The publication of the bank stress tests will require careful decision making. Stress tests are estimates, estimates of what assets might be worth at some time in the future .
Estimates can be made on either very pessimistic, or very optimistic, assumptions about economic developments in the future.
The hope in some quarters is that the EU exercise of stress testing banks will generate confidence in banks based on certainty, but we should be careful here. Certainty about the future is a logical and philosophical impossibility. All banking, everywhere and always, is a matter of confidence, not of certainty.
In Ireland’s case, the credit of the state itself has unfortunately become entangled with that of the banks. It would be no solution to anything to enhance the credit of the banks, by diminishing the credit of the state.
I hope EU decision makers will also see that the Irish banking problem has been influenced by the requirement of free movement of capital within Europe since 1990, and the deep interdependence that that has created, with all its good and bad aspects.
I would like to return now to a topic I have developed elsewhere, the lessons that need to be learned from our banking crisis, and to show that there is a European, as well as an Irish dimension, to Irelands current problems.
Let me reiterate at the outset that the main responsibility for Ireland’s plight rests with Irish institutions.
Private sector institutions were first and foremost responsible, especially the property development industry for it’s reckless borrowing, and estate agency community for encouraging the bubble.
The boards and managements of banks for the reckless lending share responsibility, as do the media, with their reliance on property advertising ,for encouraging people to climb the so called property ladder, as if one place on this ladder was a measure of one’s place in society.
The Irish economics profession has a responsibility for, generally speaking, not calling attention to the obvious unsustainability of the borrowing , and of the level of construction activity, which could not possibly have been maintained.
It is obvious that the Irish Central Bank, the Financial regulator, and Government made major errors.
But , if we are to overcome the crisis and avoid a new one, everybody must be self critical, including the ECB and other European institutions.
To make that point is not to argue for Irish institutions trying to avoid their financial responsibilities.
A bond is a promise, and promises should not be broken, especially if ones economy is based on the provision of international services, in which trust is vital.
A single currency for 16 or more separate nations was always a challenging project, intellectually, politically and economically. If there were design flaws in the project, these must be remedied. If powers to act existed, but were not used, that too must be acknowledged.
Risks inherently flowed from the decision to allow free movement of capital within the EU. Exchange controls at national level were no longer available as a means of preventing bubbles developing. That gap had to be filled at a higher, EU wide , level.
Some of these topics were addressed in an interesting speech in Lucca on the 11th March by one of the Executive Directors of the ECB, Lorenzo Bini Smaghi.
He noted that the financial crisis had caught Europe unprepared in some respects. The institutional design of the single currency did not take into account a crisis like the present one. But he defended the euro, using the analogy that the first ever cars in the road over 100 years ago did not have reinforced bumpers or airbags. Like the early motor cars, the euro, as a single currency for many nations, is a pioneering venture, and all pioneers must learn from experience. I agree with this.
He also criticised both the content and the timing of the Franco /German proposal for states to be allowed to declare themselves insolvent. Again I agree. He suggests a different approach, requiring all future debt issuance by member states in the euro should have approval at EU level, a radical proposal, but we need radical thinking.
He says that the errors and negligence of the Irish regulation and supervision of its financial markets have
“been paid for by the taxpayers of that country, but they expose others to enormous risks”.
Again I agree with him.
But he then seems to disclaim all responsibility of the ECB. He says that, in the euro area, banking supervision is not
“subject to supranational control”
(ie. The control of the ECB) , and then he goes on to talk of a “former Irish Prime Minister” having the “honour of front page headlines”
“when he reproached the ECB for not having sufficiently monitored the Irish banking system, when it is well known that in Europe the powers of prudential supervision are the responsibility of national authorities, a power they do not want to give up”
This is a reference to my speech in the LSE recently in which I drew attention to the power the ECB had, under Article 14 of the statute of the ESCB, to issue instructions to the Irish Central Bank, and to other euro area central banks.
Dr Bini Smaghi claims that the ECB’s powers are confined to monetary policy, and do not extend to prudential supervision of risks in the banking system.
On the basis of this speech, the ECB seem thus to believe that, in the period from 2000 on, it could not have given instructions under Article 14 to the Irish Central Bank in respect of the obvious credit bubble that was developing in Ireland, and the unjustified, speculation driven, increase in house prices here.
I respectfully suggest that Dr Bini Smaghi is wrong, and that a reading of the statute of the ESCB shows that he is.
Article 3.3 of the statute of the ESCB says that the ECB
“shall contribute to the smooth conduct of policies pursued by the competent authorities relating to prudential supervision of credit institutions , and the stability of the financial system”.
Note two phrases here… “the prudential supervision of credit institutions” and the “stability of the financial system”
Furthermore, Article 25.2 of the ESCB statute says that the ECB
“may perform specific tasks relating to prudential supervision of credit institutions”
and Article 34.1 goes on to say that the ECB may make regulations to implement Article 25.2 ie concerning prudential supervision.
I would read all that as meaning that prudential supervision was, and is , in fact , a core responsibility of the ECB.
I, therefore, believe that
1.) The ECB could have issued instructions to the Irish Central Bank in respect of its supervision of Irish banks, when it saw the explosion of credit in Ireland, and the imprudent concentration of that credit in one volatile sector, construction.
2.) It could also have issued instructions to the Central banks of the other euro area countries, whose banks were availing of the free movement of capital to lend imprudently to the Irish banks in a way that fed the Irish property bubble, to rein in that lending.
I would argue that, under any reading of Article 3.3, these things were the ECB’s business, as well as of course being the business of the Irish authorities and the authorities of the countries whose banks lent irresponsibly into the Irish property bubble.
Clearly, as we now know all too well, the expansion of credit in question did affect the “stability of the financial system”, in the words of Article 3.3 of the ESCB statute. So I would argue that my reference to Article 14 and the responsibility of the ECB was in fact correct.
I repeat that this does not mean that the ECB had the primary responsibility for failures of supervision of individual institutions ,like Anglo Irish Bank, but it does mean that it could, and should , have seen the overall imbalances in the lending patterns to and within Ireland, and their potential to upset the stability of the financial system, which is clearly the ECB’s responsibility.
Even if the ECB did not use Article 14 or Article 25.2, it also had power under Article 4(b) to submit opinions to the Irish authorities, and if it felt it was not getting enough information from the Irish authorities to form to form a judgement, it could have used Article 5.3 to obtain better statistical information.
I do not think it is to be either nationalistic or populist to say that, between 2000 and 2006, the ECB was in a better position to know what was going wrong in Irish credit markets, and to do something about it, than was the average Irish taxpayer , who now has to deal with the consequences. Some Irish taxpayers may have benefitted from the boom, many did not. All have to pay.
I accept that the EU institutions, including the ECB, are helping to resolve the situation, but this help is in the form of loans which will have to be repaid, and is also being accompanied by self serving demands from some other countries.
I fully accept that it would not have been politically easy for the ECB to have used its Article 14 powers in 2003 or 2004 . I have no doubt there would have been an outcry from many in Ireland decrying “interference from Frankfurt”, and all that sort of atavistic nonsense. But one should not forget that it precisely so that the ECB can ignore that sort of thing, that it was made politically independent under its statute, more politically independent even than is the European Commission.
The ECB’s power to give “instructions” to the member state central banks also seems, on the face of it, also to be greater than any power the Commission or Council had under the existing Treaties.
A suggestion has appeared in the Irish media that, when Anglo Irish Bank was on the brink of collapse, the ECB told the Irish authorities that it did not want any bank to be allowed to fail.
I wonder if this could be true, and if it is true, if it influenced the then Government to give such a wide guarantee to the banks as it gave. In light of the powers of the ECB, which I have cited above, the Irish authorities could not easily have ignored such a view from the ECB. But with power comes responsibility, and if the ECB did say this to the Irish authorities, it can hardly argue now that the sole responsibility for what followed rests with the Irish taxpayer .
I repeat that I do not make these points to out of any wish to shift blame away from where it belongs. There is a great deal of blame due to the Irish authorities and people, the majority of the blame by a long distance. The recent election result shows that the Irish people know that. So also does the fact that substantial austerity has been accepted.
But if the EU is to learn from the crisis, it has to look at the whole picture. Part of that picture is the role of the ECB and other EU institutions.
These institutions should be willing to consider reasoned criticisms, from any quarter, even from Ireland!
Having said all that, it is important that Ireland approach this week’s meetings in a realistic frame of mind.
Other European countries have problems too. For example, almost all of them have budget deficits of their own. Many of them have more severe immediate problems with the fiscal cost of the ageing of their societies and workforces than Ireland has. They are also aware that the original justification for the cohesion and regional funds of the EU, to which many were net contributors and we were net recipients, was precisely to prepare countries like Ireland to be able to face the rigours of a single currency. If we now discover we were ill prepared, the first responsibility is our own.
We also have to understand that other EU countries have domestic political constraints too. For example, Germans have a justified horror of inflation after their unique experience in the 1920s when inflation peaked at level higher than were seen in Zimbabwe recently, and destroyed the saving of all thrifty families. Reactionary anti EU sentiment, of the kind we saw here during the Nice and Lisbon referenda, is rising in many countries, and transferring money to countries that are perceived as not having managed their affairs well, feeds those sentiments. Irish people must understand these political realities, just as others must be realistic about what we can do.
It makes no sense for them, in their own interests, to make counterproductive demands of Ireland. Demanding that we change our corporation tax system is counterproductive. Corporation tax is one of the ways whereby we will be able to repay the loans we have received. Our 12 and a half percent corporation tax raises an amount equivalent to almost 3% of Irelands GDP, more than France collects in corporation tax, and a lot more than Germany collects, which comes to just over 1% of German GDP.
More importantly, low corporation tax rates to attract foreign investment , mainly from outside the EU, has been the core of Ireland economic model since 1956, before the EU had even come into being, and before many of the leaders sitting at the European Council were born! Lending us money, and simultaneously asking us to dismantle the economic model that enables us to repay the money, would not be good banking practice, to put it mildly.
At home, we must avoid the errors we see in the US, where so many areas of spending and revenue have been ruled out of consideration for closing the deficit, that all that is left is so called discretionary spending, that only comes to about 20% of all spending.
Speech by John Bruton, former Taoiseach, to the Irish Institute of Chartered Accountants at 8am on Tuesday 22 March
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