Thank you very much, Chairman. If I may take it ... the committee through my opening statement. Thank you. Ireland’s banking and economic crash should never have happened, should never have been allowed to happen, with all the consequences of huge increases in unemployment, rising emigration, enormous debt, suicides, etc., that we have seen. As well as addressing the aspects that I have been asked to deal with by the joint committee, I would like to talk about our experiences from my perspective as the head of the economics function in the Central Bank from 2005 until 2009.
In his report on the crisis, Professor Honohan described what happened here as a world-beating property bubble. As early as around the turn of the millennium, the head of the IMF Article IV mission to Ireland, James Morsink ... I remember him saying to us that a country could not prosper on the basis of selling property to one another at increasingly elevated prices - an obvious truism. The huge excesses here are well known, but I think that it is worth recalling some examples. As Donal Donovan and Antoin Murphy have noted in their book on the crash, the size of Anglo Irish Bank’s balance sheet in 2007 was six times what it was in 2001. The former chief executive of Bank of Ireland himself has stated that it took Bank of Ireland 200 years to grow its balance sheet to €100 billion; it took only four further years for the second €100 billion to be added on to reach €200 billion. And, of course, Bank of Ireland was the most conservative of all the Irish banks. A further example of the absurd mania at its height was the fact that a small site in Ballsbridge was acquired for €174 million at the height of the crisis - at the height of the boom, I should say - and purchased not so long ago for €22 million, that’s a fall of 87% ... you know, an indication of the huge excesses that we experienced.
If I can turn to the independence of the Central Bank, as you know, the Central Bank’s independence is established in law, essentially as a result of the EU treaties and the ECB statute. There's a reason why central banks are legally independent - so that they can take tough, unpopular decisions when required, without regard to populist government priorities. This applies, in particular, to monetary policy issues. However, it has to be asked how independent the Central Bank was on other matters. Patrick Honohan, in his report, stated that the authorities displayed undue deference to the banks. In my view, this applied equally to the authorities’ relationship with Government. Was the Central Bank going to act independently, and to possibly take unpopular decisions, if the Governor was always appointed by the Minister, with whom he had worked intimately for many years prior to his appointment, and with the Secretary General of the Department of Finance always serving on the board of the bank? Further, the boards of the Central Bank and regulator were also heavily weighted with political supporters of Government. In practice, it was my experience that any concerns or issues raised by staff for airing in the public arena were invariably watered down so as not to reflect adversely on matters of concern to Government. That was an undesirable state of affairs. While vested interests can be cheerleaders for asset prices, the authorities have a duty to be unflinching, straight and upfront on these matters.
I think it would be useful for me to reflect on the governance arrangements in the Central Bank. The decision-making entities in the bank in my time were the board and the Governor. The staff provided reports and advice to the board and Governor through the director general and deputy director general - what we economists would call the "kitchen cabinet", if you like. Now, some time ago, Dr. T. K. Whitaker, perhaps Ireland’s most eminent public servant, regretted the passing of the stage where public servants gave their advice and opinions objectively without reference to political or populist issues, or to anticipate what might be welcomed by the Minister. In the Central Bank, it was difficult to get views through that might impinge on vested interests. For example, as land and property prices escalated to bizarre and absurd levels, I had written, in a low key way for the bank’s bulletin ... comment in its quarterly bulletin, that there was a need to consider the issue of rezoning more land for building in order to increase housing supply. That’s also an issue of course of continuing relevance at present. I saw Colm McCarthy writing in the newspaper last Sunday about that. But that was blocked from reaching a higher level in the bank in the light, in my view, of political and property interests on the bank’s board. Of course, as the demand mania for property took off against the background of restrictive zoning which limited the supply of housing, the inevitable result was huge property price inflation.
I think I should also say a few words about the relationship between the Central Bank and IFSRA – the financial regulatory authority - at least from the perspective of the economics function in the bank. While, at the operational level, the bank interacted with the banks through market operations - in the wholesale payment system target, for example - there was little or no contact after 2003, when the new regulator was set up, on major policy matters. As far as I could see, contact with banks was primarily effected through IFSRA. This was such that at a certain point, I think towards the mid-noughties, the Governor began to arrange high-level meetings with the main banks at occasional intervals to discuss ... discuss the big issues. I would have attended quite a lot of these. Further, in the bank, we had no knowledge of the large exposures of the banks to individual developers. Such data were rigorously concealed from my level in the bank. Of course, we were aware that banks’ aggregate lending was increasing enormously and was concentrated in the property sector. I had a discussion with one of the consultants that was brought into IFSRA after the crash. I mentioned to him the name of one large developer, he, in turn, asked me how much I thought that ... that developer might have outstanding in borrowings. I suggested €1 billion; he said I could triple it. That, and newspaper reports that 15 borrowers from Anglo Irish Bank had borrowings in excess of €750 million each, together with the disclosure at your inquiry here that 20 developers had total borrowings of between €21 billion and €22 billion, were news to me.
It's sometimes said that nobody seemed to know that a property boom or bubble was developing. That's ... that is completely incorrect in my view. You will recall, for example, that, in his evidence to your committee here, Peter Nyberg - himself the author of a report on the collapse - asserted that it was obvious that a property-lending mania was afoot. At the decision-making levels in the bank, either people were unaware of what was happening, despite the clear evidence, or they were aware and chose to do nothing. Either way, it all seems quite incomprehensible to me.
While the bank in its public utterances presented a low-key assessment of what was happening, that is not to say it was not fully aware of the major excesses. The annual financial stability reports reviewed comprehensively what was happening and Patrick Honohan’s report acknowledged that the three major excesses were well recognised in the FSRs, the Financial Stability Reports: there was the huge increase in bank lending, the concentration of this lending in the property sector, and the very large reliance on the ... by the banks on potentially volatile wholesale funding. The main body of the stability reports set out extensively how almost all indicators were pointing massively in the wrong direction. By contrast, the overall assessment and tone which reflected the views of the two boards tended to be reassuring – talking of a soft landing, and so on. In fact, I should say that one member of the board did have grave doubts, to the effect that I can recollect his words still ringing in my ear, "It was all a house of cards and would all end in tears". However, his views appear not to have had any impact on policy-making in the bank. Notwithstanding that director’s views, it was probably necessary, in any event, to present such a rather hopeful overall assessment in public since the Central Bank could hardly conclude that the banks were about to collapse. However, whatever the published assessment, the authorities should have been working assiduously behind the scenes to curb the huge excesses and reckless lending of the banks – egregious risk-taking, as Patrick Honohan has termed it recently in his speech.
I don't want to go right through the whole thing, but I point out on page six of my opening statement there that, as another confirmation of us being aware of the problems emerging, the Governor and his letters to this Minister pre-budget frequently flagged the very high increase in the bank lending and the property prices and by implication, the natures of something above that. So it wasn't as if we were unaware of these things. In fact, you may recollect, the Government itself, through the Department of the Environment had around ... I think it was 1999 ... requested three reports from the economist, Peter Bacon, to assess what could be done to alleviate rising property prices.
Around that time, a memo was sent from the economics function of the bank to the then Governor, recommending that bank lending to the property sector needed to be reined in. For many years in the past, some of you may recollect the Central Bank had actually imposed credit ceilings on banks in the interest of prudence. The response to the note, which was sent up to the Governor, was that he would have to consider bringing this proposal to the board, which is fair enough. However, at the top of the note were the words, evidently added subsequent to the first comment, "That is out of the question". I have a copy of that memo as well.
Other specific responses given to me in reply to my pleas to rein in the banks were, verbatim: "The Central Bank is not going to disadvantage the Irish banking sector", and "The Central Bank is not going to collapse the construction sector", when, you know, construction sector really took off and we were completing 90,000 houses, or close to that, in 2006. On another occasion, when bank lending to the property sector was increasing at the astronomical rate of 65% year on year, I urged a very senior member of the Financial Regulator staff, that bank lending to the property sector needed to be curtailed. The response that I was given was that the lending was secured on property – that's true in almost all other property-related banking crashes that proved to be worthless when property prices crashed from unsustainable levels. I, personally, was also specifically prevented from bringing forward to the bank’s financial stability committee, data on house price levels across Europe that showed the extraordinary heights prices had reached here relative to elsewhere. In fact, prices here were higher than anywhere else in Europe, any capital city, Amsterdam, Brussels, etc, except for central London. And of course, central London is a special case where you've got Arab sheikhs and Russian oligarchs and so on, buying properties. So, the net result was that the powers-that-be preferred to adopt an ostrich-like approach to the massive problem. I offer a few more examples there of the extent to which people were not willing to recognise the problem that was emerging at the top of page 8.
If I may go on ... in fact, in addition to the red flags in the stability reports, which Patrick Honohan recognised in his report, a financial expert has also reviewed the annual reports of the Central Bank over the years in the journal studies of spring 2009 and he has come to the same conclusion that the authorities were well aware of the dangerous situation that was developing, but decided to do nothing. In fact, what Peter Nyberg, who interviewed me ... the author of the banking report ... he kept asking me "Why did nobody do anything?" ... several times "Why did nobody do anything?" And I am afraid that the answer has to be that the authorities simply did not wish to do anything. And actually, Peter Nyberg also asked me why I did not publish a newspaper article on the bubble. I said to him that that would have been highly unorthodox - it would be like a civil servant, you know, writing an article in the newspaper, criticising the Minister of financial policy ... it just wouldn't be on ... in any event, I don't think it would've had an effect at a time when the Taoiseach was saying that anyone who was questioning the sustainability of what was happening should go and commit suicide. And in fact, you should recollect in the event when Morgan Kelly ... Professor Morgan Kelly wrote about the probability of a crash, he was derided - he was literally shouted down at an economics conference where he was presenting his paper on the property market. So, you know, people didn't want to know.
In fact, one also has to ask whether there was any appreciation in the commercial banks that things were getting out of hand. On the face of it, it would seem that certain divisions of the banks – maybe the capital markets divisions - were in fact well aware that we were experiencing a property bubble. You have to ask, "Why else would the two main banks have decided to sell off their headquarters buildings and major landmark branches at colossal prices at the height of the bubble?" Was it the case that their lending colleagues in the banks were, at the same time, even financing, in whole or in part, the acquisition of these premises? And from the Central Bank side, you know, one has to ask, "How did the Central Bank see the erosion of the banks’ deposit base being halted as the Central Bank pumped increasingly vast amounts of liquidity into the banks to prop them up?" In fact, you may be aware of the fact that the total ... the maximum amount ... or at its peak rather, the amount of liquidity pumped out into the banks was €140 billion, you know, with the ... both from the Central Bank and the ECB. I mean, once you spell that out, that's €140,000 million - there are 12 digits in that. So, you can well understand why the ECB was jumping up and down when the accommodation provided to Irish banks was at ... was at that massive level.
Now, if may I turn to a few words about the role of economists in the Central Bank. During the critical period 2000 to 2007 when the property mania was at its height, none amongst the top three executives in the bank was an economist – not that economists are the fount of all wisdom, I would have to admit. This would have been less of an issue if there was a willingness to listen to the views of economists, I would admit. You may recollect the Canadian expert, Rob Wright, saying to you here that he noted the relatively small number of economists employed in the Department of Finance, having 7% of staff being economists compared with 60% in Canada’s Department of Finance. This aversion to economists really carried over to the Central Bank, I would admit, and was part of the problem.
In addition, the Financial Regulator employed very few economists. A member of top management in the bank put it to me on one occasion, that the bank wants economists and other specialists to be "on tap but not on top". So, economists were in a sort of cul-de-sac. And this rather recalls the episode in the early 1920s when the Governor of the Bank of England, Montagu Norman, said to the chief economist, "You are not here to tell us what to do, but to explain to us why we have done it".
However, it is the norm now in almost all central banks for economists to occupy the great majority of the top decision-making positions for the obvious reason that central banks are primarily concerned with issues in the area of macroeconomics, monetary policy and financial economics. On the other hand, in Ireland, the top positions in both the bank and Financial Regulator were filled traditionally by administrators and accountants. Accountants by their work and training are concerned with detail, but do they always see the bigger picture? The clean bill of health given by external auditors to all the banks right up to and even beyond the crash would suggest otherwise. In fact, you may recollect, I checked it out there on the website, the Anglo-Irish bank profits in November 2008 were declared to be €784 million and that was post the Lehman's problem in September 2008. It would seem to me that accountants tend take a more backward-looking perspective on a balance sheet ... I mean, that's maybe what they're expected to do ... whereas examining a balance sheet from an economics perspective would entail a more forward-looking consideration. Perhaps, in the wake of the crash, now, it could be argued that the type of appointments within the Central Bank structure, has lurched too far in the other direction, with economists predominating at the top of the bank and regulatory function. In my view, there should be a diversity of skills and backgrounds at the highest level of the bank and Financial Regulator.
Having said that, it is quite extraordinary that, at the highest level, there seemed to be a blindness to the fact that there had been a whole series of recent property-related banking crashes - we had them in Japan, Finland, Sweden, the savings and loan sector in the US, Norway, the Lawson mini-boom in the UK 1989, 1990. Of course, the sub-prime crisis in the US itself and the related securitisation of mortgage assets that led to massive losses for many international banks was also a property-related phenomenon. And one shouldn't forget that in the years leading up to the crash, the Bank for International Settlements, the BIS, of which Ireland, through the Central Bank, is a shareholder, had also been warning consistently for some time about the runaway evolution of asset prices with wholly inadequate attention being paid to risk.
Despite all of that, there seemed to be little interest in such experiences elsewhere, with the implicit belief that they had little relevance for Ireland. In my view, this was a manifestation of a closed mind and an unwillingness to learn. While economists were well aware of these banking debacles, their relevance to Ireland did not seem to register at a level where it should have done. The view seemed to be, as the cliché has it, that the time ... this time is different, or we are experiencing a new paradigm.
Now, some people suggest that it was the collapse of Lehman's that brought down the Irish banks. Now that event didn't help clearly, as Lehman's failure did greatly affect liquidity flows, interbank lending, etc. However, as the UCC economist, Seamus Coffey, noted in a radio interview some time ago:
Ireland's crash derived from developments between 2002 and 2007. Our problem was a pre-existing property bubble, before Lehman's hit.
And related to the fact of the enormous increase in bank lending, Irish banks of course were significantly dependent on borrowing from the wholesale markets, which were greatly affected by the Lehman's event. Countries that had no such bubble, small countries like Belgium, the Netherlands, and Finland, they experienced some problems associated with the failure of Lehman's, but nothing on the scale of Ireland's banking crash and collapse. Our problem was a banking insolvency one. As Professor Honohan's report put it, the source of our problems was homegrown. Those who suggest that Lehman's brought us down are almost wholly wrong, and are merely seeking an external scapegoat, not the first time this would have happened in Ireland, in my view.
It was also suggested that, being in the eurozone, we were the victims of huge capital inflows to Ireland. This again is a fairly thin argument. Ireland participated in a quasi-monetary union with the UK from 1825 to 1979, when we joined the EMS. We have plenty of experience of living in a monetary union. We also joined the euro with our eyes open. If monetary conditions were not particularly optimal from Ireland's point of view, the corollary was that other policies should be used to deliver the appropriate economic conditions. This would have meant, inter alia, restrictive fiscal policy as well as a tightening of bank regulation. However, this would have run counter to the naive populist policies of the then Government.
In summary, it was crystal clear from about the turn of the millennium, and even before, Ireland was experiencing a major property bubble; "a world beating one", in Professor Honohan's words. It is not credible that those who ought to have been aware of what was happening were in the dark. One can only surmise that, as Professor Alan Ahearne has said here to your committee, too many people were benefitting from the boom time for prudence avoidance ... prudent avoidance measures to have been taken. Such necessary measures would not have been popular, but that should not weigh with those whose duty it was to ensure the country did not experience the catastrophe that we so painfully and unnecessarily suffered.
Now I know, Chairman, that you want to derive some lessons from the crisis too, so I've jotted down a couple of points there, but I will leave it to yourselves, you know, to take those on board as you see fit. Thank you very much.
