Who is to blame for Irish Bank Crisis? Update

A Wall Street Journal article on the most recent government funded report on the causes of the Irish banking crisis found three parties to blame:  regulators, politicians and ordinary people.

A new report on Ireland's spectacular banking crash acknowledges that regulators and politicians allowed reckless lending to go unchecked but says ordinary people are also to blame for spurring on a property mania.

Without the reckless lending, ordinary people could not engage in a property mania, so blaming ordinary people is a non-starter.

The report, written by former Finnish senior government official Peter Nyberg, was published Tuesday after its contents were discussed by a cabinet meeting of the new Irish government. 

Mr. Nyberg told a press briefing that many players in Irish society—banking boards, politicians, former regulators, external auditors—didn't fully realize the risks of concentrated lending during the boom years and that the blame for the banking implosion should be shared with many thousands of people. The report therefore does not name names, he said. 

Since the Irish banks did not have to disclose current asset/liability-level data under the FDR Framework, market participants did not have access to the data which would have shown the reckless lending.  As a result, the banks were not subject to market discipline.

The Irish banks did and still do have regulators who face an impossible task.  The impossible task that bank regulators face given their monopoly on the current asset/liability-level data is to replace the analytical ability and market discipline of all those market participants who have skin in the game:

• They have to replace the analytical ability of the foreign banks who were investors in unsecured senior debt of the Irish banks; and

• They have to replace the analytical ability of credit and equity analysts for all the investors who purchased senior or subordinated debt and equity.

In addition, the regulators have to replace the analytical ability of all the independent third party experts.

Because so many players in Irish society were cheering on a property mania in 2004 and 2005, it would be "extremely difficult to blame one group or institution" for the subsequent crash, Mr; Nyberg said. 

Even though it is part of their mandate, bank regulators cannot be blamed for failing to take away the punch bowl when a party gets going.  Doing so would require bank regulators to incur a significant political backlash at a time when there were not significant visible problems.

It is equally difficult to blame the politicians.  Until the problems emerge, everything looks okay.

History has shown that the dynamics of the relationship between politicians and regulators will typically result in not removing the punch bowl until problems emerge.

The FDR Framework ends the waiting for the problems to emerge.  It relieves regulators of having to replace the analytical ability and market discipline of market participants or facing a political backlash for taking away the punch bowl when the party is just getting going.

By making the current asset/liability-level data available under the FDR Framework, market participants analyze the banks to see if they are engaging in reckless lending or other risky activity.  If so, the market participants vote by increasing the price of their investments to reflect the risk and limiting their exposure to the banks.  If this form of market discipline does not get the banks to reign in their reckless lending or other risky activity, the articles written by the credit and equity market analysts provide plenty of political cover for the regulators taking away the punch bowl.

However, Mr. Nyberg's report said external bank auditors were "silent observers" and that former regulators knew of corporate governance failings at the worst of the banks.

It is not the role of the external auditors to comment on a real estate mania.  Their role is to make sure that the banks accurately report the information that the regulators require the banks to report.

Update


From an article in the Irish Times on the report on the Irish banking crisis,

Mr Nyberg said the absence of sufficient information on the underlying quality of loan books at the banks impacted on the options considered by the Government when it decided to introduce the bank guarantee in 2008. 

“If accurate information on banks’ exposures had been available at the time it seems quite likely to the commission that a more limited guarantee combined with a state take-over of at least one bank might have been more seriously contemplated,” his report said.

The bottom-line of the report is that it shows why it is critically important to implement the FDR Framework and have financial institutions disclose current asset/liability-level data.