Somewhat tongue in cheek, Carlo Cipolla's essay into stupidity provides thoughtful insights, writes Bill Hobbs
The ratio of stupid people to non-stupid people is the same no matter what size group we belong to and stupid people are the most dangerous of all. So wrote economist Carlo Cipolla, in his intriguing short essay “The Basic Laws of Human Stupidity”.
His five basic laws are that (1) a stupid person is a person who causes losses to others while deriving no gain and even incurring losses for himself/herself, (2) we always underestimate the numbers of stupid people in circulation, (3) stupidity is independent of other characteristics, whatever the size of the group and no matter how well educated we find the same fraction of stupid people, (4) non-stupid people always underestimate the power of stupid people and constantly forget that dealing with them always turns out to be a costly mistake and (5) a stupid person is the most dangerous type of person.
To illustrate the destructive power of stupidity, Cipolla wrote of groups being made up of four types of people - the helpless person who benefits others with no gain or even losses for themselves - the intelligent person who does things that benefits them and others equally and two others who appear to loom large in our public narrative -the stupid person, and the bandit or pillager.
If a stupid person causes losses for both themselves and others, then a bandit acts for personal gain at the expense of others. In the extreme, bandits pillage - transferring wealth from society to themselves. Theoretically, if a society was made up solely of bandits then that it would neither be better or worse off, as gains and losses would balance out. In the real world, Cipolla reckoned that while the fraction of stupid people was a constant, their capacity to wreak havoc was amplified by the numbers of bandits acting with overtones of stupidity.
He suggested that limiting the losses wrought by stupid people and bandits depends on a counter-weight, the number of intelligent people acting. The greater the number of intelligent people the better a country will do. However as there will always be the same fraction of stupid people, if in the remaining population there is an alarming proliferation of bandits, then the composition of stupid people and non-stupid bandits will cause a decline in a country’s well being.
He wrote of how bandits, who are not stupid people, engage in activities that become stupid. For example bandits might make payments to politicians in the expectation of some form of gain or favour. The politicians may personally incur a gain. But these gains could become a loss if the payments are found to have been corrupt payments.
Does this mean the politicians are stupid people or acting as bandits with overtones of stupidity? As a politicians’ gain at the expense of society is undone over time and they incur losses, it’s probably the latter - they gain until they are found out. Perhaps then Cipolla would rate the making and receiving of corrupt payments as the action of bandits rather than stupid people.
Somewhat tongue in cheek, Cipolla’s essay provides thoughtful insights. Particularly when combined with the way we deal with memory and recall. We are not precise at recall, nor are our memories concise. We tend to recall the gist of events and make things up to fill gaps in our fuzzy memories. We fabricate stories to support and explain our previous actions. And we will do so even when faced with proof these actions didn’t happen in the way we think they did. This process is called confabulation – we construct a story from fuzzy memories. So compelling is our narrative that we then come to believe is the true version of events.
So, much of what we hear of people’s retelling of events are their stories which are frequently based on their delusion of the past rather than what may have actually occurred. For example, if our original intent and motivation was to act as a bandit and not an intelligent person, then when challenged to explain our actions we may confabulate. And our story will become so real to us.
Recognising people’s capacity to confabulate, we seek to impartially and objectively enquire into the past - to try to discern some reality from confusion.
Cipolla wrote of how non-stupid and stupid people when acting in consort cause losses for society and undermine the development of a country. Could one lens through which to view enquiries into stories people tell of the past be to use his laws Basic Laws on Human Stupidity? They may be useful in contrasting what would be the story expected of the intelligent person to those of stupid people and bandits.
A version of this article appeared in the Irish Examiner, Business Edition, Monday 28th March 2011
Tuesday, March 29, 2011
Monday, March 21, 2011
Credit must flow or economy faces long downturn
Credit supply to business is the key to growth, but the cure may be painful, writes Bill Hobbs
The outcome of a credit boom, banking crisis and real estate boom-bust cycle is what we are now seeing emerge – a creditless recovery.
Writing of creditless recoveries, the authors of a recent IMF paper found that they tend to be weaker and more protracted with economic growth on average one third lower than normal recoveries. They also report that many creditless recoveries are followed by years of stagnant growth.
It’s clear that without working banks providing a supply of affordable credit to productive enterprises and consumers, recovery here will be anaemic and largely jobless. In a creditless recovery, stagnant economic performance will push this country towards sovereign default. There won’t be enough fuel to fund the revenue tank to finance an unaffordable mountain of sovereign debt, bank losses and recapitalisation costs. Since 2008, normal financial intermediation has all but stopped and there is only one solution. And that is to get commercial banking working again at a cost this country can afford.
Economic growth rates, predicted under government’s recovery programme, are predicated on getting credit flowing again. Much of the emphasis is being put on an export led recovery. But, while multinationals don’t rely on our domestic banking system, an export led recovery won’t happen unless indigenous exporters, who are highly dependent on bank credit, have access to a supply of affordable short and long term bank loans. The same is true of almost all of the non-export sectors. Indigenous Irish businesses are acutely exposed in a creditless scenario as they have a disproportionate reliance on bank credit compared to their peers in other advanced countries. While Government is planning a small business loan guarantee scheme, it will only work if there’s a supply of credit and working banking system.
Restoring the supply of affordable credit will mean fixing some of our banks by pumping them full of fresh untainted capital to meet future trading conditions. But first their loan losses have to be paid for.
After three years of one of the worst recorded banking crisis, the wholesale destruction in collateral values underpinning banks boom time lending has not yet been accurately quantified.
The Central Bank is trying to estimate how much it will cost to make banks whole again. Its capital assessment review is expected to establish the mountain of capital required to fund expected loan losses and the higher levels required by banks if they are to retain a banking licence. Along with its close cousin the liquidity review, the outcome will set the scene for rebuilding the banking system using the new banking resolution laws.
Last week, the Bank published the base and stress case economic assumptions being used by its expert consultants to scrutinise troubled bank’s loan books. These economic assumptions have to be translated into expected loan losses. And there’s a problem as real estate collateral values are hard to pin down. Without enough people willing to buy, with banks unwilling to lend, without a national price data base and unknown future demand, it’s a classic black box. Furthermore plans to outlaw “upward only” rent reviews on commercial property will cause value to drop. And reforming bankruptcy laws - making it easier for people to earn a fresh start will negatively impact on expected loan losses. There are hints the consultants are considering a US style, property repossession loss scenario. Noises off stage are quietly softening us up for some pretty shocking figures.
The outcome will set the scene for the inevitable restructuring of banks which may include consolidating the good bits of some with others to make them whole again. Banks will also be expected to bring their loan to deposit ratios down, which is a herculean task, given that their foreign and domestic deposits continue to haemorrhage and their main largest depositors are the ECB and Central Bank.
The cost of getting banking working again and restoring the supply of credit to business and consumers will come at a price that this country simply cannot afford. The resolution for our banking system will largely depend on what happens at EU level. It could well be that the outcome of the Central Bank’s review may finally unravel the EU policy of protecting bondholders at all costs. If so bond holders would have to first share the pain of the bust, before sharing in any economic recovery. These include Irish institutional investors such as pension funds and credit unions.
Whatever the outcome over the next year, one thing is absolutely essential. To convert a creditless recovery into one that will sustain the growth required if this country is to pay its way and retain its sovereign status as a creditworthy state, credit supply to indigenous Irish businesses must be restored. And for this to happen some of the banks must be made whole again.
A version of this article appeared in the Irish Examiner, Business Edition, Monday 21st March 2011
The outcome of a credit boom, banking crisis and real estate boom-bust cycle is what we are now seeing emerge – a creditless recovery.
Writing of creditless recoveries, the authors of a recent IMF paper found that they tend to be weaker and more protracted with economic growth on average one third lower than normal recoveries. They also report that many creditless recoveries are followed by years of stagnant growth.
It’s clear that without working banks providing a supply of affordable credit to productive enterprises and consumers, recovery here will be anaemic and largely jobless. In a creditless recovery, stagnant economic performance will push this country towards sovereign default. There won’t be enough fuel to fund the revenue tank to finance an unaffordable mountain of sovereign debt, bank losses and recapitalisation costs. Since 2008, normal financial intermediation has all but stopped and there is only one solution. And that is to get commercial banking working again at a cost this country can afford.
Economic growth rates, predicted under government’s recovery programme, are predicated on getting credit flowing again. Much of the emphasis is being put on an export led recovery. But, while multinationals don’t rely on our domestic banking system, an export led recovery won’t happen unless indigenous exporters, who are highly dependent on bank credit, have access to a supply of affordable short and long term bank loans. The same is true of almost all of the non-export sectors. Indigenous Irish businesses are acutely exposed in a creditless scenario as they have a disproportionate reliance on bank credit compared to their peers in other advanced countries. While Government is planning a small business loan guarantee scheme, it will only work if there’s a supply of credit and working banking system.
Restoring the supply of affordable credit will mean fixing some of our banks by pumping them full of fresh untainted capital to meet future trading conditions. But first their loan losses have to be paid for.
After three years of one of the worst recorded banking crisis, the wholesale destruction in collateral values underpinning banks boom time lending has not yet been accurately quantified.
The Central Bank is trying to estimate how much it will cost to make banks whole again. Its capital assessment review is expected to establish the mountain of capital required to fund expected loan losses and the higher levels required by banks if they are to retain a banking licence. Along with its close cousin the liquidity review, the outcome will set the scene for rebuilding the banking system using the new banking resolution laws.
Last week, the Bank published the base and stress case economic assumptions being used by its expert consultants to scrutinise troubled bank’s loan books. These economic assumptions have to be translated into expected loan losses. And there’s a problem as real estate collateral values are hard to pin down. Without enough people willing to buy, with banks unwilling to lend, without a national price data base and unknown future demand, it’s a classic black box. Furthermore plans to outlaw “upward only” rent reviews on commercial property will cause value to drop. And reforming bankruptcy laws - making it easier for people to earn a fresh start will negatively impact on expected loan losses. There are hints the consultants are considering a US style, property repossession loss scenario. Noises off stage are quietly softening us up for some pretty shocking figures.
The outcome will set the scene for the inevitable restructuring of banks which may include consolidating the good bits of some with others to make them whole again. Banks will also be expected to bring their loan to deposit ratios down, which is a herculean task, given that their foreign and domestic deposits continue to haemorrhage and their main largest depositors are the ECB and Central Bank.
The cost of getting banking working again and restoring the supply of credit to business and consumers will come at a price that this country simply cannot afford. The resolution for our banking system will largely depend on what happens at EU level. It could well be that the outcome of the Central Bank’s review may finally unravel the EU policy of protecting bondholders at all costs. If so bond holders would have to first share the pain of the bust, before sharing in any economic recovery. These include Irish institutional investors such as pension funds and credit unions.
Whatever the outcome over the next year, one thing is absolutely essential. To convert a creditless recovery into one that will sustain the growth required if this country is to pay its way and retain its sovereign status as a creditworthy state, credit supply to indigenous Irish businesses must be restored. And for this to happen some of the banks must be made whole again.
A version of this article appeared in the Irish Examiner, Business Edition, Monday 21st March 2011
Saturday, March 19, 2011
Credit union sector needs real reform if it is to survive
The termination by the Central Bank of a credit union strategic review process, originally requested of it by Finance Minister Brian Lenihan in late 2009, comes as no surprise.
In the intervening fourteen months, in line with expected outcomes, credit union financial stability has progressively worsened.
Predictably these outcomes are a result of a combination of credit union boom time investment strategy, poor lending practices and a post-boom economic recession. Given that a credit union’s ability to generate sufficient profits to pay a decent dividend is the primary indicator of financial stability and sustainability, the dividend outcome for last year is quite telling. Three out of four paid less than 1%. One in five was unable to pay any dividend at all.
Yet the full impact of loan losses has yet to be realised as many credit unions kicked the can down the road by rescheduling troubled loans. With loan arrears breaching 15% and heading for 20%, using last June’s regulatory stress test parameters, total sectoral losses could reach €1.7bn. This figure is the mid-range of stress tested loan losses and estimated investment losses to date.
However loss estimates could be higher. Significantly under-lent, credit unions have holdings of close to €1.3bn in bank bonds of which about €300m is in subordinated paper. These could be exposed to losses under new bank resolution rules.
Since late 2009, the worsening economic recession and Central Bank intervention have exposed badly governed and managed operations. The bank’s robust requirements of credit unions to rebuild capital buffers, provide properly for bad debts, restrict lending and manage liquidity along with the impact of escalating bad debts and collapsing demand for new loans have eroded profitability to a point where the continuing independence of many credit unions is highly unlikely. As everywhere else, badly governed and managed credit unions are either shut down or merged with others, the new bank resolution laws will provide the Government with powers to respond to this eventuality. It will have the power not only to arrange for closures and mergers of credit unions with others but will also be able to order a bank to takeover their operations.
Meanwhile the Irish League of Credit Unions, having seriously dented its small bailout fund of €119m in supporting just twenty of its over five hundred affiliates, is probably left with a little over €30m in uncommitted funds. It is now asking credit unions to double their contributions to its fund to about €16m a year. But as it’s quite clear that the fund is wholly insufficient to meet the likely scale of financial stablisation support required, tax-payer’s funds could be at stake. Depending on the severity of financial stress, the cost of state support could come to well over €500m.
In the past six months two significant developments have also overtaken the strategic review. Firstly the EU/IMF programme required the Central Bank to not only to stress test the banks but to also stress test credit unions and implement a stablisation plan by the end of the year.
Secondly, many observers considered the strategic review to have been an abdication of ministerial responsibility to define policy concerning the sector. It seems the new government considers credit unions of some importance and is to set up a credit union commission.
If taxpayers’ funds are to be committed and if credit unions are to have a role in any future domestic banking system then a commission will need to be given the powers to ensure that credit unions finally deliver on long overdue reforms.
A version of this article appeared in the Irish Examiner, Business Section, Saturday 19th March 2011.
In the intervening fourteen months, in line with expected outcomes, credit union financial stability has progressively worsened.
Predictably these outcomes are a result of a combination of credit union boom time investment strategy, poor lending practices and a post-boom economic recession. Given that a credit union’s ability to generate sufficient profits to pay a decent dividend is the primary indicator of financial stability and sustainability, the dividend outcome for last year is quite telling. Three out of four paid less than 1%. One in five was unable to pay any dividend at all.
Yet the full impact of loan losses has yet to be realised as many credit unions kicked the can down the road by rescheduling troubled loans. With loan arrears breaching 15% and heading for 20%, using last June’s regulatory stress test parameters, total sectoral losses could reach €1.7bn. This figure is the mid-range of stress tested loan losses and estimated investment losses to date.
However loss estimates could be higher. Significantly under-lent, credit unions have holdings of close to €1.3bn in bank bonds of which about €300m is in subordinated paper. These could be exposed to losses under new bank resolution rules.
Since late 2009, the worsening economic recession and Central Bank intervention have exposed badly governed and managed operations. The bank’s robust requirements of credit unions to rebuild capital buffers, provide properly for bad debts, restrict lending and manage liquidity along with the impact of escalating bad debts and collapsing demand for new loans have eroded profitability to a point where the continuing independence of many credit unions is highly unlikely. As everywhere else, badly governed and managed credit unions are either shut down or merged with others, the new bank resolution laws will provide the Government with powers to respond to this eventuality. It will have the power not only to arrange for closures and mergers of credit unions with others but will also be able to order a bank to takeover their operations.
Meanwhile the Irish League of Credit Unions, having seriously dented its small bailout fund of €119m in supporting just twenty of its over five hundred affiliates, is probably left with a little over €30m in uncommitted funds. It is now asking credit unions to double their contributions to its fund to about €16m a year. But as it’s quite clear that the fund is wholly insufficient to meet the likely scale of financial stablisation support required, tax-payer’s funds could be at stake. Depending on the severity of financial stress, the cost of state support could come to well over €500m.
In the past six months two significant developments have also overtaken the strategic review. Firstly the EU/IMF programme required the Central Bank to not only to stress test the banks but to also stress test credit unions and implement a stablisation plan by the end of the year.
Secondly, many observers considered the strategic review to have been an abdication of ministerial responsibility to define policy concerning the sector. It seems the new government considers credit unions of some importance and is to set up a credit union commission.
If taxpayers’ funds are to be committed and if credit unions are to have a role in any future domestic banking system then a commission will need to be given the powers to ensure that credit unions finally deliver on long overdue reforms.
A version of this article appeared in the Irish Examiner, Business Section, Saturday 19th March 2011.
Monday, March 14, 2011
Real people with debts need real help, not just talk.
Ministers must start delivering solutions to the consumer debt crisis, writes Bill Hobbs
Surely a new broom means more than fitting a different handle to an old worn out brush? One new Minister when questioned over the weekend on a long delayed, important report said it would be published shortly. The word “shortly” is civil service speak for “how long is a piece of string”. What about the word “delivery”?
Delivery means responding to people’s real needs now. And it’s high time to get real about delivering solutions to the consumer debt crisis. The crisis is like an iceberg, the closer you get to it, the bigger it gets. And with two thirds hidden beneath the surface, you can only guess at its catastrophic impact.
Officially, according to the Central Bank’s visible iceberg data, nearly 100,000 households, “real” people, are suffering “real” mortgage debt stress. On average, distressed homeowners already owe €100,000 more than they can ever hope of repaying. Boom time homebuyer’s who can afford repayments, will have to wait until 2024 before their loan equals their home value when, if lucky, their home will be worth just about what they paid for it in 2007. The Central Bank’s data is silent on the mountain of distressed personal and small business loans. Utility companies are cutting off the population of a small town every month.
As the banks are not telling it as it is, no one knows how bad the debt crisis has and will become. The Central Bank has admitted Anglo Irish Bank only came clean on its debt after it had been told to wind down. Ominously, three out of four credit unions are suffering from varying degrees of financial stress as their customers can no longer make their loan repayments.
Out of every four households, one said they had or would a problem in paying their debts in 2010. Most of the rest said they did not feel financially secure. Financial vulnerability is worsening as recent tax increases are stripping households of disposable income. With people already paying 3% more on their mortgages than their European neighbours, ECB interest rate increases, rising inflation and declining take home pay many more will join those struggling with unaffordable debt this year.
Until now the official response has been to delay the impact of consumer debt losses on the banks by making it easy for them not to have to repossess homes. But debt forbearance is like freezing rancid meat in the hope it will somehow thaw out as fresh meat. Steps taken so far to respond to the crisis have been ineffective. Critical of the last Government’s mortgage debt group report, this Government’s programme for government document says it didn’t go far enough. It’s right - the group’s recommendations were merely solvency management tools for troubled banks.
Real people, have real debts they have no hope of ever repaying. Far too many have become easy prey for unregulated, profiteering debt management companies that falsely promise they can have debs written off. Meanwhile with growing queues’ MABS is struggling to respond to the demand for its debt management services. It neither has the proper mandate or resources to provide the level of professional social protection services needed to deal with the scale of the debt crisis.
Social protection means providing a proper financial safety for people faced with personal insolvency or threatened by it. There must be laws and supporting processes through which ordinary people can earn the right to debt forgiveness. After all, it’s a basic right found everywhere else. The good news is, thanks to the Law Reform Commission, the high level design is ready to go and it can be implemented within a year.
That’s if this Government for National Recovery does what it says on the tin. Delivery will require Social Protection Minister, Joan Burton to cut a swathe through three years of abject obfuscation and procrastination. Urgent and important, there’s no reason why a national debt management service should not be in place by the end of this year.
Right now there is nothing to stop the Minister from transforming MABS into a modern fit for purpose national debt management service. Applying the principle of the polluter pays, banks and other creditors should be made fund its development and operating costs. Its services should continue to be provided free to indebted customers, who should have the legal right to its services. The enabling personal insolvency and debt settlement legislation recommended by the Law Reform Commission should be fast tracked and delivered on it in tandem with the development of MABS.
A version of this article appeared in the Irish Examiner, Business Section, Monday 14th March 2011.
Surely a new broom means more than fitting a different handle to an old worn out brush? One new Minister when questioned over the weekend on a long delayed, important report said it would be published shortly. The word “shortly” is civil service speak for “how long is a piece of string”. What about the word “delivery”?
Delivery means responding to people’s real needs now. And it’s high time to get real about delivering solutions to the consumer debt crisis. The crisis is like an iceberg, the closer you get to it, the bigger it gets. And with two thirds hidden beneath the surface, you can only guess at its catastrophic impact.
Officially, according to the Central Bank’s visible iceberg data, nearly 100,000 households, “real” people, are suffering “real” mortgage debt stress. On average, distressed homeowners already owe €100,000 more than they can ever hope of repaying. Boom time homebuyer’s who can afford repayments, will have to wait until 2024 before their loan equals their home value when, if lucky, their home will be worth just about what they paid for it in 2007. The Central Bank’s data is silent on the mountain of distressed personal and small business loans. Utility companies are cutting off the population of a small town every month.
As the banks are not telling it as it is, no one knows how bad the debt crisis has and will become. The Central Bank has admitted Anglo Irish Bank only came clean on its debt after it had been told to wind down. Ominously, three out of four credit unions are suffering from varying degrees of financial stress as their customers can no longer make their loan repayments.
Out of every four households, one said they had or would a problem in paying their debts in 2010. Most of the rest said they did not feel financially secure. Financial vulnerability is worsening as recent tax increases are stripping households of disposable income. With people already paying 3% more on their mortgages than their European neighbours, ECB interest rate increases, rising inflation and declining take home pay many more will join those struggling with unaffordable debt this year.
Until now the official response has been to delay the impact of consumer debt losses on the banks by making it easy for them not to have to repossess homes. But debt forbearance is like freezing rancid meat in the hope it will somehow thaw out as fresh meat. Steps taken so far to respond to the crisis have been ineffective. Critical of the last Government’s mortgage debt group report, this Government’s programme for government document says it didn’t go far enough. It’s right - the group’s recommendations were merely solvency management tools for troubled banks.
Real people, have real debts they have no hope of ever repaying. Far too many have become easy prey for unregulated, profiteering debt management companies that falsely promise they can have debs written off. Meanwhile with growing queues’ MABS is struggling to respond to the demand for its debt management services. It neither has the proper mandate or resources to provide the level of professional social protection services needed to deal with the scale of the debt crisis.
Social protection means providing a proper financial safety for people faced with personal insolvency or threatened by it. There must be laws and supporting processes through which ordinary people can earn the right to debt forgiveness. After all, it’s a basic right found everywhere else. The good news is, thanks to the Law Reform Commission, the high level design is ready to go and it can be implemented within a year.
That’s if this Government for National Recovery does what it says on the tin. Delivery will require Social Protection Minister, Joan Burton to cut a swathe through three years of abject obfuscation and procrastination. Urgent and important, there’s no reason why a national debt management service should not be in place by the end of this year.
Right now there is nothing to stop the Minister from transforming MABS into a modern fit for purpose national debt management service. Applying the principle of the polluter pays, banks and other creditors should be made fund its development and operating costs. Its services should continue to be provided free to indebted customers, who should have the legal right to its services. The enabling personal insolvency and debt settlement legislation recommended by the Law Reform Commission should be fast tracked and delivered on it in tandem with the development of MABS.
A version of this article appeared in the Irish Examiner, Business Section, Monday 14th March 2011.
Sunday, March 13, 2011
Failing credit unions must adapt for good of consumers
Only fit-for-purpose co-operatives can provide a viable alternative for consumers and small businesses.
With three out of four credit unions experiencing varying degrees of financial stress and the Central Bank undertaking a full assessment of their loan portfolios by the end of April, the new government faces making a policy decision on the sector’s future. Will the reformed domestic banking system include a co-operative banking network?
Having already lost hundreds of millions in imprudent investments, credit unions are reeling from boom-time poor lending outcomes. With arrears at 15% and heading for 20%, loan losses could amount to well over €1bn.
There’s also an elephant in the room: credit unions have Irish bank bond holdings of about €1.3bn of which €300m is in subordinated paper. If they sell now they will realise immediate losses, but if they hold on they may face haircut losses under new bank resolution rules.
The Irish League of Credit Union’s, having seriously dented its small bail out fund of €119m in supporting just 20 of its troubled affiliates, is now asking credit unions to double their contributions to its fund.
Recent regulatory requirements to rebuild capital buffers, provide for bad debts, restrict lending and manage liquidity have stripped the credit union dividend cupboard bare. Dividend rates are the key indicator of financial stability for credit unions. Three quarters of them are paying less than 1% with one in five paying nothing. There is a distinct danger that the combination of assertive regulatory medicine, liberally applied since 2008 and EU/IMF programme requirements could kill off even healthy patients.
Everywhere else, badly governed and managed credit unions are either shut down or merged with others. Whether as a strategic consolidation to create a working credit co-operative system or a haphazard crisis containment exercise, closures and mergers are inevitable. Either way tax payers' funds will have to be used. Depending on the severity of financial stress, this could amount to well over €500m. Should this money be used invest in building something that works or to try to fix something irreparably damaged?
In propagating the myth that they are not banks, credit unions are claiming their ways of doing business are not appreciated by government and the regulator. But neither are they appreciated by their credit co-operative peers elsewhere, who cannot quite understand why Irish credit unions have been incapable of maturing beyond their start- up business model.
The fundamental problem is that credit unions have not been governed and managed as they should have been. With only one in ten voluntary directors having a financial background, there are far too many badly run credit unions, providing poor quality expensive products to far too few people. If they are to play an important part in a working banking system, they will have to transform - radically.
A modern, fit for purpose co-operative system, could provide a nationally owned consumer and small business banking alternative. Examples already exist. They are called federated networks and they are the heart of successful co-operative banks across the world.
These networks are distinguishable by their many small independent credit co-operatives which, through contractual obligations and cross guarantees, are leveraging off a combined balance sheet. They own a central banking operation that provides the financial resources, operational capacity and professional competence to enable them to provide a full banking service to their customers who are also their owners. The Netherland’s Rabobank is one such network.
Federated networks treat community capital as an inter-generational endowment to be protected and enhanced by one generation of owners and managers to hand on to the next generation. As their owners are also their customers, they are not driven by the short term demands of external shareholder’. Expert at governing and running co-operative banks, their long term customer advocacy focus meant they were resilient in the face of recent global and domestic challenges.
Irish credit union’s dated business model and league system acted as value destroyers of community capital. Had they been structured, governed and managed as federated banking co-operatives, over the past decade they might have generated over €2 billion in additional surpluses which would have buffered them against the economic downturn, more than covered modernisation costs and critically, provided a working banking alternative today. Instead they are financially stressed and could will incur losses of close to €1.7bn, according to some estimates.
What could a federated model look like here? Let’s fast forward to 2020. The Irish credit co-operative banking system has consolidated from 412 down to 50 independently governed, professionally managed credit unions, each with its own multi-branch footprint, offering a full banking service to consumers and small businesses. These credit unions own a central banking facility providing wholesale market access, liquidity and loan securitisation.
The facility, originally constructed from redundant commercial banking resources, also provides a full range of corporate services, acts an outsourced regulatory agent, and provides IT and operational systems along with remote and internet banking channels.
Through contractual obligations and cross guarantees, credit unions have ceded autonomy to better serve their customers.
Can it be made happen? Yes, but credit unions will not be able to make this change on their own. They will need determined government intervention and funding through a suitably empowered change agent.
When warned of an urgent need to reform the sector as far back as 2006, the then finance minister, Brian Cowen, deftly kicked the ball onto the regulator’s pitch. Last year, his successor Brian Lenihan similarly abdicated responsibility for defining policy by requiring the Central Bank to carry out a strategic review instead. With the EU/IMF programme requiring the Central Bank to establish credit union capital adequacy requirements and implement a stabilisation plan, the review is now on hold.
For now it seems this government considers credit unions of some importance and is to set up a credit union commission. Who knows? Maybe will have the power to design and deliver on the necessary changes, which may even include transforming credit unions into modern working federated network.
A version of this article appeared in the Sunday Business Post, Markets Section on Sunday March 13th 2011
Monday, March 7, 2011
Debt-management companies must be regulated
Vulnerable consumers need to be protected from firms making false statements, writes Bill Hobbs
Will anything be done to regulate a financial service that feeds off people’s fears and financial insecurity? Should dangerous financial products, not covered by our consumer protection laws and regulations, be permitted to be sold?
While the last Government procrastinated in responding to the consumer debt crisis, debt management companies started selling dangerous products to financially vulnerable consumers under the nose of state consumer protection agencies.
Many of these companies are engaging in abusive marketing, making false and misleading statements and not disclosing their product’s risks or costs. They market “free” advice and consultations to prospect for their commission driven sales forces. It’s a manipulative soft sell. Playing on people’s worries to deliberately heighten feelings of inadequacy, they say they relieve the stress of dealing with debt. But there is nothing “soft” about their products. They are designed to extract as much fee income as possible from financially inexperienced consumers.
Debt managers have only one objective, to sell lucrative fee earning debt management plans. Claiming they negotiate and agree affordable monthly loan repayments, their product only works if lenders agree to lower repayments, suspend debt collection and stop interest clocks running.
The product sees people pay the sum of agreed monthly loan repayments, through the debt management company. After deducting a hefty fee, the debt manager then disburses the money to their lenders. Monthly fees range from €35.00 to over €100.00 depending on, how much is paid, the number of transactions or lenders to be paid. But first, a plan “set up fee” is charged and nothing will be paid to lenders until this fee is paid in full. Set up fees range from €495.00 to over €800.00. VAT at 21.5% is charged on fees.
Contrasting a debt management plan with a “do it myself” plan, I synthesized paying off personal debts of €35,000. Assuming lenders agree to lower repayments and stop the interest clock, under my DIY plan, I would clear the debt in six years.
But should I buy a debt management plan and pay through a debt manager, it would take seven and a half years.
The debt manager would charge me €7000.00 in fees. At 20% of the debt it’s equivalent to an annual interest rate of 5.12%. And these figures get worse if loan interest clocks keep running.
Who are these outfits? Some are merely internet prospecting engines for British based operations, others are British owned Irish operations and some are home grown. Most of the latter two outfits have one thing in common – they are, or once were, commission driven mortgage brokers who used to sell mortgages on overpriced properties, frequently marketed by their real estate partners. They are now selling debt management plans to the same people they sold unaffordable credit to a few years ago.
There is no economic business case or supporting empirical evidence for commercial debt manager’s claims of providing economic value to consumers or their creditors. Their claims that they lower costs of indebtedness for consumers and costs of recovery for lenders are spurious and unproven. Many state they can arrange for substantial debt settlements. Totally unfounded in fact, such statements could be regarded as misleading, negligent and false declarations.
By using abusive marketing and emotive sales tricks, debt managers aim to induce people to buy dangerous products. Their emergence could be seen as an opportunistic exploitation of a social and economic debt crisis. If so it’s being made possible by Government’s failure to close off a dangerous gap in consumer protection.
Given they provide advice on their financial products and a money transmission service, debt managers should be subjected to prudential and consumer protection regulations. If authorised under a licensing system, they would have to comply with minimum competency requirements, consumer protection codes, fitness and probity, and prudential solvency standards. Their customers would have a right to complain to the financial ombudsman.
As it stands there is no consumer protection for people when sold debt management products or during the term of the plans. Debt management companies are not obliged to treat people fairly, to ensure they understand risks and costs, to provide proper advice or to recommend suitable products based on need, experience and affordability.
Abusive marketing of credit to consumers was largely responsible for the debt crisis. Have consumer protection lessons been learned? Surely rushing into empty stables, disclaiming responsibility for letting the door open, is part of the past. Protecting vulnerable, indebted consumers is too serious an issue to allow the unfettered development of economically unproven and ethically questionable debt management companies.
They should be required by Government to prove they have a cogent, rational business case supported by independent empirical evidence and if so, Government should ensure they are licensed and regulated as high risk consumer protection operations.
A version of this article appeared in the Irish Examiner, Business Section, Monday 7th March 2011
Will anything be done to regulate a financial service that feeds off people’s fears and financial insecurity? Should dangerous financial products, not covered by our consumer protection laws and regulations, be permitted to be sold?
While the last Government procrastinated in responding to the consumer debt crisis, debt management companies started selling dangerous products to financially vulnerable consumers under the nose of state consumer protection agencies.
Many of these companies are engaging in abusive marketing, making false and misleading statements and not disclosing their product’s risks or costs. They market “free” advice and consultations to prospect for their commission driven sales forces. It’s a manipulative soft sell. Playing on people’s worries to deliberately heighten feelings of inadequacy, they say they relieve the stress of dealing with debt. But there is nothing “soft” about their products. They are designed to extract as much fee income as possible from financially inexperienced consumers.
Debt managers have only one objective, to sell lucrative fee earning debt management plans. Claiming they negotiate and agree affordable monthly loan repayments, their product only works if lenders agree to lower repayments, suspend debt collection and stop interest clocks running.
The product sees people pay the sum of agreed monthly loan repayments, through the debt management company. After deducting a hefty fee, the debt manager then disburses the money to their lenders. Monthly fees range from €35.00 to over €100.00 depending on, how much is paid, the number of transactions or lenders to be paid. But first, a plan “set up fee” is charged and nothing will be paid to lenders until this fee is paid in full. Set up fees range from €495.00 to over €800.00. VAT at 21.5% is charged on fees.
But should I buy a debt management plan and pay through a debt manager, it would take seven and a half years.
The debt manager would charge me €7000.00 in fees. At 20% of the debt it’s equivalent to an annual interest rate of 5.12%. And these figures get worse if loan interest clocks keep running.
Who are these outfits? Some are merely internet prospecting engines for British based operations, others are British owned Irish operations and some are home grown. Most of the latter two outfits have one thing in common – they are, or once were, commission driven mortgage brokers who used to sell mortgages on overpriced properties, frequently marketed by their real estate partners. They are now selling debt management plans to the same people they sold unaffordable credit to a few years ago.
There is no economic business case or supporting empirical evidence for commercial debt manager’s claims of providing economic value to consumers or their creditors. Their claims that they lower costs of indebtedness for consumers and costs of recovery for lenders are spurious and unproven. Many state they can arrange for substantial debt settlements. Totally unfounded in fact, such statements could be regarded as misleading, negligent and false declarations.
By using abusive marketing and emotive sales tricks, debt managers aim to induce people to buy dangerous products. Their emergence could be seen as an opportunistic exploitation of a social and economic debt crisis. If so it’s being made possible by Government’s failure to close off a dangerous gap in consumer protection.
Given they provide advice on their financial products and a money transmission service, debt managers should be subjected to prudential and consumer protection regulations. If authorised under a licensing system, they would have to comply with minimum competency requirements, consumer protection codes, fitness and probity, and prudential solvency standards. Their customers would have a right to complain to the financial ombudsman.
As it stands there is no consumer protection for people when sold debt management products or during the term of the plans. Debt management companies are not obliged to treat people fairly, to ensure they understand risks and costs, to provide proper advice or to recommend suitable products based on need, experience and affordability.
Abusive marketing of credit to consumers was largely responsible for the debt crisis. Have consumer protection lessons been learned? Surely rushing into empty stables, disclaiming responsibility for letting the door open, is part of the past. Protecting vulnerable, indebted consumers is too serious an issue to allow the unfettered development of economically unproven and ethically questionable debt management companies.
They should be required by Government to prove they have a cogent, rational business case supported by independent empirical evidence and if so, Government should ensure they are licensed and regulated as high risk consumer protection operations.
A version of this article appeared in the Irish Examiner, Business Section, Monday 7th March 2011
Friday, March 4, 2011
Turning credit unions around
Once a success story, credit unions are stuck in the past and in dire need of rescuing, writes Bill Hobbs
Unless credit union reform is on Government’s agenda for urgent change, the future for credit co-operative banking in Ireland is very bleak.
With the way credit unions continue to be operated here, being unable to pay a decent dividend is a sign of financial instability. One in every five is unable to pay any dividend for last year. And with only one in four paying a rate over 1.00%, three quarters of the state’s 412 credit unions are experiencing varying degrees of financial stress.
It appears that the Irish League of Credit Unions has almost exhausted its small stability support fund of €115m. So far it has committed €58m to supporting twenty nine credit unions. With another seven in the pipeline requiring upwards of another €40m, all too predictably, its small fund will soon run out of money.
Clearly credit unions are going to need state support. This could see the Government providing hundreds of millions in tax payers’ funds to stabilise the sector. As part of the IMF deal, the Central Bank is currently reviewing credit unions to establish the scale of support needed. The bank must also implement a strategy to stabilise the sector. Under the deal, new laws will give the bank a statutory resolution fund and tools to close credit unions or where they are viable, merge them with others including banks. But these crisis management responses have little to do with the future role of credit unions.
Something quite important is missing - a clear, unambiguous Government commitment to transforming credit unions into a modern, well run, credit co-operative banking network.
Once an international success story, Irish credit unions have been stuck in the past for the past two decades. Perfectly designed for an Ireland that doesn’t exist anymore, their methods and ways of doing business remain rooted in the 1950’s. Unlike their peers elsewhere, they have not developed as successful full-service banking co-operatives have in say Europe, Canada and Australia.
Instead of focussing on becoming full-service co-operatives, credit unions here pursued an ill-advised strategy of maximising surpluses (profits) to pay far too high dividends to their savers. This meant they did not invest in the modernisation required to provide better quality affordable products and services. Critically they did not set aside enough money to see them through bad times.
Financial stress cracks first appeared as early as 2005 when worrying levels of bad debts were reported on in the media. Their bad loans were far too high for booming economic conditions. And unable to make enough good loans, credit unions put over half of excess savers funds into risky investments that should never have been made.
Since 2008 two things have happened. Hundreds of millions have been wiped off investment values. And boom time imprudent lending along with an economic recession have triggered rising bad debt losses that could exceed over €1bn.
The fundamental problem is that Irish credit unions have not been led, governed and managed as they should have been.
As credit co-operatives, credit unions can be thought of reservoirs of community capital to be protected and enhanced by one generation of directors and managers to hand on to the next generation. By successfully providing affordable products and services to this generation, their managers maintain and build community capital to hand on to the next generation. Because their owners are also their customers, credit co-operatives are not driven by short term demands of the market, shareholders or bond holders. Their managers become expert at running co-operative banks. This notion of inter-generational community capital twinned with managerial expertise is why credit co-operatives elsewhere were able to weather their banking and economic crisis. Their ways of doing things can be adopted here in Ireland.
Here, there are far too many badly run credit unions, providing poor quality expensive products to far too few people. If they are to play an important part in a working banking system, they will have to radically reform and change the way they do things. But for various reasons, they will be unable to make this change on their own. This is why many are convinced they have to be helped from themselves.
If the new Government considers credit unions of systemic importance to the any new banking system it must put credit union reform and modernisation firmly on its agenda for urgent and important change. Its starting point should be to establish a credit union reform authority with the power to design and deliver on the necessary changes.
A versions of this article appeared in the Irish Examiner, Analysis section, Friday 4th March, 2011.
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