Mismanagement in banking must be held to account
Criminal liability should apply to the financial sector, writes Colm McCarthy because when financial institutions fail - we all suffer
After six unbroken years of economic recovery, memories of the financial crash are beginning to fade and the anger to subside. In the early and middle months of 2009, as the bill was presented to every household in the country, the public mood was for a mass lynching of builders and bankers. Ultimately the builders ended up bust and the politicians got lynched too, at the election in February 2011. The bankers, with a few exceptions, sailed off into the sunset, as did their inattentive regulators.
Those bankers who have had to face the courts were not on trial for reckless mismanagement, but for unrelated offences concerning mis-statement of accounts and the alleged concealment of insider loans.
Every bad loan needs a bad borrower, but it also needs a bad lender. The Irish system has done an effective job, courtesy of the Nama machine-gun, in locating and punishing the foolish borrowers. It may even have shot a few innocent bystanders. But there has not been a single prosecution for mismanagement of a bank executive, director or regulator for what was one of the most extraordinary credit binges seen anywhere in recent times. Many of those responsible have not even been publicly identified.
The Law Reform Commission concluded, in a report released last week, that Ireland should not introduce a criminal offence of mismanagement of a financial institution. In this the commission has chosen to ignore the advice of Patrick Honohan, who led the Central Bank through the mop-up operation from 2009 to 2015. Honohan is an economist rather than a lawyer and is acutely aware that recklessness in the management of banks is not the same as failures elsewhere in the economy.
It would be a tragedy if a large Irish company, say a manufacturer or a supermarket or a chain of hotels, were to go bust. But it would be a small tragedy and the existing laws about insolvency deal with the consequences all the time. There are no small tragedies when the banking system goes wallop, led by its biggest units.
Measuring the scale of banking busts is a minor academic industry. When the banks go under, the State has little option other than to keep the show on the road. The Exchequer costs in Ireland were among the largest, relative to national income, ever recorded and the broader economy crashed. In a few years, total employment fell by 300,000 and the State itself was eventually forced into insolvency. It could no longer borrow and had to resort to the IMF and European official lenders for the first time in its history. On any metric the Irish banking bust was exceptional. Who was responsible?
There was a financial crisis throughout Europe and North America, of course, and cautious countries did not escape. The first line of defence against a banking bust is the board and management of each individual bank; the second the bank regulators and supervisors; the final line the central government, duly held responsible by a vengeful electorate. It was the failures of the first two lines which made the Irish banking bust bigger than elsewhere.
Incipient banking busts are never forestalled by the patriotic abstinence of borrowers. If credit is too loose there will always be borrowers. They paid the price and it is expedient to welcome back the forgiven, the resurrected Lazarus builders now rehabilitated just in time to address the housing mess.
The Law Reform Commission, whose staff naturally enough consists of lawyers, has failed to appreciate the necessity in both company and criminal law to treat financial firms differently from those in other sectors. They are already treated very differently in the statutory oversight arrangements. There is prudential regulation of banks (and insurance companies) for good reason. They are fragile institutions and their failure, especially if they all manage to fail together, has momentous consequences.
The commission declined Honohan's advice because the report's authors feared that imposing criminal liability on bank boards and management "would result in a chilling effect, compelling the market to adopt a significantly more risk-averse attitude", which they appear to feel would be an unintended consequence. I imagine it is precisely what Honohan had in mind. He was, after all, one of many who warned of the absence of risk aversion in lending policy in the years before the tragedy matured. The commission does not appear to have pondered why there is no prudential regulation of the balance sheets of manufacturers or supermarkets or hotels. It is because the community at large is not on the hazard when they fail.
Aside entirely from the efficacy of criminal liability, which has been incorporated into the legal framework in the UK and elsewhere, the various inquiries into the Irish banking bust have avoided even the identification of the individuals who drove lending policy for a decade and more. The names of directors and top management are all a matter of public record and all have departed the banking industry. Several have expressed their regrets and there have been many honourable resignations. But there has been nothing comparable to the allocation of personal responsibility among those taking the decisions which followed the clerical sex abuse scandals, courtesy of the forensic reports prepared by retired judges.
If there is no mystery about the electoral slaughter of 2011, the equal vengeance visited on the outgoing government in 2016 takes more explaining. Why was the electorate still so wrathful? There are two explanations connected with the banking bust. The first was the imposition on Irish taxpayers of full pay-outs to unguaranteed bondholders in banks already closed. The incoming ministers in 2011 had promised to haircut these undeserving bondholders and were publicly prevented from doing so by Jean-Claude Trichet and the European Central Bank.
The second was the failure of the Oireachtas banking inquiry to assess the performance, and demise, of each individual bank, thus exonerating by omission their accounting and legal advisers as well as decision-makers in middle management. The contrived appearance of Trichet, dodging questions he required to be submitted in advance by the inquiry members at Kilmainham, and refusing to testify under oath, remains an enduring embarrassment.
Who believes that only the directors and top management were remiss, or that each bank was equally mismanaged? Every inquiry in other jurisdictions uncovered people who fought unsuccessfully for caution, even in Lehmans in New York, the poster child for the crash in the USA. Is it credible that there was not a solitary hero or heroine in the entire Irish banking system? Or in the crash of Quinn Insurance, a disaster which would have been a financial scandal had it not been overshadowed by the greater scandals elsewhere?
The judge-led process employed in the sex abuse inquiries, and currently in finding the facts about the mother and baby homes, would at least have allocated personal responsibility in the banks and in the regulatory system.
The Oireachtas inquiry fed the perception of a cover-up. It is not too late to re-visit the Irish banking bust with a better investigatory instrument, nor is it wise to pretend that the law can treat bank directors and managers as though they were running bakeries.