Monday 9 December 2019

Colm McCarthy: We know about bank's failings in the US but not what went on here

Not one Irish bank has released an account of what went wrong. It's high time they did

Colm McCarthy

Colm McCarthy

THIS is a story about two enormous recent banking failures and how they have been dealt with by the banks concerned.

JP Morgan is one of the world's largest banks. Originally a Wall Street merchant bank, JPM has been absorbing large US retail banks for decades, including Manufacturers Hanover, Chemical Bank and Chase Manhattan, and has built wholesale banking operations all over the world. Its gross assets come to about two trillion US dollars and it employs about 250,000 people. It was the chosen vehicle of the US government for the rescue and takeover of Bear Stearns, the first of the Wall Street banks to go wallop in the current crisis, back in March 2008. Along the way, JP Morgan had come to be regarded as the least accident-prone, and best-managed, of the large multinational banks.

In June 2012 JP Morgan announced that it was writing off the enormous sum of six billion dollars due to dealing losses at its central treasury unit, called the Central Investment Office (CIO). This unit was established because JPM collects more deposits through its extensive retail operations than it lends out. It is a cash-surplus bank, and decided to centralise the management of this spare liquidity in a single unit, the CIO. In the normal course of events, this unit would have been a low-risk operation, putting the surplus cash to work in boring investments like US Treasury bills and other low-yielding but liquid and safe investments. If these yielded a modest premium over the rate paid on deposits, all would be well and the bank would enjoy the security of knowing that it had ample spare liquid assets for the rainy day. The rainy day duly arrived in the US markets in 2007 but JP Morgan survived and prospered as others went under or had to be rescued by the US government. But subsequently the decision was taken to broaden the CIO's remit and it began to take riskier positions in derivatives markets with a view to enhancing profitability.

What went wrong? If you would like to read the outcome of the bank's own inquiry

you can do so by logging on to JPM's website. You do not need to be a JP Morgan shareholder, or even a US citizen, just google "JP Morgan task force report" on your computer. The report runs to 129 pages and recounts major weaknesses and failures by named or identifiable individuals, many of whom have had their careers terminated. In a nutshell, the people running the CIO unit pursued risky strategies in instruments called credit derivatives, did not measure the risks properly and could not get out of large losing positions except at a huge loss. Senior management did not appreciate the risks that were being run, faulty statistical models were relied on and trading exposures and losses were not reported properly up the line. This internal report has attracted its critics and there will be further inquiries by regulators and committees of the US Congress. The report will not be the last word on the subject, it may be incomplete but it is pretty detailed and, more importantly, it is out there for all to see, just six months after the debacle emerged.

In early 2012 JP Morgan had shareholders' equity of about $180bn, so the loss of $6bn, amounting to 3 per cent of equity, was far from fatal. The share price, however, fell from about $44 to around $32 over the April-June period last year, from which level it has since recovered. There has been serious reputational damage and the bank's chief executive, Jamie Dimon, was on a repair mission during the week at the Davos World Economic Forum in Switzerland.

Now consider what happened in the last few years at what used to be Ireland's largest bank, AIB. The bank incurred losses equal to about 250 per cent of the shareholders' equity, went bust and was taken over by the State. The losses at Anglo Irish were even greater, but AIB's demise was the greater shock. Ordinary shareholders were wiped out entirely, subordinated bondholders suffered and the taxpayers have picked up the remainder of the bill. The scale of the disaster at AIB began to emerge almost four years ago. There has been no published report on the AIB debacle from any source: not from the bank itself, not from the regulator, nor from any parliamentary committee. The three official reports published to date have been broad-brush reviews of the origins of the banking bubble, each useful in its own way but with no detail on what went wrong in individual banks.

AIB's silence is not unique. There have been no reports on any of the other Irish banking disasters either, including the even worse cases of Anglo Irish and Irish Nationwide. But the AIB case is interesting because the bank suffered a non-fatal disaster, comparable to the JP Morgan credit derivative losses, back in 2002. On that occasion a rogue trader, John Rusnak, lost almost $700m of AIB's money at its US subsidiary in Baltimore. This was a serious though not fatal hit to AIB's equity, the shares tanked but the bank managed to report a profit for the year even after the write-off. Within a few months, AIB released a comprehensive report (the Ludwig report) prepared by a US banking expert which outlined the failings in risk control and supervision which led to the Rusnak episode. Names were named and responsibility was allocated. Several senior AIB officials saw their careers terminated. Releasing the Ludwig report helped to restore credibility to AIB back in 2002, and the bank weathered the storm.

This time round a far larger, indeed terminal, disaster for the bank's owners has, four years later, gone entirely unexplained. From an all-time high of €24, the shares have collapsed, effectively to zero. In the 2002 rogue trader case, US laws had been broken and inquiries by the FBI and regulators were inevitable. Mr Rusnak was eventually convicted and jailed. While laws may have been broken in some of the Irish banks and prosecutions of Anglo Irish executives are under way, there is no evidence of law-breaking at AIB. The bank simply bet the ranch, mainly on Irish property lending, and lost. There will likely be no criminal charges against anyone, and the same is true for Bank of Ireland and others. But the absence of criminal breaches and of the threat of official inquiries does not absolve the individual banks of the responsibility to explain what happened. To date, aside from a few paragraphs of contrition in annual reports and some honourable resignations, not one of the Irish banks has seen fit to release an account of what went wrong. The view seems to be that this is really a matter for the State, or that, since no laws were broken, there is nothing to explain.

Three substantial Irish-owned banks have survived, AIB (nationalised), Bank of Ireland (minority State-owned) and Permanent-TSB (also nationalised). The former Educational Building Society has been merged into AIB while Anglo and Nationwide are being wound down. The three Irish banks which have survived owe their continued existence to State financial rescue. All three will be central to the operation of the Irish banking system in the years ahead, along with Ulster, Danske, Rabobank and the other foreign banks still operating here. All three have expressed the desire to re-build trust and confidence with staff, customers, regulators, capital markets and the general public.

But that process is fatally hindered through the absence of public explanation. The Irish banks did not go bust through speculation in exotic financial instruments; they went bust lending money, mainly in Ireland to Irish people, an activity in which they had engaged successfully for, in some cases, hundreds of years.

The contrast with the 'horseburger' affair is instructive. There was no threat to public health but the food safety regulator published information promptly. No reticence, no cover-up. Inquiries continue and there is little doubt that all the facts will be in the public domain quickly. The public should be reassured rather than alarmed.

All three of the surviving Irish banks must have conducted internal inquiries along the lines of the JP Morgan report, or the earlier Ludwig report on AIB. It is time to release them.

Sunday Independent

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