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The Irish Banking Crisis – reviewing the Honohan Report
Part 1 Regulating capitalism
28 June 2010
For most people the economic crisis that has hit Ireland was due to developer and bankers’ greed, politicians’ corruption and incompetence, and regulatory complacency and failure. As an initial place for understanding it is not a bad place for most people to start. Among politicians and economic experts the agenda has been one of determining whether the crisis was home grown or imported from outside and therefore simply a consequence of the world-wide financial crisis which gripped many countries in 2008. Obviously the opposition would like it confirmed by an apparently objective investigation that it was a home grown crisis for whom the Fianna Fail was significantly responsible and for Fianna Fail that it was simply a local expression of a world-wide calamity for which they cannot fundamentally be blamed.
The Honohan Report was commissioned as one of two preliminary reports which would inform a larger Statutory Commission of Investigation. Its terms of reference left out examination of the steps taken by the State and Government after the crisis erupted at the end of September 2008. This drew the anger of opposition parties because this excluded serious examination of the initial steps taken by the Government to deal with the crisis, the blanket guarantee of bank liabilities, which determined so much subsequent policy and which the opposition opposed with its own ‘solutions’ of creation of a ‘good bank’ or nationalisation. In truth the differences are of second order importance to the fundamental agreement of all the parties that the existing banking system needed to be saved, the State had to pay for it and the State then had to get working people to pick up the bill.
What matters then is not the pantomime charade of heroes or villains or whether the report was going to reveal a radically new way for the State to address the banking crisis but whether this was a result of particular failures that can be put right or a result of international factors for which, at most, some steps can be taken to minimise the effects. This is important because the real issue for the Irish State is whether there exists the possibility of a new financial bubble that definitely would sink the State. This is a concern among many financial observers, regulators and governments. The housing bubble in Ireland and elsewhere coincided with the sub-prime securitisation meltdown in the US and follows commodity bubbles, the dot.com bubble and earlier third world debt crises. Beyond the blame game of internal or external cases lies this fundamental issue for the Irish State. That it is discussed publicly in terms of all being Brian Cowan and Bertie’s fault or those sharp suits at Lehman Brothers in New York in no way reflects the seriousness of the issues.
Working people are angry at the huge cuts to their living standards. Many have become unemployed and many more have had their future expectations radically overturned. Young people face unemployment, low wage jobs or emigration. Many bought into a lot of the ideological nonsense that came with the boom and now accept that they must pay some part of the bill for the drunken party that occurred while fuming that it’s not being shared equally. Many have protested angrily, but their horizons have been limited by the trade unions that have feigned protest and played the most effective role in ensuring that the cuts have been imposed with minimal real effective resistance. Above all there has been no perceptible growth of a radical alternative.
What there has been is a growth in support for the Labour Party which has in one recent poll become the most popular party in the State. The reason for this is clear. It has more consistently than any other hammered those in the Government who have been popularly held to be responsible for the crisis, the Fianna Fail Party and its banker and developer friends. The performance of Fine Gael, previously the recipient of support generated by anger at Fianna Fail, and its recent leadership battle, has allowed Labour to take the high ground of opposition. That it supports cuts, supports the Trade union deal which supports the cuts, supports NAMA in all essentials and agrees with saving the major banks, all demonstrates that it has no real fundamental difference with either Fine Gael or Fianna Fail. The importance of the Honohan Report is whether it needs one.
An objective and technical investigation by a respected, disinterested and specialist academic should therefore be able to convincingly report on the cause of the banking crisis, what steps might have been taken to prevent it and what steps might now be taken to ensure it never happens again. On the basis of this a new Government could reasonably be expected to ensure that its appropriate findings are effectively implemented, allowing for the fact that it is only a preliminary investigation.
The major problem is not that its author is no longer a disinterested observer, but Governor of the Central Bank subject to investigation, but that the essential solutions to the crisis have already been endorsed by all parties – austerity. This is a very powerful incentive to learn nothing of importance and continue in the illusion that this solution can be employed any time it is required. Whether admitted to or not this is the view of the bankers and developers most complicit in the disaster. The State and its political masters in government, supported by its experts in the universities, are supposed to take a more rounded and far sighted view that looks after the long term interests of the system. Politicians cannot forever promise austerity. They can lie repeatedly about delivering prosperity but not about delivering austerity.
For working people the questions are very much the same. Is the cause of the banking disaster avoidable, will it be avoided and is there an alternative to the austerity policies that make them pay for something which is not obviously their fault. The vast majority with an interest in these questions will not read through all one hundred and seventy seven pages of the report but it is important that the most militant and socialist workers have an understanding of what it says, or doesn’t say
The report’s spotlight is on the regulation of the banks by the Central Bank and the Financial Regulator, which was an autonomous component of the former, both charged with ensuring the stability of the financial system. The focus is therefore on regulatory failure even though the report places ‘major responsibility’ for the disaster on the directors and senior managers of the banks themselves, plus the mortgage brokers and similar intermediaries including the auditors and accountants who signed off the books of the banks, assuring interested parties that what you saw, healthy and profitable organisations, was what you would get. In other words all the professionals who are now doing so well from the initiative to save the banks – NAMA – were the primary culprits in creating the near or total collapse in the first place. The report was to arrive ‘at a fuller understanding of the root causes of the systematic failures’ of the banking system.(1)
While it is necessary to read the report to make a judgement on how well it does this, having done this it is more useful to present a verdict first and then provide evidence for it. We can therefore say that the report does not get to the root of the crisis and therefore is not able to convince that another financial crisis is not possible, if not actually likely. It starts by looking at the wider economic causes of the banking crisis, the way regulation worked in Ireland; and how the mounting crisis was dealt with in the years and months leading up to the near collapse of the financial system and the blanket guarantee that was stupidly called by the Finance Minister the cheapest bail out in the world.
We can immediately dive into the middle of the report and review what it has to say about regulation by firstly saying something about what the report doesn’t say about regulation, because it takes it for granted, but which is actually key to regulatory failure. To operate banks require a license, which defines the rules under which they can function. They need this license not only because of their systematic importance to society, or the relatively easy way it would be to defraud the population, but because in essence the free market cannot be expected to produce the optimum banking or finance system for the wider economy. The free market cannot be trusted, just as network utilities in Ireland, the UK and around the world are regulated, because often they are monopoly or near monopoly providers of essential services and cannot be trusted to use their power wisely.
This however is not how it is seen by the regulators themselves. For them the objective is to create conditions as close to their ideal of a free market as is possible, if possible by encouraging the emergence of markets: by splitting up companies into bits or encouraging new companies to enter. This creates absurdities such as increasing prices to encourage new companies while expecting that the new entrants will lead a competitive drive to lower prices that will fulfil the regulators’ declared responsibilities to consumers. The contradiction between expecting lower prices and the need to offer higher prices to companies to get them interested in the first place seems lost on them. Instead of recognising their own existence as proof of the failures of the market they see their role as one of creating it or substituting themselves for it. They therefore remain as ideologically blinkered to its failures as all other participants in the disaster.
The market they and all the other participants see is one written by neoclassical economists that don’t exist in the real world and which would lead to utter and complete instability and recurrent extreme crisis if it did. Even the report itself acknowledges that increased competition from foreign banks lowered lending criteria and inflated the bubble. The problem for regulation then is that its understanding of the capitalist system is flawed and is continually drawn to measures that at best fail to deal with problems and at worst exaggerate it.
The report notes the somewhat unusual position that the Irish regulator was put in by also having responsibility for promoting the competitiveness of the Irish financial system and its institutions. This however just makes explicit a role that all regulators in all countries are well enough conscious of.(2) That the report admits that this leads to a conflict between prudential measures to reduce financial instability and growth of the industry is simply proof of our analysis that free market capitalism and the dynamic of crises it produces are inimical to stability.
The difficulty can be stated differently by noting that the crisis has everywhere reduced the number of banks, including in Ireland, and so concentrated the risks that regulators were so concerned to avoid. The bursting of the illusion that new complex financial products would spread the risk and therefore safeguard the expansion of credit does not invalidate the necessity to deal with risk .or to address the worsened problem of enormous banks that are ’too big to fail’ and which concentrate within themselves all the risks of capitalist production, distribution and exchange. This may seem a not very immediate problem but it is precisely the issue that exists for financial regulation and the problem to which it needs to provide a convincing answer.
Instead, however, the report has been discussed primarily in terms of whether the Irish crisis was predominantly home grown or imported from outside and it makes it clear that it believes it is predominantly the former.
In examining regulation in detail it reviews three steps that were initially embarked upon to strengthen regulation, two of which flowed directly from previous criminal actions by the banks. This included the introduction of Directors’ Compliance Statements that basically put down on paper that the heads of the banks were complying with all the rules that they might be expected to comply with and weren’t again engaged in activities such as facilitating the sort of tax evasion from 1986 to 1998 that was exposed in the DIRT inquiry. The proposal led to the bankers expressing ‘concerns’, which led to the Department of Finance delaying implementation and the Minister of Finance informing the Central Bank that it ‘was important to assess the competitiveness issue.’ ‘Following a discussion with the Department of Finance it was then agreed by the FR (Financial Regulator) not to implement the provision as set out in the Central Bank Act, 1997.’(3)
Let us summarise what has happened here without using unfairly pejorative language. Organisations and the Directors of these organisations that had been found to have facilitated systematic tax evasion, that is law breaking, were able to say that they couldn’t carry out their work properly or fairly if they were asked to solemnly commit not to engage in such criminal activity again. Not only that but they were able to get the Government and its regulator to agree not to implement new laws which were designed to stop this criminality reoccurring.
We can have little doubt that much of the self-serving oleaginous apologetics used to justify all this revolved around the question of protecting the reputation of Ireland’s financial system.
The second regulatory measure was to ‘modernise the fit and proper requirements for Directors and Managers’, which again arose directly from the previous scandals and tribunals of inquiry into wrongdoing. This measure did rather better but the report still records that it did ‘not extend to placing the fitness and probity reviews conducted by the FR on a statutory basis for all firms.(4) This is promised in new legislation. The third measure was a new corporate governance code. This is high on the list of things that capitalist enterprises should implement in order to show themselves paragons of virtue and has been the subject of a number of high profile reports over recent decades. This too was delayed and then ‘an executive decision was taken in early 2007 to delay the corporate governance code. . .’
The report states that ‘underlying this model (of regulation) was the view that those running the banks and building societies were honourable persons. . .’, presumably despite all appearances to the contrary.(5)
The report notes numerous occasions when the regulator did not use the powers it already had and that ‘prior to the financial crisis in 2008, there were no sanctions imposed on credit institutions and none that might be said to have reflected significant prudential concerns.’(6) That is, nothing that smacked of the regulator being concerned that banks might be taking excessive risks and heading towards insolvency.
In taking this approach the Financial Regulator was simply continuing the policy that had been carried out previously by the Central Bank, which in any case still remained responsible for regulating the banks and ensuring stability of the system. By any yardstick they both failed spectacularly. The report provides incontrovertible evidence that they failed miserably to use their powers to carry out their responsibilities. The Financial Regulator Pat Neary, who nevertheless headed off to the sunset with a big pension, has received his, one hesitates to say ‘fair’, share of blame but at least some. One name however sits comfortably among the roll call of those who share this personal responsibility for failure and that is David Begg, General Secretary of ICTU.
Go to his welcome page on the ICTU web site and read his attack on the ‘ unfettered free market and unrestrained capital’ and ask yourself what fetters and what restraints he placed on capital in all the years he served, and continues to serve on the Central Bank. One has to search far and wide to read of any criticisms of his failures, shared equally with all the others who sat on the Central Bank Board and that of the Financial Regulator.
The Honohan report is damnation of him, and indirectly of the whole social partnership process which legitimates the sharing of responsibility on State Boards and semi-state companies between union leaders and big business figures. It robs him of any excuse or any mitigation of guilt. The report is therefore of immense interest to those workers paying for the banking crisis because their top leader bears direct and personal responsibility for it happening. But where are the protests? Even the naked emperor might have blushed. Instead Begg and his fellow bureaucrats have escaped scot-free and it is rather those who point out their guilt who invite embarrassment. Rather like a gentleman’s club the wagging fingers are pointed at those bold enough to say j’accuse!
Even when regulators discovered multiple examples of bad practice and frequent breaches of the rules no effective action was taken. No penalties were ever imposed. ‘Even the detection of serious deficiencies in loan appraisal and approval procedures of the major banks did not seem to trigger alarm.’(7) Persistent breaches of regulations resulted in failure to implement regulatory decisions. ‘It often took several months for a letter to be issued and at least as long for a response to arrive.’(8) ‘Intrusive’ demands by more junior regulatory staff resulted in the bankers complaining and getting those at the top of the regulator to rein them in. More resources would therefore have been unlikely to have made any difference.(9) Favourable assessments were given or problems downplayed. ‘Thus the weakest bank was given a relatively favourable assessment until close to the edge of the cliff.’(10)
All this comes under the description of ‘light touch’ regulation or ‘regulatory capture’ where the body tasked with regulation becomes an advocate of the narrow interests of the regulated organisation. These terms exist because they are not unusual. This type of regulation resulted in relatively glowing reports on the health of the banks which, read now, are absurd but which, even at the time, should have been regarded as incredible. In 2004 - ‘it is unlikely that the current good health of the banking system will be compromised over the medium-term horizon’; 2005 – ‘the central expectation . . . is that the current health of the banking system leaves it reasonably well placed to withstand pressures from potential adverse developments in the short to medium term.’ and in 2007, when house prices were already falling, – ‘notwithstanding the international financial market turbulence, the Irish banking system continues to be well placed to withstand adverse economic and sectoral developments in the short to medium term.’( 11)
Despite the evidence the report rejects ‘the suggestion by some commentators that the fact that some banking personages were well connected might have been a key factor in discouraging aggressive supervisory intervention.’ This is after noting, as recorded above, that bankers were able to halt legislation against them through the intervention of the Minister and were able to get the management of the regulator to stymie the work of junior staff. The ‘suggestion’ is rejected because ‘none of the persons interviewed during the investigation agreed with this proposition, with several noting (rightly) that it was quite predictable that senior banking figures would have political contacts.’
So we are expected to believe that there are political contacts that have no consequences even though these contacts exist because . . . well, why do they exist?
If the country was governed, and society strongly marked, by equality of citizenship, why indeed would it make any difference if politicians knew bankers? In fact why would they be likely to know them more than anyone else? But now of course we do enter a world which is simply incredible, but which is the only explanation for the equally incredible argument the report presents the reader with and which really does rob it of credibility. When the author says that no one he spoke to agreed with the suggestion one is tempted to quip that he really ought to get out more. It says more about who he spoke to than about the veracity of the suggestion.
Politicians knew bankers because they wielded power, because they came from the same class and had the same political and ideological views and interests. Unsurprising alignment of class interest is the key factor explaining the cosy relationship between bankers, politicians and high state officials but recent history demonstrates without a shadow of doubt that this ‘indirect’ corruption (of professed principles of democracy and equality) has rarely been separated from direct corruption. Loans to politicians, their friends and relations and the inter-change between regulators and top positions in the banks are all evidence of this.
There is no point venturing the claim that arriving at such a judgement was not supported by the facts; if you don’t go looking for them you never find them. Nor can it be claimed that such a judgement would be a directly political statement since to dismiss it can be no less political. What outright rejection of the suggestion reveals is really a rather complacent approach to the issues under investigation. Because if Honohan was genuinely open minded about the role of crony capitalism in the banking crisis and failure of regulation and was genuinely concerned to unearth and deal with root causes, his report would show far, far more effort to discover if cronyism really did play a major role. The unstated assumption is that everyone will have learnt the lessons of the crony relations that existed and that anyway stricter regulation will transcend and overcome such problems. But this is a piece of ideological nonsense every bit as unwarranted as the normal regulatory assumptions about the efficiency of the free market or the integrity of those regulated. When rule makers think of new ways to uphold the rule of law and expect them to succeed they fail to understand that ultimately it is people that rule not laws.
Thus the concern with the question of whether the banking crisis was primarily a result of national or international factors fails to understand that regulatory failure and crony capitalism were simply the Irish mechanisms through which the more fundamental contradictions of capitalism played out in the Irish State. The contradictions are international in scope but have their own particular Irish expression. In the second part of this article we will look at this again and the reports’ analysis of the lead up to the crisis that erupted at the end of September 2008. We will also examine the possibility that better regulation will prevent such a crisis happening again.
1 The Irish Banking Crisis: Regulatory
and Financial Stability Policy 2003-2008, A report for the Minister
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