Sigrún Davíðsdóttir's Icelog

After blogging on the ‘good borrower’ Patrick McKillen I’ve become aware of the two Irish reports on the banking crisis done at the behest of Irish minister of finance – and have been asked if these two reports are compareable to the Icelandic report by the Althingi Special Investigative Commisson. The short answer is: no, not at all.

Size is an indicator: the printed version of the SIC report is 2600 pages, the longer online version is around 3000 pages. A Preliminary Report on The Sources of Ireland’s Banking Crisis by Klaus Regling and Max Watson is 49 pages. The Irish Banking Crisis; Regulatory and Financial Stability Policy 2003-2008 by the Irish Central Bank Governor Patrick Honohan is 177 pages. Unfortunately, the SIC report hasn’t been translated but the overview and a few chapters are. Have a look here. Another excellent report is Anton Valukas report on Lehman.

The two Irish reports are excellent overviews, not deep-digging analysis but there is more to come. The Irish Government is now having yet another stab at investigating the banks. A commission led by Peter Nyberg, a Finnish government official, will examine governance and risk management in each of the banks covered by the Government’s guarantee from January 2003-January 2009.

The SIC report is based on documents otherwise protected by banking secrecy, interviews with bankers, civil servants, politicians, academics, journalists. It opens doors that have never been opened before, noticeably into the banks but also into official organisations. And most important of all: it lays bare how the banks operated, how much they lent to their major shareholders and how the web of holding companies and companies was used to draw money from the banks, publicly listed companies.

The Regling-Watson report is an excellent overview over just what that title says: the sources of the Irish banking crisis, very much focused on the macroeconomic aspects, concluding that it was a home-made crisis. ‘The report analyses developments in global, European, and Irish financial markets over the past decade. It considers the influence of macroeconomic policies and conditions; deepening financial integration; bank management and governance; banking regulation and supervision; domestic financial stability reporting; and external surveillance of the economy. It seeks to put in perspective the role of both policy and market factors in triggering the crisis.’

As stated in the report it’s ‘not built up from the analysis of large numbers of internal documents’ but taps ‘widely the assessments of both domestic and international experts, conducting interviews with them on an informal and non-attributable basis.’ Most importantly, compared to the Icelandic report, it’s ‘not drawn on documents protected by banking secrecy.’

Honohan’s  mission was to investigate ‘the performance of the respective functions of the Central Bank and Financial Regulator over the period from the establishment of the Financial Regulator to the end of September 2008.’ The aspects it deals with are: ‘crisis prevention, in the years before 2008, and crisis containment after the onset of the global liquidity crisis in August 2007.’ The report seeks to answer two questions: ‘1. Why was the danger from the emerging imbalances in the financial system that led to the crisis not identified more clearly and earlier and headed-off through decisive measures?’ 2. ‘When the crisis began to break, were the best containment measures adopted?’ Both questions are answered with the focus on the actions of the Central Bank and the Financial Regulator.

The prerequisite for choosing members of the SIC was to find people entirely independent of all the organisations SIC had to scrutinize. Its members were a High Court judge, the Althingi Ombudsman and a lecturer in economics at Yale University. All in all 46 experts worked on the report under the auspices of the commission.

Although Honohan only became Governor of the Central Bank in September 2009 it would be asking too much of him to conduct a poking and prodding investigation and analysis of the organistation he is now leading. An independent scrutiniser might have been sharper. There are plenty of somewhat hesitating conclusions such as this one, on the complex structure created by the Act of 2003 for the Central Bank and the Financial Regulator: ‘Though few would now defend the institutional structure invented for the organisation (i.e. the CBFSAI) in 2003, it would be hard to show that its complexity materially contributed to the major failures that occurred.’

Another example of the same mental limpness: ‘First, should policy makers have had a greater sense that Anglo was facing not only a liquidity, but also a potential solvency problem? The answer is probably yes. Second, would nationalisation of Anglo on 30 September – compared with its nationalisation five months later – have made a significant difference to the overall cost of the bank bail out to the taxpayer? Here the answer is – probably not.’ (Italics are mine). Probably, an independent inquirer might have been able to penetrate these issues and come up with a sharper answer. – And it would be extremely interesting to know what the banks were doing during the five months of grace they did indeed get.

When the Irish government issued a guarantee in September 2008 it was done to calm the market. The hope was that this was enough to save the banks. As the Honohan report points out it is ‘conceivable that, had international financial markets remained calm, the two main banks (AIB and Bank of Ireland) might have been able to manage their emerging loan-loss problems without Government assistance … But, given what has now been revealed about the quality of their loan portfolio … it seems clear that at that point Anglo Irish Bank and Irish Nationwide Building Society (INBS) were well on the road towards insolvency.’

Just as in Iceland, the root of the Irish crisis lies within the banks. Yes, regulators failed and politicians were naive but the banks were the instigators and the actors. Reckless lending, insufficient risk management no doubt – but in Iceland we know exactly, from the SIC report, who the clients were who benefited. We also have a clear view of the remuneration systems in the banks, maybe the most important element in understanding why the banks operated as they did. We know who got loans without necessary collaterals and no personal guarantees. In short: we know exactly how the banks operated and how their operations brought the country down.

As the Honohan report points out the Irish crisis wasn’t the fault of anyone except the respective banks. ‘Mortgage brokers and similar intermediaries, incentivised to generate mortgage business, probably played a part at the retail level. It may also be the case that auditors and accountants should have been more alert to weaknesses in the banks‘ lending and financial position. While these aspects have not been independently researched for this Report, they merit further investigation.’

Yes, indeed. The Icelandic report shows auditors and accountants to have failed in giving the clear and honest picture of the banks that they were required to. Liquidity was completely misrepresented. Glitnir’s Wind Up Board has now charged PwC, an auditor to Glitnir, for conspiring with managers and major shareholders to rob the bank of $2bn.

As a sign of the banks’ sound standing and that no one could have known what was coming the Honohan report points out: ‘… during the first nine months of 2008, Anglo paid out €0.14 billion in dividends, Bank of Ireland €0.39 billion, and AIB €0.72 billion – of which €0.27 billion was paid out as late as 26 September 2008, four days before the guarantee.’ Does that tell us that these banks were in a sound state – or that their accounts were done in a clever way?

One of the many valuable insights in the Icelandic report is the analysis of Icelandic financial policies over the last decade and consequently also of the policies of the Icelandic Central Bank during the decade up to the collapse of the banks. Iceland is a small and often cosy society. The SIC investigated the contacts between the business sphere and politics, i.a. donations to political parties. What about the contacts between politics and business in Ireland and the importance of these relations in creating a property bubble? Any unanswered questions there?

And as to the Irish banks saved by the Irish taxpayer: the reports give little reassurance as to how they were run. The Honohan report points out that ‘Even executive directors of Anglo Irish Bank seem to have had no inkling of the problems to come if we are to judge from the fact that three of them acquired and held sizeable blocks of shares in the Bank close to the peak of its share price in 2007.’

With an insight into the Icelandic banks I wouldn’t draw the same conclusion as the Honohan report unless after an in depth investigation. In Iceland, the shareholding of senior managers in the banks was widespread but far from being a sign of their faith in the banks they ran it has emerged that there were irregularities involved. They got loans from the banks to buy the shares, often with only the shares as collaterals and little or no personal guarantee. Or the managers’ limited liability companies owned the shares and the companies then just sank with the debt when the shares became worthless leaving the owners financially unscathed. Indeed, the banks lent so copiously against their own shares that their own capital eroded – and this also meant they couldn’t do margin calls against these loans. And this share parking is now also being investigated as market manipulation. Is there any investigation showing whether any of this was going on in the Irish banks?

Apart from being surprised by the Nobel prize winner’s somewhat uncritical support to McKillen’s crusade against NAMA my point with the blog on the ‘good borrower’ was that there are similarities between irregular lending by the Irish and the Icelandic banks. I find it very difficult to believe that Anglo Irish’ loan to the ‘golden circle’ of ten businessmen to buy shares from a shareholder who obviously couldn’t find a buyer on the market was a singular event. And that it was entirely proper. Again, with my Icelandic experience I wonder if this really is the only such arrangement – or is this just the only loan that has surfaced?

If a report like the Icelandic report had been done in Iceland the Irish would know who all ten in the ‘golden circle’ were. They would also know if all ten had had their loans written off like Patrick McKillen. They would know who were the biggest debtors, the terms of their loans.

The managers of the banks that the Irish state had to bail out end of January last year will have known it for some time what was coming. Can the Irish be sure that the managers acted in the interest of all shareholders or was there a bias serving the major shareholders and big clients?

According to the Honohan report ‘after the banks have sold their largest property-related exposures to the State‘s asset purchase vehicle, NAMA … and after they have made provision for all of their other prospective loan-losses the State will have taken sizeable equity stakes in most of the banks, and issued some €40 billion or more in Government-guaranteed NAMA bonds …The State will also have had to write-off in the order of €25 billion in unrecoverable capital injections into two institutions – Anglo Irish Bank and INBS – whose prospective loan losses greatly exceed their initial accounting capital … Apart from the experience of Iceland, this has turned out to have been the poorest performance of any banking system during the current global downturn.’ Most people can agree that €65 billion is a lot of money. The Irish must be adamant that this money is used to get the banks up and running to serve society, not to bury their old sins.

Icelanders weren’t happy that a group of investors and bank managers ran the country’s economy to the ground. The SIC report was written to clarify what really happened, what politicians knew and why they didn’t react, what the regulatory authorities did and didn’t do and how the Icelandic National Bank handled its role. But in Iceland, like in Ireland, the banks bear the greatest responsibility. Icelanders now have a pretty clear idea of what happened in the banks. Perhaps the Irish can say the same when the Nyberg report comes out but the reports produced so far are far from telling the whole story of the Irish crisis.

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