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Home Uncategorized They fly so high … They fade and die

They fly so high … They fade and die

Michael O’Sullivan

The economic crisis that continues to grip Ireland follows one of the most spectacular asset price bubbles and subsequently one of the most costly banking crises on record. While policymakers struggle to find a way out of the morass some sense of the potential avenues of escape comes from recent books that examine the history of previous crises, such as Reinhart and Rogoff’s This Time is Different or Raghuram Rajan’s Faultlines, and more recently Paul Krugman’s End this Depression now.

However, many economic and banking crises of recent decades are pedestrian by comparison with what we in Ireland achieved in the 2000s and beyond, and we arguably need to reach further back in history to find financial catastrophes that match the scale and colour of our own.

In 1841 Charles Mackay, a Scottish writer, published a popular book entitled Extraordinary Popular Delusions and the Madness of Crowds, which chronicled and analysed the history of asset price bubbles going back as far as the impact of the Crusades on goods and land prices in eleventh century France.

The organising theme of this book is that asset bubbles share a common and very human template, a thread that is gaining credibility in research by modern economists and central bankers. Yet, Mackay must have hoped that having read his book the public would be enlightened as to the causes and pitfalls of asset bubbles and that these would cease to occur.

In that respect he would have been disappointed but perhaps unsurprised by the global credit crisis of 2007-2010, and if he were alive today he would be furiously scribbling down details of the Irish property bubble, which like Ireland’s economic ascent of the past fifteen years places it in the vanguard of  the developed world’s descent into indebtedness.

A key figure in Mackay’s book, and indeed in the pantheon of asset price bubbles, was John Law, a Scotsman whose programme of economic and financial innovations reflated and then nearly obliterated the French economy during the Mississippi Scheme bubble period of 1719-1721. In general, asset price bubbles involve a large degree of collective failure of reason and judgement, though the Mississippi Scheme bubble is a rare case where the actions of an individual were of enormous consequence.

Mackay wrote of John Law that “the personal character and career of one man are so intimately connected with the great scheme of the years 1719 and 1720 that a history of the Mississippi madness can have no fitter introduction than a sketch of the life of its great author John Law”. Other connoisseurs of asset prices bubbles have ranked Law’s Scheme as one of the “mythical early bubbles”.

What makes John Law fascinating in the context of the disintegration of the Irish economic miracle are the parallels between his actions and policies and those enacted in Ireland in recent years. In addition, the lessons that the Mississippi Scheme and many other asset price bubbles have to offer Ireland are important.

The most attractive parallel between John Law and recent Irish economic history is that both cases have very contradictory qualities in common. Law was a mixture of genius and rogue, and without too much analytical difficulty we can break the Irish economic “miracle” into two contrasting parts – the policy-based catch-up of the period 1990-2001 (genius), and the hubristic bubble years of 2002 to the present (rogue). For instance, Law’s turnaround of the French economy from 1719 onwards (from 1715 it was mired in a deep recession) was referred to as a “miracle which posterity will not believe” by one commentator, in much the same way as a leading (French) economist at the IMF had heralded Ireland’s economic leap forward as a miracle.

The authority on John Law is an Irishman, Antoin Murphy, and he writes of him as a man who led a rollercoaster life, whose financial genius made France the most innovative country in the world with respect to banking and finance and who could be seen as a very early architect of the move away from commodity-based money (Murphy notes the resonance between the birth of Law in 1671 and the breaking of the gold standard in 1971). Similarly, Mackay underlines that Law “understood the monetary question better than any man of his day”. In this respect his genius for economics and maths stands out in contrast to the poor grasp of economics of many Irish politicians and policymakers in recent decades.

Law would later be celebrated by renowned economists like Schumpeter, who placed him in the front ranks of monetary theorists, but derided by others such as Montesquieu, who disdained Law’s practice of “catching the wind in balloons, which he then sold to travellers” and his entrapment to the “blind god of chance”. Karl Marx reflected that Law was “the pleasant character mixture of swindler and prophet”, a remark that echoes Engels’s comment that “the worst about the Irish is that they become corruptible as soon as they stop being peasants and turn bourgeois”.

One of the ironies in Law’s story, seen from twenty-first century Ireland, is that one of the few people to profit from his scheme was an Irishman, Richard Cantillon, an economist and associate of the Scotsman. Cantillon was one of the few to understand the long term implication of Law’s Scheme, and importantly one of the very few to exit the bubble with his fortune intact.

Law’s Scheme was based on his proposal to rid France of her debt, reflate her economy and effectively construct a new financial system, based in large part on the promise of riches from the land and commodities of French Louisiana. The French economist François Velde’s thorough analysis of  the scheme details four distinct steps:

The first stage, from 1716 to 1718, established a privately owned bank that successfully issued bank notes. The second stage, from 1717 to 1719, saw the parallel formation of a trading company, whose shares were publicly traded, and whose purpose shifted from colonial development and overseas trading to management of public funds. In the third stage, from 1717 to 1720, the bank and the company merged, Law became finance minister, the company reimbursed the whole national debt, and its notes became the sole currency. The final stage, the year 1720 is the period of collapse, followed by a complex cleaning-up operation.

The effects of the scheme were to create a sudden swelling in what we now understand as money supply, a sharp rise in asset prices (over tenfold in less than a year) which was fuelled by and helped create greed, ostentation and irrationality. Though Law attempted to “manage” the collapse of this bubble, its implosion was spectacular (some asset prices fell by nearly 90 per cent from their peak). The effect was to bankrupt France, destroy fortunes, expose the over borrowed and create a climate of consternation and raw anger.

Besides the vivid human parallels between Law, the few Irish policymaking geniuses and the many showy Irish oligarchs of the recent boom, there are a number of other ways in which we can draw parallels between him and the Irish property bubble.

First of all, both cases show how a nation can surrender its mind and soul to an economic bubble. Beyond the vivid colour of human folly and subsequent miseries one strand is that great shifts in economic performance and innovations in economic policy, eventually produce imbalances. More specifically, the economic changes and financial innovations sparked by Law in 1720s France have echoes in Ireland of the 2000s. Law secured the rights to collect tax revenues for the government through his Compagnie d’Occident and he later effectively securitised the potential revenues from this. The share price of the compagnie had the high octane ingredients of both a call option on land and commodity development in French Louisiana and a lower cost of capital with the conversion of its floating short-term debt into long-term debt.

By the time Law had swapped metallic currency for paper, the viability of the scheme was contingent on the value of asset prices (paper shares) remaining high. A similar pattern was evident in the US and to an extent in Irish housing and mortgage markets in the past ten years where financial “innovation” created enormous amounts of debt and derivatives based in inflated house prices.

Another very important factor is the interaction between human or behavioural factors and economic theory. Simple greed, the triumph of irrationality over the rational, overconfidence, loss aversion and denial are some of the increasingly well-established facets of behavioural finance theory that are evident in both France in 1720 and Ireland of the early 2000s.

Law’s Scheme came undone because growth in money supply and in asset prices was not matched by real economic growth, and by the failure of French Louisiana to live up to expectations. This led Law to conjure up support mechanisms whereby low interest loans were given to shareholders so that they could make further purchases (very similar to that operating at Anglo-Irish Bank in 2008), with shares in the compagnie used as collateral.

Like Irish property prices during the 2000s and the prices of other twentieth century asset bubbles, share prices in 1720s France were wildly overvalued. François Velde has estimated that the scale of overvaluation of share prices was between two to five times. As Law’s financial world fell apart, the price of compagnie shares collapsed by close to 90 per cent (from a peak in December 1720 to February 1722), which is comparable to the decline in value of collateralised mortgage debt from 2007 to late 2008.

The wreckage of Law’s Scheme took some time to clear away. The principle vehicle employed here was called the Visa – a structure that today’s economists would recognise as a “bad bank” vehicle. The aim of the Visa was to extract the paper liabilities of Law’s company from the economic system and convert them into bonds, which in turn would introduce liquidity back into the parched financial system. Of the total of 2,800 million livres issued through Law’s Scheme, 2,200 million ended up in the hands of the Visa agency and were later converted back into bonds. The Visa paid a significant discount for the livres – between 20 and 25 per cent of the original issue value. Ireland’s Nama (National Asset Management Agency) is undertaking a similar manoeuvre, though it is paying a comparatively smaller discount for property loans.

With the future of the Irish economy in mind it is worth noting Law’s Scheme wrought long-running structural changes in the French and British economies. For instance, having initially copied the Bank of England Company and East India Company models, Law’s legal, financial and corporate innovations were themselves copied by the British with the incorporation of the South Sea Company. The subsequent collapse of the South Sea Company then led to the Bubble Act of 1720, which like some of the regulatory changes proposed today signalled the encroachment of the state into the business world and a desire to limit speculation as well as create large “champion” companies. Similar legislation was enacted in France to make “entrepreneurship” less easy.

In Ireland we have the benefit of other people’s economic history at our disposal. Our first real boom and bust initiates us into the ranks of grown-up economies and in order to avoid further turmoil we should try to learn how others have reacted to the aftermath of economic crises so that we can limit the pain of discovery.

Irish economic history from well before the time of John Law to as recently as the 1980s has been a tale of sustained and painful economic underachievement. Though a good deal of this can be ascribed to its political status up to the early twentieth century, Ireland’s economic underdevelopment persisted for at least fifty years after independence. For instance, going back to 1700, just before the Mississippi Scheme, the ratio of Ireland’s GDP per capita to Britain’s 0.51 (it was .74 of the Western European average), a level that persisted through to the aftermath of the Famine in 1850.

One hundred years later there was no discernible improvement in this ratio, which remained close to 0.5 up until the 1970s, meaning that for most of the last three centuries Britain was twice as wealthy as Ireland on a per capita basis. Comparisons with other European countries reveal a similar, though slightly less unequal, picture over time.

Yet from the late 1980s onwards something unexpected happened. Growth took hold and continued for two decades. Having lagged the British and other European economies by so much for so long, Ireland caught up quickly, with the ratio of Irish output to that of Britain jumping from a level of .74 in 1975 to 1.15 by 2001. By 2003 gross national product (GNP) in real terms was five times the level of 1960).

One starting point in any analysis is to ask how the Irish economy broke from its long pattern of underperformance in the first place. Looking back on the past twenty or so years we can divide the Irish “miracle” into two broad parts (like the genius and rogue elements of Law’s character), the first wave based on investment in Ireland by foreign multinationals and an increasingly stable investment climate, and the second the flourishing of the domestic economy, roguishly aided and abetted by low real interest rates.

The latter part is easier to understand, and it has largely respected the patterns of previous asset price bubbles. But the first part is more difficult to analyse as it is hard to spot a single factor that ignited Ireland’s economy after so many years of slumber. A salad of economic factors, both domestic and international, seems to have combined to drive the turnaround. At this stage a consensus has emerged that identifies the main domestic factors in this mix as Ireland’s education system, credit growth, the role of the IDA (Industrial Development Authority), Ireland’s membership of the EU and its flexible labour market.

What is interesting from the point of view of those who look to Ireland as an economic model is that most of these factors were in place during the some of the bleakest years for the Irish economy during the 1980s as well as in the best. To a large degree they were catalysed by outside factors, principally by a falling cost of capital, the trend toward the opening up of international markets and trade, diminished geopolitical risk and the advent of new technologies – all of the ingredients of what are now taken to drive economic globalisation.

At the same time, there is very little evidence to suggest that Irish policymakers foresaw the boom in growth that started in the 1990s, as the state of physical infrastructure, institutional development and microeconomic policies all lagged developments in the economy. This suggests that Ireland’s politicians were neither the architects nor masters of its economic destiny, and this issue should be one of the central political economy questions in Ireland for some time to come.

What Ireland’s leaders did manage to create, often with a leaning toward social and political goals, was a country with a high quality intangible infrastructure. Intangible infrastructure is “the set of factors that develop human capability and permit the easy and efficient growth of business activity”. Adam Smith puts it in more colourful terms: “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.”

Smith had complained of Law that while “visionary” he was “unbalanced”. This view also describes the recent Irish experience. Some Irish policy moves were, with hindsight, visionary, though the positive lessons generated by these policies (such as an open business climate and investment in education) were soon forgotten, and in time produced a form of economic growth that become “unbalanced”.

The notion of “intangible infrastructure” is still rightly seen as a very important force behind economic growth and human development. In Ireland’s case, despite the onset of the credit crisis, a range of academics and policymakers in many countries continue to analyse and admire (and readmire in the case of the recent Time magazine front page) its catch-up period (1990-2000) and to focus on intangible factors as the secret of its success.

There is also a growing understanding of what went wrong in the above second phase or “bubble years” in Ireland’s economic renaissance. However, the contention here is that to some extent such analysis is redundant in that Ireland has succumbed to the hubris and self-correcting crash of a traditional asset price bubble, and that this process is a natural and inevitable consequence of its recent boom years. The case of John Law in early eighteenth century France is perhaps the best illustration of this process, though since then, and indeed since Mackay’s Delusions, asset price bubbles have recurred with astonishing regularity.

Mackay’s impressive and somewhat premature history of asset price bubbles notes the South Sea Bubble and Mississippi Scheme of 1720 as two of the earliest and most famous asset bubbles (there is also the Dutch tulip mania of 1636). What is important about these episodes, and relevant for Ireland today, is that many of the characteristics of bubbles we now recognise were distinctive in the South Sea and Mississippi bubbles. Financial innovation is one of these. In his time, John Law spread the use and development of paper money as well as innovative instruments like financial derivatives. In addition, in the early eighteenth century, bankers made loans available to buy shares in the Mississippi scheme, with those very shares used as collateral.

The bubbles of the 1720s also illustrated the effects of lop-sided distribution of information, manipulation of facts and figures and insider trading – all have featured in modern bubbles and financial crises. Moreover, human behaviour during the bubbles of the 1720s – in terms of propensity toward greed, denial and appetite for leverage – also strikes a chord with recent events.

These patterns have been repeated over and over though history, key examples being railroad bubbles in England in the 1840s and in the US at the end of the nineteenth century, the Florida property bubble in the mid 1920s, the US stock market bubble of the late 1920s, Japan’s stock market and property bubbles of the 1980s, and more recently the Asian equity and currency bubbles of the late 1990s, not forgetting the dot.com bubble which ended some nine years ago. This long and colourful history of bubbles provides a template which we can fit over the Irish economy of the past ten years.

The first stage in a bubble is what we can call “the favourable shock”. In many cases it is a dramatic change in economic policy or a technological shift that heralds the arrival of a new economic regime or technology. For example, the Mississippi bubble was born out of the creation of paper money and the opportunities offered by the New World (America), while railway booms in the UK and US in the nineteenth century were led by technology change and infrastructure build. More recently the dot.com bubble of the late 1990s was driven by technological change and deregulation in the telecoms industry. In Ireland the favourable shock was the wave of growth driven by foreign direct investment into the country.

One of the key changes brought about by a positive economic shock is that it lifts expectations of future economic and earnings growth and with these expectations of prosperity. Rhetoric matches these developments, with some economies referred to as miracles (in Ireland and Law’s cases), or “Number One” as was the case of Japan in the 1980s.

This first phase of a typical bubble can be classified as a boom or growth period, and not strictly a bubble. What helps to turn a boom into a bubble is more often than not the supply of easy money/excess liquidity, in the forms of expansionary monetary policy, lax credit standards and direct lending to speculators. In this way cheap money and easy credit are the monetary equivalent of throwing petrol on a fire, and there are relatively few bubbles where easy availability of money did not play an important role. Law’s alchemic experiment in turning commodity-based currency into paper currency set free the genie of money supply, especially as further money growth had very weak foundations.

Cheap money (and rising asset values) allows companies and households to take on more leverage, and this process is aided and abetted by a general lowering of credit standards. Easy credit often leads to the clustering of bubbles so that equity and house market bubbles often crop up in the same place (such as Japan the 1980s).

In Ireland, real interest rates (measured by the money market rate less consumer price inflation), averaged 0 per cent from 1998 to 2001 and fell to close to -4 per cent in 2000, having been as high as 10 per cent in 1985 and 15 per cent in the period around the first Gulf War. This “free money” and the expansion in credit (Central Bank figures show growth in credit card and mortgage debt in the high twenties for much of the boom years) that allowed it to flow through the economy go a long way to explaining the boom in the domestic economy over the past ten years. In a more conventional monetary policy framework interest rates would have been much higher but during this period the European Central Bank was effectively setting interest rates for the sluggish economies of Germany and France than for Ireland, where to make matters worse regulation of banks and their credit policies was weak.

The next typical stage of a bubble is when euphoric appetite for risk chases high returns and investment becomes speculation. A quote from JM Keynes, from some eighty years ago, sets out this change of mood and could well describe the Irish economy of the past ten years: “the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” Keynes was no fan of Law, and the above comment could just as easily be directed at the latter’s propensity to gamble.

As the typical bubble gathers momentum, people come to believe in the arrival of a greater fool (that is that other investors will take overvalued assets off their hands at a high price). Such a belief, together with specious supporting arguments such as “the world has changed” or even “this time it’s different” permits a ratcheting upwards of expectations, and sets loose “a mood of exhilarant optimism and wild speculative frenzy” as JK Galbraith termed it.

At this stage emotion and giddy expectation are the drivers of investment and consumption. The bubble is fully formed, gathers momentum and like the Irish property bubble of the past ten years, acquires a logic of its own. One very pointed example of this was a statement from former Taoiseach Bertie Ahern that those warning of the dangers of the property bubble should “commit suicide”. Similarly, warnings in the French parliament during the Mississippi period were ignored. Unsurprisingly, Law’s bubble is also peppered with examples of this kind of fervour and apparently in France in 1720 there was “no sort of extravagance of which even a wise man was not capable of”.

The existence of the asset price bubble is confirmed by evidence of its side-effects (as one author notes “a housing boom in Houston is an oil boom in drag”; in Ireland’s case its economic boom was a housing boom in drag). To return to the time of the Mississippi Scheme, those who had succeeded in their speculations spent wildly, and the prices of silver, tapestries, and jewellery rose rapidly. This orgy of consumption showed the rich to be “very fond of luxury, which has never been indulged in to such an extent as it is at present”.

As a result, to quote from Mackay’s book, “the looms of the country worked with unusual activity to supply rich laces, silks, broad-cloth, and velvets, which being paid for in abundant paper, increased in price fourfold. Bread, meat and vegetables were sold at prices greater than had ever before been known … new houses were built in every direction; an illusory prosperity shone over the land and so dazzled the eyes of the whole nation, that none could see the dark cloud on the horizon.” The wave of materialism that has taken hold in Ireland in the past fifteen years is not unlike the conspicuous consumption that gripped early eighteenth century France.

When a bubble is in its final stage it becomes very difficult to meaningfully act against or stop it. Rational voices and analysis based on fundamentals find little audience. The herd mentality goes into overdrive and this stage often sees the sharpest and most bewildering move in asset prices.

While bubbles are hard to define and identify, crashes are not. As one leading academic noted “you know them when you see them”. There is no one cause associated with the ending of bubbles, though tighter monetary policy or credit policies are often the culprits. Instead, they seem to reach an end simply when a series of factors synchronises. In Ireland’s case it seems that the tightening of credit conditions brought about by the global credit crisis was the decisive factor.

If history is again a guide, the unwind of the Irish property market bubble is showing itself to be as brutal as the expansion was giddy. IMF studies show that on average house price corrections tend to last for four years. By the standards of the UK and Japan, which have experienced severe property bubbles in the past twenty years, it is likely that Irish property values, and activity in the construction sector will be depressed for some time to come.

It is inevitable that the fall from grace of the Irish economy should bring into question many of the factors that are thought to have driven its growth in the first place. This long overdue introspection will be healthy, provided it takes place in a sensible fashion. Too often, sharp economic downturns breed economic nationalism, protectionism and a nervous adherence to short-term policymaking. In this respect, the example of John Law and the more general case of France have much to show Ireland.

An important contribution of Antoin Murphy is his demonstration of how economic policies in seventeenth century France and financial crises during the eighteenth century have shaped the regulatory framework and banking system in France today. He states that “the failure of the banking system in 1720 and the Assignats experiment in the 1790s, along with the collapse of the stock market in 1720, had deep effects on the emergence of an efficient banking and capital market structure in France”.

In assessing the impact of the Mississippi Bubble on France, Murphy writes that “in the immediate short-term, Law’s System would make France the most innovative country with respect to corporate financing and banking in Europe. In the long term it would leave a deep hostility and mistrust toward banks and financial innovation.” This mistrust, exacerbated by the hyperinflation that followed the Revolution, produced an economic system where investment was traditionally reliant on self-financing (particularly so in the case of family businesses). In the words of another bubble aficionado, Charles Kindelberger, the Mississippi Bubble made “the French neurotic, or even paranoid, about banking for years”.

Today, other authors trace the distinctive form of the French economic and financial systems to past crises and successes. The approach of Colbert to the success of the French government as a manager of innovation and investment during the Trente Glorieuses (the thirty years of expansion after the Second World War) are two particular reasons why the French have been less willing to be persuaded by the arguments of free market economics, or Le Grand Méchant Marché (The Big Bad Market) as Landier and Thesmar put it in their book of that name. As a result, the French system today is decidedly “un-Law”-like in that it militates against speculation and economic volatility, though it must be said the euro zone system is not.

The example of France as arguably the country with the longest economic history illustrates how economic structures are path-dependent on crises, bubbles and booms of the past. In other countries, notably the US, important financial legislation has been crafted in direct response to financial crises [from the Glass-Steagall Act (1933) to the Sarbanes-Oxley Act (2002) to the more recent Dodd-Frank Reform and Consumer Protection Act (2010)].

One lesson of the recent credit crisis, but that is also evident through the span of economic history, is that excessive financial pain is required to motivate collective and decisive action by policymakers. For instance, the draft of the Sarbanes-Oxley bill that passed through the House of Representatives was very similar to one that had been proposed in April of 2002, though in this case it required a 40 per cent fall in equity markets to provide the economic context in which the bill could be passed. The euro zone crisis is an even more painful illustration of this principle.

How then should we apply the lessons of John Law to the wreckage of our economy? There are perhaps two broad areas here. The first is to “explore our inner Law” and the second is to ponder what a renewed Irish banking system might look like.

John Law was clever, and also a gambler and a risk-taker, or perhaps it is more appropriate to describe him as a risk analyst given his use of probability. Many of the errors he and those around him in early eighteenth century France committed have been repeated over and again through history, as books by the likes of Mackay and Kindelberger highlight, culminating in a spectacular failure of collective judgment in our own country. In this sense we could well console ourselves that our failings were only human, and by and large have a universal quality to them. However, granted the excruciating cost of our financial crisis (one of the most expensive ever in GDP-relative terms) we should feel an obligation to search deeper, to find the “Law” in our psyche and exorcise it.

While there have been many attempts to piece together the sequences of events that led to Ireland’s bubble and bust, there have been few if any that have examined whether we as a nation take more risks than others, or to what extent “gambling” as a risk profile or tendency is entrenched in Irish society. Gambling as an industry is bigger in Ireland than in most other developed countries and a disregard for both the odds and the consequences of “bets” has been a prominent feature of our financial, property and construction sectors. More profoundly, the allure of short-term gains is a guiding light for politicians.

The second area upon which to focus the lessons of bubbles past is our banking system. Historically, banking systems where remedial action has been fast and aggressive have tended to recover. In those, like Japan, where the response has been uncertain and slow, the entire economy has suffered. Ireland falls into this bracket. A second wave of debt write-downs (personal and mortgage debt) will probably mean that our banking pillars will require more capital, while wide-ranging management and personnel changes have not yet occurred. The state owns the banking pillars, but it does not control them.

For mostly these and other reasons such as the very harsh regulatory regime, bank lending to small and medium sized businesses is meagre, and this in turn is choking the domestic economy. Neither have any of the deeper, structural issues in our financial system been resolved. Even before the property bubble, capital has habitually been poorly allocated in the Irish economy. Irish savers have behaved in a miserly fashion to Irish businesses.

At an international level, in universities, institutions and some media, there is a debate emerging on the “future of banking”. As the “ground zero” for one of the worst banking system collapses ever (some might argue that we are not yet there) Ireland should be a vigorous and curious participant in this debate. There are effectively three strands here – the changing face of banking at a global level, which apart from Basel III will have comparatively little effect on Ireland, the new regulatory and fiscal regimes that will be established from Frankfurt and Brussels which will become a legal and financial “mothership” for Irish institutions and then new initiatives to make banking and financial services in Ireland more effective.

The global banking industry has already shed a very large proportion of the workforce and capital bulk that it had built up during the 2000s. The pace of change is now picking up, as witnessed by a recent announcement from UBS of its intention to dramatically curtail its activities in fixed income. By comparison the speed of adjustment of the two Irish banking pillars is slow.

If global banking institutions are cutting back, one growth area of sales for the likes of Bloomberg terminals (data provider) is multinational institutions like the EFSF (European Financial Stability Facility). This will soon be joined by the development of a pan-European banking regulator around the base of the ECB and potentially other fiscal and financial market tentacles of the EU. Ireland, like its euro zone brethren, will be confronted by a range of ongoing, complex debates on the shape and power of these institutions and will have to figure out how the burden of EU regulation will curb, harm and reshape the banking industry in our country, in addition to the many difficult to foresee side effects that may arise from this.

One side effect for us will be the impact that pan-European banking regulation has on the City of London and the British economy. This brings to light the concept of the identity and competitive advantage of financial capitals like London, Frankfurt and Zurich in the wake of EU regulatory reform. In Switzerland, projects like Finanzplatz Schweiz try to figure out how a city like Zurich can react to the many global regulatory changes going on around it. We should undertake something as thorough with respect to the IFSC.

In Ireland, the two pillar banks are growing naturally into the role of “zombie institutions” that many have predicted for them. They exist, but feed little financial oxygen into the real economy. Our government and policymakers should not continue to show themselves to be loss-averse and should thoroughly example the long-term future of the pillars. In doing so they should ask what Irish businesses and consumers really need from the banking industry, and consider the merits of new approaches in microfinance, credit unions, dedicated financial services for women, adequate and imaginative training programmes for client-facing employees of financial services and education programmes on financial services for the public. If this kind of ambition is not shown then our long-term economic future will remain a dismal one.

In conclusion, there are clear parallels between the bubble that John Law created in France in early eighteenth century France and the one that gripped Ireland over the past ten years. In both cases an underperforming economy was resurrected by policy action. Fuelled by leverage, speculation and financial engineering, this early success became “miraculous” and then bred excesses and a logic all of its own. In both cases, the collapse of the “miracle” caused widespread economic and social pain, and in the French case sowed the seeds for eventual political change and very long-running economic change. This is what may well lie ahead for Ireland.

John Law’s Mississippi Scheme and the Irish property bubble are arguably two of the great asset prices bubbles, and if Charles Mackay, author of Popular Delusions, were alive today he would most likely pick Ireland as the totem bubble of the 2007- 2009 credit crisis. Indeed the example of this country would be likely to confirm rather than confound his view that “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

Several commentators have written that Law was an economist ahead of his time, and his behaviour still has important lessons for the world after the credit crisis. They are: the danger of excessive leverage, especially that based on financial engineering, the temptation of governments to resort to manipulation to reduce high levels of borrowings (for instance through inflation or debasing currencies), the need for central banks to target or more comprehensively include asset prices in their policy framework, and finally the important role that behavioural finance plays in decision-making.

More specifically in the case of Ireland, the lessons that eighteenth century France has to offer may well be more political than economic. France today is decidedly “un-Law”-like in its socio-economic structure, largely because this is path-dependent on crises past. In the French spirit, Ireland needs to thoroughly reassess the wreckage of its banking system, digest global and European regulatory initiatives and then act boldly to take the lead in building a new banking system.

Michael O’Sullivan is author of Ireland and the Global Question (Cork, 2006) and co-author with Rory Miller of What did we do right? (Blackhall). He was educated at UCC and Balliol College and works in the financial services industry.



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