The shares collapse began in an obscure corner of the financial world, but went all the way to your pocket, writes Barry O'Halloran
The wave of panic that hit global stock markets this week and helped to give Irish pensions a soaking started as just a ripple in an obscure corner of the world of high finance.
Chris Johns, head of global markets at Bank of Ireland Asset Management, says that "blue Monday" can be traced directly to a US company called Ambac, which insures bonds that banks use to raise debts from other financial institutions.
Bonds are documents that oblige the issuer to repay a principal sum with interest to the holder after a set period of time, normally five or 10 years. Known in financial jargon as "paper", they can be bought and sold in the same way as shares.
Banks insure them with companies such as Ambac, which guarantees their repayment and determines their value. According to Johns, bond insurers have underwritten about $2.5 trillion (€1.7 trillion) worth of debt. To put that number into context, the Republic's wealth totalled $180 billion in 2006. So, if anything happens to them, it's very serious.
AND SOMETHING DID happen, late on Friday, January 18th, when an independent agency, Fitch, cut Ambac's credit rating. This meant that Fitch believed that there was an increased risk that Ambac would not be able to meet its liabilities.
The value of the bonds that it guarantees is tied to its credit rating. As a result, Johns says, they were suddenly worth less than before, with obvious consequences for anyone who bought them.
What panicked the markets was that Fitch's decision was an unexpected result of the subprime mortgage crisis that hit the US in August. It sparked fears that the US credit system, which drives its economy, was breaking down, forcing it into recession and taking the rest of the world with it.
The first to react were stock markets in the Far East, which began trading on Sunday night while Irish stockbrokers were still sleeping soundly.
Prices on every major exchange tumbled and the panic spread west on Monday morning, when the Irish Stock Exchange took a bath with all the rest.
As the market here opened, share prices plummeted. On Monday afternoon, one Dublin broker described it as "a complete meltdown".
He said investors were simply dumping shares, taking their cash and running from the markets. They sold around six million shares in Bank of Ireland and another four million in AIB. Ireland avoided the worst of it, but across Europe stocks experienced their worst fall since 9/11. Estimates of total losses reached €300 billion.
Shares are no longer dealt in "bear pits" full of clamouring dealers, instead the deals are done digitally. But the nature of modern transactions means that the results of a slump like "blue Monday" can be felt almost instantly. The Irish market lost €3.5 billion of its value in one day.
If the world of bond insurers, credit ratings and blood on share dealing floors seems far away, then think again. It has hit your pockets. Tom Geraghty, worldwide partner and head of investment consulting at multinational financial adviser Mercer, estimates that pension funds here have lost about 10 per cent of their value since the start of the month.
Around 65 to 70 per cent of our pension funds are invested in stocks, because - in theory at least - they give the best return over the long term. The money is not just in those listed on the Irish Stock Exchange, which generally account for around 10 to 15 per cent of the total fund, but also those sold on markets in the UK, US, Europe and the Far East.
In other words, your cash has been invested in all those markets that were hit hardest this week. Geraghty believes that as a result of this and the fact that shares are down generally this year, some funds will be in deficit. In other words, they cannot meet all their outstanding liabilities.
This won't hit you if you are about to retire, because your employer is obliged to pay your pension and has to make good any shortfall.
And clearly, you won't be hit if you're not retiring, so why worry at all? Because crises like this, which have left employers with big deficits in the past, have resulted in a shift from defined-benefit pensions, which guarantee workers a return at the end of their careers, to defined contribution, which means that you pay the scheme a set amount, but the return is not guaranteed.
Other things, such as life policies and insurance, also suffer in stock market downturns. Insurers invest a proportion of the money they charge customers in shares. If the returns go down, it makes it more expensive for them to pay out on policies. So they respond by charging people more.
A LOT OF Irish people hoped that interest rates would come down as a result of the crash, which would be a definite silver lining for mortgaged householders, not to mention estate agents. For a while it looked like this would happen. The Federal Reserve - the US central bank - cut its basic rate by a record 0.75 per cent to 3.5 per cent, a move that will cut bank lending charges in the US.
The markets, economists and analysts joined Irish homeowners in praying that the European Central Bank (ECB) would do the same. But its president, Jean Claude Trichet, refused to answer them, and on Wednesday said his priority was to control inflation rather than to cut lending charges. This prompted another sell-off in European shares. By the end of the week, the US rate cut and a pledge from the US government to help bail out hapless bond insurers like Ambac brought a recovery.
However, Irish brokers say that investors are still nervous, and another shock could spark a similar reaction to "blue Monday".
The fear of recession is lurking at the back of it all. Jim Power, economist with Friends First, warns that this country is still in for a bumpy economic ride for the next year or two.
But he's confident that the world economy will emerge from any crisis, and argues that to prepare for that, the Government has to hold the line and get on with dealing with things like building roads, railways and other infrastructure, while controlling its day-to-day spending.
Johns agrees. "It sounds dull and clichéd, but that's what we need to do, the prize is that we come out of all this with our economy just as strong as it was going into it."