Croesus/ The Investor's View:The crisis that has been brewing in the financial markets since early summer bubbled over in dramatic fashion last weekend. Television pictures of panicky savers queuing outside the branches of Britain's Northern Rock hammered home that a real crisis was brewing.
In Ireland, Northern Rock only runs an internet business but there was clearly a huge virtual queue of customers trying to withdraw their savings as the system simply could not cope with the volumes. Not to be outdone by their UK counterparts, Irish depositors queued outside Northern Rock's Dublin head office on Monday morning. Reassurances from government ministers and central bankers over the weekend simply did not wash with the public.
It wasn't until the UK's chancellor of the exchequer explicitly guaranteed the retail deposits of Northern Rock, and indeed other banks that got into similar trouble, that calm returned to Britain's high streets.
The fact that this was the first run on a British bank since 1866 puts the events of this week in their true historical context, while the British government's decision to guarantee all retail bank deposits is unprecedented.
What the events of this week underline is that the crisis in the financial markets is beginning to have a real economic impact. The decisive action by the US Federal Reserve to cut the Fed Funds and Discount Rates by 50 basis points each signifies that the world's most influential central bank is determined to ameliorate any such damage. The statement accompanying this important policy change left little doubt that further cuts would be contemplated if conditions in the real economy deteriorated.
On the surface, the root cause of the current "credit crunch" is the rapidly deteriorating position of the US sub-prime mortgage market. Financial innovation has meant that many of these loans were packaged into complex financial structures whereby it is very difficult to establish who is actually going to take the hit when the loans default.
Although the absolute size of the US sub-prime market is enormous, it is in fact very small relative to the banking system's capital base.
Croesus takes the view that the root cause of current problems is that innovation in the wholesale capital markets and in retail financial products has simply evolved too quickly in recent years. As a consequence, the job of central banks and financial regulators in supervising the financial system has become increasingly complex.
Furthermore, the opaque nature of many new financial structures are poorly understood by many finance professionals working in financial institutions.
Transparency is now so limited that it is extremely difficult for both regulators and market professionals to effectively identify and manage risk. Therefore, structural weaknesses have emerged that are at the heart of the current "credit crunch" and as such it could be quite some time before they are resolved.
There is however good news in that, to date, central banks have managed the crisis effectively, and, in addition, banks across the globe are generally well capitalised and profitable. Northern Rock is, and always was, solvent. Its problem was that it relied heavily on short-term loans from other banks to fund its mortgage book. When the wholesale money market dried up, the only place left for Northern Rock to go to was the Bank of England.
The Northern Rock experience highlights just how much potential there is for financial market turmoil to inflict serious damage on the real economy. However, central bankers are well equipped to deal with the shorter-term impact of the current crisis. In the medium term both central banks and financial institutions are likely to try to make changes based on the lessons learnt from the current crisis.
There will inevitably be economic consequences, and in the Irish case this will manifest itself in the property market. Irrespective of ECB policy, mortgage finance is likely to become more expensive and harder to get. Banks will look much more closely at the terms of their commercial loans and a desire to diversify their loan books may result in less finance being directed at property.
This process will inevitably exacerbate the slowdown in the residential market and is likely to take the steam out of the still booming commercial market.
Prior to the current credit crisis, brokers had already cut their forecasts of loan growth at the Irish banks.
Croesus believes that such forecasts will be cut further in coming months resulting in slower profit growth at the Irish banks.
However, the share prices of the Irish banks have been falling so fast that they have already discounted a huge amount of bad news. While profit forecasts may have to be reduced, dividend forecasts are much more robust. During the week Bank of Ireland's share price hit a low of €11.25 - where it was offering a dividend yield of close to 6 per cent, highlighting the investment value that is now available on the Irish stock market.
