Inquiry needs to examine why ‘symptoms of bubble’ ignored

ECB says it is on track to assume oversight of euro-area lenders as ‘health check’ underway

John Bruton, Ireland’s former prime minister and current chairman of Ireland’s International Financial Services Centre (IFSC). Photographer: Simon Dawson/Bloomberg

John Bruton, Ireland’s former prime minister and current chairman of Ireland’s International Financial Services Centre (IFSC). Photographer: Simon Dawson/Bloomberg

 

The banking inquiry needs to examine why symptoms of the bubble were repeatedly ignored by politicians and regulators in the run-up to the crash, former taoiseach John Bruton said today.

Mr Burton, who is now the president of Dublin’s International Financial Services Centre, made the comments at a conference hosted by the Irish Banking Federation in Dublin later this morning.

The same cevent also heard from the chair of the European Central Bank’s supervisory board Daniele Nouy, and Deputy Governor of the Central Bank Cyril Roux.

Mr Bruton said the inquiry would need to confirm that the symptoms of a bubble were visible in the wider economy, why such signs were ignored, and should also outline the practical steps neededto ensure that similar symptoms were not ignored in future.

“Taking away the punch bowl, while the party was still on, was never going to be easy,” he said. “ It was never going to be easy politically, socially, or administratively. Yet that is precisely what has to be done if we are to prevent a bubble economy developing in Ireland ever again.”

Mr Bruton says he believes two obvious signs of disaster were “studiously ignored” by the political and regulators.

“One was the fact that house prices were rising far faster than either the rate of increase in incomes, or the rate of inflation in other prices, and meanwhile people were getting 100 per cent mortgages.”

Mr Bruton says once that process ended, and house prices were only rising at a rate at or below that of incomes, borrowers, who had been given 100 per cent mortgages or were otherwise financially exposed, were immediately heading towards negative equity or inability to pay.

“That made a soft landing inherently unlikely. Why did no one see that?”

The other issue Mr Bruton addressed in his speech was the huge deficit that developed on the Irish balance of payments.

“The country was spending more abroad than it was earning abroad. That spending was fuelled by imported credit. Given that devaluation was impossible, that could only be reversed by (an inherently unlikely) dramatic increase in exports, or by a cut back in imports,” he said.

“The latter could only be engineered by a recession of some kind. It was plain to see that such a recession would render many mortgages unsustainable.

“Why did no one in politics, in Government, in the Central Bank, or in the banks themselves do the basic arithmetic to work that out?”

Mr Bruton insisted that the possibility must be faced that policy makers, including in the Central Bank, did not truly understand the implications of joining the euro, and acted (or failed to act) as if the devaluation/inflation option, was still open to the country.

Chair of the European Central Bank’s supervisory board Daniele Nouy said preparations to assume oversight of euro-area lenders were going according to plan.

“We are working very intensely to meet the objectives and we are well on track with achieving them,” Ms Nouy said. “For the first time in the history of the European Union, we will have a supervisor with a truly European mandate. It will reduce regulatory arbitrage and remove national biases. As a result, we will enhance confidence in the supervision of banks and in the whole financial system.”

The Single Supervisory Mechanism will start wielding power over banks on November 4th as the first pillar of the nascent European “banking union” that was conceived to prevent future crises. In the meantime, the ECB is conducting an unprecedented health check on the region’s lenders, including a stress test, scheduled to deliver results in October.

“In addition to the Comprehensive Assessment of the significant banks required by the SSM regulation, an exercise of unprecedented magnitude, we are working on establishing the basis of a fully functioning mechanism,” Ms Nouy said. “You can imagine the challenges we are currently facing to get our ‘start-up’ fully running.”

Ms Nouy said the tasks that must be completed in time include harmonised practices for supervision of banks, hiring and training, and setting up of new computer systems.

As around 6,000 auditors and supervisors conduct the asset review, the ECB is pressing on with hiring the approximately 1,000 new staff required to conduct oversight from Frankfurt.

Ms Nouy said recruiting campaigns should be concluded before the end of the summer. “We are looking for the best possible candidates,” she said. “This has raised much interest, as we have received so far over 14,000 SSM-specific applications.”

Deputy governor of the Central Bank Cyril Roux told the conference the Asset Quality Review process was “well advanced”.

“We have covered not only the three largest Irish banking groups but also large subsidiaries of foreign banking groups, be they headquartered elsewhere in the eurozone, in the UK or in the US,” he said.

However, he said the first sets of preliminary results may could require a lot of validation, consistency checking, supervisory dialogue, integration and rework before the central Bank could stand over them.

“The next four months will see a period of challenge, quality assurance, integration of the AQR results and finalisation,” he said.

Smaller institutions will continue to be supervised directly in Dublin, but the ECB will have oversight to ensure a “harmonised approach and consistency of quality”.

“It is very important for us that we continue to supervise to the highest international standards of best practice. We will therefore be reviewing our supervisory engagement model for these banks in tandem with the ECB this year in order to address these findings and take action as necessary,” he said.

The shift in supervisory approach will also bring changes to the Central Bank’s structure, which are expected to be implemented in the coming months.

Fixing Ireland’s mortgage arrears crisis will continue to be a top priority, Mr Roux said.

“The high level of arrears weighs on Ireland’s banking, acting as a drag on the economy, new lending and profitability. Banks and borrowers need closure,” he said. “The targets that we set need to be achieved and banks must continue to progress resolutely to resolve this issue.”

(Additional reporting: wires)