Tapes of Irish bankers show why transparency into bank exposure details necessary

In his NY Times column, Floyd Norris looks at how Irish bankers caught on tape cynically manipulated their government into bailing them out by hiding the true condition of their bank.

The Irish bankers did this despite Irish bank examiners having access to all the useful, relevant information in an appropriate, timely manner.

The bankers knew that the examiners were not going to speak up as to do so would a) threaten the safety and soundness of the banking system and b) show that the examiners had failed in their responsibilities.

The bailout of the Irish banks set precedents that were global as banks were bailed out throughout the EU, UK and US.

Now we learn that [the bank bailout] was based in no small part on manipulative lies by venal bankers....

It now appears that the bank lied to Irish officials about how much trouble it was in when the government, at the end of September 2008, guaranteed all the bank’s liabilities.

On one tape, John Bowe, Anglo Irish’s director of the treasury, conceded that he had no rational basis for telling the government that 7 billion euros was all it would take to rescue the bank. 

“If they saw the enormity of it up front, they might decide, they might decide they have a choice,” he said to his colleagues in a tape disclosed by The Irish Independent.  

“They might say the cost to the taxpayer is too high.”

Please re-read the highlighted text as here is a banker explaining exactly why transparency is needed to prevent future bank solvency led financial crises and bailouts of the banks by the taxpayers.

Mr. Bowe's comments show how little regard bankers have for examiners and regulatory oversight.

Regular readers know that banks are "black boxes" where the only market participant that can look at the contents are the examiners.  This makes the financial system dependent on the examiners accurately assessing what is happening inside the black box bank and communicating this assessment to the market.

Mr. Bowe's comments show that he knows that either a) the examiners are not up to the task of assessing his bank or b) that the financial regulators the examiners work for will not communicate this assessment if it is accurate to policymakers and other market participants.

The comments show this because he isn't remotely concerned about being challenged on a number that he admits to making up.

With transparency, where each bank discloses its current global asset, liability and off-balance sheet exposure details, Mr. Bowe would know his made up number would be challenged.

With transparency, Mr. Bowe knows that his bank would not have been able to take the risks that it did. Simply put, as its risk increased, so too would the bank's cost of funds.  The increased cost of funds limits a bank's risk profile because it reduces, if not eliminates, any increase in earnings from taking on more risk.

Ireland had inflated a property bubble far greater than the American one, and losses were going to be immense when prices collapsed. 

Regulators were clueless, or worse, about what was actually happening.

There seems to have been no one in the government who was truly familiar with the bank. 

Outside experts were called in, but it is not easy during a crisis to evaluate something from scratch.

Again, please re-read the highlighted text as Mr. Norris has summarized why banks providing transparency into their exposure details is necessary.

Had there been transparency, regulators could have piggy-backed on the market's ability to analyze a bank.  As a result, regulators would not have been clueless or worse about what was actually happening.

Had there been transparency, bankers could not have gotten away with the lie that because there is a crisis there isn't time to evaluate their exposures.

At the beginning of the financial crisis, the entire global financial system was put on the life support it is still on.  Just like a patient who has been stabilized on a hear/lung bypass machine, there was and is plenty of time to evaluate each bank's exposures.

The result of this evaluation would be that banks take losses and banker cash bonuses cease to exist until the bank they work for has managed to recapitalize its balance sheet through retained earnings.

Had there been transparency, all market participants could have independently evaluated the banks rather than so-called experts who were a) cherry-picked by policymakers and b) wrong in their assessments provided to the public.

Of course, by limiting the evaluation to the so-called experts, policymakers waved a giant red flag and announced that the banks have something to hide.

As your humble blogger has said many times, the only way that trust and confidence is going to be restored to the banking system is when banks disclose their exposure details.  By merely disclosing these details, the banks are saying they have nothing to hide and can stand on their own two feet.

At the time, however, it was easy to think that the situation was not as bad as it turned out to be. 

Irish real estate prices had not collapsed — that would come soon — and it seemed possible that the problems affecting Irish banks, particularly Anglo Irish, were temporary. 

The word was liquidity. 

If that was the only problem a bank had — if there was a temporary difficulty in raising money to reassure depositors but the underlying loans were solid — then a bailout could work with little or no long-term cost. 

But if the real problem was one of solvency, a bailout risked throwing good money after bad.

Your humble blogger was not alone in saying that we were dealing with a solvency problem at the beginning of the financial crisis.  Anna Schwartz, Milton Friedman's co-author and an authority on the Great Depression, also observed that we were dealing with a bank solvency crisis in a 2008 Wall Street Journal interview.

It was clear then and is still clear now that policymakers are throwing good money from taxpayers and savers after bad.

This is particularly true because banks are designed to recognize losses and continue operating and supporting the real economy even if they have low or negative book capital levels.

How are banks able to do this?

The combination of deposit insurance and access to central bank funding make it possible for banks to operate with negative book capital.  Deposit insurance effectively makes the taxpayers the banks' silent equity partner.  Central bank funding means the bank has access to liquidity as it is needed.

Two weeks before the Irish bank guarantee, the financial world was shaken by the collapse of Lehman Brothers in the United States. It showed that large financial institutions were interconnected in ways that no one had really considered before and quickly led to a consensus that the American government had erred in not somehow keeping Lehman afloat. 

We now know that Lehman was broke, but at the time it appeared to have ample capital.

No.  Lehman suffered the equivalent of a run on the bank because market participants did not believe it was that it could generate earnings to cover its interest and operating expenses.

What was missing, one leading American regulator assured me at the time, was a requirement that the bank retain sufficient liquidity to deal with a panic.

The assurance by an American regulators tells you everything you need to know about why the financial system cannot be dependent on regulators.

The regulators doesn't understand what gives rise to a panic.  At the heart of a panic is opacity.

When there is opacity (banks are "black boxes"), market participants cannot assess their ability to perform on their obligations.  In such a circumstance, when there is doubt cast on the bank's ability to perform, it is prudent for market participants with an exposure to the bank to get their money back sooner rather than later.

The way our financial system is designed under the FDR Framework is to use transparency to head off a panic.  When market participants can assess the risk of a bank because the bank discloses its current exposures, it is easier to make a fact based judgment rather than an emotional judgment like panic.

In that atmosphere, it may be understandable that Irish officials fell for the tempting story that there was no real problem, just a bit of unfounded panic. 

But once they did, the power shifted to the bankers. 

Please re-read the highlighted text as the shift of power to the bankers occurred in the EU, UK and US too.

The tapes show the bankers were furious about government delays in releasing money once the guarantee was offered. 

“You’re putting the government at risk with your delays,” said David Drumm, Anglo Irish’s chief executive, in discussing what he would say to officials at a meeting. 

Talk of due diligence was ridiculous. 

Ireland had told the world “we’re all solvent.” Now, it should simply write “a two or three billion check and get on with it.”...

Please recall then Treasury Secretary Tim Geithner saying similar things about the solvency of the US banks following a stress test and pledging the full faith and credit of the US to back up the banks.

All the US government needed to do was to write a check...