Ireland, 2008
Two weeks after the Lehman Brothers investment bank went bankrupt following the housing bubble in the United States, the Irish government was holding an emergency meeting with the owners of Ireland’s largest banks on the night of 29 September 2008.
Ireland was looking at a similar scenario as the country saw a large number of residential properties erected following a construction boom in the early 2000s. Banks were providing a lot of loans to construction companies and were extremely generous in granting housing mortgages to people. When the United States crisis started influencing Ireland, their banks began feeling nervous. In particular, Anglo Irish Bank suddenly found themselves in a dire situation because they had granted a large number of loans where risks were not managed well. This bank allocated almost all of their loans on housing mortgages, and, when the payback rate slowed down, they needed 1 billion EUR a day to run as normal. Other banks were also having difficulties and turned away from granting loans to Anglo Irish Bank. As a result, a number of the largest of Irish banks asked their government to urgently issue a guarantee that night.
It took the entire night for the government to have discussions, consult with the European Union, and consequently announce at 6am in the following morning that they were issuing a guarantee of all liabilities of Irish banks. Despite having an economy of 160 billion EUR, Ireland issued a guarantee worth 324 billion EUR, and placed 50 billion EUR in banks in the morning of 30 September.
Within one day, Ireland’s budget balance turned from positive to -32 per cent, which became ten times as high as the 3 per cent requirement for the Eurozone. Their government debt, which was previously equivalent to 40 per cent of GDP, jumped to 80 per cent. It all happened overnight.
Their banks had grown too large, which meant if one fell, the entire economy would collapse. Although the Irish government saved the banks, they soon found themselves in need of a rescue as well. So they asked help from the European Union, who left them no choice but to accept a loan with high interest rates and tough conditions, in cooperation with the International Monetary Fund (IMF). It caused the Irish state to be governed from abroad, not by their own government.
Subsequently, the burden of bad loans from the private sector shifted onto the shoulders of the people. Today Ireland has still not got rid of high taxes and a budget deficit, grappling with continuing economic and political crisis.
This case shows what happens when banks in a small country grow larger than the economy, especially when their internal governance is weak. It leads to insolvency of the government as well as the nation.
Mongolia, 2018
Following the mining boom in the early 2010, Mongolia’s economy grew by two digit numbers. A heated economy affected the construction industry directly, and the property market started seeing bubbles. Residential properties and office buildings were being constructed in all parts of Ulaanbaatar.
Banks were competing with each other to grant loans to construction projects at an interest rate of 20 per cent annually. Simultaneously, the Mongolian government issued bonds on foreign stock exchanges and raised a debt of 3 billion USD, including Development Bank, Chinggis, Samurai, and Dim Sum bonds. The capital that was obtained was then taken by decision makers at the government through their own companies.
The residential properties and office buildings were designated for people with an above average income level and for companies with financial capabilities stronger than the average as well. The lack of advanced and comprehensive legislation on public properties and their ownership and use allowed for corruption to grow in special permits and licenses related to construction and infrastructure projects. As a result, the property price kept increasing to extremely high levels, soon after which the sales stopped completely.
Due to lobbying from banks and construction companies, the Central Bank together with the government signed a memorandum of understanding and started housing mortgages at an 8-per-cent interest rate, which was 2.5 times less than the market rate. The Central Bank printed more money and injected 3.8 trillion MNT into circulation. Following the announcement of this soft housing mortgage, the demand for apartments doubled, which caused their prices to double as well.
In order to continue this housing mortgage scheme and other price stabilization programs, the government raised bonds from the domestic market with an interest rate of 17 per cent, which was even higher than the savings rates in commercial banks. It did not take long before the budget deficit equaled 15 per cent of the economy, and 25 per cent of budget revenue started going to external and internal debt payments. The value of the tugrug halved subsequently.
Mongolia’s economy basically went bankrupt and was forced to seek assistance from the IMF once again. As we started using soft loans to pay off the more expensive loans, our budget deficit halved to 8 per cent. However, there is still a gap to 3 per cent, which can be said to be a normal budget deficit rate. On top of that, our external debt keeps growing.
The lobbying from banks keeps getting stronger in the government. Certain banks have been growing their power by acting as the main financier of political parties in their elections and by sponsoring campaign costs. Those banks are now controlling the government at all levels. Furthermore, they have been buying state assets at cheap prices openly and secretly, making the government issue guarantees, and competing with each other to assume ownership of key factories, properties, and valuable land. The balance between the three branches of government has been lost, and they have become unable to scrutinize each other. As a result, the government is now serving their sponsors, not their electorate. It is growing more and more difficult to predict court decisions.
Solution
The Central Bank apparently considers that ridding commercial banks of their bad loans and setting up a portfolio management state-owned company is key to bringing transparency into the operations of Mongolian banks and reducing the currently high interest rates. Although South Korea established a state-owned company to manage centrally collected bad loans after their 1998 crisis, success was only achieved because it was done in parallel with introducing foreign banking and financial services in the country.
In addition, Mongolia needs to drastically improve the scrutiny of commercial banks, strengthen their governance, isolate them from their non-banking businesses, and stop the housing mortgage subsidized by the public budget. Only then will housing prices go down as result of competition, unlocking capital and getting our economy on its feet. This would also lead to construction companies building properties that speak to market demands, which will reduce concentration in the central areas of the city.
2018.04.25
Trans. by B.Amar