How Honahan got it Wrong!

September 2, 2010

You can download the Report here

As we approach ECB decision time on an outcome for Anglo Irish Bank, it might be worthwhile to have a look back at some aspects of the Honahan Report that might throw light on any upcoming decision, please read the Report in full above. The following are a few reflections on its contents.

In fairness, it was a hard call. The authors of the report were mandated to focus on the performance of the Central Bank and the Financial Regulator during the period 2003 – 2008. Already the hand washing blame game was taking focus away from government fiscal policy and incompetent budgetary and taxation policy.

The Report highlights how two Reports in 2007 from Morgan Kelly were ignored.

It details lack of regulatory involvement by the CB and Financial Regulator and other factors such as a global downturn, but fiscal policy and political governance is sidelined to a mere contributory issue. Furthermore, the report is mandated to investigate institutional causes of the crash but not the role of individuals.

Insofar as budgetary decisions such as Section 23 tax relief benefits are authored by government ministers, detailed probing of such taxation policy is completely avoided in the Honahan report as is the accountable responsibility of individual members of government to their involvement as authors of such policy.

Another Report is needed that properly investigates Government fiscal policy during the period 2003 – 2008 in a comprehensive and detailed way that goes deeper into the causes of the Irish property bubble crash and looks at the role of government and individual ministers of government.

The Honahan report belies the possibility of both weak regulation and weak CB involvement as outcomes of Government policy rather than specific weaknesses belonging to the responsibility of these institutions alone.  The Report blames senior management in the banks but carefully avoids specific criticism of  senior management at Government level.

In the main the Report adopts a two dimensional jig saw approach rather than a more appropriate pyramid approach from Government downwards with percentile allocations of blame.

What we get is a watered down feeling of ‘we were all in this together’ . This  has the effect of distributing blame away from those responsible.

No wonder Eamon Ryan to Aoife Lawlor today on Morning Ireland makes the point people should read the Honahan Report. Specific events leading up to the bank guarantee are judiciously kept out of the frame.

As the government both FF and GP move away from a policy of  ‘good bank, bad bank’ resolution for Anglo towards a wind down scenario, it should be noted the Honahan Report of itself does not endorse the Government guarantee allowing this policy was a matter for government. 

Its important to understand prior to the guarantee there was not the information on solvency of the banks that is known now. In many ways decision making was based on false information.

Furthermore, there was a failure on the part of government to work with both UK and EU on an agreed and consolidated approach to handle the crisis. Its hard to know if this was arrogance, hubris or incompetence at government level.
Clearly Government decided for its own reasons to go with information later proved to be incomplete and inaccurate on a policy that would have potentially catastrophic losses for the taxpayer and the State. Clearly Anglo Irish Bank was being protected from the highest levels of government. Grouping it with the other Irish banks in difficulty had the effect of hiding and minimising its potential losses.

Anglo should have been separated out as a non systemic bank, without a branch network, servicing the borrowings of a small group of speculators and investors and prevented from casting its risk onto taxpayers and the economy. Honahan says there was no reason to believe help for the bank through ELA and the ECB was not forthcoming see below. In fact this is in hindsight the preferred method to deal with sovereign debt crises.

Far from minimizing loss to the taxpayer, Government has embarked on the most expensive approach possible. Anglo should have been dealt with from the beginning as a special case with involvement of the ECB in an immediate wind down to limit its damage to the Irish economy. Recent difficulties for Ireland Inc from the S&P rating agencies and difficulties in widening bond spreads clearly demonstrate the folly of Governments approach to Anglo.

From a position of containment, if 8.23 were followed below, Anglo has been allowed to grow into a systemic risk to Ireland Inc. Along with its disastrous stoking through tax incentives of the property bubble, lack of fiscal rectitude, Government with its current profligate approach to Anglo, its approach that debts are manageable without knowing the extent of such debts, must put our government in the lower tier of success rates of governments dealing with the crash.

Even at this late point in dealing with Anglo, is it not possible the ECB can wind down Anglo, reduce its systemic risk to Ireland Inc, and sterilise its debt exposure. For sure, on its own, this present Government can only make matters worse.

8.23 Second, the use of ELA itself was discussed.152 While this would have had to be notified to the ECB, and any significant amounts would have required prior agreement (strictly speaking: no objection) by the ECB Governing Council there is no reason to believe that this would not have been forthcoming. However, it was observed that ELA was normally intended to be availed of in the case of a single institution facing difficulties. Using ELA to support the entire banking system  which might end up being necessary  could, it was thought, have had a major adverse reputational impact on the Irish banking system. More generally there was uncertainty whether use of ELA, if publicly disclosed or detected (as would be likely), would boost or detract from market confidence. Finally, as with the SLS option above, the potential open ended size of the operations and the associated balance sheet risk for the CBFSAI were seen as serious concerns.

152 Provided a bank has eligible collateral, liquidity may be accessed via refinancing operations with the 

ECB. However, in the absence of ECB-eligible collateral an institution may, as indicated earlier, apply

for emergency lending assistance from the CBFSAI.

” Section 1: Introduction

1.2 The Report seeks to answer two questions. First, why was the danger from the emerging imbalances in the financial system that led to the crisis not identified more clearly and earlier and headed-off through decisive measures? Second, when the crisis began to break, were the best containment measures adopted? The Report has addressed both aspects with a particular focus on the performance of the Central Bank and the Financial Regulator throughout the period.

In particular, the relatively glowing 

2006 update of the IMF‘s specialised Financial Sector Assessment Program (FSAP)

mission – an exercise designed precisely to identify any weaknesses in prudential

regulation and financial stability policy – would have been enough to set any doubts 

that may have existed at rest. The FSAP Report‘s misinterpretation – for whatever

reasons – of the prevailing Irish situation must be considered unfortunate.

key officials involved and, for good or ill, simplified the decision making process. By

late September, it would have also reflected the broader reaction at European level to

what was considered to be an ill-judged policy decision on the part of the US authorities

not to save Lehman Brothers.

8.18 A detailed review of the ensuing discussions is hampered by the absence of an extensive

written record of what transpired.150 Although the minutes of meetings of the CBFSAI

Board and the Authority during the period contain references to various options, there is

an absence of documentation setting forth the advantages and disadvantages of possible

alternatives and their quantitative implications. While CBFSAI Board members

expressed some broad views on possible approaches, no decisions were taken, as the

solutions would need to be found at Governmental level. The key discussions took

place via the very many informal contacts and meetings between senior officials of the

DSG agencies, the NTMA, and consultants; what follows relies to a very large extent on

the personal recollections of participants.

8.19 Throughout this period  up to and including 30 September  as noted above, the clear

consensus was that the problem was essentially one of liquidity rather than of solvency.

(See Box 8.1 for a discussion of these concepts.) While some doubts may have been

felt or expressed privately, the minutes of the CBFSAI Board and Authority meetings

do not record any concerns as to possible underlying weaknesses of the various

institutions which were believed to be suffering the consequences of a world-wide

―financial tsunami‖. Thus the comforting reassurances provided to the CBFSAI Board

and Authority on earlier occasions that there were no fundamental problems were not

put into question.


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