friends First
