The right moves: Don't just blame it on property
In 1979 George Colley presented me with second prize in a schools economics essay competition sponsored by a bank. My economics teacher told me I was unlikely to win, having suggested nationalisation of the banks to control the money supply.
My schoolboy socialism faded but NAMA's latest €810m loan sale and speculation about the banks needing another €30bn of capital set me thinking again on this economic fundamental.
Money supply is the fuel driving the economy and too much or too little of it causes trouble. The conventional wisdom is that the Irish banks collapsed because they went mad lending money to property, but that's not really what happened.
Irish bank lending is controlled by European capital and liquidity ratios. In fact, the Central Bank set capital ratios of 9pc for Bank of Ireland and AIB which are higher than the 8pc required by Europe. Most other Irish banks were at 9.5pc. All the banks were complying with their capital and liquidity ratios on the night of the bank guarantee. So what caused the meltdown?
You can blame, in this order: bad lending by banks, loss of liquidity in the world banking system, loss of confidence, the single currency and European-led creativity on raising capital.
The single currency meant European banks could suddenly lend easily into Ireland and interest rates were low as Germany emerged from recession. European banking rules were changed to allow the banks count subordinated bonds as half of their 8pc capital adequacy.
The loss of liquidity in the world banking system and the collapse of Lehman Brothers caused a run on all banks. In order to meet their capital and liquidity ratios the Irish banks began selling assets (loans) at reducing prices and entered a downward spiral. Markets correctly questioned some very bad bank lending, confidence worsened and the banks ran out of time.
If you don't believe that property wasn't the main problem, look no further than Depfa, the German-owned bank headquartered and regulated in Ireland. At the time of the collapse Depfa was by far the biggest bank in Ireland – three or four times larger than AIB and Bank of Ireland. Depfa had no property loans at all but still had to be bailed out by the Germans.
Looking for an inquiry into what happened on the night of the bank guarantee is a waste of energy. The answer is – the banks ran out of cash, they had to be saved and the bankers didn't know how bad their lending was.
Saving the Germans
Whether or not the banks should have been guaranteed that night or not is moot because two years later the troika bailout insisted on the guarantee of our banks, to save the German banks.
Now the European banking regime wants to try and prevent the whole debacle happening again by increasing capital adequacy requirements by 2019. Hence there is conjecture that our banks will need up to €30bn more taxpayer cash, partly to cover unrecognised loan book losses. This will help but if we'd had that higher provision in 2008 we would still have had largely the same problem.
The big mistake we made was the establishment of NAMA, which reinforced the banks' insolvency. We should have followed the UK's blueprint which was to guarantee the assets of the banks (loans to customers) and not deposits.
The markets accepted this and the run on their banks stopped. The vastly larger UK banking system was bailed out for the £76bn put into RBS and Lloyds, compared with our €64-€100bn. Had we copied the UK our banks could have worked their way out of the property mess. That's exactly what their staff are doing now for NAMA, but the NAMA haircuts institutionalised insolvency.
Banking systems will always be liable to collapse and it could all happen again. Capital adequacy provisions are irrelevant if the loan is a bad one. Banks must pay critical attention to the quality of their lending into property and that's where top-class property expertise is crucial. The Central Bank must make it compulsory for banks to procure an independent "Red Book" valuation for every property loan.
Of the €168bn of government borrowing, €64bn relates to bank bail-outs and €104bn is the budget deficit, which is rising. So we'd made a complete mess of the economy anyway.
Ironically, the banks are blamed for lending too much money then and for lending too little now.
So it's still all about controlling the supply of money. I wonder what my economics teacher would make of all that?