Bank enquiry must examine causes not symptoms

Is the fear of discovering the underlying reasons for the financial crisis behind the delay in any enquiry, asks Bill Hobbs

Should the soon to be announced banking enquiry focus only on the symptoms and not the underlying causes, politicians may sow the seeds of another crisis worse then the one being experienced. The power of banking to expropriate and destroy financial resources has to be controlled, with the domestic banking sector shrunk to a size where it can never again wreak such economic damage.

Having concluded and published a number of enquires; the British have not only identified the causes, but are busy implementing change. Why the procrastination and obfuscation here?

Is it the case our public institutions do not have the independence, objectivity, intellectual resources or capacity to enquire and report into what went so badly wrong? Or is the case that some fear that the known underlying causes will be officially unearthed? Can our public institutions and its political leadership honestly and openly enquire into and appreciate the root causes of the banking crisis? Or will the enquiry be skewed towards conveniently determining negligence of a handful of retired bankers, regulators and civil servants?

Lauded as a benchmark model, the DIRT enquiry officially exposed a scandal privately known of for years. It allowed the state to retrospectively determine negligence and extract tax revenue foregone - knowingly - by previous Governments. But it did not lead to any real reform of the relationship between banking, the state, its public institutions and their weak public governance of banking.

It is known as Irish banks increased both the size and leverage of their balance sheets they threatened the stability of the whole system and were not prevented from doing so. And it was known that in a crisis they would become extraordinarily dependent on the state and tax-payer for support.

Mervyn King, Governor of the Bank of England recently asked “why were banks so willing to take risks that proved so damaging to themselves and the rest of the economy?” In answer he said “one of the key reasons is that incentives to manage risk and increase leverage were distorted by the implicit support or guarantee provided by government to creditors of banks seen too important to fail”

His reasoning is just as relevant here where Irish banks and their creditors knew that if they were sufficiently important to the economy and the financial system, and if things went wrong, then the Government would always stand behind them. They were “too important to fail” and were proved right in September 2008. Since then massive, unsustainable state support has created a huge dilemma. In Mervyn King’s words “the too important to fail problem is too important to ignore”

Irish bank owners and their managers benefited enormously when things went well. But limited liability status means their losses are for the tax payer’s purse. Governments worldwide have found out that their banks have become so big in relation to their economies that they cannot rescue them without seriously damaging economic growth. Many say that unless bank’s historical destructive tendency to cause economic crisis is controlled, an even bigger, more expensive crisis will happen.

Current wisdom holds that “too important to fail banks” should either be controlled so the probability of failing is extremely low or ways found to allow them to fail without imposing additional costs to society.

What are the implications for banking policy here? Our three main banks are in the “too important big to fail” category. And given inhibitive costs to society, Anglo Irish Bank cannot be safely allowed to fail. Irish banks have become too big for the state to support. The domestic banking system will have to be shrunk to an affordable size before long term financial stability will be achieved.

Our economic crisis was caused by a bursting property bubble, overexpansion in credit by Irish owned banks and their excessive risk taking. But beneath the surface of the banking crisis and its symptoms lies a serious issue that may not be enquired into. Our public institutions both political and regulatory were far too weak to prevent the expropriation of financial resources by two powerful elites – banking and property speculators. Weak public governance cannot prevent boom/bust cycles and causes frequent crisis which become more severe. Irish political and institutional leadership did nothing to control and effectively encouraged bank moral hazard behaviours to drive an unsustainable economic boom.

The Irish state became subsidiary of banking rather than the other way round. We are not alone in this. Across the world discussion is focussed on the power of banking and finance and how to control for its tendency to destroy whole economies. People are struggling with the too important to fail and too expensive to bail out dilemmas.

If a small regional economy can never afford to bail out its banks without incurring massive economic and social costs then what size banking system can the state fiscally support and what form this should take? In effect a new “fit for purpose” banking system has to be synthesised, designed and constructed.

If we are not to return to a time when we exported people we must once again become an export driven economy. Domestic wealth creation through property based boom/bust cycles must be a thing of the past. For this to happen, our banking system has to subsidiary to the national interest. No longer should banking and finance exercise disproportion economic power nor can its managers and owners trade recklessly off the good name and standing of the state and its citizens. This will require a new form of regional bank, ring fenced and controlled to craft a banking system that works in the national interest.

Will the enquiry ask the hard questions; establish the brutal facts and the Oireachtas subsequently act resolutely to effect changes? In the quest to find out who was responsible for the crisis politicians may be determined to attribute negligence of others. Should their public enquiry focus only on the symptoms and not the underlying causes the seeds of another crisis worse then the one being experienced may be sown.