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.
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