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News : Irish Last Updated: Jun 14, 2010 - 7:03:39 AM

Irish Banking Crash: Two official reports detail monumental political, regulatory and business management failures
By Michael Hennigan, Founder and Editor of Finfacts
Jun 9, 2010 - 4:20:13 PM

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Minister of Finance Brian Lenihan chatting with his French counterpart Christine Lagarde, at the Eurogroup meeting in Luxembourg, Monday, June 07, 2010.

Irish Banking Crash: Two official reports published today detail the monumental political, regulatory and business management failures that resulted in the expectation of sustained prosperity from the advent of the Celtic Tiger period, ending in the human toll of mass unemployment, damage and despair for tens of thousands of Irish people, the prospect of years of struggle to contain public debt and an indelible stain on Ireland's reputation.

One report on regulation and the role of the Central Bank in the crash was produced by Patrick Honohan, the current governor of the central Bank who was previously a professor of economics at Trinity College, Dublin. The other report is on the role of political leaders and senior bank personnel and was produced by international banking experts Max Watson and Klaus Regling, who are former IMF officials.

The Governor says that although the deteriorating international environment was what finally set the flames alight elements had been building for some considerable time beforehand. The overly sanguine, even complacent, view presented in the 2007 FSR (Financial Stability Report) and the resulting ensuing conviction that whatever problems that might arise would only be one of a liquidity led to two missed opportunities; first, to convey a strong message to the banks that they needed to build up capital urgently to be able to handle contingencies, or even to require them to do so; and second, to undertake comprehensive preparatory work to analyse quantitatively policy options available in the event the unthinkable might transpire.

Prof. Honohan says the blanket cover offered by the Irish State bank guarantee, issued in late September 2008, pre-judged that all losses in any bank becoming insolvent during the guarantee period - - beyond those absorbed by some of the providers of capital - - would fall on the State.

Given the - - no failure policy, a guarantee with its costs were inevitable.

He says the inclusion of subordinated debt in the guarantee is not easy to defend against criticism. The arguments that were made in favour of this coverage seem weak: And it lacked precedents in other countries (although subordinated debt holders of some other banks since rescued abroad have in effect been made whole by the rescue method employed). Inclusion of this debt limited the range of loss-sharing resolution options in subsequent months, and likely increased the potential share of the total losses borne by the State.

Prof. Honohan says there can be little doubt that a disorderly failure of Anglo would, in the absence of any other protective action, have had a devastating effect on the remainder of the Irish banks. Given the other banks‘ reliance from day-to-day and week-to-week on the willingness of depositors and other lenders not to withdraw their funds, and the certainty that those lenders would infer from the failure of Anglo that all the other Irish banks might be in a comparable situation, in all likelihood the main banks would have run out of cash within days.

Klaus Regling and Max Watson say in their report that while Ireland's banking crisis bears the clear imprint of global influences, yet it was in crucial ways “home-made.”

They say that there was scope to mitigate the risks of a boom/bust cycle through prudent fiscal and supervisory policies, as well as strong bank governance - - thus raising the chances of a “soft landing” for the property market and for society at large. In the event, official policies and banking practices in some cases added fuel to the fire. Fiscal policy, bank governance and financial supervision left the economy vulnerable to a deep crisis, with costly and extended social fallout.

Regling and Watson say that budgets that were strongly counter-cyclical could have helped to moderate the boom, and would also have created fiscal space to cushion the recession when it came. But budgetary policy veered more toward spending money while revenues came in. In addition, the pattern of tax cuts left revenues increasingly fragile, since they were dependent on taxes driven by the property sector and by high consumer spending. Ireland was also unusual in having tax deductibility for mortgages, and significant and distortive subsidies for commercial real estate development, yet no property tax.

As the boom wore on, some external and domestic commentators were critical of fiscal policy. The OECD flagged the case for greater prudence. The European Commission worried about procyclicality in policy as early as 2001; and by 2007 it flagged clearly the fragility of tax revenues. Nonetheless, the authors say EU Council Opinions were favourable: with earlier fiscal reforms and the impact of the boom, Stability and Growth Pact commitments did not seem in doubt. Equally, the IMF was not strongly or consistently critical of the underlying dynamics of fiscal policy. In the event, when the boom ended, fiscal policy was left cyclically and structurally depleted.

There was no room for manoeuvre to support the economy. Indeed, the need to restore sound public finances left no choice but to tighten policy as output fell and unemployment rose.

Source: Regling/Watson report

Regling and Watson say it appears clear that bank governance and risk management were weak - - in some cases disastrously so. This contributed to the crisis through several channels. Credit risk controls failed to prevent severe concentrations in lending on property - - including notably on commercial property -- as well as high exposures to individual borrowers and a serious overdependence on wholesale funding. It appears that internal procedures were overridden, sometimes systematically.

The authors conclude: "Thus it is clear that, in various ways, official policies and bank governance failings seriously exacerbated Ireland's credit and property boom, and depleted its fiscal and banking buffers when the crisis struck. On the basis of that assessment, the body of this report seeks to highlight both broad policy lessons and also areas that deserve specific consideration when the planned

Commission of Investigation further explores responsibilities. Nonetheless, the true burden of responsibility emerges as quite broad, and it extends to insufficiently critical external surveillance institutions."

Banking reports

Irish Banking Crash: Opinion; Cowardice a common trait among the damned "best and brightest" but cowards are usually the winners

"Irish banks are resilient and have good shock absorption capacity to cope with the current situation" - - Patrick Neary, Chief Executive, Irish Financial Regulator, September 19, 2008: - two days after the collapse of US investment bank Lehman Brothers.

Neary retired with a secret €630,000 payoff: He was given a special €202,000 pay-off, plus a retirement lump-sum of €428,000, according to terms disclosed by Finance Minister Brian Lenihan.

In addition, he is receiving an annual pension of €142,670.

Bank of Ireland's former chief executive Brian Goggin, triggered an option in his contract to receive his full €650,000-a-year pension, despite retiring early.

"Brian Goggin's contract provided for an option, which has now been exercised, allowing him to receive his pension, without actuarial reduction, at age 58," the bank said in a statement in 2009.

Goggin earned €12.46 million as well as millions of euros worth of stock options and conditional share awards. His management during the period 2004-2008, was likely the worst in the history of the bank, since it was founded in 1783.

Goggin earned over €3 million in his last year, which ended on March 31, 2009. It was the year when the bank was rescued by the Irish Government and Goggin's 2008 earnings included €1.4 million "in lieu of notice."

SEE also Finfacts articles:

Irish Economy: Ahern, Harney, McCreevy, Cowen and the other individuals/groups with responsibility for the economic crash

Cowen concedes "mistakes" in selective defence of pre-crisis role; Auditors, regulators/ government share responsibility for Irish banking crash

Morgan Kelly: Whatever happened to Ireland?; Bank losses may push Ireland's debt-GNP ratio up to 140% in 2012

Report says Irish Financial Regulator's failure to control property bubble contributed to economic crash and consumer wealth losses

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