Honohan on Systemic Risk

His remarks at this week’s Vienna conference are available here

18 replies on “Honohan on Systemic Risk”

“The crisis has had the effect of accelerating progress towards greater international cooperation in banking regulation, albeit not as far as some have hoped for. In particular, the proposed establishment of an elaborate new European infrastructure for financial supervision and systemic risk mitigation offers the prospect of a new era in cross-border collaboration and peer review and the development of methodologies that could set the standards for wider international financial surveillance.”

It all sounds a bit like ‘law enforcement’ doesn’t it. But maybe that is exactly where we should be looking to go forward.

I caught an episode of the ‘Spooks’, a British TV spy drama series the other evening. Had never seen it before. I believe they kill off their major characters in the show quite often and all have particularly gruesome deaths. One of the themes lately in the show (all seem very topical and well written) is prevention of global financial crisis.

The TV show is ultra-slick with nice shots of the London financial district and so forth.

The standards assessments were useful when they first came out in guiding the creation and upgrading of regulatory systems to what had become conventionally seen as best practice. Over time, however, assessments increasingly concentrated on verifying formal compliance of legislation with an increasingly complex set of requirements set out in the implementation manuals, and less on the quality of practical implementation and operational capacity of the regulatory agencies themselves (IMF and World Bank, 2009). Rather than see the exercise degenerate into a sterile box-checking exercise, the decision has been to reduce the number of standards being assessed.”

Very good point this one.

At a recent ‘Dublin Innovation Week’ panel discussion I heard Francis Ruane of the ESRI note how government in Ireland is good at introducing a new policy. But we are poor at re-visiting a policy a few years down the line, say after 5 years, to try and look at progress and importantly, to define how the direction can be defined, having achieved all initial goals during the first five years. One gets a sense of government programs put in place, which lose their direction having achieved initial goals. I compare it to the idea of zombies walking around, with no life in them.

The Dublin Docklands Authority could be one body, I put put up for review. In fact, I would do a lot more than review, but that is another matter. The point is, we need to acquire the skill to ‘dynamic-ally’ assess and re-assess progress in different programs. The goals obviously change as the organisation matures.

Another speaker at the Dublin Innovation week panel debate, a member of the private sector economy, Jim Barry of NTR noted how the Irish government can introduce a new office, the energy regulator. But the policy context in which the energy regulator operated had to wait another half a decade to come into being. In which case, the regulator basically had no teeth and no useful function to perform.

Getting back to Francis Ruane’s point again, she used the example of the program by government to fund Phd level research. The government aimed to ‘double’ the amount going through the system. Without having any knowledge, of what numbers were in the system already. We were simply going to ‘double’ the number, whatever it was.

Even before we begin programs, we don’t know where we are. We introduce programs in installments without having all parts of the jigsaw. And then when the programs have run for a number of years, we fail to understand how a ‘gear change’ or change of direction or emphasis might be required.

It all points to a generic need, right across the board to understand organisational behaviour in some basic level. It is about dynamically changing context and evolution. A book I wanted to spend more time studying in 2009, if I had got around to it, is Douglas McGregor’s ‘The Human Side of Entreprise’. Published in the 1960s, it has taken many decades for the real world to catch up. But the modern reality is starting to look increasingly like and present many problems with McGregor described back then.

“Stress tests
If standards assessments have proved to be of diminishing use in guarding against or warning of systemic crises, what is? One possibility is stress tests. Stress tests are an obvious tool for risk management of any entity: confront the business plan with a set of scenarios of extreme but plausible shocks and see whether the outcome is acceptable.”

A quick word on this, if I may. The government announced with great euphoria this week that ‘tenders’ in capital spending projects were starting to come in lower. But this is simply a bomb waiting to explode in our faces. Yes tender prices have reduced, but only because firms are pricing in order to obtain contracts at whatever cost. All ‘tenders’ are subjected to enormous amounts of ‘stress-testing’ nowadays, to try and screw the price down as low as possible. But as anyone with knowledge of projects will know, there are many things in projects which cannot be predicted.

What I mean is, the un-know-ables and un-expect-ables have a very high possibility of coming up. Our tendering system is starting to eliminate risk as a cost completely. I hinted at this here:


Very little in the Irish context is subjected to experienced analysis and study any more. It seems to me, that in the segment of the economy that I know best, it has been ‘taken over’ by a bunch of kids with a couple of years financial experience and nothing much beyond that. It gets back to my point about Douglas McGregor, do we need to look at organisations and see how knowledge is transferred effectively within the oganisation? Are we simply pushing out the experience and training altogether and replacing it with these stupid stress testing?

“Crisis management
The crisis has highlighted the need for preparedness for crisis management and improved communication and collaboration between different national authorities. Here I believe that we are on more secure and recently well-trodden ground.”

I think the environmental think tanks took it upon themselves to do some trojan work in this field. A lot of the work though has remained in academic publications of those environmental think tanks, and it a resource not fully mined by our financial institutions. It should almost be mandatory at this stage, the environmental think tanks we have in Ireland are asked to provide some form of training and induction to our financial institutions. It gets back basically to my same point on Douglas McGregor and the knowlegde based economy.

I tried to outline some of the silly-iness involved with a typical environmental think tank here:


We simply cannot afford to go on wasting this good research, and replicating the same study over and over again, by different sectors of the economy – but only seeing stuff from a certain point of view. I hope even the Irish economy website has in some small way began to soften the edges between the different fields. I am all for that.

“The data that is most relevant for private financiers is often not the best adapted to the concerns of preserving financial stability. Let me mention two aspects as examples.”

Very astute observation I would say. Nicely put.

I note that Patrick Honohan includes bank resolution laws in his to-do list. The UK passed one earlier this year. Would have helped on September 30th. 2008, but in fairness we were not alone in not having one. The US did not have one for broker-dealers – had to rescue Bear Sterns via a commercial bank (J P Morgan) and maybe let Lehman go partly because of the lack of staturory basis for intervention. Do we still cog UK Acts?

“Market data does not tell all
For financial stability, the future is all that matters.”

I normally benefit from reading Pat McArdle’s Irish Times column on economics. His piece ‘The minister did what he had to do’ included in Thursday’s Irish Times budget supplement included. McArdle’s article suggested that in 2008, the debt service bill per capita was €370, but in 2010 it will rise to €1,035.

Now looking at that sentence (sorry, the Irish Times website doesn’t have a link) you are inclinded to think that matters were rosy in the garden in 2008. We still looked to have a very manageable situation on our hands. But anyone who lived in Ireland knew that things were wrong, terribly wrong, in 2008.

In fact, most of us (if we were able to admit to ourselves) knew things were in trouble for quite some time. I disagree with this argument about the ‘sudden-ness’ of events. Dick Ahlstrom’s article about flooding in Cork provides a very useful input into the discussion about flood management.


I have been suspicious myself for quite some time. The existence of the financial crisis provides everyone with an excuse today, not to discuss some of the more dark, difficult aspects of our society and our economy. It is hard now to delve back into areas, to do with Ireland’s economy before the crisis. The Crisis seems to over-shadow everything now.

But this is not useful in terms of preventing re-occurance. To prevent re-occurance we have to put ourselves back in the shoes of a person who is living in better times, with nothing only blue skies visible ahead. This is why I use the example of Pat McArdles comments on the budget. Too much economic commentary these days, tries to paint a Mona Lisa of Ireland in 2008.

Of this ‘innocent’ maiden who was dutifully going about her business, when she was so un-fairly ambushed by some wayward band of crooks, theives and robbers. It almost sounds like Joseph Stalin, the kind of story he would invent to explain away the problems in the Russian system so many years ago.

Reading the commentary of otherwise expert analytical experts like Pat McArdle, people much more knowledgeable than I, I am painfully aware of difficulties they have in setting back their clocks, to January 2008 as it were. To pretend this ‘end of 2008’ drama never happened, and look at Ireland’s economy in a cool, calm and analytical way. It requires the skill of a real detective, who has to ignore the crime scene (the fact he is stepping over bodies etc) and try to re-create in his mind the situation before the events.

In other words, the bodies of property developers now deceased and so forth, have to be temporarily brought back to life in order to re-create the scene. In a discovery channel documentary on the JFK assasination, one investigator made a very astute observation. In order to study the scene of the crime, one has to forget about what is actually going on. Because if one didn’t, you would have to stop and think about its implications for society and the world in general. Hence, one would not be able to do one’s investigation.

Ending on that note – in a week packed with reports of departing senior bankers – what ever happened to that notion of an investigation in Irish banking. We are not even passing on a miserable few grainy frames of amateur film footage to future generations to look at. No Zapruder film.

@ colm mccarthy

Don’t worry Colm, we will soon be “seizing” the banks according to our minister for finance, but not before our profligate government has pumped billions into them. Mr. Stiglitz called nationalisation of banks “pre-privatization” which is a kinder way of looking at the process.

I realise, what you are referring to is a piece of legislation which would proceed nationalization in that, that the government would through its regulatory and fiscal audits decide that a bank or financial institution was heading towards insolvency and should be pro-actively seized by government authorities under “the Act”. If this legislation had been in place, Anglo and others could have been seized and re-structured or wound down, whichever was most appropriate under the circumstances. It would have demonstrated a degree of control rather than reacting with ill thought out, spur of the moment guarantees.

The fact that the government have guaranteed every bank in Ireland as being systemic is, in my view, the cause of our governments inaction on this front. It just shows how crazy the blanket guarantee was.

The systemic risk is actually in our political institutions. They hide what we need to know and lie about what has happened. Honohan’s qualities do not matter much as he will find out. Resignation is highly likely if he has integrity. If not, he will concentrate on theory and planning but not police the operations. Mind you, what lending will the banks engage in now? None! So perhaps he has a chance to educate a core of enforcers?

@colm mccarthy: do we cog mere acts? it goes further than that, we cog whole frameworks! 🙂

anyway, stress testing existed before the crisis, the downfall is that they rely upon the ‘test’, to give it any meaning you have to plug in potential scenarios, but if the scenarios you work with don’t reflect what happens then it becomes meaningless. For instance a test might show that if prices fell 20% that a bank would be o.k. but what if if they fell 40%? we don’t actually know what would happen because beyond a certain point there is the land in which tests don’t count, hypothetically at a 30% price drop the dynamic could change entirely (or at any point given that what we are testing is dynamic).

There seems to be this push toward finding a way to eradicate risk, but once you do that it naturally spawns reckless behavior, or at least sets the scene for it. We can’t and won’t be getting rid of risk any time soon. The thing that should be focused upon perhaps is to change the code of practice so that any liability or potential liability has a capital backing solely connected to it (not pooled). this would actually help to contain balance sheets as well via a natural self constrained market model because it would tie up money when any instrument is created and sold.

I know in the ‘health and safety’ legislation Ireland in fact added an additional piece of its own. To my knowledge, what happened was Ireland was going through some tremendous amount of work to get legislation together and get it published. The problem was, there was a parallel debate going on in the Europe parliment level. A debate which was dragging on. So someone in Ireland decided to make a judgement call, and said look, the Europeans appear to be going in this direction. Lets pre-empt their decision and introduce our legislation (with the additional wording) before the Europeans pass theirs.

As it turns out, the upshot was that the Europeans did not add the additional wording. Basically, in health and safety legislation today, Ireland has a much more difficult kind of interpretation. It spreads the liability much wider than the European legislation does. So much for trying to balance things up between member states.

The point I am making is similar to the point I made above.


That a sequence always has to play out when dealing with policy making. The order in which stuff happens may be even more important that what actually happens – in terms of deciding real outcomes. To that extent, I would much rather have bad policy introduced in the correct order, instead of good policy in the wrong. We obsess in Ireland over making the best policies, but fail to observe that the sequence in which one goes about the business is at least, as important.

“NAMA is a bargain – only 30% of Germany’s WW1 War Reparations!”

I had perhaps unrealistic expectations of Mr. Honohan. I had thought he would be the Eliot Ness of Irish banking. But I just can’t imagine Eliot Ness saying the following:

“I am not in the business of looking into old files to see what went wrong, but I can say that, while there may be institutions thinking of moving in search of lighter regulation, there is no point in them moving to Dublin, because they won’t find it here.”

Will even that prove to be the case?

“Both Mr Elderfield and his boss Prof Honohan now face a balancing act; they must show the world that what happened in Anglo Irish Bank is not typical of how the Irish financial services sector works and crack down on lax practices at domestic banks.

They must also keep the hedge funds, investment funds and foreign insurance companies based in the International Financial Services Centre in Dublin happy.”


Is this twin track approach dooming us to another catastrophic failure?
Surely a regulatory house divided against itself must fall?

Of course, to wrap this up very nicely and include ‘economics’ back into the mix, take a read of Kevin O’Rourke’s comment here:


The major problem with the environmental think tank – it thinks it will not be listened to in Ireland anyhow – so we might as well plough ahead and get whatever we can get introduced. But all of this effort and desperation to publish, to pass, at all costs takes away from the primary rule of good policy making. To get the sequence in the right order.

The following was written by Joseph Stiglitz:

Managing change is extraordinarily difficult. It is clear that rushing into major reforms does not work. Shock therapy failed in Russia. China’s Great Leap Forward in the 1960s was a catastrophe. What matters, of course, is not just the pace of change but the sequencing of reforms.

Privatization was done in Russia before adequate systems of collecting taxes and regulating newly privatized enterprises were put in place. Liberalizing the free flow of foreign exchange before the banking system was strengthened turned out to be a disaster in Indonesia and Thailand.

Educating people but not having jobs for them is a recipe for disaffection and instability, not for growth. Balance is also important: allowing urban-rural income differences to grow is another prescription for trouble.

Many of the development strategies that were not well implemented failed because they were based on a flawed vision of development. Successful countries have a broader vision of what develpoment entrails and a more comprehensive strategy for brining it about.

Sensitive to concerns such as those just described, they were better at implementing change.

@Brian O’Hanlon
“Ending on that note – in a week packed with reports of departing senior bankers – what ever happened to that notion of an investigation in Irish banking. We are not even passing on a miserable few grainy frames of amateur film footage to future generations to look at. No Zapruder film.”

As with clerical abuse only low level wrong doers are ever punished in Ireland. Systematic wrong doing is reflexively covered up: by the organisations that do it, by the institutions charged with policing them, by the civil servants in central government and by the politicians to whom they are accountable.

For protecting the reputation of the church read protecting the reputation of Irish banking and the Irish state. In the national interest wrong doing must not be revealed – they’re acting in the public’s interest, you understand.

Thanks for that response, I hadn’t thought of it like that. I am hoping to ‘coach’ the people here, if possible to think less along the dimension of what we do and more along the dimension of ‘how’ we do it.

The ‘how’ is more important than the ‘what’. I am sure that all victims in all departments will understand that. What I mean is that if we can do something, even modestly and within our means and capability – and go about that in a quiet, honest and professional manner – then some good will come out of it.

What I mean is, future generations will look at us and say, you know those guys really did pass on some good lessons to the next generation, even if it was too late to save themselves. What future generations will NOT thank us for, is if we go about making big, loud, brash statements and fail to deliver anything.

I had intended to do a short piece about stress testing in relation to a real world item like a mechanical wind turbine. There is some really interesting work going on in that field today.

Unfortunately, I didn’t get around to it. But I will blog it some time and link at IE in the future.

Comments are closed.