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What has failed to happen, I notice very much in all of the debate and discussion, is the separation or distinction between different parties that were involved with banking, and real estate development and equity investment in Ireland.
There are three distinct parties involved - the Anglo Irish bank, its customers and its owners (Anglo public stock owners). It is important to separate out these different parties, and their respective motivations (because the 'owners' of the Anglo Irish bank, received no representation in the Anglo trial whatsoever),... and this does cause concern, because Anglo Irish bank at the time of the collapse had ceased to operate like a 'bank' and was operating more like what we now call a 'real estate investment trust'.
Anglo Irish bank, was in very, very many ways the equivalent to a REIT vehicle, like those ones that we see nowadays being introduced into the Irish stock market.
With all of the discussion that has been going on in Ireland in 2013, about the legislation created to establish the REIT vehicles in Ireland,... absent from that, has been an admission that the way that Irish banks did operate during the 2000's decade in Ireland, was very much like REIT's (except they were hiding behind the guise of being retail banking organisations, and this enabled them to be 'saved' by the Irish taxpayer, when it all went horribly wrong in 2008).
The simple fact of the matter is, that in 2014, had the economic crash of a few years ago, never happened,... and the Maple 10 transaction had achieved its purpose of becoming a 'bridging loan', as the Irish financial regulator had hoped that it would serve,... we would not have any REIT's in Ireland. Instead, what we would have in Ireland in 2014, is a whole pile of retail and commercial banks, operating like REIT's, but hiding behind a guise of being Irish banks.
But we roll back the clock in Ireland to the mid 2000's (the time that is featured in the 'Anglo trial'), and what we find in Ireland,... are the existence of these behemoth blue chip equities on the Irish stock exchange,... which coincidentally happen to be Irish retail banks,... but more than anything else from the point of view of customers who invest on the Irish stock exchange,... were very large real estate asset management concoctions of that time (the mid 2000's decade in Ireland).
You had all of the large Irish lenders, BOSI, Ulster Bank, Anglo, AIB, BOI,... all of them soaked up vast amounts of money from a lot of ordinary, small investors who wanted to find returns for their money, on the Irish stock exchange. There were huge numbers of instances, where local business people in towns and villages all around Ireland, would liquidate their legitimate enterprises, and convert that wealth into equity stake holdings, in Irish banks.
But they weren't buying shares in Irish retail banks. They were effectively buying a portion of the Irish property industry. In other words, the function that Irish banks served during the bubble era, was not unlike that function served by the new REIT vehicles that have been floated on the Irish stock exchange more recently.
The Irish banks, as companies by themselves, understood that very well. They understood that apart from 'large, lop-sided balance sheets' consisting of billions and billions of euros thrown into Irish property (in all kinds of ways),.... being something that might turn investors or creditors away from purchasing equity in Irish banks, or buying debt securities,... this very large gamble on Ireland's property industry,... actually enhanced the ability of these vehicles known as Irish banks, to raise their equity capital on the Irish stock exchange.
People weren't buying into banks, as shareholders, they were buying into something more like a REIT (and as it turned out a highly risky kind of REIT, and the shareholders got wiped out totally as a result).
Now, getting back to the famous 'Anglo trial',... what we don't see anywhere in it, is any evidence or representation on behalf of the owners of the Irish banks (or REIT's or property investment behemoths). Instead we say the evidence that was given, that had to do with Anglo Irish bank, and it's customers (its borrowers).
The defense in the 'Anglo trial', seemed to be very careful to represent the Maple 10 transaction, in a way that suggested the customers of the Anglo Irish bank, the Maple 10, had some choice in the matter.
In fact it was a 'Hobson's choice',... it was really no choice at all.
The Maple 10, had the choice of absorbing more borrowings on to their already leveraged balance sheets, or watch as their whole funding situation deteriorated anyway, as the lender that was supporting them and their gamble on the Irish property industry, fell apart.
The Maple 10, were simply told, you can take it or not take, either way we all go down together. Ten out of ten individuals took the deal, as a result.
And this sums it all up very neatly,... and it all goes back to the pretense that was Anglo Irish 'bank' as a concept to begin with (and the very same could be argued about many of the other so-called 'banks' in Ireland at that time). They were all gambles on the Irish property industry. This was indeed their biggest selling point, as far as their shareholders were concerned.
What one needs to ask now in 2014,... is that if we adjusting the 'titles' given to the various players in this sordid affair,... and we called the Irish banks of the 2000's out for exactly what they were, as very concentrated gambles on the Irish property industry,... and we said, we had all of these things that were effectively large REIT type vehicles, how does that change our perception?
The question is, if it was a REIT, instead of an Irish bank, could it approach its affairs with anything like the same autonomy (and level of cooperation from the Irish financial regulator), as the Anglo Irish bank could in 2007 and 2008?
The answer is, of course it could not.
Because a REIT as a vehicle, which soaks up large amounts of private equity capital, has a lot more responsibility to convey to its shareholders (its owners) the real situation of its balance sheet. A REIT vehicle, would not be able to cultivate the kind of relationship with a group of ten property developers, which Anglo Irish bank was allowed to do, and with the blessings from the Irish financial regulator to boot.
It is important that we realize these simple truths today in 2014. Because, in terms of the Irish banks in the decade of the 2000's, they had ceased to operate merely as banking organisations, and had gone somewhere else (and the shareholders in Irish banks, rewarded those banks via capitalisation, for going wherever they went to),.... and the Irish banks of the 2000's decade, did resemble a lot more, the thing that we now call a REIT in 2014, on the same Irish stock exchange, where the Irish banks had previously been allowed to operate in the same fashion only a decade earlier.
The failure of financial regulation in Ireland, was not its complicity in the Maple 10 transaction. It was in the failure to distinguish, when it should have been able to distinguish quite plainly, between what was actually a domestic banking institution (be it commercial like Anglo, or retail like AIB or BOSI),... and what was a highly leveraged, institutionalized gambling long-shot,... on the Irish property market.
It was the failure of the Irish financial regulator, to simply look at the balance sheet of the Irish banks, in the 2000's decade, and draw this important distinction, that in turn led to everything else happening after that.
This is what is really 'on trial', or 'under investigation'. Why did the Irish financial regulator think that it was such a good idea, that every citizen and every taxpayer in the whole of Ireland, have one big sixty billions worth of a gamble simultaneously,... on the success or failure of another reckless gamble, which was the Irish property industry a decade ago.
But then, we always have to remind ourselves, that in Ireland, the property industry is more like a religion than a business. And we are all considered its most loyal followers (and most of all, that was so in the eyes of the Irish financial regulator). We all needed to worship at its altar, and that is exactly what all were made to do.
Ireland is supposed to have 'freedom of religion', but unfortunately, when it comes to the property industry, there isn't any choice. We are all expected to worship. This may have changed somewhat in the aftermath of the crash in the Irish economy. But has it changed enough?
The matter of the Sean Quinn & family stake hold in Anglo Irish bank, created in 2007 and 2008, was referred to many times it seems in the 'Anglo trial'.
Bearing in mind, what I have tried to describe overhead,... What we find in the modern discourse about the 'Anglo trial' by various reporters and news pundits,... is a kind of 'one eyed analysis'.
It was a criticism very often leveled at former chairman of the Federal Reserve bank in the United States, Alan Greenspan. Greenspan, it has been argued could spot ordinary consumer price inflation coming a mile away, with his one good eye. However, using the other eye, he appeared to be blind, in terms of seeing asset price inflation, in the bubble economies that he helped to create on two separate occasions in the 1990s and early 2000's.
In a way, this is how the commentators and the analysts in Ireland look at Anglo Irish bank as an entity.
There are actually two important levels of abstraction that are at work with Anglo Irish bank in the late 2000's period. There is a 'double Irish' going on, so to speak.
On the one hand, with have this 30 percent stake amassed by the Quinn family in the bank using the notorious 'contracts for difference'. This is one level of abstraction, which the pundits always focus upon.
However, what pundits refuse to see (like the one-eyed federal reserve chairman), is the fact the Irish financial regulator during the boom, was actively encouraging Irish banks to operate as Real Estate Investment Trusts (behind the guise of being Irish 'banks', quoted on the Irish stock exchange).
This of course, was the 'loop hole' in Irish financial regulation which Anglo Irish bank had exploited to great success, and resulted in the inflation of its market capitalisation. The history of Anglo within an Irish context, follows closely the trajectory of another blue chip stock, on the American stock exchange, that of Apple computer corporation, that rose to become the most valuable company in the entire globe.
And one has to ask oneself, faced with such astonishing levels of share price performance, what could any director of Allied Irish bank (or any other 'bank' in the country), do except chase after the example that Anglo has shown so clearly?
What we refuse to ask ourselves plainly, in Ireland, even after the crash in 2014, is how many ways can financial regulation in the country, distort the markets, producing these entities which are so much more highly valued by shareholders than anything else?
The Irish financial regulator's office, has never really confronted this, and produced a fully honest account of its own actions (or lack thereof).
The biggest difference between an actual real life Real Estate Investment Trust, and a bank, is that a REIT, tends to have a equal distribution of borrowings and capital. A typical de-leveraged REIT in the post-crisis, post-2008, world in north America (where the concept of a REIT originated from), has 50% equity and 50% debt (various mixtures of sub-ordinate debt, bonds and preference shares).
The thing that characterizes a 'bank' (and this is crucial to appreciate from a financial regulation point of view), is the small 'base' of capital used to fund an incredibly large asset portfolio on top. Before the crisis, depending on the institution, banks were working off of capital bases in the region of three or four percent.
The crucial difference between a 'bank' and a 'REIT', is like that cartoon of the ship that floats high in the water, versus the one that sits lower down. I recall one cartoon (in the Irish Indo I think), which described the Quinn family's punt on Anglo Irish bank, being like a little row boat in the water capsizing a large vessel. There is a certain amount of truth in the cartoon, because it describes much of what did happen.
What experts who studied the financial crash in Ireland, could never quite understand was how such small players, such as cement factory owners from county Fermanagh could de-stablize the 'boat' that was the Irish economy and its system of credit,... to the extent that they did.
We know that the Irish banks, during the boom period in Ireland, were like REIT's in the fact that they were trying to support these very large real estate asset portfolios. Because Anglo was classified in 2007/08, as a 'bank', this very large asset portfolio was sitting very much lower down in the water, than a REIT type vehicle could do. That was enabled by the financial regulation that we had in Ireland (and we still do).
The in turn put the large 'vessel', that was Anglo Irish bank, within reach of some very small boats. But even at that, there was still a distance to cover.
You pay a high enough fee, to these modern financial services providers, and in return you can purchase some very sophisticated financial weaponry from them.
To pursue Anglo Irish bank, all that a 'tug boat' had to do was to magnify itself enough, using a risky bet (such as 'contracts for difference), put it within firing distance of a much larger and more sophisticated vessel. Anglo Irish bank, was sort of sitting out there on the ocean, naked, and didn't know it.
There were wolves circling though, who understood this and knew how to exploit the vulnerability.
As soon as the smaller vessel acquired the 30% stake in the larger one, the game was over. This was all made possible by the fact that the Irish financial regulator had allowed Irish banks, to carry such large asset portfolios, supported on top of such a small sliver of equity at the bottom.
The 'contracts for difference', was almost like a new canon firing technology, that put a very large asset portfolio within 'reach' of a highly speculative, highly leveraged tug boat for all intents and purposes.
What should have happened of course, was that the Irish financial regulator's office, who was paid handsomely, should have observed the risk of putting such a cargo, in an inappropriate type of vessel that sat so low in the water, and as a result made it such an obvious target. The problem was, the lower the vessel that was Anglo Irish 'bank', got in the water, the more and more the 'value' of this small sliver of equity capital at the bottom, became. It continued until, Anglo Irish 'bank' became the most vulnerable, but also the most desirable vessel sitting on the ocean in the later 2000's.
There is a cautionary tale in all of this, and I feel the lessons of this 'battle' on the seas of the financial markets in Ireland of a decade ago, haven't really been fully learned. But it is important, by means of an inquiry or whatever means at our disposal, that we should document the events as they happened. If we are to have better financial regulation ever, in this small country, these are the kinds of things we ought to study properly.
It is interesting to look back now to the time of October 2008.
The senior executive at the Irish Financial regulator's office speaking on RTE television's 'Prime Time' show on October second 2008, did sound very reassuring. That is, if one can accept the Financial regulator's assessment that we were dealing with banking organisations in Ireland, in 2008, and not something else that was hiding behind the guise of being a retail or commercial banking institution.
One can understand from the senior executive's statements on television at that time, that he had framed the problem at least in terms of risks to the 'banking system', and he also spoke about having taken measures to adequately account for those risks as far back as 2006.
"The issues of lending, the loan portfolios, the risks in the loan portfolios are addressed by having appropriate levels of capital in place. In fact, the regulator has been very active since 2006 in putting these measures in place".
"The important thing is to make sure that the banks are adequately able to deal with the challenges that emerge as the economy weakens, is that they have adqueate levels of capital to absorb any losses".
"Our job is to assess the risks, and make sure that the system is able to absorb those risks. Which I think the measures we introduced back in 2006 did".
However, it should also be admitted that during this interview on RTE television in October 2008, the Irish financial regulators office would have had a full working knowledge about the fatal damage caused to at least one Irish 'bank', Anglo Irish bank, by the financial instrument known as 'contracts for difference'.
The senior executive did speak a lot about the 'normal course of events', or the 'ordinary course of business' I notice in his statements. He also referred to something called 'the lifetime' of a portfolio of loans, in his responses to Mark Little, the RTE television presenter.
"I believe there will be certain impairments over the next couple of years, as the economy declines".
"The important thing is, that difficulties emerge in a loan portfolio, in the normal course of the life of that loan portfolio. That is what day to day regulation is all about. That is our day job".
"The important thing is, that risks emerge over the lifetime of the loan portfolio and it is important that there is adequate capital there to absorb those risks. And by any estimate, the Irish banks are so well capitalized, compared to any banks anywhere across Europe, that I am confident that they can absorb any loans or any impairments that emerge in the ordinary course of business over the forseeable future".
I am not sure, why in his language, the senior executive did focus so much in responding on the phrase, 'ordinary course of business', or 'normal course of events'. This idea of normality, and continuity of operations, seemed to be quite important in his views.
What he wasn't pressed about it seems, or he did not comment about, or seem to acknowledge in this short interview at least, was the concentration upon one single asset class, by Irish 'banks', and if that was wise or not. Instead the senior executive seemed to keep coming back to the same point of, the 'normal course of events', and 'the lifetime' of the loan portfolio.
Towards the end of the short interview, the senior executive also made a reference to his 'day job', as a financial regulator. That is, again, this idea of things being normal, and things always go on, and things will continue to be. Continuity and normality, seemed to be cornerstones in the way the senior executive explained his world. In fact, he doesn't come across as being such a bad character at all. Maybe, not the right character in the right place, at the right time. But certainly not a bad guy, by any stretch.
"It is part of banking that they do take risks and it is absolutely part of banking supervision and regulation that banks are able to absorb the effects of those risks and I believe the Irish banks are adequately - more than adequately capitalized - and they are resilient and they will be able to absorb (inaudible)".
I am not qualified to say, whether this is an appropriate response or not for a financial regulator, given the calamity of the times, and particularly that in Ireland at the time. It does suggest though, that in some way the minister for finance, the government at the time and all of the regulators, civil servants and so on, thought that they would pass through the financial turmoil and somehow survive. I am not sure that that is a bad way to look at life, given the time and the context. But one of the main things, I am sure the financial regulator's office can be criticized for today, is not fully having the measure of the situation, at their grasp.
I am not sure either that this is a terribly dramatic conclusion to make, but I think that this conclusion does clearly need to be made. It is okay to talk about careful assessment of risks, as the senior executive did. But it wasn't okay, that the assessment of those risks was so very badly out of proportion with the reality. This is why we do near an inquiry into the crash in banking in Ireland, in order to ascertain what exactly the scale of the miscalculation was at that point in 2008 (or earlier), and why exactly the miscalculation seems to have been as large as indeed it was.
This is common practice is risk assessment and good risk management, where estimates and judgements are made (even with the best of good faith), that later appear to have been so wrong. It is obvious from the senior executive's statements now, that he felt that he was and had applied the best possible practice at the time. But it is also obvious today, that that best practice fell an awful ways short of desirability.
Experts who do study the financial collapse in Ireland today, would like to understand specific things in a banking inquiry. They would first like to understand the extent of direction given by politicians to the banking system from within in Ireland. Secondly, they would like to know the extent of direction that was given from Berlin. These are the two questions, which are still taxing the brains of many.
In the October 2008 interview on RTE's PrimeTime show, the executive from the Irish financial regulators office claimed,
"The issues of lending, the loan portfolios, the risks in the loan portfolios are addressed by having appropriate levels of capital in place. In fact, the regulator has been very active since 2006 in putting these measures in place".
A biopic movie was released about Field Marshal Erwin Rommel in 1951, shortly after the end of the second world war. It is an interesting movie to watch today, in the context of the ordeal that Ireland has experienced in the last few years (in trying to rebuild from the rubble). The movie contains one scene in which Rommel converses with his superior on the western front in 1944, Gerd von Rundstedt, about the so-called 'Atlantic wall'. Those were the defenses that the Germans tried to create in advance of Eisenhower and the American forces arriving in Normandy.
The two Field Marshals commented on what a joke the idea of a defensive wall was, at the time.
It was kind of the same thing, with Anglo, here in Ireland. After the debacle with the Regulator's office and the Quinn borrowings and all of that, the focus switched to things such as the Irish banking guarantee, and saving the whole of Europe from collapse, it would appear. Again, we don't understand that much about its timeline. Although Philippe Legrain, the former European Commission economic adviser, was able to shed more light upon this for us in Ireland recently.
In viewing the Erwin Rommel movie, one does get a sense that two men were sent out on a hopeless task and told to get on with it.
There is one caveat to make however, I think, and something that we should all try to learn. The analogy of the 'western wall' of 1944, does fit the story of 2008 in Ireland in some ways. It captures in a way the level of paranoia that existed throughout the financial system in European countries. Any proper and thorough banking inquiry here in Ireland, cannot be isolated from that broader context of what was going on.
Many large German and French financial institutions had gone around America purchasing a lot of high yielding financial directives at the time. The Europeans at the time of 2008, were really bracing themselves to fend off something terrible and awesome that was perceived to be 'coming there way' from across the Atlantic ocean. Ireland was the little guy, caught in the middle between two giants as it were.
This must be said. And it must be admitted that all of this was going on, at the time, very far above the heads of those in the Irish department of finance central bank, or regulator's office.
But reading again through the executive's comments from October 2008, on RTE's PrimeTime show, there is something else that springs to mind. Again, a military type of analogy is probably the best way to understand it. In the 'battle of Singapore' in early 1942, eighty thousand British, Indian and Australian troops found themselves surrounded and had to surrender. It was the largest defeat for the British army in the entire war. Military historians have studied it and concluded that while the guns were in fact used, and could revolve around to meet the land invasion of the Japanese infantry, the armour piercing ammunition that those guns were equipped with (suitable for fighting against large navy vessels), did not do against infantry on land.
What we do need to remind ourselves about the so-called 'risk capital' that is carried by a banking institution, is that the 'attack' so to speak on the solvency of the bank doesn't always come in the form, and from the direction which ones expects.
In the comments, from the executive from the financial regulator's office in October 2008, I do get the sense that here was an individual who presumed the main threat was coming from INSIDE the loans themselves. In other words, he had not constructed those defenses that he was so proud of in 2006, to face in the right direction. The attack did not come from inside the loans, where series of borrowers defaulted. In fact the attack came from outside the bank, from an investor who had diagnosed the modesty of the capital amount protecting the Anglo Irish bank from a raid, and had exploited that weakness.
The defenses that the executive spoke about had been designed for defaults by the borrowers in the loans themselves, and the 'risk' defense may well have served in that case - if the actual attack had come from that direction. But it didn't.
It gets back to this point about presumptions that we sometimes make, like the excellent British military generals did make in the Singapore in the 1940's. The 'risk capital' that the executive on RTE PrimeTime talked about, are not only designed to deal with impacts from within the loan portfolio itself,... but should also be designed to deal with leveraged buyouts from the outside as well. That was the lack of understanding the cost the Irish banking system so dearly, and that is why so much was surrendered.
What has failed to happen, I notice very much in all of the debate and discussion, is the separation or distinction between different parties that were involved with banking, and real estate development and equity investment in Ireland.
ReplyDeleteThere are three distinct parties involved - the Anglo Irish bank, its customers and its owners (Anglo public stock owners). It is important to separate out these different parties, and their respective motivations (because the 'owners' of the Anglo Irish bank, received no representation in the Anglo trial whatsoever),... and this does cause concern, because Anglo Irish bank at the time of the collapse had ceased to operate like a 'bank' and was operating more like what we now call a 'real estate investment trust'.
Anglo Irish bank, was in very, very many ways the equivalent to a REIT vehicle, like those ones that we see nowadays being introduced into the Irish stock market.
With all of the discussion that has been going on in Ireland in 2013, about the legislation created to establish the REIT vehicles in Ireland,... absent from that, has been an admission that the way that Irish banks did operate during the 2000's decade in Ireland, was very much like REIT's (except they were hiding behind the guise of being retail banking organisations, and this enabled them to be 'saved' by the Irish taxpayer, when it all went horribly wrong in 2008).
The simple fact of the matter is, that in 2014, had the economic crash of a few years ago, never happened,... and the Maple 10 transaction had achieved its purpose of becoming a 'bridging loan', as the Irish financial regulator had hoped that it would serve,... we would not have any REIT's in Ireland. Instead, what we would have in Ireland in 2014, is a whole pile of retail and commercial banks, operating like REIT's, but hiding behind a guise of being Irish banks.
But we roll back the clock in Ireland to the mid 2000's (the time that is featured in the 'Anglo trial'), and what we find in Ireland,... are the existence of these behemoth blue chip equities on the Irish stock exchange,... which coincidentally happen to be Irish retail banks,... but more than anything else from the point of view of customers who invest on the Irish stock exchange,... were very large real estate asset management concoctions of that time (the mid 2000's decade in Ireland).
ReplyDeleteYou had all of the large Irish lenders, BOSI, Ulster Bank, Anglo, AIB, BOI,... all of them soaked up vast amounts of money from a lot of ordinary, small investors who wanted to find returns for their money, on the Irish stock exchange. There were huge numbers of instances, where local business people in towns and villages all around Ireland, would liquidate their legitimate enterprises, and convert that wealth into equity stake holdings, in Irish banks.
But they weren't buying shares in Irish retail banks. They were effectively buying a portion of the Irish property industry. In other words, the function that Irish banks served during the bubble era, was not unlike that function served by the new REIT vehicles that have been floated on the Irish stock exchange more recently.
The Irish banks, as companies by themselves, understood that very well. They understood that apart from 'large, lop-sided balance sheets' consisting of billions and billions of euros thrown into Irish property (in all kinds of ways),.... being something that might turn investors or creditors away from purchasing equity in Irish banks, or buying debt securities,... this very large gamble on Ireland's property industry,... actually enhanced the ability of these vehicles known as Irish banks, to raise their equity capital on the Irish stock exchange.
People weren't buying into banks, as shareholders, they were buying into something more like a REIT (and as it turned out a highly risky kind of REIT, and the shareholders got wiped out totally as a result).
Now, getting back to the famous 'Anglo trial',... what we don't see anywhere in it, is any evidence or representation on behalf of the owners of the Irish banks (or REIT's or property investment behemoths). Instead we say the evidence that was given, that had to do with Anglo Irish bank, and it's customers (its borrowers).
The defense in the 'Anglo trial', seemed to be very careful to represent the Maple 10 transaction, in a way that suggested the customers of the Anglo Irish bank, the Maple 10, had some choice in the matter.
In fact it was a 'Hobson's choice',... it was really no choice at all.
The Maple 10, had the choice of absorbing more borrowings on to their already leveraged balance sheets, or watch as their whole funding situation deteriorated anyway, as the lender that was supporting them and their gamble on the Irish property industry, fell apart.
ReplyDeleteThe Maple 10, were simply told, you can take it or not take, either way we all go down together. Ten out of ten individuals took the deal, as a result.
And this sums it all up very neatly,... and it all goes back to the pretense that was Anglo Irish 'bank' as a concept to begin with (and the very same could be argued about many of the other so-called 'banks' in Ireland at that time). They were all gambles on the Irish property industry. This was indeed their biggest selling point, as far as their shareholders were concerned.
What one needs to ask now in 2014,... is that if we adjusting the 'titles' given to the various players in this sordid affair,... and we called the Irish banks of the 2000's out for exactly what they were, as very concentrated gambles on the Irish property industry,... and we said, we had all of these things that were effectively large REIT type vehicles, how does that change our perception?
The question is, if it was a REIT, instead of an Irish bank, could it approach its affairs with anything like the same autonomy (and level of cooperation from the Irish financial regulator), as the Anglo Irish bank could in 2007 and 2008?
The answer is, of course it could not.
Because a REIT as a vehicle, which soaks up large amounts of private equity capital, has a lot more responsibility to convey to its shareholders (its owners) the real situation of its balance sheet. A REIT vehicle, would not be able to cultivate the kind of relationship with a group of ten property developers, which Anglo Irish bank was allowed to do, and with the blessings from the Irish financial regulator to boot.
It is important that we realize these simple truths today in 2014. Because, in terms of the Irish banks in the decade of the 2000's, they had ceased to operate merely as banking organisations, and had gone somewhere else (and the shareholders in Irish banks, rewarded those banks via capitalisation, for going wherever they went to),.... and the Irish banks of the 2000's decade, did resemble a lot more, the thing that we now call a REIT in 2014, on the same Irish stock exchange, where the Irish banks had previously been allowed to operate in the same fashion only a decade earlier.
The failure of financial regulation in Ireland, was not its complicity in the Maple 10 transaction. It was in the failure to distinguish, when it should have been able to distinguish quite plainly, between what was actually a domestic banking institution (be it commercial like Anglo, or retail like AIB or BOSI),... and what was a highly leveraged, institutionalized gambling long-shot,... on the Irish property market.
ReplyDeleteIt was the failure of the Irish financial regulator, to simply look at the balance sheet of the Irish banks, in the 2000's decade, and draw this important distinction, that in turn led to everything else happening after that.
This is what is really 'on trial', or 'under investigation'. Why did the Irish financial regulator think that it was such a good idea, that every citizen and every taxpayer in the whole of Ireland, have one big sixty billions worth of a gamble simultaneously,... on the success or failure of another reckless gamble, which was the Irish property industry a decade ago.
But then, we always have to remind ourselves, that in Ireland, the property industry is more like a religion than a business. And we are all considered its most loyal followers (and most of all, that was so in the eyes of the Irish financial regulator). We all needed to worship at its altar, and that is exactly what all were made to do.
Ireland is supposed to have 'freedom of religion', but unfortunately, when it comes to the property industry, there isn't any choice. We are all expected to worship. This may have changed somewhat in the aftermath of the crash in the Irish economy. But has it changed enough?
The matter of the Sean Quinn & family stake hold in Anglo Irish bank, created in 2007 and 2008, was referred to many times it seems in the 'Anglo trial'.
ReplyDeleteBearing in mind, what I have tried to describe overhead,... What we find in the modern discourse about the 'Anglo trial' by various reporters and news pundits,... is a kind of 'one eyed analysis'.
It was a criticism very often leveled at former chairman of the Federal Reserve bank in the United States, Alan Greenspan. Greenspan, it has been argued could spot ordinary consumer price inflation coming a mile away, with his one good eye. However, using the other eye, he appeared to be blind, in terms of seeing asset price inflation, in the bubble economies that he helped to create on two separate occasions in the 1990s and early 2000's.
In a way, this is how the commentators and the analysts in Ireland look at Anglo Irish bank as an entity.
There are actually two important levels of abstraction that are at work with Anglo Irish bank in the late 2000's period. There is a 'double Irish' going on, so to speak.
On the one hand, with have this 30 percent stake amassed by the Quinn family in the bank using the notorious 'contracts for difference'. This is one level of abstraction, which the pundits always focus upon.
However, what pundits refuse to see (like the one-eyed federal reserve chairman), is the fact the Irish financial regulator during the boom, was actively encouraging Irish banks to operate as Real Estate Investment Trusts (behind the guise of being Irish 'banks', quoted on the Irish stock exchange).
This of course, was the 'loop hole' in Irish financial regulation which Anglo Irish bank had exploited to great success, and resulted in the inflation of its market capitalisation. The history of Anglo within an Irish context, follows closely the trajectory of another blue chip stock, on the American stock exchange, that of Apple computer corporation, that rose to become the most valuable company in the entire globe.
And one has to ask oneself, faced with such astonishing levels of share price performance, what could any director of Allied Irish bank (or any other 'bank' in the country), do except chase after the example that Anglo has shown so clearly?
What we refuse to ask ourselves plainly, in Ireland, even after the crash in 2014, is how many ways can financial regulation in the country, distort the markets, producing these entities which are so much more highly valued by shareholders than anything else?
The Irish financial regulator's office, has never really confronted this, and produced a fully honest account of its own actions (or lack thereof).
The biggest difference between an actual real life Real Estate Investment Trust, and a bank, is that a REIT, tends to have a equal distribution of borrowings and capital. A typical de-leveraged REIT in the post-crisis, post-2008, world in north America (where the concept of a REIT originated from), has 50% equity and 50% debt (various mixtures of sub-ordinate debt, bonds and preference shares).
ReplyDeleteThe thing that characterizes a 'bank' (and this is crucial to appreciate from a financial regulation point of view), is the small 'base' of capital used to fund an incredibly large asset portfolio on top. Before the crisis, depending on the institution, banks were working off of capital bases in the region of three or four percent.
The crucial difference between a 'bank' and a 'REIT', is like that cartoon of the ship that floats high in the water, versus the one that sits lower down. I recall one cartoon (in the Irish Indo I think), which described the Quinn family's punt on Anglo Irish bank, being like a little row boat in the water capsizing a large vessel. There is a certain amount of truth in the cartoon, because it describes much of what did happen.
What experts who studied the financial crash in Ireland, could never quite understand was how such small players, such as cement factory owners from county Fermanagh could de-stablize the 'boat' that was the Irish economy and its system of credit,... to the extent that they did.
We know that the Irish banks, during the boom period in Ireland, were like REIT's in the fact that they were trying to support these very large real estate asset portfolios. Because Anglo was classified in 2007/08, as a 'bank', this very large asset portfolio was sitting very much lower down in the water, than a REIT type vehicle could do. That was enabled by the financial regulation that we had in Ireland (and we still do).
The in turn put the large 'vessel', that was Anglo Irish bank, within reach of some very small boats. But even at that, there was still a distance to cover.
Look at it, in terms of a telescope.
ReplyDeleteYou pay a high enough fee, to these modern financial services providers, and in return you can purchase some very sophisticated financial weaponry from them.
To pursue Anglo Irish bank, all that a 'tug boat' had to do was to magnify itself enough, using a risky bet (such as 'contracts for difference), put it within firing distance of a much larger and more sophisticated vessel. Anglo Irish bank, was sort of sitting out there on the ocean, naked, and didn't know it.
There were wolves circling though, who understood this and knew how to exploit the vulnerability.
As soon as the smaller vessel acquired the 30% stake in the larger one, the game was over. This was all made possible by the fact that the Irish financial regulator had allowed Irish banks, to carry such large asset portfolios, supported on top of such a small sliver of equity at the bottom.
The 'contracts for difference', was almost like a new canon firing technology, that put a very large asset portfolio within 'reach' of a highly speculative, highly leveraged tug boat for all intents and purposes.
What should have happened of course, was that the Irish financial regulator's office, who was paid handsomely, should have observed the risk of putting such a cargo, in an inappropriate type of vessel that sat so low in the water, and as a result made it such an obvious target. The problem was, the lower the vessel that was Anglo Irish 'bank', got in the water, the more and more the 'value' of this small sliver of equity capital at the bottom, became. It continued until, Anglo Irish 'bank' became the most vulnerable, but also the most desirable vessel sitting on the ocean in the later 2000's.
There is a cautionary tale in all of this, and I feel the lessons of this 'battle' on the seas of the financial markets in Ireland of a decade ago, haven't really been fully learned. But it is important, by means of an inquiry or whatever means at our disposal, that we should document the events as they happened. If we are to have better financial regulation ever, in this small country, these are the kinds of things we ought to study properly.
It is interesting to look back now to the time of October 2008.
ReplyDeleteThe senior executive at the Irish Financial regulator's office speaking on RTE television's 'Prime Time' show on October second 2008, did sound very reassuring. That is, if one can accept the Financial regulator's assessment that we were dealing with banking organisations in Ireland, in 2008, and not something else that was hiding behind the guise of being a retail or commercial banking institution.
One can understand from the senior executive's statements on television at that time, that he had framed the problem at least in terms of risks to the 'banking system', and he also spoke about having taken measures to adequately account for those risks as far back as 2006.
"The issues of lending, the loan portfolios, the risks in the loan portfolios are addressed by having appropriate levels of capital in place. In fact, the regulator has been very active since 2006 in putting these measures in place".
"The important thing is to make sure that the banks are adequately able to deal with the challenges that emerge as the economy weakens, is that they have adqueate levels of capital to absorb any losses".
"Our job is to assess the risks, and make sure that the system is able to absorb those risks. Which I think the measures we introduced back in 2006 did".
However, it should also be admitted that during this interview on RTE television in October 2008, the Irish financial regulators office would have had a full working knowledge about the fatal damage caused to at least one Irish 'bank', Anglo Irish bank, by the financial instrument known as 'contracts for difference'.
ReplyDeleteThe senior executive did speak a lot about the 'normal course of events', or the 'ordinary course of business' I notice in his statements. He also referred to something called 'the lifetime' of a portfolio of loans, in his responses to Mark Little, the RTE television presenter.
"I believe there will be certain impairments over the next couple of years, as the economy declines".
"The important thing is, that difficulties emerge in a loan portfolio, in the normal course of the life of that loan portfolio. That is what day to day regulation is all about. That is our day job".
"The important thing is, that risks emerge over the lifetime of the loan portfolio and it is important that there is adequate capital there to absorb those risks. And by any estimate, the Irish banks are so well capitalized, compared to any banks anywhere across Europe, that I am confident that they can absorb any loans or any impairments that emerge in the ordinary course of business over the forseeable future".
I am not sure, why in his language, the senior executive did focus so much in responding on the phrase, 'ordinary course of business', or 'normal course of events'. This idea of normality, and continuity of operations, seemed to be quite important in his views.
What he wasn't pressed about it seems, or he did not comment about, or seem to acknowledge in this short interview at least, was the concentration upon one single asset class, by Irish 'banks', and if that was wise or not. Instead the senior executive seemed to keep coming back to the same point of, the 'normal course of events', and 'the lifetime' of the loan portfolio.
Towards the end of the short interview, the senior executive also made a reference to his 'day job', as a financial regulator. That is, again, this idea of things being normal, and things always go on, and things will continue to be. Continuity and normality, seemed to be cornerstones in the way the senior executive explained his world. In fact, he doesn't come across as being such a bad character at all. Maybe, not the right character in the right place, at the right time. But certainly not a bad guy, by any stretch.
ReplyDelete"It is part of banking that they do take risks and it is absolutely part of banking supervision and regulation that banks are able to absorb the effects of those risks and I believe the Irish banks are adequately - more than adequately capitalized - and they are resilient and they will be able to absorb (inaudible)".
I am not qualified to say, whether this is an appropriate response or not for a financial regulator, given the calamity of the times, and particularly that in Ireland at the time. It does suggest though, that in some way the minister for finance, the government at the time and all of the regulators, civil servants and so on, thought that they would pass through the financial turmoil and somehow survive. I am not sure that that is a bad way to look at life, given the time and the context. But one of the main things, I am sure the financial regulator's office can be criticized for today, is not fully having the measure of the situation, at their grasp.
I am not sure either that this is a terribly dramatic conclusion to make, but I think that this conclusion does clearly need to be made. It is okay to talk about careful assessment of risks, as the senior executive did. But it wasn't okay, that the assessment of those risks was so very badly out of proportion with the reality. This is why we do near an inquiry into the crash in banking in Ireland, in order to ascertain what exactly the scale of the miscalculation was at that point in 2008 (or earlier), and why exactly the miscalculation seems to have been as large as indeed it was.
This is common practice is risk assessment and good risk management, where estimates and judgements are made (even with the best of good faith), that later appear to have been so wrong. It is obvious from the senior executive's statements now, that he felt that he was and had applied the best possible practice at the time. But it is also obvious today, that that best practice fell an awful ways short of desirability.
Experts who do study the financial collapse in Ireland today, would like to understand specific things in a banking inquiry. They would first like to understand the extent of direction given by politicians to the banking system from within in Ireland. Secondly, they would like to know the extent of direction that was given from Berlin. These are the two questions, which are still taxing the brains of many.
ReplyDeleteIn the October 2008 interview on RTE's PrimeTime show, the executive from the Irish financial regulators office claimed,
"The issues of lending, the loan portfolios, the risks in the loan portfolios are addressed by having appropriate levels of capital in place. In fact, the regulator has been very active since 2006 in putting these measures in place".
A biopic movie was released about Field Marshal Erwin Rommel in 1951, shortly after the end of the second world war. It is an interesting movie to watch today, in the context of the ordeal that Ireland has experienced in the last few years (in trying to rebuild from the rubble). The movie contains one scene in which Rommel converses with his superior on the western front in 1944, Gerd von Rundstedt, about the so-called 'Atlantic wall'. Those were the defenses that the Germans tried to create in advance of Eisenhower and the American forces arriving in Normandy.
The two Field Marshals commented on what a joke the idea of a defensive wall was, at the time.
It was kind of the same thing, with Anglo, here in Ireland. After the debacle with the Regulator's office and the Quinn borrowings and all of that, the focus switched to things such as the Irish banking guarantee, and saving the whole of Europe from collapse, it would appear. Again, we don't understand that much about its timeline. Although Philippe Legrain, the former European Commission economic adviser, was able to shed more light upon this for us in Ireland recently.
In viewing the Erwin Rommel movie, one does get a sense that two men were sent out on a hopeless task and told to get on with it.
There is one caveat to make however, I think, and something that we should all try to learn. The analogy of the 'western wall' of 1944, does fit the story of 2008 in Ireland in some ways. It captures in a way the level of paranoia that existed throughout the financial system in European countries. Any proper and thorough banking inquiry here in Ireland, cannot be isolated from that broader context of what was going on.
ReplyDeleteMany large German and French financial institutions had gone around America purchasing a lot of high yielding financial directives at the time. The Europeans at the time of 2008, were really bracing themselves to fend off something terrible and awesome that was perceived to be 'coming there way' from across the Atlantic ocean. Ireland was the little guy, caught in the middle between two giants as it were.
This must be said. And it must be admitted that all of this was going on, at the time, very far above the heads of those in the Irish department of finance central bank, or regulator's office.
But reading again through the executive's comments from October 2008, on RTE's PrimeTime show, there is something else that springs to mind. Again, a military type of analogy is probably the best way to understand it. In the 'battle of Singapore' in early 1942, eighty thousand British, Indian and Australian troops found themselves surrounded and had to surrender. It was the largest defeat for the British army in the entire war. Military historians have studied it and concluded that while the guns were in fact used, and could revolve around to meet the land invasion of the Japanese infantry, the armour piercing ammunition that those guns were equipped with (suitable for fighting against large navy vessels), did not do against infantry on land.
What we do need to remind ourselves about the so-called 'risk capital' that is carried by a banking institution, is that the 'attack' so to speak on the solvency of the bank doesn't always come in the form, and from the direction which ones expects.
In the comments, from the executive from the financial regulator's office in October 2008, I do get the sense that here was an individual who presumed the main threat was coming from INSIDE the loans themselves. In other words, he had not constructed those defenses that he was so proud of in 2006, to face in the right direction. The attack did not come from inside the loans, where series of borrowers defaulted. In fact the attack came from outside the bank, from an investor who had diagnosed the modesty of the capital amount protecting the Anglo Irish bank from a raid, and had exploited that weakness.
The defenses that the executive spoke about had been designed for defaults by the borrowers in the loans themselves, and the 'risk' defense may well have served in that case - if the actual attack had come from that direction. But it didn't.
It gets back to this point about presumptions that we sometimes make, like the excellent British military generals did make in the Singapore in the 1940's. The 'risk capital' that the executive on RTE PrimeTime talked about, are not only designed to deal with impacts from within the loan portfolio itself,... but should also be designed to deal with leveraged buyouts from the outside as well. That was the lack of understanding the cost the Irish banking system so dearly, and that is why so much was surrendered.