Introduction
Before getting into the discussion about the subprime crisis in the Irish economy its better to have an idea that what Subprime Crisis actually is? Answers.com.yahoo has explained this crisis leads to an instant increase in the mortgage loans default rates, especially sub prime mortgage borrowers.
Sub prime borrowers are the borrowers who do not qualify for normal rates, but are offered alternative loans, usually with a higher interest rate, thus expecting a higher default rate.
With the beginning of this year 21percent of all subprime loans are delinquent by 90 days or more. It means that 1 in 5 of these borrowers cannot afford the repayments. These loans depict that about 7 percent of the housing loan market currently formulate 40percennt of all foreclosures. As estimated that only the defaults of subprime loans will cost the US economy $200 billion to 300 billion. The current financial markets turmoil is a result. (Answers.com.Yahoo.)
Beginning with the US economy this crisis is now extended to the European economy also. As mentioned in “Subprime crisis impacts European, US growth”, the Managing Director of International Monetary Fund Managing Director Mr. Dominique Strauss-Kahn is of the opinion that global financial stability is blown from the subprime crisis and as a result the European and US growth is getting weaker. He thinks that there are significant measurable effects at IMF. The weaker growth of course. Surely not catastrophic but will continue to exist. The Central Banks coordinated efforts are praised by IMF in order to address the credit crunch and to keep the monetary policy flexible. (Subprime crisis impacts European, US growth updated Dec 22, 2007).
In this paper we are going to analyze he implications of the “Subprime Crisis” only in context with the Irish economy. Let’s have an overview of Irish economy.
An Overview of Irish Economy
As discussed in Ireland and the European Union page in www.usna.edu.The economy of Ireland is based on agriculture. It has long been an integral part of its history and its political situation. The Irish economy comprises two economies, “the Republic” and “Northern Ireland”. At present the economies can be treated separately, whereas, both economies are members of the European Union. The Republic of Ireland is one of the fifteen nations in the European Union and Northern Ireland is a part of the United Kingdom. Moreover, the possibility remains that Northern Ireland and the Republic can again unite, taking it necessary to treat both economies in the context of Ireland and the European Union.
As an organization without the regional economic integration of the actual European Community, the European Union serves both the Republic and Northern Ireland as the members. (Ireland and European Union)
An Economic Analysis by Pricewaterhouse Coopers portrays Ireland economy developing by an estimated 5.9percent in 2006 and a projected 5.1percent in 2007. In both the years Ireland is on the top of the Euro land growth table. The speed of growth of Euro land economy is estimated at 2.7percent in 2006 and a bit slower 2.1percent in 2007. (Pricewaterhousecoopers Economic Analysis.)
Ireland and Risk of Financial Crisis
Finfacts Ireland-A business and Finance portal reveals some alarming facts and figure; ESRI, the Economic and Social Research Institute, in its “Spring 2008 Quarterly Economic Commentary” that the Irish economy is expected to grow at the slowest pace in 2008 since 1988. The new job creation is to be nil and there might be a moderate recovery in 2009 when public finances will further deteriorate and the exchequer deficit will rise above 7 billion pounds. It also forecasts that growth in Irish economy has to plunge to 1.6% in 2008 i.e., lowest in 20 years and moderate recovery in 2009.Exchequer deficit will increase to 7.5 billion pounds.
Impact on Imports and Exports
Above 90% of Irish exports are comprised of foreign owned firms and the ESRI forecasts that 47% of total exports in 2009 are to be services. In the year ending 2007 Q3 services exports raised by 15.9 % in terms of value. Data showing Balance of Payments suggest that that growth was mainly concentrated in financial services, much of that was related to Dublin’s International Financial Services Centre and business services for example Microsoft Ireland’s exports, which raised by 19.7% and 29.5 % respectively.
ESRI estimates that for 2007 services exports increased by 14.5 % as a whole in value terms, with services like non-tourism exports grew by 15 % and tourism exports by 9 %. Services export growth will be moderate in 2008 but still contributing more than merchandise to total export growth. Around 80 % of the value growth in exports will be accounted for by services this year
As service exports grow whereas, merchandise exports decline, an issue that comes forth is the relative job creation value, for instance an aircraft leasing company having payroll of 10 people will be able to transact in money volumes as compared to a manufacturing firm of almost 1,000. Ireland’s two biggest companies (by revenue) are owned by Microsoft and are operated from the offices of a Dublin law firm and have not a single direct employee.
Inflation in Irish Economy
With a slowing trend in the economy, the rate of inflation is rising in Irish economy. The CSO reported that the annual rate of inflation rose to 4.8 % in February 2008 from 4.3% January 2008.The EU Harmonized Index of Consumer Prices (HICP) accelerated by 1.2% in Feb 2008, as compared to a rise of 0.9%in February 2007. The annual rate of inflation, as measured by the HICP, rose from 3.1% in January 2008 to 3.5% in February 2008.
The Housing Bubble
Housing or property bubble for residential markets is a type of economic bubble that occurs in local or global real estate markets. It is recognized by rapid increase in value of real property such as housing till they reach an unsustainable level in relation to income and other economic elements.
Global Property guide highlights the situation in an article “Irish Property Crashes” It refers to a survey by the Irish Auctioneers and Valuers Institute (IAVI) the Irish property crash is increasing. In Dublin prices of second-hand apartments reduced by 17% in 2007.House prices in Dublin fell by f 10% in the year.
An article “US Subprime Crisis goes Global”, in The Post, IE explains when mortgage interest is not included, the per annum rate of price increase still fastened to 3.5% in February 2008 from 3.1 % in January 2008. In the 2008 budget, the Government had a forecast that, excluding interest on mortgage, average prices will rise by 2.4 % this year.
The downward trend in house building is the principal factor for declining this year’s growth rate. In its latest quarterly economic commentary, the ESRI forecasts 50,000 housing completions this year, a remarkable drop on the estimated 78,000 houses built in 2007.On the contrary the decline in property output is expected to force a 7.4 % fall in the volume of gross fixed investment in the year 2008.
Further, the ESRI foresees an ongoing weakening in house construction in the year 2009, projecting a further drop to 45,000 completed housing units next year. But the ESRI predicts that the fall in property prices have already been arrested. It shows that house prices in the early part of 2008 are 15% lower than in December 2006. On this ground, the commentary concludes that for 2008 and 2009, generally stable house prices are expected.
Continuing the consumer boom of the past three years, the development in the volume of household spending is forecasted to ease back to 3.0 % in 2008. The ESRI is projecting that money wage growth will decline from 5.5 % in 2007 to 4.0 % this year.
The first casualties of slower growth will be the labour force and the public finances. No increase in employment is now expected this year, while the numbers out of work are projected to rise by 33,000 to 135,000 in 2008.
Consequently, the unemployment rate, the number of people without of work as a percentage of the labour force seems to increase to 6.0 % in 2008 from 4.6 % last year.
This economic slowdown trend is also pushing the public finances deep into deficit. As we know that, the weakening pace of activity growth is already causing tax receipts to drop far below the targets set by the exchequer. On the other hand, public spending, current and capital, is rapidly rising since 2006.
Thus, the ESRI foresees that an exchequer surplus of €2.3 billion in 2006 is going be transformed into a big deficit of €7.5 billion by 2009. This fact clearly depicts a deterioration of around €10 billion in the exchequer’s annual financial status in the period of three years only.
Getting through a tough year in 2008, the ESRI expects a modest recovery in 2009. Growth in real gross national product is anticipated to accelerate from 1.6 % this year to 3.0 % in 2009.
Any positive trend in growth prospects in 2008 is based on the assumption that the housing shock will be absorbed on a large scale this year. Strong growth will pave the way for an employment resumption expansion. ESRI projects that 24,000 people are expected to be added to the workforce during 2009. (The Post, IE)
Impacts of Euro Appreciation Against Dollar
Another article “Rise Against Dollar Could Hurt Exports”, in The Post, IE says that with the beginning of 2007, economists were quite anxious about the prospects of the euro. Economists expected a lag between the US recovery and the European recovery, results a further downward pressure on the euro. The euro was expected to close the year at around 84 % to the US dollar.
The extraordinary rise in the euro against the dollar was surprising. Over Christmas, the euro soared to €1.05 against the dollar, and the renewed fears over war in Iraq and concern over oil prices. It was the biggest rise against the dollar in past three years.
But it may have some adverse consequences. A higher euro means more expensive exports. This may lead to damage Ireland’s small open economy as it trades largely outside the euro zone. Simultaneously, the US and Britain account for around half of all Irish trade, alarming that a strong euro could devastate our economy. (The Post, IE)
Implications of European Central Bank (ECB) on Irish Economy
An article “Why the Irish Economy is paying for its Property Dependency”? In www.freeeurope brings into light the role of ECB in this context.
The Central Bank has to set a single rate of interest across the whole Euro zone comprising 317 countries as consumers, which may be somehow “Right” for the prevailing inflationary conditions there. Thus, to maintain a standard rate for all the consumers the ECB interest rate policies are either too tight or too loose for different countries having different economic and marketing conditions. These policies are more likely to be towards the larger economies. But the agenda can’t match the interest of Irish economy having a population of 4.2m (even less than some large cities of the Euro zone). The ESB is maintaining the low rates to support larger economies of France and Germany where the weak growth still needs nurturing. Thus, ESB is acting very slowly according to Irish perspectives.
Ireland actually needs rates to fall but ESB will still be raising them to cope with the increased inflationary dangers in most of the larger Euro zone economies. So a friction does exist in the Euro zone Adjustment mechanism. To balance the uneven economic growth EU relies to move capital and labour among Euro zone members, instead of considering the interest rates. In a single currency zone, capital movement is rather easy where potential return is very positive. Whereas, labour is notoriously sticky. In 2002 when Germany had high unemployment, the Euro zone theory suggested that Ireland should provide vacancies for jobless Germans so till 2004 there has been a wave of economic migrants within Euro zone to reach Ireland. (www.freeeurope)
How to Combat the Crisis
An article in missionisi.wordpress.com. “What is subprime crisis? How to solve the subprime crisis? suggests the following measures to help combat the crisis.
Pumping money into market by loan modification may slow down the crisis:
- Establishing rescue funds for those borrowers who are facing short-term problems because of lay-offs, illness, or other reasons.
- Establishing a bond fund for paying switching over borrowers out of ARMs, they can’t afford.
- Refinancing loans for those who are suffered by predatory lending. It will involve functioning with Fannie Mae (the quasi-governmental corporation).
Altering loan terms is not easy, borrower and lender both have accept the terms, lenders may not be willing to change terms but Fed interference may work out. But lenders will accept change to avoid foreclosures.
This pumping money into markets and decreasing bank reserves may temporarily cover the crisis, but this is a two-fold operation, pumping money is going to boost up inflation which will rise subprime lending, and reducing bank reserves to small extent is good but as whole destabilizes the whole economy financial system.
References
Fin facts: Ireland’s Business and Finance portal. Web.
Global Properly Guide: Irish Property Crashes. Web.
Ireland and European Union. Web.
Is Ireland at Risk of Financial Crisis. Web.
Subprime Crisis Impacts European US Growth (2007). Web.
Rise against the Dollar could hurt. The Post.IE. Web.
What is meant by Subprime Crisis? And why is it Called so… BTW What is the Crisis? Web.
What is Subprime Crisis? How to Combat Subprime Crisis? Web.
Why the Irish Economy is paying for its Property Dependency? Web.