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  OPEN DISSENT

  Open

  Dissent

  An Uncompromising View

  of the Financial Crisis

  Mike Soden

  Published by Blackhall Publishing

  Lonsdale House

  Avoca Avenue

  Blackrock

  Co. Dublin

  Ireland

  e-mail: [email protected]

  www.blackhallpublishing.com

  © Mike Soden, 2010

  ISBN: 978-1-84218-212-3

  A catalogue record for this book is available from the British Library.

  All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior, written permission of the publisher.

  This book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, resold, hired out, or otherwise circulated without the publisher’s prior consent in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser.

  Printed in Ireland by ColourBooks Ltd.

  ABOUT THE AUTHOR

  Mike Soden was born in Dublin in January 1947. He attended Willow Park School and Blackrock College. After graduating from UCD in 1968 with a B.Comm. degree, he emigrated to Canada where he worked for Shell Canada Ltd and Xerox. He returned to Ireland in 1973 where he was appointed a loan officer with the Industrial Credit Company.

  Mike’s international career in banking was launched when he became branch manager for Citibank NA in Cork in 1975. The next ten years saw him relocate to London, Oslo, New York and Toronto in a variety of different capacities for the bank, including as global head of derivatives in New York and head of Citicorp Investment Bank Canada. In 1985 he was headhunted to set up an international capital markets organisation in London for Security Pacific, one of the top five banks in the US at the time.

  Mike retired in 1990 from Security Pacific and remained so until the end of 1994, when he was approached to build a wholesale banking operation for National Australia Bank in London. In 2000 Mike was appointed global head of retail banking for National Australia Bank, with responsibility for 40,000 employees in 7 different banks and retail divisions in Australia, New Zealand, the US, the UK, Scotland and Ireland.

  In 2001 he was approached to return to Ireland to become chief executive of the Bank of Ireland Group. He retired from Bank of Ireland in 2004.

  All royalties from this book will form the author’s contribution to 1 in 1000 – Running for Cystic Fibrosis (http://runningforcf.ie), which mobilised 1,000 women to participate in the Flora Mini Marathon on 7 June 2010.

  1 in 1000 raised over €200,000 for a cystic fibrosis isolation unit in Our Lady’s Children’s Hospital, Crumlin.

  PREFACE

  On Sunday, 3 January 2010 I was a guest on RTÉ’s Marian Finucane Show. The country having just experienced the worst financial year since the formation of the state, the reverberations of which would be felt for decades to come, was the background to the programme. The next day I received a call from Blackhall Publishing enquiring as to the likelihood of me writing a book on the subject of the financial crisis that was afflicting Ireland and the rest of the world. As a result of various meetings, I have proceeded on the basis that the objective of this book is to crystallise what happened to cause the crisis, internationally and nationally, why it has had such a particular effect on Ireland, and how and when we might see ourselves out of this conundrum. While many of us are looking for retribution for what has happened, I feel it best to leave the name, blame and shame game to an official enquiry.

  The challenge of putting pen to paper on a subject in which I had been immersed over a 35-year career in banking seemed too good to pass up. I have spent years deeply involved in the international capital markets in London, New York, Toronto and Melbourne and I have gained experience in most areas within the financial system, ranging from debt to equity, branch banking to derivatives and commercial banking to investment banking. Much has been written on both the global and Irish financial and economic crisis to date. The one thing I, as an experienced insider, can bring to the table is a clear understanding of what best practice is in managing large numbers of complex financial activities around the world, which involves knowledge and experience in governance and the control of risk.

  From my time serving on boards in Ireland I see that there is a particular culture prevalent that leads to the suppression of different opinions; I call this silent dissent. This is a somewhat intangible element of the reasons for the harshness of the crisis here. Leadership and governance are wanting in all areas of Irish society, most particularly, as recent events have demonstrated, in our Government and our banks. These themes need to be addressed in the context of our recovery; a lot of what I have to say in this book relates to our recovery and the embracement of a new reality, or a ‘new normal’. I bring my own experiences of working in international banking into the book, along with observations on banking in Ireland and its future. The measures and remedies I suggest are the result of keeping my mind open to the best opportunities for Irish banking and the Irish economy. This book discusses these ideas openly, keeping in mind that they may not perhaps be palatable to everyone.

  For Lou, the most selfless and

  dedicated partner one could have

  ACKNOWLEDGEMENTS

  Beginning at the beginning, I thank Marian Finucane for having me on her show on 3 January 2010, an event from which the idea for this book was born. I appreciate Blackhall Publishing’s initial interest in me as an author and for all the work they have done producing and marketing the book. I reserve special mention for my editor, Elizabeth Brennan, who managed to walk the line between being my saviour and the bane of my life over the past six months. Thanks to Karen Butler, who typed up the first draft of the book and gave us something tangible with which to work from the outset.

  I thank Mark McNamara of Morgan Stanley International for his contributions. Fiona Ross of the National Library offered the library as place for uninterrupted writing and thinking, and has also provided facilities at the library for the book launch. I am grateful to Matt Cooper for launching the book.

  Dearbhail McDonald, who was also writing her own book, took the time to discuss issues with me and trade information. Thanks to Neil Macdougald for his photography skills.

  A warm thanks to anyone who has helped me out with this book, and especially to my family and friends for their support and encouragement.

  CONTENTS

  Introduction Open Dissent

  Chapter 1 Birth of a Crisis

  Chapter 2 A View from Dame Street –

  The Crisis in Ireland

  Chapter 3 The Culture of Silent Dissent

  Chapter 4 Who Pays the Piper? The Concept

  of Fairness in Our Society

  Chapter 5 Recovery – Returning to Normal

  Chapter 6 NAMA − The Piggy in the Middle

  Chapter 7 Looking Abroad

  Chapter 8 The Model Is Broken – A New

  Financial Services Landscape

  Chapter 9 Misery Loves Company –

  Ireland and the European Union

  Conclusion Don’t Waste the Crisis

  Appendix

  Glossary

  Notes

  Sources

  INTRODUCTION

  Open Dissent

  When Lehman Brothers collapsed with liquidity difficulties in the US on Monday, 15 September 2008 it sent shockwaves throughout the financial world. The trust and friendliness of the interbank markets, which were a major source of liquidity for Iris
h banks, evaporated in front of our eyes. In times of crisis all head offices bring down the shutters to protect home base and this would include recalling major offshore deposits. These offshore deposits made up a great part of Anglo Irish Bank’s funding. As they were being withdrawn for whatever reason, the bank was unable to replace them and so needed government assistance. The nervousness and volatility over the next two weeks forced the Government to come out with its guarantee on the deposits and debts of all Irish banks.

  This action, while criticised by Europe and the UK, saved the Irish banking system. It was applauded by others around the world including the US Treasury, which felt it was a strong and decisive move, and reduced international concern over the viability of the Irish banks. If the guarantee had not been provided, both domestic and international depositors would have started to pull out, creating a massive liquidity crisis. Keeping pace with the international markets is not an easy task and, as an island economy attached to a European master, putting our self-interest first may not have been politically correct, but it worked.

  It might be comforting for many senior people in our community to blame the global markets for the financial crisis in Ireland. After all, we are not big enough to have influence on the global markets and so we may conclude that we are innocent victims. Nothing could be further from reality or the truth. I repeat here a statement that I made at Bank of Ireland’s extraordinary general meeting on 27 March 2009: ‘While there is a global financial crisis, the crisis that is being experienced in Bank of Ireland has been self-inflicted and not imported.’ This applies equally to all six Irish banks.

  The Central Bank of Ireland, in its Financial Stability Report produced at the end of 2007 and presented to the Oireachtas in January 2008, identified two key factors that were at the heart of the problem as it was then perceived: liquidity and the credit crunch. These were indeed the key symptoms of a critical disease that was about to beset our nation. But in the presentation to the Oireachtas we were comforted by the forecast of a soft landing. In hindsight it is easy to be critical of this judgment, but I remind those in positions of authority and power that they are paid, often substantial amounts, for foresight as they can only be judged by hindsight. With authority and power comes accountability, whether you are a politician, civil servant, regulator, lawyer, banker, auditor, clergyman or doctor. ‘Responsibility’ is not difficult to spell or pronounce but it is often unpalatable to take, even in small doses. Those who were empowered to oversee the running of the banks and have seen the destruction of these entities are not the people to be entrusted with the responsibility of turning this critical situation around.

  The Central Bank was right in 2007–2008 about the problems of credit and liquidity in the Irish financial system; it simply did not see or did not wish to see the extent of the difficulties. We have experienced the spread of the liquidity crisis across the world in a very short period of time. The crisis is unique in Ireland, however, because of the loose credit standards that existed here, which created a credit bubble. No one forced the banks to create large risky portfolios of commercial and residential mortgages. These mortgages were not being funded by deposits but by overseas short-term funding. This situation – our dependence on overseas funds and poor credit management – meant that when the liquidity crunch hit, Ireland was in a very weak position.

  Professor Morgan Kelly, in his paper ‘The Irish Credit Bubble’,1 puts forward a very logical and compelling case for the cause of the credit bubble in Ireland. An explosion of bank lending led to predictable rises in the prices of Irish houses and commercial property. In 1995 the average price of a house in Ireland was equal to four years’ average industrial earnings. In late 2006, at the peak, new house prices nationally had risen to almost ten years’ average earnings while, in Dublin, second-hand prices had risen to seventeen times average yearly earnings. So, what drove the rise in property prices? The cause was excessive bank lending. In his paper Professor Kelly illustrates that mortgages and the availability of credit have a correlation with the increase in house prices. In financial terms, for every additional €1 of mortgage availability, the price of a house increased by €1.13. According to Professor Kelly, rising house prices were driven predominantly by an increase in the size of mortgages that banks were willing to give, with interest rates playing a secondary role and the growth of the population none at all.

  For comparative purposes, where the norm for lending in the Eurozone was just over 100 per cent of gross domestic product (GDP), Ireland’s bank lending had soared to 200+ per cent of gross national product (GNP) (see Figure 1 in the Appendix). By the end of 2008, the Irish banks were lending vast amounts to property developers and residential mortgagees. The growth in credit relative to GDP created all sorts of distortions in the economy, none greater than the price of houses. The growth in property prices can be viewed from the perspective of increased demand resulting from the increase in population and the low interest levels associated with the euro. Bubbles grow when buyers are motivated by the availability of credit and the hope and expectation that prices will continue to increase. When this spiral of borrowing and increasing prices starts to work in reverse, a problem is created. This would be manageable if it took the form of a slow leak to the bubble, but if there is an edge to this reversal, and this edge is the realisation that prices have peaked, the result is a pricked bubble. As wholesale funding grew to proportions that had not been seen before, the banks became more and more dependent on the rolling over of their wholesale deposits, mostly international short-term deposits, to keep their books in balance.

  Common sense would suggest that the combination of easily available mortgages and comparatively low interest rates would create an enormous demand for property. In a developed country the construction sector would normally account for approximately 5 per cent of GDP. The combined contribution of this sector grew to approximately 21 per cent at the peak of the bubble in 2006–2007.2 Those who had property wanted more, those not yet on the property ladder were assisted by their parents and many, many more just wanted a piece of the action that would hopefully create a nest egg for retirement. The number of second homes in Ireland, i.e. not including holiday homes abroad, amounted to some 300,000 units. This figure presumes that every unit was accounted for in the €60 million raised by the Revenue Commissioners in property tax on second homes in 2009, which, no doubt, wasn’t the case.

  The side effects of the downturn forced people to reevaluate where they stood financially with their bankers or fellow investors. Negative equity was an unwelcome visitor into people’s homes and investment properties. How did some of these people get to own five, ten, fifteen or even more properties? Take the case of a hard-working public servant who, during the period of prosperity and growth, managed to put a portfolio of properties together that had a market value of €12 million with loans backing these properties of €8 million. This individual was on an annual income in the region of €75,000. One can understand the state of elation when a person manages to acquire a home for each child in the family and in a buoyant market where the value increases every day. However, the downturn came and, instead of being left with a net worth of €4 million, this public servant was potentially bankrupt.3

  There are similarities between the conditions that existed in property lending, which caused the property bubble in Ireland, and the sovereign debt crisis that we in Europe are faced with today. The principles of lending are the same for every borrower: the lender or investor demands to be repaid in line with the terms of the loan agreement. Many Irish developers are only too aware of this. European sovereign borrowers, who are now either unable or unwilling to repay their loans, face consequences for their economic and political sovereignty. At the moment the money that has been lent by the surplus nations to the deficit nations in Europe is counted by the Bank of International Settlements in US$ trillions. Running deficits have been universally accepted as an economic imperative of consumer-driven expansion or
recovery. The concern that now permeates the markets is whether repayment of debts is a realistic part of today’s economic equation for growth. The growth of the sovereign debt mountain must be addressed sooner rather than later. Can the debtor nations repay all their current outstanding debt within five, ten, twenty or even fifty years? Should part or all of existing debt be converted into some form of perpetual debt that will ease the burden of repayment? The crisis in Ireland is being magnified as the bank borrowings and sovereign borrowings of the country converge, creating one enormous problem for the state. This is not to suggest that there should be no further borrowings by sovereigns, but would it be too much to ask of governments to adopt the financial discipline they expect of their citizens?

  Financial crises have the capacity to magnify the weakest links in the leadership of financial institutions. In my working life, I not only enjoyed a diversified career in financial services, but also a global perspective of the financial markets and the privilege of working directly or indirectly for four remarkable leaders. I not only got to see the strengths and weaknesses of these leaders through daily contact with them, but I also had the experience of seeing them in action and the wisdom of their decision making.

  As I look back on my own career in the context of the current crisis, I am struck by the failures that occurred in succession planning in the four major institutions that I have worked for internationally and in Ireland. This issue of succession and leadership is the thread linking Walter Wriston (Citicorp/Citibank, New York), Richard (Dick) Flamson (Security Pacific, California), Donald (Don) Argus (National Australia Bank, Melbourne) and Laurence Crowley (Bank of Ireland, Dublin). Using these four men and these institutions as examples, I wish to describe a common occurrence that may illuminate the machinations of identification and appointment of successors in corporate life, which may in turn provide an insight for those who ask the question, in the context of the current financial crisis, ‘What went wrong?’