The Great Depression of 1929 is the only economic event comparable to our current morass. A post mortem study in the 1930s into the cause of the Wall Street crash concluded that it was due to deregulation of the financial sector.
Banks being allowed to develop new products to trade debt and inter-state banking across the US were pinpointed as disastrous. Legislation was put in place to prohibit both.
In 1989 these US federal controls were relaxed. This spawned massive growth in lending. Traditional bankers were replaced by salesmen. Growth was the mantra.
‘Securitisation’ products converted property loans into financial commodities. Loan-to-value ratios and mortgages of 100 per cent were common. When property prices started to fall the sub prime crisis was born. The global credit squeeze quickly ensued.
The outcome is the worst global recession in living memory, the collapse or nationalisation of financial institutions and endemic unemployment. These years will mark a sad seminal point in our lives. Ironically, Ireland avoided widespread direct investment in this US debacle. Instead, we had our own credit, property, and fiscal bubble.
Our politicians must focus on the optimal form of bank regulation to ensure this excess can never recur. Over the past decade commercial banks wanted to maximise their share of the exploding mortgage and property lending market. Their zeal supported property developers in their most grandiose plans. Underlying economic assumptions about valuations and sustainability were disastrous.
Banks are regulated by the Central Bank since 1943. Its role has altered since our membership of the Euro with the ECB having overall responsibility for the currency.
In May 2003 new legislation restructured our regulatory system. The Financial Services Regulatory Authority was established - commonly called the Financial Regulator. The boards of directors of the Central Bank and FSRA overlap. They are sibling organisations.
The Government recently announced there is to be radical reform in the supervision and regulation of the financial services sector. It is proposed to set up a new Central Banking Commission which will combine the roles of both bodies. Reference has been made to the Canadian model.
Specifics on this proposal are scanty. This is a key policy issue. The credit squeeze is paralysing business through the lack of cash. There can be no economic recovery until the bad debt provision in the banks is sorted. Denial and obfuscation by bankers has seen more than 90 per cent of their share values wiped out. This has devastated private pension funds and crushed investors depending on dividend income.
At the heart of this debate is an inherent contradiction and confusion about bank regulation. The three principal supervisory roles are:
Prudential considerations, ie, capital adequacy provisions, liquidity ratios - avoiding insolvency.
Consumer protection - combating fraud, dubious products, and sales practices.
Corporate governance - this includes the Anglo Irish agenda of share price manipulation, directors’ personal loans, and massaging year end figures with inter-bank deposits.
When all the current enquiries are over, we will find the failure of FSRA. It was and is not fit for purpose. It was incompetent and naïve. The palpable anger about Patrick Neary’s €630k payoff is still raw. The board should resign. FSRA and the Central Bank were primarily concerned about portraying stability and the soundness of Irish banks.
The prudential and solvency agenda completely overshadowed questions of corporate governance. FSRA actively encouraged the ‘wearing of the green jersey’. They looked the other way in order to preserve the veneer of financial credibility.
Combining and fudging these roles again under a new commission will cause the same conflict and contradiction. ‘Systemic’ arguments will prevail. We need to enhance the Office of the Director of Corporate Enforcement to police the banks the same as any other company.
Our politicians need to wake up, step up to the plate, and confront this complex issue. Vague waffle will not suffice. The right re-regulation must have as its cornerstone the clear separation of responsibilities.
