Credit turmoil not end of the world

IN THE midst of all the recent doom and gloom concerning the direction of the economy, the slowing property market and the battering the world's financial system is taking, the phenomenon known as the 'butterfly effect' has been mentioned once or twice.

This theorises that a butterfly flapping its wings on the other side of the world can cause a tornado over here. It's a good analogy in describing how the contagion from the US sub-prime mortgage market has rippled outwards, sending global stock markets into freefall and seeing long queues forming outside major UK bank Northern Rock both here and in Britain as anxious customers decided to withdraw their savings.

Reckless lending practices in the United States to poor Americans who never had a hope of repaying their mortgages has been the root cause of the so-called credit crunch. Another convenient acronym is used to describe these mortgage-holders - NINJAs (No Income, No Job or Assets). A sub-prime loan is one made to someone who has a poor credit history and who would not normally be approved by a mainstream bank or financial institution.

The mortgage companies which gave out these loans then sold on the debt in a process known as securitisation to other banks and institutions. They were combined with other 'good' loans and packaged as investment products. But, with rising interest rates, the penniless borrowers soon found themselves unable to repay their loans and defaulted. Banks and investors around the world who had bought the debt suddenly found themselves facing enormous losses.

While banks themselves must bear a good portion of responsibility for the current mess through lax lending practices, so too must developers, investors and some home buyers and sellers, though to a lesser extent. Sound banking practices, however, are critical for a property market to function in a stable way.

In Ireland, the advent of 100 per cent mortgages with house-buyers put to the pin of their collar every month to repay home loans has left some people worried. Prices of houses in a number of areas have fallen in the past few months. In our capital city, where house prices in some areas have appreciated to an outlandish degree, that is no bad thing and something that is required for longer-term stability. Some sense of sanity has to return to the market. However, the price reductions which have occurred across the residential market have been small and consistent and do not constitute a hard landing.

Our booming property market was one of the potent symbols of Celtic Tiger Ireland's success in the past 15 years but the doubling of interest rates since late 2005 has certainly cooled the market. Most people are now adopting a 'wait and see' attitude to see where rates are going to go. The current thinking is that the European Central Bank (ECB) will take its lead from the American Federal Reserve and ease rates back slightly.

It is inevitable that the news of falling property prices, the credit crunch, volatile stock markets and oil at over $80 a barrel has led to talk of a crash among some commentators. However, with the underlying fundamentals still reasonably solid in Ireland, talk of a recession is premature, Certainly, we are living through more uncertain times than before, but the Fed's half per cent cut in rates may well signal the end of bad news for borrowers and European interest rates may ease early next year.

In spite of our vulnerability to external global shocks, the Irish economy has proved resilient enough to deal with events like 9/11 and the dotcom crash in recent times. Certainly, there are challenges ahead, such as our heavy dependence on imported and expensive oil and our cost and price competitiveness, but with growth of 3.5 per cent, high consumer spending and record numbers at work, the major elements underpinning the Irish economy are still in place.

Like the old maxim 'two swallows do not a summer make', an economic slowdown like we are experiencing does not constitute an economic collapse.