Oireachtas Joint and Select Committees
Wednesday, 4 March 2015
Committee of Inquiry into the Banking Crisis
Context Phase
Ciarán Lynch (Cork South Central, Labour)
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The committee of the inquiry into the banking crisis is now in public session. Good morning and I would like to welcome you to the joint public hearing of the Joint Committee of Inquiry into the Banking Crisis. Later this morning we will hear from Professor Alan Ahearne but in our first session of this morning's discussion we will hear from Dr. Peter Bacon on the Bacon report on the housing market in Ireland and the development of the proposals to establish NAMA.
Dr. Peter Bacon is a well-known economist. He holds primary and postgraduate qualifications in economics including a PhD from Trinity College Dublin. Since September 1994 he has built and developed an economic consultancy practice. During his career Dr. Bacon has held a wide range of positions in Ireland and overseas. He has worked in the public and private sectors in Ireland, for some years as a stockbroker. In the public sector he has worked as an executive and as a ministerial adviser. Dr. Bacon's overseas experience includes working in developing economies with the Organisation for Economic Co-operation and Development (OECD), Paris, and working in developing and transitioning economies with the World Bank, Washington DC, and the EU TACIS programme. His main areas of interest are in macro-economic and financial policy issues and evaluations of policies and projects at sector level. He has published widely over the years in these areas. Dr. Bacon, you are very welcome before the inquiry this morning.
Before we begin, I wish to advise the witness that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If they are directed by the Chairman to cease giving evidence in relation to a particular matter and they continue to so do, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given. As you have been informed previously, the committee is asking witnesses to refrain from discussing named individuals in this phase of the inquiry. Members are reminded of the long-standing ruling of the Chair to the effect that they should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable.
Dr. Peter Bacon:
Thank you, Chairman. I make this statement on foot of your invitation to attend this morning, to assist you in your deliberations. You have requested that I address all or some of the following matters in my evidence: the development of the proposal to establish NAMA, including the options assessed and the conclusions reached; tax policy towards housing and property development; planning and development during the boom; Ireland's housing market in the late 1990s; debate about housing policy prior to the crisis; Ireland’s housing market in the international context; and recommendations made by me in respect of the residential property market in Ireland and their implementation.
I am happy to endeavour to assist you and the committee in relation to these issues on the basis of certain consultancy assignments carried out by me and which have been published or placed in the public domain as follows: An Economic Assessment of Recent House Price Developments, a report submitted to the Minister for Housing and Urban Renewal (April 1998); The Housing Market: An Economic Review and Assessment, a report submitted to the Minister for Housing and Urban Renewal (March 1999); The Housing Market in Ireland: An Economic Evaluation of Trends and Prospects, a report submitted to the Minister for Housing and Urban Renewal (June 2000); and Evaluation of Options for Resolving Property Loan Impairments and Associated Capital Adequacy of Irish Credit Institutions: Proposal for a National Asset Management Agency (NAMA), Abridged Summary of Report (8 April 2009).
I will start with the housing market. Developments in Ireland’s housing market in the late 1990s, in the Dublin region in particular, were symptomatic of fundamental change in housing patterns. House price inflation, especially in Dublin, began accelerating from 1993, reaching 14% per annum in the four years to 1997 and 25% in 1997.
These trends were the result of favourable macro-economic developments in Ireland including lowering interest rates, reinforced by demographic factors and changing social patterns. For example, gross immigration was occurring at an annual rate of 44,000 and concentrated in household formation ages, almost half being aged between 25 and 44 years. By contrast, emigration was concentrated in the younger age of 15 to 25 years, about 62% being of that age. Changing social patterns were reflected in a rise of one and two person households from 41.9% of the total in 1988 to 46.8% in 1997. While housing output increased 80% between 1993 and 1997, the share of completions in Dublin fell.
The recommended policy response contained in the reports considered that, to be effective, a policy response would need to: achieve a better balance between demand and supply in the short term; improve the potential supply of housing in the short to medium term; engage in infrastructure developments; and improve medium and long term planning of development of the east region. The April 1998 report proposed specific policy initiatives under each of these headings, although most debate and commentary focused on the fiscal measures which comprised the following: the repeal of section 23 relief from investment in residential property; the removal of deductibility of interest on borrowings undertaken for investment in residential property against personal income for taxation purposes; and the reforms to the stamp duty code and changes to capital gains tax as it applied to serviced zoned land.
The two subsequent reports of March 1999 and June 2000 contained more detailed proposals directed mainly at improving the supply side response. These latter recommendations were framed in the context of achieving credibility, clarity and certainty. In support of these criteria specific recommendations were made to: achieve higher residential densities; carry out key strategic infrastructure investments to overcome bottlenecks such as the northern fringe interceptor sewer; accelerate the process of securing required planning consents on significant sites in Dublin city and county through the use of strategic development zones (SDZs); improve the deployment of existing planning resources; increase the resources available to the planning system; impose fiscal penalties for non-realisation of potential of SDZs; propose revisions to the stamp duty regime; establish an anti-speculation property tax; establish measures to secure improvements in the quality and availability of rented accommodation; and to strengthen the institutional framework for securing a more effective housing response in the greater Dublin area.
I will turn now to the outcome. Rates of increase in prices of new and existing houses in Dublin and nationally slowed sharply from the middle of 1998. The peak rate of inflation in the new house market was 24.6% in the first quarter of 1998 countrywide and 33.8% in the first quarter of 1998 in Dublin. By the first quarter of 2000, these rates had halved to 12.9% and 16.2% respectively. In the existing house market the peak rate was 36.9% in the third quarter of 1998 country wide and 41.7% in the third quarter of 1998 in Dublin. These rates too more than halved to 17.4% and 20% respectively in the first quarter of 2000. At the same time, the annual rate of new house completions increased about 10%, to approximately 46,500 units, the highest annual rate of completions ever recorded to that time. However, in 2001 the measure to exclude interest deductibility was reversed. Thereafter prices re-accelerated, despite a supply response rising to almost 90,000 units annually, as speculative forces gathered increasing momentum.
I will move now to the development of the proposal to establish NAMA. At the heart of the banking crisis was a concern of capital markets with regard to the adequacy of banks' capital to meet future loan impairments and institutions’ capacity to obtain additional capital externally. Future impairments were of concern because for the previous decade Ireland had experienced rapid inflation in property values and lending to the property sector had become an increasingly important component in credit institutions’ lending. In addition, there was heightened international concern about the health of the financial sector.
Irish banks were facing an extremely unstable outlook in respect of international wholesale deposits, upon which they had become significantly dependent in the previous decade to fund expansion of their assets or lending. They were experiencing major withdrawals of these deposits, a shortening of the average duration of deposits and substantial recourse to the Central Bank for short-term liquidity support. This was not a sustainable trend. In addition, the initiatives taken by Government to that date were considered to be insufficient to achieve rates of capital adequacy that would encourage investors to hold and invest further equity in Irish credit institutions when prospective impairments were considered. As long as this remained the case, it could be expected that share values would remain depressed and deposit liabilities would be likely to experience continued attrition and foreshortening in duration. Such a prospect would hinder economic recovery, complicate further the required adjustment of the public finances and leave Ireland’s international credit rating subject to downward pressures and speculative attacks. Therefore, it was concluded that additional and far reaching measures needed to be undertaken as soon as possible to place the banking system on a sound footing.
Deterioration in the Government debt to GDP ratio was under way as the general Government deficit widened. A significant part of this deterioration arose from the effects of cyclical downturn. Moreover, discretionary budgetary adjustments to curtail the widening deficit would be partially undone by the deflationary impact of the discretionary measures themselves. To some degree, in the absence of international recovery and-or gains in competitiveness and productivity in Ireland, the domestic fiscal adjustment process had the characteristics of a vicious spiral comprising weakening economic activity leading to widening of the Government deficit and indebtedness leading to discretionary adjustments leading to further erosion of economic activity and so on.
The deterioration in Ireland’s credit terms associated with a worsening fiscal position was compounded by the additional contingent liabilities assumed by Government by virtue of the guarantee of the deposits of credit institutions from the previous September. Capital markets were uncertain how to value the additional liability of the Government on foot of the guarantee and the resulting confusion was causing Irish bond spreads to widen unfavourably. Against this backdrop, it was considered imperative that initiatives should be undertaken that would lead to stability in banks' deposits and term debt liabilities and eliminate the need for a renewal of the guarantee in place at the time. To achieve this required removing all doubts about capital adequacy of the credit institutions and their capacity to deal with prospective loan impairments.
There are a number of broad approaches, which are not mutually exclusive, to bank capital support schemes. These revolve around recapitalisation programmes involving stress testing against expected losses, asset guarantee schemes and asset management arrangements. The key features of recapitalisation programmes are future capital shortage is anticipated by testing adequacy of current capital in stress scenarios; the adequacy of capital to absorb losses is assessed; and the regulatory authority may then require more capital, which may be raised from the market, for example, by way of a rights issue or attraction of new shareholders, which may be either private or State. This approach needs to take account of implications of market conditions for cost of capital to bank, dilutive implications for existing shareholders and protection of State capital if the external shareholder is the Government. There have been many recapitalisation programmes put in place in the US and the EU in the current crisis, including in Ireland.
The key characteristics of the asset guaranteed or risks insured by the State approach are troubled assets remain on the balance sheet of the banking system; troubled assets are not subject to upfront mark-to-market write-downs; the bank usually is liable to a relatively small first loss tranche and the State covers elevated losses for a fee; equity capital is not affected as assets do not have to be sold at the current marked-down levels; no initial outlay is required from the State and a fee, premium or compensation arrangement is paid for the guarantee; compensation to the State in the form of convertible preferred shares or warrants is dilutive, of existing shareholders; and such schemes have been implemented at ING, Citigroup, Bank of America and RBS.
The key features of the asset management arrangements approach are troubled assets are transferred from the balance sheet of the banks at an agreed price; mandatory participation is required; the banks take the impairment loss to profit and loss account now; the bank is cleansed of troubled assets making valuation of the remaining part of the bank less complicated; the removal of impaired loans reduces the risk weighted assets of the bank and releases capital or reduces the shortfall in capital required; a discounted sale of assets may result in a significant reduction in the equity of the seller; and significant financing may be required from the State for the asset management company, impacting negatively on the fiscal position. Examples at the time included UBS and Securum-Nordbanken in the Swedish crisis of the 1990s.
Nationalisation was explicitly considered in the context of the report. Where a bank’s net worth has already been wiped out or would be by future impending losses or where Government are or will become dominant shareholders as a result of recapitalisation or other initiatives, nationalisation may be the most effective means of protecting the interests of all of the stakeholders – Government, equity and bondholders, depositors and the business franchise owned by the bank – and carrying out the required restructuring to enable the bank to stabilise its business in support of the wider economy in the future. For example, nationalisation could be used to facilitate mergers of operations and improve efficiencies of scale in accessing wholesale credit markets so as to bring about required strengthening of management or corporate governance. In effect where taxpayers are liable for guaranteeing the deposit liabilities of banks and also guaranteeing the bank against losses in the value of assets, in whole or substantial part, by any arrangement, such as those described above, nationalisation may be considered necessary to overcome issues of moral hazard. These situations are mostly likely to arise with respect to shareholders, who may be seen to be bailed out or gifted as a result of initiatives to support bank capital.
Another such concern may be the additional cost to the taxpayer in terms of deteriorations of the market's rating of sovereign debt instruments and the premium paid to bondholders in respect of this.
A number of nationalisations were made in the course of the current crisis in the UK, notably Northern Rock and Bradford & Bingley, and of course here in Ireland Anglo Irish Bank Corporation was nationalised in January 2009. A summary comparison of the general attributes of these approaches is contained in a table. I do not propose to go through the table because the committee has it.
The very features which make the asset guarantee approach intuitively attractive - no money up-front from Government and no write-down in banks’ balance sheet assets - contain also inherent fundamental weaknesses, namely, that a contingent liability is created in the balance sheet of the Exchequer. The situation would have significant parallels with the bank guarantee of the six credit institutions. It too was adopted on the basis that it involved no up-front outlay on the part of the Exchequer and on the basis that it would not be "called" and therefore the premium payments by banks would be a net receipt to the Exchequer. In the event, capital markets did not grapple well with the contingent liability created by the deposit guarantee. The tendency was to price Irish sovereign debt unfavourably, reflecting a view that more issuance of Government debt would be required. Indeed, an argument developed that if any part of the guarantee came to be called, in effect all would be called and that would lead to extreme problems for the Exchequer. The point of relevance here is that contingent liabilities are inherently uncertain in nature, are often evaluated in an ill-informed way with resulting errors and the potential for further adverse speculation against Ireland. As a result of the decision to guarantee the debt liabilities of Irish credit institutions the credit rating of sovereign, Ireland became inextricably bound up with the issue of Irish banks’ capital adequacy. A further guarantee approach, this time in respect of banks’ property-related loan assets, would create a further layer of uncertainty through the creation of another contingent liability on the Exchequer. This would further entwine the sovereign rating with Irish banks' capital adequacy problems without actually providing any clarity as to how capital adequacy would be achieved, other than through a calling of the contingent liability.
By contrast, the asset sales approach, while involving the recognition of "pain" at the outset contained the merit of certainty and clarity, provided of course the projection of the extent of impairment was accurate in the first place. In the particular circumstances prevailing it was considered that there was much to be said for recognising and crystallising prospective property-related loan losses explicitly, rather than allowing them to remain on banks’ balance sheets with a concomitant additional contingent liability on the Exchequer.
A feature of the guarantee approach is that assets remain on the balance sheets where they have been created. Another side to this is that they continue to be managed by the officers and executives of banks which created the problem assets in the first place. In the case where assets are complex financial instruments, such as many of the assets acquired by banks that were originated in the US and based on sub-prime borrowers, their valuation and resolution may best be undertaken in the banks which acquired them and which have the financial skills appropriate to this task. The nature of impaired property loan assets simply was not of this character. They were loans created and secured by property assets, development land, work in progress, completed but unsold residential stock and under-performing property investments, which are now worth significantly less than was envisaged by the loan. There is not a great deal banking skills can do to resolve this dilemma. Moreover, the property development companies involved in these transactions are almost entirely privately owned, championed by entrepreneurial characters and mostly without equity or recourse to equity markets, and in many cases do not have the depth of management skills to engage in the kind of portfolio sales and work-outs which ultimately are required to resolve the impairment issue.
Asset management companies, AMCs, offer prospects for avoiding many of the shortcomings associated with a continuation of the existing bank-property developer relationship. Potential advantages include: economies of scale in administering work-outs and in forming and selling portfolios of assets; benefits from the granting of special powers to the government agency to expedite loan resolution; and the interposing of a disinterested third party between bankers and clients, which might break connections that otherwise could impede efficient transfers of assets from powerful enterprises.
Sweden’s AMCs provide examples of some of these potential advantages, but other countries have found it difficult to realise them. First, government agents may lack the information and skills of private market participants. Second, government agencies do not operate in a vacuum. They, too, are creatures of the societies that create them, and government agents must negotiate, rather than dictate, solutions, just as private market participants must do. In negotiations with government agencies and private participants alike, the strength of one’s position depends on one’s “threat point”, the ability to credibly threaten adverse consequences for one’s bargaining opponent, if agreement is not reached.
Notwithstanding these shortcomings, it was considered that AMCs, by virtue of the potential advantages they contain, that I have noted, have the potential to bring about better economic resolution of the impaired loans of Irish property developers than relying on existing bank management and banker, developer relations, which brought about the problems in the first place.
The point I am about to make is one I made extensively at the time. It was never picked up and I considered at the time and still consider that it is one of the most important points. A further important consideration relates to the future financing requirement of impaired assets. Many of the impaired assets will be capable of achieving higher values if they can be worked out rather than disposed of. A key issue for successful work-out will be access to additional capital, equity and debt required for the work-out. It is extremely difficult to see how existing property developers will be able to access capital markets effectively for such equity and banks’ capacity to extend credit will be limited by the absence of collateral available from most of them. Potentially the amounts involved are large and a feature of Irish property developers is they are not publicly quoted companies and have not had a history of recourse to equity markets for their funding. I made the point when the crash occurred that the first thing that happened in the London market was that British Land, Land Securities and Hammerson, and some others, went straight to the market and raised capital to bolster their balance sheets because they were quoted companies. There was not a single one in Ireland then or now. Instead, they have relied on retained earnings for equity and bank lending for the balance. This shortcoming cannot be put right now and it represents a significant impediment looking forward to resolution of the impairment issue, at least cost. There has been a development in the past two years in the sense that there are now three publicly quoted real estate investment trusts, which is certainly a welcome development to absorb very fine commercial property assets from the resolution process.
An AMC, however, does have the potential to at least mitigate this issue in two respects. First, it has the potential to achieve scale and overview of developments and projects. Banks will be concerned about the security they hold and how that can be maximised and realised. In many instances more than one bank will be involved in the security and their individual interests may not correspond. An AMC would be able to achieve project oversight. Second, if properly structured and resourced with relevant property-related skills, such an entity would have the potential to attract long-term capital in a manner that individual development companies would not.
In conclusion, it appeared to me that the asset management approach had the potential to offer greater assistance in achieving resolution of the impairment issue upfront and maximising taxpayer returns, over the long term.
Ciarán Lynch (Cork South Central, Labour)
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Thank you, Dr. Bacon, for your opening comments. You wrote three reports, in 1998, 1999 and 2000. In the 2000 report you noted house prices were rising rapidly despite a strong response of housing supply, the law of supply and demand. The report recommended new measures including further proposals to discourage investors and another reform of stamp duty.
Maybe you could outline these measures to the committee, how many of the key recommendations were implemented by the Government and what impact they had on the housing market.
Dr. Peter Bacon:
The easy part of the question relates to the tax measures because it is an event. There is a finance Bill or supplementary finance Bill. There is a piece of legislation and the event either happens or it does not. All the tax and fiscal recommendations that were made in the reports were implemented. I highlighted one of them being reversed in 2000 or 2001. With regard to the supply-side enhancement measures, the 1999 and 2000 reports contained sections which assess the extent to which measures proposed in the previous report were implemented and what the impact was under four headings. Those headings were price and price stability, affordability and supply-side response. In the latter two reports, there was consideration of impact on the rented sector, which was something not considered at all in the first report.
In trying to answer the question of whether those supply measures were implemented, I point out that these were not an event. They form a process. The principal recommendation on the supply side related to the policies relating to residential densities. Members are either Deputies or Senators, and they will know from constituency work that densities are not an easy subject. It is easy for economists and planners to make recommendations but there are major issues with that topic. What I can state factually is there was a tendency over the period and subsequently for residential densities to rise. Did they rise enough and could they have risen more? Did they rise fast enough? These are judgments and some of these issues are still ongoing.
Ciarán Lynch (Cork South Central, Labour)
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At the core of the position, would it be accurate to state in considering the housing market between 2001 and 2002, prices started stabilising and maybe even calmed a bit?
Ciarán Lynch (Cork South Central, Labour)
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Would that effect in the market be related to the implementation of your recommendations?
Ciarán Lynch (Cork South Central, Labour)
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That brings me to my next question, before I bring in Deputy Higgins. In 2001, the Government reversed a number of measures that Dr. Bacon suggested and were introduced. Stamp duty for investors was cut, tax on second homes was eliminated and interest relief was restored as a deductible expense when calculating tax on residential income. What was your view on the reversal of the recommendations implemented on foot of your report?
Ciarán Lynch (Cork South Central, Labour)
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Were you consulted about that?
Ciarán Lynch (Cork South Central, Labour)
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There was no-----
Ciarán Lynch (Cork South Central, Labour)
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The record is that your recommendations were implemented and by your account this morning, that had a measurable impact on the housing market. We saw a stabilisation and maybe even a drop in prices as a result of your recommendations. Your recommendations were then reversed and what happened to the market? Did the prices start increasing again or-----
Ciarán Lynch (Cork South Central, Labour)
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-----did they stay stabilised?
Ciarán Lynch (Cork South Central, Labour)
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For the record again, you were not consulted on any of those reversals of the measures outlined in your report.
Joe Higgins (Dublin West, Socialist Party)
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A briefing paper from the researchers to the committee indicates the following, "The increasing role of investors and speculators in the residential property market was a source of concern to the Irish Government when it commissioned Bacon's first report." Was that Dr. Bacon's understanding of why the Government commissioned his succession of three reports? He has just told us of his belief that the recommendations put into effect from the first report had a significant impact on house prices. Which measures specifically does he think were effective in reducing house prices?
Dr. Peter Bacon:
The Deputy has two questions. The terms of reference to the first report did not contain or express, in my memory, any concern about speculation. We are talking about late 1997 for these terms of reference for the report. The terms of reference were about concerns that prices were accelerating. The concern of the Department of the Environment and Local Government at the time was to get a handle on why this was happening. People did not know. I do not think there was a preconceived view or belief at that time that speculative forces were strong. At the time, I do not think they were. From 1998 onwards, during the course of this work and as noted explicitly in the second and third reports, the significance of speculative demand was rising and ultimately driving the market. On the question of specific measures, it is very difficult to isolate one measure. Certainly, in the short term and in the sense of bringing down the rate of increase in prices, the measure that bit hardest was the tax deductibility of interest.
Joe Higgins (Dublin West, Socialist Party)
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That was for investors.
Joe Higgins (Dublin West, Socialist Party)
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Yes. Although the rate of increase did reduce in 2001, for second-hand houses, for example, prices still increased at approximately two thirds of the average industrial wage in that year alone. An ordinary person would see that as an inordinate increase. Would Dr. Bacon's proposed measures have been enough to have an ongoing effect in bringing the prices down to much lower levels than this?
Dr. Peter Bacon:
I think they would but there would have been adverse side-effects, the impact of which would probably have become intolerable for any Government. Mainly, this would relate to a shortage of accommodation in the rented sector. The first report was about house prices and there was no part of the terms of reference regarding the rental sector. The report was on why house prices were accelerating and raising headlines. That is basically the content of the terms of reference. They also asked for recommendations to stabilise the issue. That is what the report contained. I have always acknowledged that a side consequence of curtailing investment demand, as the measures did and which led to a levelling of prices, is to reduce the supply of rented accommodation. That is what happened.
Joe Higgins (Dublin West, Socialist Party)
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An article in The Irish Timesfrom 6 December 2001 by Mr. Colm Keena suggests that the decision made by the then Minister for Finance, Mr. Charlie McCreevy, to reverse a high rate of stamp duty for investors "was done against official advice and after intensive lobbying by interested parties." The briefing note from the researchers to the committee makes the following assertion, "There appears to have been an intense lobbying campaign from property and construction sector interests to remove the curbs on investors." Was Dr. Bacon aware of lobbying or the extent of lobbying by vested interests at that time?
Dr. Peter Bacon:
No, not other than what was contained in media reports. I was not confronted with representations in any formal part of the research that was going on. However, I do not think anyone in Ireland was unaware that there was a lot of pain. The measures I proposed and that the Government implemented hurt people.
Joe Higgins (Dublin West, Socialist Party)
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Which people?
Dr. Peter Bacon:
The investors. If an investor goes from a situation where he can offset interest costs against rental income to a situation where he cannot, he is feeling it where it hurts: in his pocket. Many people within the industry were pointing to the side consequence of the measure, namely, that the rental sector was becoming tighter and that rents were increasing.
Joe Higgins (Dublin West, Socialist Party)
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What is Dr. Bacon's understanding of the nature of these investors? Did they have political clout? Did that affect Dr. Bacon?
Joe Higgins (Dublin West, Socialist Party)
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I wish to explore the issue of affordability of homes with Dr. Bacon. My interpretation, which Dr. Bacon can correct if I am wrong, is that he saw affordability more for the ability to pay a mortgage. One of Dr. Bacon's recommendations was to increase the length of mortgage time. I think he may have put out a figure of 35 years on one occasion.
I am keen to explore with Dr. Bacon a different take, as it were, on affordability and ask for his opinion. Dr. Conor McCabe, from the UCD school of social justice, in an article, Irish Housing and Wages, 1977 to 2006: Portrait of a Scam, published on 8 June 2010 stated:
Best practise has house prices at 2.5 to 4 times the average industrial wage...apart from the recession years of the mid-1980s, housing in Ireland has been overpriced for the past 33 years...The figures belie the current myth of the ‘Good’ Celtic Tiger which ran up to around 2002, and the ‘Bad’ Celtic tiger which ran from 2002 to 2007...In 1997, house prices once again breached 5.0, and just kept on climbing...By the time the ‘Good’ Tiger ended in 2002, the affordability ratio stood at 8.17.
Why did Dr. Bacon not measure affordability in regard to the absolute cost of a house, rather than projecting a period of 35 or 40 years for repayment?
Dr. Peter Bacon:
There are two reasons. The average industrial wage is not representative of the average wage within the economy. Most people in Ireland now work in the services sector. I am sure Deputy Higgins has a better handle on it than me. The proportion of the labour force which earns the average industrial wage is very small. In respect of the proportion of the labour force engaged in industry, as measured by the average industrial wage, a figure of 25% or 30% sticks in my mind, although I stand to be corrected on that number. The use of the term "average industrial wage" is always, to my mind, a misleading term. It is an official term but it is misleading in the sense of providing a measure of average incomes of would-be house purchasers. I am sure the numbers that Deputy Higgins quoted are arithmetically correct but they are the result of the fact that a significant number of people earn more than the average industrial wage.
The second question Deputy Higgins asked me was why I measured the analysis in terms of mortgages. That is how most people and most first-time buyers finance the purchase of homes. It is the element most relevant to them.
Joe Higgins (Dublin West, Socialist Party)
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Our researchers have suggested that in a number of years during the housing boom the increase in the value of the average home was larger than the amount of money a worker on the average industrial wage would take home over the whole year. In fact, from 1996 to 2006, they maintain that the price of an average home increased 400%, an average each year of equivalent or greater than the average industrial wage. The result was that the increase in house prices created significant opportunities for investors to make large profits in housing development. Does the range of what were massive price increases by any standards indicate a serious level of profiteering and speculation in the housing market?
Dr. Peter Bacon:
I cannot comment on profiteering. It is not a defined term. People will make a profit if they sell a house or if they buy it at one price and sell it at another price. As to the extent to which it is profiteering in the sense that I think Deputy Higgins means, that is to say, as being excessive profit, I do not know.
Joe Higgins (Dublin West, Socialist Party)
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Anecdotally, it was said of new housing developments that every second house represented a profit for developers in some cases. Would Dr. Bacon consider that profiteering?
Joe Higgins (Dublin West, Socialist Party)
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That did happen, did it?
Joe Higgins (Dublin West, Socialist Party)
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I will move on to NAMA briefly. Dr. Bacon preferred the NAMA set-up rather than nationalisation. What is Dr. Bacon's view of the Comptroller and Auditor General's observation that the Bank of Ireland was given approximately €1 billion above the real market value of its impaired loans? In preparing his report did Dr. Bacon underestimate, perhaps, the level of impairment in loans?
Joe Higgins (Dublin West, Socialist Party)
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In essence he said that state aid of €1 billion was given to Bank of Ireland.
Joe Higgins (Dublin West, Socialist Party)
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When Dr. Bacon prepared his report-----
Joe Higgins (Dublin West, Socialist Party)
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It was about the level of impairment, as would seem to be evidenced by what the-----
Dr. Peter Bacon:
I will answer that question. The level of impairment that I estimated was not done on a loan-by-loan basis. It was done at an aggregate level. I was working from published data. Certainly, NAMA was acquiring loans from financial institutions and the level of write-downs seemed to me on average to be greater. However, one would expect when one gets into the guts of something for it to be either greater or smaller. If Deputy Higgins is asking whether I underestimated it, the answer is that I did not try to estimate it in the first place. I gave an indication at a macro level for the system as a whole of what the degree of impairment would be. Certainly, the anecdotal material, which is all I have seen, the same as Deputy Higgins, has reported that the prices paid by NAMA for loans were greater than that.
Joe Higgins (Dublin West, Socialist Party)
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The two major pillar banks were worth perhaps €500 million between them around that time.
Would Dr. Bacon consider that perhaps the nationalisation of the banks, with a return to profitability, as of now, accruing to the taxpayer, might have been a better option than NAMA?
Dr. Peter Bacon:
No, and the reason I do not is that I do not think there would have been the hollowing out of the banks' balance sheet of those bad loans unless there was, as I put it in my remarks and in my report, the disinterested third party of NAMA, the performance of which rested on getting an accurate valuation of what the worth of the assets it was taking on would be. I think the result would have been fudge. It would have been administrative fudge compounded by political fudge.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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In relation to Dr. Bacon's three reports on the housing market, how was he appointed to conduct those reports? Was there a tendering process?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Was it advertised each time?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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When Dr. Bacon was conducting those reports, did he have private clients who were property developers, be they commercial, residential or financial institutions?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Has Dr. Bacon ever served in any capacity with a property development company or a financial institution?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Will Dr. Bacon outline what that was?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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That was subsequent to conducting the reports.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Which one?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I have a couple of questions about NAMA. Will Dr. Bacon give a brief outline to the committee about the events that preceded his report which I think was commissioned by the National Treasury Management Agency at the time? How did Dr. Bacon come to conduct that particular report?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Was that a public tender process?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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The Minister at the time, being the late Deputy Brian Lenihan.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Where and when did the Minister approach Dr. Bacon?
Dr. Peter Bacon:
There were two approaches. Through a mutual acquaintance he asked if I would meet him for a chat about the situation. I think that was in November or December 2008. I met him in Government Buildings; he was present with a second secretary. The meeting happened. The meeting ended. I walked away scratching my head and I got a phone call in late January inviting me to have another chat. It was a chat about: "You know, look, the situation is deteriorating; I am canvassing views about what ought to be done, what needs to be done, what the options are." I met him again and I felt that it was a similar discussion to the previous one but he did at the end of it say to me: "You seem to have developed your thoughts significantly more than the last time we spoke. Would you do some work? Would you commit these thoughts to paper and carry out some work?" That was what happened.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Dr. Bacon is an economic consultant. I do not want to ask a leading question.
Ciarán Lynch (Cork South Central, Labour)
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Dr. Bacon will not get used to them here.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Would it have been commonplace that a Government contract like that or a commission to do a report for the Government would have been done through private conversations rather than through the usual channels of tendering?
Dr. Peter Bacon:
I honestly think in the circumstances it would not have been done through tendering. How would it be advertised? A tender such as: "Help us with a crisis." When I was sitting there I think there was already in place an international investment bank which was opining and giving advice on the same subject. That was Merrill Lynch. I do not remember seeing the advertisement for that one either.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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We might get an opportunity to ask that question as well later. At the time that Dr. Bacon was conducting that particular report prior to the establishment of NAMA, did he have any commitments to financial institutions or property companies?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I want to put a quote to Dr. Bacon from the first page of his report prior to the establishment of NAMA: "As regards their property loan portfolios, the six guaranteed credit institutions face cumulative economic impairment on their land and development loan exposures and associated property investment loans of around €34 billion on loans outstanding of €80 billion to €90 billion." Will Dr. Bacon comment on the difference between his estimate and the final figure for impairment on those particular loans? I acknowledge that it was an estimated figure when he was conducting the report.
Dr. Peter Bacon:
I am working from aggregate financial data. As the Deputy will be aware NAMA did not move loans lock, stock, and barrel. What it did was it subjected each and every loan to rigorous scrutiny. I would not have been party, at an individual level, to knowing what the security behind those loans was or what they were worth. There would have been all kinds of cross-guarantees at an individual level, which, working from macro data, one would not have had access to or knowledge of.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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How did Dr. Bacon arrive at the estimated figure which was on page one of his report?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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In more recent times Dr. Bacon seems to have changed his opinion on NAMA. I think in 2012 he said that it was not reaching its potential and that maybe a different course of action should be taken
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Will Dr. Bacon outline what caused him to change his view?
Dr. Peter Bacon:
What caused me to change my opinion is that NAMA has the biggest property portfolio, I think, under one roof, certainly in Europe, and it has acquired that at rock bottom prices. We all know what is happening at the moment in the property market. It goes through cycles. Ireland went through a particularly vicious one. I think the criticisms that I have made of NAMA have not been about the general approach. It is more about the ethos.
My personal opinion, based on what I see - no greater than that - is that it has acted more as a debt collection agency than as a property value maximising entity.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Dr. Bacon used the word "ethos". What does he mean by that?
Dr. Peter Bacon:
I will again make the point. If one asks me from an economic point of view what is wrong with the Irish property sector and where it looks funny compared with property sectors in other jurisdictions, I would say it is the capital structure. They do not have access to long-term funds, which is equity. The property sector, more than any other sector, requires long-term capital. NAMA has brought some of that to bear, but there is no quoted entity collecting equity investment from investors to develop residential or commercial property in Ireland.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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This is my final question on NAMA. It was widely said in 2009 that it would provide banks with additional collateral that could be used to borrow from the ECB. Given that excessive borrowing from the ECB played a key role in triggering Ireland's bailout, what is Dr. Bacon's assessment of the 2009 solution, which related to liquidity problems as opposed to assessing the size of the solvency problems?
Dr. Peter Bacon:
It is a good question. The fundamental problem was a solvency problem. It was masked for some considerable time to some people who were looking at it as a liquidity problem, but there was a liquidity issue. I do not think there was anything wrong. The Irish banking system, not unlike some other European banking systems at the moment which are subject to notice, did need liquidity. I do not think there is any difficulty with that, provided that one did not confuse that with the underlying problem of insolvency. It was not misdiagnosed in the end.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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My last couple of questions are on the guarantee. Dr. Bacon is on record - in the The Sunday Tribuneof 23 January 2011 - as stating that he recommended to the Minister for Finance in March 2009 that there should be an early review of the bank guarantee. I ask him to outline the nature of that recommendation.
Dr. Peter Bacon:
It was simply to get rid of it as soon as we could. There was a contingent liability sitting on it and NAMA was there with the express purpose of removing the uncertainties that surrounded that contingency. No more than that.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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If Dr. Bacon's advice had been adhered to, how could the guarantee-----
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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In regard to the need for an early review-----
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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What impact did that have?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Fair enough, but Dr. Bacon is a keen observer of everything.
Ciarán Lynch (Cork South Central, Labour)
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Can I come back to one matter Deputy Phelan was dealing with to get clarity for the committee from Dr. Bacon? Deputy Phelan referenced the first page of the NAMA report, which states:
As regards their property loan portfolios the six guaranteed credit institutions face cumulative economic impairment on their land and development loan exposures and associated property investment loans of around €XBn [Figure deleted. Market sensitive] on loans outstanding of about €80-90Bn.
An X has been inserted, as the figure was considered too market-sensitive to be put into the public domain at the time. It refers to loans outstanding of around €80 billion to €90 billion. Is that figure still market-sensitive?
Ciarán Lynch (Cork South Central, Labour)
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Okay. Can you tell the inquiry what you consider that figure to be?
Ciarán Lynch (Cork South Central, Labour)
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That may happen at this morning's inquiry later on. In regard to your reflection on what you considered figure X to be back then, is it still your view that figure X stands the test of time and is accurate?
Ciarán Lynch (Cork South Central, Labour)
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That it was underestimated?
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much.
Pearse Doherty (Donegal South West, Sinn Fein)
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Cuirim fáilte roimh an tUasal Bacon. To pick on the comments of the Chairman on the abridged version of Dr. Bacon's report, which has been quoted, I am not sure if he is aware that his entire report was released to me through a freedom of information request, which revealed the X figure. Can he clarify that the X figure on page one, paragraph three of his report is €34 billion?
Dr. Peter Bacon:
I am not going to comment. I do not doubt that the Deputy has been given that figure. I am not going to comment. If he got the figure, he got the figure, and good luck to him. Do not ask me to confirm or deny it. As far as I am concerned, I am still bound by the Official Secrets Act.
Ciarán Lynch (Cork South Central, Labour)
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Deputy Doherty is putting the figure on the record from the report being released to him as being how much?
Pearse Doherty (Donegal South West, Sinn Fein)
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Some €34 billion.
Ciarán Lynch (Cork South Central, Labour)
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Thank you.
Pearse Doherty (Donegal South West, Sinn Fein)
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As I said, the abridged version was the version that was in the public domain for quite a while. The full report is now in the public domain. In the abridged version, as was mentioned by previous Deputies, it is stated that the X figure was based on outstanding loans of €80 billion to €90 billion. The actual report states that this is based on the total value of property loans outstanding in September 2008 of €158 billion. This paragraph is one of the main conclusions of the report. Can Dr. Bacon explain to the committee why the abridged version which was in the public domain for many years contained a loan amount of €90 billion and the actual full report suggests it was higher, at €158 billion?
Pearse Doherty (Donegal South West, Sinn Fein)
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Can I stop Dr. Bacon there? I will give him the full quote, which is:
As regards their property loan portfolios the six guaranteed credit institutions face cumulative economic impairment on their land and development loan exposures and associated property investment loans of around €XBn [Figure deleted. Market sensitive] on loans outstanding of about €80-90Bn.
That is the abridged version, which specifically referred to the six institutions. The first line of the official report states: "As regards their property loan portfolios, looking forward to 2011 the six guaranteed credit institutions...", so we are talking about the exact same six institutions.
Pearse Doherty (Donegal South West, Sinn Fein)
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The abridged version does contain development loan exposures and associated property investment loans.
Dr. Peter Bacon:
Yes, but there is a separate category. It is associated investments. I mentioned in passing that there was a question about cross-guaranteeing. NAMA was only taking on the development loans and associated investments - that is to say, investments that were associated with the development loans. There was another tranche of loans called investment loans which were not included. That is the difference.
Pearse Doherty (Donegal South West, Sinn Fein)
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I will move on, because I am restricted in terms of time. Paragraph 13 of the full version of the report suggests that the €34 billion of losses in the six institutions would require further capital injections of €9.2 billion in core tier 1 capital ratios in certain institutions. Has that figure stood the test of time? What was the actual capital requirement?
Dr. Peter Bacon:
I think it was greater. There is a question of legal requirement and adequacy from the point of view of the markets. I do not know what the final figure was as I stopped looking at this when I stopped getting paid for it. It was, however, of that order of magnitude or greater and I believe it was greater.
Pearse Doherty (Donegal South West, Sinn Fein)
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The record shows that Anglo Irish Bank required a large portion of the total amount. Dr. Bacon's report came out on 20 March 2009, just a number of months after the guarantee was brought in. Paragraph 26 deals with revising the credit guarantee. It states:
A restructuring of the guarantee consistent with the introduction of the NAMA initiative should be seen as an integral element of a comprehensive strategy. In summary, the aim should be to enhance the credibility of the guarantee by simultaneously reducing the contingent liability under it and by extending its temporal scope in relation to the sort of long-term bond issuance which is critical to ensuring the covered institutions' survival.
How could the guarantee, which had a legal underpinning, be restructured at that time, just a number of months after the guarantee was introduced?
Pearse Doherty (Donegal South West, Sinn Fein)
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Why does Dr. Bacon suggest that a restructuring of the guarantee consistent with the introduction of the NAMA initiative should be seen as an integral element of a comprehensive strategy?
Pearse Doherty (Donegal South West, Sinn Fein)
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Did Dr. Bacon put something into this paragraph that he knew could never be done?
Dr. Peter Bacon:
No, I did not know it could not be done. I felt it was worth exploring whether it could be done. Why was the guarantee there? It was because people did not believe the institutions had adequate capital to cover the impairments. If NAMA was put in place and the impairments removed, would we have removed the uncertainty surrounding the institutions in question to the extent that they would not then need the guarantee?
Pearse Doherty (Donegal South West, Sinn Fein)
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Paragraph 29 asks a number of questions on bond issuance relating to the recapitalisation of the banks. Dr. Bacon states:
Another key factor relates to the underlying public finance position and current efforts towards stabilising the deficit which is widening beyond expectations. Then there is the question of the impact of such expansion on the debt and the capacity to service the debt. Ireland has the capacity to absorb additional debt service costs if these were to come about.
How wise or unwise was that statement?
Pearse Doherty (Donegal South West, Sinn Fein)
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Does Dr. Bacon still believe Ireland had the ability to take on additional debt at that time, in the context of bank recapitalisation and a report that suggests that the banks were going to lose €34 billion on property loans?
Sean Barrett (Independent)
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When Dr. Bacon was engaged in work on this subject in the 1998-2000 period, were things like loan-to-value or loan-to-income part of his deliberations or did he concern himself mostly with supply-side issues?
Dr. Peter Bacon:
They were part of my deliberations. They are contained in my first report, which differed from the subsequent two reports in containing the results of an extensive consultation with the stakeholders of the sector, including the financial institutions who provided the lending. On the question of how to judge what size mortgage to give, the answer was consistently two and a half to three times plus one. In other words, the rule of thumb was two and a half to three times the income of the principal household earner and one times the income of a second earner.
Sean Barrett (Independent)
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What about loan-to-value?
Dr. Peter Bacon:
Loan-to-value was less. I think between 80% and 90% would have been regarded as normal. It was, of course, more than 15 years ago but I recall it seemed to me at the time that the main issue was an ability to service the debt rather than loan-to-value and the greater focus was on the income multiple.
Sean Barrett (Independent)
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The graph of house prices shows that events arising from Dr. Bacon's report caused the market to go down but then we just resumed and it kept on increasing at the same rate until the collapse.
Sean Barrett (Independent)
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Were there financial forces and practices, such as weak regulation, which meant that whatever what we did the 2008 collapse was inevitable?
Sean Barrett (Independent)
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Can Dr. Bacon expand?
Dr. Peter Bacon:
I am glad the Senator asked me that question. We must remember the circumstances of the time. It was 1998-99 and a time of Ireland's near-term accession to the euro. Markets were anticipating that, upon Ireland joining the euro, there would be no currency risk between the Irish punt and the euro. This meant that Irish interest rates would converge to euro rates, by which was meant German interest rates. That assumed there would then be capital inflows and arbitrages, which there were. There was increased competition between financial institutions to gain a share of the housing market and, with the undoubted slippage in the application of income criteria, there was a reversal of the slamming of the brakes on investment demand and when that occurred Ireland was in the euro. There was no exchange risk, there were European banks with surplus funds and Irish banks with an opportunity to lend funds. Guess what happened? The brake on speculative and genuine investment demand was removed.
Sean Barrett (Independent)
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What should the Central Bank have been doing at that period?
Dr. Peter Bacon:
To be honest, I am unclear about what legal force the Central Bank could apply in determining what the criteria for banks for mortgage lending should have been. I am aware, as is the Senator, of what it is saying at the moment but at that time two and a half to three plus one was not being adhered to in all cases and as competitive pressure on the banks intensified the tendency to move outside those criteria increased. It was a one-way bet. There was no exchange rate risk and, in effect, quantitative easing was taking place in an Irish economy that was expanding rapidly, meaning we got a bubble.
Sean Barrett (Independent)
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Given where we are now, what should the Bacon report No. 4 contain?
Dr. Peter Bacon:
There will not be one. I do not think there was anything wrong with the original assessment. I do not think in the present circumstances there is a basis of a bubble in the Irish market. For one thing one does not yet have a normally functioning banking sector in relation to mortgage finance. If there were a Bacon report, what would it be focusing on at the moment? It would be saying, "Why in heaven's name, seven or eight years after the collapse, are we still dealing with a mortgage arrears problem?"
To be fair to the Government, it took a calculated risk with NAMA. The principle had been applied, but never on the scale on which NAMA was done. So that problem was removed and I think wisely so because on the basis of the way in which the arrears problem has failed to get resolved, what would have happened if one had left all of the stuff that went to NAMA with the banks to resolve?
So there was a residual left with the banks to resolve themselves. They have not resolved it. A result of that is that the supply of housing to the second-hand market in the current circumstances is constrained.
Michael D'Arcy (Fine Gael)
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Dr. Bacon is very welcome. In terms of the figure X that Deputy Pearse Doherty has just put on the record - that is €34 billion - there is some confusion whether the amount was €34 billion out of €80 billion or €90 billion, or €158 billion.
Michael D'Arcy (Fine Gael)
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We will say it was €34 billion out of €80 billion or €90 billion. Dr. Bacon's figure was remarkably close to the conclusive figure, which was a little bit less than €32 billion. His analysis was concluded in March or April 2009. Is that correct?
Michael D'Arcy (Fine Gael)
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Did Dr. Bacon have sight of the PwC report that was conducted on behalf of the Minister for Finance, subsequent to the bank guarantee? He did not. The fieldwork on that was concluded in December 2008, four months before Dr. Bacon's analysis was concluded. That report stated that the banks were solvent. I ask Dr. Bacon to outline his review of that report.
Michael D'Arcy (Fine Gael)
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Okay. From what Dr. Bacon saw in the period prior to his concluding his report, were the banks solvent at that stage?
Dr. Peter Bacon:
To give the honest answer, I think it appeared to me there was a serious risk to their solvency. Solvency itself is not a "Yes" or "No". I will answer the question in a different way. The conclusion I drew was that the problem that had to be confronted was much more in the nature of resolving a solvency problem than in resolving a liquidity problem.
Michael D'Arcy (Fine Gael)
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I will ask a leading question. When Dr. Bacon concluded his report, were the banks solvent or not in his opinion?
Michael D'Arcy (Fine Gael)
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May I ask the question a little bit differently then?
Michael D'Arcy (Fine Gael)
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Would the quantum of funds required have wiped out the banks' capital ratios?
Michael D'Arcy (Fine Gael)
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Does Dr. Bacon have any knowledge on the subsequent NAMA pricing model?
Michael D'Arcy (Fine Gael)
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So Dr. Bacon has no information on that, along with everybody else.
Point 32 on page 8 of Dr. Bacon's submission states, "In conclusion, it appears that the Asset Management approach has the potential to offer greater assistance to achieving resolution of the impairment issue upfront and maximising taxpayer returns, over the longer term." Has NAMA been run in an appropriate way to maximise taxpayer returns over the longer term?
Dr. Peter Bacon:
I am in no position to evaluate NAMA and I have not evaluated NAMA. The only remark I would make is that I think one significant development, it appears to me, subsequent to my work and subsequent to the establishment of NAMA was, of course, the negotiated programme, the bailout and the troika. I think there was a decision on foot of the troika recommendation to accelerate NAMA receipts. That certainly would have infringed on any effort to achieve a long-term maximisation.
Michael D'Arcy (Fine Gael)
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I ask about Dr. Bacon's third report, which was implemented.
Michael D'Arcy (Fine Gael)
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Yes. The implementation of the recommendations that had the effect of cooling the property market-----
Michael D'Arcy (Fine Gael)
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Sorry, the first report in 2001. Subsequently those recommendations were removed. Does Dr. Bacon believe that the then upcoming general election had any influence?
Ciarán Lynch (Cork South Central, Labour)
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I thank Senator D'Arcy.
Eoghan Murphy (Dublin South East, Fine Gael)
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I ask Dr. Bacon to clarify an issue that came up earlier. When he was designing the March 2009 report for NAMA, did he hold any positions or directorships that might have been in conflict with his designing that report?
Eoghan Murphy (Dublin South East, Fine Gael)
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The report states that it is the report of the special adviser at the NTMA. Is that just-----
Eoghan Murphy (Dublin South East, Fine Gael)
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Yes, I know. That was just a formal title that was given to Dr. Bacon on the basis of conducting for the Minister-----
Eoghan Murphy (Dublin South East, Fine Gael)
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Where did the recommendation to house NAMA in the NTMA come from?
Dr. Peter Bacon:
Me. Why? Because the capital market skills are down there. It was the only part of the public service where I would think there are high-quality capital-market skills. I think I dealt with that. Maybe Deputy Doherty would be able to fill the Deputy in. It was certainly, I think, in the main report - the why and wherefore.
Eoghan Murphy (Dublin South East, Fine Gael)
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Dr. Bacon goes through a couple of reasons in the main report, but it was unusual to house NAMA in the NTMA.
Eoghan Murphy (Dublin South East, Fine Gael)
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Dr. Bacon gave a couple of specific reasons. What I am curious about is that he subsequently talked about the ethos in NAMA and it being a debt-collection agency.
Eoghan Murphy (Dublin South East, Fine Gael)
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Was Dr. Bacon surprised at that outcome given that it was housed in the NTMA?
Dr. Peter Bacon:
Somewhat, but that is the function of the legislation. They get a report on 20 March, they implement, they make the announcement on, whatever it was, 9 April, and then there is a whole statute that grows for, I think, 18 months or two years. In the end what one finishes up with is a statutory agency implementing a statute.
Eoghan Murphy (Dublin South East, Fine Gael)
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Did it end up as Dr. Bacon intended it to end up?
Eoghan Murphy (Dublin South East, Fine Gael)
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Dr. Bacon talked about this focus on debt collection and he said it was difficult to know why it was being implemented in this way and that a possible reason was that it would not be possible to find the expertise to run that kind of operation in Ireland.
Eoghan Murphy (Dublin South East, Fine Gael)
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I ask Dr. Bacon to elaborate on that.
Did Dr. Bacon feel NAMA had the required expertise to do its job as he had intended it?
Dr. Peter Bacon:
NAMA is a major, major property portfolio. The number of people in the world who have headed up that kind of operation is quite small. It is very specialist - think of Blackstone, BlackRock and people who have bought assets from NAMA. I would think the skill set did not exist in Ireland to take on the management of that portfolio.
Eoghan Murphy (Dublin South East, Fine Gael)
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The skill set did not exist in Ireland to take on the management of that portfolio. Despite that, the NTMA was the best place.
Eoghan Murphy (Dublin South East, Fine Gael)
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Dr. Bacon mentioned the time it took from his designing NAMA to it coming into effect and then the transference of loans took some time as well. Two previous witnesses have criticised that delay.
Eoghan Murphy (Dublin South East, Fine Gael)
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Would there have been a benefit to anyone in that delay?
Eoghan Murphy (Dublin South East, Fine Gael)
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Okay.
Dr. Peter Bacon:
There was certainly a cost. The sooner one tackles the problem and gets it off banks' balance sheets, the better. I mean, what were the banks doing? One had a situation where there was going to be a major interface between the Irish banking system and a new agency, and both sides had to wait until legislation was in place before they could take their tracksuits off.
Eoghan Murphy (Dublin South East, Fine Gael)
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My final question is this. The legislation is in place and they get to work. Dr. Bacon has criticised the pace at which it has done its work.
Eoghan Murphy (Dublin South East, Fine Gael)
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"I think it would help the market if assets were sold quicker. I think the pace of sales to date has only been forestalling recovery".
Ciarán Lynch (Cork South Central, Labour)
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Who is the Deputy quoting from?
Eoghan Murphy (Dublin South East, Fine Gael)
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An interview with Dr. Bacon in theIrish Independent in October 2010.
Dr. Peter Bacon:
The context was that I think there are some assets - I think they are still there in NAMA - that had no value, have no value and will have no value. They could have been got rid of straight away.
Kieran O'Donnell (Limerick City, Fine Gael)
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I want to deal with two items. First, I want to clarify a few points regarding NAMA. Am I correct in saying Dr. Bacon presented his report to the then Minister for Finance, Mr. Brian Lenihan, on 20 March?
Kieran O'Donnell (Limerick City, Fine Gael)
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And the actual report was published on 8 April 2009.
Kieran O'Donnell (Limerick City, Fine Gael)
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I think it was 8 April.
Kieran O'Donnell (Limerick City, Fine Gael)
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Does Dr. Bacon stand over his report of 20 March?
Kieran O'Donnell (Limerick City, Fine Gael)
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Does he think it differed in any way from the abridged report that was published on 8 April?
Kieran O'Donnell (Limerick City, Fine Gael)
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The report that Deputy Doherty got under freedom of information, which is available on the website, shows that Dr. Bacon was looking at a discount of approximately 22% on all the loans. Is that correct?
Kieran O'Donnell (Limerick City, Fine Gael)
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On average. I can quote the figures for each of the institutions. Dr. Bacon was looking at around 22% for AIB, 21% for Anglo and 21% for Bank of Ireland.
Dr. Peter Bacon:
That is on loans for development and investment but NAMA was being established to take only loans for development and associated investments, not all investments.
Kieran O'Donnell (Limerick City, Fine Gael)
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However, when NAMA was actually implemented, the scale of the write downs was, on average, 57%. That is a big leap from an average of 22%. The question is how we got to that point. Dr. Bacon's report that was presented to Government on 20 March 2009 is a very detailed report that specifically goes down through each bank and Dr. Bacon specifically indicates how the €158 billion of loans is made up for each of the individual banks. That gave rise to a write-off of the order of €34.4 billion, which was a 22% average discount. We then come to a situation where, when the abridged version was published on 8 April, Dr. Bacon was looking at €74 billion of loans with a write-off of €42.2 billion, which is about 57% of a discount. When Dr. Bacon was writing his report for 20 March, if he had known that the discounts were going to be of the order of nearly 60%, would he have recommended the establishment of NAMA?
Kieran O'Donnell (Limerick City, Fine Gael)
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But-----
Kieran O'Donnell (Limerick City, Fine Gael)
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In the limited time I have-----
Ciarán Lynch (Cork South Central, Labour)
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You spent a lot of time asking the question. I have to allow the witness a respectable period of time to respond.
Dr. Peter Bacon:
I will try and make the answer as brief as I can. One would have been leaving behind a greater part. What was revealing about the final loan discounts that NAMA instituted or imposed was how large they were-----
Kieran O'Donnell (Limerick City, Fine Gael)
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Did Dr. Bacon know when the abridged report was published on 8 April 2009 that the discounts were going to be of the order that they were?
Kieran O'Donnell (Limerick City, Fine Gael)
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Dr. Bacon has agreed with Deputy Doherty that the €34 billion was in regard to loans of the order of €80 billion, which is very close.
Kieran O'Donnell (Limerick City, Fine Gael)
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Clearly, Dr. Bacon must have known when the abridged report was published on 8 April-----
Ciarán Lynch (Cork South Central, Labour)
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The Deputy is over time.
Kieran O'Donnell (Limerick City, Fine Gael)
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Surely, Dr. Bacon must have known that the discount was going to be of the order of 60%.
Ciarán Lynch (Cork South Central, Labour)
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You cannot make suggestions like that. You can ask the question.
Kieran O'Donnell (Limerick City, Fine Gael)
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How can Dr. Bacon reconcile the position he gave to Deputy Doherty, where he said €34 billion was in regard to loans of €80 billion, with the position that, when the report was published on 8 April, he did not know the discounts were going to be that high?
Ciarán Lynch (Cork South Central, Labour)
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Dr. Bacon can answer.
Kieran O'Donnell (Limerick City, Fine Gael)
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The banks were not solvent.
Ciarán Lynch (Cork South Central, Labour)
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I have to allow the witness to respond.
Kieran O'Donnell (Limerick City, Fine Gael)
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My point is that the report Dr. Bacon provided to Government on 20 March is fundamentally different to the report that was published on 8 April.
Dr. Peter Bacon:
There is no inconsistency between the two. On the numbers that are being quoted, the denominator in one case is loans for development and associated investments, that is €80 billion to €90 billion. The other figure is loans for development and all property investments. That is the only difference. The €34 billion is the €34 billion, not the estimate that I came up with.
Marc MacSharry (Fianna Fail)
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I thank Dr. Bacon for taking the time to be with us today. With regard to the Central Bank, Dr. Bacon said in his testimony that it was "unclear what legal force the Central Bank can apply to determine what mortgage lending should be". Can he expand on that? Does he feel the Central Bank had any power at the time to determine how banks acted? What is his sense of that?
Marc MacSharry (Fianna Fail)
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That is very clear. In the context of the financial crisis, Dr. Bacon has stated:
Ireland was not hit by a sudden shock in mid to late 2008 that no-one could have foreseen, as has been often contended. The fact is that the stock markets could see what was coming-----
Ciarán Lynch (Cork South Central, Labour)
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Is the Senator referring to Dr. Bacon's opening statement?
Marc MacSharry (Fianna Fail)
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No, I am quoting from the report, A Contribution to the Debate on National Economic Recovery. Why is Dr. Bacon of the view that everyone - with the exception of Morgan Kelly and David McWilliams - did not get it and failed to read what was happening in the stock markets? I refer in this regard to the Government, the IMF, the EU Commission, the Central Bank, the regulator and the ESRI.
Marc MacSharry (Fianna Fail)
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Did Dr. Bacon foresee what was going to happen?
Marc MacSharry (Fianna Fail)
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In terms of his testimony today, Dr. Bacon has clearly indicated his belief in the correct nature of the establishment of NAMA. He suggested that short-term debt recovery versus the realisation of the long-term value to the taxpayer may be debated. Is he of the view that if more capital had been available to NAMA in respect of work-outs rather than disposals, it could have given rise to better results for the taxpayer? Does he feel that the accelerated winding down of NAMA is in the best interests of the taxpayer? Should disposals and work-outs have been staggered and should there have been a focus on obtaining a better return for the taxpayer? Have the optimum results been achieved?
Dr. Peter Bacon:
The short answer in respect of the Senator's final question is that, all other things being equal, it is not optimal that realisations have been accelerated to a greater degree. To be fair, however, I was careful to use the phrase "all other things being equal". The truth is that they were not equal. One went to the bailout programme and that programme contained the requirement to accelerate disposals. Ireland needed that bailout programme so it is not a question of what was best for the taxpayer. It would have been a bad decision to say "Look, we are not going to go for this bailout programme because there is this requirement in it and we need to work out NAMA for longer". Other things being equal, the difference between a good investment and a bad investment is often time.
Ciarán Lynch (Cork South Central, Labour)
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The Senator has two minutes remaining.
Marc MacSharry (Fianna Fail)
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In A Contribution to the Debate on National Economic Recovery, Dr. Bacon refers to the potential for NAMA to be part privatised to an international private equity investor.
Marc MacSharry (Fianna Fail)
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Does he remain of the view that this could be done?
Dr. Peter Bacon:
Yes, and I think it is happening but probably in a different way. I mentioned that one had the welcome emergence of residential quoted real investment trusts. In effect, that is resulting in a privatisation of NAMA assets.
Marc MacSharry (Fianna Fail)
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Again, in A Contribution to the Debate on National Economic Recovery, Dr. Bacon refers to how cautious the EU response was to the crisis here. Did the EU response benefit or adversely affect the Irish taxpayer?
Ciarán Lynch (Cork South Central, Labour)
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Final question.
Marc MacSharry (Fianna Fail)
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With the benefit of hindsight and his expertise as an economist, will Dr. Bacon give us a sense of his view on the Irish response to the crisis?
Marc MacSharry (Fianna Fail)
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That of the Irish Government. I refer to the response here in Ireland to the crisis. With the benefit of hindsight and his expertise as an economist, will Dr. Bacon provide his assessment in that regard?
Marc MacSharry (Fianna Fail)
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Not in this room.
Marc MacSharry (Fianna Fail)
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I thank Dr. Bacon.
Susan O'Keeffe (Labour)
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Did anybody in authority, either formally or informally, seek Dr. Bacon's advice about the bank guarantee?
Susan O'Keeffe (Labour)
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Between his housing report in 2000 and his report to NAMA in 2009, was Dr. Bacon involved in compiling any other reports for Departments, semi-State agencies or similar entities?
Susan O'Keeffe (Labour)
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I appreciate that is how Dr. Bacon makes his living. However, I am specifically asking whether he compiled any other reports for Departments or whether his work during the period related to the private sector.
Susan O'Keeffe (Labour)
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When did Dr. Bacon work as an adviser to Bertie Ahern?
Susan O'Keeffe (Labour)
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What kind of an adviser was Dr. Bacon to Mr. Ahern?
Susan O'Keeffe (Labour)
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How did that come about. Was Dr. Bacon a member of the party?
Susan O'Keeffe (Labour)
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So how did it come about that Dr. Bacon worked with him?
Dr. Peter Bacon:
I think he was looking for an economic adviser and he approached me. I had left employment in Goodbody Stockbrokers and set up my consultancy practice. I think it was a year or two in existence when he approached me and asked me to be his economic adviser. I did it for a very short while - three months, I think, or maybe four. I do not think it was any longer than that. I held the position for a short duration.
Susan O'Keeffe (Labour)
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At the turn of the previous decade, Dr. Bacon made a number of recommendations in respect of how to calm the housing market. Variously, those recommendations were subsequently overturned, ignored or abandoned.
Susan O'Keeffe (Labour)
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At some point thereafter, Dr. Bacon started working for a number of developers and, as he indicated earlier, that is his job. Ultimately, how would he describe himself? Would it be as an economist or a developer?
Susan O'Keeffe (Labour)
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But Dr. Bacon was a director of Ballymore Properties.
Susan O'Keeffe (Labour)
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What was his relationship with that company if he was a director rather than a developer?
Susan O'Keeffe (Labour)
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Yes, but Dr. Bacon was also a director of the business.
Susan O'Keeffe (Labour)
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Dr. Bacon obviously identified the fact that problems were arising in the 1990s. He had concerns and he made recommendations. At what point did he realise that everything was going south and become concerned about what was happening?
Susan O'Keeffe (Labour)
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Yes, and after that did Dr. Bacon express them to anybody else?
Susan O'Keeffe (Labour)
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Did anybody in particular ask about Dr. Bacon's concerns as opposed to those who might have listened to them originally?
Susan O'Keeffe (Labour)
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If we move on from Dr. Bacon's 2000 report, he was obviously still working as an economist and he had private clients and Government clients. At what point did he think "Things are getting worse. Things are very serious."?
Dr. Peter Bacon:
To be honest, as an economic consultant one does the job and one moves on to the next one. I think the next one might have been in the area of pensions reform. One keeps in touch in the sense that one reads the daily newspapers and monitors the situation. As I have indicated, I did carry out individual projects for property developers.
They know more about property development, I do not. They use my skills in relation to economics and I am happy to provide that service.
Susan O'Keeffe (Labour)
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But they hired Dr. Bacon for his skills and they knew about his work previously.
Susan O'Keeffe (Labour)
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David McWilliams said when he was here that "...ghost estates are indicative of how supply does not respond." He was talking about the housing market. What is Dr. Bacon's response to that?
Dr. Peter Bacon:
I think it shows that demand does not respond. If one builds houses in places the market is not looking for or not willing to live, for the price one offers, or if one offers a style of house or quality of development which the market does not want, then ghost estates prove that the market penalises.
Susan O'Keeffe (Labour)
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What did Dr. Bacon think of section 23? It was in existence when he was in the Department, so did he have an observation about section 23 when he was in the Department as an adviser, as opposed to when he wrote the reports beyond that?
Susan O'Keeffe (Labour)
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But they kept going?
Susan O'Keeffe (Labour)
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Why were they unnecessary?
Susan O'Keeffe (Labour)
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So why were they there?
Susan O'Keeffe (Labour)
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Did Dr. Bacon specify to the Minister at the time that they were unnecessary?
Susan O'Keeffe (Labour)
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And what did he say?
Susan O'Keeffe (Labour)
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I meant when the witness was an adviser to the Minister.
Susan O'Keeffe (Labour)
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There was a confusion there.
Ciarán Lynch (Cork South Central, Labour)
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There is no confusion, I am moving on, Deputy Michael McGrath.
Susan O'Keeffe (Labour)
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For the record, I was trying to clarify.
Ciarán Lynch (Cork South Central, Labour)
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Quickly and succinctly.
Susan O'Keeffe (Labour)
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I am not asking a question, I just want to make sure that I have not misled Dr. Bacon. Is Dr. Bacon happy that he has clarified that?
Michael McGrath (Cork South Central, Fianna Fail)
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Thank you Chair, and I welcome Dr. Bacon. Can I make sure that we are connecting the numbers correctly here? Many numbers have been thrown around during the course of different questioning? NAMA paid €31.8 billion for loans with a book value of €74 billion, an overall impairment of about €42 billion. Are we correct in relating that back to the broad estimates, made by Dr. Bacon on a macro basis, of €34 billion potential impairment facing the banks? When Dr. Bacon was preparing the report in 2009 which informed the establishment of NAMA, he said to Senator D'Arcy that he did not have access to the PricewaterhouseCoopers' reports compiled at that time. Was Dr. Bacon aware that they existed or were being prepared?
Dr. Peter Bacon:
No. The work I did on the proposal for a national asset management agency was delivered on Friday, 20 March 2009. I am trying to think when it commenced, I know I met the Minister in late January, so it was shortly after that. It was the most intensive piece of work I have done in a 40 year career. It was done within the National Treasury Management Agency building - they kindly provided me with a room and coffee. Both were required. In terms of what was available to me, effectively that was Central Bank bulletins.
Michael McGrath (Cork South Central, Fianna Fail)
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I put it to Dr. Bacon that the task he was given was to evaluate the options for resolving property loan impairments and associated capital adequacy of Irish credit institutions. For a number of months, PwC was actually in the banks examining those very issues. PwC gave a report to the Minister for Finance on Friday, 20 February 2009, a month before Dr. Bacon's report. It comprised a detailed loan review of Anglo Irish Bank's top 70 land and development exposures, which accounted for 63% of the bank's total land and development loan book. Was Dr. Bacon not aware of that or given access to any of those records or documents?
Michael McGrath (Cork South Central, Fianna Fail)
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Even though he was examining matters which were very much related?
Dr. Peter Bacon:
Yes, but at a different level. I work at a policy level, evaluating different approaches. I am not the same kind of animal as PwC. I am a one-man band who sits down and works it out, at a conceptual level and with data. From what the Deputy tells me about the PwC report, it was in the banks looking at loans or lending, that is not my bailiwick.
Michael McGrath (Cork South Central, Fianna Fail)
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Yes, but Dr. Bacon was making ultimate recommendations around the issue of capital adequacy and the impairment of loans. There was a lot of detail there in the system which, according to evidence, was not made available to him.
Michael McGrath (Cork South Central, Fianna Fail)
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That PwC report made the point that even under the adverse scenario, Anglo was projected to meet the minimum capital requirements at the end of September 2010. That conclusion was there a month before Dr. Bacon's report was completed.
Michael McGrath (Cork South Central, Fianna Fail)
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When Dr. Bacon was doing his work in 2009 did he ever envisage that €64 billion would ultimately have to be injected into the Irish banking system?
Michael McGrath (Cork South Central, Fianna Fail)
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Did he not believe the problem was on that scale?
Dr. Peter Bacon:
I am sorry I laugh, but I remember the response when I presented the figures in my report. There was a standing committee, chaired by the Minister, comprising the suspects one would expect - finance, Central Bank and NTMA. I was invited to attend one of those and the Minister asked how my work was going and had I any numbers. I gave the meeting a work in progress account. I suppose that surprise was my memory of that meeting. Surprise from people at the numbers that were coming out.
Michael McGrath (Cork South Central, Fianna Fail)
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Beyond his reports which relate to 1998, 1999 and 2000 in terms of the property market, what in Dr. Bacon's view were the main drivers or ingredients of the rapid increases in residential property prices seen during 2004, 2005 and 2006?
Dr. Peter Bacon:
The main ingredients were: the relaxation of the interest deductibility measure; the low interest rates - excessively low for the Irish economy which was growing strongly; and the unlimited supply of finance from international banks to Irish banks, a result of the removal of euro exchange risk. They were the ingredients which increasingly fed speculative demand. There are very few laws in economics, but demand and supply is one of them. If supply goes up and prices go up then something funny is going on. That was happening in the Irish housing market. Supply was accelerating, there is no doubt - in one year 90,000 houses were built - yet prices were accelerating. One looks at the population dynamics, that is a bubble.
Supply was accelerating - there is no doubt about that. There was one year in which we built 90,000 houses, yet prices were accelerating. When one looks at the population dynamics, that is a bubble.
Ciarán Lynch (Cork South Central, Labour)
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I invite Deputies Joe Higgins and John Paul Phelan to ask some brief supplementary questions before concluding proceedings.
Joe Higgins (Dublin West, Socialist Party)
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As I have only three minutes for questions and answers, I will quickly put three questions.
Joe Higgins (Dublin West, Socialist Party)
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Dr. Bacon described real estate investment trusts as a positive development. I will put an alternative view that has been expressed to me by a mortgage holder who is having a loan transferred to one of these trusts. It was put to me that these trusts are vulture capitalists and these transfers make the mortgage holders position very vulnerable. Will Dr. Bacon comment on that alternative view?
I asked Dr. Bacon a question on the affordability of homes in which I noted that the price of a home increased in each year in the ten-year period from 1996 to 2006 by an amount equivalent to the average industrial wage. Dr. Bacon appeared to minimise the apparent severity of these increases by stating that many people earned more than the average industrial wage. While that is true, in 2006, when the average industrial wage was €30,000, two thirds of all incomes were less than €30,000 and the median annual income was €25,000 per annum. In light of these figures, will Dr. Bacon reconsider his view on whether these price increases were inordinate?
In the mid-2000s, it was reported in The Irish Timesand many other newspapers that 11 acres of residential development land in Stillorgan had been bought in 2000 for €32 million and sold four years later for €85 million before any building had taken place. Given that permission had been granted for 478 apartments on the site, the speculative gain in this transaction would have added €100,000 to the price of each apartment. As a long-time consultant on property issues, does Dr. Bacon consider it was moral or immoral to allow this level of profit-taking - some might describe it as profiteering - in land for what is a basic human need of a home?
Dr. Peter Bacon:
On the first question about the real estate investment trust, this is a quoted vehicle on the Irish Stock Exchange, with investors. As to what are the characteristics of these investors, they could include the Deputy, me or an institution. I do not think there is a particular type of investor - a "vulture", to use the Deputy's word - involved in real estate investment trusts. There is a diversity of investors. The attraction of the real estate investment trust - or the benefit, as I see it - is that it is a quoted vehicle that enables anyone to invest in its shares.
Will the Deputy briefly remind me of his second question?
Joe Higgins (Dublin West, Socialist Party)
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It related to affordability.
Dr. Peter Bacon:
The Deputy is quite right. The second and third reports recognised what was happening was at the bottom of the market. The market had raced away and there was a yawning gap for people on lower incomes trying to get on to the first step of the ladder. The reports contained specific measures to try to address that, such as shared ownership schemes and partial equity. There were specific measures contained in both the second and third reports to try to deal with that.
On the Deputy's third point, I can remember being asked by a commentator in an RTE programme, which I believe was broadcast on 9 April, how I could morally stand over something. The reason I remember the answer I gave at the time was that I got an awful lot of stick for it. I answered that I was an economist, not a moralist. I cannot give an answer on a moral issue and the morality of something; I can only deal with the economics of it.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I have three brief follow-up questions.
I want to get something straight on the figure of €34 billion. Dr. Bacon stated he had access to information that was in the public domain and in Central Bank bulletins. Did he have access to any information from the Financial Regulator or Department of Finance?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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On the National Asset Management Agency, in answer to a question from Deputy Eoghan Murphy, Dr. Bacon stated, perhaps jocosely, that he stopped having a serious interest in NAMA when he was no longer paid to have an interest in it. Several members, including me, have quoted media reports from 2010, 2011 and 2012 in which Dr. Bacon gave strong opinions and comments on the workings of NAMA. If he no longer had such an interest in the agency, on what did he base his comments? Did Dr. Bacon work for property development companies in the post-2009 period?
Dr. Peter Bacon:
To deal with the last question, the answer is "No". To deal with the question before that, I think I said that any of the comments I have made about NAMA have largely been in relation to the point that I have re-emphasised here, namely, ethos and debt collection. That is the only point I have made and it is based purely on impression.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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In response to a question from Deputy Michael McGrath, Dr. Bacon spoke about a meeting chaired by the late Minister for Finance, Deputy Brian Lenihan, and attended by the usual suspects. Who were the members of the committee?
Ciarán Lynch (Cork South Central, Labour)
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He said they were the usual members, not the usual suspects.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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That is fair enough. Where and when did the meeting take place and why was Dr. Bacon present?
Dr. Peter Bacon:
I was present because I was asked to attend. From memory, I think it took place shortly before St. Patrick's Day. It was before my report was finalised and maybe the Minister wanted to get a sense of that.
The Deputy asked who was present. There were representatives from the Central Bank, the NTMA, the regulator, the Department of Finance, a firm of legal solicitors and Merrill Lynch. I think that was it. As to what it was, it seemed to me to be a monitoring committee. I attended it-----
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Dr. Bacon stated that it was a standing committee.
Ciarán Lynch (Cork South Central, Labour)
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There were a number of committees around that time, one of which was the domestic standing group.
Ciarán Lynch (Cork South Central, Labour)
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I propose to wrap up with a couple of issues. To return to a number of responses Dr. Bacon gave to Deputies Joe Higgins, Michael McGrath and other speakers, his reports focused extensively on the need to increase supply in the housing market to dampen house prices. Is that a fair conclusion? They did not really examine the commercial and retail property sector but were focused strictly on residential and investment property.
Ciarán Lynch (Cork South Central, Labour)
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Housing supply increased substantially in the years prior to 2008, as noted by Dr. Bacon and others, and this did not appear to restrain house price inflation at the time. Loan-to-value rules were not properly implemented and, by Dr. Bacon's own terms, income ratios began to drift out of sync. In addition, in the buy-to-let sector, 100% mortgages, interest-only payments and so forth were provided. Mortgages terms were also extended to 35 years. This is a summary of the behaviour in the residential property sector at the time. Are housing markets somewhat different from other markets in that normal rules of supply and demand often do not explain how they work? David McWilliams, in his testimony to the inquiry last week, stated that the crisis was very much credit-fuelled and was not an issue of supply and demand.
Dr. Peter Bacon:
I think it was credit-fuelled but I think what the credit was fuelling was demand. The housing market is different from buying a banana. The stock is effectively fixed and adjustments to the stock take place very slowly. That is in the nature of it, and land acquisition, planning and all the rest can take five or six years. Once speculative forces start to take off in the housing market, it is a pretty safe bet that the trend will not be reversed.
Ciarán Lynch (Cork South Central, Labour)
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The Central Bank is encouraging banks to revert to 20-year mortgage loans, which are the traditional mortgage schedule. In terms of Dr. Bacon's recommendation to extend the schedule to 35 years, would such a measure enhance access to credit for purchasers?
Dr. Peter Bacon:
No. It would enhance the type of credit that is available to the purchaser.
Going back to Deputy Higgins's point, with a 35-year mortgage one is going to pay more over the lifetime of the mortgage than with a 20-year mortgage, but in the early years for a low-income householder, one enables them possibly to get on to the ladder.
Ciarán Lynch (Cork South Central, Labour)
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In July 2009, the Central Bank came out with a series of recommendations about income ratios - not setting off rooms in the house for letting purposes so that could be looked at. It was very strident on the issue of pulling back from the 35-year schedule, which would certainly be in conflict with Dr. Bacon's recommendation for 35 years. Does he still stand over the 35-year recommendation?
Ciarán Lynch (Cork South Central, Labour)
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That brings me to the present. Would Dr. Bacon still recommend 35-year mortgages in today's market?
Ciarán Lynch (Cork South Central, Labour)
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I thank Dr. Bacon for appearing before the inquiry. The objective of the inquiry is not just to look at the past and learn the lessons, but going into the future to ensure that the type of crisis that was visited on the Irish nation is not rested upon people's shoulders once more. Does Dr. Bacon have any advice or recommendations for this inquiry in a forward-looking sense?
Ciarán Lynch (Cork South Central, Labour)
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I thank Dr. Bacon for his participation today. It has been a very informative and valuable meeting, which has added to our understanding of the factors that led to the banking crisis in Ireland.
I propose that we suspend for 15 minutes and return at 11.55 a.m.
Ciarán Lynch (Cork South Central, Labour)
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We now move back into public session for the second hearing of this morning. I welcome to the meeting Professor Alan Ahearne, NUI Galway, on issues relating to early warnings, and divergent and contrarian views in the context of the banking crisis in Ireland. Professor Alan Ahearne is a professor and head of economics at the National University of Ireland, Galway. He is chairman of the steering committee governing the newly launched Economic and Social Research Institute, the ESRI, and Department of Finance Joint Research Programme on the Macroeconomy and Taxation. He has served as external adviser to the Strategy, Practice and Review Department of the International Monetary Fund. He is a member of the Commission of the Central Bank of Ireland. He is also a member of the Central Bank's audit and risk committees. Prior to coming to Galway in 2005, Professor Ahearne was senior economist at the Federal Reserve Board in Washington, D.C, where he worked for seven years. There he advised Alan Greenspan, Ben Bernanke, and other Federal Reserve governors on developments in the global economy. He was principal economist at the Federal Reserve covering the Japanese and Chinese economies. He served as a special adviser to former Minister for Finance, the late Deputy Brian Lenihan, from March 2009 to March 2011. Professor Ahearne's areas of expertise are macroeconomics and international finance. His research includes studies on property markets in Ireland and other industrial countries, global current account imbalances and exchange rates and the economic performance of the euro area. Professor Ahearne is very welcome before the inquiry this morning.
Before I begin, I wish to advise the witness that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If he is directed by the Chairman to cease giving evidence in relation to a particular matter and he continues to do so, he is entitled thereafter only to a qualified privilege in respect of his evidence. He is directed that only evidence connected with the subject matter of these proceedings is to be given. As he has been informed previously, the committee is asking witnesses to refrain from discussing individuals in this phase of the inquiry. Members are reminded of the long-standing ruling of the Chair to the effect that members should not comment on, criticise or make charges against a person outside of the House or an official by name, or in such a way as to make him or her identifiable.
I now invite Professor Ahearne to make his opening remarks to the inquiry please.
Professor Alan Ahearne:
Chairman and members of the joint committee, I thank you for inviting me here to testify today. In the invitation to appear before the committee, I was asked to discuss issues relating to early warnings, divergent and contrarian views in the context of the banking crisis in Ireland. In my opening statement, I will focus on the views that I expressed during the bubble years about house prices, the potential effect on the economy and the financial system of a reversal in property prices, and the evidence on which those views were based.
My own perspective on the Irish housing market during the bubble years was informed in large part by research on the international experience with housing booms and busts that I had done when I worked for the US Federal Reserve. In a study I wrote with several of my former colleagues, which was published on the Federal Reserve's website in September 2005, we identified no fewer than 44 episodes of house price booms and busts in 18 advanced countries since 1970. I have provided a copy of this paper to the members of the committee.
It struck me at the time that paper was published that given developments in the housing market in this country, the analysis contained in the paper could be relevant for Ireland. As I wrote in articles in The Sunday Business Postand the Sunday Independentin October 2005, shortly after I left the Federal Reserve to move back to live in Ireland, "Given the eye-popping gains in house prices in Ireland over the past decade, the foreign experience is particularly relevant". What the foreign experience analysed in the paper shows is that periods of prolonged rises followed by protracted falls are a surprisingly common feature of house prices in advanced countries. The study shows that certain financial conditions, such as low interest rates, ample liquidity, and financial deregulation, are usually present in past house price surges, though other factors such as demographics and buoyant income growth also help explain these booms.
At the time, interest rates in Ireland were at very low levels, with the European Central Bank’s main policy interest rate at 2%, having been cut from a peak of 4.75% in 2000. It was clear at the time that such low interest rates were not appropriate for Ireland’s rapidly growing economy.
A common feature of housing booms and busts is that around six to eight quarters before the peak in house prices, interest rates begin to move up. The ECB began to hike interest rates in December 2005, and within 18 months the ECB’s policy rate had doubled. Writing in 2007, I pointed out that, "The blow to affordability from rising interest rates and the knock-on effect on house prices should be obvious". The 2005 Federal Reserve study of the international experience of booms and busts shows that, after reaching a peak, real house prices subsequently fall for about five years, on average, and their previous run-up was largely reversed. Put simply, the bigger the boom, the bigger the bust.
The study found that swings in house prices can have important implications for both economic activity and financial stability. We found that in the past, major declines in house prices were often associated with economic downturns, slumps in consumer and investment spending, and at times contributed to financial distress, particularly when nominal collateral values also declined significantly.
Looking across countries, we noted that a historically high number of countries at that time were experiencing abnormally rapid rises in house prices. We warned that, "If these prices follow the same patterns as before, house prices in a large number of these countries are likely to decline in real terms at some point in the not-too-distant future". One question that arises is whether there exist indicators that can act as reliable telltale signs that housing is overvalued. The evidence suggests that comparing house prices and rents provides a useful, but by no means infallible, benchmark for valuing houses, in the same way that the ratio of stock prices to dividends is commonly used to measure valuation in the stock market. Rents are a key determinant of the value of housing and as such should not move too far out of line with prices.
House prices that are unusually high relative to rents may indicate that housing is overvalued.
Writing in October 2005, I noted: “Ireland’s price-rent ratio is currently higher than at any time for which we have reliable data, having soared since early 2002 as rents began to decline. In the first quarter of 2005, the average price paid for a house nationally was about €256,000 and the average annual rent was €8,800. The resulting price-rent ratio of 29 stood roughly 2½ times above its level in 1996.”
I concluded that this unusually high level of house prices relative to rents was mainly supported by large expected increases in house prices. The property market was pulling itself up by its own bootstraps. Property investors, for example, were not too bothered that rents were low, since they anticipated hefty capital gains on property. Once investors came to realise, however, that those rosy expectations were going to disappoint, it became clear that house prices were badly misaligned with rents and the market went into reverse.
Another question we address in the Fed paper is how house price reversals affect different sectors of the economy. We found that home buyers appear to be the most affected by fluctuations in house prices, especially if they lose their jobs in a downturn. We did note that low initial loan to value, LTV, ratios offered some protection to home owners. From that perspective, I expressed concern in 2006 and 2007 about rising loan-to-value ratios for mortgages. Data showed that one in three new home buyers in 2006 took out a 100% mortgage. Moreover, the number of first-time buyers taking out loans with little or no deposit doubled in 2006 from the year before. In an interview for Irish Property Buyerin July 2006 I said: "What we should be seeing are moves to restrict the loan to value ratios for mortgages, for instance. That would be a good start. Giving people 100% mortgages is a move in completely the wrong direction. It brought in people on the margins and in the event of a downturn they are going to be very exposed." Worryingly, the data also shows that nearly two thirds of all new home mortgages taken out in 2006 had amortisation periods of 31-35 years or longer. Such heavy borrowing rendered many households very vulnerable to a downturn.
Mortgage lenders are also affected by swings in house prices, though we found that their exposure to house prices does not, in and of itself, pose a significant risk to financial stability. We identified three factors that generally limit the prospects of credit losses on mortgage loans. First, loans are not typically made for the full value of the property, that is, loan to value ratios are usually low. Second, mortgage lenders can substantially reduce exposure by securitising a significant portion of the loans that they originate. A third factor is that nominal house prices are less volatile than commercial property prices. In the case of Ireland’s banks, these three potential mitigating factors were of limited help in containing credit losses. As I mentioned earlier, loan to value ratios were high, a significant portion of loans were not securitised but rather stayed on the banks’ books, and the banks were heavily exposed to commercial property, including speculative property development.
In the Fed paper, we also examined the recent historical experiences with banking system stress associated with declines in property prices. In particular, Japan, Sweden and Norway experienced significant financial system stress in the early 1990s, including, at least de facto, major bank insolvencies. Although declines in the value of commercial property collateral were a factor in these episodes, residential mortgage lending was not. As I put in a piece I wrote in July 2007: “The most important point, however, is that the banking crises in Scandinavia was more directly linked to drops in the value of commercial property rather than to the decline in house prices. A struggling homeowner that hands back the keys of the house causes a mild sting to a bank; a property developer that folds owing the bank a packet inflicts a terrible pain.”
Finally, we pointed out that typically the residential construction sector, home building, is very vulnerable to corrections in house prices. The evidence suggests that booms and busts in residential investment can be pronounced.
To conclude, I would like to note that, notwithstanding the patterns that we observe in the data, we did note in the paper that housing bubbles are intrinsically hard to identify, especially when they are occurring. This is because it is very difficult to differentiate between price changes coming from underlying economic fundamentals, some of which are unknown, unobservable, or unquantifiable, and those based on so-called “irrational exuberance”. That concludes my prepared remarks.
Ciarán Lynch (Cork South Central, Labour)
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I thank Professor Alan Ahearne for his opening remarks. Perhaps I can deal with two matters before I move to the lead questioners. This relates to pre the crisis of property and the banks. As discussed in his opening statement, in a newspaper article in October 2005, Professor Alan Ahearne warned of the likelihood of a hard landing in the Irish property sector where he cited evidence from research he conducted with former colleagues of his at the US Fed board. Did Professor Ahearne get an opportunity to present or discuss this research with officials at either the Central Bank or the Department of Finance and, more generally, did he get any feedback on this research from Government officials?
Professor Alan Ahearne:
I presented that paper at the Central Bank, I think, sometime in 2006 but I am not exactly sure of the dates. I was invited to give a seminar at which I presented this data. There was some feedback at that presentation in the sense that there would have been some questions about the study we had done. I was not invited to present it to the Department of Finance
Ciarán Lynch (Cork South Central, Labour)
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In terms of what was the main finding, that a hard landing in the Irish property sector was coming down the tracks, as indicated in his report, does Professor Ahearne believe that view was listened to at that time?
Professor Alan Ahearne:
When I gave that seminar, I did not give a projection. I did not say, "Here is my forecast, here is what is going to happen". I did not do it that way; I presented it in much the same way as I presented today. I presented the evidence, "Here is what we found when we looked at the international experience". Most of the questions at that seminar, if I remember rightly, were about some of the technicalities. Nobody said, "This is nonsense", and nobody said, "We are all doomed", and stormed out of the room. It was not like that.
Ciarán Lynch (Cork South Central, Labour)
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Would Professor Ahearne consider that there was a consensus in regard to the hard landing theory at that time?
Professor Alan Ahearne:
That was very difficult for me to tell just from that seminar. If one looks at the stuff that was being the commentary in newspapers and in the media, there were very few predictions of a hard landing and very little was discussed about the risks of a hard landing. It did seem to me at the time that the overall consensus was certainly that there was going to be a soft landing.
Ciarán Lynch (Cork South Central, Labour)
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In another article in or around early 2007, Professor Ahearne wrote in the Irish Independent, warning that the property market was likely to crash and advising investors to get out of the market. He also featured in the "Futureshock" documentary that was broadcast in April 2007, making a remark of stark warnings. For example, he said he could name 30 or 40 hard landings after studying booms and busts in other countries but could not name one instance of a soft landing. He said housing markets just do not work that way. It was about a seven-minute piece in which he was involved. Did Professor Ahearne get any reaction to these comments from people in property-related sectors or from Government officials or politicians following that programme?
Professor Alan Ahearne:
Not long after that I was invited to speak to the Fine Gael Parliamentary Party which, I think, was in Galway. I assume it was on the back of that programme. I spoke about the international experience of house price booms and busts at that meeting. I did not speak with any officials. In regard to the property market, I did not get any calls from people in the industry. I would have socially bumped into people who worked in that industry and I remember somebody saying to me shortly afterwards, "There are a lot of guys gunning for you after what you have said" - jokingly, I take it.
I think this was in April 2007. Somebody on the ground was saying to me that the bubble burst last summer, and that this had been the best kept secret in Ireland for the past nine months.
Eoghan Murphy (Dublin South East, Fine Gael)
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Professor Ahearne is very welcome. In November 2008, The Irish Times called Professor Ahearne "the economist who told you so". That area of his work is very important, and I want to go into it today, but another area of his work that was also very important was when he was working for the then Minister, Brian Lenihan, as an adviser. He wrote about that in a chapter of a book published recently. With Professor Ahearne's agreement, I was hoping to get some facts on the record about that period that could help us better prepare for the next stage of the inquiry in mapping out the work we would like to do.
Professor Alan Ahearne:
My invitation to come here was to discuss early warnings and contrarian views, and that is what I have prepared in my statement. To be honest, I would have to look up my records if we are dealing with some other issues. This is the context phase, and I was invited in that context. I know the committee will move on to the nexus phase when it will deal with subsequent issues. I would be delighted to come back, if I am invited, and discuss those issues. I am happy to deal with the issues when I was working for Brian Lenihan but, in fairness, in order to give accurate answers, if the Deputy wants to ask me about some of the details, I would need to have a look back at my records.
Eoghan Murphy (Dublin South East, Fine Gael)
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What I had hoped to do was go through the chapter in the book and clarify certain facts, but if Professor Ahearne would like to wait until the nexus phase-----
Eoghan Murphy (Dublin South East, Fine Gael)
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Does Professor Ahearne mind if I ask him questions about the period prior to when he was working for the Minister? I want to begin with the pre-guarantee period and those few months around the guarantee. Professor Ahearne had a meeting with the then Minister, Deputy Lenihan, in August, just prior to the guarantee being announced.
Eoghan Murphy (Dublin South East, Fine Gael)
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Where did that meeting take place?
Eoghan Murphy (Dublin South East, Fine Gael)
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Who initiated that meeting or how was it arranged?
Eoghan Murphy (Dublin South East, Fine Gael)
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Was it a meeting between Professor Ahearne and the Minister or a group discussion?
Eoghan Murphy (Dublin South East, Fine Gael)
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How long did that meeting last?
Eoghan Murphy (Dublin South East, Fine Gael)
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What was the purpose of the meeting?
Eoghan Murphy (Dublin South East, Fine Gael)
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Did Professor Ahearne find it odd that he had been invited to have a meeting with the Minister at that stage?
Professor Alan Ahearne:
Not particularly. I had written a lot of stuff and had been vocal in the media. It struck me as a sensible thing for a Minister to do, to reach out. I subsequently learned that he was meeting many economists around that time. That was his style. He spoke to many people, and bounced ideas off many people, so I did not find it odd.
Eoghan Murphy (Dublin South East, Fine Gael)
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What was Professor Ahearne's impression during that meeting? Did he believe the Minister had an accurate picture at that point of what was happening in the banking system?
Professor Alan Ahearne:
I was a little concerned that he might not have had. We had a discussion about the banking system. I talked to him a lot about the international experience and stuff that had happened. I was not there to give him advice. I was just giving my experience and talked about the stuff I had known. I did say to him that it would be important that he would have a very accurate picture of what these banks are like, and what their loan books really look like. I was not assuming that he did not have that, and he said: "Thank you. That is very good advice."
Eoghan Murphy (Dublin South East, Fine Gael)
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If I am correct, Professor Ahearne spoke in particular about the prospects of Anglo Irish Bank and Irish Nationwide Building Society. Does he recall if he or the Minister raised the issue of those two banks?
Eoghan Murphy (Dublin South East, Fine Gael)
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Was the issue of potential bank failure discussed?
Professor Alan Ahearne:
No, we did not use those terms. We were talking about the property market and we may have got on to Anglo and Irish Nationwide because those were the two most exposed to the property market. I must say I did not know much about Irish Nationwide. I remember him saying that this bank was extremely exposed, or something along those lines, and that was news to me. I knew very little about that bank. I had known anecdotally that Anglo was very exposed.
On that discussion, he mentioned that Anglo was highly exposed and therefore troubled but that it also had some good stuff. He said something like that, which surprised me because all the rumours I was hearing at the time was that it was a complete basket case, but he mentioned that. He may well have been talking about the fact that it had some properties in New York or London, or some in Dublin. He did not have any such comments about Irish Nationwide. He seemed to think that it was even worse.
Eoghan Murphy (Dublin South East, Fine Gael)
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Was nationalisation or a guarantee mentioned at all?
Eoghan Murphy (Dublin South East, Fine Gael)
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Moving on to September, on 14 September, Professor Ahearne wrote an article in the Sunday Independent. He was talking about the banks and he said that the information they had been releasing about the quality of their loan books did not always square with anecdotes about potentially huge losses associated with land purchases and unsold developments. To what extent did he understand then the threat posed to the financial system by the problems in the banks?
Professor Alan Ahearne:
I had known from my own experience and research that a big property crash is always damaging to banks. There have been times, as I wrote about, where it has put the entire banking system, or large parts of it, into insolvency, for example, in Scandinavia. There have been times where although the property market has crashed, the banking system has got through that without that much damage. Hong Kong is an example. I covered that economy at the Fed. It had a 50% decline, peak to trough, in property prices. It was a really bad crash in the property market but it did not burst the banks. The banks more or less sailed through that. I did not have information to make predictions about what the crash in the property market would do to the banks. It depended on many factors.
Eoghan Murphy (Dublin South East, Fine Gael)
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However, Professor Ahearne took the anecdotes seriously enough to make him question the information that was being released by the banks.
Professor Alan Ahearne:
That is right. They were just that, anecdotes and rumours one would hear socially. I had always tried to base my commentary on evidence and facts. Perhaps occasionally I did write commentary in terms of when I talked about anecdotes but what I had been hearing was that the property market had stalled in mid-2006 into 2007. The price index was not falling but there were very few houses being transacted. Developers had finished projects. They might have been able to sell a couple of houses at the asking price. That meant that the index did not fall. It looked like the prices were not falling but they were selling very few. That meant that these developers were not able to pay back their loans. What happened was they were getting loans. They would sell off all these properties. They would then use the money from the properties to pay off their loans, but they must have been stuck at that stage. What I was hearing was that the some of the banks may have been rolling over these loans. They were not getting repaid by the developer, and that was a problem, but rather than a developer formally defaulting, they were making a new loan to the developer. The developer would use the money from the new loan to pay back the old one, and the developer would therefore not be in default. It would look on the bank's books that the loans were fine, but there was a big problem because the developer was not selling the properties. That is the sort of rumour I picked up on, and that worried me. It reminded me of the Japanese experience where the banks kept rolling over the property developers even though they were de facto bust, and that worried me a little bit.
Eoghan Murphy (Dublin South East, Fine Gael)
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From the information Professor Ahearne had, were there any indications at the time about risk of insolvency in the banks?
Eoghan Murphy (Dublin South East, Fine Gael)
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Professor Ahearne met the Minister again at the Fianna Fáil parliamentary party think-in on 15 September 2008, and he wrote that the Minister mused whether it would be possible to knock over two dominos without knocking the other four. That was his expression.
Eoghan Murphy (Dublin South East, Fine Gael)
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Professor Ahearne assumed he was contemplating the closure of Anglo Irish Bank and INBS but was concerned about the knock-on effects.
Eoghan Murphy (Dublin South East, Fine Gael)
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Why does Professor Ahearne think he was contemplating this at that time?
Professor Alan Ahearne:
It may have been related to the earlier discussion about exposures. Both institutions were heavily exposed to the property market. The other banks had more diversified loan portfolios. They had mortgages and other types of corporate loans. Anglo Irish was a monoline merchant bank. All it did was property. I had not realised that Irish Nationwide was like that in many ways too. It probably reflected those facts.
Eoghan Murphy (Dublin South East, Fine Gael)
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I think Professor Ahearne said that he got the impression he was exploring a wide range of alternatives. Did he mention any alternatives to Professor Ahearne in that discussion?
Eoghan Murphy (Dublin South East, Fine Gael)
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Does Professor Ahearne think his thinking may have changed at all since Professor Ahearne's previous meeting in August?
Eoghan Murphy (Dublin South East, Fine Gael)
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Did Professor Ahearne speak again before the guarantee was brought in?
Eoghan Murphy (Dublin South East, Fine Gael)
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Did Professor Ahearne speak in the period immediately after it?
Eoghan Murphy (Dublin South East, Fine Gael)
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Professor Ahearne did respond to the decision on the guarantee with an article in The Irish Timeson 1 October 2008 which documents Professor Ahearne's reaction well. Other academics had a different reaction. What is Professor Ahearne's position now on whether the guarantee was a well-designed policy versus Professor Ahearne's position at the time?
Professor Alan Ahearne:
I have an open mind on it. Like the committee members I am listening to all the witnesses and I would rather wait until they have all come in and all the information is gathered before I make a decision. It is complicated. I said at the time that it was important not to let the banks go into a disorderly failure. It was important that people did not walk into an Irish bank next morning to withdraw money only to be told there was no money. That would have been chaotic. That is a disorderly failure. The Government was absolutely right to make sure that did not happen. I mentioned how important it was to safeguard deposits. A few weeks earlier there was some panic around and people saying on radio programmes that they were withdrawing money. I had written an article saying that people should not panic, deposits would be safe, that I was sure the Government would do everything to protect deposits.
I did raise the issue of subordinated debt in that article. I was puzzled as to why it was included. That does not mean there was not a good reason but only that I could not think of one. That might have been my problem. I said it would probably prove controversial.
Eoghan Murphy (Dublin South East, Fine Gael)
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Did Professor Ahearne discover subsequently why it was included?
Eoghan Murphy (Dublin South East, Fine Gael)
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Professor Ahearne said the European finance Ministers announced a co-ordinated response on 7 October but that undoubtedly Brussels and Frankfurt had sent a clear message to capitals weeks earlier that there would be no repeat of the Lehman Brothers debacle in Europe. Would Professor Ahearne like to expand on that?
Professor Alan Ahearne:
A lot of work would have been done in the European committees in August and right through September as the global financial crisis was getting more and more intense. They must have been discussing this. I think they would have come to an informal agreement on how to handle the crisis and in particular not to have a Lehman Brothers in Europe. After the Lehman Brothers collapse and the chaos it spread, I am pretty sure there would have been a message at committee level, transmitted from there back to the capitals, there would be no Lehman Brothers in Europe, no disorderly bank failures.
Eoghan Murphy (Dublin South East, Fine Gael)
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Professor Ahearne has been critical of Olli Rehn for saying the blanket guarantee was a mistake. Was that a fair assessment?
Professor Alan Ahearne:
I was not critical but I said it was puzzling that he said it was a mistake when it had to go to the Commission for legislative approval and it approved the guarantee. Under the legislation it can approve an intervention like that only under certain conditions. I cannot remember the exact terms. The Deputy may have them in front of him, something like if the intervention is appropriate and proportionate. If it deemed the guarantee to be an appropriate, proportionate and not excessive response in approving it, how could it then be a mistake? That puzzled me and I said that might be clarified at some stage.
Marc MacSharry (Fianna Fail)
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I thank Professor Ahearne for coming here. At the time economists like him would consider the output gap and whether there was one. Since then it seems they consider structural deficits. Can Professor Ahearne outline how the system has changed and how that may now show things up that they did not see at the time?
Professor Alan Ahearne:
It is not so much that the techniques economists use have changed but that one can get different answers if one adds some more data. That was quite dramatic in the Irish case. For example, when the IMF was here in 2006 and 2007 for its annual estimate of the Irish economy, it made estimates of things like the structural deficits and the underlying budget position in which it tried to look through the cyclical factors. At the same time it considered what economists call the output gap which is a measure of whether the Irish economy is overheating or going along about where one would expect it to be.
In 2006 and 2007 it said the output gap was zero, the economy was exactly where it thought it should be, there was no overheating. It thought the structural balance was in surplus so it said even if one went deeply into it and took out the cycle, the public finances looked fine. That was published in its Article IV reports. I presume at the time that must have been taken as a sign. Here was an experienced international organisation giving the green light to the Irish economy.
When it reworked that, using the same methods but with more data now, and everybody is wiser after the fact, it estimates that the Irish economy was greatly overheated to the tune of almost 7% of GDP in 2007 and there was an enormous underlying structural deficit of 9% of GDP. It is now saying that the public finances were greatly boosted by the property bubble but the techniques they had did not identify that. Now it sees the bust and that changes everything but at the time it issued its report and other economists were making similar calculations it did not have the benefit of seeing the bust and those techniques produced what looked like benign results.
Marc MacSharry (Fianna Fail)
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Dr. Peter Bacon said earlier this morning that the stock market could see clearly that there was a serious problem here. What is Professor Ahearne's sense of why the IMF, the ESRI, the Commission, the regulator, the Central Bank and everybody else got it so wrong? Was it because of the output gap?
Marc MacSharry (Fianna Fail)
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Notwithstanding that, all these organisations have this expertise, they are all examining everything and with the exception of Professor Ahearne at a later stage, Morgan Kelly and David McWilliams, no one spotted what appears with the benefit of hindsight to have been the elephant in the room.
Professor Alan Ahearne:
It was particularly disappointing in the case of the IMF. It is an international organisation that had seen these booms and busts all over the world in advanced countries and developing countries many times. Part of what happened is that when the EMU was formed the view was that now there is a currency union in Europe, exactly the same as in the United States and therefore we will think about it the same way. For example, Ireland had a big current account deficit but in 2006 and 2007 it was borrowing huge sums of money from other countries, through the banks.
Marc MacSharry (Fianna Fail)
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Is that sovereign borrowing?
Professor Alan Ahearne:
It was the country as a whole and it was coming through the banking system.
If one looked at Ireland borrowing from abroad, there was massive borrowing. The sovereign position was fine but it was Ireland as a whole. Usually that would ring alarm bells for the IMF, but the IMF does not care if, for example, Pennsylvania or California have a current account deficit. It does not even measure it because it is part of a currency union. Therefore, the whole issue of current account deficits, which would normally trigger alarms in the IMF and other observers, because we were now part of the euro area, one would no more look at Ireland's current account than one would look at Pennsylvania's.
Marc MacSharry (Fianna Fail)
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Were the way things operated at the time adequate or inadequate in terms of economic analysis by these organisations?
Marc MacSharry (Fianna Fail)
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In Professor Ahearne's time with the Federal Reserve, and his examination of the 44 booms and busts that he looked into, can he outline the impact of actions by governments, political parties and oppositions in each of them? I do not want him to go through 44 of them, but can he give us a sense of the impact of their actions and the role they played?
Marc MacSharry (Fianna Fail)
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Are there patterns of activity?
Marc MacSharry (Fianna Fail)
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What causes the economic activity? Was there a discourse in each of these countries that led to an economic policy that led to a particular outcome?
Professor Alan Ahearne:
That I do not know. What I do know is this - as I mentioned in my statement, they are surprisingly common. Some countries have booms and busts every couple of decades. That has to tell us something about how popular they are and how difficult it is to stop them. If we only had one or two and did not have another one in 40 years, we would say: "We learnt the lessons and now it is easy to stop booms and busts." However, the fact that they repeat so often and there are so many of them, tells us that when they get going there must be something in the system that makes it very difficult, even though we know they are devastating if one gets hard landings. We know they do terrible things to society and to people's standard of living.
Marc MacSharry (Fianna Fail)
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Were the 44 instances equally missed by the international community?
Marc MacSharry (Fianna Fail)
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To go back to the earlier question, in the context of the Irish situation, did the political discourse in the run-in to the crash here, in terms of government, political parties or media, contribute to our problems? Did it fuel the problem or not?
Marc MacSharry (Fianna Fail)
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It is not political. It is a case of the economic fact of the day and what caused the economic actions to be taken.
Professor Alan Ahearne:
There was a consensus that there was going to be a soft landing. That was a very general consensus, including, I think, across the political system. I did not move back until 2005 so I cannot speak of what happened before then in terms of the politics. I do remember noting in the run-up to the general election in 2007 that none of the political parties was recommending the sort of policies that one would have needed to stop the bubble, which were to get rid of tax deductibility of mortgages; force much higher loan-to-value ratios, perhaps with new regulations; and increase income tax. I presume that if a political party wrote down those policies as an election manifesto, it would not get elected. However, that is what it would have taken in those days to try to stop the bubble.
Marc MacSharry (Fianna Fail)
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The discourse was consistent with the policy of a pro-cyclical nature, rather than counter-cyclical.
Ciarán Lynch (Cork South Central, Labour)
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A question.
Professor Alan Ahearne:
It is difficult on the political system in the sense that booms are very popular when they are happening. It is fantastic. The amount of money coming into people's pockets is just brilliant. I remember that, in 2005 and 2006 at the height of the boom, people were complaining about the price of houses but, boy, there were a lot of people employed and wages were rising fast. The amount of cash coming into people's pockets because of what was going on - this money was being borrowed by the banks from abroad and put into cash in people's pockets - it was extremely popular.
Marc MacSharry (Fianna Fail)
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In Professor Ahearne's experience as a economist who has worked in a number of different areas, what sort of regulatory system ought to exist? He has just said that governments want to get elected. What should exist to be able to take the punch bowl out of the room? What safeguard ought to be there, or should be there, given the realities of the political discourse, as Professor Ahearne has outlined them? Booms are good and people like them.
Professor Alan Ahearne:
What needs to happen is that the Financial Regulator and the Central Bank need to do intrusive, proper banking regulation. It is not so much the structure of it, or whether one has a financial regulator separated from the Central Bank, or whether they merge together. I do not think that is particularly important. What is important is that the regulator does good regulation and acts like a referee in a football match.
Marc MacSharry (Fianna Fail)
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Earlier this morning, Peter Bacon said that he was unclear what legal force the Central Bank can apply to determine what mortgage lending should be. Others have questioned the force of the regulator, and so on, in other testimony. What is Professor Ahearne's view of that in the period? I have just two other questions after this.
Professor Alan Ahearne:
I do not think the regulator lacked the tools that were available which could have prevented the increase in loan-to-value ratios, for example, and could have been much more intrusive with the banks and limited the concentration of property lending. The regulator could have done all that stuff, but they had a certain interpretation of principle-based regulation which meant that they really just looked at whether the banks had certain governance systems in place, including having an audit committee. They put a lot of trust in the senior management of the banks. That is the very opposite of intrusive, proper regulation and so the implementation of regulation failed dismally.
Marc MacSharry (Fianna Fail)
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Professor Ahearne said earlier that there was an informal agreement, to quote his own words, at European level that we were not going to have a Lehman's in Europe. As an economist, can he give his view of the scale of the fiscal adjustment here if we had allowed banks to fail or if we did not pay bondholders? Would there have been an adjustment in the fiscal adjustment we had to undertake and what would that be?
Professor Alan Ahearne:
As regards the vast bulk of the fiscal adjustment we have had to undertake, the €30 billion since 2008, very little of that has to do with the banks. People often look at the €30 billion put into Anglo and the €30 billion of fiscal adjustment and say that every single penny that was taken out in terms of fiscal adjustment, all the tax increases and all the reductions in wages, all that money has just gone into Anglo. That is simply wrong, however, and it is an inaccurate way to think about this.
In terms of the banks, the headline number is €64 billion. Anglo or IBRC is €35 billion. One really needs to think about the financing cost of those. If one can finance a bank recapitalisation at a very cheap interest rate, the actual burden of that is much lower than the headline number. For example, with Anglo and IBRC the vast bulk of that capital being put in by the State has been financed via the Irish Central Bank. It is the Central Bank which initially owned the promissory notes and now owns the bonds. They are only now selling debt into the markets.
Interest rates are extremely low at the moment. They are less than 1% which means that although the headline number looks huge, it is being financed at a really low cost. If one looked through all the payments from one arm of the State to the other, the annual cost of Anglo is probably somewhere like a couple of hundred million euro. That is not a small amount of money but it is small relative to the €30 billion adjustment, or relative to the total amount of Government expenditure.
Marc MacSharry (Fianna Fail)
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I have a final question and there are two brief parts to it. First, can Professor Ahearne clarify whether or not, in his view, the fiscal adjustment that had to be made would have been close to the same? Second, in testimony here, Governor Honohan has said that the cost of saving the banks is €40 billion. Is he right or wrong with that figure?
Professor Alan Ahearne:
The net cost would be a lot less than €40 billion I think. The problem is that the cost is changing all the time. As long-term interest rates have fallen dramatically over the last 12 months, the cost of the burden of recapitalising the banks has been reduced. The €64 billion is a particular number, it is the headline number, but the actual cost, the burden in terms of the Irish people paying out, has fallen quite dramatically over the last 12 months because long-term interest rates have fallen because of the ECB's OMT programme that it announced, and more recently the quantitative easing. The cost is determined by when the State issues the debt into the market that it is using to recapitalise. The debt that was used to recapitalise Anglo was not issued into the market. It was given to Anglo and given to the Irish Central Bank. That has not gone into the market. It is still within the system. It is only now that the Irish Central Bank is issuing that debt to the market. That is the key time period. At the moment ten-year money is less than 1%.
Ciarán Lynch (Cork South Central, Labour)
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The question that Senator MacSharry asked was about the tax hole that had to be filled of in and around €30 billion.
Professor Alan Ahearne:
If, for example, no money had been put into Anglo, so that the €30 billion fell on the depositors and the senior bondholders, it would make a difference I think at the moment of a couple of hundred million euro less expenditure for the Irish Government. It is in that ballpark.
Ciarán Lynch (Cork South Central, Labour)
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Can I clarify one matter that Professor Ahearne dealt with in regard to Deputy Murphy. It comes back to that article on 14 September 2008 which I think was in the Sunday Independent. Professor Ahearne said:
The rumour mill concerning the health of Irish banks kicked into overdrive last week. Frankly, I find some of the more alarmist statements unhelpful. Still, banks must take their share of the blame for the heightened sense of uncertainty. The information that they have been releasing about the quality of their loan books does not always square with the anecdotes about potentially huge losses associated with land purchases and unsold developments.
Can Professor Ahearne expand upon this point? What is his assessment, if any, of the quality and reliability of the information contained in the published accounts of the Irish banks at this point and were there any indications that the Irish banks were insolvent at that time?
Ciarán Lynch (Cork South Central, Labour)
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How would Professor Ahearne view the reliability of the information that was published?
Professor Alan Ahearne:
At the time I just did not know. I did not have any details. I was concerned that some of the practices I had seen before, particularly in the Japanese case, that that may have been going on, and therefore distorting the picture, giving a much more rosy picture. If the banks were doing that, and I do not know if they were or not, they may say that was proper practice. After all, if one thought that this was going to be a temporary downturn one may try to evergreen one's developments.
Ciarán Lynch (Cork South Central, Labour)
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That is just speculation on Professor Ahearne's behalf. That is not based on hard evidence that he had before him.
Susan O'Keeffe (Labour)
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Can I clarify something that I think Professor Ahearne said to Deputy Murphy? The Deputy asked Professor Ahearne about subordinated debt and he asked him what had happened. Professor Ahearne said that he did not discover a reason for including subordinated debt. Is that what Professor Ahearne said?
Susan O'Keeffe (Labour)
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So in all the work that he did subsequently and in the last two years, Professor Ahearne never discovered a reason for including subordinated debt?
Susan O'Keeffe (Labour)
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Professor Ahearne will recall being accused of dangerous talk and he will recall the expression "merchants of doom". He responded to that by saying that such comments were an attack on democracy. I am just wondering what was going on at that time, if you like, for ordinary people looking on and seeing economists at odds with each other, many people at odds with each other, and the Taoiseach making inappropriate comments about naysayers. Why does Professor Ahearne think all that was going on? It seems extraordinary looking back.
Professor Alan Ahearne:
I suppose it does but maybe it goes back to an earlier point that this was extremely popular and there were many people getting money from this. If one thinks of a property boom there are many different stakeholders who are getting a lot of money out of it, from people selling land, some professionals, the banks themselves. The property sector, if one defines it broadly, includes not only construction workers, but a huge number of people, all of whom were benefitting personally from what was going on. Then I think in a wider dimension the Government was a stakeholder in the sense that the Exchequer was taking a huge amount of money from the property bubble in the form of capital gains tax and stamp duty and all that, and was then dishing that money out left, right and centre. So it was great. It felt great at the time. People were saying, "There's something wrong here, there's a large imbalance, and there are risks and this thing could all go pear shaped". However, people just did not want to hear that.
Susan O'Keeffe (Labour)
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In 2008 the ESRI in its medium term review said among other things, "The fundamentals of the Irish economy are sound." When Professor FitzGerald gave evidence here he said that the ESRI had done no research on the financial sector for a number of years. Can an economist ever say the fundamentals of an economy are sound without examining the financial sector?
Professor Alan Ahearne:
The surprising thing about the economics profession, particularly the academic economics profession, is that banking sectors essentially got dropped out of economic models in the 1980s and through the 1990s. Most graduates getting PhDs in economics would have worked with extremely complicated models on computers, and they look very sophisticated, but they would not have had a banking sector. There was no credit in those models. They started to develop some models with money in them but not credit. So the profession went down a certain path in which credit, certainly for advanced economies, was completely ignored. So it does not surprise me, in a way, that economists here, working with the models and the techniques they were working with, would not have paid enough attention to a banking sector.
Susan O'Keeffe (Labour)
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So it was true for the model but not true in the real world.
Professor Alan Ahearne:
I think that is true. I had come from a central bank and I had worked on countries like the emerging Asian countries and Japan and Hong Kong and these countries, which in the real world had banking crises and stuff like that, so I had seen it, but to publish a paper in a top journal one would not put a banking sector into one's model.
Susan O'Keeffe (Labour)
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In 2007 Professor Ahearne wrote in the Sunday Independent, "If the degree to which new homeowners had to stretch themselves to buy property last hear doesn't convince you that the housing market has overheated badly then nothing will." And he went on to say:
It's obvious to everyone, that is except the economic commentators who this time last year seemed to think that rapidly increasing house prices and rising interest rates were perfectly consistent. Five minutes with a simple calculator would have told them differently.
Why does Professor Ahearne think the economists did not spend five minutes with a simple calculator?
Professor Alan Ahearne:
It is very hard for me to put myself in somebody else's shoes. One of the things that was said a lot is that interest rates were low. The ECB's interest rates were 2%. They had doubled to 4%. People point out that 4% is still low. That is true but they had doubled and I think people forgot the last part of it, namely, that they had actually doubled. If one had an interest-only mortgage one's interest payments would have doubled, even though they had gone to what one might think is a low rate of 4%. If one is extremely stretched, if one has borrowed a lot of money, one would be very sensitive to that. So if I said the interest rate went from 10% to 20% one would say that was disastrous, but that is a doubling as well. So I think it was that point that people may not have appreciated fully.
Susan O'Keeffe (Labour)
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David McWilliams said here in February 2015 that the Irish property crash and the banking crash were both incredibly predictable and absolutely preventable. What does Professor Ahearne think?
Professor Alan Ahearne:
In my very last paragraph I did try to emphasise something we had said in the paper even after studying all of these patterns that seem to reoccur, namely, that notwithstanding the patterns that we observe, housing bubbles are intrinsically hard to identify, especially when they are occurring.
Susan O'Keeffe (Labour)
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Professor Ahearne used the expression "housing bubble" in 2005 so he must have known that there was a bubble.
Professor Alan Ahearne:
No, because we were talking about the previous experiences.
We were able to identify bubbles that had occurred since 1970 in 18 advanced countries but we were looking backward with the benefit of data. The very definition of "bubble" that we used was that house prices had to have fallen in three years following the peak, so we picked out these bubbles but we were doing so looking backwards.
Susan O'Keeffe (Labour)
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Professor Ahearne said we were on our own if the bubble were to burst.
Michael McGrath (Cork South Central, Fianna Fail)
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Professor Ahearne is very welcome. I will start with the September 2005 study he did with his colleagues in the Federal Reserve. He looked at 44 episodes of house price booms and busts in 18 advanced countries since 1970. If he were to go back to update the study in light of what has happened in Ireland in recent years, where would Ireland stand or rank in the context of the countries he studied?
Michael McGrath (Cork South Central, Fianna Fail)
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From peak to trough?
Michael McGrath (Cork South Central, Fianna Fail)
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What other examples would be up there in the top three?
Michael McGrath (Cork South Central, Fianna Fail)
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Just to take Professor Ahearne on to the link between the property price crash and the impact on the banking system, was that link fully understood in the years leading up to the crisis? Was it understood that the risks that were being built up through dramatic property price increases could potentially have a major impact on the banks and the banking system? Does he think that was sufficiently understood by the authorities?
Professor Alan Ahearne:
It is difficult to say. There have been examples in which even a very large decline in property prices did not create an outright banking crisis. The example I gave was Hong Kong, where property prices in the late 1990s, at the time of the Asian financial crisis, fell by 50%, but they did not have a banking crisis. What happened there was that they had very low loan-to-value ratios, which protected them. The banks also had huge amounts of capital and they may well have been more exposed to residential rather than commercial property. So it is not automatic that if there is a property boom and bust the banks are all going to go bust. It depends on the extent of it: how bad is the boom and bust, what is the wider context and what happens to the economy. If the economy goes into recession, does it go into a depression? One has to take all of that into account and then see what the banks are like and what is their ability to withstand that bust in terms of capital. That is extremely complicated. One would have to have the details.
Michael McGrath (Cork South Central, Fianna Fail)
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In the Irish context, in terms of the banking crisis that did develop, and looking at the exposures in commercial real estate and residential mortgage lending, if Professor Ahearne were to attach a weighting to both of those in terms of the underlying risks and losses in the banking system, which was more important and what kind of ratio would he attach?
Professor Alan Ahearne:
I am sure one can actually get the hard data, but as far as I know, the losses suffered by the banks from commercial property lending, and particularly lending for property development, have been greater than the losses they have suffered on the mortgage lending, but I say that without any hard numbers in my head.
Michael McGrath (Cork South Central, Fianna Fail)
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When Professor Ahearne was answering Deputy Murphy earlier about the meeting he had with the late Brian Lenihan in August 2008, he said that around that time there were rumours and anecdotes about Anglo Irish Bank. The term he used was "a complete basket case". Was that what he was picking up socially? When was he talking about exactly? Was it July to August 2008?
Professor Alan Ahearne:
It was probably around then. I used the term but perhaps I should not have. I do not think anybody described it to me as a complete basket case, but there were worries that this was a bank that was deeply exposed to property and the property market was in trouble, and so the logic was that there had to be risks and worries about that particular entity, perhaps more so than for the other banks.
Michael McGrath (Cork South Central, Fianna Fail)
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What is Professor Ahearne's view, then, on the characterisation a month later, at the end of September 2008, of the problems within the banks and even in Anglo Irish Bank - we will explore that, obviously, in much more detail - that it was a liquidity issue and not a solvency issue at heart? Does Professor Ahearne think, given the loose talk that was going around at that time, that it was credible that people in authority - the Central Bank, the regulator, the executives of the banks themselves - would have been of the view that it was a liquidity crisis? Is that credible or not credible in Professor Ahearne's view?
Professor Alan Ahearne:
I would only be speculating. I do not know. It is difficult to really know whether the bank was insolvent. First, one does not have the data. One does not know exactly what is going to happen over the next couple of years and one does not have the information on when the economy went into such a deep recession. One would really have to know the bank's books. One could say €100 million was lent to a certain developer against collateral, but is it real collateral or is it unrealised capital gained from some other property project that has been used as collateral? One would have to know that and know the loan-to-value ratios. One would have to know whether the developer has a different income stream on which to draw or dividends from some shares he or she has bought in order to make good on the loan. The amount of detail one would have to know to make that assessment is huge.
Michael McGrath (Cork South Central, Fianna Fail)
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Finally, in Professor Ahearne's opening remarks he characterised quite starkly the change in the nature of mortgage lending in Ireland around 2006 and the data from the Department of the Environment, Community and Local Government that one in three new home buyers in 2006 took out 100% mortgages. That rate had doubled from the year before. Two thirds of all new home mortgages taken out in 2006 were 31 to 35 years or longer. Is Professor Ahearne satisfied that the tools were there within the legislative powers that the regulator and the Central Bank had to deal with that issue? Why does he think those risks were not identified and action was not taken?
Professor Alan Ahearne:
I am satisfied that the regulator could have done something about that. The 100% mortgages in particular were extremely dangerous instruments. They were being used by people who clearly could not afford a property, and they were used to get them into the property market. I remember, when I lived in the United States, hearing guys talking at half time during a football match about buying houses using these exotic mortgage products in which they got very low interest rates for a few years and then they were restructured. The point is that one must refinance before the interest rate is reset, or one sells the property before it resets, so the higher interest rate is irrelevant. That is an instrument that allows people to get into the property market, but boy, is it dangerous, because if the property market falls you are caught. These seem to me the same sort of thing. Loan-to-value rates of 100% seem fine if prices are rising, because if house prices go up by 20% the following year a house will have generated equity, so as long as the market is going up it is fine, but the problem is that if the market goes down one is in negative equity. I was very concerned about that particular development.
Ciarán Lynch (Cork South Central, Labour)
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Let me expand on that with Professor Ahearne, in that the mortgage products that were there at the time, as he indicated to Deputy McGrath, were very much for the home purchaser, but those products were also available for investors, particularly in the buy-to-let sector. Earlier in his testimony, Professor Ahearne discussed how the traditional model of valuing residential property was through rental income. I think it is ten to 12 times the annual rental income that determines what the price of a house should be, and so forth. Given that in the buy-to-let sector there were100% mortgages and interest-only payments, and the rent was required to justify the repayments back to the banks, even though no capital was being paid back due to the interest-only payments, did that in any way distort the valuation process? People could afford the rent even though the landlord was not clearing any capital on the loan.
Ciarán Lynch (Cork South Central, Labour)
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Perhaps I will give the lecture to Professor Ahearne.
I am simply saying that if somebody buys a house over a 20 or 30-year schedule, he or she will pay interest and capital during that period and pare down the debt. One could value a house in terms of affordability, at three times the income of the purchaser and his or her partner. Another way to value it is to consider the rental income it would accrue annually and multiply it by ten or 12. In terms of prices increasing, and given that there were investors in the market as well as people buying homes, for the purchasers of buy-to-let properties who were paying interest only, spread over 35 years with a balloon payment at the end, the loan-to-value ratio was very low but because the rent serviced the interest no capital was paid down. Was that distorting the value of rents and therefore distorting the value of the property?
Ciarán Lynch (Cork South Central, Labour)
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Was that picked up at the time? Professor Ahearne spoke of writing about rent ratios and other matters in October 2005, but was the picture I gave picked up at the time?
Professor Alan Ahearne:
I brought up the fact that prices were getting out of line with rents because we had seen it before. It was an issue. Some investors had no rents coming in. The 2006 census found a large quantity of empty properties. They were buying up property but not even bothering to rent it out.
Ciarán Lynch (Cork South Central, Labour)
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Was that because the equity in the property was accumulating so rapidly that one could turn it around in 12 months without having let it and still make a profit?
Ciarán Lynch (Cork South Central, Labour)
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On that analysis, the equity increase on a compound basis was greater, in some cases, than rental income on a property.
Professor Alan Ahearne:
It was all driven by the capital gain investors were expecting to get. If they had been told the capital gain would be zero they would not have bought these properties because the rents would not have made it worth their while relative to the interest they had to pay. The interest rates rose and that made buy-to-let investing disastrous.
Michael D'Arcy (Fine Gael)
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Professor Ahearne is very welcome. What was his reaction to the news that the bank guarantee had been put in place on the night of 29 September?
Professor Alan Ahearne:
I would have heard about it the next day. I was a little surprised at how broad it was. I had thought the Government would eventually do something to safeguard deposits. In early September a deposit of €20,000 was guaranteed but one could lose 10% of it, which I wrote at the time invited a run. That was increased to €100,000, but I was pretty sure that if push came to shove the Government would increase it again, as many countries had done, and make it unlimited to secure deposits.
As I wrote, the wholesale funding was a little more puzzling, particularly the subordinated debt part of it. I had not appreciated how intense the funding pressure was. When I wrote that article I was writing about money flowing out of some of the banks and into AIB and Bank of Ireland. It turned out that those banks were under pressure as well but not quite as much pressure. I had not appreciated that this was not just a couple of banks but a system problem.
Referring to the earlier discussion about dominos, this guarantee included all the institutions, so there were no two dominos separated from the other four, and I concluded that the Government had decided it was not possible to knock down two dominos without knocking the other four. I assumed it had considered it carefully and determined that that was the outcome.
Michael D'Arcy (Fine Gael)
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At that stage, when no major analysis or empirical research were available, did Professor Ahearne think it was a good or a bad idea?
Michael D'Arcy (Fine Gael)
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Professor Ahearne had spoken with the Minister, Brian Lenihan, in mid-September 2008 - the dominos conversation. The guarantee was put in place, and at the end of December he wrote:
In the case of a failing bank, the EU will only allow state funds to be used to wind up the bank or for a complete restructuring. Rightly so. Pumping funds into failing banks is simply pouring taxpayers' money down the drain.
Was there an alternative to pouring taxpayers’ money down the drain?
Michael D'Arcy (Fine Gael)
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Professor Ahearne used it.
Michael D'Arcy (Fine Gael)
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We knew subsequently that Anglo Irish Bank and Irish Nationwide Building Society were failing. In that case, pumping money into failing banks was simply “pouring taxpayers’ money down the drain”.
Professor Alan Ahearne:
Even in those banks the money was not literally going down the drain. Somebody was getting it. In the case of Anglo Irish Bank, the people who got it were the depositors and senior bondholders. If the Government had not recapitalised those banks there would probably have been a 50% discount on all deposits and all senior bonds. The fact that the money went in made the deposits good and kept them whole. If the failed banks had not been recapitalised the guarantee would have been triggered. They were recapitalised to prevent the guarantee from being triggered.
Michael D'Arcy (Fine Gael)
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Did the bank guarantee lead in part or completely to the nation’s bailout in late 2010?
Professor Alan Ahearne:
The collapse of the banking system and the economy meant that the markets were not confident about lending to the Irish State at adequately low interest rates. The fact that the Irish State had to recapitalise the banks was an element of that. It was expensive. The headline figure was €64 billion. There was uncertainty around that period about how much extra funds would have to be put in. That uncertainty was an element, but only one element. If the Irish economy had grown strongly - if the growth prospects were strong - the markets would have been less worried. If, for example, outright monetary transaction or the ECB’s quantitative easing had been introduced in mid-2010, presumably that would have calmed the sovereign debt market and the market would have continued to lend to the Irish Government at low interest rates and Ireland would not have needed official assistance. There were many components.
Michael D'Arcy (Fine Gael)
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One third of tax receipts prior to the collapse of the banking sector were coming from transaction taxes and capital taxes. How would you itemise that quantum of tax coming from a source of funding that is not available every year?
Professor Alan Ahearne:
In retrospect, that is a very risky source of funds. It means that a large chunk of tax revenue will only come in if the bubble keeps going.
At the time, perhaps in 2006-07, I talked about Norway, which had huge budget surpluses. This is, of course, because the country has oil and is squirrelling away all the oil revenues. The oil will eventually run out in 50 years or so, and revenues are therefore being squirrelled away. I said at the time that if one has a temporary source of revenue, it is a good idea to squirrel it away and not spend it. In retrospect, that did not happen in Ireland. There was a temporary source of revenue, the one to which the Senator referred, but it was spent because it was given out in higher public sector pay, welfare payments and Government expenditure. When the bubble burst the revenues disappeared but the expenditure remained, and fiscal adjustment was required.
Pearse Doherty (Donegal South West, Sinn Fein)
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Tá fáilte romhat go dtí an coiste. Professor Ahearne signalled a series of warnings in the period leading up to the crisis. How convinced was he that he was correct? Perhaps he could express his answer in simple percentage terms.
Professor Alan Ahearne:
I did not say at any stage that I was absolutely certain that this was going to happen. I did not have a crystal ball. All I could do, and it was what I did, was to look at other countries' experiences and say there was a risk. I tried very reluctantly to put some numbers on over-valuation. I think I mentioned, possibly on the "Future Shock" programme, a figure of 30% and I gave a figure of 20% to other people. It was very difficult to put a number on it but it was a significant risk. The problem I saw with it was that even if one thought there was only a 30% chance of a crash and a 70% chance of a soft landing, the effect - that is, the devastation caused by the crash - would be so large that one would have to take that into account. One cannot always make policy based on what one expects to happen. One has to look at the distribution of risks.
Pearse Doherty (Donegal South West, Sinn Fein)
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With regard to Anglo Irish Bank, on 4 January 2009, the Sunday Independentpublished the following comment from Professor Ahearne:
The markets quite clearly don't believe in the future of Anglo, and yet the Government is saying it's too important to let go. I'm not convinced by this.
Will Professor Ahearne outline the reasons he was not convinced of the Government's view that Anglo Irish Bank was too important to let go? What should have been done at the time?
Professor Alan Ahearne:
"Let go" is a loose term, and I should have been a bit tighter in that regard. I think the talk at the time was that the Government was going to put capital into Anglo, which was going to continue running as a functioning bank. We were going to have Bank of Ireland, AIB and Anglo Irish Bank and they were just going to continue. What I was not convinced about was whether Anglo Irish Bank really had a future in the sense that it was a monoline bank. Where was it going to make its money in the future? Running Anglo Irish Bank as a going concern into the indefinite future was the part I was unconvinced about. That was different from saying it should have been shut down there and then, because that was not possible in the sense that Anglo was a very big bank with €70 billion or €80 billion of funding. If one shut it down there and then, one would have to pay back all the guaranteed funders because it was covered in the guarantee. Where would the State get €80 billion to repay them all?
Pearse Doherty (Donegal South West, Sinn Fein)
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On Anglo Irish Bank, Professor Ahearne described how he arrived at his assessment that there would be a hard landing. He did not have access to the internal data available to the banks, which the Central Bank may also have had. If he had been aware of the information provided in the Nyberg report, which shows that 50% of Anglo Irish Bank's loan book was held by 20 individuals, what types of warning would he have issued before the crisis?
Professor Alan Ahearne:
I am not sure it is per sean issue of concentration among certain individuals. One could lend a lot of money to an individual and the loan would be perfectly fine if he or she was able to make the repayment. The question is whether there was genuine collateral behind the loan or whether these developers were completely exposed to the property market without any sort of diversification. What we know now is that the latter scenario was the case and, therefore, the loan losses were colossal. There was not much genuine collateral there and the developers in question had not diversified. The loan-to-value ratios, even on commercial property lending, were extremely high. All of those risky bank practices were in place.
Pearse Doherty (Donegal South West, Sinn Fein)
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A number of names have been mentioned today, including those of Professor Ahearne, Mr. David McWilliams and Professor Morgan Kelly. Does Professor Ahearne share the view that there were only a number of contrarian voices, or was the evidence wider? Will he comment on the note that UBS issued to its investors in January 2008 in which it advised them to sell shares in Anglo Irish Bank and AIB? This was done at the start of 2008 and was based on its expectation that commercial property prices would fall by 30%. How widely available was this information in terms of people who were trained or had access to this information?
Professor Alan Ahearne:
I do not think the really detailed information one would need to make a very good projection about how bad things were getting in the bank was available to anybody. I do not think the Financial Regulator had that information. The Financial Regulator's approach - so-called light-touch regulation - meant that regulation was not intrusive and the regulator did not gather the sort of information that one would really like to have. I mentioned talking to the late Brian Lenihan about really needing to know what the books looked like. That is the sort of stuff I was getting at.
Pearse Doherty (Donegal South West, Sinn Fein)
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Professor Ahearne noted in response to Senator MacSharry that in the period leading up to the 2007 election none of the parties recommended policies to stop the property bubble. He also stated that booms were very popular and that no party would have been elected it if had recommended policies to stop the property bubble. Will Professor Ahearne clarify the matter by indicating which parties he was referring to? Did he mean all the parties? I am only familiar with the 2007 election manifesto of the party I represent, which referred to high-risk 100% mortgages, ending property tax incentives and intervening in a market that was in crisis. I am wondering, therefore, to which parties Professor Ahearne was referring. Does he include the Socialist Party, the Fine Gael Party, the Green Party and others? He made a very broad statement on a matter that the inquiry may address subsequently as part of its terms of reference.
Professor Alan Ahearne:
I understand the Deputy's point. I was referring to what were the three major parties at that time - Fianna Fáil, Fine Gael and the Labour Party. I remember thinking myself at one stage, and I may have said this to somebody, that if one took the covers away, it would be difficult to tell which party the manifestos were coming from. They were similar in many ways.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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One of the previous questioners referred to the report on banking crashes that Professor Ahearne produced for the Federal Reserve. Professor Ahearne referred to his meeting in August 2008 with the late Minister for Finance, Deputy Brian Lenihan, which was held in the Minister's office. Did any other officials or politicians approach Professor Ahearne in the period leading up to the banking difficulties? Was the meeting with the Minister the only meeting he had at that time?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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There were no other discussions with any Ministers at the time that Professor Ahearne can remember?
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Can he rationalise the apparent decision of the academic economics profession to exclude the banking sector from economic modelling? This issue was raised by Senator O'Keeffe. It appears to be a glaring omission, even if I accept that we have the benefit of hindsight. Why was banking omitted from economic modelling?
Professor Alan Ahearne:
There were two reasons.
In the 1980s, much of the literature tried to explain why economies go through booms and busts and why we get business cycles and seemed to be able to explain this without referring to banking sectors. The literature suggested the booms and busts were driven by different factors, either by productivity shocks that hit our economy or, at a later stage, by monetary policy, but that there was no need for credit cycles per se.
In addition, modelling for this was different technically, as the more elements put into a model, the more difficult it gets. Therefore, when one added in credit markets - although critical - the model got very complicated. Deputy McGrath asked me earlier what we would see differently if we added extra countries and their experience over the past six or seven years into a study like ours. What we see that is different - the IMF has done this type of study - is that the relationship between the credit and property is now very clear. However, it was far less clear when we were doing our study. We had some property booms where credit had not expanded that much. The finding we all talk about now is that we should get worried about property booms if there is an accompanying credit boom. This is a more recent finding, which benefits from the fact we have far more observations in the current experience.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Last year, Professor Ahearne co-authored an IMF paper on economic surveillance. Can he briefly outline some of the principle findings of that paper, in terms of improving economic surveillance in the Irish economy? I think the paper was produced in July last year.
Professor Alan Ahearne:
We were looking at a certain type of surveillance, a surveillance of structural issues. We had recommended, for example, that in its annual surveillance of a country, the IMF should look for evidence of what we call "rent seeking" where there are distortions. The IMF does not do that, but we believe it would be a useful thing to do. We also talked about regulation of State owned enterprises, such as energy, as something that should be included in the IMF's surveillance. We also mentioned negative findings, but the IMF does not have the expertise to add value in the surveillance of the labour market. That was the purpose of the study.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I will refer briefly to the first part of Professor Ahearne's response. Does he believe the IMF's surveillance, and its report from 2006, exacerbated the problem because it was seen to give the all clear to an economy that was in difficulty?
Professor Alan Ahearne:
I think it must have. One can imagine the fact that a number of different external organisations were all sending clear signals that there was deep trouble here and that the country was in trouble. When one is in the middle of it, it can be hard to see the facts, but outsiders have an advantage, particularly international organisations with experience. Their voice can be very powerful, but if their voice is very quiet, it is difficult.
John Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I want to refer to chapter 1 of the book, Brian Lenihan: In Calm and Crisis, which quotes Professor Ahearne as saying that a lethal expansion in credit had occurred due to borrowing by the Irish banks. Will the professor elaborate briefly on what he meant by "a lethal expansion". When does he believe that expansion became lethal? Can he put an approximate time on that?
Professor Alan Ahearne:
If one looks at the numbers, lending accelerated from 2003 to 2007, but the three years from 2004 to 2006 were particularly damaging in the expansion of banks' loan books. It was not just that they were lending more, but there was very concentrated lending, particularly into speculative property.
Ciarán Lynch (Cork South Central, Labour)
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in that regard, was that the optimum period for an intervention to have been made by the State or the regulator?
Ciarán Lynch (Cork South Central, Labour)
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Would it have been possible to have made a successful intervention after 2004?
Sean Barrett (Independent)
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I welcome Professor Ahearne. Will he refresh my memory in regard to his time in the Minister's office? When did he join and when did he leave?
Sean Barrett (Independent)
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When was the hard landing seminar in the Central Bank held?
Sean Barrett (Independent)
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Who attended the seminar and what was the reaction when the professor gave the "hard landing" finding?
Professor Alan Ahearne:
It was mostly people from the Central Bank. I remember somebody remarking that there were very few people from the regulator - they were separate at the time. Somebody remarked at the time that it was disappointing some people from the regulatory side had not attended. It was mostly economists from the Central Bank.
Sean Barrett (Independent)
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The finding in the Wright report is that there was far too little economic expertise around. He estimated that approximately only 7% of senior people in the Department of Finance had qualifications at master's level or above. He compared that to 60% in Canada and 40% in the Netherlands. Did Professor Ahearne find that a problem when he went to work in the Department in March 2009?
Professor Alan Ahearne:
Not particularly. I found people were very knowledgeable. Of course, they had been in the trenches for quite a while. They were extremely hard working and very knowledgeable. It was not clear to me at that stage that the country could be saved by more economists. Perhaps more economists during the bubble years could have made a real difference.
Sean Barrett (Independent)
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Did we understand the full implications of euro membership?
Professor Alan Ahearne:
I think most counties did not, in the sense that once they joined the euro, that had implications for all other types of economic policy or how it had to react. This was because they had now lost control of their interest rate and exchange rate, two of the most powerful economic tools an economy has. Having lost control of those, everything else needed to adjust, but nothing adjusted. That was not just true in Ireland, but all across the euro area. I think governments had been exhausted by the effort to join the euro and from meeting the Maastricht treaty requirements and so on and had kind of relaxed. They seemed to believe that now that the euro was up and running, that was good, without recognising that now they had to be cognisant and very careful of other aspects of economic policy. They were not. They took the benefits, in Ireland and other peripheral euro countries, of the very low interest rates, which was good, but that also created risks and the risks were ignored.
Sean Barrett (Independent)
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Did we understand the implications of the savings and loans collapse in the United States, given what happened to building societies and financial institutions here?
Sean Barrett (Independent)
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Did economists working in banks ever relay any fears to Professor Ahearne that the bank they were working in might go down the tubes? Did they see it coming or discuss it?
Ciarán Lynch (Cork South Central, Labour)
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In regard to Senator Barrett's earlier comments on the period during which Professor Ahearne was working for the late Brian Lenihan, were you compensated for your role during that period?
Joe Higgins (Dublin West, Socialist Party)
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In regard to the bubble period, the professor said on a number of occasions today that property was extremely popular, that many people were making lots of money - land sellers, professionals, banks, construction workers - and that this felt great at the time. He was an adviser to the then Minister for Finance, Brian Lenihan, in October 2010 when he said, controversially, "Let us be fair about it, we all partied." Is the professor re-echoing that sentiment in regard to the bubble?
Does that tally with the fact that a substantial number of people felt they did not party? Many people were excluded from the housing market because of the huge price increases. The generation that managed to get on the property ladder were saddled with 35-year or 40-year mortgages pitched at unsustainable levels. Plus, a substantial number of people never bought or sold a home over that time.
Joe Higgins (Dublin West, Socialist Party)
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Yes, I understand. Does the professor echo that belief?
Professor Alan Ahearne:
No. I agree with the Deputy that the effects of booms and busts, as I said much earlier, are devastating for people. With the huge increase in unemployment and huge declines in employment, added to the fact that people had borrowed huge amounts, many ended up in huge financial distress. People have lost a lot of money because the Government had to raise taxes and cut expenditure to restore order to public finances. All of these things are terrible.
Joe Higgins (Dublin West, Socialist Party)
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Yes.
Joe Higgins (Dublin West, Socialist Party)
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In the course of the ten years between 1996 and 2006, our researchers have told us, based on hard facts, that the price of a home for an ordinary person increased by the equivalent of the average industrial wage each year for ten years. It finished up at 11 times the average industrial wage, when the normal value was considered to be two and half to four times that amount.
Professor Ahearne said it was difficult for the Government to intervene in the bubble while this stuff was happening, with policies such as income tax increases and loan-to-value ratio adjustments. There was also what many people would call an incredible, breathtaking, increase in house prices. What about radical policies to outlaw profiteering in building land and housing, which many felt was underpinning what went on?
Ciarán Lynch (Cork South Central, Labour)
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Please allow Professor Ahearne time to respond.
Professor Alan Ahearne:
I agree that unsustainable increases in house prices, or bubbles, are bad. One of the things that added to this situation was the reduction in capital gains tax. That meant the profits for people buying and selling land were taxed at 20%, which was extremely low. That situation added to the incentive to speculate in property and, therefore, was extremely damaging. If land is going to be used for buildings then it should be used to build houses at a reasonable cost. In terms of policy, that was certainly a contributory factor and a problem.
Ciarán Lynch (Cork South Central, Labour)
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Deputy Higgins has a minute and a half remaining, so I suggest he move towards asking his final questions.
Joe Higgins (Dublin West, Socialist Party)
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The NAMA assets were transferred with a haircut of about 57%, but the European Commission later judged that the banks had received €5.6 billion in State aid by the end of 2011 as a result of loan transfers, which amounted to a 22% aggregate premium above the November 2009 loan market value, according to NAMA's section 227 review in July 2014. What is the professor's view of the NAMA setup in retrospect? Why was an alternative course not more seriously considered, such as nationalising the banks and burning the bondholders, rather than transferring the loans?
Professor Alan Ahearne:
NAMA did not prevent any burning of bondholders. It is not true to say that we had to either set up NAMA or carry out nationalisation and burn bondholders. Anglo Irish Bank was nationalised, but it sold a lot of property to NAMA. There was a bit of a debate at the time that these were alternatives. That was just flawed thinking, because they are not alternatives. I think the system we have now has done very well. The pricing was fair and it gave a big discount on the loans it bought. I do not think one can be too precise about these things. Sometimes we suffer from false precision. The discount was 57%. If somebody is going to argue that it should have been 59%, 55% or 60% I would wonder how he or she could be so precise.
Joe Higgins (Dublin West, Socialist Party)
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The Comptroller and Auditor General estimated that Bank of Ireland got €1 billion in State aid in reality.
Professor Alan Ahearne:
One had to come up with some sort of number. NAMA followed EU regulations. It presented a formula for calculating things, and an allowance of 8% was given for long-term economic value. If one looks at what property prices have done over the past 12 months, that allowance looks modest. Let us remember that the formula, although it looked complicated, came from the European Commission. I can understand why the European Commission would want every country to follow the same formula. The formula is still just an estimate, and that is all. One is trying to value a piece of land in Leitrim, for example, but there are no sales going on. How can one possibly value land with accuracy in that case? The best one can do is talk about a range or margin of error. I think what NAMA did, in terms of pricing, is that it got the price approximately right. It is better to get things approximately right than precisely wrong.
Kieran O'Donnell (Limerick City, Fine Gael)
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Professor Ahearne wrote extensively around the time of the guarantee, and stated that he had questions about the information on the quality of loans that was released by the banks. Does he believe that on the night of the guarantee, Anglo Irish Bank should have been allowed to fail? Does he believe that it should have formed part of the guarantee, or not?
Professor Alan Ahearne:
To be honest, I have an open mind. I just do not know. I might be able to come to a better opinion at the end of the inquiry when more information has come in. I just do not know.
I heard that Governor Honohan had a footnote in his report in which he talked about an alternative scenario in which Anglo Irish Bank was not included in the guarantee but was put under some sort of administration. That is an interesting hypothesis, but it was only a footnote in a report. I have not seen a ten- or 20-page paper that goes through that in a counterfactual manner explaining how it would have worked - that the next morning the Government would have announced this, that excluding Anglo Irish Bank would have affected things in a particular way or that it would have worked in a particular way. Without seeing a worked-out scenario and a detailed paper, it is just a hypothesis at the moment. It is a footnote in a report, so I do not know.
Kieran O'Donnell (Limerick City, Fine Gael)
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There was no question of looking at how much this would cost or what potential saving could be made for the taxpayer if Anglo Irish Bank had been kept out of the guarantee. Did that aspect ever come up in discussions?
Professor Alan Ahearne:
The numbers are the numbers. Anglo Irish Bank was recapitalised to the tune of €30 billion, as I have said. If I remember rightly, it had, on the night of the guarantee, about €50 billion of deposits and about €10 billion of senior bonds. Again, I am talking a hypothesis or a counterfactual scenario. If one considers the counterfactual scenario in which the Government says it is not going to put a cent into Anglo, the €30 billion of losses that the State covered would have fallen on its creditors. Then, one had €60 billion of senior creditors - €50 billion in deposits and the €10 billion - and one would have discounted them by 50%, which is the number I gave earlier. That measure would have saved the State €30 billion, if that is what the Deputy asked. On the other hand, one is talking about depositors, small businesses and individuals with their life savings getting back 50 cent in the euro. That means that if an elderly person had €200,000 saved with Anglo Irish Bank, he or she would have got €100,000 back. If one were a small or medium-sized enterprise with the wages for the next few months on deposit then one would have got half of them back.
Kieran O'Donnell (Limerick City, Fine Gael)
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Is it fair to say that if the State had guaranteed just the deposit holders in Anglo, and not the bondholders, there would have been a significant saving to the taxpayer?
Professor Alan Ahearne:
I do not think so. What if the bank had been liquidated? In a liquidation all unsecured creditors must be treated equally.
The liquidator could not have told bondholders he was going to give them nothing back but give all the revenues from selling the assets to the depositors. Maybe the State could have made good all the depositors but we would still have diluted the losses that could be forced onto senior bondholders by the fact that there were depositors. It may have saved 50% or €5 billion of the total of €10 billion.
Kieran O'Donnell (Limerick City, Fine Gael)
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Professor Ahearne wrote an article about NAMA in July 2008 in which he said the best practice was for banks to recognise the losses of the loans up front and sell the assets at fair market value. Dr. Bacon, who was before the committee this morning, was the architect of NAMA and he said there were €34 billion in impairments on €80 billion of loans, a write-off of between 50% and 60%. When the then Minister for Finance, the late Deputy Brian Lenihan, introduced the legislation in the Dáil, he said NAMA was being put forward on the basis of a discount of 30%, which would have been some €23 billion rather than the €42 million it transpired to be. Did the design of NAMA, and the fact that it was based on a 30% discount rather than a discount of nearly 60%, feed into the need for the banks to be recapitalised? If the eventual level of discount was known at the early stages of setting up NAMA, would the professor have proceeded with setting up the agency?
Professor Alan Ahearne:
Absolutely. The Minister did not put forward NAMA on the basis of a certain discount but gave an estimate of the figure. The actual discount could only be determined by European Commission rules after they had calculated it loan by loan. The extent to which the property market fell mattered as to the discount but NAMA would have been a good idea irrespective of whether the discount was going to be 20%, 50% or 80%. The arguments put forward for an asset management company never depend on there being a certain discount as the argument for an asset management company stands on its own two feet.
I was struck by what Professor Dirk Schoenmaker from the Duisenberg School of Finance said at a conference last month. He is one of the world's leading experts in banking. He is an independent and highly regarded individual who has also written a paper about the Irish banking crisis. On page two he writes: "The establishment of the bad asset agency, NAMA, serves as an international example of the successful management of bad assets." On page 24, he states: "The establishment of NAMA was instrumental in the successful management of the Irish banking crisis." That is his assessment
Ciarán Lynch (Cork South Central, Labour)
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We will wrap up soon. I invite Deputy Eoghan Murphy, followed by Senator Marc MacSharry.
Eoghan Murphy (Dublin South East, Fine Gael)
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I have two brief supplementaries. In his opening statement, Professor Ahearne talked about the price-rent ratio as an indicator of a bubble. How important an indicator is it? Does it rank in the top three indicators? Is it something that needs to be scrutinised continuously?
Professor Alan Ahearne:
As I said, it is not foolproof. We looked at this in a 2005 paper and we found examples of price-rent ratios which suggested a boom or a bust but where a boom or bust did not materialise. There is no infallible tell-tale sign. It is useful but it has to be supplemented with other types of information.
Eoghan Murphy (Dublin South East, Fine Gael)
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There has been some discussion in this context phase of the extent to which this crisis was home grown. Professor Ahearne wrote in The Sunday Independentthat the housing market began to turn sour around the middle of 2006, a full year before the global credit crisis erupted in August 2007. Can he give an opinion on the relationship between the international and domestic factors?
Professor Alan Ahearne:
At its most intense, the crisis here was an interaction between both crises. If the bubble had burst here but the global economy was still flying, we would still have had trouble here but not as much, and the recovery would have been much faster. The first sign of trouble in 2006 was some failed auctions in Dublin's high-end market. The market had been flying as the overall market rose but some failures in 2006 represented the start of trouble for developers and sellers.
Marc MacSharry (Fianna Fail)
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I would like to seek clarification on my last question. I put a question to the Governor of the Irish Central Bank, Professor Honohan, about the costs of recapitalisation. He said it would amount to some €40 billion but Professor Ahearne said it would be much less than that. How much does he think it will be?
I asked earlier if the fiscal adjustment would have been less or more had we allowed Anglo Irish Bank or another bank to fail. The professor said that, as of today, the saving would be just a couple of hundred million euro. Can he clarify those two points?
Dr. Peter Bacon said in his closing remarks that the main causes were interest rate deductibility for investors, low interest rates, capital inflows and interbank lending. If that were true and a Government could see there was going to be a boom in, say, six years' time, what kind of lead-in time would it need to act to alleviate the difficulties coming down the line?
Professor Alan Ahearne:
The final cost of recapitalisation, by which I mean the true burden, taking into account financing and not just the headline rate number, changes every day and, indeed, every time bond yields move. It depends how quickly the Central Bank sells these bonds into the market. These are all factors.
Marc MacSharry (Fianna Fail)
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Is the trend upwards or downwards?
Marc MacSharry (Fianna Fail)
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I used the word.
Marc MacSharry (Fianna Fail)
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Is it correct that the real cost so far has been a couple of hundred million euro?
Ciarán Lynch (Cork South Central, Labour)
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I want to wrap up a couple of matters. I return to a earlier question by Senator Michael D'Arcy. Did the way the guarantee was designed have any relationship with Ireland being required to enter a bailout programme two years and two months later?
Ciarán Lynch (Cork South Central, Labour)
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I was asking about the way the guarantee was designed.
Ciarán Lynch (Cork South Central, Labour)
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I am asking if there is a relationship between the design of the guarantee and our ultimate entry into the bailout programme.
Professor Alan Ahearne:
There is no simple answer to that. It is very complicated.
If, for example, the State could have put on to somebody else the €30 billion that was put into Anglo, let us say, by not including it in the guarantee, then clearly the national debt would have been lower by €30 billion. However, the €30 billion would have fallen on to depositors and bondholders and there would have been economic consequences from that. As to where that would have led us, it is difficult to say.
Ciarán Lynch (Cork South Central, Labour)
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The other matter I want to deal with goes back to an article Professor Ahearne wrote in 2008 and I believe it was written for the Sunday Independent. He posed the question of how much of what ails the Irish property market we can blame on the US sub-prime meltdown and the resulting international credit crunch. He answered it by stating that it was probably a lot less than some people would have us believe and that the housing market here began to turn sour around the middle of 2006, a full year before the global credit crisis erupted in August 2007. With the benefit of hindsight, what is his assessment now of the roles played by the domestic and international factors in regard to Ireland's banking crisis?
Professor Alan Ahearne:
The bubble was always going to burst. There was always going to be deep problems in the Irish economy as a result of the domestic bubble. The international factors contributed to the bubble, for example, the inappropriately low interest rates in the economic and monetary union. It intensified the downturn and made it worse because the external environment was so poor. There was a global recession, the worst downturn in the global economy since the Great Depression. All that deepened the downturn here.
Ciarán Lynch (Cork South Central, Labour)
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If international factors were not at play and given the behavioural aspects in Ireland, in terms of weighing up the situation with regard to international and domestic factors, in Professor Ahearne's judgment where does it fall at either side with regard to the behavioural aspects of it? Was it a domestically manufactured crisis or was it an internationally manufactured crisis?
Ciarán Lynch (Cork South Central, Labour)
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In terms of weighing them, was it a ratio of 40:50 or 50:50?
Ciarán Lynch (Cork South Central, Labour)
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In view of the severity of the banking crisis in Ireland and the hard lessons learned by the country, what does Professor Ahearne believe are the main lessons for improving economic surveillance and policy-making by Irish authorities in the coming years? Given that this inquiry is as much about looking to the future as it is about looking back to the past, does he have any thoughts that he would like to share with the inquiry in his closing comments?
Professor Alan Ahearne:
It would be only to emphasise the importance of proper financial regulation. The good news is that I think that lesson has been learned. Financial regulation has changed dramatically in Ireland and now it has been moved to Europe. The importance of financial regulation is key.
Ciarán Lynch (Cork South Central, Labour)
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Professor Ahearne would have confidence in the surveillance mechanisms used by those external international agencies.
Professor Alan Ahearne:
They, too, have learned lots of lessons. That said, we cannot depend on outsiders. As a country, we have got to have our own institutions and we have got to take care of ourselves. It also underscores the importance of having proper institutions here that guard against these sorts of excesses and imbalances.
Ciarán Lynch (Cork South Central, Labour)
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Much of the testimony of people, like Professor Ahearne, who have examined booms and bust cycles has been that the difference with the next boom is that there will be a material difference compared with the previous one and that is why it is not actually identified. Given the current context of the Irish property market, does Professor Ahearne see any abnormality in it at present that was not spotted in the past that could indicate towards a future crisis?
Professor Alan Ahearne:
It is problematic that Dublin house prices are rising so rapidly because it is pricing lots of people out of the housing market. That is the problem. Consistent with the evidence I proffered earlier, one really gets worried about housing booms when they are associated with credit booms. So far we have not seen a credit boom accompanying the recent increase in house prices, but that does not mean that it would not morph into that. It may well morph into that and that is why it was very important for the Central Bank to introduce the loan-to-value rules that it did. That will help to keep people safer.
Ciarán Lynch (Cork South Central, Labour)
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Is Professor Ahearne in agreement with the Governor's position on that?
Ciarán Lynch (Cork South Central, Labour)
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Thank you very much, Professor Ahearne. I thank you for your participation before the inquiry today. It has been a very informative and a valuable meeting which has added to our understanding of the factors leading to the banking crisis in Ireland.