“trouble is, excessively cheap credit fuels ‘growth’ in the form of, for example, buildings nobody wants. What was the true rate of growth over, say, 2001 to 2007 with the buildings that were constructed valued at today’s prices? Some ‘growth’ came in the form of retail employment that cannot be afforded now, and over-payment for public service activities which go into the macro numbers at cost, not value.”

Reminds me of some thing I read from a wise old sage.

“Markets have inherent and well-known inefficiencies. One factor is failure to calculate the costs to those who do not participate in transactions. These ‘externalities’ can be huge. That is particularly true for financial institutions.

Their task is to take risks, calculating potential costs for themselves. But they do not take into account the consequences of their losses for the economy as a whole.

Hence the financial market ‘under prices risk’ and is ’systematically inefficient,’ as John Eatwell and Lance Taylor wrote a decade ago, warning of the extreme dangers of financial liberalization and reviewing the substantial costs already incurred – and also proposing solutions, which have been ignored.” - Noam Chomsky

sorry for the typo in your name

H’mmmmm. Narrative or rhetoric?

Interesting interview. Thanks for the link.

BTW - Bertie, being a good politician, left people to choose a range of options about how they could end their own lives. He probably thought that hanging was too good for them. Sigh, if only he would come back and save us (yes, I am being sarcastic).

“CMcC said that commercial lending and balance sheet expansion lies at the heart of Ireland’s problem. Lloyd Blankfein of Goldman Sachs goes further. He blames real estate lending decisions (and presumably absolves investment banks in large part) for the global crisis.”

There has always been this fight going on within Goldman Sachs culture between those who are traders and those who are leaning more towards investment banking. Ellis’s book which I talked about above, has a very interesting couple of chapters about Sydney Weinberg.

Malcolm Gladwell wrote a piece for The New Yorker a while back.

http://www.newyorker.com/reporting/2008/11/10/081110fa_fact_gladwell

There is 5 no. pages in the article, click ‘next’ at the bottom.

“The question is why did so few people in positions of authority comprehend what was happening in 2007 and earlier? In my opinion the key reason was psychological. As the Romans put it centuries ago, mundus vult decipi ergo decipiatur: the world wants to be deceived, therefore let it be deceived.”

Cormac, I think you would enjoy that PBS, Bill Moyers interview I referred to above.

http://video.pbs.org/video/1380851536/

“Eamonn Moran: trouble is, excessively cheap credit fuels ‘growth’ in the form of, for example, buildings nobody wants. What was the true rate of growth over, say, 2001 to 2007 with the buildings that were constructed valued at today’s prices? Some ‘growth’ came in the form of retail employment that cannot be afforded now, and over-payment for public service activities which go into the macro numbers at cost, not value.”

Good points made there about growth, cost and value. It is no harm at all to puncture that myth about Ireland’s growth in the said period.

In the United States, the concern seems to be, folks in ‘main street’ are often told, feel happy, the Dow Jones is doing well. When in fact, Dow Jones has little to do with ordinary folk, except when it collapses.

I suppose, Ireland, in the best American tradition developed its own personal version of the same narrative - perk up people, feel good about yourselves, everything is doing well.

Bill Moyers PBS interview (available at the website) with ‘Mother Jones’ journalists David Corn and Kevin Drum on money, politics and banks, most recently was informative to listen to.

What comes up in the interview, is how thoroughly that folk in the US have become accustomed to accepting the narrative, as it is given to them. Perhaps, in Ireland, a similar criticism could be made. Barring David McWilliams, the ‘grim reap-er’ and a few more, how many people were allowed question the myth?

Anyone who did was encouraged to hang themselves by the Taoiseach.

‘What was the true rate of growth over, say, 2001 to 2007 with the buildings that were constructed valued at today’s prices?’

Truth was a casualty in this war too. Employment, taxes and growth rates matters to politicians, SMEs and the public, but that is really not how big money is made. Our movers and shakers were fully focussed on getting the global tap opened up to the limit.

There was lots of employment and investment as a result, but it looks like the financial process became detached from the real economy. As the ‘big deal’ came to dominate everything, opportunities were explored for spinning off bigger and bigger chunks of it in cash. Creative thinking.

In the ‘Irish CDS’, risk was concealed by packaging it in green jersey, covering it politically, and ‘dispersing’ it over various banks with overlapping and ill-documented personal guarantees. Over the long term, wealth was transferred from those without capital to those with it. The former got immobile and illiquid property equity and the latter got highly mobile liquidity. The banking intermediaries, or more properly risk entrepreneurs, and their associates, got plenty of that too.

No one really anticipated how far this process would go, but it turns out that we have as much animal spirits as anyone. The current spirit here is resentful and rightly so. Maybe we are not talking hot money here, but it sure feels warm enough for an enquiry.

The bondholders must have known all along that bank insolvencies would ensue. It’s likely they were given some form of nod and wink state guarantee much earlier than 2008, but we can’t find that out for thirty years.

@ Colm also
‘The charge sheet is: excessive balance sheet expansion, loan concentration, bad lending decisions on poor security, and risky liability management. The regulators failed too, but AIB and BoI should not need regulation to stay solvent’

Globally, many CEOs have made personal fortunes from bankrupting their instituitions. The Green Jersey was a cover for a huge lowering of banking standards, in which long-established reputations were treated as tradeable or expendable. Anglo is simply the most egregious on view.

Its time we faced up to about our traditional waeknesses of croneysim and double standards. They are IMO the main obstacles to genuine economic development here. If this crisis teaches us to go back and learn the alphabet of corporate and social governance, (e.g. C for Conflict of interest, I for Insider, T for transparency, not to mention D for Common Decency), it will not have been a wasted experience.

@ Zhou
You are quite right in pointing out the failure of the professions to exercise independence. The move towards corporate working is giving rise to new and very significant governance issues for them. Slices of ‘equity’ are very tempting for professionals involved in dealmaking, but their tacit compliance can sanitise corporate piracy.

Such issues were certainly not confined to the property professionals, as lots of others were involved in processing the big deals. Some solicitors, for example failed to carry out title searches dilgently during the boom, if at all, and are now bring sued as a consequence. You will not that the relevant professional bodies are rather silent.

IN A MATURE, HEALTHY, DEMOCRACY, THE GOVERNMENT IS RESPONSIBLE FOR THE STATE OF OF THE COUNTRY.
THIS COUNTRY HAS HAD A MAN MADE DISASTER.
THEREFORE, THE GOVERNMENT IS RESPONSIBLE FOR THIS DISASTER.

THIS IS NOT A POLITICAL POINT. IT IS A STATEMENT OF FACT.

We need to start recognising this. Starting with yourself I fear.

I agree completely underpricing risk has been rife in the US and western europe all I am asking is will it not have a longterm effect on growth potential if we play by the rules from now on?

Can’t a large part of our growth over the last 10 years be contributed to cheap accessable credit?

As you say the guarantee has to be explicit. I understand the implications of the “we are where we are” scenario but maybe this 80% or so deposit guarantee should be a long-term goal and not just confined to an Irish context (EU-wide etc.). As you stated the moral hazard involved in 100% guarantees is dangerous and i think such guarantees encourage lazy decision-making and mask all manner of problems that just grow underneath.

Seeing as we’re talking long-term how about introducing a system whereby sound management by institutions could increase this guarantee to 100% and vice versa to 60% or 50% for the opposite with a 5% incremental change in this occurring annually based on performance within preset criteria? This might begin to separate the Anglos from the BOIs. Decisions on limits to amounts and timing of withdrawals and yield rates could be made by the relevant experts and some type of Tobin-tax equivalent could be applied for particular types of withdrawals as a small penalty for large corporate deposits that are sloshing around the system and may encourage increased inertia (@yoganmahew).

Could a similar approach apply to the future guarantees of bondholders?

When it goes wrong, as in Iceland, accounts are frozen overnight and are thawed out over two years with a nasty c. -75% shock at the end.

http://www.fcic.gov/hearings/pdfs/2010-0113-Blankfein.pdf

Lloyd Blankfein:
“As the Commission appears to indicate through its lending-related questions, almost all of the losses that financial institutions sustained over the course of the financial crisis thus far have revolved around bad lending practices, particularly in real estate. According to Goldman Sachs Research, the vast majority of the losses can be traced to bad credit decisions in general, and most of those can be traced back to bad real estate loans. While positions in securities like CDOs and in derivatives, such as CDS, led to losses, these instruments embedded and leveraged what were essentially credit risks emanating from lending decisions, not trading decisions.”

One wonders how many clients advise by Goldman sachs loaned money into the banks making these bad lending institutions…

“I am not sure it is correct to confine criticism to the regulatory failure alone. The bank boards and management failed too, and have not even commenced to explain what happened.”

I think it is clear that the boards simply did not comprehend what was happening. How else can one explain, then AIB chairman, Dermot Gleeson’s decision to invest €3m of his own money in AIB shares, right at the top of the market, in the summer of 2007?

The question is why did so few people in positions of authority comprehend what was happening in 2007 and earlier? In my opinion the key reason was psychological. As the Romans put it centuries ago, mundus vult decipi ergo decipiatur: the world wants to be deceived, therefore let it be deceived.

“The organisers of the 50th Eucharistic Congress in Dublin in 2012 are seeking commercial sponsors after just €500,000 was raised from a national church collection.

Revelations in last year’s Ryan and Murphy reports about the church’s record on child abuse have rebounded on preparations for the biggest international pilgrimage in the Catholic calendar….

….Fr Kevin Doran, who has been appointed by Diarmuid Martin, the archbishop of Dublin, as general secretary of the event….

Asked if he expects the state to cover some of the costs involved this time, Doran said: “I would certainly say things are not going to be all one way. “If it is successful, clearly it will bring large numbers of people into the city in terms of nights in hotels, dinners in restaurants and cappuccinos in cafes. Hopefully, there will be a spin-off for the economy.”

A government spokesman said: “It’s too early yet for any commitments to have been made but it’s very likely the state will play its part.”

http://www.timesonline.co.uk/tol/news/world/ireland/article6982536.ece

“The regulators failed too, but AIB and BoI should not need regulation to stay solvent.”

Good diagnosis, no more than the heart muscle should require assistance to keep itself pumping.

David McWilliams is right. A lot of it is not complicated, more like first year economics should-know stuff - that is, had I even attended first year economics.

Tim Morrissey: Given what has happened, I guess we are stuck with 100% deposit guarantees for retail banks for the foreseeable future. What alternative exit strategy is practical? But best make it explicit and charge for it. Implies tight regulation (no prop trading, for example) and the moral hazard implications are scary.

Eamonn Moran: If banks are to distribute credit efficiently, they must charge adequate risk-adjusted margins. Margins may have gone too low.

An article I can recommend, is Cliff Taylor’s SBP article from last Sunday, Getting the Big Picture. He looks carefully at the situation now, in the cycle relative to where Ireland was 12 months ago. It is an interesting and useful approach to take with an article, and I enjoyed reading it this morning.

http://www.sbpost.ie/newsfeatures/getting-the-big-picture-46662.html

Paul Hunt
“Big margins will be needed to attract private equity and this will do even more damage to the productive economy.”

Underpricing risk, encourages risk which leads to growth.

Will it not be the case that risk insurance and larger margin requirements lead to a long term growth ristrictions for the economy?

The banks are going to be restricting growth in the medium term anyway
to get their balance sheets in order. If you guys are suggesting different ways of ensuring fair pricing for risk I for one would welcome it but surely these ideas always come up at this point in the cycle but are shelved once the economy starts growing again.
Am I being too Cynical?

“Another matter which needs to be looked at is systemic borrowers. We cannot again have a situation where an Irish Bank cannot take control of a borrower’s assets because it would cause huge losses for other banks. We need to limit borrowers and groups of companies to one lender or another.”

I am delighted you have brought up that point Zhou. I could not agree more with you. Taking Liam Carroll as an instance - his borrowings were diversified between various types of assets, stock market takeovers, land assets interests etc. But of course, the problem as you correctly interpreted, is the fact that so many other lenders were affected immediately if only 1 no. lender moved in. This game of chicken went on between borrower and lender(s) for far too long. Who the heck knows how much good money was thrown after bad. If not for the ‘crisis’ of September 2008, how much worse could it have become? I have already mentioned before at IE blog, that ACC bank were competing aggressively in 2007 to begin opening credit lines to Liam Carroll’s companies.

In one of the early chapters of Charles D. Ellis’s book The Partnership, the making of Goldman Sachs is a historical account of Waddill Catchings and his Goldman Sachs Trading Corporation - the one behind Shenandoah and Blue Ridge investment trusts, which collapsed after the 1929 Wall Street Crash. As I read through Ellis’s excellent historical accounts, I kept getting ‘flash-backs’ of the 2009 Liam Carroll court cases. Indeed, I wondered if the high court and supreme court judges had borrowed some of their vocabulary from that very book.

very useful and insightful points raised above. Well done all, as per usual. I will insert one quick comment if I may. Obviously what Colm McCarthy describes is a procedure to improve the long term health and chances of the Irish economy. The discussion here has all been very well informed by the economist’s point of view.

However, pretend for a moment that you are not economists, but are all standing around the patients bed performing a differential diagnosis. If Gregory House M.D. was standing here now, he would be reluctant to proceed without an informed and substantial patient history. Any course of treatment would be depend on this basic component. Gregory House M.D. would be sending his team in through back windows of organisations, and going through underwear drawers to find out what the patient (and extended family) finds it easier to lie about. In the timeless words of Gregory House, everybody lies.

I am reminded of a quote from Shane Ross’s brilliant book The Bankers. Where he compared the approaches of BOI and AIB bank. BOI would knock politely at the front door of their prospective client. AIB would be breaking in the bank window with a crow bar.

We unwisely allowed our state and leading professions to be dominated by monopolies and private vested interests. The individuals concerned cashed out, via the financial service sector, because we looked up to them and trusted them not to. They did it anyway. That’s human nature. There are no Higher Persons.

Now we are stuck with a moribund economy. Of course, we are not the only ones to have fallen for the various Ponzi schemes.

Colm states:

‘Given the scale of the risk-to-the-fisc, commercial banking is an industry in which small European countries should plan to punch below their weight. Shame the Irish banks were’nt bought out in a European consolidation!’

Banking takeovers were always inevitable here, but the local players held onto the steering wheel as long as the going was good. The eventual takeover terms, if there are any, are now going to be disastrous for the fisc and the real economy.

This was not simply a problem of regulatory failure in a single sector, or old-fashioned links between builders and politicians. Our problem of political governance extends into the heart of the state and its institutions. A banking enquiry could not fail to reveal its systemic nature.

We are no longer afraid to investigate the Church, but our economic collapse is still as mysterious to the citizens as Swine Flu. It seems things have to get much worse before we will ask the hard questions.

Meanwhile, our younger folk have been reared on a diet of slick Anglo-American culture and ‘free market’ individualism. There is an upside to that, but the downside has arrived. And then some.

Absent any meaningful process of institutional accountability and social solidarity, is it likely that the brightest and the best will stick around to pay the bill for our Green Jerseys ?

@ Pat Donnelly
We have had the Great Moderation, and the End of History. Or so they said.
Like the pitchfork, the C word has been out of fashion for a while, but I’d say your instincts are sound.

But observation is instructive in terms of behaviour (i.e. what do people do, rather than say).

I suspect there is no way to offer less than 100% below a certain limit. The reason being that whatever you set it at, when push comes to shove, people will neglect the benefits they get from higher yield, want to skip out from the restrictions and get 100% back. The politically acceptable old ladies and cripples will be pushed to the front to make the case “sure nobody believed that this could happen, we’re not financial experts”. And, largely speaking, they would be right. Deposits already pay DIRT on the small gains they make. Is DIRT ringfenced as deposit protection money? (The point being that the government is happy to tax and regulate, but not be responsible?).

So we are back to limits and costs. What should the limit be pegged at? What should be the cost of the deposit guarantee? Who should pay? Who should be covered? Should there be a large deposit guarantee too? (Since the slosh of large corporate deposits was deeply destabilising, a very private run…).

I take your points and am far from being an expert.

I don’t think a 0% guarantee is politically acceptable in practice though and for any figure other than 100% is there some way to mitigate the effects you suggested will happen e.g. restrictions on timing of withdrawals and amounts allowed, more attractive higher yield than fully guaranteed deposits etc.?

The people who queued for their savings from Northern Rock largely stood to lost at most 10%, many even nothing. But at the level of deposit rates, why would you risk losing anything at all? At the first sign of trouble, you would move your money to safety.

This would have multiple bad effects:
- runs on banks
- a shorting of deposit terms
- more expensive deposits?

How about 80%? - high enough not to lead to widespread distress in the case of a bank collapsing but low enough to make people carefully consider where they are putting their money.

I know of people in Iceland who have lost in the region of 75% of their retirement savings in bank deposits which is devastating and this needs to be avoided at all costs. Having 0% guaranteed deposits available with higher yields will not help the many thousands of customers who do not understand the financial risks involved and if and when a bank goes under there would be a lot of very angry people (largely pensioners) outside the dail demanding action.

Your forward-looking post is very welcome. Hopefully it will encourage some focus on the looming challenges. (Btw, does this indicate that you have eased off on your demand for a banking inquiry? I think for most people the diagnosis in your post is more than enough. In any event, the Government seems determined to kick an inquiry into the long grass - and even if it is compelled to establish one its TOR will ensure there will be no examination of its (or its predecessors’) culpability.)

For me, and I suspect for other, the outlook is depressing. “Shifting existing assets off bank balance sheets through market transactions would complement NAMA, and help to avoid adjustment through an excessive restraint on, for example, working capital lending to private business” as you suggest is likely to increase the recap required - i.e., on top of the recap generated by the transfer to NAMA. Given the current fiscal capacity, this is probably more pressing than excessive tax-funded guarantees to bond-holders and depositors.

Big margins will be needed to attract private equity and this will do even more damage to the productive economy.

Could you comment on whether any complementary legal or institutional provisions would be necessary to prevent bond defaults from collapsing domestic banking services, or from triggering hard-to-finance calls on the Government deposit guarantee?