Ireland's EU commissioner has given a characteristically blunt assessment of the risks facing the economy, writes Jamie Smythin Porto.
Internal market commissioner Charlie McCreevy has warned that the liquidity crisis in the financial markets may have a "recessionary effect" in Europe.
In a blunt assessment of the risks facing the economy, he also warned that the weakening dollar and the US deficit may also create problems for the economy.
"If this turmoil was to continue, it would inevitably lead to higher interest rates, lack of confidence, lack of a risk appetite and lack of consumer spending and of course that would have a recessionary effect," Mr McCreevy told The Irish Times at an EU finance ministers meeting.
Mr McCreevy said the global economy was doing pretty well and economic fundamentals were good. But he said it was impossible to tell when the current liquidity crisis would end. The rising euro and the US deficit created extra difficulties.
"Honestly, neither I nor the governor of the ECB, the governor of the Bank of England, or the Fed governor in the US can honestly tell when it is going to end," said Mr McCreevy, referring to the liquidity crisis, which forced the Bank of England to bail out Northern Rock bank yesterday.
He said he supported the bank's decision to offer rescue loans to Northern Rock but warned this action should only be taken to cover short-term problems.
"Central banks cannot just bail out bad institutions who are engaged in very risky policies. If this was the case you just make the long-term situation worse because you encourage people to give in to bad behaviour," he said.
"But there is a difference between bad commercial behaviour ... as against short-term difficulties when it is legitimate for the Bank of England to deal with these particular problems."
Mr McCreevy criticised some European banks for being too aggressive in pursuit of profits and taking too many risks in the subprime mortgage market. Many of these banks had ignored repeated warnings, he said.
"Interest rates in the last number of years have been at historic low levels. And it is always a historical fact that lending institutions get lax in their objective analysis of risk. If you look over the last 10 years, there is a lower and lower percentage of bad debts being written off in that benign credit cycle I pointed out the danger," he said.
He also warned that this lax attitude to risk had become a "contagion" in the industry because institutions saw the increased profits that their rivals were making and also started to take chances and had not priced risk at the appropriate level.
Despite the lax attitude taken by certain banks, Mr McCreevy said it would be unfair to criticise banking regulators for contributing to the current market turmoil. "I would not like to say that the regulators have failed there is not one single issue, it is a number of factors," said Mr McCreevy, who noted the complexity of the subprime mortgage market and new financial instruments created in recent years.
"The complexity leads me to believe that people taking on this risk didn't really appreciate the type of risk they were taking on," he said.
He said politicians needed to be sensible at the current time about regulation. "Ninety-nine times out of hundred, if you react immediately, it is wrong," said Mr McCreevy, who pointed to the example of the Sarbanes Oxley Act in the US introduced after the collapse of Enron. That law had proved problematic and reduced the attractiveness of the US capital markets. In contrast, the EU had introduced much better financial regulation and the US was revising its own, he added.
He also described recent calls for the regulation of hedge funds as ill-timed. He said the current crisis did not involve this so called non-regulated portion of the financial markets but the regulated banking sector. But he acknowledged there may be a need for some changes to the regulatory system for credit ratings agencies. These agencies, which assess the risk of debt default, are paid fees by the financial institutions that issue the mortgage-backed securities that are at the centre of the current crisis.
"I don't for the moment want to give the impression that credit rating agencies are the single cause of this particular problem. They are not But I have raised questions about the possible conflict of interest, and I know in the US they are looking at this as well," said Mr McCreevy.
