Crisis was three-quarters home-grown, says Honohan

IRELAND’S FINANCIAL crisis was “three-quarters” home-grown the governor of the Central Bank, Patrick Honohan, has said. Addressing a conference on international finance at Trinity College Dublin yesterday, Prof Honohan said Ireland’s property and construction bubble was driven by a “myth . . . an expectation that the Irish economy would grow beyond an unsustainable level”.

The sharp fall in nominal and real interest rates that Ireland experienced in the run-up to joining the euro also precipitated the property-led bubble according to Prof Honohan, leading many investors to exaggerate the degree to which a higher capitalisation rate would apply to assets such as property.

While highlighting the “home-grown” roots of Ireland’s financial crisis, Prof Honohan stressed the role played by international events, pointing out that Ireland is one of the world’s most globalised economies with an exports to GDP ratio approaching one.

In addition, foreign borrowing financed the bubble he said, with net indebtedness of Irish banks to the rest of the world jumping from 10 per cent of GDP to over 60 per cent in the four-year period 2003-08.

The over-dependence on “transient forms of tax revenue” such as stamp duty and capital gains tax during the property boom gave rise to a “hidden vulnerability” in Ireland’s fiscal situation, he told delegates.

Prof Honohan, the author of one of two banking reports published last week, also expressed confidence in the National Asset Management Agency (Nama) describing it as a “viable solution” which is “being handled pretty well”.

One of the main advantages was that it had crystallised losses on banks’ books and given a “fairly good picture about the scale of the losses” with the result that there is not a “cloud over the fiscal picture” as has been the case in other countries.

The issue of financial transaction taxes was also addressed by the Central Bank chief. He noted that, while the taxing of financial intermediaries was back on the agenda, it may not improve the safety or efficiency of the financial system.

Nonetheless, he suggested that some sort of corrective taxation may have a role to play in regulation.

“It may be possible to use tax as a gradual form of regulation” he pointed out, suggesting that a form of “Tobin tax” could potentially be a better option than either an outright ban on certain practices or the regulation by ratios approach that had informed regulation over the last 20-30 years.