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The Irish Banking Crisis – reviewing the Honohan Report
Part 2: Capitalism regulating
25 July 2010
In the first part of our article we noted that the issue of whether the banking crisis was home-grown or essentially an import dominated political reaction to the Honohan report, with the opposition and governing parties looking for evidence within it to support either the former or latter explanation. We also noted the high stakes involved in reaching a serious answer – that another financial crisis would more or less immediately force the Irish State into bankruptcy. Our criticism of the report is that it has not understood that it is not a simple question of either/or; that the Irish crisis was a particular expression of a worldwide phenomenon and that the focus of the report had to be on the mechanism that linked them. Early on in the report it is clear that this was not the approach adopted.
In paragraph 1.7 of the introduction, after noting that a clear failure of regulation had occurred, the report states that ‘the same can be said to a greater or lesser extent with respect to several other advanced economies. However, the task in this Report is to characterise the ways in which the failures occurred in the Irish context and to identify the underlying reasons.’ The report is therefore limited to purely local failures assuming, without any evidence or argument, that international factors can be parked.
The report considers ‘what might have been the relative contribution of local factors to the Irish output loss’ caused by the economic crisis precipitated by the banking collapse, but then engages in a purely accounting exercise which attempts to apportion a weighting to domestic and international imbalances as explanatory factors. The report therefore compares the difference between the actual fall in income within Ireland with that which would have occurred had the Irish State the same growth as the whole Eurozone area. This amounts to about one fifth of Gross Domestic Product and the report estimates that about three quarters of the fall in Irish output can therefore be attributed to local factors.
The problem however is in thinking that a purely accounting treatment explains anything. A set of accounting statements can show a company having a huge loss and facing bankruptcy but this does not explain why it is facing ruin – why is it not selling, why are its costs so high, why perhaps it is selling its product but isn’t receiving payment etc.etc.? And even this sort of explanation would be an extremely limited and superficial one, one that ignored the deeper way in which the capitalist economy functioned. For our purposes however the immediate question posed is what lies behind the figures that explain what the figures simply count (not account for)? It is perfectly possible to argue that the greater downturn in Ireland is wholly and completely caused by the same international factors that caused a less severe crisis elsewhere. Unfortunately the whole economics profession is littered with mathematical propositions that explain nothing and are impressive only for their complexity and obscurity. The same features as the financial products that caused the financial meltdown in much of the world’s economy.
It should not need saying that failure to locate the problem will almost inevitably lead to failure to locate the solution.
The failure of existing regulation to prevent the crisis is outlined in the report and the various levers open to the financial regulator are reviewed. Moral suasion, that is influencing the bankers’ thinking, is one, but the report notes that ‘there is no evidence that the CBFSAI’s (Central Bank and Financial Service Authority of Ireland) concerns – such as they were – were taken heed of to any major extent.’
Increased capital requirements were another, the requirement of banks to hold more money in reserve should things go wrong, both helping to protect them if they did and lessening their ability to stoke speculative asset bubbles. The report notes that some steps were taken but that ‘it was too little too late.’ Limits on lending in certain sectors, so avoiding concentration of risk, were also available but the report notes that ‘it is fair to acknowledge, however ,that experience shows that quantitative credit limits can be circumvented fairly easily.’ Other steps could have been taken including banning mortgages that exceeded a certain value of the property; limits on the credit creation of individual institutions; or bigger provisioning of problem loans – that is setting more money aside to cover loans that look as if they might go bad.
Often these and other regulatory measures are viewed as purely technical questions which will either work or not work, and there is indeed this aspect to them. It is possible to draw up a blueprint for a financial system that would ensure that speculation was prevented. The real question is whether such an assurance is possible for a financial system that is part of the lifeblood of a capitalist system in which risk taking is extolled, greater and greater growth is the desired state of the economy, profits are the overriding consideration and instability and disequilibrium is the natural condition? What those seeking after financial stability really mean is not the absence of risk, absence of growth, absence of profit maximisation or absence of dynamic development but how the finance system can play its role in providing the means for all this to happen without the inevitable crises not bringing disaster to the system through the financial architecture’s inevitable concentration of risk and imbalances within itself. This being actioned either by being too big to fail, concentrating too much risk or paradoxically being the network of contagion, or abusing the inevitable power that accumulation of money gives.
This last aspect makes explicit that regulation of the financial system is also a political matter and not subject to purely technical considerations. The report notes a number of such reflections that influenced regulation in Ireland before the crisis. This includes the concern already noted that more intrusive regulation would adversely affect the competitive position of Irish credit institutions in relation to local subsidiaries of foreign institutions not subject to the same regulatory scope. The report downplays such concerns and notes that ‘Irish regulated credit institutions between 2000 and 2008 comprised in excess of 96 per cent of the domestic mortgage market.’ Related to this however was and is the concern that ‘more robust regulation might make Ireland less attractive for international financial investment’ and it is in just such considerations that the link between what appears purely national and international factors becomes exposed. . Dependence on outside investment has been fundamental to the Irish State and to make some sort of distinction between purely financial and other direct investment would be very hard to sell never mind create and implement.
What this ignores also is that the money to fund the massive property speculation that destroyed the banks came not from within the State but from outside. The report itself notes that this amounted to ‘more than 50 per cent of GDP in the 4 years after 2003.’ ‘At end-2003, net indebtedness of Irish banks to the rest of the world was just 10 per cent of GDP; by early 2008 borrowing, mainly for property, had jumped to over 60 per cent of GDP. Moreover, the share of bank assets in property-related lending grew from less than 40 per cent before 2002 to over 60 percent by 2006.’
This was not a purely Irish phenomenon. ‘Data compiled by VoxEu.org shows that holdings of Spanish debt by euro zone core banks grew from less than €100 billion a decade ago to more than €600 billion at the end of last year. The bank’s holdings of Irish debt increased from €60 billion to almost €.350 billion over the same period, Greek debt holdings climbed almost six-fold to more than €140 billion, and exposure to Portuguese debt jumped more than four-fold to €110 billion.’ This flow of money to both the private sector and state came from large surpluses in countries such as Germany and the Netherlands. Free movement of money is a fundamental of the EU enshrined in the Maastricht Treaty. Free movement of money is an article of faith of the Irish State and not just the EU. EU money has been decisive not only in facilitating the crisis but now in holding the Irish financial system up from complete collapse. To imagine that this situation, so fundamental to creation of the crisis, is going to be changed by new financial regulation to limit the international movement of financial capital is to engage in a flight of fancy that no one else will follow.
We can now easily see how mistaken an approach it is to try to attempt to analyse the purely national origins of the Irish financial disaster and therefore seek a purely national solution. The report at one point comes up against such a concern. In a footnote to the report the author notes that ‘it has been suggested at times that restrictive actions vis-à-vis Irish-regulated institutions would not have curtailed the property boom as other institutions would have entered to pick up the slack.’ The reply in the report is anything but convincing. It simply notes that it is not ‘relevant’ because at the national level the Central Bank can only do what it can do and only at the European Central Bank does responsibility for such action lie. But then here too the problems are just blown up to a world level. In effect the problem of international money blowing up the bubble is not ‘relevant’ only because the Irish State is incapable of doing anything about it. The problem was put directly by someone from the Taoiseach’s office: ‘it is arguable whether any regulator acting in an economy focused on growth and fostering competition could have materially mitigated the property bubble.’
The problem therefore lies at three levels. The first is the inherent instability and irrationality of the economic system at both the world and national level. The second is the weakness of the Irish State when inserted into this system, again more or less inevitable. The last should not be ignored, and that is the particular failures at the level of the Irish State and financial system, its corruption, incompetence and cronyism. These are not accidental features of the situation but mediated results of conditions at the first two levels. To point to the rotten character of the local establishment in creating the economic disaster is not to ignore or to remove from the scene the ultimate systemic cause of the crisis. Capitalism exists everywhere, to a greater or lesser extent, through greed, corruption and not a little incompetence by those who present themselves as its experts. As we have seen, this is inevitable in so far as the main actors in the drama actually swallow uncritically the theoretical errors at the foundation of their economic understanding of their own system.
It is not therefore wrong to simply marvel at the sheer stupid incompetence of those in charge; that is if we are really to believe some of the findings in the Honohan report. ‘At no point throughout the period did the CBFSAI staff believe that any of the institutions were facing serious underlying difficulties, let alone potential insolvency problems – even at a late stage as the crisis neared. Explaining this is not easy considering that all the staff involved were specialists, working diligently on what was understood to be an important task. Thus, the failure was clearly of a systemic nature rather than related to any one individual.’ The report notes this even while it also notes that ‘from late summer 2007, the CBFSAI had been in increasingly crisis mode as it sought to prepare for the consequences of a possible looming liquidity squeeze for some or all of the Irish-controlled banks.’
What Honohan fails to explain is how otherwise very intelligent people got it so wrong. It is no use saying that the crisis was of a ‘systemic nature’ because this explains away not elucidates. Like the phrase ‘institutional racism’ used to absolve individuals of racist motivation it is an explanation only if it is understood that incompetence, blindness to reality or racism is ‘systemic’ or ‘institutional’ only because individuals don’t have to think about it to be either racist or incompetent. It flows from the nature of their job, which flows from the nature and purpose of their organisation which in turn flows from the deep pathologies of the economic and political system which generates the ‘rationality’ of such organisations and their behaviour. The report comes close to acknowledging one aspect of this through noting that the hierarchical character of the CBFSAI ‘clearly [inhibited] staff presentation of alternative analyses and assessments.’ Unfortunately in both the private and state sectors all organisations are strictly hierarchical.
The questions that arise therefore include – if the crisis was a result of the system and the weak position of the Irish State within the system is another crisis inevitable and does it then really matter what regulatory steps are taken on foot of lessons learned from the report and the more extensive one planned in its wake? The short answers are yes and no, with a more qualified character to the ‘no’ answer.
The first question really asks if world capitalism has witnessed its last financial crisis or whether the Irish State could escape its consequences and the second asks whether the full extent of autonomy which the Irish financial system possesses could not be exploited to protect it from future international instability. Between the possibility of escaping international instability and strong local prudential regulation could another Irish banking crisis be avoided? This possibility exists but is not likely, especially while the Irish financial system is now so weak that a double dip recession in the most advanced countries would tip it and the Irish State over the edge into insolvency and default on its debt, which would nevertheless not be the end of the world.
In Ireland, colonialism and the failure of the national revolution to defeat it has left a deep-seated inferiority complex which only reflects the objective economic dependence of the economy, and therefore wider society, on imperialism. This is reflected in the penetration of US multinationals; low corporate taxation that affects the whole taxation and state expenditure system; membership of the EU and lack of its own currency, stunted economic development in general leading historically to massive emigration; partition and the confessional character of the Southern State which facilitated horrific abuse of children and women by the Catholic Church and now a muted reaction to the devastating cuts in workers living standards. We could go on.
What this means in the context of the banking crisis and its aftermath is a willingness to accept the word of, and do the bidding of, the international organisations that so spectacularly failed to spot the looming financial crisis, not only in the US or UK, caused by exotic financial products, but in Ireland through an old-fashioned, bog-standard property bubble. The Honohan report includes a review of the failures of such organisations as the IMF and OECD to spot the giant bubble inflating or warn of necessary measures to deal with it – ‘admittedly, the views of outside bodies such as the IMF and OECD – especially in later years[!!] – were not sharply different and must have provided reassurance to internal doubters.’ ‘The outlook for the financial system is positive’ said one IMF report in 2006. House prices may not fall back, despite steep rises, as they had done in the 1980s and 1990s and anyway, ‘the IMF did not demur from . . . conclusions that banks could cope quite satisfactorily with quite substantial property price falls’ if such falls happened. The IMF backed up such statements by quoting the evaluations of the credit rating agencies The OECD believed that ‘a soft landing is the most likely scenario.’
Yet hardly a week goes past without spokesmen from either of these organisations, or the mandarins of the EU in Brussels, telling the Irish people that they must take their revolting austerity medicine. In fact we are regularly asked to be grateful that we are part of the club that facilitated both the disaster and the disastrous means of clearing it up. All this is regularly reported in the mass media of television, radio and newspapers echoed through politicians, economists and journalists’ statements. Even the rather critical voices within the mainstream economics profession- such as Morgan Kelly or Karl Whelan of the irisheconomy web site, agree essentially with the medicine. To that extent they play a valuable role in enforcing the political consensus – sure don’t even our most vocal expert critics agree with what we must now do?
What this means is that there is no point looking at what wiser and saner heads at the centre of world finance are doing in order to borrow a suite of regulatory measures that will promise that the Irish banks can join the world financial system in being able to promise future stability. A much referenced book by two prominent economists in the international debate is entitled ‘This time is Different’. What this means is that there is going to be a next time. At the beginning of the 1980s a financial crisis of third world states blew up because of lending by big banks in the first world, which were lending money earned by oil producing states following oil price increases. A decade later the savings and loan crisis in the US erupted. Less than a decade after this came the collapse of Long Term Capital Management and the Asian financial crisis caused by outside money flooding in and then flooding out again. Less than a decade later the dot com boom took off and crashed down and less than a decade after this the sub-prime property bubble burst. Could anyone seriously believe that we have witnessed our last financial crisis, especially since so much has been done to encourage and facilitate one in the way the current one has been dealt with? After each financial crisis regulatory steps are taken, supposedly to prevent disaster happening again. So the Basel I accord followed the third world debt crisis and we are now on Basel III. The first two failed, why should a third succeed?
to be continued
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