Ignorance is bliss when a property crash looms

HOW on earth did the Government miss the fact that the country’s banks were so over-exposed to property?

The answer seems to be that the banks themselves didn’t realise – being blissfully ignorant to the looming catastrophe. Or if they did realise, they glossed over it and simply didn’t tell the Government.

The only people who seemed to truly appreciate the depth of the hole that the banks had dug for themselves were international investors. They began avoiding Irish banks a long, long time before the crisis truly erupted.

That warning signal was passed onto the Government. Amazingly, though, the Government didn’t seem to appreciate exactly what was being signalled.

Instead, it seemed only to believe that the banks had a temporary liquidity problem – ie, obtaining funds from the international money markets – rather than a potentially ruinous structural one.

This is clearly illustrated in the Department of Finance documentation released to the Dáil Public Accounts Committee and published yesterday.

Parts of the documentation are heavily redacted. Other documentation is still being sought by the committee, which is examining the collapse of the banking sector. But there is enough in yesterday’s material to illustrate a clear pattern.

In 2006, the Government established an inter-agency committee to deal with, among other things, crisis management issues in the financial sector.

Known as the Domestic Standing Group (DSG), it drew members from the Central Bank, the Financial Regulator and the Department of Finance.

DSG memos and briefing papers show the degree to which the Government and state agencies believed the banks’ main problem was one of liquidity, rather than solvency.

In August 2007, a Central Bank/Financial Regulator summary presented to the DSG indicated that liquidity problems had arisen in Europe. But the summary concluded that “the domestic economy and banking system remain sound and there is no cause for alarm”.

A similar assessment in November 2007 indicated that while the liquidity problems were beginning to increase: “Irish banks are generally able to access their funding requirements with undue difficulty though the funding available is quite short.”

The assessment did also report that the share price of Irish banks was continuing to fall “as there is a perception internationally that they are exposed to the property market”.

“It is also understood that some international hedge funds may be targeting the share price of at least one bank,” it added.

But it said little more than that – and a separate note to Brian Cowen, then finance minister, stressed the “importance of highlighting the inherent strengths of the Irish financial system and economy”.

Another Central Bank/Financial Regulator assessment was delivered to Mr Cowen via the DSG in January 2008. Again, it noted liquidity issues. But as regards the banks’ structural health, the assessment was sanguine. “It is important to emphasis that the Irish banking system is strong, liquid and well-capitalised.”

The following month’s assessment referred again to the fact that international investors viewed the Irish banks in a “negative” light. Oddly, though, the assessment did not seem to dwell on this, and instead cited the fact that the “Irish banks are generally happy with the ‘big players’ in property developments”.

It is, therefore, hard not to conclude that the Central Bank and Regulator were simply taking the banks at face value when they insisted they were in rude health.

In March 2008, there seemed to be a shift, with the latest assessment pointing to difficult conditions in the property market, with no new developments being undertaken and the banks increasingly pushing developers to repay loans.

But just the following month, the Central Bank and Regulator reported that, despite such problems, “the Irish banks remain solvent, well-capitalised and have loan books that are performing well”. Once again, the assessment pointed to liquidity as the real issue.

In one sense, this was correct – the September 2008 bank guarantee scheme, after all, was put in place over liquidity concerns: ie, the fear that the banks would run out of money.

But the real problems, as we have since learned, were mostly to do with the reckless lending to developers that the banks had engaged in. The Central Bank, Regulator and Government never seemed to understand the depth of this problem until it was far too late.

In one of their final assessments prior to the crisis erupting, the Central Bank and Regulator referred to the “widespread perception that Irish banks are very heavily dependent on property lending”. But of course, it was no perception. It was fact.

Sadly, only the money-makers in the hedge funds and international investment banks realised it.


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