Bank crashes large enough to inflict substantial damage on taxpayers require failures at three levels. The boards and managements of banks need to incur large losses on dud loans. The regulators and supervisors need to miss what is going on, and to neglect timely remedial action. Finally, the Government needs to socialise a large portion of the losses, imposing them on taxpayers. That third failure, particularly the very broad state guarantee of bank liabilities, has dominated blame allocation in Ireland, but there is less information in the public domain on failures elsewhere.
The Oireachtas Banking Inquiry, expected to complete and publish its report next February, provides the opportunity to shed more light on the first two failures. It looks as if the legal constraints on parliamentary inquiries are restricting the process, and February's report may be incomplete. A critical issue is the failure of regulators and supervisors to recognise and curtail the credit boom that began in the late 1990s. The inquiry's public hearings have in recent weeks been supplemented with written testimony from non-appearing witnesses, and there have been spats among former Central Bank personnel, with conflicting accounts of events in 2007 and 2008. The inquiry should pay little attention. The bank loan losses were mainly incurred much earlier, and action from regulators in 2007 or later would have been too late to contain the most serious damage.
In 2007 the liquidity pressures on Irish banks had already begun. Their share prices had started to weaken and they started to rein in credit growth. Most of the astonishing loan losses that eventually emerged were already embedded in their balance sheets by that time. No doubt some losses relate to decisions taken in 2007 and 2008, but all available evidence suggests that most of the mistakes had already been made. The absence of Central Bank action in those years is not a core issue. A re-run of history featuring timely regulatory action and the avoidance of the worst consequences would need to begin about 2004, or even earlier. The publication during the week of Frank Browne's evidence to the inquiry, and the disputing responses of some of his superiors, relate in the main to events that occurred after the damage was done.
Mr Browne was a senior official, the head of the Central Bank's unit dealing with financial stability. This unit had no role in supervising individual banks - the task of the Financial Regulator - but was concerned with the stability of the broader financial system. From 2004 onwards, Mr Browne maintains that he was concerned about the escalation in property lending and particularly about the over-valuation of residential property.
His unit prepared documents for the Central Bank's senior management, expressing these concerns. No action was taken, and the annual Financial Stability reports published by the bank, while noting areas of concern, were characterised as too complacent in the Honohan report published in 2010 after the bubble burst. Patrick Honohan was by that time Governor of the Central Bank and had expressed publicly his worries about the credit expansion back in 2004. He was not the first: William Slattery, a former Central Bank official and then a commercial banker, had penned a prescient piece as early as 2000, and David McWilliams had published numerous articles expressing alarm at the condition of the housing market. In the autumn of 2004, The Economist magazine published a supplement on Ireland that expressed similar worries, including a quote from this writer to the effect that the banks were dangerously exposed to a correction in house prices.
So if Frank Browne and his team were concerned about the Irish banks and mortgage lending in 2004 - early enough to do something about it - they were not alone. What is significant is that they were inside the policy machine. A familiar narrative beloved of the senior politicians, bankers and regulators called to the inquiry is that "nobody saw it coming".
The polar version of this story is that Ireland would have been fine had it not been for the collapse of Lehman Brothers in New York in September 2008. This comforting tale was comprehensively demolished in the Honohan report. The credit bubble had driven bank exposures on both residential and commercial property to a point where insolvencies were a real risk. The significance of Browne's evidence, along with that of another senior Central Bank economist, Tom O'Connell, is that these concerns were not confined to assorted commentators or academics, but were raised inside the policy- making machinery at a high level.
Real-time evidence for the existence of a credit bubble is never conclusive, and there were other analyses in the Central Bank that appeared to be less alarming. However, it appears that the bank's senior management chose repeatedly to rely on these less alarming analyses while privy to competing material that suggested the credit expansion was getting dangerous. It is one thing to ignore the public wittering of journalists and academics, but rather a different matter to sidestep internal reports from the people paid to worry about financial stability.
The Central Bank, notwithstanding the constraints of membership in the common currency area and the free movement of capital, had options to stop the rot in 2004, had it felt so inclined. At the simplest level, it could have capped loan-to-value ratios on mortgages and required much higher holdings of loss- absorbing capital against commercial property loans. Had it done so, there would likely have been serious problems in the banking industry regardless. There were costly bank failures in many countries, but the exceptional scale of the Irish disaster would surely have been reduced.
The material released on the Banking Inquiry's website has been heavily redacted (an appendix to Mr Browne's evidence is not available at all - it is on a mysterious USB key that contains key memos and minutes), so it is difficult to draw conclusions on the disputes between Central Bank personnel about who said what and when.
The inquiry members should insist on access to all of this material or they will be unable to draw conclusions either. They should also focus, not on the disputes about what happened in 2007 or 2008, but on what did not happen around 2004. It was open to the Central Bank and the Financial Regulator to curtail the credit boom and the house price explosion around that time and to consider the adequacy of Irish legislation to resolve failing banks, an issue also raised in good time, according to Mr Browne.
It should be conceded that Ireland was not alone in having an inadequate framework for bank resolution when the crisis struck, but Mr Browne claims to have flagged this problem many years earlier. The Central Bank and Financial Regulator, possessed of far more information than anyone else, failed to take timely action commensurate with the scale of the credit bubble. The Department of Finance left itself unprotected with adequate bank insolvency legislation when the bubble burst. The banks, of course, made the dud loans in the first place.
Let's hope the legal constraints do not inhibit the inquiry in a fair allocation of responsibility.