What *Really* Caused the irish Banking Disaster ?

We were somewhere around Barstow, on the edge of the desert, when the drugs began to take hold. I remember "Fergus O'Rourke" saying something like:

It took long enough for the penny to drop, but well done on getting there in the end. It was utterly crazy that well-established prudent banking practice of lending more than 3 or 3.5Xincome was thrown to the winds. By sticking to the practice, the bubble would never have developed in the way it did

- sure, there would have been a much slower steadier rise in property prices and values, but nothing like the craziness we saw, that was driven by the endless greed of the estate agents, developers, BTLs, speculators, banks, etc.

Welcome to the late 90s/early 2000s when I was already worried about this. I cannot claim any specialist banking knowledge, but if it was obvious even to me that something was seriously wrong, ffs why didn't it stick out to others who could have done something about it? It wouldn't have taken much - at least for a Regulator and/or Finance Minister who wasn't a useless chair-polishing bastard.

FFS, indeed. First Dr. Zoidberg, and now you. Is the whole of ukrm migrating here?

Hold on, let?s not forget how, in the US, at least, this practice was encouraged by the sub prime lending dreamed up and demanded by the politicians.

Let?s also not forget that here in the UK, and probably Ireland, many banks were retail banks selling only mortgages.

If they had stopped selling mortgages they would have gone out of business and the only way they could keep selling mortgages was to compete into all that housing inflation.

At the end of the day, it?s not the banks? job to control inflation - not least because the only way open to them, to collude with each other on mortgage products, would have been illegal.

It?s at times like this you look for some responsibility from the politicians and their appointed central bank.

What we got here in the UK was f**kwitt Brown removing house prices from the inflation calculation.

He then fell out with the governor of the BoE (because King insisted on telling him what he didn?t want to hear) and then claimed the whole monumentally stupid f**king bonanza could carry on forever because his financial genius (PhD History of the Scottish Labour Party) had ended boom and bust forever.

I don't buy that. There is plenty of blame to around others.

The Banking Community, along woth most large business entities, have a fundamental flaw in their planning structure because they don't have any long term planning function within their organisations.

CEO's and other senior managers are put in place with incentives to grow based on 'Short Term' performance. There is no balancing function within these organisations to look at the long term.

If there had been, they would have been forced to conclude that continued disproportionate growth in property values inevitably leads to some kind of valuation crash and any such crash leads to defaulting by mortgage holders which is seriously damaging to the Banks long term interest.

The practice that did most demage imho was not the multiple income calculation, but the lending of 100% and in some cases 110% of the market value of the property ! INSANITY.

The multiple of income practice did encourage some to over borrow, but if valuations kept their levels up then the banks would not have lost because the propeties could simply be sold off.

The government also carries their share of the blame in willfully ignoring the damage a valuation crash could cause. But it is a certain fact that NO POLITICAL PARTY had any plans or any intentions to behave differently than the governing party. So it is pointless and dumb to put all of this share of the blame on one of the parties, FF.

Another area where ALL of the parties should share blame is the widespread support for new buyers subsidies. I wrote many times to the newspapers and TDs protesting that all these do is inflate the price of houses! But no one would listen and it wasn't politically correct for any politician to object - because the public was DEMANDING it.

The People also carry their share of the blame elsewhere. They over borrowed. They followed the upward valuation like Lemmings! Instead of stepping back and saying NO. Had they acted more prudently then the valuations and prices would not have ballooned.

As Fergus has written on his blog however, I firmly believe that the BIGGEST cause of our present predicament is the criminally negligent (NOT criminal behaviour) bank lending to developers based on totally unsubstantiated and inadequate evidence of an ability to repay - followed by home mortage lending.

The remaining blame lies with the People, who demanded higher and higher and higher government spending on welfare, health, education, AND tax cuts.

There is plenty of blame to spread around.

We will get no where as a country unless we accept that, learn our lesson and try to make sure it doesn't happen again.

Howard

If the BoE had been free to raise mortgage interest rates then the UK property boom at least would have come to a halt.

There would have been no UK property bubble burst and several of the UK banks would have probably not gone under because of it.

Banks were private sector businesses operating in a free market. It was inevitable that some banks would have been operating more responsibly than others and that those that weren?t operating responsibly had a perfect right to do so.

Tolerating a housing boom for over a decade, up to the inevitable crash, was bound to put the system to the test and reveal who had been swimming without any trunks on, all along, that?s what happens in crashes in any sector of an economy.

One point worth making, so far there has been little in the way of new banking regulation but there has been a new committee formed within the BoE charged with monitoring for excess and controlling inflation within individual sectors of the economy (house prices in other words).

So, clearly someone believes the property market was at the root (cause) of the problem and tolerating another boom might not be such a good idea.

It?s all been downplayed and kept very quiet because house prices long since became a national religion.

Hold on, lets not forget how, in the US, at least, this practice was encouraged by the sub prime lending dreamed up and demanded by the politicians.

Lets also not forget that here in the UK, and probably Ireland, many banks were retail banks selling only mortgages.

If they had stopped selling mortgages they would have gone out of business and the only way they could keep selling mortgages was to compete into all that housing inflation.

-----------------------------------------------------------------

That's not true. For more than 50 years mortgage banks quite happily made a living out of the margin on lending the money.

Then they went for securitisation of the loans thus giving someone else that margin. And, as you say they moved to "selling" mortgages making their "profits" from the initial charges.

That didn't have to happen and had it not happened mortgage banks would still have made their money.

tim

Thanks, but what makes you think that I didn't know it for a long time ?

I wrote the post because so I was coming across so many people, even in financial services, who attributed the problem to other factors. Just look at the comments made to get a flavour.

P.S. Thank you for your kind words elsewhere

You are just dodging the issue. If you rob a bank, it is no defense to say that someone else would have robbed the bank if they had had the opportunity to do so.

In any case, I don't believe Enda Kenny or Eamon Gilmore would have played golf with Fitzpatrick or bailed out the Anglo Irish pseudo-bank. Their parties did not have the corrupt connections of FF with the developers.

Well said.

Howard

Unfortunately, like a religion, it is too tempting to self serving prejudice for people to dump all blame on nasty politicians or nasty bankers. It wraps up the blame in an easy package and they can rest easy knowing who to aim their hate and resentment at.

Real life is complicated. Each finger pointing outward leaves three pointing backward.

Howard

The government put 35 billion into a pseudo-bank run by their friends. The bankers and the ministers involved should be behind bars.

Check the back history of UK finance around then for examples. Otherwise intelligent people denied the existence of the credit bubble even when the evidence was laid very carefully before them

People generally won't believe that which they'd rather not were true.

Governments have a vested interest in believing credit bubbles to be economic miracles that they personally wrought. That said though, Brown deserves special plaudits for falling for his own nonsense.

FoFP

There's nothing special about property except that it happened to be the Golden Ticket this time around (it'll be something else next time around

The loaning against future gains isn't at all unusual in the final blowoff of a credit bubble. The unwinding of claims after the Tulip Bubble pretty much consumed Dutch courts for a decade and the subsequent debt-deflation left Holland unable to compete in the naval race that was to lead to Britain becoming a world power.

Once you look into it though, it's obvious that for an ambitious man, it was perfectly sensible to sell a house, a brewery, and ten acres for a single tulip bulb. If the bubble hadn't burst when it did, he'd have had the possibility of being very much richer.

The dynamic of a credit bubble is that it must continually grow, If it stays steady for any real length of time, it collapses. This is because the debt becomes too much to servive frojm income and thus must be services from capital gains. Once those gains stop, it collapses because creditors who don't get paid start calling in their loans to pay their own debts and the debt-deflation dynamic replaces the prior credit expansion.

Brown really believe that we moderns were too smart to create a credit bubble and that economists were so clever they could anyway cure it. Like many others, he believed that 1929 was ancient history.

I believe that this sort of thinking is why we get credit bubbles every third generation or so.

The bubble in the UK started around 1985. We've had quite a few governments during it.

Politicians are there to get votes, not to do the right thing for the economy. It's what they do. It's all they do, and they absolutely will not stop.

You'll discover that people are somewhat reluctant to believe that too, however accurate.

Sooner or later circumstances will force some sort of fix. This will be so limited that all it actually prevents is domestic housing being the Golden Ticket next time. The current generation will be reluctant borrowers for the rest of their lives. They'll raise their kids to be the same. The generation following that will regard our travails the way we did those of 1929 and the whole cycle will kick off again around the time that inflation peaks and disinflation begins. Those who spot the Golden Ticket then will have the chance to get rich.

FoFP

I'm no fan of Greenspan, but he was correct in 1996 when he stated that the sorts of interest rate rises required to burst the bubble would be such that they'd destroy the rest of the economy. Once people have a bbble going, anyone who tries to stand in their way will simply be trampled.

The best cure for a bubble is not to get into one in the first place, but the only way I could see that happening is to heavily enforce an edict against any borrowing at all. I suspect the cost in economic growth would make this a price not worth paying.

It would have burst earlier and most likely not so badly because less debt had been accumulated.

They'd be wrong. Debt is the problem. Property was just the Golden Ticket this time around.

FoFP

You are absolutely right. It is the incompetence of the management decisions that is important not that it is property as such.

That confirms the instaity of it.

The same comment applies to both multiples and 110% loans.

Brown had no power in Ireland.

Irrelevant to Ireland.

The reason why the people need to share the blame.

The guilty are always reluctant to admit their role.

Howard

The thing is that the lenders, whoever they happen to be, cannot lend what people do not want to borrow. It's the mania in people which creates that desire, and the anticipated future gains which make it possible. In a credit bubble, the lenders and borrowers all suspend their own powers of analysis in favour of their greed.

Pretty much everyone in Ireland went completely mad. I went over in 2001 to see it for myself and knew for certain that the country would be bankrupt when the bust came. That it continued for another 6 years is astounding.

There is however currently a bubble which makes Ireland's look like a mere hiccup: China. Their equivalent of subprime loans is the local (partty) government loan. People take loans to buy flats in the belief that they'll sell these flats on for more later. While the bubble has been running, this has been working and local government has been financing itself from the loans (often made through gangs) and the land price gains from the flats built. However, in many flat there aren't even renters. They interest must be paid purely from the gains. Now there are entire cities of empty flats, shops, schools etc.

When that bursts, the middle-classes in China will revolt against authoritarian rule. The people most likely to revolt are those who've seen a richer future, and then had it snatched from them. The effects of all this on the Chinese economy will be felt around the world.

FoFP

True. However the responsibility to the bank shareholders means that the bank management is responsible to them for the lending policy. That policy has been exposed as incompetent. It is no use them blaming the public.

I don't buy that s*it for a second :-)

if that is the case then you are likely to be right. The US managed to avoid their fall out because they are so big and their economy so big and credible. China may also be able to do the same.

Howard

What about limits on bank leverage?

IMHO we should have let them go bust rather than bail them out which enables the bad practises to start up all the more quickly.

Property is quite likely to be a "golden ticket" since it is actually useful!

much of the leverage in the latest bubble came from the shadow banking system which is pretty much uncontrolled. That said, the US libertarians may be correct in that a move to abolish fractional reserve banking and any sort of limited liability might well constrain credit bubbles. Again however there is the suspicion that there'd be a cost in economic growth during the good times.

There's also Schumpeter. Looking at past bubbles, his creative destruction is startlingly obvious. During the blowoff phase, some unlikely new technologies tend to obtain finance. The bust phase weeds out those which are weak, and leaves standing those which may lead to a new economic boom. This was true of radio and auto manufacturing after

Sadly my suspicion is that the same was true of financial engineering - that we should have let the weak go to the wall and the strong survive. Japan saw its bust in 1989 and has since bailed out its own deadbeat banks, leading to 22 years and counting of debt-deflation (stocks down about 80% and housing pretty much back to prices at the start of its bubble in 1982). I can't see that's an example the West really ought to be following.

I believe we should have guaranteed depositors (British ones - those in iceland should have known they took risks for all that extra interest) up to the statutory limits. Bondholders and shareholders should have paid the price of their risk-taking rather than load the costs onto innocent taxpayers - that's how capitalism is supposed to work. If that had been done, people would be a great deal more careful about lending or borrowing than they currently are and Northern Rock wouldn't dream of again offering 90% mortgages.

So were tulip bulbs - everyone who had money wanted to buy them in 1635. The Golden Ticket is just whatever people of that generation believe will always rise in price exponentially. There is of course no item which will always rise in price exponentially and there never was.

Nevertheless, there will be a new Golden Ticket around by 2060 or so, unless we figure out how to change human nature.

FoFP