Recommended: Patrick Honahan on the Irish Banking Crisis
12 August, 2009
For a balanced and informative overview of the Irish banking crisis, I recommend “Resolving Ireland’s Banking Crisis” by Patrick Honahan in The Economic and Social Review, Vol. 40, No. 2, Summer, 2009, which is available online here.
Described as a “Policy Paper”, it is written in a calm, dispassionate manner; however, if one deconstructs the understated and analytical prose, one is left in no doubt that we taxpayers are victims of a massive failure by our highly-paid regulators to do their job properly.
It is worth reading all of it (and it is no hardship to do so), but here are a few quotes which I think are worth highlighting.
Although international pressures contributed to the timing, intensity and depth of the Irish banking crisis, the underlying cause of the problem was domestic and classic: too much mortgage lending (financed by heavy foreign borrowing by the banks) into an unsustainable housing price and construction boom…..
How could traditionally conservative banks – some of them with a 200-year history – have been so careless as to leave themselves exposed in such a conspicuous and obvious property bubble? ….
Banks …. began to increase the share of their assets in property-related lending from less than 40 per cent before 2002 to over 60 per cent by 2006…..
According to the 2006 census of population, some 15 per cent of the housing stock was vacant at census date, mostly reflecting speculative purchasing of additional housing by prosperous households (less than 3 percentage points of that being holiday homes)……
…..a renewed acceleration of house prices from 2003 was also fuelled by a reversal of earlier tax tightening, reinforcing Ireland’s tax bias towards construction……
…..banks had not been the main players in the residential mortgage market until the late 1980s: before then, fiscal privileges ensured that building societies held the lion’s share of that business. Thus the banks were not steeped in the deeply ingrained suspicion of the mortgage market as a source of systemic difficulties that now prevails in, for example, Japanese banks……
A very simple warning sign used by most regulators to identify a bank exposed to increased risk is rapid balance sheet growth. An annual real growth rate of 20 per cent is often taken as the trigger. Each of the locally-controlled banks had at least one year in which this threshold was triggered. One of them, Anglo Irish Bank, crossed it in eight of nine years, and indeed its average annual rate of growth 1998-2007 was 36 per cent….. this was a very obvious and public danger sign not only for these two banks, but because of the potentially destabilising effect of reckless competition on the entire sector (Honohan, 1997). The rapid growth in the market share of Anglo Irish (from 3 to 18 per cent of the total assets of the six locally-controlled institutions that subsequently received the Government guarantee) was certainly an important influence inducing the other banks to relax lending terms to avoid losing even more market share……
It might be thought that nationalising the banks on a semi-permanent basis and requiring them to pursue government objectives instead of profit would ensure an increased flow of lending enhancing the public good. But the evidence from around the world is that private for-profit banking systems have, in normal times, contributed more to growth (and poverty reduction) than government-controlled ones. The latter, responding to political pressures, tend to keep large but faltering borrowers afloat for much longer than is healthy for the economy as a whole (cf. World Bank, 2001, 2008, for reviews of the evidence). So, even for banks over which it acquires a controlling stake, I would not be advocating close administrative direction over lending policies. Government may wish to shape the overall strategy for its banks, but should remain at arms length from lending policy…….
….the danger of regulatory over-reaction must be present, and there is insufficient evidence in the public domain as to the current stance of regulatory policy. Reforms to incentive structures for management would of course be good. But much of the current global rethinking of regulatory design will not necessarily be particularly relevant to the Irish scene: the Irish problems relate to a very old-fashioned credit boom and not to financial innovation. The failure was one of insufficient scepticism on the part of the Regulator.