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Friday, 11 Jun 2010

Banking Crisis Reports: Discussion with Klaus Regling and Max Watson

I welcome Mr. Klaus Regling and Mr. Max Watson, the co-authors of the report we are about to discuss. I advise everybody that there will be short opening remarks followed by a question and answer session. I request that everybody ensures mobile phones are switched off as mobile phone signals interfere with the live webcasting process.

By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of the evidence to this committee. If directed by the committee to cease giving evidence on a particular matter and the witnesses continue to so do, they are entitled thereafter only to a qualified privilege in respect of evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, witnesses should not criticise or make charges against any persons or entity by name or in such a way as to make him or her identifiable.

Under the salient rulings of the Chair, members should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable. Before commencing I congratulate Mr. Regling on his appointment to the special purpose vehicle of NAMA, which will have €500 billion to look after for the next couple of years. I wish him every success with that as our future depends on it. We will commence with opening statements.

Mr. Klaus Regling

I thank the Chairman for his kind words. Mr. Watson and I are happy to be back and we thank the committee for the invitation. The committee will remember the mandate received from the Minister for Finance in February when we were asked to analyse the sources of Ireland's banking crisis. We have worked on that mandate for the past three months and the report has been delivered.

To prepare the report we had a series of meetings in Dublin and abroad. In Ireland we spoke with present and former bankers, central bankers, consumer representatives, Government officials, journalists, politicians, financial regulators, trade union representatives and members of the academic community. Outside Ireland we met representatives of the European Commission, the European Central Bank, the International Monetary Fund and the Bank for International Settlements. In all we met approximately 100 people during the three months to inform ourselves, and we assured the people that they were protected and we would not quote any source.

We also met the Governor of the Central Bank, Professor Patrick Honohan, on two occasions for a broad range of discussions. On the one hand we looked to avoid overlap between the two reports and we also sought to benefit from his insights because he has lived in Ireland, which we have not. He is a respected economist and our meetings were very useful in that respect. We did not try to co-ordinate the two reports but we are happy, now that Mr. Honohan's report has been published and we have read it, that the reports are complementary to each other. The committee will form its own judgment on that matter.

We were asked to consider the sources of the crisis in Ireland. I should clarify at the outset that the mandate to look at the sources of the crisis is not the same as answering the question of who is to blame for the crisis. That is something different. It would be quite easy to blame persons or institutions. It would be easy to say that the Central Bank should have rung the alarm bells earlier and louder. It would be easy to blame supervisors for not taking a more "hands on" approach. It would be easy to blame fiscal policy for being pro-cyclical. It would be easy to blame tax policy for providing the wrong incentives, or to blame bankers for ignoring risks.

All these statements would be correct, but they would miss a very important point. They would be too simple. To get the full picture of the sources of the crisis, one really has to take into account the international context in which the Irish economy operated over the past ten or 20 years. At an international level, we had monetary policies that were too loose, with too much liquidity, and pro-cyclical fiscal policies in many parts of the world. To get the full picture, one also has to take into account that the surveillance in the euro area was insufficient with respect to imbalances or competitive positions. One also has to remember that supervision worldwide was too lax during the period under review.

It is also important to remember that Ireland's economic developments during the preceding 20 years were very successful and that created a certain environment. This was a period in which European financial markets integrated very strongly, with very important implications for interest rates and the availability of liquidity and funding. Irish society has a strong preference for real estate, and that added to some of the developments. It is very important to see the interaction of all these elements, so it would be far too easy to pick one or two persons and institutions and blame them. It is important to understand how the global and the domestic Irish macro-economic situation interacted, and how the different factors contributed to the crisis in a comprehensive way.

I will now highlight the key points in our report. The first point deals with the international environment in the past two decades and the second point deals with specific issues related to Ireland. I will begin and Mr. Watson will take over at certain stages.

It is important to look at the global and European setting, because it is there we could see mutually reinforcing interaction between global developments and national policies. In the 1990s we had a worldwide phenomenon called "The Great Moderation", with strong growth and low inflation, and low interest rates as a result. We argue in the report that this benign inflation environment led to monetary policy mistakes. Key interest rates around the world were too low for too long. This situation was amplified by exchange rate policies in major economies, including China, which fuelled global liquidity. That contributed to the increase in global imbalances, which again put downward pressure on interest rates and risk spreads. This monetary environment eventually led to strong rises in asset prices in many parts of the world and to a succession of bubbles in equity, bond, housing, commodity and credit markets.

The other key worldwide macro-economic problem was in fiscal policy, which was too loose and pro-cyclical in many parts of the world. It was excessively expansionary, particularly outside the euro area, but it happened in important countries.

It is also important to remember that there is an excuse for policy makers. It is easy with hindsight to identify mistakes made on the monetary policy side and on the fiscal policy side. On the fiscal policy side, we have to admit that our methods for assessing the fiscal stance in real time, which is what policy makers have to do, is not easy. Our tools are not very good in that respect. The experts — we consider ourselves to be part of that community — have been working on this and continue to work on it to improve these methodologies to have a better understanding of the underlying structural fiscal situation. It is not easy. Work is ongoing. That is the international macroeconomic context and Mr. Watson will comment on the global context before we move to Ireland's specific issues.

Mr. Max Watson

Turning from the global and euro area macro issues to the global and euro area financial issues, I will make six brief points. The first is to recall that the process of financial integration of markets, cross-border funding of banks and competition in mortgage markets was an article of faith. The risks were not very strongly questioned. When we say in our report that there were very large cross-border flows of wholesale funding to Irish banks during this period, that remark was almost seen as bad taste. There was a feeling that the euro area was one entity and the balance of payments for some policy makers no longer existed. Now that we are very aware of national economies, national debt crises and national banks' funding problems we tend to forget that the psychology of the times, especially in Europe, was that this was one market and one should ignore the cross-border dimension. We have learned that one cannot do that in a world where fiscal policy and labour markets are very much national.

The second point is that there was, as Mr. Regling said, international liquidity slopping around and banks faced a rather difficult choice, namely, what to do with it if they were not to lose market share. They did three things, depending on their local circumstances. First, they found something at home that was uncompetitive and they went for it. In many cases, like here, it was the mortgage market, which here was uncompetitive and an object of public policy was to encourage greater competition. The second choice was that they found a neighbouring country where there was a sector that was uncompetitive. British banks did it here, Austrian banks did it in south eastern Europe and Scandinavian and Nordic banks did it in the Baltic countries. There was nothing special about Ireland but what was notable was that some of the banks also went into cross-border securities and securitised assets, that is, the toxic assets which were very obscure. That was not a problem in the domestic banking system here. As our report said, it was plain vanilla in Ireland. It was no coincidence that all of those outlets had something to do with real estate because we were in an environment of very low interest rates and risk premia in which one tended to go for real estate.

A third element is accounting conventions. We saw a huge shift from the 1970s to the last decade when originally banks accounts were a buffer in the system — in many countries banks had hidden reserves to serve as an economic buffer — to a world in which banks were pushed to an extreme state of marking assets to market. There was very little scope, even for supervisors, unless they almost broke the rules, to build up provisions in advance of problems. It was viewed as bad for accounting reasons and not deductible for tax reasons. That was an international and European development.

The fourth element was supervisors. We tried to be quite understanding in that part of the report. Supervisors faced some pretty bad dilemmas. They had large and complex financial institutions. What does one do with these animals, especially when they are cross-border? They had very complex financial products, which was partly a product of macroeconomic policy. They also had banks that were adaptive. The banks went in for what technicians call "regulatory arbitrage", that is, they found a regulation and went around it. For supervisors that posed genuine problems of structure, which we saw here. That is why I refer to them internationally. What kind of structure, relative to the Central Banks, was in place? The style of supervision could be principles-based or light touch. What instruments were there in place to deal with the semi-macro financial problems? There is still no real agreement on that.

The fifth element happened in some countries just as it happened here and was quite different. We make a very harsh distinction. It was egregiously bad banking practices which should have been picked up in any supervisory system. One can see that in the United States. It has been documented very well that practices in lending were quite unacceptable and a clever system of supervision or a new structure was not needed to spot them. They were just bad and dangerous banking practices and supervisors in some countries missed them. One cannot excuse that by saying the world had become more complex.

Mr. Regling already hinted at my sixth and last point in regard to integration, low interest rates and the great moderation. These factors were in many cases perceived as positive shocks but they interacted to create a death trap in terms of financial stability because their interaction was an accident waiting to happen. Some institutions, including the Federal Reserve and the IMF, viewed this as a positive development that would end some day because of exchange rates but very few, such as the Bank for International Settlements, warned that it was an accident waiting to happen or that the elastic was stretching to breaking point and that domestic banks would go. Broadly speaking, that was the somewhat extenuating financial context.

Mr. Klaus Regling

I apologise for being lengthy in outlining the international side but it is important to stress the background against which Irish developments occurred. When I read the newspapers in the past few days, I noted this side was not really picked up. For understandable reasons, everybody focuses on Irish points but to get the full picture one has to understand what happened in the world before looking at Ireland, which is what I shall do now.

The first important point to remember is that Ireland had two decades of successful economic development. When it joined the European Economic Community in 1973, it was its poorest member but it has since become the richest after Luxembourg. This background creates a certain mindset. Developments in the past decade were less robust than in the 1990s. The sources of growth shifted significantly to become demand driven and the financial vulnerabilities increased. For example, wage settlements accelerated markedly from the late 1990s. We include a chart in our report which shows that compensation for employees, which had grown more or less in line with the euro area average until the late 1990s, increased two to three times faster than the average from 1997 to 2008. On the budget side, the gross rate of public expenditure accelerated markedly in the past decade to become the highest among OECD countries. Another important factor was that the share of the construction sector in the economy became excessive. According to OECD estimates, Ireland was the most overheated of OECD economies. One good indicator of a shift in the economy is the current account of the balance of payments, which was in surplus in the 1990s and became negative from 2000.

In asking why this happened in the past decade, I will concentrate on the macroeconomic side and Mr. Watson will deal with the financial sector. Interest rates were low and falling even before Ireland joined the European Monetary Union. Everybody knew that in joining the Union, the interest rate instrument would no longer be available for individual countries and this should have led to the conclusion that other available policy instruments would have to be used to compensate for the expansionary effects of new membership. We are convinced, however, this does not mean it was a mistake to join the euro area because being a member of the Monetary Union certainly protected Ireland during this global crisis. The other issue on the macroeconomic side is that the underlying fiscal situation deteriorated during the past decade. The structural fiscal surplus became smaller. Current expenditures grew faster than nominal GDP throughout the decade, while in earlier years in the 1990s current expenditures had grown less than nominal GDP. On the revenue side, we had a shift in the composition of taxation and a strong increase in what economists call tax expenditures, which are tax allowances, tax reliefs and tax exemptions from income tax. In Ireland, these expenditures increased more than in any other OECD country. Every country has some sort of tax expenditures but in Ireland the share of tax expenditures in the budget is three times higher than the EU average. Those are the main elements on the macroeconomic side.

I forgot to mention that the Irish taxation system is also characterised by favouring systematically, and more than in other EU countries, property and, in particular, home ownership. That is particularly important in the context of our report.

Mr. Max Watson

Lastly, on the conclusions on the financial sector in Ireland, let me highlight five points. I know members will have read this in some detail and I will not repeat it all. These are five points which we thought were rather important. The first point, one which is clearly shared, now that we have had a chance to read his report, by Governor Honohan and his team, is that by about 2006 it was no longer possible to envisage a soft landing for the Irish economy. In our view at least that reflected two things. One was the degree to which large institutions were exposed to commercial real estate, with its much higher rate of variability in prices when things go up and down, and within commercial real estate to really a rather small number — a couple of dozen — of end borrowers and their nominee companies or families or whatever.

Interacting with that was the fact that the economic cycle was absolutely set to turn. It could not have failed to turn at that point. The economy was going to have to slow down and become more competitive. In the euro area that means naturally a rather slower rate of growth. When that exposure to commercial real estate vis-à-vis capital and the economic slowdown came together with a fiscal policy that was overstretched and could not support the economy, there was going to be a lot of financial stress. That is the term we use. What does it mean in day-to-day language? It means it was overwhelmingly likely that the Government was going to have to intervene in some way on a couple of banks. Governor Honohan says that even more explicitly.

The second point is that everyone missed this. When we talked to people — this goes certainly as much for the people overseas as in Ireland — and asked them, "Did you put these factors together?", they said, "No, we did not put them together." In retrospect, they could have been put together. What could not have been put together — this is my third point — except by the supervisors was the extent to which there were also huge problems in certain cases of loan documentation, borrower evaluation and down-to-earth, nuts and bolts banking problems, even the securing of collateral, which meant that certain institutions, one in particular, were very much more vulnerable than any lay observer, even any general Central Bank official looking at economics, could have guessed. Governor Honohan adduces that as a supplementary reason the system simply could not have survived a bump, even without Lehman Brothers.

On the fourth point, we see — we checked this with a lot of people, particularly towards the end — two distinct types of governance problem. "Governance problem" like "credibility" is a great phrase but what does it mean? We see certain really egregious governance failings. They raise questions that deserve forensic investigation of some kind and that is starting. Those did not happen in all countries in a big way — they did happen in some countries, typically in those countries that had the worst problems — and they were not system wide. We say they affected more than one institution but they were quite limited. That is exactly what Governor Honohan, with his bottom up knowledge and access to banking secret data, says.

The other type of governance failing was rather widespread, namely, the overriding of sensible lending guidelines and sensible loan-to-value ratios and generally taking a risk on the boom. That was pretty widespread and both of those areas deserve checking because people should have noticed the breaches that were taking place.

We also emphasise and state clearly that this was not a one-bank problem. Although it was not in our scope to discuss the guarantee position, this is one of the areas where we provide information relevant to the guarantee decision. We say that a problem emerging at one major institution risked triggering recognition that the concern was systemic. This is an important point that seems beyond reasonable doubt and the language in Professor Honohan's report is almost identical. This is very important when looking at the guarantee decision.

Our last point is also important. We say frankly, that senior policy makers lacked information they should have had about banks. At the end of our report, we say that when the economy reached the point where questions about guarantee and nationalisation had to be taken, we believe it was very serious that information about the governance of certain institutions was not available or coming up to the senior policy makers through the supervisory system. We, therefore, had to conclude and recommend the following two things. We suggested policy lessons. However, for specific inquiry the recommendations that flow out of our side of the work are more technical and more amenable to judicial inquiry. They are more factual. They are not available under the Freedom of Information Act to normal people because they concern banking secrecy as well. These are the governance practices. Have all the conclusions been drawn about the widespread governance practices? Then, and it did not require two geniuses to say this, the specific very major breaches that occurred in certain institutions, two of which are the most obvious, are cited by Professor Honohan from his much deeper knowledge of those papers. That probably covers the ground of the two sides of the report.

The report and this morning's presentation give plenty of food for thought and questions.

I thank Mr. Watson for the work he has put into this. I am sure it has been an onerous task, but it has been very helpful to us. He portrays, if one likes, the perfect storm — internal catastrophic errors amplified by global forces where nobody wanted to take away the bowl of punch. The property bubble was the punch-bowl that was keeping Government — these titans of the financial sector — walking tall in the world. It was the culture of: "If I have it, I will spend it", and "This is party time." Many well known politicians exalted that as the approach to public spending. I find it alarming that we have found our banking system so easily corruptible. We have found a government that simply fuelled the flames and did not pay heed to the government role in terms of leaning against the tide of such runaway forces. We had regulators who met power not with probing scrutiny, but with blind, accepting faith and we had a Central Bank which saw the alarm signals but which simply did not cry "wolf".

Mr. Watson has shown an appalling vista. The question I would like to probe is why did these catastrophic policy errors happen. Let me start with fiscal policy. Mr. Watson has looked at the development of fiscal policy. Can he explain on whose advice these wrong-headed budgets were put together? Was strong counter cyclical advice being furnished to government that was ignored or was it that those who were advising government did not understand the task in hand? Were there other influences at work in deciding the direction of tax or fiscal policy? Mr. Watson is quoted as having said that some of the tax policy was ad hoc and not transparent. At whose behest was it ad hoc? What is Mr. Watson’s understanding of the quality and nature of the advice that was coming forward or of the capacity of those who were advising government to assemble and distil information? This is important because the Government is saying the terms of reference for the subsequent inquiry will air-brush out the whole area of fiscal policy development, claiming we do not need to look at it. I believe we do have to look at it. I am not convinced good advice was objectively furnished while other inappropriate voices were influencing policy development. I am not convinced political decisions were not made to simply stamp down what was wise advice on tax shelters, for example. It seems to me voices like the Revenue Commissioners were saying these tax exemptions should have been closed immediately but subsequently were spun out for a long time.

It is important for this committee to understand what went wrong with fiscal policy from the assessment of these independent experts. Mr. Regling and Mr. Watson recommend a more open budgetary system with independent views of fiscal policy from outside government and more scrutiny of what decisions are taken, a development Fine Gael has recommended for years. This whole area needs to be investigated and we need to come out with a robust way of putting together our budgets. That, however, will not be included in the terms of reference for the proposed inquiry. What do Mr. Regling and Mr. Watson make of this?

Mr. Klaus Regling

I understand why the Deputy raised this question. We were not able to get into internal government workings. We could not, for example, examine internal memoranda in the Department of Finance. It was not part of our job and we would not have been able to do it in the limited time available. Instead, we looked at the facts and came to the conclusion that fiscal policy was not sufficiently counter cyclical and that tax expenditure got a bit out of control.

On fiscal policy, as I stated in my introductory statement, one has to see there was a worldwide problem, particularly in the UK and the United States, where budgets benefited on the one hand from rapid revenue increases from asset-price increases, which, in turn, were used to increase expenditure. This occurred not just in Ireland but in many countries observed which had these asset-price booms.

In real time, economists do not have good tools to analyse where underlying structural budgets stand. We are much wiser with hindsight but not in real time when decisions have to be taken. That shows up in the estimation of output gaps which is important for economic analysis.

On the tax expenditure side, Ireland has more flows than other EU countries. At least from what we could see from the documents that were publicly available, it seemed to be somewhat ad hoc, as the Deputy mentioned.

The Deputy referred to a more open budget system with outside advice on budgetary matters. We also said in our policy conclusions that it might be useful to have what economists term "fiscal councils". These would be a council of outside experts who give advice on the budgetary situation and appropriate fiscal polices. There could be fiscal rules that supplement the Stability and Growth Pact or expenditure rules. For example, the Germans have a clause in their constitution on debt developments. Those kinds of issues and policy conclusions should be considered. We recommended this but did not think it would be a good logical element in a legal investigation because they are policy issues.

I accept that policy issues are how we put together the budget but I do not accept the way advice was filtered, the quality of advice available and the extent to which there was political overriding of good advice. I do not accept those are issues that should not be investigated. Those issues are at the kernel of the catastrophic failure of fiscal policy. Mr. Regling, I or anyone else could come up with some policy proposals but if we are trying to get to the root causes — the sources of what happened here — surely we must question the competence and quality of the advice, the acting on the advice and the external influences.

Perhaps Mr. Regling does not want to go into that but he is being cited as the reason we should not investigate those matters further. While I accept the final decisions will be policy ones — how we frame our fiscal counsel or what sort of scrutiny we have of the budget — understanding what happened in this area is crucial to getting the right policy prescriptions at the end and in holding people to account. At the end of any process, people — not just politicians but professional people who lead organisations — must be held to account for the professionalism and quality of what they do. That is my view and if Mr. Regling wishes to dispute it, I am fine with it. The terms of reference being proposed are inadequate. If Mr. Regling wishes to come back to that, he should feel free to do so but I wish to move on to another issue.

Mr. Regling contrasts the regulatory failures in Ireland, even with a bog standard property bubble rather than sophisticated financial products, with some other countries which got their supervision right. What characterised those systems which did not characterise ours? What did they do? Did they have a different way of appointing key officials? Did they have different types of boards? Did they have Chinese walls? Did they have clear protocols which we did not have? Can Mr. Regling tell us the nature of the good systems to which ours manifestly failed to aspire?

I know it is a couple of years ago but when this regulatory structure was put in place, my party opposed it for two reasons. First, it put consumer oversight — consumer protection — in the midst of prudential supervision and it distorted the prudential supervision necessary. Second, it did not look at international best practice in regulation after Enron and other catastrophic financial mistakes occurred in the international sphere. With hindsight, part of our problem was that at the phase of design, we simply got it wrong. We did not impose the structures, disciplines, Chinese walls and appropriate independence.

Mr. Klaus Regling

On the Deputy's first point, I am not trying to convince him and talk him out of his opinion but he said good advice was overruled. We came to the conclusion that there was not a lot of good advice and that is a different starting point. Not looking at what the Central Bank of Ireland did——

It is on record that the Revenue Commissioners recommended the immediate closure of many of those tax schemes. That was good advice.

Mr. Klaus Regling

Overall, there was not that much. I would stick to that point. Also, from the international side, we looked at IMF reports for much of the last decade, they did not criticise really very actively nor, to some extent, did the European Commission, so I take blame for that because I was in charge at the time.

Later in 2006 and 2007 it changed a bit. The OECD became more outspoken as did the European Commission. For a long time we were all impressed by the economic successes of Ireland. With hindsight, domestically, the Central Bank should have been more outspoken and should have had more authority. We made the point in our report that the economic resources within the Department of Finance may be too limited; it may need more resources to do a good analysis internally. Mr. Max Watson will reply to the other point.

Mr. Max Watson

On the question of what made for good supervision, perhaps I can give some pluses and minuses in that respect. Was it the supervisory structure? No, there is not a clear mapping in that respect. Some work has been done on this at the BIS and other places. There is not a clear mapping between having an independent regulator or having it in the Central Bank or having a hybrid. People were quite interested in the Irish structure and the Dutch structure because most of them were clever variants of that. The Dutch went for functional types of supervision, the Central Bank looked at systematic banking supervision and the Irish one seemed to have a twin-headed approached. When they were done, I remember reading the literature on them very carefully; there were a lot of intellectuals of appeal in these models when one looks at what happened in the Netherlands and in Ireland. Those models did not work well. If one looks at the UK, it does not advertise how well the FSA structure works. Other countries got into trouble when they had only central banks doing this. The implementation of it was more important than the structure. That is fairly clear.

The second point that is fairly clear is that a litmus test was intrusiveness, and intrusiveness was unfashionable but good. I will give a few examples of that. In Ireland there was very little intrusiveness into banks' practices. There were only a couple of people working on a major bank. If one looks at the commercial banks in Spain, and I say this advisedly, the Banco de Espana had a floor-load of people in Banco Santander or BBVA continuously monitoring, checking and looking at the books. That seems very old fashioned and bureaucratic. I was mission chief of Spain at the time and I wondered was this not all a bit of a waste of public money but we believe these guys were on top of what was happening in those banks. That intrusiveness went out of fashion to the extent that people talked about light touch regulation. Nobody now admits they were a light touch regulator but certainly some countries were not heavy touch regulators. That intrusiveness turned out to be very important.

The next point that was quite interesting, and this may surprise members, was that in some cases the authorities concerned about social issues got a little in the way of prudential issues. If one thinks of the United States or Ireland, people became very worried about the unaffordability of mortgages in both countries. They tended to therefore push people to give out mortgages on easy terms. There was a genuine social concern, but the concern to look at would have been why house prices were rising and rising wrongly for macro-economic reasons.

There was confusion in some cases, Ireland being a classic example, between competition policy and prudential policy. The potentially good aspect of the Irish structure was that it should have brought the Central Bank and the regulator close together with the overlapping boards. We know it did not work particularly well. The bad aspect in Ireland was endemic at the beginning; it was emblematic. The prudential director was not on the board — it is fantastic. If one told me that before I read it, I would have said: "No, look back, that is a typo." I would not have believed it. Everybody knew it was wrong so much so that they wrote to the Department of Finance and said: "We can't possibly do that, we are going to put him on the board anyway." This tells us that there was a problem there, but the problem was that many people were concerned that Irish banks had been uncompetitive, that they had not passed on cost savings to customers and there were big concerns rightly about charging. We should remember that when certain very famous banks and subsidiaries of foreign banks started breaking down barriers in the market and approving loans quickly, that corresponded to public policy concern. If one was to increase competition, and if from the 1990s one was to allow building societies to get into commercial real estate, the answer should have been a parallel, strong, intensive, strengthening of supervision because when one goes for competition in banking — we know this from what happened in UK from 1971 onwards — one also ends up with financial stresses because there are countervailing risks.

The last point is on tools instruments — some supervisors just toughed it out. I will pick two. Again one will not surprise the Deputy, one will. The one that will not surprise him is the Bank of Spain, which was told, "You can't raise provisions like that in the boom. You can't ban special purpose vehicles. You can't tell an American mortgage reinsurer that it's not a timely moment to enter the Spanish market to approve lots of insured mortgage bonds". However, the Bank of Spain said, "We have, just try us" and on all of those, they just succeeded. They were not very consistent with tax and accounting regulations. That was just sheer courage. Spain has problems in its savings banks and I am not holding up any country as an example but these are interesting stylistic examples.

The other is Croatia, which was advised by the IMF and the Commission to be careful because it was at risk of putting on capital controls and inhibiting the free movement of capital. The governor of the central bank of Croatia simply said, "Yes, I heard that and I'm turning a blind eye. We want reserve requirements on foreign currency lending and we want to build up the reserves of the central bank and I want this place firewalled in case there's a shock." He was absolutely against European and Washington advice.

That was just a question of a supervisor being very robust and saying, "Yes, I heard all that but it's nonsense. Actually the place is at great risk and we're taking action." That is unusual and one cannot hold anybody up to that standard all the time.

We must move on.

We had practices which the witnesses described as "bad, dangerous and dishonest". They were seen by the Regulator but not escalated. That was not a question of being out of fashion. We had practices where problems identified by underlings were overridden by supervisors. That was not a fashion. We had a system where the former Secretary General of the Department of Finance was made Governor of the Central Bank. That surely killed independent macro-analysis coming from the Central Bank. We had prudential directors, as Mr. Watson rightly said, not on board. I cannot understand how the witnesses are pushing this as the fashion of the time. These are specific failings in the Irish system, which were not replicated elsewhere, and we need to understand why they were there. Was this the prevailing culture where nobody faced down these people? Was it that they thought they were doing the right thing by overriding underlings who identified problems? Were they putting on the green jersey, as commentators said?

I will leave the Deputy to come back later on those questions.

I would like to hear the witnesses' views on those because they are central to the debate.

Mr. Max Watson

I should have mentioned — and the clearest documentation is in Professor Honohan's report — the issue of follow up. Things were spotted and not followed up. We do not go into that in great depth because we were not using internal documents. We flag this as a problem but his text will go down in the literature as an epic example of documenting where supervisory follow up failed. He also speculates very interestingly and rather courageously on what might have been the reasons for that and gives some interesting comments. We were not in a position to do that but he covers that very well.

Like others, I congratulate Mr. Regling and Mr. Watson on their report. To say it does not make for pleasant reading would be an understatement because it is a damning indictment of what went wrong here. It is a masterpiece in clear English, even if the text is dense. Perhaps that reflects the mix of a German person and an English person. It will be hugely helpful to the country in trying to find a way out of the serious difficulties we are in. International commentators are surprised at the modest forbearance of Irish people regarding what has happened. While they may have not rioted Greek-style, they are like pitbulls. We have a great deal of experience of violence here but people want a way out of this crisis and they want to see some justice done regarding those who perpetrated the crisis.

I will take up a number of the points. It seems a ghost is not specifically mentioned by the report. I do not know whether this had to do with the terms of reference or the witnesses' interpretation of them. The ghost is the role of the Department of Finance, to which Mr. Regling alluded in his comments. Speaking as an Opposition spokesperson during the time, we are past the point of political point scoring.

What we are doing now is trying to help to work our way forward. We have some history of political corruption, but so do many other countries in the EU and elsewhere. Our history and the fact we are a small country where people know one another creates an intimacy that makes Ireland attractive. In this case, however, it seems to have worked to our detriment. The Department of Finance, the major Department advising the Government and the Minister for Finance of the day, was not at the races as regards comprehensive oversight of and insights into the problems, emerging issues, strengths and weaknesses. Will the witnesses explore further how we might pick up on in a valuable way how other countries seek to address this issue? As Mr. Watson suggested in respect of the Croatian example, is it down to the integrity of individuals in the system or, as in the case of the Bank of Spain and Santander, their bravery? One might claim there was considerable recklessness on the part of Irish Ministers, but was there a fear among senior civil servants in the Department of Finance of speaking out to their political masters or in public? In this context, would a move to the greater publication of information, be it through freedom of information requests or other mechanisms, be helpful and how soon should we do it?

I wish to ask a related question. In some ways, the most stunning parts of the report are the charts on pages 31 and 32 regarding average loan growth and loans for construction and property, respectively. Two institutions stand out in these reports, namely, Anglo Irish Bank and the Irish Nationwide Building Society. At the time, I raised an issue in this committee. From the middle of 2007 and certainly by the time Anglo Irish Bank's share price collapsed around St. Patrick's Day of 2008, there must have been detailed knowledge in the Central Bank, among supervisors in the Financial Regulator and within the bank itself. In particular, how could a functioning Department of Finance, including its Civil Service and political leaderships, not have been aware of what was happening to that bank and, to a lesser degree, the other bank? In the course of the debate on the guarantee, Members from the Government side accused me several times of "not wearing the green jersey". Others have referred to it as the green jersey agenda. I am in politics, but I found it hurtful that Members would throw that accusation. Did all of the people I have mentioned know about what was happening, but the green jersey argument won out because we are a small country? Was it a case that where the governor in Croatia decided to be brave our people decided the green jersey was not so much a jersey as a shroud? As a consequence any kind of open discussion and debate was stifled. How can we give people courage to speak out frankly, or how can we create structures that enable them to speak frankly? Those are my first, related questions. I have another.

Mr. Klaus Regling

I will begin and Mr. Watson will continue. On the Deputy’s first broad point, whether there was comprehensive oversight inside Departments and the Central Bank, as I said, we could not go into details and internal memorandums. However, let me stress again this should be seen against the international context, what happened at the time in many countries. There were many prominent politicians and policy makers at the time, like Mr. Greenspan, who argued we live in a new world, that we would permanently have higher productivity growth and low inflation and, therefore, growth can be higher, credit expansion can be stronger and interest rates can be lower. Many other people believed in that and it was a minority group of economists who disputed this mainstream view. One has to take that into account to assess what happened in Ireland. The IMF, therefore, also followed this general mainstream advice and was not forceful in arguing for the other direction.

Now the world has learned from that, as it should have. In Europe and in the United States macro-prudential issues are now very much at the forefront of policy making. In the EU we are in the process of creating the European systemic risk board, filling the gap which existed, to look at the overall situation and draw the right conclusions for monetary and fiscal policy. This was missing in the past but has now been created in Europe, the EU and also in the United States.

Returning to Ireland, as I said, it is probably worth considering strengthening the resources for economic analysis in the Central Bank among supervisors and, in particular, the Department of Finance. As the Deputy suggested, more transparency is useful and getting outside advice. I mentioned proposals that exist to create fiscal counsels, meaning that outside advisers ought to have routes established in your legal framework that would supplement and complement the EU's Stability and Growth Pact. I believe those kinds of policy conclusions arising from the crisis are very useful.

Mr. Max Watson

Leading on from that, I offer an example of speaking out and openness which crosses over between the two areas. Unless I am mistaken, Ireland was unusual in this period in not publishing the closing statements of IMF missions. Most and probably all the euro rate economies publish those. Unfortunately, in this case the IMF closing statements were not particularly trenchant documents. They often are; they are often a little tougher than the published documents from the IMF board's review. That may be a little emblematic of a feeling we need to get things out fully into the public.

Individuals matter much more than one would wish. However, there clearly was a culture of not rocking the boat. I have worked in three or four bureaucracies in my life and I know what that culture is like. One does not find it on paper. People put their head round one's door and say, "Are you absolutely sure you want to push this issue now?" I would be quite sure that sort of thing happened to some extent. It is not corruption and Governor Honohan makes this distinction very clearly.

It is hard to prove.

Mr. Max Watson

It is very hard to prove. One would spend a lot of public money looking for the evidence of the door that was looked around.

On the question of who knew what and who should have known what, I shall try to give some clear answers about what we know. I will not escape by saying — although I will say it — that when members get a chance to read fully through Governor Honohan's report, there are some really enlightening passages in it on this topic. Let me make a few limited comments. The Deputy mentioned two institutions. Every picture tells a story and we have several pictures. We looked very carefully at whether the Central Bank should have known and if it published data from which the regulator should have known that there was a very dangerous concentration of exposure to the commercial real estate sector. The answer was a clear "Yes" and the tables were published. They may not have been in the prudential returns but they were in the EUROSTAT returns and a particular table of the Central Bank report. A look at that table should have indicated the capital of the banking system was being invested to a high degree in assets with a very variable value, to put it mildly.

The IMF's financial system stability assessment did not make the point either, which is surprising. In June 2008 I was asked by the IMF board to do a report, which is on its website. Why was the IMF financial system assessment not better in this period? Some of the findings tally very much with our discussions today. There is also a link to an interpretation of what was going on in the world economy, which was misleading.

With regard to who should have known what, there are distinctions. I will resort to Professor Honohan's method of talking about bank A and bank B. In bank A there was no knowledge of the really bad governance practices that were ongoing; the issues came as a real surprise. In Anglo Irish Bank, for example, there was a series of audit reports commissioned and it is quite interesting to consider what emerges in stages through these reports. The role of auditors is mentioned and I am not sure auditors would be good with business strategy but they should be good on certain basic processes.

Returning to abstraction, in bank A there was no knowledge, which proved rather lethal. In bank B there was clear knowledge of governance problems, which were pursued. It was like waves of warm water breaking on a soft cliff as nothing was ever eroded in the process. There was a series of protests about governance. Professor Honohan mentions this clearly and documents it.

With regard to systemic exposure the facts were known but nobody spotted the problem, and it is really fantastic to think outsiders did not get it either. In one bank the problem simply was not known, which is amazing again. That is a problem with not having the numbers of banking inspectors. As I am British I am not very much in favour of bank inspection by tradition but it helps in such matters. In another case the governance problems were known, identified, boxed but not pursued.

I will follow up on that. I assume from Professor Honohan's report that bank A is Anglo Irish Bank and bank B is Irish Nationwide. I know A and B are mixed up at certain points to disguise this. He reports that 28% of the credit approvals were outside the credit policy. I once worked as an auditor and if that did not raise red flags, I honestly do not know what would raise them.

At the time of the guarantee, when the Labour Party was invited to be briefed by the Department of Finance, I asked about those two banks. I was told that with regard to what I believe to be bank B, the Irish Nationwide Building Society, the person who ran the bank had such peculiar insights into how to run a bank that nobody else could run it. I asked the question of the Department of Finance, as the issue formed my advice to colleagues in my party as to how to treat the proposals brought to the Oireachtas by the Government. We did not want to give the Government a blank cheque or a blanket guarantee, as that would have been wrong. I was told that the bigger bank was composed of extraordinary individuals with an extraordinary track record.

The question for future policy is what needs to be done in the Department of Finance. It has some economists but not of a strong independent voice within that institution. The Governor of the Central Bank has recognised that and has moved to change it. They do not seem to have any accountants. Maybe they do, but they may be in a basement somewhere talking to each other. They do not have people who move from the public to the private sector and who can make reasonable assessments on both worlds. If we are going to change governance in this country in terms of investigations, how do the witnesses think that might best be done?

I made a positive policy proposal that Ireland should have a tax commission and that tax expenditure should be costed, published, evaluated and reported on. Given that Ireland is a very small island nation, there is a profound macro-economic argument for Ireland to use certain instruments in a responsible manner to sponsor development and employment. Our difficulty is that where we have done that, they have often been abused, just as the tax breaks came to be abused. In the context of the role he is now taking up in the European Union, does Herr Regling see a framework evolving on macro-economic structures? Does he think there should be an Irish framework?

We have an institution called the ESRI, which is independent on policy reporting. However, it is entirely dependent for its funding on the Department of Finance, yet it is reporting on the Department of Finance. Many of the people in it are independent minded, but at the end of the day, the people to whom the ESRI is reporting are paying for the reports. Should there be institutional development in this country, either through the academic institutions or in some other way?

My final question is about the role of share value at banking and financial institutions in the case of Ireland and other economies. One of the fatal things that happened in Ireland, especially in respect of Bank of Ireland and Allied Irish Banks, is that having experienced the phenomenal growth of Anglo Irish Bank and Irish Nationwide, the former banks began to chase share value. This is an issue for Ireland and Europe. Did the witnesses reach any conclusion that, in March 2008 and the year leading up to that date, there was a concerted effort at share price support of the banks, particularly Anglo Irish Bank, that hid what was happening from the markets and from the wider economy? Do they think there is a way of taking some of the damage out of this excessive chasing of share value, at the expense of long-term and more steady growth? The development companies to which the banks sold were also experiencing massive surges in share values, which, in turn, fuelled our boom.

I suppose I am asking a question about capitalism, about which I am not a total fan, as I prefer a mixed approach. It seems to be partly at the heart of the current crisis. It seems to be ironic that European workers' pension funds are being used to play the markets, in which hedge funds and private equity funds are basically shorting companies according to how the market is moving. I would like to know whether we in Ireland can learn how to utilise the markets more effectively, both in the public and in the private sectors.

Mr. Klaus Regling

I thank the Deputy for her questions. I fully support her comments on tax policy and greater transparency. It is relevant and correct to conclude that tax expenditures must be transparent, costed and subject to impact assessments.

On economic expertise in the Department of Finance and other Departments, I can only reiterate the comment in our report that resources are probably insufficient. As we have noted on many other occasions, however, it is an issue not only of investing sufficient resources but also of finding people who have the courage to stand up and say the right things. That is a more difficult matter. In regard to numbers, the Department of Finance is probably not sufficiently staffed in that area.

More broadly, the Deputy asked about a framework for growth. I refer her to the EU approach that was adopted by the European Council in March and which will be taken up again later this month in Brussels. Ireland is also part of Agenda 2020, in which regard the institutions in Brussels provide an overall framework, while the obstacles to growth and the appropriate policies for accelerating productivity are investigated on a country-by-country basis. The issues with which Germany must contend are very different from those of Finland, Spain or Portugal but the European framework is being actively pursued and discussed. I am sure Ireland is playing an active role in these discussions, which are welcome because they will lead to an internally consistent approach by the EU. Does Mr. Watson wish to address the questions on share value?

Mr. Max Watson

On the chasing of share value, it was a fantastic experience to read the brokers' circulars on banks written during this period. They include several spectacular examples of praise of corporate governance in certain institutions. It is pretty tough in that environment but the UK experience revealed considerable differences in banks' responses to competitive conditions. Some banks emerged stronger than others. I recall an investigation into the question of whether a bank is more profitable if it prepares an aggressive strategy. It was found that the conservative approach tends to result in very low funding costs over time. On average, therefore, being conservative can have its own rewards.

When people say other countries did better, they often identify Australia, Canada and Spain. Canada did not have the same climate of competition and the banks were not hungry in that visceral sense, which made it much easier. On the question of share prices, hidden somewhere at the top of page 36 of our report is a recommendation that it might be worthwhile to investigate whether market manipulation took place in the share market. This specific concern is not picked up in the conclusion, which is shorter, but it is a question that is worth investigating.

To raise a point on auditing, when the terms of reference are being decided — I hope I do not sound condescending — members should be sure they ask whether auditors do what reasonably could be expected of them. Auditors are not meant to be visionaries, so it is helpful to focus on that part of the inquiry specifically. As with market manipulation, I presume this is an offence in Ireland.

Can I ask Mr. Watson specifically——

We must move on. I call Deputy Michael McGrath.

——about the report.

The Deputy can ask her question later.

Is Mr. Watson suggesting there was market manipulation?

I am asking Deputy Michael McGrath to take the floor.

I merely ask him to clarify the issue.

I welcome Mr. Regling and Mr. Watson and thank them for the comprehensive report they prepared on time and, no doubt, within budget. The executive summary of the report concludes by stating that the true burden of responsibility for the crisis emerges as being quite broad and extends to insufficiently critical external surveillance institutions. The true burden of responsibility for the crisis emerges as being quite broad and extends to insufficiently critical external surveillance institutions as well. In his opening remarks, Mr. Regling referred to some of the reporting in recent days on the publication of the reports. Some politicians have made up their minds on the cause of the crisis. They have decided it was caused by Government policy and while acknowledging that there were some international factors they consider they were of minor relevance and essentially the blame for the crisis lies at the door of the Government and the Taoiseach. That view has been articulated in recent days. Perhaps today presents an opportunity for the witnesses to help us with the interpretation of the report. The witnesses provided a very good analysis in their report of the various factors which created the environment for this crisis domestically and internationally.

I submit, from reading the two reports and all the information in the public domain, that what lies at the heart of this is a complete breakdown of risk assessment in the main financial institutions in Ireland. They engaged in reckless lending to one sector, the property and development sector. Page 32 of the report has a graph on the loans for construction and property, excluding residential mortgages. In the case of Anglo Irish Bank, 80% of its total loan book was accounted for by loans to property and construction. In the case of Irish Nationwide it approached 75%. In the case of Anglo Irish Bank, 12.5 times the value of its capital base was accounted for by its exposure to property and construction.

Essentially, it seems very clear that the main banks in Ireland put virtually all of their eggs in one basket. We all now know what the consequences were and the implications that were created when the bottom fell out of that basket. Would the witnesses agree with Professor Honohan's comments when he said that the major responsibility lies with the directors and senior managements of the banks which got us into this crisis?

Mr. Watson referred in his opening remarks to egregiously bad and dangerous banking practices in Ireland. While everyone acknowledges that the environment internationally and domestically was conducive to the wide availability of credit and the enlargement of a property bubble, surely that key issue and the issue of the practices within the banks needs to be clearly highlighted and articulated. I would like Mr. Watson to give some overview, if possible, and attach a weighting to the different factors.

He has again verbally outlined the range of factors which contributed to causing this crisis. As Mr. Regling said, the report was focused on identifying the sources of the crisis rather than allocating responsibility or blame to any individual or institution. Is it possible for him to give an overview in terms of attaching a weighting to the different factors domestically and internationally which caused the crisis we now have to deal with?

Although the report prepared by Mr. Regling and Mr. Watson fell short of an examination of the bank guarantee at the end of September 2008, in his report Professor Honohan took the opportunity to comment on it. Mr. Watson made some outline remarks on the guarantee. Would Mr. Regling and Mr. Watson agree with Professor Honohan's comments on page 14 of his report that as regards the substance of the guarantee, it is hard to argue with the view that an extensive guarantee needed to be put in place since all participants rightly felt they faced the likely collapse of the Irish banking system within days in the absence of immediate decisive action? He states the consequences of not doing so would have been immediate and lasting damage to the economy and society and that there would have been additional lost income and employment amounting, if it could be quantified, to tens of billions of euro.

I acknowledge that Mr. Regling and Mr. Watson's terms of reference did not take them up to including the guarantee but they have examined all the conditions which prevailed at the time. In general terms, would they agree in principle with the comments of Professor Honohan and the decision to introduce the guarantee scheme? To bring the debate up to the present, the report states that justice has to be done and lessons must be learned but closure is also needed. What are the views of Mr. Regling and Mr. Watson, as renowned economists, on the measures the Government has taken since 2008 to arrest the fiscal deficit, clean up the mess in the banking system and reform the Central Bank and financial regulatory function? I would be grateful if the witnesses would address those points.

Mr. Klaus Regling

I thank the Deputy for his questions. On his first questions, I do not think anybody will be able to give an answer. To put weights on the different sources of the crisis is not feasible. I only want to repeat what I said earlier, that one has to look at the full range of elements from the outside — the international environment, liquidity, the fiscal side, the lax regulatory environment worldwide — and then look at the Irish components that Max Watson and I talked about in our different statements. It is the interaction of these different elements. That includes Government policies on the fiscal side not responding appropriately during the transition phase to monetary union and during the initial phase of monetary union when economists knew that interest rates would be too low for certain economies in the euro area. It would have been advisable to use more strongly the available instruments on the supervisory side and fiscal side to compensate for that effect of monetary union, which was known and was not a surprise. All those things have to be taken into account.

We talked about tax exemptions and tax expenditure policies, which here went further than in all other EU countries. It is this combination of factors and because there were so many factors contributing to the crisis, that is, in a way, the reason the crisis became so deep. If there had been only two or three elements, certainly the situation would not have become so bad. I am sorry I cannot give the Deputy weights for that. I do not think anybody would be able to do that.

On the Deputy's question on Professor Honohan's statement on the Government decision on guarantees and the crisis management since, as the Deputy rightly said, this was not part of our mandate so we do not talk about it in the report. We follow with great interest what has been happening here and what is happening in other countries. In principle, and without going into details, both of us have the view that crisis management here has been very good, particularly compared to some other countries in the European Union. That is a very general statement and we do not want to go into any details because that is outside our mandate and outside the topic of this session. However, that is our general assessment and, therefore, we also agree with the quote from Professor Honohan's report that when the decision on the guarantee was taken there was little alternative because the risk of a much deeper crisis was real. One has to accept that decisions are taken in a crisis without having all the information one would like to have. That is, in a way, a characteristic of a crisis. Looking at all of that together, we definitely would agree with Professor Honohan's quote on this point.

I will be brief. I thank Mr. Regling and Mr. Watson for their answers so far. On rating agencies, which are referred to in the report, we know they were quick to apply triple A status on some repackaged assets. Governments and banks reasonably claim that they rely on the classification provided by the rating agencies. This clearly posed a significant difficulty. What can the Government do to try to correct the assessments of the rating agencies and hold them to account in some reasonable fashion in the future, whatever about the past? Perhaps the witnesses will comment. This is obviously a difficult problem given that the agencies in question are offshore, as it were.

Mr. Regling rightly says that external auditors can be reasonably expected to comment on what they know. However, are they a significant part of what happened in the past and are they, therefore, likely to be a significant problem with regard to what happens in the future? For example, one set of auditors found a profit on Anglo Irish Bank's 2008 accounts of €784 million, yet a few months later we all knew there was €12.7 billion of a loss. Will Mr. Regling comment on whether he finds that extraordinary? With regard to what one might reasonably expect auditors to know, in what context would he put their finding?

Mr. Regling and Mr. Watson have been about town for approximately three months now and I am sure they must have got a sense, particularly when compared to other European cities with significant populations in which they have spent time, that here on an island of just 6 million we all know each other quite well, particularly within certain sectors. In the banking sector people would clearly be very well known to each other. If somebody changes his or her car, wife or husband, it is usually out there inside of 24 hours. Given that sense of community, is it ——

That is one interpretation.

Is it their view that what was going on at all levels of the banking sector simply could not have been happening without, at least, the knowledge of those in key positions within the sector? Therefore, was there a blind eye turned at many levels, particularly senior level, to activities in the financial sector?

Mr. Klaus Regling

The Deputy asked what the Government can do with regard to credit rating agencies. It cannot do very much, because this is not an Irish problem. Credit rating agencies have played a negative role in the financial crisis worldwide and were one of the elements that contributed to the crisis. That is well documented. The Deputy mentioned the triple A rating for complex structured products, what we now call "toxic assets". Therefore the ratings are a problem. Various efforts are being made in the European Union, the Basel Committee, the Financial Stability Board and the G20 to do something about them. Another general problem is that our supervisory system — the global system — has given a very prominent role to credit rating agencies. Perhaps they went too far in that respect. Also, there is not that much competition among credit rating agencies as we only have three big ones and one small one. There are problems and they are being addressed, rightly so, at the global or European level. The Government of Ireland cannot do much on its own in their regard apart from playing an active role in the other fora, like the European Union where the Government is represented.

On the question of the auditors, as we say in the report, one must be surprised at some of the statements one reads. On the other hand, with regard to the example given by the Deputy as to how, within a few months, there was a move to such a significant estimate of losses, that can be justified, because as the markets move, the underlying estimations for provisioning and for the value of assets can change rapidly. That in itself is not, necessarily, a reason to believe that auditors are not doing a good job. However, we still say clearly in our report that we have concerns that some of their work was not perfect.

The Deputy said, and it seems everybody says this, that people here know each other well. That is nice in a way.

I am not so sure.

Mr. Klaus Regling

However, that can create problems, as alluded to by the Deputy. We are not really in a position to comment on that. We did not actually live here for three months. We also had some other work to do. Occasionally, we could not even come to Ireland because of the ash cloud and we had to cancel some meetings and do more telephone conferences from Brussels than we would have liked. We got the sense people in Ireland know each other well. Sometimes that can be an advantage. I have been in countries whose society's cohesion has been so loose it has led to problems. It could be an asset in Ireland's case.

Mr. Max Watson

In the spirit of what Deputy Morgan said, page 35 of our report refers to the concentrations of exposure not just to commercial real estate but a really small number of end-borrowers. We stated, "In an economy which is not large, and which has one main financial centre, it would be surprising if this state of affairs was unknown to banks". The same would go for supervisors.

If it were known, then accordingly it should have been corrected.

Mr. Max Watson

Those concentrations were dangerous. Even if the standard lend concentration tables did not show it up, somebody should have jumped on it. We did say a credit register is not a panacea or silver bullet. However, a credit register centrale de risques, a rather continental European device, does help pick these things up. While it is not perfect because debts or loans can be registered in the name of a nominee company or one’s dog, it still picks up a lot and tells one where to look.

I call Senator Quinn.

Was the Chairman not calling party spokespersons first?

The opening statement was a good economic lecture, one which every student of economics should read.

I always like to think that for whatever work I do there is an end objective. The introduction to the report states, "The report was also commissioned in order to identify areas for further follow-up by the planned statutory commission of investigation." I assume the investigation will not just look at the past but the future to ensure this does not happen again. Ireland never before had a property crash, the experience of war or inflation like in Germany in the 1920s. Other countries have known experiences that have taught them to avoid repeating certain policy decisions and actions.

Do we need this commission of investigation? Why should we have an inquiry at all? We have a history of not prosecuting white collar crime and having investigations that go on and on, spending huge sums of money. I accept Mr. Regling, Mr. Watson and Professor Honohan have managed to achieve their conclusions in a short time. However, I believe a commission of inquiry may not finish by the end of the year as promised. What is Mr. Regling's and Watson's view on this?

I would be more interested in hearing from them proposals for legislation that would ensure this does not happen again. Mr. Regling referred to us knowing each other well. Mr. Watson mentioned us having a culture of not rocking the boat and, therefore, supervisors and politicians could influence developments. Since the decision to have the inquiry, we have had two appointments, Mr. Matthew Elderfield, as Financial Regulator, and Professor Honohan, as Governor of the Central Bank. I believe they are strong individuals who will not be influenced by those above them such as politicians and senior civil servants telling them not to rock the boat.

I suggest we should ask Mr. Regling and Mr. Watson what legislation we need rather than for information to consult another inquiry.

Mr. Klaus Regling

The Senator is absolutely right. It is always important to know why one is doing something. The reason we were asked to write this report was to find ways to ensure that it would not happen again. For us there was a second important purpose, namely, to draw lessons that might be useful for other countries not yet in the euro area. We know the euro area will continue to grow. We are already advising some other countries in eastern Europe, which are members of the EU but not yet in the euro area, to draw the right lessons from this crisis. We hope this report helps. It was for us, given our past where we worked on European affairs, an important element of this report. One can draw good lessons.

Is an investigation needed? We were asked to come up with points that should be covered if there is an investigation. It is up to Ireland to decide and I would not want to tell it that it must have one. The two points we mentioned on page 45, looking into corporate governance, the governance failures on risk management and why there was no reaction in banks and regulatory authorities to these obvious developments which we described in the report, would be an obvious choice if Ireland has an investigation. It is up to Ireland to decide.

Apart from the investigation, the Deputy was right to ask, as a parliamentarian, what kind of legislation is needed to prevent this from being repeated. That is a question which many countries around the world asked themselves. Work is going on in many fora to come up with some answers. G20 summits, in particular the one in London about a year ago, came up with a very good agenda of what needs to be done in a co-ordinated way. It is useful to discuss it at the G20 but it needs to be implemented at national level.

In regard to filling gaps in supervision, we know certain markets and certain activities are not covered by any supervision. That should be closed. The G20 agreed on that. For instance, it agreed to look at credit rating agencies and their role. The Basel Committee is looking at the capital adequacy of banks. The Financial Stability Board is looking at many elements under that heading. That is very important work, which is ongoing. It is good that it is being done in a co-ordinated, global way.

As far as Ireland is concerned, most of the decisions will be taken in the context of the EU. Ireland, of course, plays a role in the European Council and in the European Parliament. Ultimately, it will come to the Irish Parliament because it needs to be transposed from EU law into national law. That is the right approach and the agenda defined by the G20 is the right one. It is a question of implementing it rapidly. It is working on it but there is not always agreement on everything. When one looks at the outcome of the G20 finance ministers meeting a week ago in Korea, it is clear there is no agreement yet on some important elements, such as capital adequacy and accounting rules. The work will continue. There will be a G20 summit in Toronto in two weeks and there will be another one in Korea in November.

Implementation is key. The agenda is well defined but the devil is in the detail and they are working on that. It is not an individual, Irish agenda that needs to be implemented. It must be done in the context of the global agreements and, in particular, the EU agreements in which this country plays a role.

Mr. Max Watson

Ireland already has legislation to merge the Central Bank of Ireland and the supervisor. In practice, it has sort of been done even ahead of the legislation. It clarifies the lines of control a bit.

Like Mr. Regling, I think there is quite a case for looking at an independent fiscal or economic council of independent minded people who will look at projections and fiscal projections and the interactions between the financial economy and the real economy.

I am not sure if Mr. Regling or I said it but we say in the report that the economic and financial analysis capacity of the Department of Finance needs to be strengthened. That is important. To be honest, the two reports take Ireland a long way. There may be mezzanine level things these reports could not get into, including for legal reasons, and things that were not actually criminal. Maybe there is something there to go after and we have rather focused on that intermediate level, but we would not like to tell members whether they should have the investigations.

I thank Mr. Regling and Mr. Watson for their concise report. I wish Mr. Regling well in his new appointment.

In terms of the banking crisis, the first line in the executive summary of the report on page 5 states: "yet it was in crucial ways ‘home-made'". I would like to know the home-made ingredients of the crisis. In this context, Professor Honohan's report states that 75% of this was attributable to local factors. The witnesses state that "this was a plain vanilla property bubble''. I am using some license here in saying it was a ripple bubble to use the analogy drawn between the property bubble and ice-cream, which I assume is the basis of the reference to vanilla. Effectively, this ripped through the system.

In the executive summary, the authors state that official policies added fuel to the fire and fiscal policy heightened the vulnerability of the economy. Furthermore, they stated earlier that by 2006 it was not possible to expect a soft landing, yet the bulk of fiscal policies that fuelled the flame were introduced in 2006, 2007 and 2008. The witnesses refer to this in their report where they state that public expenditure was particularly marked in 2006 and 2007. They indicate that the OECD stated that "by 2005 the cost of tax expenditures had become larger than the remaining income tax receipts" and that we were way above the EU average in that respect. In that context, I would like the witnesses to comment on the tax incentive schemes. It was clearly flagged in 2005 that there was an issue in this respect, yet the tax incentive schemes were not closed until 31 July 2008, some three and a half years later. We are being told they were closed in 2006, but when one examines the finer detail, they were not closed until we were at the edge or in the middle of the banking crisis. I would like the witnesses to comment on that and on the fiscal policy during that period.

Mr. Regling referred earlier to the advice given. Alarm bells were ringing about this issue at that time. The dogs in the streets knew from 2007 onwards that property here was over-valued. It was not a question of whether this was good advice, alarm bells were ringing about this issue. The witnesses stated that there was a property bubble, yet the tax incentives continued. We had a 20% tax rate for developers in terms of land. I would like the witnesses to comment on that.

The witnesses referred to meeting people and they were obviously getting to know the Irish people. Who did they interview? They state in the preface to the report that they met financial regulators, representatives of the Central Bank and bankers. Did they meet the current and former regulator? Did they meet the current and former governor of the Central Bank? Which politicians did they meet? We are a small country and it is a question of getting the feel for the way we did business, which was very loose and, as Mr. Watson stated, it was a case of a person looking around the door and saying: "Not now, leave it, do not move on it at the moment". I would like to know who they interviewed? Did they interview the Minister for Finance? Did they interview the Taoiseach?

The Deputy asked that already.

I am reiterating the point.

I know the Deputy is, but we do not have time for that.

My final point relates to the commission of investigation that is taking place. The terms of reference specifically stated they should "thoroughly examine how events, banking, the regulatory and the wider governance of peer responsibility contributed to the crisis". Can there be a proper commission of investigation without examining fiscal policy, as has been proposed? I hope the witnesses enjoyed their stay in Ireland.

Mr. Klaus Regling

Yes, but there was more work than we thought.

Perhaps there is a little more to be done.

Mr. Klaus Regling

As economists, it is an interesting subject and, in that sense, we enjoyed it, although, as the Deputy's colleague said, these are topics one would rather not have to work on. It is better not to have crises like this but given a crisis exists, it is useful to look at the reasons for it and to draw appropriate conclusions for Ireland and for other countries because this is a wider issue. I found that quite rewarding.

What about the home-made ingredients?

Mr. Klaus Regling

The Deputy's first question was about home-made ingredients. I mentioned several times that one has to look at the overall picture, the external and domestic factors.

Mr. Regling has said it is feasible to disentangle the home-made——

Will the Deputy allow Mr. Regling to reply to his questions?

I am just giving assistance.

He does not need the Deputy's assistance.

He does not need assistance but I am guiding him because my time is limited.

The Deputy's time is up.

Mr. Klaus Regling

As I said before, it is not possible to put weights on that but different elements that affected different countries around the world were in a way all present here. They were less present in other countries and that is why there is this differentiation. The reason the crisis became so deep and serious in Ireland is all these factors that one can identify — and it is a long list — in a way played a role here and often they played a very important role. They were unusually severe in Ireland in certain aspects.

Then we had serious breaches of corporate governance to which Mr. Watson referred, which again were probably more severe here than in other countries. When one adds it all up, that is the reason the crisis became more serious here than in some other countries. All western economies were hit by the crisis and few countries do not have negative growth rates but the severity varies a lot. The reason is all the different elements that one finds around the world and in Ireland were all more severe here and were all present.

The Deputy asked who we met. We will not give him names because that was the understanding when we met the people. I mentioned in the report the category of people we met but we did not meet the Prime Minister, for instance. That is obvious. The Deputy can probably see it from his diary. We met the Minister for Finance on two occasions because he explained to us the mandate and we used those opportunities to have a broad and long discussion but I will tell the Deputy what we discussed.

Does Mr. Regling not think it would have been appropriate to meet the Taoiseach?

Will the Deputy please stop interrupting?

This is a critical point.

Will the Deputy allow Mr. Regling to finish? He can ask supplementary questions later.

Mr. Klaus Regling

We did not do it and I think we worked from the facts and data that could be objectively identified. We thought it was not necessary.

Will Mr. Regling elaborate on that?

Will the Deputy hold on? This is a regulated meeting.

I am entitled to ask a question.

I will allow the Deputy to ask a supplementary question when Mr. Regling is finished.

Mr. Klaus Regling

We share the Deputy's view on the tax concessions. I think it is in the report. The problem was recognised at some point in the decade, although not early. They were closed only in 2008. With hindsight, this was clearly too late, so tax breaks contributed to the crisis.

Did Mr. Regling not believe it appropriate that——

Will the Deputy please allow Mr. Regling to finish?

Mr. Klaus Regling

I am finished.

Not to tell Mr. Regling his business, but would he not have viewed it as appropriate to speak with the then Minister for Finance when examining the build-up period? The report identified that, from 2004 or 2005, there was a pro-cyclical pumping of the economy when it did not need it. Speaking with the then Minister would have given the report, which is a good one, an overall perspective. The fiscal and budgetary issues were fundamental.

Mr. Max Watson

We did not waste too much time on things we knew.

Mr. Klaus Regling

Our statements on fiscal policy are clear. We were confident that we analysed the situation appropriately.

Did the witnesses seek to meet the Taoiseach?

I have three questions, but I wish to make a couple of comments. First, I agree with the witnesses' description of Professor Honohan's report as epic. Their excellent presentation has the same status. I hope that members, individually and collectively, take on board what has been stated. In future economics classes, this presentation will go down as a worthwhile piece of advice in terms of the analysis of a crisis. The succinct way in which the cross-spectrum shortcomings have been outlined is impressive. We owe Mr. Regling and Mr. Watson a debt of gratitude in this respect.

Second, I will not go into some of the matters mentioned, but——

A question, please.

I acknowledge the witnesses' point that, while Ireland's crisis management has been good, a fault was that we as a Government did not respond to the monetary union and that the cross-border integration of the banking sector did not get the attention it deserved.

I will ask my three questions after my third comment. Regarding the guarantee——

The Deputy has not asked a question yet.

I welcome Deputy Burton's remark that we are past the point of political point scoring, so I will not go into the matter. It was stated that the bank guarantee scheme was a disaster and was rightly opposed. I will say no more, but I am pleased the witnesses have confirmed the situation.

If Deputy Fahey has some questions, would he please ask them?

My first question regards the need for expertise.

Will Deputy Fahey not give the reference for that quote?

Please direct questions to Mr. Regling and Mr. Watson.

We have a détente following Deputy Burton’s earlier remarks.

Deputy Fahey is into political point scoring. Normal service has resumed.

No. I will go no further.

This started earlier. I ask Deputy Fahey to direct his questions to the witnesses.

The proper strengthening of macro-economic resources and expertise in the Central Bank and the Department of Finance were mentioned five times. In response to the question on whether good advice had been overruled, the witnesses' stated there was not much good advice. They believe that getting the right people who are prepared to say the right things is critical. They stated that policy makers lacked information about the banks and so on.

In the past two years, there has been much debate, particularly among economists who write in newspapers and whatnot, and a serious divergence of opinion. Will Mr. Regling and Mr. Watson give their thoughts on what kind of expertise is necessary and whether it would be better to try to source that expertise outside Ireland? They have come in from the outside and have been a success.

Regarding the commission that is to be established, the report states, "In order to learn lessons promptly, and to achieve closure rapidly, it would seem wise for the subsequent process of statutory investigation to focus mainly on issues that stand out as potentially highly blameworthy but also very concrete, and feasibly verifiable by a legally oriented process." If they know the terms of reference for that commission, will the delegates comment on whether they are happy with them and that they are satisfactory? The committee had a debate when the delegates were appointed. They were described as a whitewash and a cover-up. I hope the people who made those points will now have second thoughts.

The Deputy is incorrigible.

Is it important that this investigation be held in public or is it important to hold it in private? My view is that it should be a combination of both. The delegates might comment on that.

The delegates made much comment on what they called the "egregious failures" of the banks. The proposal to sort out the property bubble problem is NAMA. I know this is not in their brief, but might the delegates comment on whether they are satisfied NAMA is the appropriate approach to take to try to deal with the crisis the economy is left with, in view of the property bubble that caused the crisis in the first instance?

Mr. Klaus Regling

Thank you for the questions. The first was on economic expertise. One of our conclusions was that this needs to be and should be strengthened. The Deputy asked how, and with what kind of expertise. Central banks and finance ministries and, increasingly, supervisory agencies need economic expertise. In supervisory agencies we see all over the world that last point was missing. That is why the term "macro-prudential supervision" is now so prominent. People realise in analysing the crisis that is where the gap was. Traditionally, supervisors looked at one bank and analysed its portfolio and whether it had good or bad lending but they did not really try to put it all together in an overall picture. Perhaps an individual loan is quite appropriate, appropriately priced and provisioned but when we put it all together there are macro risks. This kind of work was not done. That is one general lesson of the crisis, not only in Ireland but worldwide, and that is why the macro-prudential risk bodies have been created.

One needs the right staffing for that. It is something new that was missing in the past. Economists are needed for it but they are needed also in finance ministries and central banks. I would not advocate relying on outside resources. Outsiders like us, who come from all sorts of countries, are only an ad hoc measure. For the day to day work the Government needs these people in-house to give daily advice, if necessary.

Should they be Irish, non-Irish or a combination?

Mr. Klaus Regling

As a good European, I have always been in favour of national administrations including non-nationals among their staff to broaden the mix and understanding. That would be a good move. There are some countries which do this. Others, including my own, are very reluctant to do it. I think it would be a good step.

The Deputy asked for our view on the terms of reference for the investigation. We should not really comment on that except to say that the points we mentioned are possible candidates for areas of investigation. They are there and reflected and in that sense we are quite happy they have been picked up. It is now up to the Government to look at the details.

I ask Mr. Watson to comment on NAMA. It is outside our——

Should the investigation be public, private or both?

Mr. Klaus Regling

There could be a case for a combination. If there is an investigation one may want to go into some secret documents that should not be made public. That is my feeling. I have not thought deeply about it. To the extent that secret documents are involved, a combination would be needed.

Mr. Max Watson

On the question of bringing in outsiders, if one sets up things like economic counsels and so forth, one wants one or two people there who are a breath of fresh air. Having people from other European countries is an approach that has been taken in a number of countries. There is something to be said for it. It is a good idea to bring people in who can contest ideas, perhaps from the academic community.

I agree very strongly with what Mr. Regling said as regards some of the banking component of the investigation.

I strongly agree with Mr. Regling's comments on some of the banking component of the investigation. It would be hard to imagine that some parts of that could be held in public if it was to be efficient. At an absolute minimum, I would guess that some parts would need to be private.

On NAMA, the Deputy is putting questions to us as outsiders, commentators or visitors. The process has impressed many people relative to processes elsewhere by its open, quick and clean function. The haircuts have come out looking realistic to outside people, although nobody knows where it will all end up. There are some lessons.

The next speaker will be Deputy Terence Flanagan, to be followed by Deputy Chris Andrews and Senator Dan Boyle.

I thank Mr. Regling and Mr. Watson for coming before the committee again and for the excellent work on the report, which clearly puts to bed much of the spin arguing that international factors brought about the property bubble and crash in Ireland. It is clear that was not the case. As there had never been a property crash in Ireland up to this point, was there a false sense of security and a level of arrogance from the Government and the authorities? Did they feel it would not happen here and the property boom could continue?

With regard to the penalties for those who acted wrongly, what normally happens in other countries to politicians or regulators in such a position? Are they stripped of pensions or golden handshakes if they are proven to have acted wrongly? With regard to internal auditors, there was much poor documentation within the banks. Should the role of an internal auditor be examined if he or she did not spot properties without proper security or documentation?

Does the management bonuses and remuneration system that rewards those in Irish banks and banks in general need to be examined? Bankers were being paid significant bonuses in order to generate lending so did this ensure much of this reckless lending took place in the first instance? If such people did not get such large bonuses, events may have turned out differently. Were various drafts of the report provided to the Government or was it just the final report published ten days ago?

Mr. Klaus Regling

The Deputy's first point is very relevant in the Irish context as there had never been a crisis, negative growth or a fall in real estate prices. That created a false sense of security and not only among Government officials and the political class; everybody thought as much. This was particularly true for the private investors, who thought prices would always go up and it would not matter if debt was taken on because the property could be sold the following year at a higher price to pay the debts. Where would be the problem? That forms part of the explanation and one can see in many countries a false sense of security leading to negative consequences. That sense of security was particularly strong in Ireland, which is why I spoke earlier about the 20 years of very successful economic developments and concurrent rising prices. That played a significant role.

On the question of remuneration, bonuses etc., the Deputy is probably aware of ongoing work in the G20. The finance and stability board produced principles for sustainable remuneration systems. In the EU, there are proposals on how to make remuneration approaches in big companies more transparent, for example by prescribing that shareholders have to approve the salaries of top officials, including bonuses. These proposals are being implemented in some countries around the world, but I do not know how far Ireland has gone in this respect.

One wonders why both internal and external auditors were not more outspoken, but I do not have a good prescription on what to do about that. We only wrote one report. We had one final correction because we got new data, but we did not send several drafts to the Government and discuss it with it. We did our work. We had good co-operation from the Department of Finance in obtaining data. Requests for information were always answered quickly. There was no attempt to do any unjoined work on this, as it is only our work.

What normally happens in other countries if politicians or regulators are shown to be involved in wrongdoing and making poor decisions?

Mr. Klaus Regling

If it is real wrongdoing, then there is always the courts system. The most obvious case in point is corruption. That fortunately does not happen very often. Wrong policy decisions cannot end up in court.

It is the ordinary taxpayers who are paying for the consequences of the decisions of bankers. Somebody has to be held accountable here, otherwise history will repeat itself again.

Mr. Klaus Regling

Government legislation needs to be changed to prevent the repetition of such a crisis. Bankers are being taken to court in many countries. This always depends on the specific circumstances, but in Germany the first two bankers are now appearing in court for not providing appropriate information to their boards. The outcome is not decided, so I cannot comment on that, but these court cases are coming up in different countries.

Was specific legislation put together in the German Parliament to ensure this?

Mr. Klaus Regling

It was not done to ensure that bankers can be taken to court. If they did not fulfil their duty of informing their boards appropriately, then that is not a new crime as it is already under existing legislation. This may differ in other countries and I am not aware of what happens here. If it is so clear that wrongdoing occurred, then there is no need to change the legislation in most countries. What must be changed is the framework that might allow for gaps in supervision, inadequate bank capitalisation for crises, bank provisioning and accounting rules that lead to pro-cyclical behaviour. These are the things that only the Government, with the help of the Parliament in some cases, can change. Incentives need to be changed for less risky banking activities.

Mr. Max Watson

We point out in our report that one tends to focus on the bonuses and share options, but we should not forget the incentives for middle managers, bank managers and loan officers. We were not able to go into this, but it was flagged as an area that needs to be watched, because it sets pervasive incentives.

I think the Deputy was referring indirectly to the importance of adequate asset recovery. This is something to which we see increasing alertness and it is very important for the public purse.

I welcome this excellent report. It is clear, detailed and most importantly, it is understandable. Like the witnesses, I have read the newspapers over the past number of weeks and months on the banking inquiry. Mr. Regling and Mr. Watson's opening comments are in stark contrast to what has been in the newspapers. As they said, it is easy to blame people and there is an international context for what has happened, which is not being highlighted or discussed. Therefore, we are not getting the full picture as to what happened.

They also said it is important to highlight the fact that it is important to see how the global and Irish context interacted, which is very welcome. During the presentation they said Ireland went from being one of the poorest OECD countries to the second wealthiest. I heard a commentator say yesterday that the country was ruined. I would not agree with that — nobody would objectively — but that is what some commentators are saying. Do the witnesses have a view on whether we are ruined? It is related to the point that people like to simplify things and score points.

The witnesses referred to pro and counter-cyclical fiscal policy a number of times. Obviously we had a pro-cyclical fiscal policy. When there is strong growth what countries had and maintained a counter-cyclical fiscal policy? What role does societal expectation play in determining whether one has a pro or counter-cyclical fiscal policy? Mr. Watson said the IMF is one of a number of sources of information and institutions which governments refer to and base any decisions they make on. I may be wrong; Mr. Regling may have referred to it. The witnesses said the records of the IMF were not up to date or accurate. Why was that? They might expand on that. What were the implications for people and governments across Europe who were relying on that information?

The witnesses said no one knew of the bank practices in bank A. Why did no one know? I ask the witnesses to expand on that because it seems extraordinary that no one knew what was happening in that bank.

Mr. Klaus Regling

In answer to the Deputy's first question, Ireland is not ruined. This was the most serious crisis it ever had. Globally, this was the most serious crisis of the past 75 years since the Great Depression of the early 1930s. Ireland was hit more during this crisis than most other countries; that is why we were asked to write the report. In light of the rapid economic development before the crisis and even after the big drop in 2008-09 Ireland still has a per capita income that is above the European Union average.

As I said earlier the crisis management in this country has been better than in some other European countries. With the right policies there are good prospects for good growth again. It may not be as high as before the crisis. That was probably somewhat excessive, fuelled by pro-cyclical policies and excessive bank lending. That should not be repeated and will probably mean that what the columnists call "trend growth" or "potential growth" will be lower after the crisis than it was until 2007. With the right policies there will no doubt be growth again. Incomes will again begin to go up. My firm view is that Ireland is not ruined.

I never doubted it.

Mr. Klaus Regling

The Deputy asked which countries had better policies which were not pro-cyclical, particularly on the fiscal side. One could also extend this to monetary policy but this area is better researched. Fiscal policy is not analysed to the extent we would consider appropriate.

In 2007, which was the last year before the crisis fully erupted, the euro area as a whole had a fiscal deficit of 0.5% of GDP. Ideally, it should have been in surplus but at least the deficit was not large. It was the smallest deficit among the 16 eurozone countries for 25 years. I personally believe that the Stability and Growth Pact and the euro area arrangements that govern fiscal policies have been helpful in reducing deficits in the euro area, albeit not equally in every country.

The US, the UK and Japan had deficits of almost 3% of GDP in 2007, despite five years of above potential growth. These countries were clearly conducting pro-cyclical fiscal policies and this is why the US and the UK, in particular, now have double digit fiscal deficits. Their starting points were already bad. After five years of boom, these countries, like Ireland, benefited on the revenue side from a surge in temporary tax revenues which they thought would always remain high. Also like Ireland, they learned that their revenues reversed rapidly with the onset of the crisis because they were based on rapidly rising asset prices. These countries were clearly pro-cyclical but the majority of the euro area did a much better job, partly because of strict European rules. Many people argue these rules did not work and I agree they need to be strengthened but at least they offered something that was missing in the UK and the US. One can analyse which countries did better before the crisis and identify the reasons for their success.

The Deputy asked why the IMF did not give better or stronger advice earlier. To be fair, this question can be directed at the European Commission and certain other institutions as well as the IMF. The Bank for International Settlements was more worried about global liquidity and early on it began to write about excessive bank lending in many parts of the world but this was the exception. The mainstream view was also shared by the Federal Reserve and Mr. Greenspan, who thought we were living in a new world in which bank lending would grow faster and that productivity growth would be permanently higher. This wrong analysis led to wrong policy conclusions. I do not think they were trying to hide anything or ensure certain countries or sectors benefited. They merely had the wrong analysis. This attitude was widespread and we all have to learn from this crisis how we can do better, including a better methodology for analysing the conduct of fiscal policy in real time.

Mr. Max Watson

If one looks for countries which learned this fiscal lesson, the natural resources countries, such as Chile and Kazakhstan which set up copper and oil funds, respectively, had such big swings that the entire policy decided it had to get ahead of them. Fiscal policy was surprisingly good in these cases. I have nothing further to add to Mr. Regling's comments.

There is a catch in that policy makers in the last decade of the last century believed they had to deal with and influence markets. One way of achieving this end is to set out strict and clear rules and principles, including inflation targeting, currency boards, cyclically adjusted balances and standardised agreed output gaps. They came to rely on these things like crutches. More peripheral vision was needed. I completely agree with Mr. Regling that the European rules were extremely benign in helping people but there always will be this need to look beyond the rules and see what prudent policies really mean. There is no replacement for that.

Finally, even in the European Commission, which was the first to jump on this, there was not a good understanding of the adjustment dynamics in the euro area. What happened when an economy got advanced? It had to lose competitiveness but up to what point? What instruments could be used to correct this? Was this a stable process? The Commission brought out a report at the end of 2006 which addressed these issues and was very relevant to Ireland. In the course of 2007, the international community was starting to think, "Oh, so that is how the euro area works." There was also research done in the Commission in 2007 on whether it was the case that in places like Spain the fiscal position was twice as wide in its swings.

To be honest, there was an analytical gap and that is an extenuating circumstance for Ireland. To the extent that the IMF did not do the surveillance well, it was not really so much that records were not up to date, it is that the IMF was very influenced by the American economic community. I do not mean politically but as a way of analysis. The BIS was a bit of an outlier and got it very right but again the IMF was not very good in the case of developed or advanced economies at imagining how much better financial shocks and linkages would work into the emerging market economies. It probably would be a lesson for all of us to go back and think about this.

If I may, I will follow up on a point on which I did not receive a response, namely, the role of societal expectations in determining fiscal policy. It was stated in relation to bank A that no one knew.

Mr. Max Watson

I apologise. Some people knew very well but not the outsiders. Where is the surprise? One cannot pre-judge the issue but it does seem very surprising. As the external auditors went over the process of the internal auditors, one would have thought that would have shown it up. That is one of the things that needs looking into. When I talked about egregious practices I was very clear that these were not system wide. These things were pretty localised.

There was a wider question about internal audit and external audit. We have asked several people, particularly bankers and former bankers, a question about the corporate governance systems and processes in the sense of the UK Walker report and in the sense of the efforts that never eventuated to improve corporate governance design in Ireland. Was it, we asked, mainly processes or was it that they were not well implemented and there was no insight? The answer repeatedly came back that implementation was the problem. It would be good to get behind that a little more.

What about societal——

We must move on.

I thank Mr. Regling and Mr. Watson for their report and the mental stamina they have shown this morning which I greatly envy. I will concentrate on two areas. One relates to developing what was known in regard to the Irish economy, while the second relates to the recommendations Mr. Regling and Mr. Watson are making as to how the investigation should proceed.

The witnesses referred to a number of calendar dates and stated it should have been known by 2000 that the economy was overheating and it should have been known by 2006 that a soft landing was not possible and there was a failure to pick up on that, not only by Irish regulatory agencies and oversight bodies but also international bodies. It is most peculiar that we are finding out this in retrospect. Perhaps Mr. Regling would be interested to know that also permeated our political system and the general election in 2007, despite the fact we now know public expenditure increased over the ten-year period between 1998 and 2008 by 140%, higher than any other European country. Growth was far higher than the rate of economic growth or the rate of inflation. In the general election campaign in 2007 all political parties had expenditure programmes that planned to continue to increase public expenditure by more than the rate of economic growth and inflation. Therefore, that information certainly was not out there in 2007.

I remember the Green Party had a poster saying the old age pension would be €400 a week.

I am saying that in 2007 all political parties were talking about increasing public expenditure, over the rate of inflation and economic growth. That is an established fact.

In 2007, the Green Party was in Government.

May we have some questions from the Senator?

That was a question about the rate of growth over ten years — 140% growth between 1998 and 2008. We went mad, did we not? That growth was totally unsustainable. It was hard to justify then, never mind in retrospect. Is there any example of another economy that sustained that rate of growth in public expenditure over and above the rate of economic growth and inflation? I cannot think of a parallel in modern times. That growth may be the root cause of part of our current problems.

The graph on page 32 shows the multiplier effect of the loans on the capital base with regard to commercial lending. The multiplier in the case of Anglo Irish Bank was 12.5 and in the case of Irish Nationwide was 7.5. Is there an accepted form of multiplier of the capital base in particular areas of lending or is the multiplier itself seen to be flawed and should we have prudence and caution in this type of spending?

With regard to how we proceed from here, Mr. Regling may not be aware that the legislation that governs our commission of inquiry is recent. It talks about the presumption of the inquiry being in private. Given Mr. Regling's experience of investigations in other countries — I have the UK and US models in mind, where there is a mix of public and private — how would he define the best use of the public and private mix in investigations? For example, in terms of what we are investigating, I think that because State agencies, whether the Department of Finance, the Office of the Financial Regulator or the Central Bank, operate on behalf of the State, their role should be as open as possible to public scrutiny in whatever investigation takes place. In terms of getting information from the financial institutions and the legal difficulties that might surround that — mention was made of commercial concerns and secret documentation — there may be a case for some of that being heard in private to enable the information to come out more easily and quickly than it otherwise might and to stop it being tied up in legal red tape. Does Mr. Regling accept that is a definition of where we stand?

Towards the end of the report a distinction is made of the policy errors before coming to the recommendations about areas of investigation. It seems to me that the bullet points on pages 43 and 44 could form a useful agenda for an investigation by this committee, which would be open to the individuals or actors involved in the process, whether political or administrative people involved in the agencies I already mentioned. The principle is that if one operates on behalf of a nation, state or government, the scrutiny element should exist at all possible times. In terms of parliamentary scrutiny, the role of a committee like this, as it seems to operate in other jurisdictions, would be very valuable in looking at the agenda outlined on pages 43 and 44. I would be grateful for any comment Mr. Regling would make on that.

Mr. Klaus Regling

On the first point of what was known and when, it is interesting to recall exactly what was known and what was not known. Some things were known immediately. One knows immediately when one brings out a budget whether expenditure goes up by more than normal GDP. It was known this started in 2000 and continued for almost a decade. It was also known that credit growth was very strong and tax exemptions were high by any comparison. What was not known was that the fiscal stance was very pro-cyclical. As I explained earlier, our methodology for calculating output gaps, and therefore underlying fiscal balances, is weak. Normally, they become known when there are these large corrections. It is a mix of knowns and unknowns. One could have acted on the knowns while the unknowns only come to attention now.

Regarding the best use of public and private mix in an investigation, I am not an expert on this area but it needs to be considered. It is correct the Central Bank and Departments act on behalf of the people. There is, therefore, a certain expectation that they must be scrutinised.

I would not draw the conclusion, however, that every action of these agencies and Departments must be scrutinised in public. It is accepted when it comes to commercial banks that certain matters must remain confidential. That qualification also applies to certain activities of public institutions. For instance, when they deal with banks, one cannot make the public side transparent while not the other. Government authorities and Departments must be scrutinised on everything by parliamentary committees, but not necessarily with all matters in public.

Before Mr. Watson responds, can I ask a specific question on tax reliefs?

Please allow Mr. Watson and Mr. Regling to finish their replies.

Mr. Regling asked technical questions.

The Senator can ask them after Mr. Watson has finished.

Mr. Max Watson

There is a not a good rule as regards the multiplier effect of the loans on the capital base. Supervisors, under the Basel procedure, will compare the capital, now with more attention paid to its quality, with the risk-rated pattern of the assets overall. In Ireland there used to be a rule that not more than 100% of the capital should be invested in property-related assets. That got muddied because all mortgages are property-related assets. Even if the commercial real estate loans had been well documented, the collateral had been perfected and given to a small bunch of people, that kind of ratio to capital still looks surprising to me and I used to be a bank regulator. It is also apparent at the system level, but to a lesser degree. This should have been spotted by most people because of the volatility of that. This was a point made to us by various bankers.

On the policy lessons from errors, is it not the case the Government invited an examination of three of them?

There was correspondence.

Mr. Max Watson

We do not recommend investigating the way the rules apply in Ireland and the lessons to be taken. They are certainly, however, matters that deserve careful thinking as how they should apply in the future as a surveillance of policies.

I thank Mr. Regling and Mr. Watson for their responses. Are they aware that when the tax reliefs were eventually closed it was not to cool down the overheating of the economy but to put it on a simmer? Most of these tax reliefs have considerably long tails and their benefit would continue over a considerable period. What are their views on the use of tax expenditures and how they should be deleted when no longer needed?

Mr. Klaus Regling

As I said earlier in my introduction, tax expenditures are an instrument used in almost every country. Quite often they are questionable because they are normally not as transparent as real budgeted expenditures. In some countries, that is a reason to use them a lot. Governments sometimes — I am not talking about Ireland — want to be less transparent. It happens in countries. We have been to countries like that. In a general sense, normally the advice from economists is not to have very many of them but we find them in all countries. In Ireland, we find more than in other EU countries. I said it is three times as much as the EU average. There is always a risk that it leads to misallocation of resources because it is less transparent. One should be very careful. Therefore, it is better not to have them. Once they are there, they must be phased out in a way that respects the expectation of investors because once they are there, people make their investments. One cannot in a way retroactively destroy the basis for their decision-making. Unfortunately, one has to live for a while with the consequences. One cannot change the legal basis retroactively. That could be economically very damaging.

My first question is on fiscal policies. Given the backdrop against which they were framed, the weak methodology in terms of analysing them, the reinforcing view of the international surveillance organisations, such as the IMF, the EU Commission and others, and domestic ones, such as the ESRI, the resources available here and the projections made at the time, again reinforced by the analysis of these external and domestic organisations, do the witnesses believe the pro-cyclical fiscal policies being pursued by the Government at the time were reasonable? I would like a "Yes" or "No" answer to that question.

In the context of monetary policy, in particular in the eurozone, for a small economy like Ireland, do the witnesses believe there are sufficient counter-cyclical options available to offset the impact of low interest rates? For example, we had 2% money and 8% growth and everybody wanted to be at the party. What is the witnesses' view on that? I am not advocating that anybody would want to leave the eurozone but is it something on which the European Central Bank needs to focus? Ireland constitutes less than 1% of the eurozone economy and, therefore, our economic situation will not overly dictate the interest rate levels.

The way in which the crisis was dealt with was not within the remit of the witnesses but as economists, they seem to believe it has been very good. So that we are absolutely clear, can the witnesses cite any other government which is dealing better with the crisis internationally?

Mr. Klaus Regling

I thank the Senator for very precise questions but I will not just say "Yes" or "No". It is normally not so easy.

People might not like to hear that but I think I would. To the extent Mr. Regling can, he should do so.

Mr. Klaus Regling

We demonstrated in our report that we can be quite concise and brief but it is often more complicated than saying "Yes" or "No". For instance, on the Senator's question on whether the pro-cyclical policies were reasonable, in a way pro-cyclical policies are never reasonable. Ideally, policies should always be counter-cyclical. That is an economist's dream. Very often that does not happen.

I talked at length about all the other examples, the US, the UK and so on, of pro-cyclical fiscal and monetary policies. Even countries which have their own currencies are pro-cyclical on the monetary side. It happens all over the place but when we, as economists, try to analyse why something went wrong, pro-cyclical policies almost always play a role. In that sense pro-cyclical policies are never good.

The question, therefore, has to be what was known at the time. I talked about that before the Senator raised the questions. I said a few things were known such as public expenditure was growing faster than nominal GDP and credit growth was obviously very strong, excessively so. Other things were not known because we do not have a good methodology. It then gets complicated. In a general sense, pro-cyclical policies are never good.

Is "Yes" or "No" the answer?

It is definitely a "No".

Mr. Klaus Regling

The typical response from economists when they do not have a good answer is "it depends".

Politicians say that too.

So the answer is, "it depends".

Mr. Klaus Regling

The Senator's second question is very important. Are there sufficient options to offset the low interest rates some countries face when they join monetary union? This is not only an issue in Ireland but also in other countries that join the euro area, particularly in countries that are catching up such as Greece, Spain and Portugal. Estonia will most likely join the euro area next January. There will be other eastern European countries that will catch up, which will mean they will have a higher growth rate than the euro area average and the core old countries of the euro area. They will also have a somewhat higher inflation rate. This is a typical situation where, first, interest rates come down from a higher level and then they will stay at a level that is too low, in a general sense, compared to the economic situation. This is a typical phenomenon when we have a monetary union consisting of countries at different stages of development. It is not a surprising phenomenon. People who designed the European monetary union knew that. They thought about it and about the available policy instruments because it was clear that one had to do something. Perhaps it was not stressed enough but it was discussed. We make reference in the report that in Ireland, for instance, a few months before it joined the monetary union in January 1999 there was a final appreciation of the currency. I was very actively involved in that from the German Ministry of Finance at the time. The only reason for that at the time was to take some heat out of the economy because it was known that interest rates, which had been coming down, would stay low in Ireland. They might be appropriate for the average of the euro area, and I would always assume that the ECB will make sure that interest rates are appropriate for the average of the euro area, but it means that fast-growing countries' interest rates are too low. Therefore, an appreciation was possible once more before entering. It probably helped a little but that was a one-off. Once a country is in a monetary union, that possibility no longer exists.

The other policy instruments are on the fiscal side and on the regulatory side. That is the reason the pro-cyclical fiscal policy, even though the full extent of it was not known at the time, was so damaging because fiscal policy was needed as the compensation for the too loose monetary policy, which could not be changed. That was the price to pay to enter monetary union, which we say clearly, on balance, is still very positive for Ireland, but on that specific aspect it was clear that monetary conditions would not be appropriate for Ireland and therefore other measures had to be taken on the fiscal side — not pro-cyclical but counter-cyclical policy — and on the regulatory side. We described extensively, as did the Governor of the Central Bank, Professor Honohan, that the system failed there because the option did exist. It was used in Spain and Portugal, for instance, to lower loan to value ratios and force banks not to give mortgages of 100% or 110% but only to give mortgages of 80%. The possibility existed but it was not used. Regulators have certain options that were not used and after the crisis regulators will probably get even more options. That will be one that will be no surprise.

Senator MacSharry asked should the ECB focus on all of this. The answer is "No" because it cannot. It can only look at the average of the euro area. There will always be cases at both ends where monetary policy is too loose and there will be others where it is too tight. In Germany, there were complaints early in the last decade that ECB policy was too tight for Germany because it was in a low growth, low inflation mode, and that was probably right. If the Bundesbank had still been around interest rates could have been lower only in Germany. For other countries such as Ireland, Spain and Greece monetary conditions were too easy. On average, they were probably right. That is the only thing the ECB can do. It should not be blamed because it is one of the few one cannot blame. We have blamed many others here, but not the ECB.

On the Senator's third point, it was a case of crisis management. We have stated our views on this. In the euro area, I would rank Ireland best at crisis management among the countries that are in a real crisis.

Mr. Klaus Regling

Outside the EU area, some countries have also been very courageous, in particular, the Baltic countries such as Latvia where the crisis is even deeper in terms of loss in output than in Ireland and they are also doing well and they do not have the protection of monetary union. They deserve credit for that. They were doing well but in the euro area, Ireland sets a good example and I hope others will follow.

Mr. Max Watson

On the business of the offsetting, the answer to the question is can one offset it. There are enough instruments to offset it partially but in a small, open economy like Ireland, fiscal policy could never neutralise it, even when there is bad regulation. One will have a big cycle but the two together can avoid disastrous results. One cannot fully neutralise it.

International bodies such as the IMF, OECD, Commission and others got it so wrong. As recently as the summer of 2008 they were predicting we would have a soft landing. With hindsight, errors we made were judgment calls. Perhaps we made wrong decisions but when one looks at how wrong the international bodies were, were our decisions not reasonable in that context? Has there been fall-out in the IMF or the other bodies? Are they examining themselves in the context of the errors they made?

I was disappointed when Mr. Regling would not put a rating or a score on some of the problems that we faced because there is a huge difference between making a wrong call in hindsight and sloppy work in the banks. There should have been scoring out of ten because since the report came out, there has been a concentration on elements of it and there might be a great deal of looking in the wrong place. The bankers might be delighted with the response of politicians who like to turn on themselves.

Looking back, we consider that we have been prudent. We had good years with surpluses generated ten out of 11 years up to 2008. We made huge progress on the national debt, reducing it to 25% of GDP. The National Pensions Reserve Fund was set up and the Government resisted calls to raid that fund frequently by some people who now profess to support counter-cyclical policies. Many people have changed sides but the Government was wary and successful. If we were not so prudent reducing the national debt through the NPRF, how much worse off would we be today?

The Deputy is rewriting history.

What kind of revision is he writing? Is this the final chapter?

He must be trying to defend the brother.

Property tax incentives are popular here. I acknowledge the panel's point. We began the process of winding them down in 2005.

Yes. I hear Deputy O'Donnell's voice. If I recall rightly, he was proposing property tax incentives for his constituency as recently as the Finance Bill a few months ago. That was probably genuine from the point of view of regeneration, etc.

He should just keep quiet.

I am glad the Deputy is putting a word in for people. We are discussing balance.

Deputy Ahern has the floor.

Property tax incentives are always popular. We have been great believers in them.

I was being inclusive.

Yes, it is about turning the tap on selectively and when to turn it off. However, the issue popped up as recently as a few months ago.

The presentation was balanced and reasonable. Mr. Regling and Mr. Watson are not responsible for how things are taken up in the media or by the Opposition. One night while I was watching television, I did not know whether to feel flattered or something else about being an Irishman. The situation was being painted as a home grown problem that we brought on ourselves. On television, one can see problems in Greece, Spain, Portugal, Italy and the UK. There might even be a worried brow or two in Germany. One wonders how little Ireland managed to influence all of them.

How did Fianna Fáil swing it?

Fianna Fáil has a few home grown problems.

Is that not backwards?

From our point of view, it is difficult to understand. The statistics might be 10% home grown——

The Deputy should speak with Professor Honohan. He stated——

Deputy O'Donnell should listen and learn.

I am directing the Deputy.

——and 90% foreign. I accept that we must consider our difficulties.

Deputy Ahern's colleague cannot take that.

Senator MacSharry cannot listen to any more.

He has not had a chance to speak.

I listened to the witnesses, but would they like to revise their comments on weighting between the fiscal, banking and regulatory sides? We would be interested in listening. I thank Mr. Regling and Mr. Watson for their presentation.

Do the consultants want to comment?

Mr. Klaus Regling

I think there was no real question.

It was a rhetorical question.

Guess which side he is on.

Mr. Klaus Regling

I still do not want to give weights. I would not ignore the international side and the global context, but I would also warn against reducing the importance of the domestic situation, which added to the problems and is the reason the situation was worse compared with the situations of most countries in the euro area. It is a question of culmination and interaction.

Ireland has had many successes and it is important that public debt was reduced by so much, otherwise the crisis would have been really bad. We have clearly identified the problems on the fiscal side. As I have repeatedly stated, some aspects were known and others have only become known through hindsight. It was a culmination of factors.

Does the committee agree to sit for another ten minutes? Agreed.

I have a specific question on the inquiry.

I also have a short question.

It depends on time. There is no such thing as a short question.

I thank the witnesses for their interesting presentation. I only have one question, which is directly relevant to the report. I am constantly mystified by the role played by the Department of Finance, which Mr. Regling and Mr. Watson have not addressed at this meeting. Do they believe it has responsibility for what occurred? In all of the areas covered — the supervisor, the Central Bank, the regulators and Government policy — the Department has a significant input. After all, it is the engine room and source, receiver and distributor of information. It has contacts with and is not under the influence of politicians. It has contacts with and is not, although perhaps not enough, under the influence of the regulator. As the witnesses are aware, its Secretary General is almost inevitably made the Governor of the Central Bank. Professor Honohan is the first not to have been the Secretary General.

I am interested in hearing how, in the delegates' experience, the Department compares with equivalent departments outside Ireland and whether, because of the huge influence it undoubtedly exercised in this nation, its officials should be questioned and challenged rather more closely than they have been. In the delegates' report, why is there not really very much about them and the role they played? I see them as utterly central because they have octopus claws everywhere. That is not meant to be pejorative.

It is extraordinarily important we do not merely say, "Hey, these guys were understaffed. There aren't enough economists there and they don't have the resources", but that we ask whether they were doing their job, which was necessary for the economy and the politicians, and whether they were watching the regulator. That is my only question. I am interested to hear the delegates' comments on those points and on the power these people exercised.

Mr. Klaus Regling

In every country, the ministry of finance is the most important ministry. That is very clear. I worked long enough myself in the German ministry of finance so I must have that view anyway but I think it is really true. When ministries of finance do not work well normally a country is not well governed. That is a very general statement.

It is very difficult for us to compare the Irish Department of Finance with other ministries. We made the obvious points that are easy to make because they come easily out of the statistics. They are probably understaffed on the economics side. However, they are in charge of supervision. The political responsibility for bank supervision is with the ministry, as in most other countries. Obviously, they are in charge of fiscal policies. We talk about that in our report. They are not in charge of the Central Bank, as the Senator said at the beginning, because the Central Bank is independent, according to European law. There is the indirect fact, also mentioned earlier, that until recently the Secretary General of the Department of Finance always became the next Governor of the Central Bank. In itself, that is not at all unusual. When one looks at the EU area about half of central bank governors were former ministry of finance officials at the top level. Think of Mr. Tietmeyer in Germany who used to be my state secretary for a while. He became a very successful Bundesbank president. You see this in the Netherlands, Belgium and Spain. At one point of the calendar the number was about half and, as I said, this is not at all unusual. Obviously, central banks are independent by law.

That is as far as I can go with comparing situations.

My question was about how the Department of Finance here performed in the situation. Mr. Regling said it is responsible for bank supervision, fiscal policy and all of that. There is no doubt he was highly critical concerning the areas of bank supervision and fiscal policies. Can we extend that criticism to being very critical of the Department of Finance? That is the logical conclusion of what Mr. Regling said.

Mr. Klaus Regling

Yes, sure.

You are very critical of the Department of Finance.

Mr. Klaus Regling

They are in charge and, to the extent that they are politically responsible, the criticism goes to them.

Does Mr. Regling rate them pretty low?

He is not rating them

I just want to finish this. Does Mr. Regling rate them pretty low because of the responsibility they had?

Mr. Klaus Regling

I would not use those words because, as I said earlier——

It would make a good headline.

The delegates are not recommending investigation.

My questions are very brief. Have Mr. Regling and Mr. Watson had a copy of the Government's draft terms of reference? There are three points I wish to make about that.

That question was asked already.

It was. The Deputy was out of the room at the time.

The Department of Finance is positively excluded from the draft terms of reference. The delegates spoke of finance committees such as this one helping the debate, as it were. It seems extraordinary to me that the Department of Finance is excluded from the terms of reference of the Government's proposal

Just one second, Deputy. We will discuss that later but not today.

May I just finish my question?

You can, but I will say this. The Deputy can make any recommendations she wishes to have included in those draft terms of reference when we discuss it. I am sure you will ask——

I am asking our experts.

The witnesses could be asked for a recommendation on the grounds that they have not yet been asked.

I am asking the international panel for its advice.

The Deputy may ask away, I am not stopping her.

It is a legitimate question.

Nobody is stopping the Deputy.

Thank you. On pages 35 and 36 there is a description in the report of "graver issues", including examples of the disclosure of loans to directors and the window dressing of balance sheets beyond acceptable levels. There is also the question of whether loans by financial institutions were linked in some clear and problematic way to purchase of their own shares, as well as the possibility of market manipulation in the share market as a specific concern deserving consideration. That is entirely absent from the Government's terms of reference regarding the two institutions highlighted in the report. The Government's terms of reference are extremely vague and soft.

Has the panel had the opportunity to offer advice to the Department of Finance, which I presume drew up the terms of reference which are grotesquely inadequate? My next point relates to the role of the IFSC. Does that sector deserve some consideration?

We received a second letter from the Minister for Finance which I do not believe is yet in the public domain. It is not dated but I got it last night; it is addressed to our distinguished Chairman. The Minister for Finance wants a report from the committee on the policy lessons of the macro-economic management, the tax base and tax breaks by 15 September. The committee does not have much in the way of resources but this is an important challenge that I and others on the committee would be happy to undertake. For such a process to be done properly, do the witnesses believe a parliamentary committee such as this should be properly resourced in trying to find a way forward?

Has the panel had the chance to consider the exit strategy of the bank guarantee, taking into account that there will be a €74 billion loan roll-over issue in play by the time the guarantee expires?

Mr. Klaus Regling

On the question of why we did not include the Department of Finance, on page 45 we indicated our view — which does not need to be shared — that it makes sense to focus on verifiable facts and processes in a legal-oriented investigation. The Deputy is referring, with regard to the Department of Finance, to political processes that are in a very different category. It is not something that can be legally verified. That was the thinking behind our selection.

From his experience in other countries, does Mr. Regling believe there is a better way to address the issue, given that there are political sensitivities involved? He might come back to us with suggestions on how to address that critical issue.

Mr. Klaus Regling

Government bodies such as Departments, working on behalf of the people, should always be scrutinised by parliaments, although not necessarily in a public way, depending on topic. That happens in many countries but I could not say how to do it here because I do not sufficiently understand the country's legal framework. That is what Departments must accept in general.

Why did the witnesses not investigate how the Department operated to see if it was efficient?

I call Deputy Frank Fahey.

Will the witnesses answer the other questions?

Mr. Klaus Regling

I will answer the other questions. The way a Department operates is a political process, which is very different from the areas where we think there is a need for legal investigation. It is a different category for us and that was our thinking.

We received a copy of the terms of reference published by the Department of Finance two days ago but we were not asked for any additional advice. We assume our report was used before the drafting but there was no additional advice. The Deputy asked me how the committee should react to a request from the Department to do a report on fiscal and tax policy. I do not know the committee system sufficiently, how many staff are on the committee and so on. The committee would obviously need some expertise to do that, but I cannot give any more detailed recommendations at this point.

The exit strategy in respect of the guarantee is clearly outside our mandate. One should be very careful to give advice today, because this will evolve in light of the economic circumstances, which are partly the result of policies in Ireland and partly the result of global developments, given the open nature of the Irish economy. Nobody can say today what the precise exit strategy will be and what the precise cost will be. That is just not feasible.

What about the IFSC?

Mr. Klaus Regling

We did not look at that in detail, but when we asked questions, we always got the response that they were treated like Irish banks by the supervisors and that there was no specific issue that needed to be explored in a manner separate from the general investigation.

In view of the interesting comparison given by Mr. Regling between the overall eurozone deficit of 0.5% of GDP and 3% of GDP for the US, the UK and Japan, what is his opinion of the current status of the Irish economy when compared with the UK? What are our prospects for the future when compared with the UK?

I do not think that is relevant to the report.

Mr. Klaus Regling

I do not think we can get around to the UK details, because that would not be fair and it is outside the scope of our discussion.

Would it surprise the witnesses to learn that a public official from the Department of Finance cannot come in here and discuss advice tendered to a Minister? As Mr. Regling rightly says, parliaments should be holding ministries accountable, but we operate under a crazy myth that the Minister is responsible for everything that happens in his Department and public officials will not tender any information on advice they gave. The role that Parliament should conduct is not possible in our system. Part of a better way of overcoming problems would be to have open, proper scrutiny of officials. It will probably surprise the witnesses as well to learn that no outsider has ever been appointed to a senior position in the Department of Finance, with the exception of one person who was previously an official in the Department of Finance. There is no cross-fertilisation of ideas in the Department on all the macro-economic analytic skills to which Mr. Regling refers.

This failure of the Department of Finance needs to be examined. Unfortunately, given the way the witnesses have framed it, they seem to be putting it out of bounds. We will hear from our colleagues on the other side of the House that the experts did not say that they should be included, so it will not be examined.

Mr. Klaus Regling

I do not think I need to comment again, because I already said it——

I was hoping we might be able to persuade Mr. Regling to rethink what he said already.

Mr. Klaus Regling

I already spoke in favour of recruiting outside experts to Departments, including experts who are not Irish.

Should they not be answerable in here for the advice they tender?

That suggestion is a bit unfair.

This has been a very worthwhile meeting and it has clarified many concerns and queries for members of the committee and for the general public. Hopefully, the information that has been disseminated today will be fairly covered in the media. I thank you both for delivering a concise and honest analysis under the terms of reference that were given to you. It gives a clearer understanding of the crisis that we are still experiencing and which will be of great assistance to the work of the commission of inquiry.

I thank the witnesses for the work they have done on our behalf. If there is no other business will we adjourn.

The joint committee adjourned at 1.20 p.m. until 10 a.m. on Tuesday, 15 June 2010.