Open Dissent (15 page)

Is the real purpose of the Commission to discover the weaknesses in the system and take measures to ensure there is never a recurrence of a crisis like this one? While many have sought a full public enquiry, the Government insists that this process will be much shorter and less costly than a tribunal. Provided the truth is forthcoming and transparency on all aspects of the enquiry is of the highest standard, we should be satisfied. That said, we will be fortunate if we enter 2011 with a satisfactory understanding of what was at the heart of the crisis, the steps we must take to avoid a recurrence and the guilty parties named.

I
N
F
OREIGN
H
ANDS
– N
EW
Z
EALAND

A country that has similar demographics to Ireland and, some might say, similar harebrained ambitions, New Zealand should be examined for the similarities between the national crisis in that country in the 1980s and our own current predicament. The crisis that affected the financial markets and the banking system in New Zealand began in 1988 as a result of reckless lending in the commercial property sector through a handful of investment holding companies. The majority of the loans were highly
leveraged and many of the eight major borrowers simply had cross shareholdings in a variety of companies that had little substance and possibly even smaller cash flows. The cross ownership through subsidiary investment vehicles reflected the real economic value of these companies. Initially, through active trading in the shares, the market capitalisation of the traded companies grew quickly and the perception was that real value had been created. On the contrary, there was no real value created and the consequences of this reckless lending and trading led to the collapse of the New Zealand banking system. There were other peripheral activities attached, most of which had a trading element, that simply compounded the financial crisis.

The following commercial property transaction highlights the similarities between New Zealand's crisis and Ireland's. At the peak of the market a bank syndicate put a loan together for the acquisition of a premier property in the heart of Wellington for NZ$100 million. With the collapse in the market, this property was foreclosed and taken over by the syndicate. The market for commercial property had collapsed, there was no liquidity and there were very few, if any, potential acquirers with cash in existence. The property subsequently sold for NZ$29 million. That property, some twenty years later, is purported to have a value of NZ$250 million.
³³

Former Chief Executive of Bank of New Zealand Peter Thodey explained that it was important for the recovery in New Zealand for the banks to have taken a 71 per cent
haircut in the property sector in order to re-establish a realistic pricing structure in the marketplace – a salutary lesson for all of us. This laid the foundations for confidence slowly but surely being brought back into the market.

It is worth noting that the New Zealand experience was a consequence of irrational lending and equity trading activities, which contributed to the demise of the domestic banking system. During the crisis, the Government was forced to hand over control of the four major New Zealand banks to Lloyds Bank (UK), National Australia Bank, ANZ Bank (Australia and New Zealand) and Westpac Bank (Australia). The losses associated with property lending and trading destabilised not just the banking industry but also the country. The price of survival was the loss of financial independence and the creation of a foreign bank infrastructure that replaced the domestic shareholders overnight.

One might feel comfortable that as long as the branch network remains the same, with the same name over the door, one's financial system is safe. Safe it may be, but how sympathetic is it to the needs of the local market? When annual budgets were presented to head offices in London, Sydney or Melbourne, with requests for additional credit facilities for agriculture, these requests often were greeted with a steely silence. What had been viewed as a sectoral allocation of resources by the domestic banks of New Zealand was now seen as an international sectoral allocation from a head office perspective. Channelling resources to the preferred sectors in the New Zealand economy was
now out of the hands of the traditional decision makers and, in part, a national economic policy was being determined outside the country.

Some twenty years have passed since the New Zealand crisis occurred and the banking system still remains in foreign hands. Having a clearly thought out national plan for the Irish financial services industry would ensure that each decision would be made in the overall context of national recovery rather than on a piecemeal basis, hence preventing foreign ownership. Such a national plan would require strong leadership and the various constituents working together on a consistent basis. The difficulties that arise between the banks as lenders, NAMA, the Regulator and the borrowers are compounded by the lack of clarity being displayed by the leadership of the country. The complexities as to who is to be considered the most important constituent in any given transaction, be it the shareholders, borrowers, lenders, policy holders, regulators or the taxpayer, causes unnecessary confusion. Each piece of the financial jigsaw has its respective position but the need for an overall plan for getting the best deal for the country, in which each constituent has its place, appears to take a secondary position to the bureaucratic process.

A B
LUEPRINT FOR
S
UCCESS
– S
WEDEN

Closer to home, the handling of the Swedish property bubble of the 1990s is another example that could give us guidance as to how we might manage to extricate ourselves from the mess of our own burst bubble.

The Swedish banking crisis had its origins in the domestic commercial real estate market, as is the case in Ireland today. Rapid increases in lending fuelled the crisis; financial companies that were subsidiaries of the banks were lending to the commercial real estate market, funded by the issuance of commercial paper. A liquidity crisis arose when this source of funding dried up and financial companies reached the edge of insolvency. With a rapid expansion of credit growth in the course of five years, private borrowing grew from 85 per cent to 135 per cent of GDP. If we care to remind ourselves, in a similar time frame, the growth of credit in the Irish private sector grew from 100 per cent to 200 per cent.
³⁴

One of the major failures in terms of credit decisions in Sweden was that banks lent to customers, projects and geographical areas of which they did not have sufficient knowledge (sounds very familiar). A further mistake in the lending habits of the banks was that they accepted, knowingly or otherwise, high risk concentrations, not just in terms of individual companies but also in economic sectors, primarily real estate, and within particular geographical areas.

It was uncovered after the fact that the supervisory authority had not adjusted to the changing market conditions. It continued its traditional formal supervision, ensuring that reports and permits, etc. were formally correct rather than supervising the actual risks. This lack of good practice was experienced some seventeen years ago in Sweden and all we can say today is ‘Déjà vu'. Lacking
relevant crisis experience, the authorities in Sweden did not perceive that the 1980s could pave the way to a new financial crisis.

The first signs of a potential crisis were observed in autumn 1990. In early 1991, one of Sweden's middle-sized banks, Forsta Sparbanken, disclosed severe credit losses in real estate lending and its capital ratio fell below 8 per cent, threatening its survival.
³⁵
The Treasury gave a credit guarantee to the bank in order to improve the bank's ability to raise funds in the market. There was no sign at this time of the systemic nature of this crisis being recognised by the authorities. This background sounds familiar in the context of events relating to Anglo Irish Bank in September 2008. However, the global financial crisis forced our decision makers to recognise the potential catastrophe of a liquidity crisis in one bank having a potential contagion effect on the whole Irish banking system.

Later in 1991, one of the larger Swedish banks, Nordbanken, disclosed large credit losses that took its capital ratio below 8 per cent.
³⁶
The Government now gave a new guarantee and in return took a majority shareholding. In 1992, Nordbanken and Forsta Sparbanken found themselves in trouble again as credit losses in the commercial property sector were revealed. Behind the scenes, the Government decided to merge a number of the smaller savings banks under an umbrella organisation (the current Swede Bank). At the same time, the Government bought out the remaining shareholders since it believed it would be easier to restructure the company with sole ownership. When it
became clear that the credit losses were bigger than expected at Nordbanken, the Government decided to create a new company, Securum (a ‘bad bank'), whose sole purpose was to take control of the distressed debt. Some 25 per cent of Nordbanken's outstanding stock of credit was transferred to Securum. The comparison between Securum and NAMA is obvious.

On 9 September 1992, Gotha Bank, a major bank, went bankrupt. Real estate prices in the previous six months had continued plummeting, and the provisions and write-offs at the bank were enormous. Sweden was now in recession, and over the three-year period in question GDP fell by 6 per cent. While the country is twice the size of Ireland in population terms, we must remember that in 2009 our GDP fell by 11.3 per cent.

At the time of Gotha Bank going bankrupt the Swedish Government issued a guarantee that no counterparties to the bank would suffer losses. This meant that the Government guaranteed all forms of bank debts, not just deposits. The Government ensured that the shareholders should bear the cost and not be included in any guarantees. Two weeks later the Government expanded the guarantee to be a general guarantee for all Swedish banks. The big question was what the limits to the guarantee should be. The answer: an unlimited guarantee in order to create the best conditions possible to rebuild confidence in the financial system.

By early 1993, the Swedish Government decided to create a new agency – the Bank Support Agency. The guiding
principles of this agency were:

•  All banks were eligible for support.

•  Support in the form of equity was more preferable than debt, as the taxpayer would benefit from the improvements in the stock price when the bank recovered.

•  The Government (strongly socialist) had the express wish not to take over banks as it had no interest in socialising the industry. Only as a last resort would banks be nationalised, and if it happened it would be a temporary solution.

•  All participating banks had to disclose all known and expected losses and collateral values.

•  A tricky conundrum was how the Bank Support Agency should value debt and collateral. If the value was set too low, the banks would go bust. But if the value was set too high, taxpayers would risk making a bad deal. The guiding principle was to make conservative assessments rather than the opposite (perhaps NAMA could have taken a lesson here).

•  The Bank Support Agency also had to determine which of the banks were worth saving from a long-term perspective.

•  A law was passed that saw the creation of a board of independent judges who were deemed to have the inalienable right to decide what the fair value of the existing shareholders' equity should be. The decision could not be appealed.

All of the foregoing has a great similarity with NAMA.

So, why was the management of the Swedish banking crisis deemed a success? The Swedish Government sought and received backing from the main opposition party for the above strategies. The achievement of political consensus was probably the most important factor that aided
the quick recovery in Sweden. The two entities that were formed as the good and bad banks, which were expected to last for a fifteen-year period from their creation, were done liquidating their assets after four years and they ceased to exist thereafter. This was achieved because of the speed and independence of their NAMA-equivalent vehicles in operation. They created a market and participated actively in it with the purchase and sale of assets that led to the rebuilding of confidence in the country. This confidence originated within the country but was valued externally by the international investment community.

While the crises are similar in many ways, the dimension of the Irish crisis is unfortunately far greater than Sweden's ever was. However, there are number of simple lessons to be gleaned from the Swedish crisis that have application to our own situation today. First, confidence needs to be restored rapidly. This was achieved in Sweden's financial sector and was reflected in the real economy. A prolonged lack of confidence would have delayed recovery by years. While a severe crisis can wipe out confidence, this confidence can be restored through transparency in the reporting of the extent of the losses and the magnitude of the bad loans. The Swedes divulged all aspects of the losses publicly, everyone grasped the enormity of the national problem and consequently there was a cohesive response to the Government's proposed solution. Second, it was acknowledged that someone had to take responsibility for the losses. It is important to realise that, once the crisis had occurred, the losses could not be hidden and were
dealt with in a straightforward fashion. Party politics was separated from commercial realities and an acceptable framework was set up to accommodate all parties. The shareholders were not rescued. People in general had to take major cuts in living standards. Fairness, real or perceived, was served through astute and cohesive decision making.

At this time there is a full-blown exercise underway to rehabilitate the financial system in the country. As those responsible for this huge undertaking try to harmonise our system to an unclear European plan, we face a dilemma due to lack of vision or lack of clarity of vision.