Anglo-Irish Bank: Unanswered Questions (#01 & #02)

Late on the evening of December 18, news broke that the Chairman, former C.E.O. and arguably onlie begetter of Anglo-Irish Bank, had resigned. This coincided with the revelation that, for 8 years, he had hidden from shareholders the fact that he owed the bank €87 million.

The news reached me as I retired to bed, but from early next morning I left many comments on the affair via Twitter. It is now time to expand on some of them.

Question # 01

This aspect has received plenty of attention in media comment, most notably from Joan Burton F.C.A.,T.D. (Labour Party Finance spokesperson) and Niamh Brennan F.C.A. (Professor of Management at University College Dublin), who both echoed my comment on this aspect as well as adding their own observations. (See e.g.Burton statement and Brennan article.)Nothing has yet emerged to explain how a respected firm, such as the auditors to the bank (Ernst & Young), apparently had the wool pulled over their eyes for 8 years.

Mr FitzPatrick was, in fact, only one of three chartered accountants in the Bank's top management layer. Perhaps unsurprisingly, the Institute of Chartered Accountants has started an enquiry.

Question # 02

There has been very little turnover in the composition of the Board of directors of the bank in the last ten years. If, as we have been told, the loans were properly authorised and on normal commercial terms, who, if not the Board, was involved in the decision to extend them ? And if the Board was involved, how is it that none of the directors noticed that the note to the balance sheet regarding directors' loans gave a total for such loans which could not possibly be correct ?

One hopes that there is no way that the reason could be that the Board itself was kept totally in the dark, even though - in one sort of parallel universe - one might so conclude from the fact that only the CEO followed his Chairman out the door.

Update on Tuesday, December 30, 2008 at 10:48AM by Fergus O'Rourke

I have re-titled this post and have numbered the questions, with a view to making it easier to follow

O Tempora ! O Mores !

Kevin Myers was ranting on the George Hook programme the other day about how the loans to Anglo-Irish Bank directors came to €150 million while those at Barclays Bank, a very much bigger bank, were a mere £1 million.

I decided to check this out (it's nearly true) and in the course of my researches, I came across a news story from 2006. The theme of the story was the outrageous behaviour of the directors of Barclays Bank in regard to their borrowings.

Ah well, plus ça change, and all that. Are we surprised ? etc. etc.. But at least the Brits sorted it out earlier than we did, will we ever learn ? etc. etc..

Oh wait ! The complaints about the Barclays' directors were that they had sourced their borrowings from other financial institutions and had thereby failed to show faith in their own "products".

The story is here. It is hard to believe that it was only two years ago !

So, all is now clear:Sean FitzPatrick was only showing faith in his own bank. Oh, yes.

The Market Can Stay Irrational Longer Than You ... Can Tolerate

Recently, I referred here to "Liars Poker", a book about his experience as a Wall Street investment banker by Michael Lewis.

Lewis has now written a long reflective piece on recent events here. In all modesty, I do think that I said much of it more tersely myself in the post to which I have already referred, but as in his book, Lewis does it very entertainingly, without losing focus on its informative substance.

Paul Kedrosky quotes this excerpt

Six months after Liar’s Poker was published, I was knee-deep in letters from students at Ohio State who wanted to know if I had any other secrets to share about Wall Street. They’d read my book as a how-to manual. In the two decades since then, I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces ? At some point, I gave up waiting for the end. There was no scandal or reversal, I assumed, that could sink the system.

Kedrosky comments

Like me, Lewis left the financial brokerage game years ago thinking it was absurd and about to end. I was a decade too early, and Lewis left almost two decades early. Who knew the madness could go on so long ?

The Market Can Stay Irrational Longer Than You Can ... Tolerate

Last month, I referred here to "Liars Poker", a book about his experience as a Wall Street investment banker by Michael Lewis.

Lewis has now written a long reflective piece on recent events here. In all modesty, I do think that I said much of it more tersely myself in the post to which I have already referred, but as in his book, Lewis does it very entertainingly, without losing focus on its informative substance.

Paul Kedrovsky quotes this excerpt

Six months after Liar’s Poker was published, I was knee-deep in letters from students at Ohio State who wanted to know if I had any other secrets to share about Wall Street. They’d read my book as a how-to manual. In the two decades since then, I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces ? At some point, I gave up waiting for the end. There was no scandal or reversal, I assumed, that could sink the system.

Kedrovsky comments

Like me, Lewis left the financial brokerage game years ago thinking it was absurd and about to end. I was a decade too early, and Lewis left almost two decades early. Who knew the madness could go on so long ?

Update on Monday, November 17, 2008 at 04:08PM by Fergus O'Rourke

My apologies to Paul Kedrosky for mis-spelling his name.

Neary Confronts Some Critics

The top trio of the Financial Regulator met the Oireachtas Joint Committee on Economic Regulatory Affairs on Tuesday morning, 14 October 2008.

Whether by design or otherwise, this was a timing which guaranteed minimal media coverage, as the greatest parliamentary set-piece of the year was only a few hours later.

You can judge for yourselves here (I warn you that there is quite a lot to peruse), but I (again) felt that Mr Neary did quite well, even though the politicians were not in much mood to listen.

As we hear from all over the world - not just from politicians - we again were told that the Regulator permitted the banks to lend too freely, which was a Bad Thing, and that a Brave New World was needed, in which customers could borrow more freelywould be facilitated in a less restrictive way.

On a more serious note, I again failed to see any explanation of how it could be sound prudential regulation to permit the Irish banks to become nearly two-thirds invested in property (including residential mortgages).

However, as noted above, there is quite a lot to peruse, and I will be studying it further.

Lenihan Plan: More Details

The Irish Government has now provided more details of its guarantee for bank liabilities and the price it plans to extract from the banks in return. The official documents are here.

Highlights

• A "premium" of €500 million per annum to cover the liabilities of a little over €500 billion
• The impact of this on each bank will be on risk-adjusted basis - some scope for fun there
• The Government will draw up a list from which each institution will have to appoint a director to represent the public interest - more fun there
Remuneration will be strictly controlled (allegedly)

Rumour has it that some banks may now try to decline the assistance, but it seems to me that there is little possibility of them getting away with that. That said, if, as seems to be the case, the State is not offering re-capitalisation any time soon - nemo dat quod non habet seems an apt expression here ! - then there might be a case for a lower premium if an individual bank can show on strict criteria that it no longer needs the scheme.

Rocket Science, huh ?

Megan McArdle is once again insightful. Quoting the late Richard Feynman's Appendix to the Challenger disaster report, she concludes that

[Rocket Science]like the financial markets, is so complicated that we may never gain full understanding. The most dangerous thing is that we are so confident in our assessments of the uncertainties.

It is not so different from Nassim Nicholas Taleb's point in Black Swan. Financial "rocket scientists" constructed probabilistic models to predict market outcomes. In Taleb's terminology, they used Gaussian models inappropriately and ignored the evidence that the real world was not conforming to the formulae. In Feynman's words (regarding the evaluation of the risk of seal failure on a space vehicle),

The empirical formula was known to be uncertain, for it did not go directly through the very data points by which it was determined. There were a cloud of points some twice above, and some twice below the fitted curve, so erosions twice predicted were reasonable from that cause alone. Similar uncertainties surrounded the other constants in the formula, etc., etc. When using a mathematical model careful attention must be given to uncertainties in the model.

Taleb, among others, has shown that such careful attention was not being given in the financial markets. We now struggle with the consequences.

McArdle characteristically sums it up tersely

Foam had come off the shuttle before, but never with disastrous results; NASA accordingly seems to have decided that it must therefore be safe to have the insulation break free. This heuristic was probably the best we could do as East African Plains Apes. In the modern world, however, we have better substitutes, like reason, if we'll only use them.

Paulson Plan: Legal Summary

I have added a link to this summary by Boston law firm Nutter, McLennen & Fish LLP of the legal provisions of the U.S. $700 billion scheme to the Links page of this site's Bank Rescue Watch section.

(Unfortunately, I cannot remember which thoughtful commentator recommended it to me.)

Banking: Opportunities Still Plentiful

The merits of the Lenihan Plan were debated in The Sunday Business Post by Dan O'Brien of The Economist and Colm McCarthy currently of University College Dublin (UCD) (where he is a colleague of Morgan Kelly ) but who has had a varied career including stints in the Central Bank, and acting as advisor to both Governments and private sector organisations.

Somewhat to my surprise, because I am a long-term admirer of Dr McCarthy's approach, and have tended to find Dr O'Brien's a bit ethereal, I found myself in agreement with O'Brien and rather unhappy with McCarthy.

As in his contribution to Prime Time (link is here), it seems to me that in his approach, Colm McCarthy is somewhat obsessed with the regulator and his role in permitting the Irish banks to become over-exposed to the property markets. He is the chief source, as far as I can see, for the view, most influentially peddled by RTE Economics Editor George Lee - quite capable of sourcing it himself, mind you - that last week's Irish crisis was not so much an episode of a global convulsion as specifically Irish "chickens coming home to roost". It was precipitated, on this view, by the international money markets finally losing patience with the Irish banks' failure (and that of their regulator) to face up to the (alleged) fact that they were, due to the property "bubble" ending, effectively in need of more capital - and quickly, if not actually insolvent.

Now, as obsessions go, this is not a bad one to have. I agree, as I imagine does Dan O'Brien, that there are questions to be asked about that.

However, it seems to me that the occasion of the crisis was not so much that situation, as what Patrick Neary (prescient profile here) described on Prime Time as a "flight to quality". Absent the local weaknesses, this still might have happened later or to a lesser degree, but it is unrealistic to believe that it might not have happened at all.

It really does not matter, though, when considering the merits, in broad terms, of the Lenihan Plan. Unless it is being suggested that the Government should have accepted the inevitable huge disruption to the economy while a comprehensive solution was being constructed, my view is that it was right to act as it did. (I am not to be taken as necessarily happy with every provision of the legislation, still less with the - still awaited - regulations to implement it).

On Prime Time, one of Dr McCarthy's severest criticisms was that, by not insisting on mergers and/or the resignation of one or more top executives, the Government had passed up an important opportunity at a time when its bargaining power was at a maximum.

I disagree again. The opportunity is very much alive, just as the crisis is not going to go away for some time yet.

All those complaining that the banks have been "taken off the hook" and have been freed to carry on regardless, please take note.

(The trouble for the Government is that the case for "heads to roll" is - to put it mildly - a double-edged sword).

You Think More Regulation is the Answer ?

Warren Buffett is not so sure.

Craig Newmark (the economist) has the story.

I am constantly bemused by the virtual unanimity among commentators that more and better regulation would have avoided the crisis, and will be necessary to guard against a recurrence. Buffett's story is but one piece of evidence suggesting otherwise.

One question is where the regulatory expertise is going to come from - even Colm McCarthy, Brendan Keenan,Morgan Kelly, Patrick Honohan, David McWilliams and I do not together have all the skills, and, besides, we are going to be spread fairly thin ! :-) Another is where the political consensus on the nature and purpose of such regulation lies, and whether it is sensible.

Links Page

I have now set up a links page here on the Bank Rescue. My intention is to include some U.S. and other international material in time, but it may prove beyond me, depending on how demanding the Irish situation proves.

So far, I have just added links to the Irish (framework) legislation, as well as RTE audio and video material, including what has - somewhat unfairly, in my view - become known as the Irish Financial Regulator's notorious television interview.

A Sale is Not the Same as a Credit, People

A couple of people (who prefer - sensibly ! - to remain anonymous) have e-mailed me to query last night's criticism by me of Morgan Kelly's interpetation of the Lenihan Plan bailout guarantee. (Incidentally, that link works but the one I used last night no longer does for some reason).

One of them, a fellow-economist, expressed himself thus:

However I wonder if Morgan Kelly is incorrect in the way you say:if a bank sells a paper based on the bundled IOUs from dodgy developers for a loan on the global foreign markets my understanding is that the Lenihan package does guarantee that money lent on that basis to Irish owned banks.

The first point to make is that Irish banks have little need to use any assets as security for finance on global markets when the Irish state is guaranteeing that finance.

The second point concerns that word "sell", which is also the word that Professor Kelly used, and is not the same as a loan or deposit. In the case of the latter, cash comes in but will some day have to be returned. The foreign provider has a natural interest in the credit-worthiness of the borrower. The Lenihan Plan addresses the needs of such providers, on which the system is very reliant.

A sale means that in return for cash, the Irish bank hands over an asset. The bank's credit-worthiness is not an issue. If the buyer is anxious about the quality of the asset it is buying, it may seek assurances, but I have seen no report that the Lenihan Plan (which I propose to call the scheme until or unless a better name comes along) incorporates any such assurances on the part of the Irish taxpayer.

Professor Kelly is Wrong

Morgan Kelly, Professor of Economics at University College, Dublin, has been warning us for some long time of the risks to the banking system arising from the excesses of the property market. As I recall, I supported pretty well everything he said.

In today's Irish Times (which I have only now finished reading), however, I was alarmed by some of the statements in his article on the "bailout" of the Irish banks.

First, he asserts that

Of every €100 that Irish residents have deposited in banks, €60 has been lent for property speculation

It is indeed shocking that 60% of Irish bank lending is to the property/construction sectors,and no-one doubts that significant difficulties are being experienced by the banks as a result. However, to equate all lending to those sectors with financing "property speculation" is wrong, and unhelpful.

Secondly, he tells us how taxpayers will "carry the can"

Suppose that you are a bank that has lent €100 million each to 10 developers who are having problems meeting their repayments. What you do is bundle the loans into one asset and sell it, with Brian Lenihan's signature on the bottom, on financial markets for €1 billion. When the borrowers default, the taxpayer will be left taking up the tab.

Professor Kelly does not appear to know that the "bailout" is about guaranteeing lenders to the banks; it does not give a guarantee to the banks that the loans they have made will be repaid. (The Paulson Plan does do this, in effect). Brian Lenihan (Ireland's Finance Minister) will not be providing the kind of idiotic assistance suggested.

The article ends:

Irish banks were facing potential losses on their property lending of the order of €10 billion to €20 billion. Thanks to Brian Lenihan's master stroke it looks as if it will be you, rather than bank shareholders, who will be taking the loss.

A loss of even €20 billion will not cost the taxpayer even a significant fraction of that, under the scheme just enacted.