Apart from the tax incentives in property and construction that you have heard a good bit about I know already in the committee. Local authorities collected over €3 billion through development contributions imposed as part of planning permissions between '99 and 2008.
It's perfectly clear in retrospect that the appetite for risk was excessive and the lending strategy of AIB in respect of property was too expansive. That's not actually how it appeared at the time. In 2007, for instance, there was a strong national consensus widely confirmed by international commentators that Ireland was on a track of rapid sustainable expansion and development, and a good example is provided by the statements made at the launch of the national development plan in 2007. Just one detail from it: it was planned to spend €70 million a day every day for seven years on infrastructure with full employment, net inward migration, low debt-to-GDP ratio, budget surplus and buoyant tax revenue, and lots of civil servants were about to move out of Dublin. Martin Wolf, who has been described as the most respected financial columnist, expressed the view in June 2007 that the possibility of huge calamities being generated by financial markets looked remote. The IMF, in its financial stability report in 2006, expressed the view that risk dispersion as now organised in banks was less - made banking failures less likely. And of course, the reverse turned out to be the case.
In viewings with the benefit of hindsight, looking back now, it seems to me that a great deal of the issue in Ireland comes back to the question of whether at a certain stage a correction that was coming was going to arrive in the form of a so-called soft or hard landing. I think that's central to the errors. The OECD, the EU, the IMF, the ECB, the Central Bank, the Department of Finance, the ESRI, the great majority of published economists in Ireland and abroad, although not all, the risk section of AIB and the board of AIB all favoured the consensus of the soft landing and the consensus, of course, was entirely wrong.
There's a striking example or expression, I suppose, of this consensus comes from the OECD report published on Irish banks in April 2008. And I think the date is important because most of the loans ... nearly all the loans would have been made by then. And the OECD said, having looked at the Irish banks, the Irish banks were profitable and well-capitalised and provide a buffer against a future downturn. It's easy and certainly tempting to dismiss everything that went on in 2007 as irrational exuberance, but I actually think that there were - although this is not a popular thing to say - some policies, some justifications for the policy at the time, some rational justifications, and I want to briefly mention three of them. The first was the calculated demand for housing in Ireland, the second was the reassuring effect of Basel II, as it's called, and the third was reliance on risk modelling in banks.
There was hard statistical information which indicated that Ireland needed more housing. One of the things AIB did was get independent economists to come and talk to the board every year or so, and a distinguished independent economist in the middle of 2007 brought a paper to the board, which pointed out that of a selected group of European countries, Poland was below us, but Ireland was next lowest on the list in terms of dwellings per 1,000 citizens. Poland was 330 about, and we were about 370. And then Estonia, Holland, UK, were all well above us, and Denmark, France, Germany, Portugal and Spain were all over 100 dwellings per 1,000 citizens ahead of us. They were all over 470; we were at 370.
The second feature is Ireland has, as you're undoubtedly aware, a very unusual demographic history in the last century. The peak birth rate in most western European countries was in the '60s; people stopped having large families. The peak year in Ireland is 1980, so there were large groups of children born in the late 70s and early 80s and the 1980 crop will be 35 this year. So there's the feeling that there was this group of citizens coming into the ... what I would call the house purchasing age, and we took that on board. Those are the two things I want to say about housing demand, and I suppose the fact that there is now emerging something of a housing shortage in Dublin, certainly in some urban areas, suggests that this wasn't entirely irrational.
I don't want to say much about Basel II; it was promoted with banks by the Bank for International Settlements in Zurich, reinforced by the CRD, the Capital Requirements Directive. Its purpose was to ensure that banks had adequate capital. We bought into it heavily and expensively, €200 million between engaging experts and consultants and installing the systems in AIB.
It went live at the start of 2008 and frankly it wasn't much good to us when the trouble came. Part of Basel, a large part of Basel is to do with mathematical risk modelling, I remember we had to hire maths PhDs and so on to help us with this. There was a fraud in the American operation of AIB in 2002, a man called Rusnak stole a lot of money, and immediately after that, every regulator from Washington to Warsaw crawled over AIB and, we got the services in conjunction with the Irish regulator, of a man called Gene Ludwig, who had been a bank supervisor in the States and he investigated us up and down. One of his recommendations was that we needed to set up a world-class risk management system and that we needed a world-class player to head it up and we duly engaged undoubtedly distinguished and experienced risk specialists from JP Morgan in New York at a very high salary. I think ultimately 200 people came into the risk section. At the same time, on foot of the same recommendations, we got a group internal auditor from outside Irish banking, the individual in question had been director of audit for risk and finance in Barclays Bank, then gone to work for the Italian regulator for a short while and then was engaged by AIB. A third initiative at the time that I was involved in, was setting up a whistleblowing system. There's a not-for-profit in the United Kingdom called Public Concern at Work, and it will act as a facilitator, and this was published to staff; they could ring up there and their messages would come only to my office and they could preserve their anonymity if they wanted to.
Stress testing was done, installed, and in April '07 we had a stress test that looked at what would happen if things went wrong. There were two stresses: a plausible stress and an extreme shock test. The extreme shock test wrote down, for instance, unzoned land by about 60%, wrote down residential by 30% and I have the various figures if you need them ... but it went for a one in 25 year downturn and of course that wasn't enough. The stress test just didn't avail when we got a one in 100 year event. We didn't pay sufficient attention to the fact that the stress machinery didn't cater for that event and there was what I'd call an intellectual failure, for which I have to take my part of the blame, to envisage that if there was a serious property downturn in Ireland, a really serious one, and if at the same time there was a worldwide contraction of demand so that Irish businesses started doing badly, you started having unemployment and redundancy ... and at the same time as those two things, that the wholesale money markets closed up that we'd have a very serious crisis on our hands. When Lehman's failed on 15 September 2008, that in effect is what happened.
I want to say something briefly Chairman, if I can, about 2009 and what it was like. Now it's painful, it's not long ago but it's possible, in the collapsing of the historical perspective, to forget just how bad things got say from the December of 2008. In the autumn of 2008, the Department of Finance had estimated tax revenue for 2009 at €43 billion and the outturn was €33 billion. They'd also estimated the contraction in GDP in Ireland at 1%, a 1% drop in GDP, and the outturn was 11.3% for 2009, ten times worse than the prediction. In December 2008, a range of international banks were, this was unheard of before, downgraded. That included Deutsche Bank, Barclays, Credit Suisse, Citigroup, JP Morgan, Morgan Stanley. Anglo was nationalised in January 2009 and just as an indicator of how the general population felt, how public confidence had just gone at that stage, new car registrations in January '09 were 65% down on the previous year. Irish banks were downgraded in February by Fitch and then in the spring, AIB and Bank of Ireland had to get help from the Government on capitalisation.
Now you can ask the question why did everyone get it so wrong? I think it's very hard to get it right, that economic forecasting is less reliable and more complicated than people think. Credit has to be given to Professor Morgan Kelly, he detected the bubble but even he said he thought the downswing in prices in real terms would take eight or nine years. He also expressed the view that the Irish banks were well capitalised.
I'd like to say something briefly about the accounting standards that applied at the time. After the dotcom bubble, where accounting standards had given rise to alleged opacity in the accounts of public companies, IAS 39 was introduced.
It prevented banks, in very simple terms, doing what was called cross-cyclical provisioning: putting something away in the good years to save you the trouble in the bad years. It also had another effect. It insisted that certain parts of a bank book had to be marked to market, and I don't think the people who designed it ever envisioned there'd be a day when there wouldn't be a market. So you were now marking to market when there was no market and getting extraordinarily low values for assets. And there's ... the best description of this - which I think is a key dynamic of the crisis - the best description of this that I've found is in the so-called EU high level group chaired by Jacques de Larosière ... Mr. Nyberg was a member, Sir Callum McCarthy and the great and good of European financial regulation. It's a bit turgid but starting at paragraph 33, if I can read you into the record what they said. It is about five or six sentences, Chairman, if you'll indulge me:
Financial institutions understandably tried to dispose of assets once they realised that they had overstretched their leverage, thus lowering market prices for these assets. Regulatory requirements (accounting rules and capital requirements) helped trigger a negative feed-back loop amplified by major impacts in the credit markets ... Financial institutions, required to value their trading book according to mark-to-market principles, (which pushed up profits and reserves during the bull-run) were required to write down the assets in their balance sheet as markets deleveraged. Already excessively leveraged, they were required to either sell further assets to maintain capital levels, or to reduce their loan volume. "Fire sales" made by one financial institution in turn forced all ... financial institutions holding similar assets to mark the value of [those] assets down "to market" ... What was initially a liquidity problem rapidly, for a number of institutions, turned into a solvency problem.
I would like, Chairman, to say something now about the milieu in which Irish banks functioned before the crisis. Analysts and large shareholders, pension funds and stockbrokers were always interested in earnings per share and particularly where your earnings per share was going up as much as your peers. If you were going up as much as your peers that was fine but if you weren't, then your share price would drop and that meant your capacity to raise money would drop, your capacity to expand would drop, vulnerability to takeover would increase. Governor Honohan in his report in 2011 adverted to that dynamic. The other issue was Anglo being held up to us as an exemplar and you'll all be aware of that. Commentators in Ireland and abroad repeatedly said, "Anglo is the best bank. Why can't you be more like Anglo?" It was determined by one international consultancy to be the best bank of its size in the world. It was the darling not just of the Irish but of European stock exchanges generally. And I had customers saying, "Why can't you be like Anglo? Why are you always asking for more? Yourself and Bank of Ireland give slow responses and you ask for paperwork", and things like that. I think we tried in some way not to be drawn into the wake but inevitably we were, I think, in some respects. Professor Honohan described the effect of this sort of competition in a memorable statement before he was the Governor. He spoke to an economic conference in Dubrovnik in June 2009. This is what he said, "Competitive pressure on the leading banks to protect market share came especially from reckless expansion [from] one bank, Anglo-Irish whose market share among Irish controlled retail banks jumped from 3 per cent to 18 per cent in a decade".
Can I say something briefly then about the regulator? We had a perfectly professional relationship, mostly between executives and the Central Bank and the regulator. I would meet the head once or twice a year maybe. We invited the CEO and chairman of the regulator to come to an AIB board meeting and they accepted that invitation. I know there has been a lot of criticism of the regulator and that is not my business. I am wary of sporting analogies in a serious matter such as this but I did look at ... one of the witnesses I did get a chance to look at was Professor Alan Ahearne and he was in this room on 4 March. And he was asked by one of the members here what was needed at that time and he said what was needed was a more intrusive regulator - someone who behaved like a referee in a football match. And it strikes me, having reflected on it since, that that's apposite, that it's instructive ... that if you've a referee in a football match which is highly competitive - and Irish banking was enormously competitive at the time - and the referee does not blow the whistle much, then the more aggressive team tends to prosper and other people can get injured.
Just to say one more thing about the bubble. No bank could stop a bubble. If, through some amazing piece of insight or wisdom which we certainly didn't have, AIB had decided on some day during this period to close up for loans and say, "No more loans. We're not lending anymore", it would have damaged the bank at the time but not as much as the crash did. But, all of our customers who were claimants for loans would have been met within the following week by our competitors with glee, the competition was so fierce. So, the point I make is that no bank could stop a bubble inflating; only authorities can do that.
I will now turn to the night of the bank guarantee decision on 29 or 30 September 2008. The committee are in possession of three separate near contemporary records which I made of the events of that night. The main one is, of course, a seven page note, not perfect I'm afraid, but which I dictated a few days after the events of that night and which I've given to the committee. There is also much shorter paragraphs in a memo that I sent to the CA two days later just as a couple of paragraphs that recites my recollection of what went on at the night and also a letter of complaint to another chairman of another bank which has a couple of paragraphs again about my recollection of the night.
On Sunday, 28 September 2008 - this was a Sunday evening - AIB directors heard from the CEO at a board meeting at 6 o'clock that the word from the authorities was that two financial institutions in Ireland were likely to fail, the timescale was unknown and that a limited guarantee would be put in place for the remainder of the banks. I furnished you in my supplemental statement a quote from the AIB minute:
The purpose of the meeting of the 29th September which the representatives of AIB and Bank of Ireland requested with the Government was to discuss the dramatically deteriorating international situation, the apparently dire staits in which Anglo found itself and the possible repercussions of Anglo's imminent collapse for Bank of Ireland and AIB. We learned that Anglo could not open the next morning and had run out of liquidity. The banks expressed the view that Anglo and Irish Nationwide needed to be decisively dealt with in some way by the State and then [and I emphasise the "then"] for a guarantee to be provided for the remaining banks to protect the surviving banks against the turmoil which would inevitably follow from an Irish bank being either liquidated or nationalised.
The Governor of the Central Bank stated during the meeting, in the presence of the Government representatives, that it would be disorderly, or ... and I remember this expression, "or there could be a fumble if Anglo were dealt with mid-week", so what was needed, the Governor said, was for AIB and Bank of Ireland to try and provide €5 billion each in liquidity to support Anglo until the coming weekend.
Most of the evening was spent in efforts by Bank of Ireland and AIB to assemble enough liquidity to keep Anglo going until the weekend. That effort was successful and, by morning, €10 billion in liquidity, in excess of our own liquidity, half provided by Bank of Ireland and half by ourselves, had been assembled with its repayment within seven days guaranteed by the Government. I want to emphasise that AIB's representatives were not involved in discussing or the making of the decision that was ultimately made. The so-called "blanket guarantee" to include six banks, including Nationwide and Anglo, was not sought by or discussed with AIB. I make no complaint about that. I simply record the fact. The representatives of AIB and Bank of Ireland were not present in the room where the decision makers were for most of the evening, perfectly proper as well. I first learned that Anglo and Irish Nationwide had been guaranteed along with the other four banks from the media early the next morning. I acknowledge that the Government was faced with very difficult decisions on 29 September, which had to be made very urgently and I am not privy to the information or advice which was available to the Government on that evening. Two days after the guarantee, I sent a note to the CEO of AIB which included the following, and this perhaps is the most encapsulated confirmation of what I think went on:
Our name and reputation has been damaged by our perceived role in asking for the guarantee. We have maintained silence on the fact that what we asked for was that Anglo and Nationwide, what brought us all down, be taken out of the market and then for a guarantee to be put in place. What we did not ask for, and I underlined that in the original, was that Anglo and Nationwide should be boosted and baked into the system going forward.
The significance of the getting to the weekend, referred to by the Governor, is that at the weekend, the worldwide stock markets are closed for about two days, I think 51 hours, whereas during the week, worldwide stock markets are only closed at night for about three hours, between Japan ... between US closing and Japan opening. Just ... finally, Chairman, to say about other options, very briefly, during that week other options, Fortis was rescued by the governments of Luxembourg, Belgium and the Netherlands using ELA and I think that option was discussed briefly by Senator MacSharry with Professor Lane at this inquiry on 21 January.
Later that week, or maybe at the start of the following week, the Bank of England made a secret loan of Stg£63 billion to solve the allegedly critical liquidity issues at Halifax Bank of Scotland and RBS and that wasn't announced publicly until Mervyn King, the Governor of the Bank of England, said it to a Treasury select committee in November the following year. Since then, like many other countries, Ireland has enacted special legislation to deal with bank resolution, the Credit Institutions (Stabilisation) Act 2010 and the Central Bank and Credit Institutions (Resolution) Act 2011, and they obviously provide much more options for the sort of events that occurred on the that night. Those are my opening remarks, Chairman.
