To succeed, banking enquiry must face brutal facts

As 2009 draws to a close, the demand for a public enquiry into what went so badly wrong with Irish banking is rising. To be of any benefit a Banking Enquiry should surface the brutal facts. It should look to appreciate not only what went wrong with banking but should also address how banking, business and political interests conspired to create an unsustainable credit fuelled consumption boom.


With the dust of the international credit crisis blown away, it is abundantly certain Ireland’s problems were entirely home grown. Banks have come up with novel ways of losing money – the most recent being toxic sub-prime bonds. But Irish banks lost money in the old fashioned way - by making bad loans to people who ought never to have been given them.


There would have been no market for overpriced houses had banks not wilfully engaged in the most destructive bouts of credit creation from 2003 on. A confluence of builders, bankers and politicians interests, allied to weak central bank and regulatory supervision, meant that a small group of rogue bankers who controlled Anglo Irish Bank had a disproportionate effect on property values. The explosion in Anglo’s lending should have set off alarm bells instead of pressurising others to follow suit. Once AIB decided it wanted a greater slice of the action, the dye was cast for Banking’s destruction of the entire economy.


Professor Morgan Kelly’s argument that property prices were driven upwards by bank credit is compelling because it is brutally true. Lulled into believing in a never ending boom in asset prices, high economic growth rates and a bountiful supply of external money, bankers relaxed their lending standards promising a house for everyone who wanted one. At the height of their lending frenzy, they advanced billions in 100% mortgages for terms of over 30 years and lent billions more too amateur property investors who knew nothing of the risks they were being exposed to. Bank relationship managers were spectacularly effective sellers of the leveraged wealth creating property loan. The heady mix of credit, cement and concrete blocks, drove employment, incomes, government tax revenues and spending to unsustainable levels. By 2008 construction activity accounted for nearly one quarter of national income.


When the credit bubble burst, banks were left with three insurmountable problems. The first was the scale of speculative property lending, the second an enormous dependence on wholesale funding from abroad and the third the sheer size of mortgage credit on their balance sheets.


All Government achieved last year, through NAMA, was to try to deal with speculative property lending. But speculators can only pay back what they can afford. If as suspected, Governments assumptions on future property prices are overly optimistic, NAMA will cost the taxpayers tens of billions in years to come. While it may have stabilised a sick patient, Irish banks remain terminally ill.


Buying into Banking’s wealth creation doctrine, Ireland’s business classes borrowed billions to invest in overpriced property. Consequently many fine small and medium sized businesses are now drowning under the weight of debt they can no longer afford. Banks business bad debts will get far worse as households tighten their belts and consumption inevitably declines further next year. At the same time household mortgage defaults are escalating alarmingly.


Irish banks business model is frighteningly dependent on an abundant supply of cheap overseas funding which has now all but dried up. Propped up by the ECB, banks must shrink their balance sheets or expire. This means they must rapidly shrink their lending. New credit will be more expensive and credit supply will adjust back to 90’s levels, when banks were predominantly funded by retail deposits – ordinary people’s savings. The reduced supply of bank credit will depress property prices for years to come.


The simple fact is had there not been an abundant supply of credit there would not have been a property boom. But for every loan that ought not to have been made there was a borrower who ought not to have borrowed.


In the latter stages of the 20th century, deregulation of banking, an abundance of international liquidity and financial innovation made credit available to the masses on an unprecedented scale. In the past decade Irish consumer’s once prudent attitude and behavioural use of credit fundamentally and dangerously shifted ground. Rising incomes, reducing taxation rates, low interest rates led to a consumer spending boom. And as incomes couldn’t keep pace with spending bank debt was used to plug the gap. Overly optimistic and turning a blind eye to risks of over-borrowing, far too many households acted to plug a rising gap between income and spending by using bank credit – spectacularly so in buying overpriced houses. And as mortgage debt rose, so too did non-mortgage debt. Today households owe about €150bn with most of the loans represented by long term mortgages taken out after 2003.


Political populism wilfully fuelled rampant consumerism, raising people’s income and life style expectations whilst at the same time making people more responsible for their own financial security. Government promoted the notion of the responsible rational atomised citizen - a revenue generating economic consumption unit. Despite increasing income risks and with job security declining, many ordinary people were lulled into a false sense of financial security as double income households did not ask the question- what happens if I cannot work?


All the while central bankers and regulators ignored the dangerous explosion in bank credit and did nothing to control lending standards. The simple expediency of restricting mortgage lending would have meant there was no market for overpriced houses and the spectacularly destructive financing of property would not have occurred.


An enquiry into banking will succeed if it truly appreciates and surfaces the dangers inherent in uncontrolled bank lending and understands how people’s behavioural use of too much credit can be controlled for. It will succeed if the lessons of the credit boom are acted on and steps taken to ensure that banking can never again become the destructive force it became.

© Thomas Crosbie Media 2009.

Ireland needs a modern equitable system to save homeowners

If we are to come out of this crisis, it is not just banks that need a bailout, we also need a NAMA for homeowners, writes Bill Hobbs

21st December 2009

Never before in this states history, have so many owned so much and yet earned so little. Tens of thousands of households face a bleak New Year uncertain and fearful for their financial security. Though scant, publicly available data illustrates how unaffordable indebtedness is rapidly reaching crisis proportions for far too many households. Will 2010 see the development of a homeowner mortgage resolution system – a “Homeowners Nama”?

Over a quarter of a million households representing nearly three quarters of a million adults are struggling with debt. Next year household financial circumstances will deteriorate further as the costs of financing the dark side of a bust economic model hits home. Mortgage affordability once aggressively promoted by bankers, real estate agents, mortgage brokers and property cheerleaders has inevitably and dramatically collapsed.

When and if finally told the story of what went wrong with Irish banking will record a time when small influential groups of senior banking executives dominated their organisations and wilfully manipulated banking resources for personal gain. Had senior bankers acted out traditional banking core values there would have been no market for overpriced houses and property.

For almost a decade, Irish banks have been captive of senior executives whose values and behaviours differed radically from traditional banking values. The vast majority of bank employees are ordinary decent professionals whose shared values are rooted in prudent banking and its wise creation of credit. But they were led, managed and manipulated by a breed of executives who eschewed traditional values for differing values – those of greed, avarice and self-enrichment. Emboldened by illusions of omnipotence, they wilfully and recklessly took risks they should never have been permitted to take. Regulators and central bankers failed to appreciate a fundamental shift in values, as bank executives dangerously expanded bank lending. Political leadership, similarly emboldened by illusions of omnipotence, actively promoted a credit fuelled consumption boom and did nothing to stave off its inevitable bust.

Most people have experienced a permanent reduction in household income, some are facing long term joblessness, and all face a permanent reduction in the value of their homes. Through no fault of their own, many have boom time loans they can no longer afford. Homeowners are struggling to finance repayments on debt on overpriced homes they were encouraged to buy. They risk losing their homes as they can no longer afford to make repayments.

There is a dire need for a homeowner mortgage resolution scheme – a “Homeowners NAMA”. Existing distressed home mortgage arrangements merely offer a temporary bank friendly solution. Insisting banks forestall on repossessions, reflects outdated social, legal and economic thinking that demands financially distressed borrowers make good their obligations no matter how long it takes and unduly favours the legal rights of creditors. And favouring banking solutions that essentially force people live long term at near poverty levels, so that they can make repayments on mortgages they can no longer afford, is neither socially acceptable nor economically viable. Advanced societies have long recognised the need for debt resolution systems that equitably adjust the balance of powers and rights between creditors and debtors.

Currently some commentators are promoting notions of shared equity, where banks or the state might take an equity share in homes rather than expect loans to be repaid in full. Whilst attractive, such solutions do not deal with the span or continuum of options required. Any legislative approach to debt resolution should appreciate the scale of the problem, identify solutions and establish a process through which people arrange to manage their debt.

A regulated homeowner debt management system should identify solutions based on what people can afford to repay and schedule their debt accordingly. It is eminently possible to identify a range of options which would be made available depending on the homeowners’ financial circumstances and disposable income. For example debt resolution systems found elsewhere propose one method of managing unaffordable debt. Typically homeowners budget for living expenses and identify what’s left over to make loan repayments. They then enter agreements to pay a fixed amount, usually monthly, to their creditors who agree to freeze interest and accept the lower amounts. The process works as both lenders and borrowers stick to the agreement.

The starting point is of course a co-ordinated Government response. It could establish a task group to create a mortgage debt resolution system and empower it to take whatever action is required. This group should reflect the interests of those owed money and those who owe money. And it should deploy the principle that ordinary people cannot be expected to repay what they cannot afford, nor should they be forced to live a life in financial stress from debt, they have no hope of paying within a reasonable period of time.

The responsibility for causing the negative equity trap and billions owed on overpriced homes has to be borne by those who wilfully and negligently made credit available and ignored the risks they were running. Banks and their senior executives had the wherewithal to understand the risks taken but chose instead to engage in reckless lending.

Redressing the dominant supplier power of banks is an accepted principle in all debt resolution systems. The principle of shared costs is also present- where borrowers pay what they can and lenders are forced to accept lower repayments – and are forced to write off debt should borrowers stick to their agreement. It is a principle not yet recognised by Government although the Law Report Commission proposals on personal insolvency may result in an equitable system based on sharing economic costs and addressing the unequal power relationship between bankers and homeowners in trouble.

© Thomas Crosbie Media 2009.

Growing plague of Bullying in the Irish workplace

Growing Plague of Bullying in the Irish Workplace

In the current climate with many companies downsizing and cutting costs, bullying is likely to escalate, writes Bill Hobbs

Ireland’s toxic workplaces with their abusive behaviours are about to get a lot worse. And many more people may experience one of modern Irelands’ worst organisational attributes – bullying in the workplace.

Mary was once a senior, well respected and liked manager until she became the target of a bully. Within two years she went from being an outgoing, confident, personable, competent employee to a sullen, withdrawn, depressed individual who was shunned by her colleagues. Mary’s family suffered as she became increasingly irritable and short tempered at home. Losing all interest in her work and family life, she dreaded going to her office each day. Only after confiding in a close friend, an organisational psychologist, did Mary understand what was happening to her. She had become the target of a bully, her boss, whose behaviour towards her escalated from sarcasm, intimidation, exclusion, isolation, denial of meaningful work to eventually refusing her annual salary increase without explanation. While her company had a bullying policy, Mary realised it was a worthless piece of paper as she learned of others who had also been similarly targeted by her boss. On looking into the sudden departures of previous employees, Mary learned of millions paid by her organisation in discreet termination agreements and legal fees.

Management training, including business school educators, emphasise the positive aspects of organisational leadership. But managers do not learn of the dark side of leadership when bullies thrive and are promoted to senior positions. As managers, bullies are skilled at manipulating HR policies and financial resources. Their organisations typically exhibit high levels of sudden staff departures, absenteeism, low morale, intimidation and harassment. More often than not bullying cascades down from one or two senior managers to supervisors and becomes acceptable and unchallenged behaviour. Not only are those targeted by bullies traumatised but others who witness bullying are also affected.

When Mary eventually complained her boss to her HR manager, he responded by instigating disciplinary action accusing Mary of poor performance and making false allegations against him. On her doctor’s and lawyer’s advice she removed herself from her toxic workplace and stayed at home. Her legal action for bullying and harassment was quietly settled, without admission of liability, by her employer. Mary had to sign a gagging clause promising not to talk to anyone, except her family, of her experience. She is not alone, as in the vast majority of cases, the person who is being bullied is left with no option but to leave their job. Mary didn’t get an equivalent position elsewhere and remains deeply affected by her experience.

Mary’s story, whilst fictionalised, illustrates how bullying is known to cause people to suffer long term medical and psychological illness where they develop symptoms similar to post traumatic stress disorder. With over 100 suicides a year linked to bullying in the workplace, employers and their trade organisations fear successful bullying law suits. Cases are settled quietly and bullying remains an insidious aspect of far too many public and private organisations.

Bullying, intimidation and harassment is known to worsen when organisations experience dramatic change, in particular downsizing. Unless an organisations values and management behaviours stress employee integrity and dignity, chances are bullying will feature. It’s not enough to have a bullying policy in place - it must also be rigorously practiced. Unchecked, the bully boss or manager creates an environment in which others adopt the normative behaviours of the bully.

The social manifestation of bullying escalates from sarcasm, threats, verbal abuse, intimidation, bad-mouthing, manipulation, duplicity, unpleasant assignments, demeaning jobs, exclusion, isolation, and in extreme cases physical violence and forced resignation.

At any one time between 10-15% of adults are said to be genetically predisposed to sociopathic type behaviours which sees them consistently bully others. Bullying is also nurtured within certain types of organisations, whose leaders fail to understand what it is and pay lip service to employee rights to be treated with dignity and provided with a safe place to work. And it’s reported as being more prevalent in larger organisations than smaller ones.

Documented behaviours include changing and devaluing work, excessive and unreasonable demands, social isolation, withholding information, excessive monitoring, personal attacks, ridicule, insults, verbal threats, spreading rumours , cyber bullying, undermining, humiliation, intrusion, unreasonable assignments and deadlines, harassment, exclusion and blaming people for things beyond their control.

Bullying usually occurs where there is an imbalance of power. More often than not behind closed doors. The most reported incidents occur amongst middle and senior ranking males in their 30’s and 40’s. But only because they are more aware of what bullying is and correctly identify when they are being bullied. Studies are likely to underreport bullying as many people don’t know when they are being bullied.

When last studied in 2007, a report to Government on workplace bullying, estimated that 160,000 people had been bullied in the previous six months and bullying had increased since 2001. The highest incidence was found in the public administration, education, health, transport, communications and financial service sectors. Close onto nine people in every hundred had experienced bullying which was studied using a set of unwelcome behaviours occurring persistently over a six month period. Seven in ten people bullied, experienced bullying behaviour more than once a month and many several times a week. Having a policy on bullying in place was found to be largely irrelevant. Although 82% of pubic sector bodies had a policy in place they also had the highest incidence of bullying.

Regrettably Irish workplaces seem ripe for the dark side of leadership and abusive behaviour will become far worse. In current economic circumstances with so many organisations downsizing and cutting costs, bullying is likely to escalate. What’s more with people trapped in their jobs, unable to find employment elsewhere, many more may experience the trauma of being a target of bullying. It is a distressing outcome that needs to be understood and robustly dealt with by those whose responsibility it is to govern, oversee and manage organisations.

© Thomas Crosbie Media 2009.

Budget 2009 Bangers, Booze and Bonds won't inspire us

US President John F Kennedy, once ignited a nation by challenging people to put a man on the moon. Yesterday people were challenged to buy Booze here, trade in Bangers and invest in Bonds.


Three words – Booze, Bangers and Bonds – captured the extent of budgetary largesse. The unpatriotic Newry day tripper is to shop local for cheaper Booze. Near worthless ten year old Bangers have a trade in value of €1500 and national solidarity Bonds will give households another opportunity finance the costs of economic recovery. What’s more Government is to introduce an entirely new concept in banking – the Second Guess Agency.


To fight an oil fire you need to starve it of oxygen by spraying it with foam. In spraying billions of budgetary foam onto Irish households, Government is threatening to douse any chance of igniting economic recovery for years to come. Rhetoric about hope and the right stuff won’t make it any easier for people to manage deflating incomes and a rising cost of living.


Spraying liberal doses of economic recovery retardant, the Ministers budget will amplify household financial fragility to levels never seen before. With one in four households finding it hard to meet their financial commitments – which is about 750,000 income earners - any reduction in take home pay or increase in living costs will have a disproportionate impact on consumption. Increased consumption encourages business to invest in growth and job creation. And it provides for the all important tax revenues required to plug the huge gap in public finances.


Income reduction and higher taxes suck money from an economy and with banking unable to generate new money, it sets off a deflationary spiral. Most households are already experiencing it, as the proportion of income required to cover debt repayments and other financial commitments increases. Once discretionary income declines, people stop spending and businesses go bust.


How many beleaguered households will be able take advantage of the “cash for bangers” scheme and buy a shiny new fuel efficient car when credit is being rationed by banks?


Yet not one euro was budgeted for the states biggest economic retardant, Anglo Irish Bank, which needs billions more in tax payers funds just to keep its banking license. It’s already cost €4bn. And what of the other banks which have as yet no idea of how much they will require in state aid to keep their licenses?


The costs of financing state borrowing will jump by over €2bn next year even before the costs of finalising the bank bail out are factored in. A national solidarity bond echoes a time when governments used war bonds to finance wars. Used to finance the Napoleonic wars, British consols, issued in perpetuity, never to be redeemed, are still traded today. Government’s version will have a shorter time span and be used to underpin a worsening sovereign debt rating.


Yet by raising money through solidarity bonds, the state will compete for household savings at a time when banks are struggling to rebalance their loan to deposit ratios. Just how much Government intends to hoover up in household savings is unclear. But bankers will not be too happy. Nor should they be as they cannot create credit without raising deposits.


Not content to compete on one side of the banking balance sheet the Minister unveiled a new concept in Irish banking – the Second Guesser. It seems that should a small business or farmer be refused a loan, they can appeal to an independent government agency which might force the bank to lend. And the Minister will also write bank credit policy or at least his appointed agents will. Enterprise Ireland may have a reputation for helping small business but it has no competence as a financial intermediary or as a commercial lender.

It’s a uniquely Irish solution to an Irish problem. As banks are too big to bail out and own outright, we get creeping nationalisation. NAMA will spend billions in cleaning up bad loans. And now a Second Guess loan decision appeal agency is to make certain banks lend. Rather than building a good banking system, which is empowered to lend wisely and prudently, we are seeing an unplanned, haphazard and dangerous nationalisation of banking.

Government inaction could lead to a debt revolt

A recent poster on the influential Irish Economy blog site wondered if they’re might be a debtor’s revolt. The notion of ordinary people revolting en-masse and refusing to repay their bank debts in full is not at all far fetched.

Household unaffordable indebtedness is known to cause immense social damage and incur immeasurable economic costs. Government’s budget this week will almost certainly worsen household financial fragility. Published last month, the 2009 Genworth Index, measuring financial vulnerability and security, reported Irish households as the most financially vulnerable of the countries studied. It seems four out of every ten households have difficulty in meeting their financial commitments and expect to have problems in the future. And only 2% feel financially secure.

During favourable economic circumstances and the low interest rate environment of the recent past, Irish household use of debt underwent a dramatic and fundamental transformation. Two powerful forces were at work. The first was “keeping up with the Jones’” as people emulated their neighbours lifestyles and role models promoted by mass media advertising. The second saw bankers relax prudent lending policies and broaden credit availability through financial innovation. Responding to these forces, households changed their behaviour, significantly increasing spending relative to income and consumer debt skyrocketed. People believed it was safe to borrow more and banks believed it was safe to lend more to them. Government, whose policies encouraged the debt fuelled consumption party, was blind to the twin dangers of exploding household debt and bank reckless lending to consumer and property sectors. Central bankers and regulators were lulled into a false sense of financial stability. By 2008 Government’s economic mismanagement created the conditions for a perfect storm for over-indebted households and triggered a dramatic collapse in consumption and tax revenues.

In the early 90’s a double income couple had to put 20% down and could borrow a maximum of 2.5 times one income and once the second income, to buy a home. By 2007 they could have borrowed 100% at multiples of four to fives times their income, and have two car loans, two credit cards and one or two unsecured loans. Experts argued the debt burden was affordable as incomes were rising and interest rates were quite low. They worried only about interest rates rising. Few considered a boom to bust cycle.

By 2006 household debt was running at dangerous levels – all it would take was an income shock and vulnerable households would be plunged into financial distress. This is precisely what has happened. Should interest rates rise, as they will, household financial fragility will worsen.

Experiencing increasing demand, largely from people on social welfare and low incomes, MABS offices took on 15,000 new troubled debt cases in 2009. MABS says its 30,000 active cases have average debts of about €16,500 which represents about €500m in collective debts. But with consumer loans of €140bn comprising some €110bn in mortgage debt and €30bn in other loans, the number of households experiencing financial stress requiring debt management and counselling services is likely to be considerably higher than the numbers currently going to MABS for help. Its figures are but the tip of a very large iceberg of household over-indebtedness.

Estimates put the number of overly indebted households at close to 300,000 with about 750,000 individuals experiencing problems with personal debt. By far the most vulnerable cohort is couples under age 40, with children, who have experienced a long term reduction in take home pay. Heavy users of debt many will or have become hopelessly insolvent.

So far Government has done little to understand or address the massive burden of unaffordable household debt built up during the boom years. Getting banks to forbear on home repossessions is like pouring sand on a land mine and claiming it’s been decommissioned. People’s capacity to participate in modern society depends on income security, access to affordable credit and ability to meet their financial commitments. Well documented, the social consequences of unaffordable indebtedness are dire, causing reduced workplace productivity, family breakdown, depressive illness and in some cases suicide. Stigmatised many people withdraw from being active members of society. Hopelessness and loss of self-esteem add to the misery of being unable to repay loans.

Exacerbating the problem, Ireland’s draconian debt collection law emphasises borrower’s obligations to pay debts in full and overly protects creditor’s rights. Lenders and their debt collectors are engaged in an unsecured loan collection arms race, with each one trying to get into court first to stake a claim on a debtors household income. What’s more when banks start lending again, they will tighten lending conditions, charge more for loans and refuse credit to over-indebted households. Consequently many people, once considered good borrowers, will be marginalised and financially excluded.

Other societies have long recognised the adverse social consequences and economic costs of household unaffordable indebtedness. The Danes led the way in 1984 when they introduced a landmark personal insolvency system designed to provide a full debt discharge over a reasonable period of time during which people pay what they can afford and the balance owing is written off.

NAMA whilst designed to rescue banking from failure, will write off billions in unaffordable loans over time. Most of its customers are hopelessly insolvent or unable to repay their borrowings in full. They will pay what they can and NAMA will write off billions in debt – some say it may cost well over €30bn.

But what of ordinary people who cannot afford to pay what they owe in full? People who borrowed believing it was safe to do so and who made rational decisions based on their expectation of continuing income security? Their expectations were fostered by a government that first promoted a consumption boom and then a soft landing. It could well be that ordinary people will organise into a collective group and demand a “NAMA for the little guy”. In the absence of affirmative action that promises a way out of unaffordable debt, Government runs the real risk of a citizen’s debt revolt.

AIB Mending the Cracks

“AIB is facing a period of majority state ownership. The trick is to change its dominant culture and craft a new bank that acts in the best interests of all its stakeholders” writes Bill Hobbs

How AIB’s newly appointed senior managers unwind its aggressive business model and build a safer bank is key to its future as an independent bank. It is facing a period of majority state ownership and could be forced to divest itself of its international business in return for billions in state aid.

By making credit available to people and business, who make effective use of it, banks are central to what makes modern consumer economies and wider society thrive. It’s why banks are special and why they are regulated as public interest bodies. Without careful and prudent bank managers keeping a weather eye out for risks, a boom to bust credit fuelled economic cycle happens, as it has here.
Good bank managers should act responsibly in the best interests of all stakeholders and not solely in the narrow shareholder interest. Banking goes badly wrong when its managers use their power and influence to manipulate banking assets for short term gain and reward. It goes spectacularly wrong if they trade off their banks’ “too big to fail” status and take excessive risks, gambling that Government will always step into bail them out.

Moral hazard is the term used to explain this phenomenon. Governments and regulators are supposed to police and protect society from moral hazard risk. Bank managers should be constrained by public policy and regulations that inhibit their ability to destroy money and consequently undermine economic and social well being.
Banks are not inanimate objects that exist in parallel with the real world. They are business organisations of groups of people who act and behave according to norms they establish to get work done. They are led by small groups of powerful influential executives whose personal interests are aligned with shareholder interests. Bad banking happens when senior executives act irrationally and myopically to maximise short term gain at the expense of long term viability.
There are or course many fine people working in Irish banking who truly believe in prudent management. But if the dominant senior managers behaviours and values encourage excessive risk taking and insist on blind loyalty then bad things happen. Bad banking happens when good people remain silent and are manipulated and at times intimidated into acting out the designs of senior executives and their overseer boards.
Much has been written of the need to change banking culture or “the way things are done around here”. But changing culture isn’t easy. It takes authentic leadership and effective management to turn large organisations of thousands of people around. Unwinding from excessive risk taking embedded in “the way things are done around here” cannot be accomplished overnight.
This is the task of AIB’s leadership, both of its board and senior management team. But the jury is out on whether this aggressive, profit maximising, banking leopard can truly change its spots. AIB has a rich history where its private interests have collided with the public interest, stemming from a time when its senior executives learned how to leverage off it’s “too big to fail” status. Twenty years ago AIB management’s foray into insurance almost ruined the Irish banking system. Government stepped in and bailed it out by taking over the Insurance Corporation of Ireland and in the process burned up the states foreign currency reserves to support the Irish banking system.
Today AIB’s insistence on its absolute right to trade without due regard for public interest is seen within its arrogant rejection of a dire need for state aid and in subsequent behaviour during the process of appointing an insider as its most senior employee. While Bank of Ireland experienced flak for its own internal appointment, it has not engaged in protracted altercation with Government. Perhaps we are seeing the contrast between Bank of Ireland’s long experience of carefully aligning its interests with the State and AIB’s mercantile banking culture with its ambition to become an international bank headquartered in Ireland.
All organisations have a positive core – something they do well that forms the basis for their success. When things go badly wrong as they have for AIB, learning how to move on is as important as acting it out. The danger is that that internal change becomes a negative force intimidating people to fit the designs of those who continue to be wedded to the way things were done in the past.
Should its managers use the same forceful aggressive style that gave rise to the way things were done, then AIB may not change its ways. The trick for AIB is to change its dominant culture and craft a new bank that acts in the best interests of all its stakeholders – and gets good credit flowing again. Unfortunately bank managers are not known for their leadership ability – they may be good managers but can be extremely poor leaders.

Consumer protection agency must go hand on hand with bank regulation

“For too long policy has concentrated on regulating banks but consumers need protection too, writes Bill Hobbs”

Throughout the boom years both banking regulation and consumer protection failed to prevent financial intermediaries’ excessive expansion of credit. Like balloons, banks expanded their balance sheets to a point where they had to burst. What is now needed is a reformed, systemic bank regulator to protect banks from themselves and a consumer financial protection agency to protect ordinary people from banks and other financial firms.

In the US a new body, the Consumer Financial Protection Agency is being created in response to what is seen as a spectacular failure to protect citizens from banks excessive, value destroying financial intermediation. The response here has been muted, with no public enquiry yet into what went so badly wrong in Ireland.

“Safe as houses” was coined during the Great Depression to convince people it was safe to borrow long term to buy their own homes. Today such action, now termed behavioral economics, sees Governments and others look to influence ordinary people’s consumption, savings and borrowing behaviors.

As in the US, economic policy here influenced people’s behavior as consumers. Both the property bubble and consumer spending boom were wholly reliant on excessive credit provided by financial intermediaries who engaged in misselling on a gigantic scale. Borrowing vast sums from abroad to make excessive loans here, our banks became the most economically destructive force in the history of the state.

IFSRA, the Financial Regulator, is a carbon copy of Britain’s “Financial Services Authority” which evolved from a number of self-regulatory agencies. Dominated by career central bankers, it interpreted its role through the lens of a prudential banking culture with its roots in “principles” based regulation from a time when financial firms self-regulated through cozy cartels. Principles for bank safety and soundness are established and banks get on with the business of maximising shareholder value as long as they satisfy the regulator that they have applied the principles to their business operations.

Regulators such as IFRSA have twin conflicting mandates. These are to ensure bank safety and soundness and to protect consumers. Safety and soundness means profitability. And as unfair, abusive and deceptive practices can be highly profitable, consumer protection is trumped by prudential regulation save for the most egregious of practices more often than not exposed here by whistleblowers in the media.

Bank regulators look on consumer protection as a tool to regulate financial firms, which makes life easier for the regulator. Protecting consumers is dominated by the notion that improving financial literacy creates wise, educated, experienced citizens who as consumers are capable of self-regulation. This notion holds that “a person’s vulnerability to misselling is a matter of their imprudence which is most effectively controlled by them acquiring the basic knowledge and confidence to ask the right questions and to seek out the products that best suit them”.

Protection also requires financial firms to disclose basic price information, print health warnings and allow for cooling off periods. The objective is to provide information so that consumers can make an informed decision. Financial advice or selling must be done in a certain way for certain types of products. But critically there is no review of new or existing financial products for safety. Nor is there a requirement to modify dangerous products before they are marketed to the public. Generic high level product regulation does not stipulate minimum safety standards and only applies to regulated firms.

Banks create value by making more credit available to people who would safely use it. But it is possible for people to have access to too much credit as happened here. Products and services were designed to allow consumers borrow more than they ought to have or could prudently afford to repay. Marketing tricks encouraged people to behave as if they could afford to buy cheap abundant credit without fear.

Government policy considers consumer protection subordinate to ensuring the profitability, safety and soundness of financial firms. It does not extend to protecting consumers from themselves or from firms more dangerous products. It believes in a form of citizen that doesn’t exist - the rational, financially literate, well informed, self-regulating consumer. So consumer protection is crafted to make regulating financial firms easier and reduce public expectation of the Financial Regulator’s responsibility for the state of the market.

Regulating financial products is always met by a powerful industry lobby on one side that is not be balanced by an equally effective consumer lobby on the other.

What’s needed is a US style consumer financial protection agency that protects consumers from excessive and destructive innovation by financial firms; polices unfair, deceptive and abusive practices; whilst also ensuring they can continue to innovate.

Credit Union Members need to toughen up on their act

With some credit unions in the red, members should attend AGM’s to get some answers, writes Bill Hobbs

With a worsening economic climate, many credit unions face serious challenges in funding day to day operations, paying dividends and maintaining prudent levels of reserves.

Significant regulatory interventions to control risk taking and maintain capital reserves have been put in place. More recently the Minister for Finance has ordered the Financial Regulator to review the sector. Heightened public concern may also result in large attendances and challenging sessions at credit union annual general meetings this year.

Ranging in size from less than €0.5M to over €370m, credit unions are accountable for the safety of €11.5bn in household savings. 100 medium and large sized credit unions ,having full time management and staff, control close onto 80% of all savings.

It appears that 50- as yet unidentified credit unions - will be unable to pay a dividend this year. If these are medium or larger credit unions then upwards of €4.5bn- the savings of tens of thousands of ordinary people- may earn a zero return this year. Due to a lack of public information, people can’t judge the financial performance and relative safety of their local credit union until it publishes its annual accounts. From now too early in the New Year, credit unions will publish annual accounts and hold their annual general meetings.
Credit unions are owned and governed by their shareholding members, who are also their customers. Electing directors from their membership, members empower a board to govern and manage the business. In turn directors are held accountable, principally through producing annual accounts and holding an annual assembly of members.

A study on the financial accountability of Irish credit union boards to their members, published in Financial Accounting & Management in 2004, found “accountability is not discharged in the most appropriate manner by credit unions in Ireland”. It also found that “users of credit union financial statements (in particular members) are not provided with appropriate financial information to make judgments and decisions. Given that the powers of direct interrogation by members of credit unions are limited, such weaknesses can disadvantage members.”

The study highlighted the absence of standards for financial accountability and also noted “ If low quality financial accounts are prepared and audited (without qualification), and members rely on these as a ‘health check’ of the financial performance and position of the credit union, then the potential for members being misled is high.”

Provided with only basic financial accounting information and limited commentary on performance what might credit union members look out for this year? There are four “health check” issues people should be concerned with. These are losses in investments (funds not lent out in loans), bad debts and loan losses, liquidity (sufficient cash to fund operations) and reserves (sufficient capital to cover expected and unexpected losses). All four are unlikely to be dealt with in credit unions annual accounts through detailed notes showing policy in each area, data comparing one year to the next and commentary on performance.

Concerned members might prepare questions and look for “plain English” explanations during the AGM. Questions might be asked on investment portfolios such as the type of investment’s made, with whom, the risks being incurred and expected or anticipated losses. They might ask for an explanation of the investment policy and whether or not the credit union is in compliance with regulatory investment accounting requirements and guidelines. If not, then the board should be asked of its plans to achieve compliance.

Recent media reports indicate at least 10% of credit union loans are in trouble but less than 1% may be written off. Yet banks are reporting far higher levels of loan losses on their troubled consumer loans. Members might ask of the number and amount of loans in default, considered at risk of default and what the expected losses are. As a credit union is legally restricted in its lending activities, the board might be asked if it is in compliance with these restrictions and if not, how compliance will be achieved. Last year 90 credit unions were found to have been in breach of legal lending limits by the Financial Regulator.

Credit unions are generally expected to maintain liquidity (cash) in instruments that can be encashed without delay or loss. Typically these include bank current accounts, short term bank deposits and government bonds. They should have at least 20% of assets held in this way. The board should be asked if it is satisfied liquidity is sufficient as some credit unions are borrowing from others to meet their cash needs. Some have had their lending restricted by the Financial Regulator. The board should be asked if the credit union has been or is being restricted in its lending and what actions it’s taking to resolve the issue. With loan default risk rising in a recessionary economy, questions might be asked of lending policy, in particular if the credit union is using repayment capacity lending assessment. If it is not a member of the Irish Credit Bureau, then an explanation should be given for this.

Credit unions are expected to maintain safe levels of reserves (capital) as a safety buffer against expected and unexpected losses. From September this year the Financial Regulator requires them to maintain minimum reserves of 10% of total assets. International best practice indicates a ratio of 15% as being prudent. This new requirement was introduced in part to prevent reserves being used to fund dividends to savers. Credit unions are only permitted to use reserves previously set aside specifically to pay future dividends. The majority did not create these reserves. Members might question their board to explain its reserve policy and what plans it has to achieve and maintain the regulatory reserve ratio.

Typically less than 2% of members attend the Annual General Meeting and few robustly question their board on credit union performance. This may be about to change as many people are deeply concerned that credit unions should continue to provide a safe place to save and make affordable loans.

Without a personal debt resolution system we face a bleak future

“Negative equity is only the tip of the iceberg on personal debt, writes Bill Hobbs”

Countless thousands of ordinary people, through no fault of their own, are caught in a spiral of indebtedness that may prevent them becoming productive members of society again for years to come. That unwelcome scenario faces many citizens unless an alternative debt resolution or modern personal insolvency system is put in place – and quickly.

In 1995 the ratio of household debt to disposable income was 46%. By 2009 this had risen to a world beating 176%. In the space of five short years, between 2003 and 2008, consumer mortgage debt rose by over €70bn and other personal debt rose by over €11bn (excluding lenders such as car leasing companies and credit unions). Much of the money was borrowed by people under 40, many of whom have personal debt they cannot ever hope to repay and are now or will shortly be living in a state of long term insolvency.

It seems that one in three mortgaged households will end up owing more than their homes are worth – in negative equity. This recent estimate is based on a 50% decline in house prices from their peak 2007 values. In drawing parallels with other countries experience of property busts, it’s said that 10% of borrowers could default. But as Ireland’s property bust is of unprecedented scale and impact, defaults will probably be far worse. By year end it appears upwards of 36,000 unemployed homeowners will be on mortgage interest relief income supplement. This does not include people earning an income who are struggling with mortgage and other debt repayments.

Negative equity is only the tip of a large ice-berg that threatens not only to freeze economic activity at recessionary levels for years to come but is also currently causing a social disaster. Consumer’s unaffordable indebtedness is not fully captured by headline negative equity statistics. Add the billions borrowed to finance cars along with lifestyle debt and the real landscape of personal indebtedness becomes clearer. Not only are those with mortgages caught in a debt spiral but tens of thousands of others are unable to make their loan repayments as they fall due.

Clearly it is manifestly unfair to commit people to unending indebtedness with little hope of becoming once again productive members of society. Modern advanced societies realise that honest people who can’t pay must be given a chance to get out from underneath unaffordable debt. In the US, debt resolution laws allow people to declare personal insolvency and exit with a clean slate in less than six months. European debt resolution systems which stress responsible borrowing, allow for full debt relief over a 3-5 year time frame.

What’s more advanced societies realise that unsophisticated consumers are hopeless at understanding risks when borrowing money. And realise that pursuing people who cannot pay through the courts to try to recover debt in full is an outdated system belonging to a time when borrowers knew more than bankers. At one time the power in the banker/borrower relationship rested with the borrower and banking was far riskier. Banks did not make loans to ordinary people because banks could not manage the risks involved.

Today, banks deploy sophisticated credit and behavioral scoring models in lending to ordinary people. They are better able to judge risks than borrowers. Explicit within this is the notion that the responsible lender and not just the responsible borrower must bear losses when consumer banking fails, as it has here in Ireland. The power in the banker/borrower relationship rests with banks that have the capacity to understand risk and act accordingly. Borrowers must pay what they can and banks must write off the balance.

The outcome of the banking crisis here has seen far too many people being marginalised, as banks are lending only to their better credit risk customers. And bankers will also undoubtedly escalate aggressive court based debt recovery, unless tempered by a fair and just alternative non-court debt resolution system.

So far talk has been about doing something for home mortgage holders. From earlier this year, banks have had to comply with a code of conduct in dealing with mortgage arrears – but this merely piles more sand on the land mine of unaffordable mortgage debt. It is abundantly clear solutions will have to be implemented to stave off what will otherwise become a home repossession nightmare no one wants.

Recently published, the Law Reform Commission’s consultation document on personal insolvency, proposes an alternative debt resolution scheme similar to ones used in advanced societies for decades. The Commission distinguishes between people who “can’t pay” their loans and those who “won’t pay”. Under its scheme those who “can’t pay” would earn a debt discharge over time. It would; have open access for honest and long-term insolvent people; be a legally binding debt settlement agreement between a borrower and their lenders; preserve a reasonable standard of living for people; and would result in a debt discharge after a reasonable length of time. As such schemes typically exclude mortgage debt; the Commission did not propose solutions for homeowner mortgages.

It seems that Government is to contemplate an alternative to the current Dickensian debt recovery system which jails people who cannot afford to repay their loans. But is it to be left to Law Reform Commission’s slow pace of inquiry and consultation to ensure a just equitable solution to personal indebtedness?

Creating an alternative debt resolution system is not the stuff of rocket science nor does it require a uniquely “Made in Ireland” solution. Proven systems and mechanisms exist elsewhere. All it takes is resolute government action to implement a system. Bringing all stakeholders together within a fast track process aimed at enacting the requisite legislation and executing on a new system is something that should be done immediately.

It should not be conveniently long fingered by political rhetoric and lame excuses that home repossessions are low.

Nama business plan attempting to predict the future

The NAMA saga is set to become even more arcane with the onset of the Orwellian-named SPIV, writes Bill Hobbs

26th October 2009

Understanding NAMA’s business plan is as frustrating as trying to pin jelly to a wall. Last week, Finance Minister Lenihan said the business plan was an indicative draft, meaning it will of course change in time. Anyone familiar with drafting business plans knows full well that trying to plan beyond a two or three year time horizon is so fraught with risks as to be nonsensical. And business plans have an annoying habit of becoming worthless pieces of paper when it comes to executing them - more so as their underlying assumptions often prove to have been too optimistic. The longer the planning horizon, the greater the chances of getting it wrong – the NAMA plan is ten years long.

The odd thing about the Minister’s indicative draft plan is its assumptions – the gelatine used to bind it together- were central to Government’s proposal to keep the €54bn it will pay for toxic loans, off the national balance sheet. Yet this inventive proposal remained hidden from public view until an EU agency, Eurostat, published communications between it and the Irish Central Statistics Office.

Governments’ solution to its balance sheet conundrum was disclosed over the internet, not by the Minister or his department but by Eurostat’s public transparency process. In publishing communications between it and the CSO, it showed how the mechanism hatched to keep the national balance sheet clear of toxicity is an eloquent sleight of hand requiring a hefty dose of lateral thinking – in short a convenient fudge to prevent Irish sovereign debt adopting Icelandic rating characteristics. Eurostat’s public transparency starkly contrasts with the Minister’s fuzzy disclosure on all things related to NAMA and the banking crisis.

NAMA will not take ownership of bad loans and will not be responsible for recovering whatever value can be extracted from fallow fields, uninhabited residential property and vacant office blocks. Instead a special purchase investment vehicle, a SPIV, will buy the loans and will oversee their break-even or profitable repayment. It, and not NAMA, will issue government guaranteed bonds to buy the banks bad loans and will also issue the non-guaranteed risk sharing bonds – the ones that act a claw back mechanism should NAMA incur higher losses than assumed in its ten year business plan.


The SPIV will have governance and operational responsibility in persuading near bankrupt borrowers to repay €77bn in loans from assets assumed to be worth at best only €47bn today. Another assumption is it may make a profit of over €4bn should property values rise under an assumed future value trajectory. Just how borrowers are going to trade property to realise the profits required to fill the €30bn difference between what the loans are assumed to be worth today and what they really worth, which has yet to be assessed, is not clear.

What’s more the SPIV will be capitalised by €100m with the state taking a 49% share and a group of as yet unknown private equity investors owning 51% - a controlling interest. However the intention is the Minister and NAMA will be able to override any commercial decision the SPIV board makes were it to conflict with the taxpayers interests – which brings to mind how exactly the tax payers interest is to be defined, transparently overseen and protected. The risk is, within the labyrinthine governance and operational complexity of the NAMA/SPIV, sectional business interests may be commercially afforded extreme forbearance at ordinary people’s expense. Is the citizen to be blindfolded by the invocation of the all too convenient insider excuse of “commercial sensitivity”? Bland assurance that Ministerial oversight will best protect the public interest hardly holds any water given the events of last week when the Irish political and civil servant cultural predisposition to secrecy and partial disclosure was exposed over the internet.

Both the NAMA business plan and CSO/Eurostat communications illustrate how captive ordinary Irish people have become of the business interests of two overly dominant enterprise sectors- construction and banking. Government, for largely ideological reasons, is eschewing temporary bank nationalisation and promoting NAMA as some form of low cost profit making property investment and economic recovery vehicle that will get banks lending again.

There is no legally enforceable mechanism that will force commercial banks to use the cash released from their bad loans to make new loans to struggling Irish businesses and consumers. As the ECB unwinds its extraordinary intensive care support, the two dominant universal banks, AIB and Bank of Ireland, will be forced to fend for themselves in the money markets. It is highly likely they will use the cash raised from trading the bonds the SPIV pays for bad loans, to replace the ECB’s emergency cash life-line. Banks may also use the cash to adjust their balance sheets by investing in high yielding low risk Irish Government bonds. The circular flow of money from loans to bonds to cash, facilitated by the ECB and Eurostat, is seen by many as a mechanism to ensure Government can finance a gaping hole in its budgetary arithmetic.

Meanwhile NAMA and its daughter, the SPIV, will take the tax payer on a magic mystery tour during which zombie builder and developer businesses will not be required to pay a cent until 2013, in the belief that property values having floored will once again begin to rise.

Yet there is no public manifestation of property prices stabilising – instead house prices continue to slide. As a paper exercise NAMA’s assumptions are flawless designed as they are to bail out banking and to keep the costs off the national balance sheet – but as a realistic business plan they are at best loose approximations of a desired state that depends on factors outside NAMA’s control.

Should the state continue to subsidise credit unions?

Should the state continue to subsidise credit unions?

Benefits such as state aid and exemption from corporation tax need to be reformed in this climate, writes Bill Hobbs
28th September 2009

In poor shape to deliver on their core purpose to generate credit in the economy and requiring fundamental reform, Irish credit unions may need to justify why the state should continue to subsidise their operations. Similarly the ILCU (Irish League of Credit Unions) may need to justify why its state subsidy should continue.

Ten years ago, Finance Minister Charlie McCreevy’s move to tax dividends on credit union savings accounts sparked an intense national lobbying campaign spearheaded by the ILCU during which activists threatened to run as general election candidates. Under pressure from Independent TD’s, then Taoiseach Bertie Ahern forced McCreevy into a climb down. Citing non-resident account abuses McCreevy warned that credit unions could become a haven for tax evasion.

Close to €9bn, has since accumulated in credit union non-DIRT “ordinary share” accounts, notwithstanding the availability of a DIRT account. As untaxed dividends are taxable at a person’s marginal rate many people may not have declared their credit union dividend in their tax returns. It is probably also the case that a sizeable amount of savings balances is undeclared income hidden away from the taxman. Should Revenue have a mind to investigate the use of these accounts it may well uncover a treasure trove in tax revenue. As a form of state aid, many consider the non-DIRT exemption distorts the market for savings with credit unions benefiting from higher savings balances.

But there is another, far more valuable state aid. Credit unions are exempt from paying corporation tax. It’s a discretionary exemption, wholly dependent on prevailing government policy, which has been withdrawn in other countries and never applied in others. The tax exemption is based on the notion that untaxed profits paid as dividends are taxable in the hands of savers. Such is the scale of this state subsidy that credit union reserves of €1.4bn arguably represents tax foregone by the state.
Credit union’s primary economic purpose is to advance credit using savings gathered from ordinary people. With less than 52% of assets in loans and the balance on deposit with Irish banks or held in investment portfolios, credit unions are not fulfilling this core purpose. Loans as a percentage of total assets peaked in the late 90’s and have been declining ever since. Pursuing a policy of maximising savers dividends and unable to generate enough profits from lending, credit unions adopted an ill-conceived investment strategy that ultimately led to large losses over the past two years. At the same time to bolster lending they also made more risky loans such as speculative property development finance which have led to rising bad debts. Far too many pursued a strategy of maximising profits for distribution as dividends to savers at the expense of building reserves and investing in improving products and services. It’s fair to say this dividend maximisation policy contradicts the intent of the state subsidy which was provided to underpin and support credit union’s economic and social function to provide affordable credit, bolster financial stability and fund development and growth.

Credit union leadership maintains that servicing the “financially excluded” justifies a state subsidy. In 2006, a Combat Poverty Agency research report estimated the number of financially excluded adults at about 180,000 and found that they did not use credit union services. With over 2m customers the vast majority of credit union customers are not financially excluded. Indeed a recent report commissioned by ILCU found that credit unions are predominantly servicing middle class customers. Whatever about community based credit unions, it can hardly be said customers of employer based credit unions, such as teachers, police, prison officers, utilities etc are financially excluded. And with a vibrant official licensed and regulated money lender sector, combating financial exclusion does not appear to be a dominant enough feature of credit union activity to justify continuing state aid.

Much is also made of “social finance” which is repayable financing of local community initiatives. The ILCU maintains about 10% of credit union lending or about €700m is for social finance purposes. This figure includes start up business loans to individuals. A narrower definition favoured by others would reduce this figure considerably below €100m or less than 2% of loans. While legally permitted to allocate profits to build social funds, credit unions have been criticised for not using these funds. A small number have funded successful local community initiates but the majority have not. An ad hoc approach to social finance does not support the case for a global tax exemption. Nonetheless a well designed national credit union social finance strategy would probably justify a degree of state aid.

Overall the case for a state subsidy is not at all compelling and requires a cogent rational justification if it is to continue. But there appears to be no compelling reason for the state continuing to subsidise the ILCU which is also exempt from paying corporation tax. When queried during a High Court case, the explanation provided for its tax exemption was it was “best to let sleeping dogs lie”. The ILCU has consistently declined to incorporate as its activities subjected to regulatory supervision or its commercial businesses exposed to tax. Yet it comports itself as a corporate entity, commercially engaging in regulated financial intermediary markets in which its competitors are not in receipt of state aid. Observers have commented in particular on how it capitalises its wholly owned insurance subsidiary ECCU using tax exempt profits earned through a management service agreement.

Credit unions should have the capacity to deliver valuable financial services to ordinary people and small businesses. But after a decade of pursuing an ill-conceived business strategy many are unable to deliver on what society requires of a vibrant, competitive and financially stable credit co-operative sector. As Minister Brian Lenihan deliberates on the future of the Irish banking system no doubt he will be concerned about reforming the credit union sector. The trade off for continuing state aid may well require credit unions to implement long overdue changes in structure, governance, management and operational competence.

A version of this article appeared in the Irish Examiner, Business Section, Monday 28th Sept 2009

Government playing fast and loose with banking

Brian Lenihan is using estimates of estimates to justify the NAMA plan writes Bill Hobbs
21st September 2009
NAMA is designed to do one thing and that is to stop banking destroying the economy. Playing fast and lose with language, Government is busy spinning misleading and inaccurate sound bites designed to sell the new dogma – the NAMA soft landing and social dividend.


NAMA is designed to bail out the banks at the expense of taxpayers who are overexposed by at least €16bn. This figure is made up of two quite startling numbers. €9bn in loan arrears (rolled up unpaid interest) and a €7bn overpayment principally engineered to keep AIB and Bank of Ireland in private ownership.


The two big banks are so large they are impossible to bail out using traditional options. Given the dire state of public finances, nationalisation is unaffordable and it is taking a unique arrangement with the ECB to orchestrate what has at best will buy some time. And as the entirety of commercial land and property loan book of five banks is being nationalised, NAMA will become the only game in town for financing the recovery of what is left of the Irish property sector.


Government is saying the €77bn in loans it is buying are currently estimated to be worth €47bn but will pay €54bn and has declined to say how both these figures break down between the banks. It needs to pay more as if it were to stick with the lower amount the two big banks would have to be nationalised. This is something government cannot afford.


So it has to manipulate the value upwards by an amount it reckons will prevent it having to take the banks into full public ownership. It also needs their share price to improve as if it has to provide additional capital it will end up with a lower shareholding. The hope is private investors may find the banks an attractive proposition. But while NAMA may have to provide for liquidity, the banks capital base remains dangerously thin and exposed to further loan losses.


As soon as Minister Lenihan finished unveiling NAMA in the Dail, AIB started claiming its share of the pain was lower than the Minister’s overall estimates. It is not the first time AIB has said something only to have to retract it months later. After an initial speculative jump, its share price has slid back to semi-zombie price status. As has Bank of Ireland’s, which was a tad more circumspect in telling its story as it warned of challenges it still faces.


The logic of Minister Lenihan’s story is based on estimates of what approximates the full extent of Irish banks catastrophic loan losses. But the estimates are subject to verification as every loan and each bank is different.

With estimates based on estimates of estimates, trying to figure it all out is like trying to pin jelly to a wall which is of course what was intended. In short the story spun by the Minister allowed the banks to spin their own version or as he said the market would be able to make out what he was saying.


To add spice to the NAMA soft landing story, Minister Lenihan confidently predicted that property has reached the floor and could only go up from here, as prime commercial property yields in Dublin are high when compared to other capital cities.


With only €8bn of the €77bn loans apparently lent on good quality commercial property, the Minister extrapolated his confident prediction for all Irish property. But yields are high only as rents haven’t come down yet and anecdotal evidence is rents are rapidly adjusting downwards. Meanwhile Government is sitting on legislation doing away with upward only rent reviews which underpin property values.


A critical factor in the Ministers estimates is the belief property on average has fallen by 47%. Yet not a scintilla of supporting evidence has been produced to support this figure. In talking up the property market he seemed to thread a thin line between optimism and delusion as have other Ministers since. Some are leading property economists saying property could yet collapse by 60-80%, which means the bottom has not yet been reached.


Based on the Minister’s lead, his colleagues maintain property has only to increase by 10% over ten years for NAMA to be a success and it will cover its costs from the start.


This has all the hallmarks of a calculated deception, as it all too conveniently ignores the costs of funding NAMA which will probably rise by at least 200% within the next few years.


Some Ministers are even saying the ECB is providing a special deal on “cheap money”. Yet the interest NAMA will pay is 50% higher than its best rate, reflecting NAMA’s risk profile. The ECB may have a temporary arrangement but does not cut sweat heart deals nor has it said it has for NAMA. And as it begins to unravel its emergency support system for European banking, NAMA and the banks face an uncertainty fraught with interest rate and liquidity funding risks.


NAMA may well initially cover its costs only because some good loans will generate interest. But loan quality will come under pressure as the ECB rates rise ands default risks rise.


Government says that NAMA provides an economic stimulus. However this is likely to be too weak and subject to leakage. As the banks swop or sell on NAMA bonds for cash they will use the bulk of it to mend their balance sheets and the balance to make good low risk loans.

Both Anglo Irish and INBS will transfer 35bn in loans, including the lion’s share of rolled up interest. Anglo will not be able to generate a red cent in lending, if any at all, for years. INBS already a dead man walking will shrink to a husk to be taken over.


This week the Minister produced some more pieces of the NAMA jigsaw puzzle but did not produce the box with the picture on top. He has done nothing more than invite people to imagine what the picture might look like. Which is worrying as no one not even the Minister knows what’s on the lid of the box.

Bet the house, then hope for the best

Nama is projecting into an imagined future in order to value property today. But what price will we pay if it gets this future wrong, asks Bill Hobbs

The British Academy recently assembled an expert group of eminent people to respond to the Queen’s simple but powerful question “why had nobody noticed the credit crunch was on its way?”
In response its letter, in summary said it was “principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole”.
Commenting on people who thought novel financial instruments virtually removed risks altogether the letter said “It is difficult to recall a greater example of wishful thinking combined with hubris”. A novel financial instrument that tries to replicate the future is a controversial feature of the NAMA strategy to rescue banking.

The novel concept being used to fix the banks is called “long term economic value”. Asset management companies similar to NAMA have been used worldwide to rescue banks but none appear ever to have deployed it to value bad loans. Government is claiming ECB endorsement for its use in its recent letter.
Yet others reading the ECB letter say it clearly warns against overpaying for loans. The ECB is also concerned that any process should ensure bank’s should start lending again and not engage in risk adverse behavior. Whilst not a fan of nationalisation it does accept greater public ownership may be necessary and says risk should be shared between tax payers, banks and their shareholders.

So far the Minister has provided scant insight into how it will work. NAMA intends buying billions in loans, some good but most bad, at a price yet to be determined. The price will be based not on the value of these assets today but their value some time in the future calculated using a “statutory formula”.

Some claim the intention is to financially engineer the value of the loans and their property collateral to remove the risk of insolvency from Irish banks and having to take them into public ownership. If the Minister pays too little for the loans the fix won’t work, so he has to pay a price for it to work.

The fix works as the banks do not have to write off all of their losses, they improve their capital ratios and can swap the bonds used by NAMA to pay for their loans for cash. The Minister says they will then start lending again. Will they? The evidence from other credit crisis is loan starvation lasts long after banks are rescued.

It’s said that once banks are freed of their bad loans, investors will be happy to invest equity in them again. But will they? No one knows for sure in the case of Ireland’s experience of what the IMF has called the deepest recession of all advanced countries.

Good science fiction writers tell plausible stories by projecting today into an imagined future. NAMA will use a formula designed to project loans and property into an imagined future economy to value them today. The Minister is betting his formula may get it right. Yet its very use amplifies the risk of getting it wrong. Should he overpay for loans, the economy grows too slowly and property stagnate in value for years, then NAMA will incur massive losses. Should he pay the going rate he faces taking the banks into public ownership. For now all have to wait for the 16th September when the Minister will unveil his statutory formula.

Asset agency must be accountable and transparent

After months of dithering, Government finally acted to begin reconstructing the Irish banking system with its planned take over of some of Irish banks most toxic loans. Without doing so the economy stood no chance of recovery.

Ever since last September getting banks back to reasonable health was an absolute requirement of any state facing deflationary meltdown. The creation of the National Asset Management Agency or NAMA, is an EU first, proclaiming as it does the states “Banama Republic” status – a combination of sovereign rating and bad bank.

The numbers keep getting bigger. €90bn with its toxic mess of €29bn are headline figures that hide a complexity that will cost the state and tax payer billions no matter how sugar coated the bitter pill is. This bitter pill amounts to buying toxic assets, probably for more than they are worth, as paying fair value will destabilise the banks.

To hedge against overpayment, Finance Minister Brian Lenihan says he will “levy” the banks with a recovery fee if NAMA falls short on breaking even. The true cost will not be known for years and any “levy” will be carefully constructed to fit a different state v banker relationship.

It also seems the door is being left open to nationalisation should a bank not survive NAMA’s haircut pricing mechanism as it mandatorily hoovers up property loans. This is probably safety cover, as the full due diligence on loans to be bought will not be done for some time yet.

For now Government has no intention of taking the next logical step which should be nationalisation. Instead it hopes the banks will feel liberated to get credit flowing once again rather than acting to save their shareholder and bond holders skins.

Extreme risk aversion is a documented feature of private banking behaviour in banking crisis as they are susceptible to a paralyzing fear that new loans will put their capital at risk.

Furthermore because future bank profits will be only be generated as banks have been freed from their toxic assets, their shareholders gain at the expense of the taxpayer who foots the bill for swallowing the bitter pill. Government’s structuring of the deal does not allow for a tax payer dividend unless that is banks are temporarily nationalised which is what happened in Sweden.

A recent IMF report on “NAMA” type approaches said “Fiscal costs, net of recoveries, associated with crisis management can be substantial, averaging about 13.3 percent of GDP on average, and can be as high as 55.1 percent of GDP. Recoveries of fiscal outlays vary widely as well, with the average recovery rate reaching 18 percent of gross fiscal costs”

But this may only the first NAMA scheme, as the scale of wider distressed debt problems becomes apparent in consumer mortgages and wider business sectors.

The NAMA deal will swap government bonds for bad loans, allowing banks to deleverage and bolster capital levels depending on what price NAMA extracts. Some say the price will be carefully calculated to maintain capital at legal regulatory requirements. Whatever the outcome after banks have realised their property loan write downs, they face the reality of increasing consumer and business loan defaults.

All eyes are on the price to be paid for toxic loan assets, details it seems will not be divulged for “commercial reasons”. In short the tax payer is being asked to “trust us we know what we are doing” despite a recent history of doing exactly the opposite.

NAMA will become a powerful manipulative force in the property market for years to come as it takes ownership of vast portfolios of land and property. Clear accountable and transparent governance will be required along with proper public oversight. The public should not accept bland assurances of governmental and regulator system whose opacity and failure to regulate led to the property bubble.

NAMA must be made more accountable to taxpayers

One of the critiques of nationalisation is that state owned banks are open to risks of political influence and cronyism.

Surely then NAMA, a state owned “bad bank” is also exposed to the same risks?

Can the Government realistically avoid the threat of cronyism that risks favouring the property speculators at the expense of the taxpayer?

One of the glaring omissions in framing NAMA is not the entity itself but the policy context in which it will live. It is being proposed in a post-bubble policy vacuum that has not sought to understand or apply the lessons from past.

The missing piece is the public enquiry into and appreciation of the reasons why a NAMA has become so necessary for the financial survival of not only the entire banking system but of the economic survival of state itself.

In socialising bank debt, NAMA will mothball property for years in the hope that that once again people will speculate on rising property prices. The higher the price paid by NAMA for the banks loans the larger the required upturn in property values. The unpalatable fact is for it to succeed, property values will once again have to surge in value. Whose interests are served should this happen?

Banks shareholders and certain classes of bond holders are not the only equity investors to benefit from NAMA. During the boom, developers raised private equity through pooled investment schemes promoted by wealth management divisions of stockbroker and other financial intermediaries to their wealthy clients. Banks not only lent to developers but also lent to billions to private investors who took equity stakes in development schemes.

Wealthy professionals such as barristers, lawyers, dentists together with successful businessmen and women, leveraged off their personal balance sheets, borrowing vast sums to take a stake in the latest venture.

Most private equity investors never considered the shareholder risks involved in agreeing to stand first in line to absorb losses. It appears that billions of these private equity “borrow to invest” loans are to be transferred to NAMA. Many investors are facing financial ruin as a result should their loans be called in. Who are these private equity investors and how politically connected and influential are they?

Despite Government’s assertion that NAMA will pursue defaulting borrowers to the “ends of the earth” it will not happen. NAMA will buy loans not based on their near worthless value today but use a formula that mimics a future property market. It will enter into and fund work out arrangements and do so in private. Inherent within this process is a forbearance that buys time for people to protect their wealth and exposes NAMA to powerful influential forces.

For certain those that in the past colluded to manipulate property assets, generating unprecedented wealth for a small number of people, will use their power and influence to protect their wealth.

Public representatives will shortly debate and pass legislation giving birth to a NAMA, in one form or another. How many are private equity investors in property schemes or directly or indirectly exposed to property loan losses and facing financial ruin? It is the public interest that those in positions or power and influence are not conflicted by their own personal financial affairs in deciding on one of the most serious of pieces of legislation.



Before any vote, citizens should be assured that their public representatives’ conflicts of interest, where they exist, have been declared and openly dealt with. Each year, members of the Oireachtas and boards and senior employees of state and semi-state bodies must declare their financial interests. Perhaps, they should also be required to declare their bank borrowings and whether or not they are not they are in default on their loans and will become NAMA clients.

Rarely has banking posed questions of society as it has it Ireland as few societies have ever become so exposed to severe consequences of a bank led economic collapse.

One solution proposed is for a body of eminent respected international experts to oversee and publically report on NAMA as it decommissions billions in toxic debt. It has been done before in another context when other weapons of destruction were being put out of commission.

NAMA is a classic hallmark of "groupthink"

Taoiseach Brian Cowen’s defiance in the face of robust critique by experts of his and Finance Minister Lenihan’s bad bank plan is worrying in the extreme.

Labour’s Joan Bruton has spoken of a “Cowen-Lenihan parliamentary dictatorship that is allowed to rule by decree without scrutiny or amendment”. Politics aside, their behaviour suggests a dangerous psychological phenomenon called groupthink.

Sticking to the plan in the face of disconfirming information is not a hallmark of good leadership. It is a hallmark of groupthink, sometimes called bunker mentality. It occurs when small groups of people become blind to external influence and is an understood facet of poor governmental policy and decision making systems. Disastrous policy decisions have resulted. Examples include the US escalation of the Vietnam War, Watergate, the invasion of Iraq and more recently the global credit crisis.

On the opening day of the Battle of the Somme on 1st July 1916, the Ulster 36th Division was close to breaking through German lines. Spotting the opportunity General Perceval wanted to commit his 49th Division to support the Ulster men and exploit the gains made. But his superior General Morland, who could see the opportunity from his observation post high in a tree, refused as it wasn’t part of the plan. The Ulster men were decimated as the Germans counterattacked due, it is said, to Morland’s inflexibility.

Similarly inflexible Taoiseach Cowen’s insistence in sticking to the NAMA plan ignores the possibility of better alternatives.

Like General Morland both he and Minister Linehan are insisting on sticking to the plan. Yet at least two formidable alternatives have been proposed having substantive support from a wide body of experts. They are Richard Bruton’s Fine Gael good bank/bad bank option and Professor Anthony Honahan’s hybrid called NAMA “2”.

At the heart of Government’s decision making processes may lie a psychological phenomena well understood and guarded against by effective leaders. Called groupthink, it seeks to explain the dangers of small cohesive groups. It seems such groups can have a psychological drive for consensus at any cost that suppresses disagreement and prevents the appraisal of alternatives.

During an Oireachtas committee session enquiring into the causes of Ireland’s banking crisis, a senior Department for Finance Official, when asked to divulge the advice provided to the Minister for Finance, declined as convention was not to divulge such information. He did say the advice reflected the consensus at the time. The Irish consensus and its powerful evocative metaphor of a “soft landing” is an example of groupthink at work.

Bertie Ahern once wondered why sceptics of the soft landing consensus –whom he called moaning minnies- didn’t commit suicide. The sceptic’s warnings were ignored by the small groups who set policy and made decisions in Ireland’s banks, it’s financial regulator, central bank and government.

Such is the small internecine village of Irish business, banking and politics that few if any are ever willing to swim against the tide. It is unlikely that any of the people involved realised the dangers of groupthink and acted to guard against them. Their cosy consensus cross contaminated all groups and none acted to prevent what was a predictable and inevitable outcome of a credit fuelled, construction led boom in consumption.


Economist, Colm McCarthy has rightfully called for an enquiry into what went wrong in Irish banking. There are many answers to what went wrong during the latter stages of the Celtic Tiger. If groupthink with its drive for consensus at any cost is one explanation then the danger is this behaviour is embedded in the way government continues to be led, for most of the same actors remain on stage.

One of the critical aspects of groupthink is poor decisions made under pressure invariably result in poor outcomes. Crisis decision making by one such small group last September when Government pledged the wealth of the state in support of the banks may have been groupthink behaviour.

Having hoisted their petard called NAMA, Taoiseach Brian Cowen and Minister Brian Linehan should be mindful of another leadership lesson from the past. When faced with critical decisions during the Cuban Missile crisis US President Kennedy ensured that his decision group was not exposed to the risk of group think.

The hallmark of great leaders is their capacity to guard against the dangers of groupthink through including for diverse views, testing assumptions and enquiring into alternatives when reaching decisions. Defiance, obduracy and unwillingness to accommodate alternatives to NAMA is worrying as it suggests that the phenomenon of groupthink is a feature of Irish governmental decision making.


Note:
Groupthink occurs when a group makes faulty decisions because group pressures lead to a deterioration of “mental efficiency, reality testing and moral judgement”. Its symptoms include amongst others; Illusions of invulnerability - creating excessive optimism that encourages taking extreme risks; Collective rationalisation - where people discount warnings and do not consider assumptions; Belief in inherent morality – groups believing in the righteousness of their cause, ignore the ethical or moral consequences of their decisions; Pressure on dissenters - where people are under pressure not to express arguments against any of the group’s views ;Self-censorship - where doubts and deviations from the perceived consensus are not expressed. Self-appointed “mindguards” - where other people protect the group and the leader from information that is problematic or contradictory to their cohesiveness, views and decisions.

Stabilising our banking system is key to the national interest

Government’s strategy to stabilise Ireland’s banks and make them work again has a wider national interest dimension as the national banking system could become dominated by foreign owned banks.

Of all banking systems Irelands’ is the most acutely damaged. No other government is faced with tackling the insolvency of all its domestic banks. Few countries have had to support their entire banking system to the degree Ireland has been required to do and will be required to do for the immediate future. Much public concern and commentary has been focussed on Government’s strategy of adapting a bad bank model whilst eschewing temporary nationalisation.

Much as people would prefer banks were forced to book losses in full, the systemic risks posed by their imprudent exposure to a handful of large borrowers means that choices are limited in the extreme. NAMA may not be the only option but for now it appears to be the only game in town.

Debate is focussed on how best to structure the clean up to limit tax payers’ costs, with public opinion highly sensitised to the price to be paid by NAMA for developers debts. Government may yet fall should it not convincingly sell its banking strategy. No one, including Government is adequately addressing what form of national banking system will be required and how its regulation, governance, ownership and control may be optimally structured to support economic recovery.

Having a workin banking system is critical. Cleaning up banks or arranging for new banks that work is key. The banking system is in a perilous state as a consequence of an economic policy that facilitated a bank credit fuelled, construction led boom in domestic consumption.

The hope is that the rising tide of global recovery will once again lift all boats including Ireland’s. The risk is recovery will be too weak, more so if predictions of a double dip recession triggered by rising commodity, food and oil prices come to pass.

Sorely damaged, the economy will struggle to recover in the face of fiscal constraints, a mountainous national debt, mass unemployment, increased taxation together with consumer and business reluctance to spend and invest. In the throes of a deflationary spiral Government is leaving the prospect of additional state equity support for banks, or temporary nationalisation, quietly on the table.

So far Government has deploying an escalating stabilisation strategy through its blanket guarantee, emergency capitalisation of AIB and Bank of Ireland, nationalisation of Anglo Irish Bank and NAMA bad bank approach. Rather like an earthquake the first shock wave serious damaged banks property lending portfolios. But powerful after shocks impacting commercial real estate loans, but-to-let lending, home mortgages, small business and consumer lending are exposing banks to further losses.

The IMF, anticipating losses yet to be realised as the wider economy contracts, advised extending NAMA’s powers to buy up other assets. It also advises temporary nationalisation as responsive strategy should banks be insolvent as a consequence of bad debt buy outs.

For Irish banks the headline data is ominous. House prices will fall by 50% and housing completions will drop to 10,000 next year from a height of 70,000. Residential rents are down over 20% forcing investors to default. Commercial property vacancies are climbing, rents are falling as yet to be completed buildings add to a massive stock pile of “see through” vacant buildings. Unemployment may reach 540,000 next year. Tens of thousands of homeowners are in negative equity. Private sector credit is contracting as consumers and business increase savings and pay down debt. New car sales have shrunk dramatically. Retail sales are falling and VAT receipts are down. Governments’ revenue targets, set in April will not be reached.

The elephant in the room no one has attempted to synthesise the scale of economic downturn and banking system capacity required to support recovery. The real problem is not just how bad things will get but how the economy responds to improving global circumstances. Downsizing may rob the country of the resources needed when times improve. Through what economists call the gap between actual and potential output, should national resources shrink to match actual output at far lower levels of activity then there may be no capacity to aid recovery.

One of the national resources required is a functioning banking system. A critical dilemma faced by Government is how to ensure that any reconfigured banking system that evolves is not dominated by foreign owned banks. Some observers maintain the national interest requires that at least one major bank remains headquartered in Ireland and is predominantly national in focus. As Government rolls out its bank stabilisation strategy it may also have an eye on the design of the new banking system and how to ensure the national interest is protected. Governments elsewhere have been known to hold strategic stakes in banks to ensure a functioning banking system is not captive of the constraints of foreign owned banks.