Market Fundamentalism and Bank Robbery

The government is still too trusting in markets and not aggressive enough on regulation.

As the saying goes, “in Soviet Russia, television watches you.” The Irish version should probably read “in modern Ireland, the banks rob you.”

White collar crime in the banking sector spread across the western world in the run-up to 2008. Financial institutions became snake-oil salesmen, piling unintelligible complexity into their so-called “products” in order to blind investors with science and trick them into parting with their money. Investors were misled as to how much risk they were taking on.

Anyone with a 401k plan or who has played the stock market will be familiar with the concept of risk. The greater the certainty of earning a profit, the lower the return. The less the certainty, the higher the risks but also the higher the potential rewards. Place a high risk bet on a volatile stock in the hope that you’ll make a quick killing and you only have yourself to blame if the stock tanks. However if your broker lies, sells a risky investment as a safe one, and then then you make a loss, you become the victim of fraud.

This is what caused the 2008 global financial meltdown, the fraud taking various forms in different countries. In Ireland the shadiness was centered on the property market in which banks sold variable rate mortgages to anyone with a pulse, regardless of ability to pay, feeding into a culture in which anyone could get rich quickly with no work by stepping onto the property escalator. The government was happy to feed into the fiction, driven as it was by “light touch regulation” and a cozy relationship with property developers.

Deregulation is not necessarily bad policy in itself. In certain industries it can eliminate red tape, enable companies to grow, and spur more competition that benefits the consumer. Tony Blair exploited the principle during his tenure as British Prime Minister, taxing the resulting economic growth and using the revenue to better fund public services. However deregulation in the financial industry has seldom led to good outcomes. In the United States it led to the subprime mortgage crisis and ensuing financial collapse of 2008. In Britain in the 1980s it fed into a boom-and-bust cycle and rampant inflation. In Ireland it led to investment banks getting away with all manner of shady practices.

Ireland’s Financial Regulator, a part of the Central Bank of Ireland, was charged with keeping an eye on the banks and preventing excessive lending. However the regulator was so ineffective that they barely knew how big the banks were. This was a key factor in the Cowen government’s fateful decision to guarantee deposits in the entire banking sector.

Bailing out the banks was a necessary evil since the alternative was for ATMs and debit cards to stop working when people tried to buy their groceries. However the second part of the fateful decision, to nationalize the Irish banks, divided opinion among economists. The feeling was, “if we’re going to pay your bills, then we’re going to own you.” This would mean that the taxpayer would benefit from any profits that the banks made subsequently, similar to how the US government made a profit on the bailout of the US auto industry.

However due to the ineffectiveness of the Financial Regulator, the government had no idea how much debt the banks were carrying. The government, literally forced to make a decision in the heat of the moment before the markets opened the next day, was flying blind.

Only when the scale of Anglo’s liabilities became clear did the horror of the burden that had been placed on Irish taxpayers become clear.

In hindsight it is difficult to see any option other than bailing out these financial institutions. However the decision to nationalize is the fateful part, and the Fianna Fail-led governments of Ahern and Cowen can rightly be blamed for it for two reasons. One is that they should never have taken on those liabilities on behalf of the taxpayers without knowing how big they were. The second reason is that the government was responsible for ensuring that the Financial Regulator knew what was on the banks’ balance sheets. Had Bertie Ahern not been worshipping at the altar of light touch regulation there is a better chance that the Regulator would have done its job, and Mr Lenihan would have had the information he needed to make the best decision on the night when it all went south.

Market fundamentalism, the idea that the actions of the market always coincide with the public interest, is an idea whose time has passed. Yet it still keeps a stubborn hold despite all the evidence that has piled up against it over centuries. It is unflushable.

Matthew Elderfield, the financial regulator who served three years until June of this year, warned in a parting statement that not enough has been done to prevent a repeat of the mistakes of the past. Enforcement against corporations has improved, but there is still a reluctance to prosecute individuals and seek prison time for white collar criminals. Fining a large wealthy corporation is one thing, but the sound of a cell door slamming closed behind a corrupt executive stands a much better chance of concentrating the mind.

It could be that Ireland’s small size is a weakness. If bankers and their regulators all know each other on a personal level then this leads to conflicts of interest, but there should be distance between them. A gamekeeper cannot be drinking partners with the poacher.

So far there is little evidence that the government has learned any lessons from the whole sorry mess or has gotten any more aggressive about prosecuting errant individuals. It is almost as if they are afraid of upsetting someone. Perhaps a new government, less enamored with the “magic of the market,” is needed.