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Demanding questions needed for bank inquiry to work

Date: 10 Feb 2010

Published: Sunday Business Post Money & Markets

Author: Professor Eamonn Walsh

For the banking inquiry to have any lasting impact, it needs to ask questions that go to the very heart of our political and financial systems.

Any hope of seeing the architects of the banking crisis humiliated in public appears to have been dashed. A ceremonial grilling on prime-time TV is unlikely to occur, so a national catharsis is now on hold.

However, many commentators and politicians oversold the cleansing impact of a public inquiry. To these individuals, the outcomes of an inquiry were a forgone conclusion. A good inquiry should pose questions that do not have known answers.

Furthermore, it should result in recommendations for a more robust financial system in the future. Finally, the cutoff date that is chosen by the government will represent a key signal of a sincere commitment to address the issue.

Credit-fuelled property bubbles involve more than huge bonuses and poor regulation.

There is an entire food chain of participants involved in the suspension of sensible underwriting criteria for home mortgages.

Did individual citizens misrepresent their capacity to repay loans? Were mortgage brokers responsible for helping citizens to window-dress their financial capacity? In 2006, RTE’s Prime Time reported on information exchanges between an estate agent and a mortgage broker. How widespread were these practices?

What actions did the government take to address concerns about the regulation of estate agents? Were professional appraisals of properties conducted in a sensible manner?

How were interest-only mortgages presented to customers, and was capacity to repay based upon the interest element? Did mortgage-granting institutions choose to see no evil?

Did the Financial Regulator engage in any serious analysis of underwriting and lending practices? Is there any evidence of predatory lending? What is the correct way to apportion responsibility for turning the dream of home ownership into the nightmare of negative equity?

Surging house prices gave rise to hubristic real estate developments.

Soon they will have a proud new owner: the National Asset Management Agency (Nama).These developments involved massive concentrations of credit risk - a small number of borrowers concentrated in the greater Dublin area. The danger of these concentrations has been well known since the US savings and loans crisis two decades ago.

Did the banks understand these risks? Were they reported to boards of directors? Did the regulator gather systematic data on concentrations? If not, why not? If so, were these concentrations misrepresented by banks? Is there any evidence that banks sought to mislead the regulator by structuring transactions to escape its radar?

Prudential regulation is concerned with ensuring that deposit taking institutions manage their risks. How did the regulator measure and manage these credit risks? Did it routinely obtain data on concentrations from banks and, if so, what additional analysis did it perform?

Answers to these questions will be helpful. However, the demand for an inquiry also reflects a deep distrust of the government and its motives.

Selective perception ensures that, no matter how well-intentioned a proposal may be, it will be perceived as an attempt to cover up.

The desire to exclude the bank guarantee scheme introduced at the end of September 2008 is a case in point. Setting a cut-off date during that month will serve to further undermine the credibility of this inquiry.

In mid-September 2008, following the collapse of Lehman Brothers, short-selling of bank shares was outlawed and deposit guarantees were extended.

Nevertheless, there is some evidence that the banking sector was receiving additional attention prior to the Lehman collapse.

On which dates did a serious engagement with the banking sector commence? Can one conclude that Lehman precipitated the problem? Would it be more appropriate to conclude that Lehman offered a convenient scapegoat?

On September 29, 2008, the shares of Anglo Irish Bank fell by almost 50 per cent. That evening, the bank guarantee scheme was announced. Given that short-selling was not permitted, it should be straightforward to identify who sold these shares and why. What information prompted this sell-off?

Following the bank guarantee scheme, the public was assured that it was a temporary liquidity problem, rather than a solvency issue. How did the administration reach this conclusion?

This conclusion must have been reached in advance of the decision to offer a blanket guarantee.

What analysis did the government receive on bank liquidity?

Was the analysis based upon the earliest date at which cash was contractually expected or was it modified for the interest ‘roll-ups’ that were being granted to property developers?

What effort was made to assess the impact of concentrations of credit risk at that time? Such an analysis would be necessary to reach a conclusion that the banking sector was solvent.

At the end of September 2008, there was an unconventional €7 billion deal involving Anglo and Permanent TSB.

Leaving aside the architects of this set of transactions, who knew about it and when? Was there an attempt to cover up this arrangement? Why would such a cover-up occur? Was it related to efforts to raise private capital for the banking sector?

The answers to these questions are unknown, but they could be fruitfully addressed by an inquiry. First, citizens would have a firmer understanding of which parts of the system were broken, and which parts functioned as intended.

This would be a significant step forward, as many believe that everything was broken.

Second, a thorough understanding would create opportunities for appropriate interventions to prevent such events in the future. Third, most of the evidence that would restore faith in government is likely to arise from September 2008. The government’s choice of cut-off date (late versus early September) will do much to signal whether such evidence exists.

Eamonn Walsh is PwC professor of accounting at UCD’s Michael Smurfit Graduate Business School

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Demanding questions needed for bank inquiry to work

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