ANALYSIS:Reports on the causes of the banking crisis are likely to blame a heady cocktail of cheap money, greed and lack of controls
THE FIRST official investigators into the causes of the banking crisis have a job akin to a doctor treating an unconscious drunk in AE, examining the patient to determine what led this frail being to collapse. They’ll find that a heady cocktail and a long party were responsible.
Today, Minister for Finance Brian Lenihan will see two “scoping” reports that will form the basis of a statutory commission of investigation setting down on record why taxpayers are being forced to foot a €32 billion bailout for the banks and a € 40 billion agency to buy their most toxic loans.
Central Bank governor Patrick Honohan assessed the failure of the regulator to prevent or forewarn sufficiently about the crisis in one report, while a more general overview into the reasons for the crisis has been undertaken by former IMF officials Klaus Regling and Max Watson.
Their reports are likely to show that many spirits and mixers combined to make a potent cocktail, though one or two components may have proved more noxious than others.
Certainly, Government policy on tax-driven property incentives is one area of particular interest assessed by Regling and Watson. The tax breaks lavished by the Fianna Fáil-led government upon the party’s key supporters – builders and developers – created incentives for building, renting and buying property. This contributed to the boom in lending, leading eventually to spectacular losses on the balance sheets of the banks.
More broadly, Regling and Watson have pondered the economic phenomenon that occurred in Ireland. Money came cheap and credit easy following Ireland’s entry into the euro zone in 1999. This allowed Irish banks to tap vast quantities of external capital, giving them the ability to borrow heavily in the long-established wholesale money markets with no domestic currency risk.
The banks jumped head first into this pool of cash particularly after 2003 when they couldn’t buy in deposits at the same rate as they were selling loans for frenzied property buying.
Loans at the six domestic lenders more than doubled in just four years to €409 billion in 2007 when the property market turned, far outstripping growth in their traditional raw material – deposits. The difference – now almost €200 billion – was borrowed in the money markets, which froze in the global financial collapse in September 2008, and later reopened at exorbitant prices.
These loans now have to be repaid at huge cost by loss-making banks propped up by a government with a €20 billion deficit in its finances and a broken tax system.
A low interest rate environment in the euro zone was compounded by ferocious competition in banking with foreign lenders – primarily the UK’s HBOS and RBS through their respective Irish banks, Bank of Scotland (Ireland) and Ulster Bank-First Active – chasing unstable returns.
BoSI’s tracker rate and interest-only mortgages and Ulster Bank’s 100 per cent home loans forced down the cost of borrowing and gave deposit-less, lower-income buyers a tenuous grasp on the bottom rung of the property ladder. This spurred a flurry of building and lending where conventional credit checks went out the window as the domestic banks ignored the risks of over-concentration on an inebriated property market in a bid to hold market share.
Builders’ bank, Anglo Irish Bank, a one-trick pony which became a thoroughbred Group 1 winner during the property boom, enjoyed massive spoils, annual returns of 35 per cent. Greed pushed the envious two big banks, AIB and Bank of Ireland, ever deeper into development lending under pressure from shareholders and the markets seeking similar gains.
Loose international accountancy rules meant banks did not set aside more money for future bad loans but only as loans went bad. The big banks put away just one-third of 1 per cent of their loan books to cover soured debts when losses are now heading towards 12 per cent of loans.
Internationally and at home, capital rules were deficient and banks did not have enough in reserve, while skewed pay strategies meant bankers were rewarded for unsustainable short-term gains.
Honohan, who called for a banking inquiry earlier this year, will assess why the Central Bank and Financial Services Authority of Ireland (CBFSAI) was not alert to out-of-control banks.
His views on the Financial Regulator are known. Shortly after taking over as governor last year, Honohan said the regulator lost sight of the details of the banks’ loans, did not scrutinise the quality and extent of the collateral and guarantees provided on loans by the big borrowers, and failed to question the robustness of the banks’ business models.
On a more general level, he has said it would have been unpopular to call an abrupt halt to the “intoxicatingly profitable boom” but that it was not clear whether any of the authorities even considered making that call.
The splitting of the Central Bank and the Financial Regulator under the CBFSAI meant key responsibilities for financial supervision fell down significant cracks between the two organisations, while individually they each failed on their own watch to protect taxpayers.
The new regulatory system, the creation of which was inspired by customer overcharging scandals at the banks, was too focused on consumer protection at the expense of more systemically important prudential supervision.
There was a reluctance or fear of intervening and reining in bank lending at the Financial Regulator under first, chief executive Liam O’Reilly and his prudential director Pat Neary. When Neary moved – after taking charge in 2006 – to curb the bank’s speculative lending on development and 100 per cent mortgages, it was too little too late. The damage was done.
The regulator was too focused on contingency planning for an emergency rather than trying to pre-emptively head off a crisis. By the time of the meltdown it struggled to deal with an international financial crisis but in fact was oblivious to the true scale of the problems at home.
The macroeconomic surveillance by the Central Bank proved worthless. Weak and inaccurate technically-laden warnings fell on deaf ears. The failure to stop or even spot an inflating asset bubble caught others out as well. The Department of Finance, the ESRI and the banks were – right up to the eve of the crisis – speaking of “a soft landing” in the housing market and still anticipating continued economic growth.
Successive budgets overlooked that the boom in tax revenues was due to an overheated property market and debt-fuelled spending. Government expenditure spiralled on a narrowly focused tax base, creating – when the crash came – a massive hole in the State’s coffers next to the one on the banks’ books that taxpayers must help fill.
We await the diagnosis of Honohan, Regling and Watson – this week or next if the Cabinet needs time to peruse the reports – and further triage by the commission of inquiry. In the meantime, there will be nervous shuffling among politicians and officials in the waiting room outside.