Oireachtas Joint and Select Committees

Wednesday, 24 June 2015

Committee of Inquiry into the Banking Crisis

Nexus Phase

Department of Finance - Mr. John McCarthy

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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The Committee of Inquiry into the Banking Crisis is now in public session. And can I ask members and those in the public Gallery to ensure that their mobile devices are switched off. We begin today with session 1, public hearing with Mr. John McCarthy, chief economist, Department of Finance. In doing so, I would like to welcome everyone to the public hearing of the Joint Committee of Inquiry into the Banking Crisis. Today, we continue our hearings with senior officials from the Department of Finance who had key roles during the crisis period. At this morning's session we will hear from Mr. John McCarthy, chief economist, Department of Finance. John McCarthy joined the Central Bank as an economist in 1996 but has spent most of his career on secondment to the Department of Finance. At all times in the Department, he worked in the economic section of the budget and economic division. He was appointed chief economist at the Department in November 2013 following an open competition. Mr. McCarthy, you are very welcome before the committee this morning.

Before hearing from the witness, 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 you are directed by the Chairman to cease giving evidence in relation to a particular matter and you continue to do so, you are entitled thereafter only to a qualified privilege in respect of your evidence. You are directed that only evidence connected with the subject matter of these proceedings is to be given. I would remind members and those present that there are currently criminal proceedings ongoing and further criminal proceedings are scheduled during the lifetime of the inquiry which overlap with the subject matter of the inquiry. Therefore, the utmost caution should be taken not to prejudice those proceedings. Members of the public are reminded that photography is prohibited in the committee room. To assist the smooth running of the inquiry, we will display certain documents on the screens here in the committee room. For those sitting in the Gallery, these documents will be displayed on the screens to your left and right. Members of the public and journalists are reminded that these documents are confidential and should not publish any of the documents so displayed.

The witness has been directed to attend this meeting of the Joint Committee of Inquiry into the Banking Crisis. You have been furnished with booklets of core documents. These are before the committee, will be relied upon in questioning and form part of the evidence of the inquiry. If I can now ask the clerk to administer the oath to Mr. McCarthy, please?

The following witness was sworn in by the Clerk to the Committee:

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Once again, thank you Mr. McCarthy for being here this morning, and if I can invite you to make your opening remarks to the committee please.

Mr. John McCarthy:

Sure, thank you, Chairman, and thank you members of the joint committee. I can be very brief, Mr. Chairman, as I have submitted a more detailed witness statement to the joint committee already. Just by way of introduction, you have directed me to give evidence relating to my role as chief economist/assistant secretary and all other roles in the Department of Finance. As you mentioned, I was appointed to the position of chief economist in November 2013. Prior to that I worked at a technical level in the Department, at grades equivalent to that of assistant principal and principal officer from about 2001 onwards, with the exception of 2004 when I was back working in the Central Bank. For the most part, during this period, my work involved producing economic forecasts for the Department, as well as undertaking some technical work on the public finances, mainly related to the Stability and Growth Pact, the structural budget balance, fiscal stability treaty and so forth. Please let me briefly summarise the, the main points of ... or what I see as the main points of my witness statement.

As I've outlined, the stance of macroeconomic policy during the first decade of monetary union was completely inappropriate. While monetary policy was exogenous, it was determined externally by the European Central Bank with regard to economic conditions in the euro area as a whole, fiscal and incomes policies in Ireland should have been counter-cyclical with the view to stabilising aggregate demand in the Irish economy, which was essentially operating at full capacity or even beyond full capacity for most of this period. The contraction of the tax base and the ramping up of public expenditure on a permanent basis were clear policy mistakes and ultimately led to a very large structural deficit once the crisis kicked in. That the public finances were in broad compliance with the requirements of the Stability and Growth Pact during most of this period provides no comfort.

Let me say a little bit on the ... on the Department's warnings. The Department did advise, both internally and externally, regarding the pro-cyclicality of fiscal policy, regarding the loss in competitiveness, as well as the over-dependence of the economy on new house building and construction more generally. This is acknowledged in various reports, Wright and Nyberg being good examples. However, it is also clear that the Department should have adapted the tone of its warnings as the imbalances were becoming more acute and I would certainly agree with this analysis.

Now, in relation to the housing market, the general approach in the Department was to highlight the central scenario of a soft landing but also to outline, in various internal memos and so forth, that there were risks to the ... to this ... such a benign outcome. I think it's important on the outset to stress what is meant by a soft landing. This was the assumption that prices would level off or even decline moderately so that with continued consumer price inflation, real house prices would realign with fundamentals over time. In addition, it involved the assumption that activity would revert to more sustainable levels in a gradual manner, rather than in a very disruptive manner. Clearly a soft landing did not materialise and this was an incorrect call.

Finally, if I could just say a few words on the resources of the Department, and specifically within the economic division. Certainly, when the crisis hit there were very few economists working in the economic division. The number of people that I would consider as technical economists you could count on one hand, I think it's fair to say, in the division at that time. But I think it's fair to say the picture has changed in the intervening period with improved resourcing, especially on the quality. Okay? I think we are now approaching a critical mass of economists within the Department and we are publishing some of our technical work, something which never happened before, and we are engaging in a more structured manner with the wider economic community. So, from an economic perspective, I think it's fair to say that the Department is in a much better place now. Chairman, with this brief summary I will conclude my opening statement. Thank you.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much for your opening remarks, Mr. McCarthy, and if I can invite our first lead questioner this morning, Senator Sean Barrett. Senator, you have 15 minutes.

Thank you very much, Chairman, and I welcome Mr. McCarthy. I echo the Chairman's welcome to you. You were just saying there the critical mass of economists, what's the number that you would put on that?

Mr. John McCarthy:

Within my own division, within the economic division, there are about 20 positions for economists. Not all of those are filled at the moment. I have about 15 people on my team. There are a number of vacancies including one crucial vacancy on the macro-economics side. I am holding that vacancy for the next month or two because there is an excellent economist employed in the Department but in another division, so I am willing to wait. When his job finishes there he will move across.

I think you need to look beyond the economic division as well, there are economists elsewhere in the Department and I also think it's important to highlight the fact that the role of the Irish Government economic and evaluation service, which was established I think in about 2011 or 2012, it is situated within the Department of Public Expenditure and the rational for this is to create an economic service for the Civil Service as a whole. So there has been a large amount of recruitment there both at the AO level, there is currently recruitment ongoing at the AP level so the rationale and I'll finish here is to create a career structure for economists all the way up to and including chief economist which is at the assistant secretary grade.

Photo of Sean BarrettSean Barrett (Independent)
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Outside your 20, how many other economists are there in the Department of Finance?

Mr. John McCarthy:

I think the number with masters level degrees or more is just under 40. I think it's 37 or 38.

Photo of Sean BarrettSean Barrett (Independent)
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The ones that moved across to public administration, public expenditure and reform, how many are there roughly? I know it's not your Department but-----

Mr. John McCarthy:

I would have to hazard a guess and it would be an educated guess, there would be the guts of 40 or 50. That is a reasonable guess. It is not zero and it is not 200, it is somewhere of that magnitude.

Photo of Sean BarrettSean Barrett (Independent)
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Thank you for that. Some of the literature says that those specialists should move on after three years. I take it that what you're doing is integrated fully into those departments and there wouldn't be a suggestion that specialists should depart the scene.

Mr. John McCarthy:

Absolutely not. One of the problems in the past has been that there is this generalist versus specialist approach. I think there is a general recognition that there was a lack of specialist at the time. Not just in economics but I think in other areas as well. There was no career path for economists within the Department. John FitzGerald has spoken about this, I think in this forum, but certainly at other fora he has spoken quite a lot about this. He had to leave the Department because he felt if he wanted to move up he would have to move outside the economic space and into the sort of ... and that is what we are trying to address now is to create a career structure so you can join as an economist and you can move up the ranks as an economist. So as I mentioned, there is currently a competition under way for AP economists and as I said before you can go all the way up to my position, to assistant secretary, and remain an economist.

Photo of Sean BarrettSean Barrett (Independent)
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Very good. Now 2003, did the interaction between the Government's economic analysis function with the economic research section of the Central Bank because of the restructuring and the creation of the Irish Financial Services Regulatory Authority, did that change or was there a change in emphasis when the Financial Regulator was established in 2003?

Mr. John McCarthy:

No, not on the economic side, Senator. The reason for that is that we would engage - when I talk about "we" I am talking about the economic division - we would engage with the Central Bank on an informal basis and the nuts and bolts of our discussion would essentially be about the short-term outlook for the economy. We would, sort of, exchange views on where things were going. There were a lot more people employed in the bank, so you could argue maybe there was a comparative advantage there but we would have informal discussions pretty much around the Central Bank's quarterly bulletin, we would discuss where things were going. We might often, or from time to time, we might run some technical issues past the economic division of the bank, but this was purely in the macro-economic space.

So, the whole rationale was to ... you know, if the bank were talking about a forecast of, we'll say, X%, we would say, "Well, what's the savings rate that underpins your consumption figure? What's the exchange rate that underpins your export?" It was purely a technical discussion. We did not have, in the economic side, any dealings with the Financial Regulator.

Photo of Sean BarrettSean Barrett (Independent)
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In your own core documents, on Vol. 1, page 38, what Nyberg says on that arrangement, Mr. McCarthy, is, "Had the DoF [Department of Finance] taken a greater interest in financial market issues early on, preparations for dealing with the financial crisis would have been more comprehensive." So, in retrospect, was that a flaw in the way we organised the relationship between the Department of Finance and the regulator?

Mr. John McCarthy:

The responsibility for dealing with the regulator within the Department was on the banking and finance division. My own department, or the department ... the section that I was engaged in, or employed in, was purely looking at macro-fiscal issues. We did not look at financial stability issues, so I couldn't comment on any discussions that may have taken place between our banking and finance division and the regulator.

Photo of Sean BarrettSean Barrett (Independent)
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Wouldn't the two overlap, though, if you saw credit expanding at 25% a year? You know, that must have implications for the macroeconomic state of the country, so you couldn't have remained immune from such a heavy increase, year after year, in the amount of credit that the banks were extending.

Mr. John McCarthy:

Yes, no, I do think you're making a fair point, Senator. I do think there was a lack of joining the dots, if you like, between the real economy and what was going on on the credit side. We tried to address that in 2006. I think there was a proposal to establish a working group within the Department and possibly involving others, to look at everything, to make sure everything was joined up, but at that stage, I suppose the horse had bolted and, from what I recall, the group never met.

Photo of Sean BarrettSean Barrett (Independent)
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I see. And you mentioned Professor FitzGerald earlier. He said to us that there was a cultural change in the Department of Finance in the last decade, that they became more concerned about the politics of things and less interested in technical detail and he, in the ESRI, and yourselves had had less interaction. Did you have any response to what John FitzGerald was saying in that very chair?

Mr. John McCarthy:

Two points on that. I think John FitzGerald, when he was in this chair, made reference to two sets of interactions between the ESRI and the Department. He referred to technical level discussions and he referred to political level discussions. He was quite complimentary regarding the technical level discussions and those technical level discussions would have involved myself and some of my team. He expressed concern about the over-politicisation of some of the ... well, maybe I'll ... of some of the comments coming from other parts, or more senior levels, within the Department. They were very political. He was complimentary on the technical discussions. He has also ... my second point is he has also been very complimentary of the various changes that have taken place within the Department over the past couple of years: the fact that we now publish working papers; the fact that we now publish technical papers; that I speak at conferences, both domestically and internationally; that my team speak at conferences; that people have published in the Journal of the Statistical and Social Inquiry Society of Ireland; The Economic and Social Review. He has been quite complimentary about the technical capacity of the Department; less so about the over-politicisation of some of the-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Would you concur with Mr. FitzGerald's comments on the politicisation, Mr. McCarthy?

Mr. John McCarthy:

Yes.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Would you like to expand upon that?

Mr. John McCarthy:

I do think, in my time in the Department, there were instructions given to people to, "Take this out; they can't say that; this is too political; get them to not say that." My own view is that independent thought, be it from the IMF or the ESRI, is actually good.

The Department needs people saying controversial issues. So, I would agree that there was some over-politicisation.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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And where were those instructions coming from? Sorry about that now.

Mr. John McCarthy:

They were coming from beyond my pay grade.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, within the public sector?

Mr. John McCarthy:

Within my Department.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Within your Department. Okay.

Photo of Sean BarrettSean Barrett (Independent)
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And when we look at-----

Mr. John McCarthy:

Sorry, can I just?

Mr. John McCarthy:

I did the technical work-----

Mr. John McCarthy:

And then at a higher level, the instructions.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thanks.

Photo of Sean BarrettSean Barrett (Independent)
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When we look at Vol. 3 in the core papers, around pages 17 and 20, there's quite a lot of the same kind of factor that you refer to there, Mr. McCarthy, in relation to taking chunks out of IMF reports in Ireland. And particular, on page 17, their discussion of a deposit insurance scheme and, you know, a warning on page 12 that it would be:

[I]mportant to be prepared for the worst. In this context, pay-outs from the bank deposit insurance scheme should be available more rapidly and the scheme better funded to reduce liquidity concerns in case a bank comes under pressure. Enacting an insolvency process specifically adopted to banks [would] should also be considered.

I mean, given what happened, wasn't it unfortunate that we ... that Ireland asked the IMF to take those chunks out? For instance, "the housing boom is over" was replaced by "the housing market cycle has turned", that, if we're going to rely on the IMF and the ESRI to say they supported what we were doing in policy, we shouldn't be engaging in, kind of, altering those documents before the public gets to see them.

Mr. John McCarthy:

OECD report.

Mr. John McCarthy:

OECD rather than IMF. Just the ... these were, they're not my own comments I would stress Senator, but I would agree with you. It is good to have people making these recommendations. Sometimes they're not entirely accurate and so forth, but they are good to provoke thought and certainly on the deposit guarantee scheme and some of those other issues, they were important. Just because there is a suggestion from somebody in the Department, and its not myself, that these be removed, does not mean that they were actually removed. This report, and its an OECD report I think from 2008, the twice ... every two years review of the Irish economy. That is ... the ownership of the report belongs to what's called the economic development and review committee of the OECD. So just because we ask for changes doesn't mean changes are taken. There is a meeting every ... there is a meeting around this and the committee can take on board any comments or they can delete comments and see them as inappropriate. But I would accept your point in the sense that it is good to have some of these recommendations. They may not necessarily be correct in all circumstances but it is good to provoke thought and it is good to have the debate as to whether they are relevant. But I would also point out, and it's the final point, every finance ministry in the world when they come to deal with the IMF or the OECD in this case, would come back with recommended changes. Some of them are just nuances, some of them are more substantive.

Photo of Sean BarrettSean Barrett (Independent)
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Was the definition of competitiveness used when we were talking about competitiveness, too restricted? It seemed to be just the consumer price index and wage claims. Was the property influence on competitiveness, if you take that Deputy Higgins has repeatedly drawn attention here as you know, that the fact that house prices are rising by more than the average annual income in every year, so that must have been reducing Ireland's competitiveness and did that not set off alarm bells in discussions of competitiveness in the Department?

Mr. John McCarthy:

The ... we looked at a number of measures of competitiveness. There is no single measure of competitiveness but the most comprehensive one that we would look at would be what's called the real effective exchange rate. So if ... essentially the effective or the trade weighted exchange rate adjusted for relative price developments. So you're taking into account how the exchange rates are going and then how prices are evolving, relative to major trading partners.

That's the one that feeds into our export model and I think that is, typically, among finance ministries and central banks, that is the key metric of competitiveness. But you're absolutely right in the sense that rising rents, rising house prices, do damage the competitiveness of the economy and that was certainly, you know, something we were conscious of.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Put your supplementary, Senator, and I'll bring you back in again.

Photo of Sean BarrettSean Barrett (Independent)
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Thank you. No, it's just houses going from 2.5 to up to ten times income and being paid for over 40 years instead of 25 years, that must have affected the competitiveness of the Irish economy. And I think in general, the literature - not just yours - didn't acknowledge that until after the event.

Mr. John McCarthy:

Not just house prices, but the cost of rents as well.

Mr. John McCarthy:

I think you're right. I think you're right.

Photo of Sean BarrettSean Barrett (Independent)
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Thank you very much. Thank you, Chair.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much. Deputy John Paul Phelan.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Thank you, Chairman, and good morning, Mr. McCarthy. Can I just start with that document just referred to previously by Senator Barrett, Vol. 3, the document that you refer to as not being ... you know, the notes being written on it were not your own? Page 9 of Vol. 3, the executive summary. I'm very good on executive summaries usually myself. On that particular page, the word "boom" has been circled three times by whoever. Now, first of all, can I ask you whose work was this, do you know, at the time? You said it wasn't your own-----

Mr. John McCarthy:

Am I allowed name names, Chair?

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Well, the ... the level-----

Mr. John McCarthy:

It was the assistant secretary in charge at the time.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Why would you think that the word "boom" was being circled?

Mr. John McCarthy:

I did consult on this and the feeling was it was a little bit journalistic rather than economic.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Well, that's, I suppose, one way of looking at it.

Mr. John McCarthy:

That's the information I was given.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Yes. Yes, that's fair enough. I suppose, I want to also refer to another document-----

Mr. John McCarthy:

Sorry-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Mr. McCarthy, yes, go on.

Mr. John McCarthy:

I mean, if it was up to me, I would have put in "bubble" rather than "boom".

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay. Vol. 2, page 105, which is a document prepared by yourself for the Tánaiste and Anne Donegan. The second paragraph of that document:

In summary, the OECD is forecasting a growth rate of [around] 3 per cent next year, with a slightly stronger pickup than we have assumed in 2009. However, the language regarding Ireland is somewhat 'sensationalist'; we proposed (on a number of occasions) a number of textual changes but these have not been taken on board. The comments on the property market pre-date the Budget confidence-building measures.

What was the sensationalist language being proposed by the OECD that you were commenting on there, can you recall?

Mr. John McCarthy:

I can't recall is the simple answer. But I would come back to a point I made earlier on - having dealt with the OECD and participated in meetings for years, every finance ministry will try and get changes to the text. Actually, we do it less than other finance ministries. I have seen finance ministries who will try to rewrite a whole document for the OECD. We will try and maybe nuance the text somewhat - the "boom" being a good example. Sometimes they take them on board, sometimes they don't. To be honest, it doesn't really bother me if something is sensationalist. It is good from an Irish Inc. perspective to have outsiders making comments that may be a little bit provocative, that maybe force us to think, to get rid of the kind of groupthink that we may have.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Was it common for the OECD to use that term "sensationalist" style of language?

Mr. John McCarthy:

I'm-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Was it common for them to use ... like, you're ... I'm referring to-----

Mr. John McCarthy:

Not ... not really, no. No, the OECD would typically be very ... a technocratic type of organisation.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay.

Mr. John McCarthy:

It is ... economists tend to dominate rather than journalists and stuff would, with "boom" language-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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So, was there-----

Mr. John McCarthy:

But it would be ... it would be technically based and the language would typically be economic.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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That's fair enough. The fact that they were using, to use your own term, sensationalist language in this document, was that an attempt by them to ... or was it ... or was it not - I should ... I can't ask a leading question - to highlight that there was pressures building in the Irish economy that should be acted upon?

Mr. John McCarthy:

Probably, I don't have the text, but in all likelihood, yes. It's autumn 2007, so clearly there were pressures and problems were beginning to manifest themselves at that stage. So in all likelihood ... definitely, yes, that was the case.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I want to refer again in relation to the OECD, to the evidence by Mr. Tom O'Connell, which he gave to the inquiry a few weeks back, and it was in relation to the way OECD and sometimes IMF, but it was specifically OECD country reports were produced. He said:

We would be discussing or interacting with the IMF and the OECD, in particular with the OECD country reports, it was embarrassing. When I used to go to Paris to ... with people to look at the reports, almost every line was parsed and any, anything of a negative nature needed to be taken out.

Was that your experience too of how those events would happen?

Mr. John McCarthy:

I wouldn't say everything of a negative nature would need to be taken out. My experience is that some issues might need to be nuanced, so for instance, when in the 2006 report of the OECD, which is the one that talked about house prices and some over-valuation, there was some nuancing of the word but no attempt to change the overall message that the OECD was trying to convey. Remember, it is a report, not compiled by the Irish authorities, but compiled by the economic development and review committee, the so-called EDRC: it is their language. So, if they want to say black is white, they can say it. They have to stand over it but what we can try and do is say, "Well, listen, a better understanding of the Irish economy might involve looking at the wording here, a little bit of nuancing here and there." But I would stress we do not engage in as much of that as a lot of other countries.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Now I want to turn to the ESRI quarterly commentary from the summer of 2007. It was referred to in the Honohan report, I think page 84. Morgan Kelly, in an article which was published in it, argued that most house price surges had ended in a fall of at least 50% in values. Furthermore, he went on to say there had been no quantitative, analytical evidence provided from the Central Bank, I think, at the time and there was a reference made to "The central scenario is, therefore, for a soft landing." I think Senator Barrett has already touched on it. To your recollection, what were the reasons for the Department of Finance in agreeing with the Central Bank in favouring a soft landing scenario for the property market over a hard landing?

Mr. John McCarthy:

Okay. Well, in a number of documents that we would have sent to the Minister or the Tánaiste at the time, we did outline the central scenario or the baseline scenario of a soft landing, but we did outline the possibility of a hard landing.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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It was, kind of, given that there was options for want of a better term. But there was still-----

Mr. John McCarthy:

On the one hand and on the other hand.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Yes, but the dominant hand, was the soft landing hand.

Mr. John McCarthy:

Now, the evidence base for a soft landing was ... well, it was along the following lines: there is a soft landing on the prices side, and there is the soft landing on the volume side - volumes, I mean housing output and so forth. Let me deal with the latter first. We made the assumption in various budgetary forecasts, and we modelled a soft landing on the basis of we were currently, or at the time, producing 70,000, 80,000, 90,000 units at the peak. At the time, it was estimated that, on the basis of demographic trends, and on the basis of fall in headship rates, in other words an increase in the percentage of the population who are heads of household, that there was an underlying need for about 50,000 units per annum. Now how do you go from 90,000 to 50,000?

Does it fall like that or does it like it fall like that? In the budget documentation, our central scenario was a gradual easing - a fall of about 5,000 or 6,000 units per annum. So, operating over the medium term and converging towards sustainable levels of output. That was the central scenario but we did model internally - in a document that I wrote with a colleague who is now the Secretary General - what would be the implications on the public finances of a hard landing if output was to go from 90,000 down to sustainable levels more rapidly? In fact, it didn't go to sustainable levels, it overshot on the way down, as sometimes happened. And we concluded that the impact on overall economic activity of each 10,000 reduction would be to shave about a percentage point of the growth rate, add about a percentage point to ... a half or a percentage point, I can't remember, to the unemployment rate, add a half a percentage point to the deficit, and these were simply the first round effects. Clearly, we went from 90,000 to 10,000 in the space of three or-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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On the other end ... on the value end?

Mr. John McCarthy:

On the prices.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Yes.

Mr. John McCarthy:

I'll come to that now, Deputy. The evidence for a soft landing ... we took the view that house prices in Ireland had never fallen in nominal terms and data have been collected back as far as 1970. So there was no precedent for this in Ireland. We did have a number of models. So we looked at issues like price earnings ratio, price income ratio, we had an affordability model. So, in other words, the ... when you looked at the growth of employment, the growth of wages, the decline in taxation, the new monetary regime, the portion of disposable income ... of household disposable income that is absorbed by debt payments or debt service costs was in line with the historical norm, about one third. The problem was we didn't realise that these fundamental factors could change so dramatically, that employment would fall by nearly 15%. Now, there is also ... economic theory is also quite consistent with a soft landing in house prices-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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My time is very short now and I have just one more question that I want to get in. Really what I'm asking you, Mr. McCarthy, is, there's very little evidence, from looking at other countries in particular, whether in the European Union or outside of it, to support the soft-landing scenario, and yet ... and I'm talking about the value soft landing scenario, not the reduction in units produced. What evidence did you gather from looking at other countries to support the soft-landing scenario or was there any analytical work done to gather that evidence?

Mr. John McCarthy:

Yes, yes there was. So if you looked at the situation in Japan, an advanced country ... it's outside Europe but an advanced economy nonetheless. In the period leading up to - I think it's about '91 or '92 - house prices had risen by 180%, ballpark - 100%, remember, is a doubling in house prices ... so, 180%. In the five years after the peak, price levels had fallen by just 15%. That to me would be consistent with a soft landing. Now, Japan subsequently got into a deflationary spiral and prices have subsequently kept going down but five years after the peak, price levels were just 15% below the peak. So there was evidence-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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So was Japan the only example that was looked at?

Mr. John McCarthy:

It's one example that I looked that. But, certainly, there were examples in which you didn't get that ... I think the Kelly paper looks at 20 or 30 OECD countries where that didn't happen, okay, but-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Was there enough of that analytical research and comparison done with other countries closer to home maybe than Japan?

Mr. John McCarthy:

Well, what we were doing was, if you look at the theory behind house prices, and let me ... just bear with me one second here-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I have a minute and 20 seconds to bear with you and I have one more question that I have ask, so I can't really-----

Mr. John McCarthy:

Well you asked-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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-----well, if you can be very brief.

Mr. John McCarthy:

Okay, if you're asking me for the evidence on a soft landing ... I mean, economists think of housing as not just an investment asset but also a consumer good. In other words, it provides consumer services, accommodation and so forth. So unlike a stock in share where if there is overvaluation, it can fall dramatically; in a housing market, if prices begin to fall, people will take the house off the market rather than sell at a loss.

So you can get prolonged periods of disequilibrium in the housing market. So, in other words, if the actual prices here, the fundamental prices here, you can get a levelling off and eventually fundamentals catch up. That's the theory and that's the sort of supporting evidence.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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And is that what the Department of Finance at the time was-----

Mr. John McCarthy:

That's what we were, that's what we were thinking.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay. I need to turn to one more area, I've a half a minute left. Comments from contributors to the Wright report indicated that there was a lack of leadership and direction in the Department of Finance during 2000 to 2010, and its effectiveness was limited. Would you agree with those comments? And I'd ask you finally what should have been done or is still to be done to improve the Department's role and effectiveness going forward?

Mr. John McCarthy:

I think the Wright report is quite clear on this. There ... the Department wasn't called upon to lead during that period. The Department was sidelined by the social partnership process, the programme for Government process, all of these had the effect that the Department simply existed to pay the bills. I think that phrase is actually used in the Wright report. The Wright report is also quite clear that the Department took leadership once the crisis kicked in. The Department produced the national recovery plan upon which the programme was based, and it was a very successful programme. The economy is now doing very well on foot of coming out of the programme and so forth. So leadership was shown when it was needed and when the Department was called to lead, when it wasn't sidelined. Sorry, I've forgotten the second part of your question now?

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Well, is there anything to be changed in the way the Department is run that, you know, the recommendations for changes in the Wright report that hasn't been implemented or-----

Mr. John McCarthy:

As far as I know, the vast majority of the recommendations have been implemented. Those that haven't been implemented have been overtaken by events. In other words, the separation of the Department into Finance and the Department of Public Expenditure. So, for instance, the number of economists, a lot of those are now in pair.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Thank you very much, Deputy Phelan, and I'll bring you back in the wrap-up again. Just in regard to one matter you were discussing with Deputy Phelan there, Mr. McCarthy, and that was the changes that were made in some of the reports that we've discussed and they were the OECD report wording, "the housing boom is over" changed over to "the housing cycle has turned" and other changes being implemented. Can I put the question to you in regard to the present: are these OECD or IMF reports still being revised before publication by the Department of Finance?

Mr. John McCarthy:

Oh, we always get the opportunity to comment on the report.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay.

Mr. John McCarthy:

Always. And that will always be the case and for every finance ministry in the world that would be the case.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. And has the tone of the revision or the input into those reports changed? Are you talking things up, talking things down or what is the sort of discourse and narrative that's being placed upon them now?

Mr. John McCarthy:

The ... from what I've seen, Chairman, is the main changes have been purely of a factual nature, "This figure is wrong, you need to change that." Minor nuances, maybe. I have put in one or two issues myself that have made it more hard-hitting.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. And on the issue of the modelling for a soft and hard landing, was there any worst-case scenario done in regard to the hard landing?

Mr. John McCarthy:

Just the document that I referred to earlier on, where we looked at-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Which is the 0.5% of unemployment?

Mr. John McCarthy:

Yes, yes.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay.

Mr. John McCarthy:

So it was done on the volume side rather than the pricing side.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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There was no ... was there any examination done in regard to ... as we learned subsequently from the Keane report and other issues with regard to the property market, it wasn't just losing employment that put stresses on people's ability to pay for their homes, drops in income, overtime and so forth, which is reflected in the 2009 Central Bank report, when the rules for getting a mortgage were tightened up, where you couldn't include a room-to-let or overtime and so forth? Was the affordability to be able to meet the debt, as opposed to unemployment, ever considered?

Mr. John McCarthy:

I think a lot of the research in that space has been done by the financial stability team in the Central Bank rather than in the Department of Finance, so we're almost takers of the research. We're aware of the research but I don't think we have done it ourselves.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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No, the Department ... even though the Department of Finance was talking about soft and hard landings, it had no research of its own in this regard?

Mr. John McCarthy:

Sorry, Deputy, I thought you meant subsequently, when the crisis hit.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Yes.

Mr. John McCarthy:

Not ... what I can say definitively is not on the economic side of the Department. I'm not aware of research that may have been done on the other, on the banking and financial side.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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No, but on the hard landing, on the soft and hard landing theory, was there research carried out by the Department of Finance on the hard landing theory?

Mr. John McCarthy:

Just, just on the volumes issue----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Just one model, which was on the 0.5% tied to construction-----

Mr. John McCarthy:

Yes, yes-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Nothing around affordability, nothing with regard to what Senator Barrett was talking about, people on 40-year mortgages - the difference being that, on a 20-year schedule, once kids would be going to college the mortgage would be cheap, you know on a 40-year mortgage, you are still in the middle of your mortgage and your kids going to college - all these affordability things; drops in overtime allowances, and other factors, affordability measurements as opposed to unemployment, anything done like that?

Mr. John McCarthy:

We had an affordability model with all those factors factored in, okay, but we didn't shock the model, so to speak; in other words, if employment fell by 20%, what would be the impact on affordability? No is the answer.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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And, any realisation between that the Irish economy was 24% into construction, and this was twice above the European norm, that an impact upon construction in this country would be twice what it would be in the European norm, and you were looking at the European norm as your template with regard to the hard and soft landings. So, was that not a bit of an incongruence that construction in this country was twice above what it was in the European norm, but you were looking at European norm models instead of landings?

Mr. John McCarthy:

We certainly should have modelled it, absolutely, we certainly should.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Right. Deputy Pearse Doherty.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Go raibh maith agat, a Chathaoirligh, agus fáilte, John. Can I ask you, in your opening statement, you agreed that the staffing numbers of economists in the Department was inadequate. You also mentioned that there was, there has been, and continues to be, efforts to address this. You also, and you've given some figures to the Deputies, or the Senators, in relation to that. Could you outline your opinion on how, and in what areas of your division, this inadequate number mainly impacted on the work of the Department?

Mr. John McCarthy:

Are you referring to my opening statement or the witness statement?

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Well, the fact that you, yes, your statement that there were an inadequate number of economists. So how did it affect the work of your Department?

Mr. John McCarthy:

There's an important issue here, which I think you're raising. To me, there is no correlation between the number of economists and the quality of policy-making on the one hand, or the number of economists and the ability to foresee the crisis. Let me give you a couple of examples, Deputy. The IMF, an organisation that I have huge respect for, employs hundreds, if not thousands of economists, and they did not foresee the crisis coming. So, in 2008, when we brought forward the budget, we based it on the IMF's forecasts, which were published at the beginning of October. The budget was then in mid-October. A week or so afterwards, the IMF revised its forecasts, so even though there was all of these economists, it simply was not possible to foresee the crisis. The number of economists and the quality of policy-making: the ECB, not an institution I have particular affection for. This was an institution that currently employs thousands of economists, and actually tightened monetary policy in 2008 and 2011 - absolute policy mistakes. So I just wanted to get across the point that it's not necessarily the number, but, having said that-----

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Are you saying that the number wouldn't have made a difference?

Mr. John McCarthy:

I think it would have made a difference in some respects but not in others. If we had 100 economists we still would not have foreseen the global crisis, but what we could have done, Deputy, is we could have allocated more resources to looking at where the imbalances were really becoming problematic. Where the Chair mentioned, we could have shocked the property model, the construction model, to see, but we simply didn't have the resources to do that.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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There has been evidence given to the committee that it's about the framework used in modern macroeconomics that was at fault here, and there's been suggestions that no matter how many economists you had in the Department, there was a bit of herd mentality there. Do you subscribe to that notion, that-----

Mr. John McCarthy:

I do, I certainly do. In my witness statement, which is why I asked where ... I do refer to the fact that the economics profession failed. And I think it failed in a number of aspects. I list them there - it's general ability to foresee the crisis ... sorry, it's on page 4 ... to even acknowledge that cataclysmic events were possible in a market economy. There was a general herd mentality, to use your own phrase; there was a general herd mentality on 'the Great Moderation'.

There was a belief that the business cycle had been permanently tamed - clearly wasn't the case - and there was also a failure to understand the linkages between the real economy and the financial sector.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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But some people ... some people were calling ... like, for example, in your opinion now today, do you believe that Morgan Kelly was correct in his analysis?

Mr. John McCarthy:

I think Morgan Kelly's analysis ... well, I mean, there was a 50% fall in nominal house prices. I think he said between 40% and 60%, so he is correct. I think where his ... where his model was innovative was in the sense that we were looking at our own models - and I mention price earnings ratios, the affordability model - others were looking at the so-called residual-type approaches. So you look at actual house prices and then you look at house prices when they're modelled on the basis of the driving forces ... the fundamentals.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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What about the details of how you were looking at it and how he was looking at it in terms of ... in terms of summing it up and not agreeing with everything but do you believe on the ... on the ... in fairness that his was mostly correct in relation to his analysis while the analysis of the Department and the team of economists that you had failed to see what he was ... what he was seeing in his paper?

Mr. John McCarthy:

We didn't look at it the way he did and it was an innovative approach and it was a very useful approach.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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But can I ask you ... can you give the committee any examples where economic policy was changed as a direct result of a critical report from the Department's economic division and also can I ask you to give an example where your own analysis differed from the consensus view? Did you yourself offer - and I'm not just talking about a number of years ago ... today or in the last number of years - offer contrarian views and were these taken on board?

Mr. John McCarthy:

I would stress on that, that during the bubble years I was very much at the technical level. I sent in the org charts to the committee. My job between 2003 and up to 2006 was analysing consumer price inflation and competitiveness. So it wasn't to advise on fiscal policy and so forth. From the end of 2006 into 2007, I assumed overall responsibility then for the macroeconomic forecasts. So an important distinction needs to be made between the technical level job, where you're modelling inflation, you're modelling competitiveness and so forth, and my job today, which is closer to the policy space, where anything that affects the economy, I advise the Minister on. Back in 2006, I advised on price dynamics and competitiveness.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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But, Mr. McCarthy, we know from-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Question now, Deputy.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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It's on the same question ... but we know from people, for example, Marie Mackle, who was answering parliamentary questions ... and she wasn't in the position that you were in but she was offering a contrarian view. The question I have ... and to go back to the question is: can you give an example to the committee, right up until now, where economic policy was changed as a direct result of a report from the Department's economic division and can you also give an example to the committee, if you yourself offered any contrarian views to the consensus during the bubble period and up until now, and were those taken on board?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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And just maybe if you could refer to the two specific questions that Deputy Doherty has made and then I can move on, please, Mr. McCarthy. Deal specifically with them rather than generally.

Mr. John McCarthy:

Okay. I think it needs to be remembered that the economics function was very, very small in the overall Department. Our job was simply to produce the forecasts. People did not come to the economics division to ask, "Should we do this policy or should we not?" Our role was simply to produce the forecasts at the time. That is no longer the case, where we are consulted on wider policy issues. So you cannot have a situation in which there is a change in policy because the economics division is consulted-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Processes here ... sorry, Mr. McCarthy, we're getting into processes here. That's not what Deputy Doherty asked you. He asked you in situations where an editorial position was taken and also asked you in situations where you may have contrarian views yourself. So can you deal with those two matters-----

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Perhaps give examples where an example where economic policy was changed as a direct result of a critical report from the Department's economic division, that's the first part of the question. The second part was an example of where your analysis differed from the consensus view. Was that offered and was it ever taken on board? Examples-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I don't want to be repeating myself-----

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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And if there was never one, then let's just state that. If there was, give examples.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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This is going to be answered. We'll be here all around the house if we need to but I'm going to be very direct with you on this, Mr. McCarthy, and answer the questions directly, please. I don't want to be going into processes, okay?

Mr. John McCarthy:

I cannot recall a situation in which a policy was changed on foot of the macroeconomic forecasts. I did not have contrarian views.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you very much. Deputy ... Senator, sorry, Senator Marc MacSharry.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Thanks. As early ... welcome. As early as 2001, a paper presented in the MAC meeting on 26 April shows that the Department was facing a specific skills challenge and had a broad spectrum of skills requirements, amongst others, in economic modelling. Can you give us your opinion if efforts made by the Department were insufficient after 2001 to further improve the skills level in there?

Mr. John McCarthy:

Yes. After 2001, the Department approached the Central Bank and the ESRI to second somebody to the Department to undertake technical work on their behalf. I moved from the Central Bank to the Department at the time and a senior economist from the ESRI moved. We undertook some of the technical work. So, in other words, the economic capacity or the modelling capacity was improved.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. Just following on from what Deputy Doherty had asked you there about you giving an example of a policy change as a result of advices coming from the economic division, can you give us an example - and perhaps the one the most relevant to our work here in the inquiry - of advices coming from your division being specifically suppressed and ignored by Government to the detriment of what played out?

Mr. John McCarthy:

Well, let me reverse slightly what I said to ... to Deputy Donnelly in the sense that contrarian views-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Deputy Doherty.

Mr. John McCarthy:

Who did I say?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Deputy Donnelly.

Mr. John McCarthy:

Apologies to Deputy Doherty. In various publications, the stability programmes and so forth, if you look at the economic text there, we were the contrarians because we were saying that fiscal policy is inappropriate, we were saying that there is an over dependence on construction, we were saying that there is a loss in competitiveness that needs to be addressed. That was coming from the economic division. Did the Government act on it? Well, to be fair, the Minister signed off on the budget strategy memorandum each year. So he agreed with a more prudent fiscal stance. That's typically June or July. Unfortunately, later on in the year that process was overtaken by events. So what was agreed initially and what was brought to Cabinet early in the summer was subsequently taken over by events and policy became-----

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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You are talking about 2006 here, are you?

Mr. John McCarthy:

I'm talking right the way through 2001 probably right through to 2006-07.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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So where can we, these ... this is documented where? The-----

Mr. John McCarthy:

This is documented in a chart in the Wright report, where it shows the level of spending that should have been put forward and then the actual amount that was agreed in the budget. And there's a massive gap between both.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Yes ... no, no, we know that. So the economics ... what you are saying is that the economics division within the Department was saying since 2001, you know, "Cool the economy, go counter-cyclical on policy ... on fiscal policy." Is that your position?

Mr. John McCarthy:

It's ... yes, but with one caveat. It wasn't an economics division on its own at the time. It was the budget and economic division. So it was the co-ordinated view of the budget and economic division.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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So you're ... so is it ... is what you're saying that those responsible for budgeting and economic analysis and policy within the Department were saying to cool the economy and introduce counter-cyclical policies from 2001 on and that Government of the days ignored that advice?

Mr. John McCarthy:

The Minister didn't ignore it in the sense that he signed off on the budget strategy memorandum - and this is detailed in the Wright report - each June or July. But between then and when the budget ... in early December, other events took over that allowed a more pro-cyclical fiscal stance.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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All right. So just so we are clear now, you're saying that at the beginning of your process, which was earlier in the year, you would sign off and you would say "Look, we want you to go more counter-cyclical." Are you saying that the situation improved then, which allowed the Minister to take a pro-cyclical approach, or are you saying that your advice remained, so that these circumstances taking over ... I mean, did circumstances take over for the better so that your advice had become obsolete or was it the case that your advice was ignored and, albeit having signed off on it, the Minster of the day decided to go pro-cyclical despite what he had signed off on?

Mr. John McCarthy:

I can't answer definitively because I wouldn't have been as close to the political space as I am now. But I will give you my suspicion and I think it's probably a combination of both. I think you had these other processes at play but also you had massive surges in tax revenue in the second half of the year which, typically, when corporate taxes come in and so forth ... which some would see ... if you get the tax revenue coming in, maybe you can spend a bit more and so forth.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Finish up, Senator.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Yes, just on a separate issues, but briefly. You mentioned earlier about people above your pay grade, is how you put it, would tell you, ''Take that out, don't say this, we can't say the other'', I think, were in or around what you were saying. In your ... in your time in the Department, was dissent discouraged to the point that it could hamper one's career progression in the Department?

Mr. John McCarthy:

Not ... not really would be my ... my ... I mean, there was a kind of departmental view that policy was moving in the right direction. Most people bought into that. Some were more vocal than others. So I think there was a consensus within the Department that there ... there were problems but we simply weren't being listened to. There was ... it was a case of the ... the boy who cried wolf, really. We were talking about risks, these risks never materialised so we could almost be ignored.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much. Senator Michael D'Arcy.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Chair. "The risks never materialised", but they did materialise.

Mr. John McCarthy:

Yes, but not until 2007.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Yes, but they did materialise in 2007.

Mr. John McCarthy:

After 2007.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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And do you think you or the Department were strong enough?

Mr. John McCarthy:

No, no. We should have ... we should have - and I acknowledged this at the beginning and it's acknowledged in the Wright report - we should have articulated our views more strongly. But at the end of the day, we advise; we are not the decision maker.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Senator, I'm picking up ... just ... maybe it's not coming from your space directly but somewhere in proximity to you there is some phone distortion there coming off.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Do you feel that the Department were kept up to speed by the Central Bank and the regulator's office sufficiently about financial stability? Did you have enough information?

Mr. John McCarthy:

I can't comment. I wasn't in the division in the Department that dealt with the Financial Regulator. I dealt with the economics division of the Central Bank and our discussions focused almost exclusively on short-term and sometimes medium-term macroeconomic prospects. I did not give and don't know anybody ... or didn't know anybody at the time in the Financial Regulator.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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And in terms of the Central Bank information flow between the Central Bank and yourselves, was that sufficient in relation to financial stability matters?

Mr. John McCarthy:

The ... the division of labour within the ... the central banking system is ... was that the regulator looked after micro-prudential and the Central Bank looked after macro-prudential regulation. The Central Bank team that dealt with macro-prudential regulation dealt with a separate division the banking and finance division, I think it's called, within our Department. We did not deal with those guys. We dealt with ... as I said, our job was forecasting the economy so I talked to people in the Central Bank who are forecasting the economy.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Okay. Did you have sight of the SR ... FSR reports from the Central Bank?

Mr. John McCarthy:

I would have seen one or two of them. I would have been asked to comment on the macroeconomic outlook. I think maybe the first page or even the first paragraph might briefly go into what the short term outlook was. I would not have looked at issues ... you know, bank capital or anything like that.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Can I ask your view in relation to the level of indebtedness outlined in those reports? I think 2004 was the first period when they outlined a 71% level of indebtedness in relation to GDP, climbing to the 2007, the final FSR report, to 248%. In terms of financial stability did anybody in the Department of Finance consider that that was a concern?

Mr. John McCarthy:

I understand my colleagues in the banking and finance division were concerned about those issues. I do know - when the Central Bank raised it in one of their quarterly reports, so not the financial stability report - we did have a line, a speaking point or ... or a line in a note we did for the Minister, saying that they were concerned, sorry that we, the Department were sharing the concern of the bank regarding the level of - I think it's household indebtedness you're referring to Senator rather than public or NFC indebtedness - that the Minister and that the Government shared the concern and that it was incumbent upon the banks to lend prudently and to take into account the fact that interest rates could change and so forth. It's in one of the documents here, if you bear with me I'll be able to find it but-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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You don't really-----

Mr. John McCarthy:

-----it's in there.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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I suppose what I'm trying to scope, Mr. McCarthy, is ... what you ... what the Department did about it apart from a line?

Mr. John McCarthy:

Well I mean-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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To put it into context, we went from a very, very low level of household indebtedness to the highest in Europe - 248% of GNP according to the final FSR report. What did the Department do in relation to that matter specifically? Can you itemise anything that was done from the economics section?

Mr. John McCarthy:

I think we have the third highest level of household indebtedness in Europe. Denmark and maybe the Netherlands are higher but that's ... the point is it's still very, very high. I'm not aware that the Department could do anything about it but it would be ... if anything was to be done it would be colleagues on the banking and finance side who look after credit growth. This was not on the economic ... the short-term and medium-term economic forecasting side of the house. Credit growth and indebtedness don't feature in our short-term models.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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But would it not surely ... I'm not allowed use the word "surely" I believe, sorry, could it not have been a danger to the financial stability of the banks-----

Mr. John McCarthy:

Absolutely ... I mean if-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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-----overall, overall? Would that not impact upon the macroeconomic perspective?

Mr. John McCarthy:

Had I been the chief economist at that stage, or had I been at a higher level, I would have been encouraging-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Sorry, can I just-----

Mr. John McCarthy:

-----macro-prudential tools to be brought in.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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I'm not asking you about you being chief economist at that stage, I'm asking for your view of what the Department of Finance did in relation to that level of growth.

Mr. John McCarthy:

Subject to being corrected by somebody else, I'm not aware that the Department did anything about that level of credit growth.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much, Senator. Deputy Michael McGrath.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Thank you very much, Chair, you are very welcome Mr. McCarthy. Can I start by asking you, after 2004, the IMF, OECD and ECOFIN all clearly recommended a tighter fiscal stance and the building up of a cushion for the time when income from property related transactions would fall. Can you discuss why, in your opinion, the Central Bank's recommendations in Ireland, to the Minister, did not more forcibly highlight this issue?

Mr. John McCarthy:

Can I just be clear, Deputy, you are asking why the Central Bank was not more forceful in its recommendations on fiscal policy? Is that-----

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Yes, and linked in to the issue of, you know, a property collapse and the impact that would have on Exchequer finances.

Mr. John McCarthy:

I think, to be fair to the bank, they did raise the issue of the pro-cyclicality of fiscal policy on many occasions in the various quarterly bulletins. I know there is another process whereby the Governor of the Central Bank sends a letter to the Minister in advance of the budget, it's essentially a pre-budget submission, and typically warns about the need for fiscal policy to be countercyclical and not add to the overheating of the economy. Maybe those ... maybe the bank's comments could have been a little bit harder hitting. In fact, it would have helped us in the Department if they were harder hitting but I would have to go back and check and see exactly what they said. But I'm certainly conscious that in many of the bulletins they would have raised the inappropriateness of fiscal policy at the time.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Sure. Can I raise the issue of the structural budget balance, or the cyclical balance as such, and you say on page 8 of your witness statement, "Measures of the underlying balance (the so-called structural balance [...] did not raise any red-flags either." And you're referring to the pre-crisis period presumably. So, can you just clarify for the inquiry, who measured the structural balance, was there a common methodology across Europe, for example, and what kind of figures were being reported for Ireland in, say 2006-2007, for structural balance?

Mr. John McCarthy:

I think, Deputy, this is a very, very pertinent question. Because if you look back, not just in real time - in other words in 2003, looking at the position in 2003 - but if you look now, going back, and I've spoken a bit at a Bruegel conference at the tail-end of last year, it shows that we were compliant with the requirements of the preventive arm of the Stability and Growth Pact. We were running, I think it's every year, bar one, structural surpluses. So, we were overachieving our medium-term budgetary objective. So there was no-----

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Who measured this structural surplus, just to be clear, who measured it?

Mr. John McCarthy:

Who measures? What is done there, Deputy, is twofold. There is a harmonised methodology that is applied across all member states. It is a huge problem for Ireland, for Slovenia, for small member states it is a huge problem. This is a methodology that is designed to fit France and Germany. Unfortunately, it is a one-size-fits-all approach. It does not work for Ireland and I can say that quite definitively.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Even today?

Mr. John McCarthy:

Even today. It gives counter-intuitive results in many instances. Let me give you an example, if I can. So, in theory, and for a large country like Germany or France, the change in the structural balance is tantamount to the fiscal effort. So, in other words, if the fiscal ... if the structural balance deteriorates by 1% of GDP, that's equivalent to a fiscal stimulus. So, in Ireland we consolidated since the crisis kicked in by 17% of GDP, whereas the change in a structural balance over that period is about 6%. So, it gives a completely misleading picture of the fiscal stance in Ireland, even today. There have been some minor improvements to the methodology but they are not game changers.

One of the inputs here is trying to measure the business cycle, so when a large country had a big problem estimating what's called the NAIRU, changes were agreed. We've been raising issues for years, almost ignored, except this year when we did raise an issue regarding the so-called expenditure benchmark. Now, can I just, I'm sorry for eating into your time, recognising the shortcomings of the structural balance, the so-called six pack - about two of the regulations refer to the Stability and Growth Pact the others are for the macro imbalances procedure - introduced the concept of an expenditure rule, the so-called expenditure benchmark, which is a little bit easier to measure because it smooths potential output over a ten-year horizon looking at just year-to-year changes. So it's a little bit better but it's not the be all and end all. It's ... this issue is still a problem for Ireland.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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So can I just put it to you, Mr. McCarthy, one of the key observations or criticisms that is made is that during the pre-crisis years, while Ireland was reporting, you know, budget surpluses in headline terms, that in reality when you strip out the cyclical tax revenues that there was a major structural deficit there as such. But are you saying that Ireland was actually complying with the structural balance requirements from Europe at the time, in accordance with how the structural balance was measured in harmonised terms during all of those years?

Mr. John McCarthy:

Yes.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Yes?

Mr. John McCarthy:

Yes, it's a huge problem and yes that's exactly what I'm saying.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Okay, thank you.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you. Just on that point, Mr. McCarthy-----

Mr. John McCarthy:

In one year we didn't, but by and large over the 2000 to 2007 period, yes, Deputy.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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On that point specifically, in the Regling and Watson report, which I assume you're familiar with, I'll just quote the specific paragraph that relates to that under heading D: The Fiscal Stance:

For a long time Ireland's overall fiscal policy was considered to be exemplary because the country achieved fiscal surpluses every year from the mid-90s to 2006, including the creation of a Pension Reserve Fund to make budget surpluses politically more acceptable. However, the nominal budget figures mask and underlying deterioration in the fiscal situation after 1999.

So, in Regling and Watson, they're saying that there is a faultline in the Irish economy going right back into the 90s. Why was that there and how was it not identified by people like yourself whose job would have been to examine, in micro-detail, the economic structure of the Irish economy?

Mr. John McCarthy:

The answer is quite simple. We are legally bound ... legally, it's in the treaties, to apply ... it's not in the ... there's a gentleman's agreement among Ministers that, I think, was signed off in 2001, 2002. But it stems from a legal provision, from a regulation, that there is a harmonised approach that applies to all member states. So, we can produce whatever measure we like, but when it comes to assessing compliance with the pact, the Commission will apply the one-size-fits-all policy. That's where the faultline lies.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Mr. McCarthy, there's an anomalous situation in Ireland where country boreens in the west of Ireland have a speed limit of 100 km/h on them, but you don't drive 100 km/h on those country boreens because it's quite dangerous. Just because the sign says you can drive at 100 km/h, you don't do it. Likewise, when there are rules like this, and you identify difficulties, you don't proceed exactly to the letter of the rule. And that's the question I'm asking you. Was this difficulty identified and was anything actually done about it?

Mr. John McCarthy:

Yes, the difficulty ... we highlighted ... if you look, Chairman, at the stability programme update in 2003, I think it was, we go into great detail outlining the shortcomings of the approach to Ireland. We have made a number of submissions to DG ECOFIN, the economics Ministry in the Commission, including as recently as, I think it was, March, April of this year, in which we produced, myself and a colleague, a detailed critique of the expenditure rule. And the Commission actually said, for the first time that I can remember, "Actually, Ireland has a point. We are unilaterally changing the approach to calculating the expenditure benchmark." That did not apply for all the years we have been saying, "This doesn't work for Ireland", we were ignored. It was one-size-fits-all, but we have made progress this year.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Deputy Joe Higgins.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Mr. McCarthy, I'll just quote a paragraph from Nyberg's report, IV. You don't really need to see it on the screen:

The Commission [Nyberg's commission] considers that this pervasive pressure for consensus may explain why so many different parties in Ireland simultaneously were willing to adopt specific policies and accepted practices that later proved unsound. At the same time, the apparent consensus of banks and authorities around the view that markets remained sound and prospects remained positive gave further comfort to both. A number of banks essentially appear to have followed the example of peer banks in a “herding” fashion; there is little evidence of original critical analysis of the advantages and risks of the policies. Widespread lack of critical discussion within many banks and authorities indicates a tendency to “groupthink”; serious consideration of alternatives appears to be modest or absent.

Now, when you moved, or you were in the Department through the whole of the 2000s, and then you moved to the macroeconomic responsibilities in 2006, I think. So, to what extent was this pressure felt and absorbed, or not, inside the Department, in your own experience?

Mr. John McCarthy:

Well I mean, I think Nyberg is right there, there was a ... there was an element of groupthink; there was a kind of a consensus, it has to be said, on where the economy was going, and I wouldn't dispute any of that. Yes, the paragraph you read, Deputy, refers quite a lot to banks. I simply couldn't-----

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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-----authorities as well, which-----

Mr. John McCarthy:

Yes, absolutely ... and I'm commenting on one part of the authorities. I couldn't comment on the banks but, to me, it seems logical.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Yes. Now, the ... occasionally hard landing scenarios were mooted, Central Bank and various reports, but was there any time that anything, other than a soft landing, was seriously entertained as a range of ... or, as a possible serious option?

Mr. John McCarthy:

Yes, and I come back to the report - it's in one of the core documents - where myself and the current Secretary General did a detailed piece of economic analysis on what the impact would be of a fall in the level of economic activity in the housing market. We did not ... to be fair, we did not read across to what the implications were for financial stability. It wasn't our job at the time.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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But that did not move up then to the final views that were dominating policy-making, etc.

Mr. John McCarthy:

No, I mean, the approach that we take is similar to what would be done in most finance Ministries. We produce a model forecast, a central scenario, the most likely outcome, but then we look at various scenarios around that, upside risks, downside risks, and we model some of those. So we modelled the hard landing, if output was to fall more rapidly than assumed. We did that and we came up with results that ... I think the ESRI published a paper around the same time and they were very, very similar results.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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And, Mr. McCarthy, in this remarkable consensus that developed, as Nyberg stated, which included the regulator authorities and Department, indeed, just ask yourself, was the predominance among establishment circles, nationally and internationally, of neoliberal economic ideology, and, as Nyberg put it, "the paradigm of efficient markets" ... was that a big factor in that consensus that was so universal?

Mr. John McCarthy:

I think it was, Deputy. I think ... and to give you a specific example, I think the models that we had, I'm talking here about, for forecasting purposes, were not dissimilar from models that other treasuries would have, that other central banks would have. In fact, a couple of years ago the fiscal advisory council, as part of their mandate, looked at our forecasting model and concluded it was in line with best practice. But where it failed, and where other models failed, was in one particular area, and that was they did not incorporate the impact of the financial sector onto the real economy. The real economy, I mean, production, output, employment and so forth, and-----

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Just to-----

Mr. John McCarthy:

-----and, just ... sorry, if I could, just, Deputy, the assumption at the time was that, within financial markets, you had this efficiency markets hypothesis, which I think you referred to. The assumption was that markets were fully efficient, that the cost of capital was simply the policy rate plus a term premium, a liquidity premium, and so forth, and once you had the price or the cost of capital, financial intermediation then brought savers and investors together and everything was kosher. That was proved to be incorrect.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Let me just pursue that a little bit further, Mr. McCarthy. In your opening statement you say economists failed "to acknowledge that cataclysmic breakdowns in a market economy were indeed possible" and "in the widespread assumption that the business cycle had been permanently tamed". Now, presumably, going through college, economists learn, for example, some of the basic ideas of Karl Marx, who 170 years ago told us how inherent in capitalism was the boom and slump scenario, and explained it in detail. And also, we had the experience, as you said, of Morgan Kelly's study of about 30 boom and slumps, and particularly-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Final question, Deputy. This is it.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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------particularly the Scandinavian one in the 80s and 90s. Is it remarkable that none of that found its way into the consciousness of the Department, the Central Bank, the regulators, as a huge risk considering the bubble that everybody saw?

Mr. John McCarthy:

I don't think the Department, Central Bank, and regulator, have a monopoly on failing to see that. I mentioned before there, the IMF. I could tell you every finance Ministry, every central bank ... my own job as the forecaster, I would participate at European Commission meetings, where all 28 member states would be discussing forecasts at an OECD level. Everybody failed to see this.

There was this "Great Moderation" as it's called. Inflation had been tamed. In the past you had ... here's your trend growth rate and GDP, you know, fluctuates around that whereas it was now more like that, so this was the "Great Moderation". I think it was the economist Hyman Minksy who famously said that stability breeds instability. I think that was part of the problem here. We had years and years and years of stability, so people assumed there was this new paradigm, this "Great Moderation", and the models couldn't capture financial disruption. So models themselves failed, although I always think it's the users of the models rather than the models themselves. But what we are doing is trying to develop a model that better incorporates the financial sector into the real economy, how the ... how financial disruption can be brought across into output and employment and so forth. So this is being done in conjunction with the ESRI and I have a PhD economist working on my team, working on that, currently completing a PhD and working with the ESRI on it.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Deputy Kieran O'Donnell.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Mr. McCarthy, in 2005-06, the Minister was advised that the country was, depending ... the Minister for Finance ... depending on unsustainable tax revenues. How robustly was the Minister challenged on the tax and spending policies implemented, and what contingency plans were put in place by the Department to deal with the problems which were envisaged? And I note you've made references to it already. You prepared a report in May 2005 around the whole issue of housing where you looked at 10,000 decline and the impact that would have. If you would just answer the question in that context and did you look at worst-case and best-case scenarios rather than just looking at incrementals of 10,000 units?

Mr. John McCarthy:

I think what the paper says, each 10,000 units ... So I think we do go into if you went from 90 down to 50, which was, at the time, the estimated sustainable level of output, what the impact would be. The Minister was informed-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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David Doyle in his interview to the Wright report, the then General Secretary, this was the basis of this comment. You might ... Just to continue, sorry.

Mr. John McCarthy:

We did in various publications, and I assume my colleagues on the fiscal side also, did outline that there was a substantial narrowing of the tax base, that you were cutting income tax and so forth and that this was being replaced by transitory revenue from, you know, stamp duties, capital gains tax and-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Did you look for, in your role as an economist in the Department ... did you look for ... that the tax incentive schemes around housing ... the various tax incentive schemes, that they would be discontinued earlier? They were due to finish at the end of 2004; they didn't finish until July 2008. Did you specifically in your role as an economist in the Department look that they should be discontinued?

Mr. John McCarthy:

No, I was looking at inflation and competitiveness.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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But you did a report on housing.

Mr. John McCarthy:

I was asked to do that because, at the time, I was moving across into looking at the macroeconomic forecasts so what-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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You did a report specifically on housing.

Mr. John McCarthy:

On housing and housing feeds into forecasts.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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And being, we'll say, a highly experienced and professional economist, would you not ... did it not arise that as part of that review you suddenly said, "One of the elements here has been how the tax policy by Government has driven house completions?"

Mr. John McCarthy:

Colleagues on the tax side were advising along those lines. It's not my job to look at their area. They were advising along those lines.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Were you operating in silos in the Department?

Mr. John McCarthy:

I think that's acknowledged in the various reports. In fact, it is acknowledged in the various reports.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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You were all operating in the same building.

Mr. John McCarthy:

Yes. Sorry, not the same building. There were a few buildings. But, yes, it is quite clear. I do not know whether it's the Nyberg-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Try not to be leading if you can. Just ask the question.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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The question I'm asking is someone looking in with the Department of Finance, with various elements that they should have been integrated, how do you come up with a cohesive policy within a Department without sections of the Department not discussing specific aspects of policy with each other?

Mr. John McCarthy:

It is quite clear and I don't know whether it's the Nyberg or it is the Wright report, that there was a silo-based culture at the time, that no longer exists. We now have various governance changes and procedural changes, whereby all policies are discussed every fortnightly by what is called our policy committee. All staff members in the Department are encouraged to bring issues to the policy committee and every division in the Department is represented but, at the time, there was a silo-based culture.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Was there any encouragement for people to come forward within the Department at the time, either from top, we'll say, general secretary level down or Ministers, for people to come forward with contrarian views or views that were left of field?

Mr. John McCarthy:

Every year each division in the Department would tog out in front of our management advisory committee and everyone could bring whatever issue they wanted to the table, so any contrarian views, they could have expressed them there.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Can I just move on very quickly? You made reference to the OECD report and it's Vol. 3, Chairman, and I just want to make reference to a couple of areas. Who pays for the OECD report?

Mr. John McCarthy:

We make a contribution to the OECD. I think it's done through the Department of Foreign Affairs.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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So it's the Government pay for it.

Mr. John McCarthy:

Yes, I mean, all governments fund the OECD.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Now in the report-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Can we have the page numbers there, please, Deputy?

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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The page numbers are page 9. I want to make reference, Chairman, to the draft report that was provided to the Department and then to the final report that was published. The draft report runs from page 9 to page 20 and the final report runs from page 23 up to page 37, but I've only two quick specific references. This report was ... the OECD came and did an on-site inspection on 20 February 2008 which was seven months before the night of the guarantee, per the report. They say on page 25, "The economic situation and policies were reviewed by the committee in February 2008 and they were approved then on 5 March 2008." The question I want to ask is there's wholesale changes within the two reports. The word "boom" suddenly becomes "buoyancy", which is a very different connotation. Two specific areas I want to look at are page 9 on the draft report, Chairman, which specifically deals with "financial stability risks remain". And the relevant page on the revision is page 26. Now that read, "financial stability risks remain"; when it came to the final report it went, "containing risk to the financial system" so they changed that. And there's one specific reference that I want to make reference to, Chairman. It says-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I need to push you to a question now, Deputy, because you're going to run out of time.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I want to ask why these changed, and they are specifically around the banks, "...while some features of the deposit insurance scheme should be reconsidered and a special swift procedure for closing failed banks should be enacted". That is completely deleted from the final report in page 26 and equally, Chairman, page 12 deals with a section then where it speaks around in the context, sorry, it says:

Payouts from the bank deposit insurance scheme should be available more rapidly and the scheme better funded to reduce liquidity concerns in case a bank comes under pressure. Enacting an insolvency process specifically adapted to banks should also be considered.

That's on page 30 of the final report.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I've afforded you a bit of time now, Deputy, but I do have to push you to a question.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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It's completely deleted. So those two issues which are to do with the liquidity of the banks, to do with putting in place a special swift procedure for closing failed banks, which is a resolution mechanism and, secondly, about insolvency legislation being enacted for banks, they are completely deleted with the final report. That's seven months before the guarantee is put in place. The question I want to ask is who would have reviewed the report? Would the Minister of the time have been involved in reviewing the report? Who would have interacted with the OECD? And did we find the situation where the key elements which the OECD had identified, which came to pass - liquidity of the banks and the insolvency of the banks - are completely deleted from the draft final report?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I said already, Deputy, I do need the question to be made so we can move on.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I want to ask can you give me the procedure, how would that have happened?

Mr. John McCarthy:

The Minister would not see this report until it is published so would have no interaction at all.

The process is officials deal with the technocrats in the OECD and then the report is published, usually with the Minister in ... in presence, but he would be informed ex anteregarding what's in the report.

I could only find the first reference you're referring to here, that's on the procedure for closing failing banks. I don't see any suggestion from the Department that that should be amended, other than there seems to be something enacted, or something like that-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Yes.

Mr. John McCarthy:

-----so I don't know why it-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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It says "Delete". It says "Delete" underneath it.

Mr. John McCarthy:

Is that not referring to-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Page 9.

Mr. John McCarthy:

Is that not referring to, "Transparency in financial markets needs to be improved to restore confidence?"

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Well, it says, that whole area, "Delete", "Delete" and there's a sign ... a line down by the side. The question I suppose I want to ask is, would it be the general secretary of the Department, would the chief economist of the Department have interacted with the OECD?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, that's the final question, Deputy. I'm moving on. Mr. McCarthy?

Mr. John McCarthy:

There was no chief economist in the Department at the time, this is 2008. I currently deal with the OECD and there is an EDRC currently under way, but we will always make comments on OECD reports.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I want to know who?

Mr. John McCarthy:

Who?

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Who in the Department would have been interacting?

Mr. John McCarthy:

That would have been the assistant secretary at the time.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you very much.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Who was?

Mr. John McCarthy:

The assistant secretary in charge-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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For what period?

Mr. John McCarthy:

----- of budget and economic division.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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What period?

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Period? That was 2008.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you. So we have that answer. I just want to return to one item there that Deputy O'Donnell dealt with and I'm just going back to ... it's ... the core document's coming up in front of you there, Mr. McCarthy. It's the third paragraph down on it.

Mr. John McCarthy:

Sorry, Chair, which core document?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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It's coming up in front of you there actually-----

Mr. John McCarthy:

Oh, yes, okay.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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-----the page itself, so it's DOF01B06, but it's a meeting with David Doyle, former Secretary General, and there's an outline of issues here. It's the third bullet down, which says:

The pace of economic activity was strong [from] 2001-2006 but the Department did not believe that this could continue. In2005/6 the Minister was advised that the country was depending on unsustainable tax revenues that the economy had been dramatically over-heated and that problems would emerge which would be due to domestic policies and that a more sustainable fiscal position had to be maintained. A presentation to this effect was made to [the] Secretaries General.

Now, in that regard, that's ... the big hidden message there, the country is very, very exposed in a lot of different ways and there is significant trouble pending ahead. Can I ask you how robustly was the Minister challenged on the tax and spending policies implemented in that period by you, your officials and your Department, given that this was the summary and aggregates position of the Irish economy at that time?

Mr. John McCarthy:

How was ... well, I think what the Minister did on foot of this, which is what I think the Chair is referring to, is that, in 2005, it was announced that there would be a review of the various tax incentives for the property market and, if I recall correctly, most ... I think it was undertaken by Indecon and possibly Goodbodys. And all of the recommendations, from what I recall, or certainly the bulk of them, were contained in the Finance Bill for 2006. In other words, the phasing out of all the ... the biases within the tax system that favoured construction and so forth. However, quite clearly, the horse had bolted at that stage. It was too late. But we had been saying it for some time, the review was done, it was concluded that these tax expenditures needed to be reduced, that the tax treatment of construction needed to be made more neutral and the Minister acted on that. But there was a transition phase, from what I understand, in that you didn't want to ... you wanted to avoid a sudden stop.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Given that a lot of these tax incentives were due to be wound up in 2004, could the proposition be made that a review of these tax incentivisations was just a means to elongate their implementation and to put off the day of their removal?

Mr. John McCarthy:

I genuinely couldn't comment, Deputy. It was handled by the taxation division within our Department and we were not consulted on the economic side.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you. Deputy Eoghan Murphy.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Thank you, Chairman, and thank you, Mr. McCarthy, you're very welcome. I'd like to look at Vol. 1, page 88, please in the evidence books and my question relates to the over-exposure of banks to commercial property, which was a flaw identified by the Regling-Watson report and if you look in that evidence book, it's page-----

Mr. John McCarthy:

Vol. 1, page 81?

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Yes, page 88.

Mr. John McCarthy:

Okay.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Yes. So, it's ... this is an issues paper from May 2005 and, if you go down to the fifth paragraph, beginning:

The section has identified the need to explore data sources and development of analysis of non-residential construction as a priority. Data is more limited in this area and up to now. Non-residential construction accounts for about half of construction output so it is worth devoting time to.

So, can you recall, Mr. McCarthy, what steps were taken on foot of that paragraph in the issues note identifying construction related lending and property activity and the need to find more information or develop more data and look into it further?

Mr. John McCarthy:

I can't recall exactly, but what I suspect, Deputy, was that the assistant principal in charge of the area would have been tasked with looking at various reports that come from the likes of, you know, the kind of construction groups, Savills and so forth, who look at commercial property, what the vacancy rate is in the various urban areas and so forth. So kind of building a database along those lines is what I strongly suspect was the, was the action point so to speak.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay. Well then if we ... if we fast-forward then to March 2006 issues note from the Department, it's on page 92 of the same booklet and it's the third paragraph down, and this is a year later:

The development and analysis of non-residential construction remains important. Data is more limited in this area [and the exact same sentence, non-residential] construction accounts for about half of construction output, so it is worth devoting time to.

Now, this is a year from the issues note of 2005 and it's saying essentially the exact same thing.

Mr. John McCarthy:

Yes, it is, it is a problematic area, in the sense that data are not readily available in this area, so constructing a database is not a straightforward task. It's not a case of simply looking at CSO data or Department of Environment data in terms of tax ... or house completions and so forth. It's just ... it's not a data-rich space.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay, but in 2005, the assistant principal says, "We need to look at this because we don't have the data." And, a year later, the exact same assistant principal is saying the same thing, so-----

Mr. John McCarthy:

So, I suspect it's the ... it's the same-----

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Well-----

Mr. John McCarthy:

Yes, it looks as if-----

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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-----it is according to-----

Mr. John McCarthy:

Yes, yes, okay.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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-----the name given-----

Mr. John McCarthy:

Yes.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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-----at the top of the section in each issues paper. So can you help me understand? Is the assistant principal being ignored? Is the assistant principal not getting the resources to do this work?

Mr. John McCarthy:

No, I genuinely ... and I'm only speculating here, I genuinely think it's a function of the lack of reasonable data in this area.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Even after a year?

Mr. John McCarthy:

Even after a year, yes.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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A year has passed and still don't have the data?

Mr. John McCarthy:

Yes.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Even though it's identified as a significant concern?

Mr. John McCarthy:

Yes.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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A year later, the Department still can't get the data together?

Mr. John McCarthy:

That's my suspicion.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Is that acceptable?

Mr. John McCarthy:

I'm sure actually if you went out, even now, to try and get a data series in this area, it would be problematic because for house building, you simply go to a time series produced by the Department of the Environment. If you want to look at overall building and construction, you go to the CSO's databank. There is no one, single data point or data series that you can just go to. Instead you kind of have to amalgamate it yourself from a different ... from different sources and then you have to kind of quality adjust the figures as well, you know, what's the vacancy rate? You might get vacancy rates for the urban areas in terms of, you know, industrial units; what's the equivalent in rural areas?

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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I think I understand the scale of the problem, or the task, but you're saying it can't be completed within a year?

Mr. John McCarthy:

I suspect you could probably make a stab at it, but I don't think you could probably complete the information within a year.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay. I want to move on from that then, if I may. I'll just go back a page, to page 91 in the evidence booklet, it's the Government saving scheme, the SSIA, and this note I think you're involved in compiling because your name is there, John McCarthy. The second paragraph, "Impact of SSIA maturity remains an imponderable; we have assumed a low propensity to spend the proceeds." So can I ... do you remember drafting this? Were you involved in drafting this section?

Mr. John McCarthy:

I remember looking at the SSIA issue and what the impact ... the issue was, the SSIAs were coming to maturity and we were trying to forecast consumption. So you had this kind of windfall gain that was coming to the household sector, what was going to be the impact on consumption? So what we did, we actually asked the CSO to compile a study on our behalf and to make it public to everybody, so it's in one of their modules as part of the QNHS, to improve the evidence base for us. They did it, they made it public. And on foot of that, we made an assumption then what the marginal propensity to consume from these additional income would be.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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I mean, you say impact remains imponderable, but then you conclude, or you assume, a low propensity to spend the proceeds. So how do you come to that assumption and was the assumption correct?

Mr. John McCarthy:

This is 2006, I suspect the ... that there may be two issues there, we may have had the CSO study at the time but I genuinely can't remember. The assumption of a low propensity to spend would typically be ... we would tend to have a cautious view anyway, and if it's stronger so be it. But typically you have to remember about 0.6 or 0.7, well maybe closer to 0.6, of everything you and I consume is imported, so it doesn't really impact on GDP that much. It does impact on taxes and on-----

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Is the assumption correct though?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Supplementary now, Deputy.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Sorry, was the assumption correct and did the maturing of the scheme contribute to overheating the economy?

Mr. John McCarthy:

Is it possible for me to come back? I just don't know what the consumption figure was in 2007. I just don't have the figures with me-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay.

Mr. John McCarthy:

-----what personal consumption was. I can e-mail the secretariat or whatever what consumption ... but even saying that, you couldn't break down if it was 5%, how much of it was due to the SSIAs maturing and everybody spending the whole lot or people not spending. You simply don't have the information to make that conclusion.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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So you could make a conclusion on ... as to whether or not it might have contributed to the overheating of the economy then?

Mr. John McCarthy:

You couldn't. You can make an educated guess, but you can certainly not be definitive.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you. Senator Susan O'Keeffe.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Thank you, Chair. Mr. McCarthy, specifically, did the Department make attempts to quantify the effects of a soft landing? That is in terms of loss of revenue or increased expenditure, was that a specific task that was carried out? I know you've referred to soft landing before that people have asked you.

Mr. John McCarthy:

Yes, if you look at the paper that a number of your colleagues have referred to, we looked at a situation which each 10,000 fall in the level of housing, and the impact on that on GDP, the impact on employment and the impact on the public finances. So on the public finances, it is roughly a half percentage point onto the deficit for each 10,000. So in other words, if housing out by the time went from 80,000 units down to 70,000, the deficit would have been half a percentage point higher because of lower tax revenue and because of higher unemployment payments ... social welfare payments, because unemployment would have gone up.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Was there any argument about those calculations or were they largely-----

Mr. John McCarthy:

No, no because ... Senator, the ESRI who use the so-called Hermes model, it's a very large-scale structural model of the Irish economy, had published a piece of analytical work either just before ours or just afterwards ... we were doing it independently we didn't even know that they were doing it. And what they did was, they went from, I think, it was 90 down to 50, and concluded that the impact on GDP would be 3%, similar on employment and other variables. Ours was, each 10,000 shaves between a half and one percentage point off the growth rate - so let's call it the mid-point of that, 0.75%. So you multiply that by four because it went from 90 down to 50 and you're getting very similar results to what the Hermes model was punching out. So there was a kind of ... we were coming at it from two different ways, so to speak, but we were coming up with the same results. So I think they are plausible results.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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And that was passed obviously on to Government, to anyone who needed it?

Mr. John McCarthy:

There ... the document, Senator, is in one of the core documents and you can see that it is sent from the Secretary General, it was written by myself, and the current Secretary General, it was sent from the Secretary General of the day to the Minister.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Not surprisingly, I'd like if I might, to come back to this document again in Vol. 3, the one that has the changes. Because you've given in evidence here this morning and you've said to us that it was good to provoke thought, I think was the way that you put it, and you talked about changes being purely of a factual nature. I would draw attention then to page 12 of that document, that's Vol. 3, page 12. It says:

Prior to the weakening in the property market and the recent financial market turmoil, the Irish banks were highly profitable and well capitalised, which will help to adsorb the shock. But it would also seem important to be prepared for the worst.

Now when that came out in the report, the final report, it said, "The Irish banks are highly profitable and well capitalised, so they should have considerable shock absorption capacity, but it would also seem important to be prepared to deal with downside risks." Now it seems to me there's quite a difference between saying the Irish banks are highly profitable and, prior to the weakening, the Irish banks were highly profitable. And they should be "prepared of the worst" turns into "downside risks". Would you continue to describe that as a factual change?

Mr. John McCarthy:

I think in my evidence earlier on I said yes, there would be some factual changes but we would also give some nuances. That ... I think that probably falls into the definition of a nuance, but I would stress those sort of changes would not have come from the budget and economic division. It could even be, Senator, that the OECD themselves ... I actually couldn't follow where the text was. Sometimes the secretariat in the OECD can nuance these things themselves. So it's not necessarily coming from the authorities. They have an internal process themselves, but to come back to your question-----

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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That was marked "delete", that was marked "delete".

Mr. John McCarthy:

Oh was it? Okay.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Oh it was, yes.

Mr. John McCarthy:

I think that falls more into the nuanced rather than the factual.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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And again on page 20 of the same document, there's one sentence, "Implement an insolvency procedure, specifically adapted to banks." That was a summary of recommendations on financial stability. There's a line put through that and indeed it does not appear on page 38 where the summary of recommendations on financial stability appear.

Now, I want to draw your attention if I may to page 6 of your own statement that you provided to us. You say:

On the international front, the European Commission, the OECD and the IMF provide expert advice. Over the period 2000-2007, the advice of these institutions was, by-and-large, similar to the advice being provided by the Department of Finance.

We might conclude, Mr. McCarthy, that the advice was similar, because the Department of Finance had a say in this document and had the capacity to change it, so I would argue that its not surprising that the advice was similar. And we've heard others give evidence here of changes made to similar international documents and I wonder, you know, whether, if you like, the public is aware that the documents that are held up as being-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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We're running out of time now Senator I need you to put the question.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Yes. Documents held up as being the ones that were international advice, had in fact quite a significant input made by our own Department of Finance and other institutions in Ireland.

Mr. John McCarthy:

Again, I would stress we're not unique in this at all-----

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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That doesn't make it right though.

Mr. John McCarthy:

Well, certainly when there are factual issues, we would have a better understanding of how the Irish economy operates than the OECD and the IMF-----

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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But the ones I've drawn your attention to are not-----

Mr. John McCarthy:

Yes-----

Mr. John McCarthy:

-----they're more nuanced, I accept that. What I can say on ... I mean I've never had any interaction on any banking type issues. I think the Chairman, when he read the opening statement, I've never been involved on that side so I can't make any comments on why there would have been changes on bank capital and issues like that.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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But "nuance" is a polite word-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Final question, Senator.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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-----for a change. Isn't it? A nuance is a polite word for changing something that ... those arguably were quite significant points that were made in that document.

Mr. John McCarthy:

Some of them are, yes.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Yes, so they're not-----

Mr. John McCarthy:

Yes.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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So calling them nuanced seems to me to soften them a bit. I'm arguing that it's no wonder that the advice was similar.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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You are arguing, you need to ask a question.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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I'm asking. The advice your ... you have said in your statement is similar, I'm saying its similar for a very good reason and that is that the Department of Finance had an input into the advice.

Mr. John McCarthy:

No, no ... I mean, the ... I mean, the institutions would ... would make recommendations to the Irish authorities. That is ... that is factual. That will always happen. There will always be a situation which we might want to nuance but it is up to the authorities, to the foreign authorities, whether or not they want to take on board these comments. I said at the ... earlier on that, on occasion, I would actually have preferred if the international organisations were even more hard-hitting. So I don't take the view that we need to nuance it and make everything pretty for Government and so ... sometimes we need them saying even more difficult things because there's messages we can't say that they need to say.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you. I'm going to move towards wrapping up. And just to deal with two matters before I invite Senator Barrett and Deputy Phelan to close themselves, if I maybe could ask you that in the past then - this is coming from our earlier discussions of this morning, Mr. McCarthy - a major problem was that there was no banking or financial experts working in the economic division. Has this issue now been addressed or responded to in the meantime?

Mr. John McCarthy:

What we have, Chairman, is we have economists ... ramped up the number of economists in the economic division and we have ramped up the number of banking specialists in the banking division. They're on secondment, typically, from the NTMA. But we do interact much more. So I mentioned the policy committee. So there is more joined-up thinking. The rationale behind this policy committee is to break down the silo approach to make sure that everybody is on the same page. So not ... to specifically answer your question, not financial experts in the economic division - they're in a separate division - but we work closely.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. And just on the broader issue of groupthink, which was mentioned earlier and you mentioned it yourself and the mentality that goes with it - specifically in your response to Deputy Phelan's question, how is it now ensured today that no groupthinking culture can take hold again in the economics division? If you move people out of silos and move them into a broader sphere, you can still have a groupthink on a broader sphere, even not in a silo, so how is that being addressed?

Mr. John McCarthy:

Well, I mean, what we're doing, and what the economic division is doing, and what we've been very proactive is ... is engaging much more with the outside economics community. I have encouraged my team to publish a lot more of the technical work. So we have technical papers, we have working papers - they're all online. You can see some of the views that we have. Let me give you a specific example: we recently, somewhat controversially, made a submission to the Low Pay Commission, which was actually contrary to Government policy. The Minister was in favour of us doing it, not because he necessarily agreed but he doesn't want the, sort of, groupthink to take hold again. This was reported in parts of the media. So we are making these submissions on issues that we think are important and they're not necessarily in line with Government policy. So there is a practical example in that particular one, Chairman.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. And, finally, just in reference to Senator O'Keeffe's earlier question on quantifying the effects from soft landings on Government finances - and just maybe to expand upon that - that apart from the general impact on GDP and the impact on Government surplus/deficit, were there also concrete and specific estimates made on changes in the amounts of stamp duty, capital gains taxes and other property-related taxes?

Mr. John McCarthy:

No, no, no. It was purely the first round effects that we looked at.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay.

Mr. John McCarthy:

What's the impact on stamp duty? What's the impact on CGT? But it didn't mean, from a policy perspective, that we were recommending any changes to those variables.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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If those measures were included in the modelling, would it have given you a different type of approach or a different type of finding?

Mr. John McCarthy:

Yes, I think the finding probably would have been different. It depends on, of course, what the policy recommendation might have been.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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More accurate?

Mr. John McCarthy:

Well, I think the figures are reasonably accurate themselves because they do tally with what the ESRI's HERMES model had punched out through the hundreds and hundreds equations that are included in that. So I'm quite happy to stand over - and I do stand over - the results that are in that model.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Thank you. Senator Barrett, three minutes.

Photo of Sean BarrettSean Barrett (Independent)
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Thank you, Chairman. Do we know the nationalities of that OECD team that came to Ireland in 2008?

Mr. John McCarthy:

Yes.

Photo of Sean BarrettSean Barrett (Independent)
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Yes. Could you tell us, yes?

Mr. John McCarthy:

I'm trying to think who was on ... I think one person whose name is listed there is Sebastian Barnes, who's from the UK. He's currently a member of the Fiscal Advisory Council.

Photo of Sean BarrettSean Barrett (Independent)
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While you're looking, I mean, they would quite likely come from countries which had a much smaller banking crisis than Ireland, so, I think, listening to them ... could I point out when you compare, in Vol. 3, the summary recommendations on financial stability on page 20 that the OECD recommended ... there were five and only three of them made it through to the final version which is on page 38, the last page of Vol. 3. I also note that paragraph 90 on page 17 was deleted and what it ... it ... it says how to deal with bank failures and how the regulator could have closure authority and you could ensure there wouldn't be a run on the banks and - a deposit interest run - and that the losses should be confined to shareholders. Was that not vital information for us to have as we faced into the banking crisis in 2008?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I need the questions and answers wrapped up in the three minutes now. So, Mr. McCarthy?

Mr. John McCarthy:

Having had no role in deleting it, I would absolutely agree with the Senator, yes.

Photo of Sean BarrettSean Barrett (Independent)
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Okay. Now, page 61 in Vol. 2, the final question - and thanks, Chairman - your notes for the Minister, "the bank expresses concern about ... high current rate of credit growth, including mortgage credit, which has been increasing ... around 25 per cent.", and the Minister advised, "I would encourage the Central Bank and Financial Regulator to remain vigilant on the issue of personal credit and mortgage debt." Surely he was gone beyond remaining vigilant and there was need for action to deal with that 25% annual increase.

Mr. John McCarthy:

I would agree and if it had have been up to me, macro-prudential tools would have been implemented at the time.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you very much.

Photo of Sean BarrettSean Barrett (Independent)
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124 was "[We] note[d] [on 10 July 2008] Irish banks were well capitalised with good asset quality and the banking sector's shock absorption capacity remains strong." That was only ... that was in July and, you know, they were in trouble by late August and September.

Mr. John McCarthy:

Yes, in terms of compiling these notes, we get input from around the house and that was the line at the time, not my line but-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you. Deputy Phelan.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Thank you, Chairman. Mr. McCarthy, earlier, when I was asking you about analysis of other crashes, you referenced Japan. Can I ... as the chief ... or one of the countries that have been examined, why were we analysing a country with an independent monetary policy, given that our own monetary policy is exogenous and, you know, it's a complete difference from Japan, I suppose? And, furthermore, you referenced, when you were talking about why the soft landing theory gained such traction, that in Ireland we hadn't had reductions in property values before. Is it not a central tenet of macroeconomic forecasting that you don't derive future outcomes from localised past history?

Mr. John McCarthy:

Just on the first question, why Japan has an independent monetary policy, just the Kelly paper, which is, sort of ... also looked at the experience of 30 countries - I think it's 30 - across the OECD, and they, of course, had independent monetary policies as well. So I think that point needs to be borne in mind. On the second point, I mean, typically, economists, when they're looking at issues, they look at what's happened at the past. Does it set a precedent? Or they look at kind of cross-country experiences.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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But they're not bound, in a sense.

Mr. John McCarthy:

No, no, absolutely not.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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You gave that as the major, kind of, reason for that thing.

Mr. John McCarthy:

It was one of the reasons for ... I mean, you had not seen nominal price declines. The big problem at the time, Deputy, was that, you know, you had seen massive structural change in the Irish economy from the mid-1990s up to 2007. Now, some of that was real - it was the Celtic Tiger, it was the convergence ofper capitaincomes, it was real growth, it was driven by the traded sector of the economy - and the price increases were all justified on that basis.

The problem was from 2002, 2003 you saw a misallocation of resources away from the trading sector and into the non-trading sector.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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And that's fair enough but the point I'm getting at, we shouldn't ... or should we have been basing our soft landing analysis on the past history of the Irish housing market as that kind of central plank, that we should have been looking outside,? Isn't that the way economics works?

Mr. John McCarthy:

Well, I think on the soft landing, the key point that I would make is that, rather than the volume side, we've devoted a lot of time to that, but on the prices side, even if there is over-valuation, it does not necessarily mean that there can be ... that there will necessarily be massive destruction to the real economy. So it was a point I was making earlier on that you can see modest declines in prices-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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My time has ended and I don't wish to cut you short but we should ... just simply putting the question to the ... and I'm not blaming you specifically, you were part of a wider team at the time, but we should not have been basing that analysis on the main plank of it being that Irish house prices hadn't fallen in the past.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Are you making a statement now, Deputy, or are you asking a question?

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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No, I'm just asking that question in light of ... I've studied economics for years and past history in any localised situation, we're always warned against using that as the basis of future analysis and development.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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That's your question. Mr. McCarthy, can you respond to that please and we'll move to wrap things up then?

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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What I am saying-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Sorry, Deputy, I must stop you there now. No more questioning.

Mr. John McCarthy:

It can be used as a guide but it's not the be all and end all. I would accept your point that there are limitations of looking at the historical experience. As I mentioned to Deputy Higgins, you know, we had the historical experience of the Great Moderation. That looked as if everything was great for the next 20 years and so forth, suddenly things changed overnight. So, it can be used as a tool but, you know, there are, there are limitations and there are health warnings with the tool.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much. Okay, Mr. McCarthy, I am going to bring things to a conclusion. Is there anything else you would like to further add to this morning's proceedings before I close?

Mr. John McCarthy:

No, thank you, Chairman.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, with that said I'd like to thank Mr. McCarthy for his participation today and for his engagement with the inquiry. The witness is now formally excused and I propose that we suspend until 11.30 a.m., at which time we will recommence our engagement with Mr. Cardiff. Is that agreed? Agreed.

Sitting suspended at 11.12 a.m. The joint committee resumed in private session at 11.36 a.m. and went into public session at 11.39 a.m.

Department of Finance - Mr. Kevin Cardiff

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, so we will now commence with session 2, public hearing discussion with Mr. Kevin Cardiff, former Secretary General, Department of Finance. The Committee of Inquiry into the Banking Crisis is now resuming in public session, and can I ask members and those in the public Gallery to ensure that their mobile devices are switched off.

Today we continue our hearings with the senior officials from the Department of Finance who had key roles during the crisis period. At our next session this morning we will hear again from Mr. Kevin Cardiff, former Secretary General of the Department of Finance. This second session will focus upon developments during Mr. Cardiff's tenure from January 2009 until he left the Department.

Mr. Kevin Cardiff was Secretary General at the Department of Finance from 2010 to 2012. He joined the Department in 1984 and had a number of roles in the Department including responsibility for the taxation and financial services division and tax policy. In March 2012 he was nominated as Ireland's representative to the European Court of Auditors in Luxembourg for a six-year period. Mr. Cardiff, you are welcome back before the inquiry today.

Before hearing from the witness, 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 you are directed by the Chairman to cease giving evidence in relation to a particular matter and you continue to do so, you are entitled thereafter only to qualified privilege in respect of your evidence. You are directed that only evidence connected with the subject matter of these proceedings is to be given. I would remind members and those present that there are currently criminal proceedings ongoing and further criminal proceedings are scheduled during the lifetime of the inquiry which overlap with the subject matter of the inquiry. The utmost caution should be taken not to prejudice those proceedings. Members of the public are reminded that photography is prohibited in the committee room. To assist the smooth running of the inquiry, we will display certain documents on the screens here in the committee room. For those sitting in the Gallery, these documents will be displayed on the screens to your left and right. Members of the public and journalists are reminded that these documents are confidential and they should not publish any of the documents so displayed.

The witness has been directed to attend the meeting of the Joint Committee of Inquiry into the Banking Crisis. You have been furnished with booklets of core documents. These are before the committee and will be relied upon in questioning and form part of the evidence of the inquiry. So if I can now ask the Clerk to administer the affirmation to Mr. Cardiff.

The following witness was sworn in by the Clerk to the Committee:

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Once again, Mr. Cardiff, welcome back before the committee today. As you have already made your opening statement in your last appearance before the inquiry, we will proceed directly to questions. However, there is just one or two issues that I would like to address first before we go into the formal questioning.

Mr. Cardiff, on pages 235 to 243 of your composite statement, you include copies of handwritten contemporaneous notes made on the night of 29 September 2008. You also include your own transcription of these notes on pages 231 to 234b of your statement. A substantially identical typewritten version of these notes, provided by the Department of Finance, was included in documentation sent to, among others, Mr. Dermot Gleeson, former chairman of AIB, in connection with his appearance before the joint committee. During his evidence to the joint committee on 23 April 2015, Mr. Gleeson disputed the accuracy of parts of these notes, as he says that remarks attributed to Mr. Burrows were, in fact, made by himself. The reference to this is the final paragraph, page 33, of Mr. Gleeson's evidence transcript. Mr. Gleeson subsequently repeated his assertion in correspondence with the joint committee dated 27 April 2015 and on 15 June 2015. Could you please verify the text of your own note and confirm that the remarks are correctly attributed to Mr. Gleeson?

Mr. Kevin Cardiff:

No. Mr. Gleeson is right and wrong at the same time. If you see, my notes are ... as I explained to you, these were notes I wrote in a jotter - a habit - they weren't intended to be a minute, they're not a minute. So you'll see that there are notes there attributed to Mr. Burrows and then, a couple of lines down, there's a change in indentation, which, in the way I generally note these things, means that someone else spoke. So I don't think you can take it ... and I've seen, incidentally, in the package I think there are two different versions of transcripts ... so, my transcripts are accurate transcripts of my notes and, as I think I said to you last time, one shouldn't over-read notes that were intended for that purpose. But what was said was said. What's written down was said; it was said, it was written down at the moment it was said and where there's a line attributed to somebody ... someone said that line, but that doesn't mean they said every line afterwards. And, as I say, in the notes you can see there's changes of indentation and so forth.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you. And just on another matter related to your statement, you say that on the night of the guarantee, you do not recall any suggestion from any of the official parties at any stage that undated, unsubordinated debt, should ... would be recovered by the guarantee. However, you refer also to a previous meeting on 26 September at which some of the Merrill Lynch team had felt that inclusion of dated subordinated debt in any broad guarantee was warranted. You go on to state that your mention of this at the meeting of the 29th led to the inclusion of such debt in the guarantee. Was the inclusion of subordinated debt accepted by all present, were any contrarian views expressed in this regard and was any elaboration sought by either the Taoiseach, the Minister or anyone else present? And if you could maybe please elaborate on that.

Mr. Kevin Cardiff:

Well, if the answer is no, it will probably be hard to elaborate, but I don't ... I don't recall anybody saying "No". But the matter was discussed in the sense that at least it was raised and discussed. There was a slight bit more discussion - because I discussed a little bit more - about the issue of existing bonds but, no, I don't recall a contrarian view. On the other hand, when I've had contrarian ... when I recall my own contrarian views, not everybody recalls them, so. You recall better what you say yourself, I think, Deputy.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. So was the ... the position on 26 September generally reflected as being the same position on the 29th?

Mr. Kevin Cardiff:

I believe so, except, remember, on the 26th, people were putting together options and, on the 29th, they were making decisions. So there was a more ... certainly more firmness about it on the 29th.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Thank you very much. We now proceed with our lead questioners this morning and if I can invite Deputy Eoghan Murphy. Deputy, you have 25 minutes.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Thank you, Chairman, and thank you, Mr. Cardiff, you're very welcome back. The committee has gone over NAMA in a lot of detail already but there are still certain elements that we want to look into. And one thing I'd like to ask you about is, the first tranche of loan valuations by NAMA was completed in March 2010 and Governor Honohan has written that "it was clear then, extrapolating from this information at the time, that this would be the most costly banking crisis ever recorded", and that's page 76 in the book Lenihan: In Calm and Crisis. Was this clear to the Department in March 2010, after that first transfer of loans?

Mr. Kevin Cardiff:

I don't think it mattered. We were dealing with the crisis we had, we weren't going around trying to compare this with someone else's crisis and say which was the most costly and which wasn't. That's simply the case. The more pertinent issue for us was that the first round ... the first tranche, was coming in at a discount of, I think, around 50%, certainly heading for that, maybe 47%, and the NAMA draft business plan which was only a short few months old at that stage, had been based around a 30% discount. So the more ... much more pertinent concern than whether it was better or worse than someone else's crisis was what this meant for our crisis. And what this meant, in fact, was more capital and that was a serious consideration - and it was a serious consideration from then on. More seriously still, the discounts got bigger as we went down to the smaller borrowers. Remember the first two tranches, I think it was, covered the first 30 borrowers. The tranches later had a great many more borrowers in smaller amounts and, as I recall it, when NAMA got to those borrowers, they were finding a lot of incomplete legal work, a lot of concern about title, a lot of those kinds of issues, which wouldn't have been evident at the time the NTMA was working on the NAMA business plan because they were working at that point, as was very explicit, on data from the banks themselves. Some other factors in the meanwhile would have been that the ... all this had to be cleared with the European state aid people and they were quite explicit that they wanted very strict adherence both to their guidelines but also to valuation procedures and so forth. So there was a serious issue; but the issue wasn't whether, you know, ours was the best crisis.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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I think, Mr. Cardiff, Mr. Honohan's point was that this was going to be worse than we'd anticipated ... is the point that he was making, looking at the first tranche passing over. But just to follow on then from that, in May 2010, the IMF mission chief to Ireland phoned the Governor to discuss the possibility of Ireland applying for one of the IMF's new precautionary programmes, just in case. Was this suggestion put to you at the time?

Mr. Kevin Cardiff:

In May 2010?

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Yes.

Mr. Kevin Cardiff:

I don't recall it being putting to me at the time, Deputy. I'm not saying it wasn't. Just to be clear, the idea of a NAMA programme or of an IMF programme, one imagined the guarantee and the associated responses in 2008 or 2009 had gone badly wrong. Well, at that point, we might have looked for some .... we might have had to look for some external support. Certainly, it wasn't the plan ... it was nobody's intention but the first time I asked for some very, very preliminary and informal work on, you know, how one actually gets an IMF programme, was in September 2008, and at that point, I was thinking, you know, there was no work done on it. I just asked a colleague to make a discreet inquiry as to how you get into these things, if you do need them, just as a precaution because things were very bad from then. Then in 2009, I believe there were hints in Washington, possibly also in Dublin, that, you know, IMF would be available if we wanted them. At that point, the Minister gave a pretty firm instruction to me and to others that we were not engaging with that suggestion but in part because ... remember, a bank crisis means you have to fill gaps in liquidity and gaps in bank liquidity are enormous. Capital is a lesser problem; liquidity is an enormous gap. And you really need the firepower of a central bank to do that. Now, in 2009 and into 2010, we had no problem getting funds for the Government, which is what the IMF provides. What we had a problem with was the banks getting funds for themselves and, for that, we needed the ECB. So there would have been no huge advantage, let's say, to an IMF programme before we got it, if it didn't come with some ongoing access to bank liquidity. The banks were our problem and then by the time we got into the IMF programme, the sovereign itself had a problem and that's what IMF programmes are for.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Perhaps the Governor looking at what was happening with NAMA and speaking to the IMF was looking forward to September and what would happen in terms of a banking problem becoming a sovereign problem but Governor Honohan has written that he was quickly put in his place by Merrion Street officials when he conveyed this request or the suggestion from the IMF person in Ireland. Do you recall any conversation with Governor Honohan around the time in relation to a precautionary programme?

Mr. Kevin Cardiff:

Well, that could well have happened but I had conversations with Governor Honohan, sometimes several times a week, about all sorts of potentials. I don't recall myself ever putting him in his place. In fact, we had a very respectful, professional relationship. So, if he's implying that tone, then it couldn't have been me. But, certainly, at that stage, the Minister and myself would have said, "Well, hang on now", if we were asked. There is a real problem there because that programme would not fill our gap. We would need, if there were to be a programme, we would need something bigger and we would need European assistance as well. So, I would have thought ... I don't remember the conversation but I would have thought if I had been asked at the time, I would have thought this is a little bit premature. But I wouldn't have ruled it out because, I mean, we had a difficult situation and had had for two years.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay. Thank you. Moving forward then to the end of July 2010 and the dependency of the Irish banking system on emergency liquidity assistance is increasing. Anglo is approaching, I think, €15 billion, and the guarantee is due to expire in September and again, Governor Honohan has written how he made sure the ECB was fully aware of how this situation, the dependency on ELA was shaping up and the consequences for the sovereign. Did the Governor make the Department aware ... fully aware in July? Was the Department aware of this September bank funding cliff and the implications for the State in July?

Mr. Kevin Cardiff:

Yes, as I just said, myself and the Governor, other colleagues were talking to each other all the time, of course, and the Minister was fully aware as well. There was no ... this was no great secret, Deputy. In fact, we had been working very hard with the European Commission to ensure that the guarantee, on which many of the deposits still relied, was renewed at the end of September, so as to help with that. In fact, they only finally conveyed approval, I think, in ... excuse me, if I have the date a day or two wrong ... but I believe it was around 21-22 September 2010 when the guarantee was due to expire ten days later or, you know, only around a week later. That was a problem.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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You write about there being a quite lengthy delay in receiving the Commission approval for this limited extension of the bank guarantee system, which may have exacerbated the situation. So what was happening in August that led to this delay and how did it exacerbate it?

Mr. Kevin Cardiff:

Not just August. July and August, I think, maybe even June. We were in discussion with the Commission over a lengthy period. I don't recall the details of their objections, Deputy; if you wanted, I could probably find out. But, remember, they didn't like the guarantee. It was a problem for them. It was a state aid that was going on for a long period in all sorts of philosophical and principled ways, it was ... this was not a thing they wanted and, on the other hand, they knew that the Irish financial stability was relying it, so eventually they ... after a lot of toing and froing, negotiating back and forth, they conceded an extension. As I say, I can't remember the details of their objections but I'm sure they're available to you in documents.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Did the delay make the situation for Ireland worse as we entered the end ... approached the end of September?

Mr. Kevin Cardiff:

It would probably be difficult to quantify it but, yes, it must have because, remember, people ... if you had a one-month deposit with an Irish bank, at the beginning of September 2010, that one-month deposit was no longer guaranteed for the full term. If you had a three-month, then it was going to be unguaranteed for two months. So, I can't see how it would not have had some impact and, in that sense, I think, yes, it must have exacerbated the situation but I don't see how you could quantify it at this stage.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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But just to clarify, it wasn't due to a lack of action on our side?

Mr. Kevin Cardiff:

Well, I think we were actively engaging with the Commission for at least two, and probably three, months beforehand. There was no ... this was seen coming from a long way. And you'll notice, for example, I think when the ELG guarantee expired finally, the Department did a report. I have it if you want it. At the break, I can give it to you. And that report outlines the regular views of the guarantee schemes over the whole period. So, every three or six months, there was a review. So, at the very moment that one review finished, you would be talking to them about the next review.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay. I want to move forward then to mid-October 2010, if I may. Minister Lenihan went to the IMF annual conference in the US with his adviser, Alan Ahearne. Did you attend that conference?

Mr. Kevin Cardiff:

No.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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On the flight, the Minister and his adviser discussed the pros and cons of a possible euro exit. Did you ever have those conversations with the Minister?

Mr. Kevin Cardiff:

There was never a serious suggestion from the Minister to me that we would think about a euro exit.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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But you had conversations with him about it?

Mr. Kevin Cardiff:

He was a gentleman who had very broad conversations and broad interests, so you would have conversations with him about every possible possibility, yes.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay. And was any risk work done by the Department of Finance while you were there to investigate the pros and cons of a possible Irish exit from the euro?

Mr. Kevin Cardiff:

There was certainly work done on what would happen if we found ourselves unceremoniously shown the door or if that became the only option.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay, and what did that work involve - a unit being set up or a paper being drafted?

Mr. Kevin Cardiff:

There was a number of contingency papers drafted but the work was kept to an absolute very small group of people.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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For confidentiality reasons in case the information-----

Mr. Kevin Cardiff:

This was dynamite stuff. I remember being in a committee here when, I think it was Deputy Ross, was trying to get me to admit that we were working on a default and the notion that you would stand up in the ... and default with an exit ... the notion that you would stand up in or sit down in a committee and declare that to the world was just ridiculous. I mean we had to work on it ... of course, we did but it was ... how could one have even hinted in public that this was a serious consideration?

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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So it was a serious consideration?

Mr. Kevin Cardiff:

It was a serious contingency consideration. Just as I would imagine that there are people ... well, just as I imagine that at the time, there were people all over Europe who were having similar conversations.

I had a conversation with a colleague from another jurisdiction who said, "Kevin, are you working on such and such?" I said, "No, of course not, how could I be working on that?" And he said, "Well, could you have whoever is not working on it telephone whoever who is not working on it in my office?" But no one could admit to this, of course not.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay. And just to clarify the nature of the work, this secret work. You said about being ... finding yourself I think, unceremoniously outside of the euro. But was it contingency work in case we decided to exit or in case we were forced out?

Mr. Kevin Cardiff:

The policy was clear and it was clear. And it was ... the Minister's view that the Government's view was clear. We are not working towards exiting the euro; we were working towards staying in it. That was always clear; there was never a debate.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Okay, but we were doing contingency planning in the case that we might, through no fault of our own or through a conscious decision, should events change?

Mr. Kevin Cardiff:

Well, remember, we all talk as if this programme we had was a foregone conclusion; it wasn't. Not everybody wanted to give us that money. In the IMF, there were naysayers, people who said: "Look, this is beyond our normal range; this is, I think, ten times the quota that is usually available to a country like Ireland for the size of the borrowing". In the ECB, there were people that were saying, "Look we are too exposed to Ireland, this is ... it's not worth the trouble of keeping them going." Philosophically, legally, we were at the edge and a lot of people in those organisations would have thought, "Actually, this is not ... it's not our role to keep this happening." So when we talk about, as I do quite critically, ECB and even the IMF on some points, the fact is there were people in there who were willing to fight for us and keep us in. So it wasn't a foregone conclusion that we would get that money and it wasn't a foregone conclusion in, say, 2011, early 2011 in particular as things kept getting worse, that we would continue to get the money.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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When did this unit finish its work? Or when was it stood down?

Mr. Kevin Cardiff:

I'm left. I don't know if it's stood down yet.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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So it was still in operation when you left?

Mr. Kevin Cardiff:

Well, there was ... I think ... I mentioned the work had eased a little bit, or the pace of it, because there was no ... by the time I left, things were much, much more, on much more sound ground. But it certainly would have been active. And to be honest, Deputy, we are getting towards the kind of discussion that, I don't know if it's within your terms of reference but it certainly makes me uncomfortable to talk about work that still might be going on or might not still be going on. I'm not aware of it anyway.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Let's move on then. Before the bailout, before we actually entered into the bailout, close to €19 billion of unsecured bonds came out of guarantee in September 2010. €4 billion to €5 billion were bonds to Anglo and INBS and between September then and the actual beginning of the bailout programme, €2.4 billion of unguaranteed, unsecured bonds were repaid. Did the Department have any plans for burden-sharing, even on a contingency basis prior to entering the negotiations with the troika?

Mr. Kevin Cardiff:

Well, you will have your figures there. Those were senior bonds?

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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These were senior, unguaranteed, unsecured bonds.

Mr. Kevin Cardiff:

No, the settled policy at that time was that there would be no burden-sharing. It was based on both legal considerations but, more importantly, on the advice from the NTMA that this would be a bad thing and I think my statement is ... or my long ... what Senator O'Keeffe calls my "long statement" goes into that in a certain amount of detail. Remember, the NTMA was concerned, quite rightly, that it had to fund Ireland in the market. It had a view that if we were burning senior bondholders, we could easily lose that access to the market. Two months on, it was pretty clear that we didn't have access to the market, so the balance of advantage for Ireland changed.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Did you seek advice from the Central Bank?

Mr. Kevin Cardiff:

Excuse me. I don't recall a formal advice. But I think we were all at one and the view you will see also in my long statement, there's a reference to a document and the document is a statement made by Matthew Elderfield that around that time which, sort of, sets out the Central Bank view of it. And that view is very similar to the one I've just expanded.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Are you aware that for a time the Central Bank was contemplating recommending to the Department that there be a bail-in of Anglo and INBS bondholders at the end of August, beginning of September?

Mr. Kevin Cardiff:

Well, I think you will remember that, Deputy, you are asking me these questions and throwing dates at me. At various times, we had this discussion. Even in September, I think in my notes I have a conversation in which the NTMA said, ''No, we can't do it now''-----

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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It wasn't settled policy then?

Mr. Kevin Cardiff:

Well, it was settled policy.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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But you were still discussing the possibility?

Mr. Kevin Cardiff:

Of course. You talk about what your next step is going to be at all, at any stage, Deputy. So it was settled policy, but the situation was changing and the NTMA was, sort of, saying, "Well, look, we can't, Ireland can't burn bondholders but it might suit us if Europe forced us to because then you wouldn't have any negative impact on, you know, the group of bondholders that were also financing the Irish Government." They wouldn't be upset or offended or they wouldn't pull their funding, he would have thought, if at the same time there was a European diktat in some legal from that said we must. So, I think in September, certainly by September and into October, the balance of advantage was changing and people were talking about, or were thinking about and were talking about, where we would go if things changed, but the policy was, and continued to be, that were not burning senior bondholders through October and into November.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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You have given us a huge amount of information about processes leading up to the negotiations with the troika and the formal negotiations and the conclusion. But I just want to look at the relationship, maybe, between the Irish Government and the troika partners and in particular, the ECB and I want to look at some of the language you use in relation to the ECB at various parts of your long statement. You talk about the "fiction that the ECB was present in negotiations only to do with banking matters"; "an increasingly hectoring tone on the part of the ECB'' - this is in October after the Deauville Declaration; then moving into November, "increasingly strident rhetoric from the ECB"; "the ECB's panicky state of mind"; the November Trichet letter to Lenihan was "a very direct warning and threat"; "It is easy to attribute a bullying attitude in retrospect"; on recapitalising the banking system, "the ECB had a different agenda"; on the proposed interest rate, "ECB showed a little less solidarity''; on burden-sharing you talk about "the fallacy that the ECB was simply giving advice". So what was the relationship with the ECB like? And do you blame the ECB for the fact that we had to enter a bailout? And do you blame them for those terms that were not favourable to Ireland in that final agreement?

Mr. Kevin Cardiff:

No. Look, this is a negotiation. All parties have something they want out of it. So, I mean you have read out a lot of comments I made there and they are honest and I mean every one of them. But almost every single time I made the comment, there is a counter-comment in the next paragraph, almost always, which you haven't read out. Remember, think of us and Anglo or not Anglo. Just take Ireland and a bust bank and just reverse the situation somewhat. We had all of the same problems with the bust banks as the ECB would probably say they had with us. And the bust banks might say that were increasingly hectoring in our tone and so forth. This was a negotiation. People who I was dealing with were very tough at times, definitely hectoring. Sometimes they changed their minds and it didn't suit; other times they seemed to make a promise and it didn't seem to be kept. But they were doing their job to negotiate. So, I mean if you were to go into any negotiation that's a tough negotiation with a lot of different agendas and found that there was no one was being tough, then there was something wrong with the negotiation, frankly. I don't think they were doing anything other than what they saw as their job and, remember, as I make abundantly plain more than once in my statement, they were giving us a huge amount of support. The slight irony in it was that they were dong so with a public reluctance, which actually made the level of support that was required, I think, slight ... bigger. So if the ECB had said November 2010, just after we had agreed to go on the bailout ... if they had said in a very public way, ''Okay, so long as the Irish are sticking to the programme, we are supporting them come what may'.' They would probably have actually have to give us less support than actually arose because in the event, they, sort of, said it's a good thing that they are joining the programme but no big supportive statement. The big supportive statement only came in March after a lot of effort and, you know, the ECB will tell you, legally, they couldn't make those kind of statements.

I don't know if that's true, I expect it's not, or they might tell you that, you know, it wasn't appropriate because we hadn't done all that they wanted us to do, those kind of things. Or, they might have just been holding their fire in order to make us concede a bit more than we wanted to on the various issues between us. But that's life, that's negotiation, that's discussion. They had their agenda; we had ours.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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In terms of-----

Mr. Kevin Cardiff:

We fought hard too incidentally, not just them.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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In terms of that agenda, and the agenda ... Mr. Trichet spoke about a global consensus against burden-sharing. Was Minister Lenihan part of that global consensus in November 2010?

Mr. Kevin Cardiff:

No, there was no global consensus. If global means everybody, no. What he may mean ... well I explain in my statement. When the IMF programme discussions started and the EU programme discussions started in ... so, 21st thereabouts of November 2010, even a day or two before in truth, the IMF was not just saying, as I say in my statement, that they were in favour of, but I've looked over my notes since then, in some ways they were saying, "We might even make it a requirement, this might be something that we would think is essential," - this burden-sharing with senior bondholders to be clear.

The other partners were clearly not so anxious to do so and while we genuinely tried, because we needed this programme to hold together, we genuinely tried not to force differences between the parties. We did explore a little bit more with the IMF than with anybody else about this. They said, "Look, we've talked to Dominique Strauss-Khan [their managing director], he thinks that he can get the other parties, the big European and American governments over the line, he thinks he can persuade them that this is a good thing to do."

Myself and the Minister in discussion didn't think that we could, so if Strauss-Khan could do it that would be wonderful. So the plan was that Strauss-Khan would speak to these sort of G7 types, the big countries, and he was pretty confident. There was even, at least as recounted to us by the IMF staff on the ground, and there was even a hint back, we got an e-mail ... or I got an e-mail, I think on about the 24 November or thereabouts, 24th or 25th, maybe the 25th, that Strauss-Khan had reason to believe that Geithner, the American secretary ... the American finance minister, Secretary to the Treasury, that he would ... he was sort of showing himself to be a little bit favourable. And then ... so they have the telephone conversation as I understand it and the message we got back was actually the opposite - it was very negative. What we were hearing was that among the negative people were Geithner and Trichet of the ECB, but others too.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Is this the conference call that happened between-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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You would want to move on to a final supplementary, Deputy, because I do need to move on.

Mr. Kevin Cardiff:

I'm sure it was a conference call, yes. It wasn't a meeting; it was call.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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You weren't on that conference call?

Mr. Kevin Cardiff:

No.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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No. My final question is to clarify then is, in relation to what the IMF was proposing, because when we got to March 2011, I think we're talking about €6 billion, but is it the case that in November were talking about €30 billion of bonds being haircut by as much as two thirds?

Mr. Kevin Cardiff:

Well, the IMF numbers would have included the subordinated and the senior and I think the senior was probably by then about €18 billion or €19 billion. Those that were already guaranteed wouldn't have been included in the numbers, those that were secured on loans and so forth probably wouldn't have been included in the numbers because they had other protections. So I recall the number of about €19 billion being in the mix, but the numbers moved around a little bit depending on, you know, exactly how you wanted to define them.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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But that didn't come to pass obviously following that phone call that you-----

Mr. Kevin Cardiff:

Well, it came to pass in regard to some of that €30 billion, in regard to the subordinated debt, but not in regard to the senior.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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The subordinated debt on a voluntary basis?

Mr. Kevin Cardiff:

The legal strategy, Deputy, was that you would do it on a voluntary basis but there wouldn't be much choice.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Thank you.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Senator Marc MacSharry. Senator, you have 25 minutes.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Thank you very much and welcome, Mr. Cardiff, again. Just two very quick questions at the beginning which arise; we had John McCarthy in earlier from the Department of Finance and while it goes back perhaps to the evidence of the other day, he told me in questioning that his Department were vocal and consistent in their recommendation for counter-cyclical policies throughout the period. He said, right from 2001 up but ... that this, that's how he put it - circumstances always changed between the agreed budget strategy signed by the Minister and what happened later. Do you agree with that statement?

Mr. Kevin Cardiff:

For most of that time I wasn't the ... in the division that was given the fiscal ... you know, that was working on the budgetary and fiscal package. At times I was on the tax side, but the people who put it all together were in a different division. So it wouldn't have been me who was doing that but I mean, yes, I'm aware that we were given advice at different times, and I've read the Wright report, like all of you have and it's clear from that that we were given advice. Wright says that we should have been more, I forget the word he says, strident or more vocal, at different points than we were.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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He did mention that at different times people would be told, he described it as the pay level above his ... not to say certain things, to take certain things out. Would you have been aware of that and was this political interference or was it pragmatism by the officials who had this authority?

Mr. Kevin Cardiff:

Well, it depends on what a document is about, Senator. If a document is a Minister's speech or is a policy statement or whatever, well it's the Minister's statement and it's not ... so long as we have a democracy it's not for civil servants to insist. Civil servants ... and there's a real question about how ... to what extent the Civil Service should be an internal opposition, but I don't think Ministers particularly ever want it that way. But certainly the ... you would, if you were framing a response to a parliamentary question or you were framing a public speech, what you would be framing would be the document that you think the Minister wants. If you were framing your own advice, that would be different. So if you were framing your advice to the Minister that might have one thing in it, but once the Minister has decided a policy or once there is a policy line for something, then in terms of what you have the Minister say, because you draft the speech for him, or a line or a parliamentary question answer, then that's his speech you are trying to draft, not your own.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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To what extent, if ever, did the wish to say what the Minister wants, affect the integrity of the facts?

Mr. Kevin Cardiff:

The facts as spoken by the Minister or the facts as given to him by the officials?

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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I mean ... in an important speech, for example, like the budget or an important policy directional thing, I mean, what I'm trying to get at was there political interference to the extent that ... Let's talk - you said you were in tax - about the tax incentives. Would Ministers have said, "Mr. Cardiff, I am not doing that, we'll lose votes if we do that, we're not doing that." I mean, did it ever get down to raw vote getting or was there responsible, mature consideration of policy direction?

Mr. Kevin Cardiff:

Ah no, there'd always be raw vote getting, that's how democracies work I'm afraid.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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And specifically to do with tax incentives and the property tax incentives that we spoke of, did you feel undue ... did you feel that there was an undue influence with regard to that issue, for example?

Mr. Kevin Cardiff:

There was a lot of support by the Minister of the day for the evaluation, the very detailed evaluation we did of those tax incentives and a lot of support also for the ... it was his decision to phase them out ... but I understand and it's sort of a .. the folklore of the place, that there was, you know, the tax incentives had come about mostly because of suggestions from the political level. I don't recall ever hearing of a property tax incentive being something that the official level would have thought was a wonderful thing to suggest. But that's not to say they weren't, but in general we had concerns about property tax incentives, in particular because if you incentivise a lot of things, then the incentive effect actually is reduced.

You have ... if you have only one property tax incentive then that ... that policy objective really is incentivised. But if investors have 20 different options, all with an incentive, then the incentive effect for any one of those options is much reduced.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay, just one very last question, just to do with the era that, really, we were dealing with the last day, and that was just, on the guarantee, was there a lobby, from anywhere, specifically to include the UK subsidiaries of the banks?

Mr. Kevin Cardiff:

Oh it was more than a lobby. It was an absolute insistence from the UK and from Europe.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Was it ... was there any political influence in that, in that decision? Was there political parties calling for that, were there politicians calling for that?

Mr. Kevin Cardiff:

Well, the British Prime Minister and their Chancellor were calling for it.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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No, here in Ireland, particularly?

Mr. Kevin Cardiff:

In Ireland? I've some vague recollection of someone saying in the Dáil, in the ... on the guarantee debate, that, you know, maybe we'd have to look at this, but there was ... I don't think anyone ... any party here was seriously pressing for a broadening of the guarantee beyond what, what it was at.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. At what point, post-nationalisation, did you become aware of the extent of debt concentration to a small number of debtors and were there any indications of this debt concentration prior to NAMA acquiring the portfolio?

Mr. Kevin Cardiff:

Oh yes, absolutely. The debt concentrations were becoming quite evident, at the very least, by ... at the very latest, by October 2008, in the PwC documentation.

Mr. Kevin Cardiff:

In actuality, one of the things that was regarded as a potential advantage for NAMA would be that it would be able to get more value from particular debtors because they would be able to concentrate three or four of their exposures into one place and manage them as a group, rather than having them managed separately in three different places.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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What's your assessment of the ultimate consequences to the State of the decision to contribute the National Pensions Reserve Fund?

Mr. Kevin Cardiff:

Of the decision to use pension reserve fund money towards the-----

Mr. Kevin Cardiff:

It's neutral.

Mr. Kevin Cardiff:

Neutral.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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What do you mean by neutral?

Mr. Kevin Cardiff:

Well, if something had to be done then it doesn't really matter whether you take it out of your side pocket or your back pocket.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. Why did the Government proceed with the amount of €3.5 billion for AIB, given that it was clearly outlined that this amount was insufficient to meet their capital needs with, ultimately, them requiring €19.8 billion?

Mr. Kevin Cardiff:

I think you're mixing three or four different things there, probably deliberately. The €3.5 billion was an assessment at the time, but, at the time, the assessment was that they needed a couple of billion more, not that they needed €19 billion, and a couple of billion more was to be made up by themselves because they had assets that they could sell which would accrue to capital. In particular they had a Polish subsidiary which was sold later. So their plea, if you like, was, "Don't give us more capital; please, please, not more, not more capital. We'll find it ourselves; we'll find the balance ourselves." So that's why, at the time, they got less capital than was estimated to be required.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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In his witness statement, Patrick Honohan states:

One of the measures pressed on the Irish authorities by the troika was the merger of Anglo with INBS and that of EBS and AIB. From my perspective this measure served no strategic purpose. It seemed largely a pointless cosmetic exercise.

Could you comment on that statement, and these mergers, and his view that they were a pointless cosmetic exercise?

Mr. Kevin Cardiff:

€67 billion, Senator ... if they're giving you €67 billion and they want something that's pointless and cosmetic, if it doesn't hurt you, you say "Yes".

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Is this view similar to the one given by the Central Bank at the time?

Mr. Kevin Cardiff:

I can't remember what they were saying at the time about that, Senator. What was really important was not ... much more salient, if you like, was not whether those would be merged together, and I gave a slightly glib answer, in part because I don't remember all the discussion. Much more important than whether those would be merged together would be what would happen their deposits, which, as you remember, were passed on to other institutions. That mattered because if those institutions lost those deposits they had to rely, even more, on ELA, which meant that we had to rely even more on the ECB to continue to sanction that. So, a lot of our concern about this was not ... about these rearrangements was about protecting the deposit base and ensuring that we would continue to have as much ... as many deposits in the system as possible. And we were afraid we would lose those. So when the deposits were moved out of IBRC, and into other institutions, at the time we were relying on a, sort of, a tacit agreement from the ECB that that would ... you know, they would make up the difference, and they would allow the difference to be made up in ELA.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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So, you think it was a good thing.

Mr. Kevin Cardiff:

Well, it was a good thing to ... if you could continue to ... if you were sure you had the funding it was a good thing to ... to reduce the scale of the business to the scale of the balance sheet on both sides of those institutions, yes. So, it was a good thing to have them made smaller and to have them on a clear path downwards and out. In that sense, yes, definitely.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Back to the line of questioning that Deputy Murphy had in relation to burning of bondholders. Did you watch the evidence of Mr. Trichet at the event in Dublin Castle?

Mr. Kevin Cardiff:

I watched a good bit of it, I don't know that I saw it all.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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You described, and, again, I don't want to be-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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What-----

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Yes, okay, so, the words that you mentioned in your report, while you said that you would give, "on the one hand this and the other hand that", words like "fiction", "fallacy", "hectoring tone", "bullying attitude" and so on. How would you assess the evidence given by Mr. Trichet on the day?

Mr. Kevin Cardiff:

Well, I think I've said some of it was perfectly accurate. Other pieces I thought were perfectly valid but maybe he didn't have the whole story and other bits that were ... were just plain ... those kind of truths that, you know, every word is true, but the impression is not. And the impression of, as I said, very explicitly, in my document ... the impression that they were simply giving advice simply isn't true.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Would you have a view as to why the ECB preferred to engage in an external meeting with this inquiry rather than come in, like yourself, under oath, to give evidence?

Mr. Kevin Cardiff:

Oh yes, I mean, look, remember ten years ago ... more than ten years ago when the ECB was set up. There was an early ... a legal case quite early on about whether they were ... they could be brought to the ECJ, and they fought that very hard. They ... this is ... they have an absolute belief in their legal position as being independent. And it's not purely self-serving. Remember, some of these people, in some of these countries, don't have a tradition of independent central banking or of a ... or, don't have a tradition of a lack of political interference in central banking. Some of these countries are ... have done enormous things to make themselves democracies in a very short period of time, from a ... you know, a transition from an out and out dictatorship, where nothing was independent. So there's a reality to their desire to be independent but they try to protect that, sometimes in ways that we mightn't all like. And then they have a legal problem, frankly, I imagine, coming and being, you know, directed to attend the committee, because they are ... you know, they have these various protocols and so forth. Just as I would if I were representing the European Court of Auditors here.

I would probably come, I would probably have the same discussion but I would not allow you to direct me because that would be contrary to the protocols.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Yes. Again, just to cover the Strauss-Kahn issue, which you have dealt with, would it be your understanding or not that Minister Brian Lenihan at the time felt that the Irish Government were going to be in a position to burn bondholders?

Mr. Kevin Cardiff:

He had one very optimistic day, yes.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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He had one great optimistic day. You mentioned the call coming in then which said that Trichet and Geithner were not in favour of this and, presumably, this was the call that gave the bad news. Who was that call with?

Mr. Kevin Cardiff:

I imagine we got the news first from the IMF themselves because they were the ones who were co-ordinating with Strauss-Kahn. It must have been from there.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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It must have been?

Mr. Kevin Cardiff:

It must have been the IMF people on the ground in Dublin because I remember they were sitting in the building with us at the time. Sorry, just to be clear-----

Mr. Kevin Cardiff:

-----I mention Trichet and Geithner because they're, sort of, documented but there were other countries on that call too and I don't know who was for and who was against. I don't know if there really was a global consensus, as Mr. Trichet says.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Who else would be on that call? If it was G7 I mean-----

Mr. Kevin Cardiff:

Well, the UK would probably be on it, the Canadians may have been on it, the French, the Dutch, I don't know.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. Have you learned anything since that you could share?

Mr. Kevin Cardiff:

No. After six months of fighting with the US Treasury over an FOI request, they gave me one document that was irrelevant. I was almost admiring their manner of handling it. You can have the whole document, if you want it, Deputy, but it's not very helpful. It is, though, documented in Geithner's book in part and so I put the relevant extract in my statement because that is ... we know what happened to an extent but what we don't have is the documentation, because we weren't on the call. So the only documentation I have found is Geithner's book but I can tell you what was recounted back and it was confirmed on phone calls I might have with counterparts in the Treasury that yes, sort of, Geithner was against but the way it was put to me was he wasn't the only one.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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I am sorry. Can you remember a passage in the book, did it not say that he found Trichet more animated than he ever found him or something to that effect?

Mr. Kevin Cardiff:

I don't remember but I can do better because it is the statement you have there.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. Have you any view on why Trichet, for example, would not have accepted the arguably more experienced position and authority of the IMF on matters such as these in the context of burning bondholders?

Mr. Kevin Cardiff:

Yes, because Mr. Trichet was trying to hold together the entire EMU project. So we are there, we have a particular national problem and we're fighting hard and he's trying to think well, what's the implication of this for the entire eurozone. So he has a different perspective. What was really important to us might seem to him, you know, that to achieve a saving of several billion is quite a good deal, if we got a 15% reduction on that 19 that would be nearly €10 billion. That was really important to us but for him ... if you're sitting in Frankfurt and you're saying €10 billion and we could have risked the whole project, you might think it is not worth doing.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Who were the beneficiaries of Ireland's not burning the bondholders?

Mr. Kevin Cardiff:

The people who held the bonds.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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We know that but in the European context. Who had to gain?

Mr. Kevin Cardiff:

I imagine Irish bank and Government bonds were broadly held across Europe and the US, so I would have thought that most large investment funds around Europe would have some small exposure.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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You said last week when we spoke and I asked you had Ireland's actions saved the euro and you said that it had but so too had the actions of other countries. How many other countries proportionately paid bondholders in a similar way as us?

Mr. Kevin Cardiff:

Nobody paid as much as us.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Nobody. So is it fair or not to say that in the context of saving the euro, that the Irish people have done most?

Mr. Kevin Cardiff:

In the context of saving the euro and saving ourselves, we have spent more than anybody else and we have made a much greater fiscal effort than almost everybody else. I mean, the Portuguese and the Greeks have similar problems. The Greek problem is, unfortunately, quite a bit deeper even than ours so your heart goes out to them. If ours was bad, how bad it must be there.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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As you mentioned Greece, their negotiating approach, with the benefit of hindsight, would you have done anything differently?

Mr. Kevin Cardiff:

My remarks last week were reported in the Greek financial papers. This is not a fair conversation to have. They are in the middle of a really shite problem so let's leave them alone.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. The other issue I wanted to ask you about was on 18 November, Patrick Honohan did an interview with "Morning Ireland" and there are various views of the implications of why that interview took place and no doubt we'll be speaking to Mr. Honohan tomorrow about that. Can you give us your view as to why it happened and the implications of it?

Mr. Kevin Cardiff:

Like every other country in Europe, we had set up an independent central bank and we have explicitly in law said to the governors of those central banks, even more so incidentally in Ireland than other places because we put a great deal of responsibility on the Governor himself, as opposed to the board, who we said, "You are independent and you've to act in the public good but entirely independently of government." So he took a view that was different to the Minister's and different to mine at the time as to when was the time to talk more openly to the Irish public. I think, in truth, there was only a day or two in it. It was very clear, at that stage we were having gone, in the lingo, from contacts with the EU-IMF to by then what were being called short and focused discussions actually in Dublin. I mean, it was clear that there was a momentum building. I think probably what Patrick said on the Thursday, the Minister would probably have been willing to say himself on the Friday evening. So I was not especially upset by it, I thought, "Well, I would not have done it but he has to do his duty as he sees it." I think Minister Lenihan thought the same because there was no sense of rancour between them afterwards. I think they just saw each other as doing a slightly different job. It was a little bit... I would have liked an hour more notice of it, that's all.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Would the independence of the Governor of the Central Bank, which, of course, we all respect and uphold ... in that instance do you feel Mr. Honohan was acting as Governor of the Central Bank of Ireland or council member of the European Central Bank?

Mr. Kevin Cardiff:

He has a legal obligation in relation to his duties as a council member of the European Central Bank and he would probably never be able to say this himself but I never saw a moment when I didn't think he was working for Ireland.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Do you feel the dual role sometimes is bad, not necessarily specific to Mr. Honohan, but where does one's national responsibility stop and the fiduciary duty to membership of the Governing Council take over?

Mr. Kevin Cardiff:

It is a complex thing for a person in that situation to manage but remember the alternative is not to have an Irish Governor sitting on the council of the ECB and that would be a bad thing, I think.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Is it something that is clearly defined?

Mr. Kevin Cardiff:

No, it is clearly undefined.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay, so it is a grey area.

Mr. Kevin Cardiff:

There is no ... there is nothing written down as to how you manage that conflict but it is written down that, of course, you are there as a ... that you have responsibilities as a member of the Governing Council and you have to adhere to those.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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So it could be a case perhaps or not of when one is in Frankfurt, one is an ECB Governing Council member and when one is in Dublin, they are not.

Mr. Kevin Cardiff:

No, I think one is always in a complex situation. I don't think that it changes because you're in Dublin or Frankfurt. You have to work two jobs. A lot of people do that.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Very finally, do you feel that the interview that morning, 18 November, strengthened or weakened the Ireland position in the context of negotiations at that time in terms of options available?

Mr. Kevin Cardiff:

We had already done a lot of negotiation by then, in fact ... I mean, we had done so on the basis of what-ifs because, you know, we couldn't run ahead of Government agreements. Everything was done very closely with the Minister, so the officials were not running ahead of the Minister, but the Minister was having to manage this ... the discussion, the prior discussion was all about "If we were to join a programme, what would be the terms?" So, by then, we were at that point where a lot of the, "Well, if you do, then the terms will be X, Y and Z", a good deal of that had been discussed. So, I'm not sure. So long as his statement didn't lead the other side to start rowing backwards and say, "Well, we could get more", then it wouldn't have made a huge difference. I don't think it did make an enormous difference to the endpoint.

Mr. Kevin Cardiff:

Oh, we'll never know, but-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you, Senator.

Mr. Kevin Cardiff:

-----probably not, in truth.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I'll bring you back in in the wind-up.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I just want to deal with three items there before I move on with the next round of questioners, Mr. Cardiff. Just to put the question to you and that is: did the structure or design of the bank guarantee, along with its period of duration, have any bearing on the Irish State entering a bailout programme two years and two months after the bank guarantee?

Mr. Kevin Cardiff:

Clearly, yes, but maybe in a slightly different way to the way people have suggested. It clearly did, because the structure of the guarantee ... the structure of any guarantee puts the sovereign credit behind the bank credit. And the combination of circumstances in ... from about May of 2010 onwards, meant that that was a difficult situation to be in. If you remember, in April, or thereabouts, 2010, there was actually an optimistic moment or two. The Central Bank had announced its stress test results. The Government had announced what it would do, in terms of capital, about those stress test results. I think the Bank of Ireland even got in a modicum of private sector equity, which implied that, for that month, the private sector was convinced that things were changing in Ireland. And then the sovereign crisis happened - April, May, a little bit of it in March, even, but accelerating a lot into April, May, June; the Greek crisis. And at that point bond investors became really, really risk averse, both in relation to banks and in relation to sovereigns. So the Irish guarantee became worth less, if you like. So, by the time we got into September 2010, at the time when ... well, even June, July, August, September 2010, at a time when really the banks ought to have been renewing their long-term loans to deal with the end-September cliff, it simply wasn't possible for them to get into the market because they were relying on the sovereign credit and the sovereign credit was suddenly less good, so in that sense, the combination of the two was difficult but, you know, it wasn't so much the structure of the guarantee as that the end of the guarantee happened to coincide with this huge risk averseness arising from the Greek crisis and then spreading to others later.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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So, given what you're saying there about the banking guarantee and the cliff that was relating to it, the structural deficit that was in place, the funding cliff that was arising out of the banking guarantee and the sovereign relationship to the banks because it was a written guarantee, as opposed to a political guarantee, could I now ask you were Irish banks that were covered by the guarantee still solvent and, therefore, qualifying for ECB ELA funding at the time of Minister Lenihan's last letter to Mr. Trichet? That was the letter of 21 November 2010.

Mr. Kevin Cardiff:

I'm trying to remember timeframes. I think they were at that time. Anglo might have had a brief period when it wasn't really, earlier on, but it was covered by periods of ... well, they were solvent in the sense that it was always the case that the State would stand behind them, so they could only then be insolvent ... and when I mentioned Anglo, there was a moment when, you know, there was ... the State had to say, "Yes, in fact we are behind them" to make sure that they remained solvent." And then your ... the next question would be, if the State is insolvent, how would its credit make the banks solvent? But the State wasn't insolvent, the State was, as has proved to be the point ... proved to be the case, the State was capable of adjusting in such a way as to come out of the ... of its problems provided it had a supply of funding, which came from the EU-IMF programme.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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And going back to your earlier comments, between fundings for the bank and funding for the State, I think when you were talking to Deputy Murphy, IMF funding would help the State to deal with its deficits and the European Central Bank was dealing with the bank liquidity issues. Given that the adjustment programme ... that the bailout programme actually brought was approximately addressing a €30 billion deficit, could the proposition be made that the Irish State was actually now insolvent and that's why the bailout programme was required and, therefore, the banks were not solvent at the time of that letter?

Mr. Kevin Cardiff:

You could make the proposition, Chairman, but I wouldn't see the point of it, I mean, in the sense that it doesn't have any special meaning. The fact was that the Irish State did access funding and, as it turns out, it was not insolvent, it was able to meet all its obligations and, therefore, the banks were not insolvent at the time. But it was not an unreasonable concern of the ECB to be coming to the Minister and sending him a letter saying, "Actually, look at what's going on. We are concerned about the solvency of the Irish banks, who owe us a lot of money and we're concerned, in part, because they are relying on your solvency and you owe the world a lot of money."

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. In your witness statement, when you were with us last, you comment on Jean-Claude Trichet's letter of 19 November 2010 to the late Minister for Finance and your comments were, "In many ways, this letter was entirely superfluous since it was already clear by the time of the letter that the Government was going to opt into a programme." Speaking on the same, related matter, Jean-Claude Trichet, when he appeared at the IIEA event in Kilmainham, said:

[As] you know, we could also have continued on our side after having gone up to 100% of GDP go to 200% of ... GDP, and why not 300% of GDP? And why not 300% of GDP? Then what would ... the Commission [of] inquiry [be] asking for [relating to this inquiry]. You would say, "Were you totally crazy at the ECB to continue when we going in the wall at 100 miles per hour to continue to provide liquidity and liquidity and liquidity?"

So, Mr. Cardiff, can I ask you, was Mr. Trichet right in this regard? If this action hadn't happened and the entry to the programme had been delayed, would the cost of the bailout have actually been bigger for Ireland?

Mr. Kevin Cardiff:

Well, I'd like to say this was wonderfully planned but remember what happened in 2011: things got a lot worse in sovereign markets before they got better. And had we waited until, say, March 2011 to get the programme, it might have had to be bigger, it might have been ... had conditions that were a lot stricter. It might have had ... it might not have worked, so the amount of moneys required at that point mightn't have been available. Because the programme started in the relative calm ... it didn't feel calm at the time, but the relative calm of November 2010, we had funding for all of 2011 and 2012 and we didn't need to rely on a market that was extraordinarily difficult and so, yes, in that sense, it was better to start earlier than later. Remember, in July 2011, the interest rate on two-year Irish money wasn't the 2% or the 1% or the 0% that you might find it at now, it was at 20%.

So, people wouldn't even give you money for a short ... for a relatively short term, unless getting that interest rate. That's how bad things were. By the end of 2011, November-ish probably ... but certainly by the end, that was down to 8%. We weathered the storm. That was the stormiest period and we were able to weather it much more happily, with much less problem than we would have had, had we not had the programme. But remember in that period ... I mean it would be interesting to talk to ... I haven't done it, but it would be interesting to talk to people about what's, what was going on inside the IMF and inside the ECB at the time, because I would bet you that they were starting to say it looks like we've done a really bad deal here, look at the way things are going, if it continues like this we'll never get our money back.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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So to return to the question again, and as you indicated there, the pension reserve fund, for instance, was indicating that current expenditure may be possibly maintained up to July 2011, that the cost of outgoings were in or around the level of expenditure that the pension reserve fund would be depleted by July of '11. But to come back to the question, was the entry into the programme in November, even though the costs were quite, quite significant, of a lesser cost if the programme had not been entered to at that time and had been delayed into, let's say, quarter one or quarter two of 2011?

Mr. Kevin Cardiff:

Well I think, I'm saying not only yes most likely - its hard to predict, retrospectively - but most likely it was cheaper that way. But let's be clear, you might not have been able to get a programme in March, or certainly in July of 2011.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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How so?

Mr. Kevin Cardiff:

Because the people who ... these are lenders.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Yes.

Mr. Kevin Cardiff:

They're judging the balance of advantage for themselves, as well as for us. And there was a genuine, I think, a genuine sense of solidarity behind it. It wasn't ... there was some altruism in it, it wasn't just a cynical decision. But the decision would have been ... would have been a more difficult one to make in March or in certainly in July of 2011 because things were much worse. You would have less chance of your loan, your very significant loan to Ireland, having the desired outcome at that point.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Cardiff. Senator Michael D'Arcy.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Thank you, Chairman. Mr. Cardiff, in your statement you said, "I said, in response to a direct question, that I thought the immediate nationalisation of Anglo, with guarantees as required for that institution, but only a strong political declaration in relation to support for the others, was a better option in my opinion." That was the answer that you gave. Who asked you that question?

Mr. Kevin Cardiff:

The Taoiseach was, I think from recollection, asking the room in general. My boss, David Doyle, turned to me and said, "What do you think?" And I was ... and I made my statement direct to the Taoiseach.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Was that question put to most people in the room or just some of the people in the room?

Mr. Kevin Cardiff:

Well, I think it was an open question for the room. I mean I can't recall exactly, Senator, but that's my recollection. But certainly it wasn't, I mean it wasn't put directly to me, it was put ... because my boss turned to me and said, "Kevin, what do you think?" So I had ... I was responding to somebody else's question if you like, or to a general question.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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It wasn't a single question to you, as a person who had perhaps the most knowledge within the Department of Finance?

Mr. Kevin Cardiff:

Well, I had been actively engaged in the discussion all night so it wasn't that this was, you know ... that suddenly, you know ... no one spoke to me all night and then they ask me one question. I'd been engaged in the discussion all night but that in ... I made that particular statement in response to Mr. Doyle's asking me to say what my view was.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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And could you offer some insight into why the people in the room were asked that question and why Brendan McDonagh and the NTMA were in the room next door and that question was never put to them?

Mr. Kevin Cardiff:

Well, I can ... the reason that the question was put was, I think obvious enough. The Taoiseach was about to ... was coming close, I suppose, at that stage at finalising his mind and other people were coming close to finalising their minds so I suppose it was a check on where we were around the room. As to whether, as to why Brendan was outside, well Brendan was outside because the people in the room ... the senior people in the room, didn't choose to bring him in.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Was William Beausang in the room and was he asked that question also?

Mr. Kevin Cardiff:

I think at that point he was not.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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He was not. Was the ... there was an e-mail between William Beausang and yourself. You ... the e-mail was shared to you from Brendan McDonagh, the question of the impact on the Irish sovereign, I think it was 26 September. Was that e-mail, was it-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Can you make a reference to that, Senator, please?

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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I don't have the reference but it was 26 September, Chairman, from Brendan McDonagh. The question went from William Beausang to Brendan McDonagh in relation to the impact on the sovereign of a full Government guarantee.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I think I actually have that, that's the e-mail document you're talking about?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
Link to this: Individually | In context | Oireachtas source

Yes, that's referenced I can get that up on the screen there for you.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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You got it, thanks.

Mr. Kevin Cardiff:

Yes, that's fine, I remember the document.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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You remember that one?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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You referred to this e-mail yourself in your testimony last week, Mr. Cardiff.

Mr. Kevin Cardiff:

What was happening was that we were preparing a set of options for the Government and the NTMA was being asked, from recollection, to give its view.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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And was ... were people in the room, given the information on the impact of the sovereign rating, that it would cost the State for a Government guarantee, via that e-mail in question, the view of the NTMA?

Mr. Kevin Cardiff:

Yes. People in the room were clear that this would cost ... this would potentially give rise to a damage to the sovereign credit rating. Yes.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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You're ... the Minister-----

Mr. Kevin Cardiff:

Sorry, but just to ... just remember, Senator, that night was not the first discussion.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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No, I'm aware of that.

Mr. Kevin Cardiff:

So it would have been aware.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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You're ... the ... on the same date, document DOF-01731, which is the Merrill Lynch strategic official document to the NTMA, on ... sorry ... this is William Beausang's-----

Mr. Kevin Cardiff:

I think I remember it anyway, go ahead.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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You've a good memory, Mr. Cardiff. The SLS scheme that was being considered, and it says, "a qualification from Merrill Lynch, Anglo had...". Can I ... I assume I can read this, Chairman? This isn't section 33AK protected? I don't think it is anyway.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Senator, I'd usually advise members to maybe just talk to legal beforehand.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Okay. Well, I didn't get a chance, sorry about that.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Let me see. What document are you talking about there-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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The Merrill Lynch strategic document to the NTMA, strategic options, 26 September 2008.

Mr. Kevin Cardiff:

It's also part of my statement so-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Yes it is, yes.

Mr. Kevin Cardiff:

-----so it should be-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Yes. Qualification, Mr. Cardiff:

Anglo has €3.3 bn of loans on the watchlist.

A 10% fall in commercial property value would result in an additional provision of €7 bn.

€23 bn liquidity deficit by the end of the year.

Additional €17 bn of liquidity expected to be lost once information becomes public.

Total €40 bn.

I mean, those are startling figures. How could the Minister for Finance subsequently - I know they didn't go down the route of SLS, but the numbers were so enormous - how could it be stated that this would be the cheapest option available to the Government at that stage?

Mr. Kevin Cardiff:

I never made that statement, and nor did I ever advise that it be made.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Do you know who advised the Minister to make that statement?

Mr. Kevin Cardiff:

He didn't always need advice.

Mr. Kevin Cardiff:

He didn't always need advice to make statements.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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But I assume he would have discussed it with senior officials, prior to the speech being made on the floor of the Dáil.

Mr. Kevin Cardiff:

I don't recall him asking me, certainly, can he say this is the cheapest ever. I don't want to say that absolutely ... without absolute certainty for fear I'll go back and discover a document where it said that he was advised to say that. But I doubt, to be honest, that he was advised to say it in those terms certainly.

Remember ... look, I don't know. I ... I ... it was a slightly strange comment.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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I don't want to be-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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If you don't know the origin of it, I wouldn't ask you to speculate on it, Mr. Cardiff.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Yes, no, that's ... no, that's ... no, that's fine, I just wanted to know was it discussed with senior officials.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, so two minutes there now, Senator.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Yes. Was there an understanding within the Department of Finance ... you said last week, Mr. Cardiff, that you didn't know ... I put it to you that you were the last man standing on the nationalisation of Anglo but that you didn't know that you were right. Was there an understanding that these decisions were going to cost the State tens of billions or billions?

Mr. Kevin Cardiff:

No. There was an understanding that they could be expensive and they could ... certainly there was an understanding that it could be in the billions but there was no understanding of the sheer scale of what came after.

Mr. Kevin Cardiff:

Well, did we think that there was a €64 billion bill that ... you know, up-front bill with some of that coming back? No.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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The decision to nationalise Anglo, could you discuss the measures and the associated timelines that were put in place to try to quantify the debt exposure to the State?

Mr. Kevin Cardiff:

Okay. Well, the ... the measures to quantify the exposure were twofold: there was the Pricewaterhouse work being done, with Merrill Lynch also working on them, and you have all the documents that are ... that-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Sorry, just to clarify that, Mr. Cardiff, the PwC ... that's Project Atlas?

Mr. Kevin Cardiff:

Yes.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Yes. Where PwC took the bank's valuations - they didn't source valuations for themselves?

Mr. Kevin Cardiff:

Well, that's true and yet not true because as soon as they had done that work, Jones Lang LaSalle were brought in to look at the valuations as well. I can't recall when they finished that work - probably after the nationalisation. But there was also a due diligence process which looked at the ... some of the legal aspects, some of the blown aspects and so forth of the bank, and that was a process that went on over ... mostly over the course of December and into January in ... of 2008 into 2009. But in the ... of its nature, a one-month exercise doesn't provide for you what, you know, the nine or ten-month NAMA exercise later provided, which is a loan-by-loan exposure.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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The Project Atlas and the PwC report ... in evidence, Peter Bacon said that he was conducting a report almost in conjunction with that and his evidence was that he felt there would be a €35 billion loss. Was that the first occasion anybody started talking in terms of tens of billions of euro loss for the banks?

Mr. Kevin Cardiff:

Well, there was no-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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And, sorry, your reaction ... I think my time is up. And your reaction to the first occasion people started talking in terms of tens of billions of euros loss?

Mr. Kevin Cardiff:

Well, I don't know what ... what Peter said because I didn't see his evidence but, as I recall, there were different scenarios in his report and ... including a ... scenarios where you, sort of, support the bank through a process and scenarios where you just let it ... let things collapse or let them fend for themselves in terms of managing these loans. And, as I recall, there were quite different numbers between the two different scenarios. So I don't know precisely which scenario he was talking about when he was talking to you.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Well, he said there would be a €35 billion impairment.

Mr. Kevin Cardiff:

Okay, well, I've no doubt that's correct. But, no, I mean, certainly it would have been around the time that the Pricewaterhouse-Jones Lang LaSalle work was concluding that we started talking about bigger amounts of capital. But, remember, the outcome of their discussions and of the initial thoughts on NAMA were not for anyone to say that, you know, there's a ... there's suddenly a €30 billion hole here. The outcome was that we were looking at a capitalisation of the two big banks that amounted to €7 billion, with a requirement for them also to raise capital. So for the two bigger banks, we're talking about €10 billion and then ... I forget what we were talking about for Anglo. We were saying ... I think by then Anglo was going to be put on a drip feed, so it was ... it was never going to get all of the capital it might want upfront. But even into the middle of that year, I don't think anyone was talking about €10 billion for Anglo.

The ... there were two things happening at once. First of all, with the NAMA process later in 2010, the loans were being exposed and their loan qualities were being exposed in a way that wasn't known before. But, at the same time, the economy was performing worse and worse and the property values within the economy were performing worse and worse. So there was a sort of a rolling worsening on almost all fronts of the situation, which hadn't happened. I mean, it got worse and worse so if you pick any time between September '08 and, you know, the middle of 2010 or into 2011 probably, you could find you'd have a different estimation of capital requirements based on what the particular position of the economy was at that moment.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Thank you very much. Senator Kieran O'Donnell. Sorry, my apologies, Deputy Kieran O'Donnell.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Welcome back, Mr. Cardiff. Could you elaborate ... on page 23 of your own statement where, speaking about NAMA, when Dr. Bacon and the NTMA presented a proposition they had been working on to the Minister for Finance, it came as something of a shock to the Minister and to the Department of Finance officials. Can you just elaborate on that - your views at the time?

Mr. Kevin Cardiff:

Yes. We had been working very closely with the NTMA all along but, I suppose, they had, over a course ... over the course of just a couple of days, they had finalised their view on what NAMA should look like and they were preparing to report on it to the Minister and, I think, just the morning before they reported on it to the Minister they reported on it to a small group of officials. The scale of ambition they had in mind was huge. The value of the property loans that they ... the book value of the property loans that they were intending to ... or suggesting would be taken from the banks was ... I think it was €140 billion or €150 billion, so a huge amount of additional Government paper would have to be issued to make that work.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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So they ended up taking half. How did it ... how did it come about to be the €77 billion that they took rather than €150 billion? Can you remember that?

Mr. Kevin Cardiff:

Well, I think, yes, it's quite clear. I think there was a discussion in which people, including the Secretary General and the Minister said:

Look, lads, that looks like it's more than the Exchequer will be able to bear. It will cause problems for the sovereign credit, and are you sure it's necessary?

And they said well ... they, sort of, seemed to have a fall-back position that came ... came readily to hand. So they clearly had given it some thought which was that we take a particular type of loan, the ones which are most likely to be stressed. That would probably achieve most of the benefit with less potential for knock-on effects for the sovereign.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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That would have been based on a 30% discount at the time. Am I correct in that, Mr. Cardiff?

Mr. Kevin Cardiff:

I forget what discount Bacon had but the-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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The draft was ... yes.

Mr. Kevin Cardiff:

But the NAMA business plan which came later was around 30%, yes.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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And the amount that the State ended up paying-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Phone interference.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Sorry. The ... my apologies. The amount that NAMA ended up paying, which was around €42 billion, which was nearly a 60% discount, was equivalent to 30% discount on €150 billion, was there any coincidence they ended up both being the same figure, more or less?

Mr. Kevin Cardiff:

Well, I think what NAMA ended up paying was probably closer to the €34 billion than €42 billion.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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They ended up paying ... sorry, they paid €32 billion, that was actually ... it was ... the discount was significantly higher.

Mr. Kevin Cardiff:

Yes, the discount was higher because as NAMA went through the exercise of valuing each loan, one by one, it was finding flaws, and, remember, if you are relying on collateral, most loans you never get to the point about worrying about the collateral in the normal course. People get the loan, they pay it back, that's fine. But if you get to the point where you're worrying about the collateral, then if there's any flaw in the legal documents, just as an example, you're loan is worth less.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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And that meeting that took place with the ... the NAMA proposal was considered at a meeting with a large attendance at which the Taoiseach presided. Who would've been at that meeting and were you asked for your own opinion on NAMA and what was your view on NAMA at the time?

Mr. Kevin Cardiff:

Oh, there was a very big attendance ... I may even have given you some notes, I'm not sure-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Was it the same as the night of the guarantee, Mr. Cardiff?

Mr. Kevin Cardiff:

Bigger. Different but bigger. I think there were people there from Merrill Lynch, there were people there from the NTMA, there were people there from the Central Bank, there was myself, there was the Secretary General of the Department, there was the Minister for Finance, the Taoiseach, the Governor ... so quite a large attendance. I remember the Taoiseach asked everybody, I think, to say whether they were in favour or against.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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And what was the Taoiseach's own view?

Mr. Kevin Cardiff:

Well, the Taoiseach ... in the end, the Minister brought it to Government and the Government decided in favour of it, so I'm sure he was in favour of it.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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And what was your own view on the night?

Mr. Kevin Cardiff:

I think that one might have been a day. My view was that NAMA had a good and strong prospect of improving the situation and, therefore, I was in favour of it-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Okay, and-----

Mr. Kevin Cardiff:

-----as was, incidentally, a number of people who later claimed they weren't.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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So you're saying everyone was in agreement on the night. And who would you be ... would you feel at liberty to indicate as to who ... people that were, for want of a term, sitting on both sides of the fence?

Mr. Kevin Cardiff:

Well, Dr. Somers of the NTMA later ... at committee, maybe you were there, I think it was a public accounts committee ... made a very negative assessment of NAMA. He didn't do so that day. In fact, he ... he said that he was in favour of it that day. And later, even after the appearance of the committee, he was back in favour of it. So I won't say that he was sitting on the fence, he was on both sides of the fence at different times.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Okay, and who else on the, on that day, Mr. Cardiff?

Mr. Kevin Cardiff:

Well, when I said a number of people I was covering for the fact that there was just one.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Just one. Okay. Can I take it that the fact that the original NAMA draft plan was based on a 30% discount, which would have been the ... the ... NAMA paying around €54 billion for €77 billion of gross loans and that ended up ... that NAMA paid over €20 billion less. So for €74 billion they ended up paying €32 billion, so, instead of a 30% discount, it was nearly 60%, so €20 billion less went into the banks and we had reports in 2010 were ... could one bank bring down a country? If those level of discounts hadn't arisen in NAMA, was it ... did it have an impact in bringing a banking crisis to a sovereign crisis and precipitate our, as a country, going into a bailout?

Mr. Kevin Cardiff:

If ... well, what you might have had is a different problem. Imagine we paid the full amount ... the ... the ... imagine there was a 30% discount instead of a 60% discount-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I'm talking about in terms of recapitalisation of the banks.

Mr. Kevin Cardiff:

I know. We would have had to put a lot less money into recapitalising the banks and if we had to put a lot less money into recapitalising the banks, in theory, that would have mean ... meant less need for external support. So that ... that's part of the equation. On the other side of the equation is that it would have become evident quite quickly because we would have been transparent about the valuations, unless we were hiding it - it would have been evident quite quickly that NAMA was sitting on a very large loss, which would sit immediately on the Government's balance sheet. So, instead of having the loss in one pocket of area where the State was supporting, you'd put it in another area where the State was supporting. So it would even out. The only way you could have ... it could have avoided a bailout, you know, precipitation or a worsening would be if we were ... if we had hidden this in some way.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I'm not saying that but the point-----

Mr. Kevin Cardiff:

I'm not saying you're saying that but it's happened in the past with other crises where there has been less transparency and, ten years on, banks find themselves back in-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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If the discounts hadn't happened at that level, would we have ended up going into a bailout at the time we went in, or would we have ended up going into a bailout at all at any time?

Mr. Kevin Cardiff:

If we were €20 billion to the good, let's say, if the NAMA values had genuinely been higher than the were, we would have ... we might just have skirted ... avoided a bailout but probably not. If you think of ... well, that assumes everything else would unroll in the same way but if everything else unrolled in the same way, we might have found that we would be in difficulty in 2011 rather than the end of 2010.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Chairman, can I just move on. In your statement, on page 26, you say, "Rightly or wrongly, there was a view that the ECB did not fight ‘fairly’ in all cases ... [what] they would ask for actions ... [to] a particular direction". Did the ECB and Mr. Trichet play fairly with Ireland, both in terms of the guarantee and the bailout? And did they have a ...I suppose, did they simply advise in terms of NAMA as well?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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That's your final question. Thank you very much, Deputy. Mr. Cardiff to reply.

Mr. Kevin Cardiff:

Well, in terms of NAMA, they didn't advise at all but they gave huge help. Remember, there were two things ... two almost prerequisites for NAMA to work. One was that it didn't immediately add, in an accounting sense, to the national debt - and that was that was managed by a ... we were very transparent about what we were doing but we created an extraordinarily artificial structure to keep it off the debt in which, you know, the entire NAMA structure sits on about a €20 billion investment from the private sector, it's an amazing ... it's a fiction. It's a real fiction, I mean, there's no credit problem but in terms of accounting, it's a fiction. And we were very transparent that we were doing this.

On the bailout, well, remember what I was talking about was negotiating tactics and in a negotiation there are tactics but, in the round, the ECB gave, at its risk, enormous amounts of capital ... of funding to Irish banks, without which Ireland, as an economy, would have had much greater difficulty. So ... and I think I brought attention to this ... what I think is the irony. The irony is that, at the same time as they were talking down their involvement with Ireland, they were in practice giving us much more. So, practically speaking, they gave us great help but, publicly speaking, they were a little bit reticent. So I ... I ... and that's what I'm trying so bring attention to. This is a public inquiry about bringing the facts to light. Some of the presentation of the ECB actions are not as transparent as they ought to be.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Cardiff. I just want to tidy up one matter, if you can deal with it promptly, and then we'll take a short break. In describing the principal reasons why the NAMA option was chosen over the only other realistic alternative of an insurance scheme, given especially the scale, complexity and relatively untested nature of the NAMA option - this relates to an engagement you had with Senator Barrett last week - could you maybe just explain why that option, the untested option which was the NAMA option, was ultimately the decision, against maybe some type of insurance scheme or some other model that could have been outlined?

Mr. Kevin Cardiff:

Well, the insurance scheme would also have been untested in an Irish circumstance. I mean, a bad bank/NAMA-type operation had been done in a number of different jurisdictions ... and they had always, you know, they had always proved ... always in the jurisdiction they were used in, they proved to have some effect. The asset protection scheme-type approach had been just started in the UK. The big difference ... about pros and cons, the big difference is that, with the NAMA approach you value every single loan and you know exactly what your exposure is but it takes a year to do it - big problem. The asset protection scheme, you take a punt up front on what the values are going to be. Now, as it happens, had we taken the punt up front, we'd have been very wrong.

That's a simple fact. The banks would've made a killing at our expense. We were afraid ... at the time, we were afraid that the asset protection scheme exposures were too unknowable - turned out we were right. But in the UK case, where they did much the same, they actually did okay out of it. So ... but they were different type of assets. It was probably one of those instances where you can claim wisdom after the fact. But we didn't ... we weren't sure, which was best, but we thought it was better to have a transparent, though slower, NAMA operation than an asset protection scheme operation. The other great advantage of the NAMA operation was that it meant that the ECB, very willingly, handed over billions and billions ... tens of billions of euro to Irish banks; the asset protection scheme wouldn't do that.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much. With that said, Mr. Cardiff, I now propose that we take a short recess. In doing so, I would like to just remind the witness that once he starts to give evidence to the committee, you should not confer with any other person other than his legal team in relation to his evidence and matters that are being discussed before this committee. With that in mind, and bear in mind that we still have a fair bit ground to cover with yourself, Mr. Cardiff, and we have Mr. Beausang here this afternoon, I'm proposing a ten-minute break that we would return at 1.30 p.m. Is that agreed? Thank you.

Sitting suspended at 1.21 p.m. and resumed at 1.37 p.m.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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So with members' agreement I now propose we go back into public session. Is that agreed? Agreed. And commence immediately with Deputy John Paul Phelan. Deputy, you've ten minutes.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Chairman. Good afternoon, Mr. Cardiff. Briefly, at the start, I want to ask you about NAMA, and, in particular, the effectiveness of NAMA now, I suppose, with ... in reference to what was envisaged before it was established, and, principally, in relation, if you could, maybe, give the main strength or weakness of NAMA in terms of its effectiveness. I also want to ask you in relation to NAMA, we've had evidence from them of interest roll-ups of up to ... of €9 billion on acquired loans, lending backed by paper collateral only, substantial issues relating to varying degrees of due diligence, and significant debtor borrowings across different institutions. And against that background, can you comment on the steps that were taken pre the establishment of NAMA to establish the true loan book positions of the covered institutions?

Mr. Kevin Cardiff:

Yes. Before NAMA was established, there was an interim board set up, and an interim chief executive, which was Mr. McDonagh. And as I recall it, because he would have been reporting to us at the time, he was in very intensive discussions with the banks even before NAMA was established to see ... to establish the facts about their loan books. So, in a sense, he's much better placed than I to say, and I'm recounting what he told me, but I know that he has afterwards said to Oireachtas committees that the information he got turned out to be incorrect, and in some ways very incorrect, quite a long way away ... quite a long way from the actual position. I don't know whether that was because the banks themselves didn't understand their situation or because what ... I don't know why. But certainly that's what NAMA found as it worked. It, sort of ... it emphasises the wisdom of acting on the basis of a loan-by-loan valuation for all the big loans, even though that loan-by-loan valuation did have the problem of delaying the whole process. It was a much slower way of acting.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I want to turn now to evidence that you gave last week in relation to minutes from Bank of lreland where they indicated that just two weeks after the guarantee, that they were exploring the issue of taxpayer capital injection. And you responded by saying, "Well, if they knew that two weeks later, then they were "bowsies", because they didn't tell us that." On the night of the guarantee, just for clarification, did anyone from the State side ask any of the institutions present about the likelihood of capital injection by the taxpayer, can you recall?

Mr. Kevin Cardiff:

I don't recall the specific question being asked, no. And also I just, bear in mind, I think the way the question was put was along the lines of that they really needed capital at that point, and the minutes you've sent to me talk a bit more about precautionary capital. Capital is ... in a sense, they're consistent with what I was saying last time, that at this point, there was a need for capital mostly based on changing market expectation, that they're already saying, even on 18 October, "Look, let's look at that." And also, you'll recall from ... I'm not sure if I said it last week ... but we and the official system started to focus on capital also almost immediately, probably around the 15th or so, I think, I sent an e-mail to people saying we have to now do an exercise about capital, and about whether nationalisations may be required, and so forth.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay.

Mr. Kevin Cardiff:

So, in that sense ... having said that, I think even now they may have been a little bit coy, at the very least, because it was some months later we were still discussing with them how much capital they needed. I don't think they were entirely upfront, let's say, about their own desires.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Yes, well I just wanted to put two quotes from the minutes from 13 October and, I think, 17 October, where the first quote from the Court of Bank of Ireland said: "Mr. O'Donovan also reported that he had a signal from a CBI executive who was attending the IMF that Bank of Ireland should approach Government for capital", and in the last paragraph of those minutes it said: "There was however, a general recognition, that it would be inappropriate to push the Government at that time, as the Exchequer budget was due to be announced the following day." And further on, then, on the 17th, Mr. Goggin, the chief executive, was quoted in the minutes. There was proposed a range of immediate actions that he sought endorsement from the Court of Bank of Ireland, including to explore a capital injection by the State; and that was 17 October. Again, I'd just like to ask you briefly for your reaction to that evidence? And seeing those minutes now, you used the word "coy", can you elaborate maybe a little bit more, particularly in light of the fact that Bank of Ireland, proportionately to other institutions, didn't receive as much of an injection subsequently? We haven't had any other evidence from other institutions that at that point in time, in their minutes at least, that they were aware of the need for a possible State injection.

Mr. Kevin Cardiff:

I haven't, since I saw this document only last night. I looked at what records I had, and there seems to have been a discussion with the Central Bank round about the 18th. I'm not sure of the date because, as I say, I haven't been able to check for sure, but in and around the same time as that board meeting was happening. And that discussion was probably the first, - it may have been, I don't know - the first discussion where the Central Bank, the regulator, was pressing on the banks to say what were their next plans. It seems from my notes of that conversation - I wasn't at that meeting but it was recounted back - that they were a little bit frustrated by the Bank of Ireland, who seemed to be saying they had less available, less to do. So, that together with the fact that even two months later, we were still having discussions with Bank of Ireland, and other banks, where we were saying, "Look, you know, what's going on? What are you doing? How can we raise capital for you?" And which they weren't averse to taking capital, but there was a sort of a toing and froing going on as to how much, and how-----

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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That was kind of at odds, or would you agree that that may be at odds with what is contained in these minutes, where they were specifically referencing a State injection?

Mr. Kevin Cardiff:

Well, I think, if they had been more upfront about that, we might have moved along a little bit quicker.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I want to turn now to your revelation, I suppose, this morning about a tentative approach that you made in 2008 to the IMF about a possible bailout. When in 2008 did it happen? Under whose direction were you seeking or making that particular approach, and was there a response?

Mr. Kevin Cardiff:

Now let's be clear, there was no approach to the IMF in 2008. No, I was just doing what a civil servant should, I was just saying to a colleague, "If something big was happening, if we needed some external support, what's the process? Can you do a little bit of desk research?" It was no more than that.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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It was on your own initiative, then, pretty much.

Mr. Kevin Cardiff:

Yes.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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You weren't operating under any direction from-----

Mr. Kevin Cardiff:

No, but there was no intent behind it, so there was no need to have anyone's imprimatur; it was just me trying to do my job.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay. Then I also want to turn to your comments about communications with Mr. Strauss-Kahn in relation to the burning of bondholders. You say that you received an e-mail from IMF staff members suggesting that he was positive on the matter. Has that e-mail been made public?

Mr. Kevin Cardiff:

Unless you've made it public, I haven't.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay.

Mr. Kevin Cardiff:

But, in fact, that's not quite what I said. There was an e-mail from the IMF to us, saying that they understood he had an indication that Geithner would be positive. So it was only about one of the members of the potential phone call, let's say.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Okay.

Mr. Kevin Cardiff:

And that would have been, I think, 25 October 2010.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Finally, can I ask you, in light of what has transpired since, and in public comment by commentators, politicians, whoever else, do you feel yourself that you have been scapegoated for some of the decisions around the guarantee, the capital injections by the taxpayers into the banks, and the subsequent entrance into a bailout?

Mr. Kevin Cardiff:

Well, the country's been through an awful thing, so whether I personally have been attacked is not really that important for the country. It has some importance for me personally, or for my family, but it's ... I mean I don't think it's all that important from your point of view as an inquiry. I would say that, probably some things, you know, some criticism is valid and some is so far off the mark as to be laughable. Personally, I only take offence when the criticism seems to be deliberately untrue.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much, Deputy Phelan. Deputy Joe Higgins.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Thank you. Mr. Cardiff, at the end of 2008, PricewaterhouseCooper's loan bank analysis of the core banks showed 22 borrowers had total loans of €29.4 billion, and, in 2010, in the total debt of €74 billion taken in by NAMA, 29 borrowers accounted for €38 billion. Can I ask you if the Department of Finance tracked, through 2009, for example, the situation vis-á-visthe banks, these developers and NAMA, to guard against moral hazard, to safeguard the interests of the taxpayer, and to make sure that no one was taking extra advantage?

Mr. Kevin Cardiff:

I don't think we tracked them directly, no, but we did spend a great deal of effort in the NAMA legislation to make sure that it would be proof against that kind of thing. If you look at the NAMA legislation, for example, there are even lobbying offences, I think unheard of before in Ireland, where a person other than an agent of a borrower may not lobby on their behalf. I think that even if ... and if they do, NAMA is legally obliged to report the matter to the guards, or it is committing an offence. There's all sorts of provisions and so forth in there about confidentiality, about ensuring that the State's position is protected. There are even provisions in there about ... we had a concern about ransom strips, in other words that if a borrower had control of both a building and a piece of land outside the building, that he wouldn't be able to manipulate the control of the piece of land outside the building to the, to manipulate also the value of the underlying asset.

There were planning provisions and so forth to make sure we could ... that NAMA could get access, could complete its business. So, there was a huge effort in the NAMA legislation to try to anticipate what kind of tactics could a reluctant borrower engage in and to address each one of those as much as we could in legislation. So, a very big effort there and then in relation to the institutions themselves, well, I mean Anglo had been nationalised, new board, new management and they were expected to manage in the best interests of the bank, not in the best interests of any borrower. And in 2010 then ... beginning of 2010, the NTMA was given a ... had a form of roll up to them but it was given the job of being the Minister's ... acting for the Minister in negotiations with the various institutions and to ensure that there was a professionalisation, let's say, of the relationship management with the institutions and at that stage then, new chief executive in NTMA and so forth, they were able to bring in a new approach, a new set of staffing to deal with that. So there was a pretty intensive effort to make sure that ... that things were being looked after more or less right but it still, and still I imagine even now, relies hugely on the managements of individual institutions to ... to do their job. NAMA was a bit different. NAMA, sort of, progressed from a point of not really trusting because we were taking all these loans on to the State's balance sheet. So, there's a lot of anticipated cynicism in the NAMA legislation that probably doesn't ... didn't exist in Irish law before.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Mr. Cardiff, just slightly along the same lines, when recapitalisation of the banks became seen to be inevitable by the Department and the system, was there confidence or was there scepticism within the Department on the veracity of the data shown by the banks themselves to allow you to gauge how much recapitalisation would be necessary?

Mr. Kevin Cardiff:

It wasn't a negotiation that was entirely pleasant. It wasn't, a sort of a sense of "Let's all sit around and have a cup of tea and make this work, lads." It was ... the negotiations were quite combative so in that sense, I suppose, we weren't taking too much for granted. But in the end, the banks had the advantage in having access to the information much more closely than we did.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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This is a point, is it that ... I mean, more and more recapitalisation became a factor as a year or two or three went on, so was it the case that the banks didn't give full disclosure at the beginning of the process?

Mr. Kevin Cardiff:

I ... what I remember, the situation got worse which undermined their book but you don't ... in a negotiation like that, you don't often get the ... it's like playing poker with someone and they don't necessarily turn over their cards at the end to let you know whether you've ... whether it was a bluff or not. So, in fact, this is the forum for turning over the cards, if you like. This is where we'll find out but ... but, no, and through the period we never ... never could be 100% sure.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Mr. Cardiff, can I turn and revisit, as briefly and as concretely as possible, the issue of the solvency of the Irish Nationwide Building Society on the night of the guarantee? Now, last week we looked at a meeting on 7 September of the regulator and the banks where AIB and Bank of Ireland said, "INBS was insolvent". We don't need to go over that again. But, I wish to look in the evidence at two instances which I would put to you would say that clearly INBS was insolvent. So, if we take Doyle, first of all, because this not in your core documents, Mr. Cardiff, but Doyle, Vol. 1, page 163, which is the Goldman Sachs analysis and you are probably familiar with this, anyway, Mr. Cardiff. But, page 163, total loan book of €11.7 billion, then mark-to-market the best mark of 67 ... 69.1%, worst mark 40%. So, giving a situation where a potential loss from €3.6 billion to €7 billion, which is quite a spread, no question about it, and in page 152 of the same document, total regulatory capital of INBS is put down as €1.8 billion. So, on that basis, INBS is clearly insolvent. If I can move forward quickly then-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Rather than going into the judgments on the company, if you could maybe just throw the question at Mr. Cardiff, please, Deputy Higgins. Go on, I'll let you continue but just be mindful of making any narrative on it, okay. Just state the facts.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Just on the face of the figures ... the figures we hope don't lie. Going forward to your own core document, Vol. 2, page 54, Mr. Cardiff, and this is the presentation by Merrill Lynch to the National Treasury Management Agency on 26 September and the top right-hand corner of page 54, "INBS has €11.7 bn of loans ... Writedowns of 30% - 60% results in an impairment of €3.6 bn - €7 bn", which is more or less exactly what Goldman Sachs said and remembering that regulatory capital is €1.8 billion. On the face of those figures, was INBS insolvent?

Mr. Kevin Cardiff:

Well, I have slightly the advantage of you, Deputy, because I was also talking to the Goldman Sachs people at the time and I know what they were saying as their sort of general view. First of all, if you mark-to-market ... remember, a bank typically earns ... I don't know, a few per cent on a loan. In fact, it earns the difference between the few per cent they pay to the depositor and the few extra per cent that it gets on the loan. So, it's working on a return of, you know, a net return of a margin of a couple of per cent on any given loan. Now, if you take that loan and you sell it into the market, which is what a mark-to-market approach would do, then you're selling it to people who are looking for a return of maybe 10% or 12% or 15%. So, the market value of that loan will be ... could be quite heavily discounted relative to what the value it would be on the bank's books and the banks assume, generally speaking, unless things have changed very radically, they assume that over time, they will hold that loan over time and they will get the full payment in the end less whatever provision they might make for the likelihood of a default and the amount they get on default. So, the mark-to-market value would be quite different from the going concern value for a bank that is in ongoing mode. Now, at the end of, you know, in the week before 29 September 2008 just to be clear, we spoke to Goldman Sachs and they were saying, "Well, look actually the loan book may be not quite so bad as we had initially thought it might be and that, in fact, over time, they might just trade through all this, they could trade through all this without actually burning through all their capital, assuming they are allowed to trade through." That was the difference in the assumption, I suppose, assuming allowed to trade through, they were saying, "Not, on that basis, insolvent."

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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A very short supplementary, now, Deputy. A very short supplementary.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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But, Mr. Cardiff, on 26 September, on the most benign scenarios put forward by both Goldman Sachs and Merrill Lynch, INBS, on the face of it, was it not insolvent? And, when you came in front of the public accounts committee, Mr. Cardiff, why was that information in relation to the NTMA presentation redacted? I haven't time to show it on the screen but you will remember, perhaps, it was redacted ... the information I've just given here. And, secondly, and because I have to wrap up my-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Quickly now, Deputy. Come on, quickly, quickly.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Let me just ask the last question because otherwise I'll be cut off.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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You will indeed.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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And then this presentation on 26 September was to the NTMA, which wasn't consulted on the night of the guarantee, in relation to the state of INBS and, indeed, Anglo. Was somebody or some bodies working to hide the insolvency of any institution on that night?

Mr. Kevin Cardiff:

It's a fair question. The answer is no. Nobody that I was aware of was working to hide anything. We wanted the best decision that we could get. Secondly, nobody ... there was no evidence to suggest that INBS was insolvent at that moment. But, certainly, if it had to sell all of its loans straight away or if market conditions deteriorated over time, they would start to burn through their .. first of all, through the whatever profit they were earning, then through their capital and then could eventually fall into a negative capital position. So they were likely at some stage to need capital. Why was the document redacted? It was redacted probably on my judgment for legal reasons or for commercially-sensitive reasons ...sensitivity reasons. But to be clear, Deputy, I spent two hours I believe it was in July 2010 in private session at the public accounts committee - the previous version of it - and we went through the records and I explained why things had been redacted. I explained the philosophy or the approach I had taken to all the redactions. I explained, even, probably going beyond where I should about what was redacted for legal reasons ... or for legal privilege reasons and so forth. So it wasn't that the public accounts committee was given this set of documents and no explanation for redactions. They got explanations for the redactions. But in the end, I had to make a judgment. You might just remember ... well, you won't remember, Deputy, but initially, the public accounts committee asked me for a document ... a single document. I gave a lot more than that because I didn't think they could get a perspective without that. But I had to ... in the light of my job, in the light of the legal position, in the light of the market position, I had to make quite a few redactions which I tried to explain.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much. Deputy Pearse Doherty. Deputy, ten minutes.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Go raibh maith agat, a Chathaoirligh, agus fáilte arís, Can I ask you why, in your view, was bank recapitalisation progressed on a phased basis, given that the original intention was for a recapitalisation programme of up to €10 billion only?

Mr. Kevin Cardiff:

Because we went in cheap, Deputy. It would have been very expensive to give them a lot more capital than they clearly needed up front and people didn't want to give them that luxury. Remember-----

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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So did you ... when you say than ... give them more than they clearly needed? So at that time, were you aware that they needed more capital than the €10 billion?

Mr. Kevin Cardiff:

No. The €10 billion was to ... we knew that they might, later, because if the market keeps going in the direction it was going, then that could be ... could be the point you would get to. Remember, Deputy, if ... for example, we wanted them to contribute to their own recapitalisation, we wanted them to sell assets, we wanted them to look at their profit centres, we wanted them to reduce their costs. So if you give them more than they need-----

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Yes-----

Mr. Kevin Cardiff:

-----you give them an incentive not to do any of that.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Well, that takes me onto my second question. Can you tell us about the level of co-operation by both AIB and Bank of Ireland at the time of the ... capital-raising options, including asset sales, that you mentioned and, in particular, whether the level of co-operation may have contributed to the amount of capital ultimately required by both institutions?

Mr. Kevin Cardiff:

I don't know if it made much difference to the end number, Deputy, but we didn't ... AIB, in particular, was very slow on its asset disposals. They really, really liked their Polish subsidiary and they didn't want to sell it. Actually, it was probably a much better bank, as it turns out, than the head office was, so that's understandable - other subsidiaries too. So they ... we thought ... but, again, this is ... as I said, you don't know until the very end, until someone turns over the cards, you don't know exactly what cards people were playing. But we thought that they were going much too slow on that. I recall a quite tough conversation in which AIB said, ''Look, you've always been [I've always been] negative on the Polish subsidiary'', and I said, ''No, I think the Polish subsidiary is great. The problem is I'm negative on AIB and you need to sell the Polish subsidiary to support AIB''. It was the jewel in the crown, naturally they didn't want to get rid of it. But there were other subsidiaries too, other asset disposals they could do. In ... in Bank of Ireland, at least they thought ... they started thinking quite quickly about their UK mortgage book. I mean, it's evident, from that document you just gave me last night, they were at least thinking "Well, here we have this mortgage book if we could sell that we would ... that would generate capital also". So we had a sense that the co-operation could have been better. We pushed, eventually it happened. Had we been able ... had we had the advantage of time, that Polish asset could probably have been sold three days - two or three years later for a good deal more. But we didn't have that advantage.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Okay, can I ask you ... just I'm just referring to your core booklet, Vol. 3, and it's page 146, and this is the document from the NTMA on the 28 March 2011. It's the document that recommends the burning of bondholders - senior bondholders - in all of the six institutions to the Government at that time. I think the eligible senior debt they estimate across the six banks was €16.367 billion that was up for burning. It goes on to say:

[Given that] fact that the markets are expecting and have priced in burden sharing with subordinate and senior debt,

it is the recommendation of the NTMA that, subject to a view being taken by Government on the potential implications of an adverse reaction from the external authorities and the implementation of an appropriate legal framework, immediate steps should be taken following the announcement of the PCAR/PLAR results to enable burden sharing with both senior and subordinated debt.

Can I ask you a particular question? Given that the NTMA is responsible for ensuring the country stays in the market and that our funding under the programme would have been exhausted at the end of 2013 and a requirement on us to be back in the markets by mid-2013 ... in your view, how was the NTMA recommending burning senior bondholders while at the same time knowing that they would have to be back in the markets within two years?

Mr. Kevin Cardiff:

Actually, it might have been three ... two and a half. And the reason for that is that you know the Johnny Logan song "What's Another Year?", well, we had a thing called the Johnny Logan working group, which was to find from our own resources an extra year of funding and we actually found that we could probably generate quite a little ... quite a lot. Maybe not a full year of funding, but we could find ways to extend the funding of the State beyond the end of ... of 2013. Now, that was important because, even in 2011, people were starting to say well how are they going to be able to fund in 2014? The answer is we were already working on that. It ... it started you know, we had plans, we would have been able to ... we would have been able to extend the moneys we were getting from the programme. That's ... that's ... so ... so we weren't quite so ... quite so pressed as you might suggest. But okay, so there ... a few months at least of extra funding was potentially available.

Now, why would the NTMA suggest this? Well, the ... the suggestion was that if we could reduce our debt by a few billion arising from this exercise - in other words give less capital to banks, reduce debt a little bit - that would improve our overall situation in such a way as to make us a little bit more of a ... a good bet for the market in terms of giving us money. The downside was that if you want to continue to get funds from your funding partners, then they had to be on board. And, in the final analysis, I think the Government's view was that actually, they should certainly or would be anxious to burn the senior bondholders in the banks that are not going to survive.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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At that time, now, the Minister was talking about Anglo and Nationwide, but the NTMA recommendation was across all six banks. And my particular question was that the NTMA were supporting the burning of senior bondholders while at the same time being of the view that they would be able to access money from the ... the international money markets within a number of years. That the case wasn't that we'd be shut out for a period for an extended period. Would that be a true reflection of what the NTMA were arguing at the time?

Mr. Kevin Cardiff:

Well, the whole undermining ... the whole underlining philosophy of a ... underlying philosophy of the ... the programme was that you would be able to get back in the market. It was a stopgap arrangement, it wasn't a ... a permanent arrangement. So I don't think there is any ... any conflict between those two positions.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Can I ask you, in your statement you say, on page 90, in relation to the Government's proposal to the troika, you say:

As we expected, the Troika were not dissatisfied with the Plan – in some ways it was more ambitious than they might have expected in regard to structural reform. Of course there remained differences arising from differences in the economic forecasts, but the basic thrust was generally acceptable to them.

Can you clarify that to ... for the committee that the memorandum of understanding that was drawn up between the troika and the Government, it was based mainly on Irish Government proposals?

Mr. Kevin Cardiff:

Yes, well, the ... if you exclude the banking sector adjustments, the EU-IMF programme documents are not that different from the national recovery plan that was produced by the Government in, I think it was around ... the Government meetings were around or about 18 or 19 November 2010, so the document would have been produced the following week, maybe the 21st or thereabouts.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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So it was mainly made up of Irish Government, with ... excluding the banking part of it?

Mr. Kevin Cardiff:

Yes, I can remember it was quite a ... as people, including maybe some of the people in the room, said, it was quite a challenging set of actions, none of them very pleasant. But it was more or less what the Irish Government had decided was the appropriate set of measures, yes.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Okay. Mr. Cardiff, in your statement, on page 2008 or 208 - 2008, Freudian slip there - 208 you say, "I had spoken to the Minister during the summer [this is the summer of 2010] about the necessity to make greater upfront fiscal adjustments for 2011, and to announce them early." You go on to say that at a gathering of senior civil servants in September or early October you outlined the issues and "demanded their active participation in the adjustment processes that would be required." Is this the "be a hero speech" that you're referring to in terms of your address to the civil servants that is referenced in the documents that you attached?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Final question, Deputy. Thank you.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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If I can ask - if that is the final question - at the end of that speech Mr. Cardiff, you ask those, to be a hero, you ask them ... you say, "We have a crisis, get into it, fight for change, fight for savings, fight to deliver more services with less money, get radical, think the unthinkable." And then you pose a question where you say "in four years' time we'll look back and we'll ask ourselves what type of character we were in a crisis, be a hero". It is five year's time since that speech was delivered. Mr. Cardiff, the question I have to you is were you a hero during that period? And is that ... is the actions of these heroes what the Irish public expected in budget 2011 when you were asking them to think the unthinkable, which included cuts to child benefit, to social welfare, the introduction of USC, cuts to the carers' allowance, disability cuts, cuts to the blind, cuts to the minimum wage? Was that the type of heroic actions that the Irish public expected from their heroes?

Mr. Kevin Cardiff:

It's a fiercely one-sided presentation of it, Deputy. If you read what I said, I said get into it, deliver the best services you can, with less money, because we had less money, there was no choice about that. We had less money. We had two possibilities at that point; either the country could go bankrupt ... three possibilities ... either the people would continue to lend to us, in which case we could continue to provide services, but nobody would lend to us based on the level of fiscal adjustment that had been planned up to the middle of that year. There had to be more or we would have no lenders ... no market lenders.

The second possibility was that we would have to seek assistance from the EU and IMF, and it was fairly clear at that point that they also would require very substantial fiscal adjustments, therefore, we would have no choice there. And the third possibility was that we would cease to be able to fund ourselves at all, in which case our fiscal adjustment would have had to be, instead of being of the order of 4% or 5% of GDP, it would have to have been of the order of the entire scale of our deficit, which in 2011, even without the adjustment, was around about 10% of GDP. So, that would have meant cuts and tax increases of €16 billion, even before we'd taken account of the negative buoyancy effect, so even more.

We, you know ... look, I also said in that speech that at that time our ... the scale of our deficit was about the budget, I think, of the education and health sector combined. That's what we had to find. Without fiscal adjustment, without cuts that really hurt people, we would have had to do an awful lot more. And even if it was a dreadful situation for us to find ourselves in, it was a situation in which people a whole lot more vulnerable than the people making the decisions would suffer, but the alternative was a decision ... was a non-decision approach where we would let worse things happen. So that's what I was saying and when I was telling people to fight, I meant it. They had to get out there and find ... I mean if we were going to have that much less money, I wanted people to be out there finding the ... fighting to improve the services, to do the best they could for their citizens within that. I don't think that's wrong.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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But the ... sorry, the direct question, because Mr. Cardiff you introduced the quote-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I'm not going to open up a new line now.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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No, it's not a new line. Mr. Cardiff, you introduced this to the committee, your speech, your "be a hero" speech and you posed the question yourself, "In four years' time we'll look back and we'll ask ourselves what type of character we were in the crisis, be a hero." The question I asked you is looking back - it's now five years on - do you classify that your actions were heroic?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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We'll take Mr. Cardiff, and then I'm going on to Senator O'Keeffe.

Mr. Kevin Cardiff:

I had the advantage, Deputy, that I didn't get sick in the middle of this. I didn't fall over, I didn't have the problems that many of the people who were working on this ... on these crisis things did. There were real heroes, people who worked through illness, worked through stress, worked through family difficulties, who really kept going. So I'm not classifying myself with them, but there were real heroes, there were people who ... there were real sufferers but there were real heroes and I saw them. I saw people, you know, in about 2010 I had a series of transfers in the Department in 2011, some of them were just purely because the people concerned were at the end of their physical endurance. So ... and there were the same in other Departments too and the same even in banks, you know, because they had to be rescued and they had to saved too, so I mean, I saw heroes. I'm not going to start naming them, and I'm not saying I was one, but I did see them, they were there.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you. Senator Susan O'Keeffe.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Thanks, Chair. Mr. Cardiff, why was there not a merger of ILP, INBS and EBS as a joint building society? It was one of the options that was considered. Why did it not happen?

Mr. Kevin Cardiff:

There was a lot of merger options considered and the real problem, Senator, was that no one of them was really sound enough to take the others on. You see, what you hope when you do a merger is if you take, say, a bank that's reasonably well capitalised but is short on funding, and you put it into a bank that has plenty of funding but may need the capital, you have a synergy there that really works, but there didn't seem to be a strong enough case for doing that, especially since you would lose time and effort in the merger arrangements. There was a significant ... I think the most likely merger that didn't happen, if you like, was between ILP and EBS, in part because EBS had access ... EBS had a set-up of what they call a covered bond bank, so it had a mode of funding which ILP did not have, and ILP had a very high loan-to-deposit ratio and this might have helped. But, to be honest, as things went on, it seemed clear that first of all EBS's loan-to-deposit ratio itself wasn't so healthy and it was not big enough to create a big difference for ILP and even covered bonds, in other words secured bonds, were getting hard to issue, so at that stage, I think people just said, "Well, look, there's not much more to pursue here." So it ... it mostly was because there were no marriages of institutions that looked like it would make a stronger couple than they were as individuals.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Did the troika have a particular view or were they taking the advice, the knowledge on the ground, or were they saying, "There has to be something ..."?

Mr. Kevin Cardiff:

Later on there was a few different views from the troika and they weren't actually at one on all of this. But you saw the impact of what they were saying ... saying that we put EBS into AIB-----

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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And that was their viewpoint was it?

Mr. Kevin Cardiff:

Yes, that was, in part, their viewpoint at least. The idea was to deleverage the sector and to have a couple of pillar banks.

The place where there is the most disagreement, if you like, was on ILP, where some parts of the troika wanted to wind it up on the basis that, look, it was hanging out there and it was a bit vulnerable, and, you know, let's be a bit macho now and just close it down. And others were saying, well, like ... for example, the competition people in the European Commission were saying, "But hang on now, we're here, we're supposed to protect competition, and if you do that you only have two banks in ... each with a huge retail franchise in Ireland, so let's keep it going." And we were towards that side. But since ... since ... so we didn't have to fight too hard since they were fighting with each other on that particular point, so ILP survived in part, despite the advice of some parts of the troika, and ... even in the ... because I was interviewed recently by the IMF evaluators, evaluating their own programme, and they were ... this was one of the points they were focusing on. Shouldn't we really have got rid of ILP? So those kinds of discussions did happen, yes.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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If the bailout had been agreed earlier than it was, would there ... would it have reduced the burden on taxpayers ultimately? Would it have been wiser to go earlier?

Mr. Kevin Cardiff:

It's certainly an arguable case, Senator. If you knew that interest rates would be 3% or 4% as opposed to at 6%, then you might have been much more tempted earlier. If you remember, we went in at about the 6% interest rate and then they were negotiated down, and then the Greek thing came along and that helped even more. So, the first discussions ... I mean, they're quite early, but there were discussions on reducing the interest rate even in the spring of 2011, so very soon after the start we were back saying, "Look, you should think about this." And actually, I remember, in March 2011, Minister Noonan's first contact with Mr. Rehn. Mr. Rehn was quite positive. He was saying, "Yes, well, let's see if we can get you a reduced interest rate." But we didn't know that up front. We assumed we could do some negotiation on it, but if he knew he had a 4% interest rate when the Government was being charged 6% or 7% in the market, you might have ... it would have changed the calculus a little bit. We might have been more tempted to go in earlier, yes.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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When Mr. Honohan made the phone call to RTE that morning, you said earlier that if you'd had even an hour ... I think you said "If I'd had more than an hour's notice ...". Did you have any notice, is the question? Did you know he was going to do that?

Mr. Kevin Cardiff:

I don't recall getting any notice.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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No notice, okay. Now, he will give evidence to say that part of the reason he made the phone call on that day was that the previous day had seen an outflow of €900 million of retail deposits, by far the largest daily figure before or since. Do you remember that figure and do you remember whether there was concern about that figure or that whole question?

Mr. Kevin Cardiff:

There was certainly concern that whole month about the pace of outflows, which was high. I don't remember that ... €900 million retail is a very specific number, but I knew ... I would have almost certainly have been hearing the total number, if not the retail number, and it was very large.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Mr. Beausang will give in evidence today that his e-mail records show that at 21:11, he's very precise about that, so that's 11 minutes past nine, and I'm going back to the night of the guarantee now ... switch your head ... he received a document intended to be a draft Government press release announcing the introduction of a guarantee for the domestic banks:

It appears to have been authored earlier in the evening in the Central Bank in advance of the commencement of the meeting in Government Buildings. My electronic files show ... I was subsequently involved over the next twenty minutes or so in preparing a revised draft of the statement which set out its intended scope.

I wonder if you can explain to us why there was, in existence, at such an early stage, a press release that said a guarantee has been agreed, when in fact people were still in ... still with the Taoiseach, having the conversation about whether there would be a guarantee.

Mr. Kevin Cardiff:

Well, the straight answer is I can't, Senator. I had nothing to do with that at the time, so I just don't know. I can only speculate, and the speculation would be that ... two possibilities, either the Central Bank had in mind, before the meeting started, the possibility that there would be a guarantee, or else they communicated in the course of the meeting, but I simply don't know.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Their press releases, the drafts, which Mr. Beausang has actually provided to us, are quite similar to the eventual draft, so, you know, I mean, there are some changes, but they're very similar. So, you never saw those drafts, is that ... am I correct in understanding that - the drafts that Mr. Beausang has provided?

Mr. Kevin Cardiff:

I don't want to be as specific as that but I have no recollection at all of having seen those drafts. But Mr. Beausang was there, so he could have been guiding the drafting with me. I mean, when I was passing drafts back and forth, he might well have been involved, so.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Yes, I suppose I'm just curious as to know why they were so early in the day. Now, in that original draft it said the Government guarantee will remain in place initially for six months. Obviously, that's not what materialised at the end. Do you recall whether there was an agreement or a suggestion of a six-month guarantee, and at what point it might have changed to a two-year guarantee, which was what was in the final statement?

Mr. Kevin Cardiff:

I think, Senator ... do you mind if I just check ... I'll check a note for a second, because I think I might be able to answer that.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Sure. I'm just mindful, as well, that you may not have seen Mr. Beausang's-----

Mr. Kevin Cardiff:

No, I haven't, but, no harm in that. Bummer, I'm afraid I can't find it, Deputy. I have a vague recollection of the ... of six months being mooted during the course of the evening, and then people saying well, you know, what's gonna change in the six months, you know, so it needs to be longer, but I can't recall and it's not in my notes, apologies.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Do you recall whether you might have had a personal view about six months or two years or-----

Mr. Kevin Cardiff:

I don't recall, except it seems ... it would have seemed pretty optimistic, let's say, for the world to change so much in six months that that would be an adequate time period.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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I have two short questions. The night of the guarantee, was that the first, if you like, big meeting that took place with the Taoiseach, in that way?

Mr. Kevin Cardiff:

No. No, there----

Mr. Kevin Cardiff:

There'd been at least one and, maybe, two beforehand, probably two.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Okay. And was there ... there has been suggestions made that there was a tacit understanding that nationalisation of Anglo could follow the following weekend, and various suggestions were made that that then didn't happen because the guarantee appeared to work, for want of a better word. Was ... is that your memory or is that a complete fabrication?

Mr. Kevin Cardiff:

No, it's ... I don't think it's ... my memory is not exactly like that but it's not a complete fabrication at all. Remember, we didn't know that night that the guarantee would work, so, almost immediately one would ... one would have been thinking, what's next? What's the next thing? And if you look, even at my notes, there's a suggestion. Mr. Doyle asked the Taoiseach, you know, what about such and such a measure, I think swaps, and the Taoiseach says,"Yes, get that prepared", and then he says, "And what about [you know] NPRF?", in other words, getting the ... throwing more public money into them, and the Taoiseach said something like, you know, "Prepare it but don't do it yet." So there was a sense that this was the thing we were doing tomorrow, but it mightn't be the last thing.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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And finally, can I-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Final supplementary very briefly now, Senator.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Finally ... yes ... you ... you wrote an e-mail on the 15 October 2008, which was only two weeks afterwards, in which you actually talked about what recapitalisation might be required, what consolidations might be required, and whether any nationalisation might be required. You wrote that to Patrick Neary and John Hurley, and people like that. You say it's not Government policy, you're just brain-storming, but it seems ... it was soon after that night that you were asking questions, particularly about recapitalisation. So, what was the result of this e-mail?

Mr. Kevin Cardiff:

Well, what I was trying to do was refocus. We had focus on the guarantee. There was a great deal of technical work to be done in a very short time, but I didn't think that was going to be the last intervention measure by a long shot. It was clear that we had to be ready for other things, and so I was saying, "Okay, guys, clear your heads a little bit, the guarantee is now moving along, continue that work, but we have to start thinking about the other options and the other things."

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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It's clear to everyone, not just you-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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We're moving on, Senator, I have to move on, I'll give you ... I'll give you-----

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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No, that's it. I just want to make sure it wasn't just clear to Mr. Cardiff.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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No, please. You're pulling on time, now, please. I'm moving on.

Can I move on to Deputy Michael McGrath, please?

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Thank you very much, Chair. You are very welcome, Mr. Cardiff. Can I just ask you about the Financial Regulator, when you were asked on the last occasion here who the regulator was accountable to, you said the regulator was accountable to the Oireachtas. Can I ask you to clarify who the regulator would be operationally accountable to, would it be the board?

Mr. Kevin Cardiff:

Its own authority. The authority, it was called at the time. To be clear, the regulator, people tended to talk about an individual but actually the regulator was the whole authority but the management were responsible to the authority and the authority had its accountability, being independent, to the Oireachtas. But the Minister was entitled legally to ask for information at any time more or less and also they had to clear their budget with the Minister, which never was a problem.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Can I take you to the letter from Jean-Claude Trichet on 19 November 2010 and you express some surprise in your composite statement as to why that letter was sent because the ECB was very much involved in the preliminary discussions with the Irish Government on the possible scope of a programme and so forth. So why do you think that letter was sent and why do you think the threat, for want of a better phrase, on possibly withdrawing the ELA support for the banks, why was that so explicit and why did the letter have to be sent, if all of this was in train anyway?

Mr. Kevin Cardiff:

As a rough guess, I would say, and it is only a guess, I am only trying to read peoples' minds but, at a guess, I'd say that they probably decided on the Thursday, which was their council meeting, that this letter would be sent and the decision had been made. The person who sent it probably decided he'd send it anyway.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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He had been getting a bit frustrated at governing council level that the expectation that Ireland would enter a programme hadn't materialised quickly enough for them.

Mr. Kevin Cardiff:

Let's be clear, they were afraid that first of all the Irish banking system, then the Irish Government and then the rest of the eurozone was going to be pulled down the tubes. You know, like one of those little ... when you throw a weight with a string on the end of it over an edge, you know, it falls but everything attached to it falls too with increasing momentum, so they were afraid of the contagion effect of Irish difficulties on, first of all, Portugal but then on others.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Can I ask you, Mr. Cardiff, notwithstanding what you have said about the Deauville declaration, for example, in October 2010, the reports that were coming out of the G20 in Korea, the possibility that there was briefings going on against Ireland, had it become inevitable in any event that Ireland would require external assistance at that stage?

Mr. Kevin Cardiff:

I think my statement probably says yes to that, but certainly even if those things hadn't happened ... well, we don't know about the impact of Deauville on the market but given the market circumstance at that point in time, I think even if there had been no such briefings and so forth, I personally would have advised that we should go into a programme and we should do so sooner rather than later.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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We had been borrowing at 6% for eight-year money back in September, which is a high rate in today's terms but, even in the succeeding two months, things had deteriorated and moved quite quickly, that you felt a programme would be required.

Mr. Kevin Cardiff:

The real reason I would have advised is because there was no ... there was nothing in sight, there was no particular reason to be hopeful that we would get back into the market on our own, you know, in our own right without assistance. If you could see, you know, if there was some particular thing about to happen that would change the trend, then you would say "Let's wait for that", but there wasn't. The thing we had waited for all along in some one sense was the four-year plan, what became the national recovery plan, and the fiscal parameters of that but those had been known since October in the market and they hadn't done the trick. The problem was that even if the market was saying "Okay that's a good effort by Ireland, we could trust that", they had to look at it against the international backdrop, which was getting worse and worse.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Sure. The interest rate on the official programme, the bailout, 5.8%, was that higher than the Government expected at the time? Certainly there was a letter from the Governor on 21 November when these issues were emerging and at that time he was stating that the interest rate looks like it would be higher than expected. The NTMA subsequently said 5.8% was not unreasonable. So to what extent was it a negotiable element of the programme? The IMF element appears to have been pretty fixed, the European side perhaps less so. So to what extent was there an actual negotiation on the interest rate?

Mr. Kevin Cardiff:

It wasn't much negotiable at that point. The Minister had done some talking to other Ministers in the Eurogroup and so forth, so far as I know. It was fairly clear there was not much shift on that. So the focus was on other things. But even in the memo for Government saying "Let's join this programme", there was a line saying "and by the way, the interest rate could be lower and we are going to continue working on that". And there was, you know, people were making approaches as early as February, I think February, certainly March ... of the ... of the following month. We almost succeeded and it would have been a pity because, in fact, we got an even bigger reduction than we had been looking for or than we had been hoping for, let's say, in July. So in a sense, the little bit of delay helped. We also had in mind, I mean, we talk about other people being cynical, we were a bit cynical ourselves. We also had in mind that if things got worse in other parts of Europe, the case for an interest rate reduction for those other parts of Europe would be much stronger than for Ireland even and that we would be able to piggy-back on that, which is more or less what happened.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Sure. The national recovery plan which you spoke about was published by the Government on 24 November 2010. Roughly, when did work start at Department level on preparing that national recovery plan?

Mr. Kevin Cardiff:

I think-----

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Are we talking about weeks, a few months?

Mr. Kevin Cardiff:

No, more than ... I think in the late summer probably. We were ... a low point in terms of ... initiative was in probably summer 2010. We had done an awful lot of work, which seemed to be paying dividends in the late spring-early summer and then the - late spring - and then the sovereign crisis accelerated and seemed to be unravelling all the work. We were sort of stuck there and the Government was a bit at a loss I think too. Well, what next, what haven't we done? The answer was, well we haven't produced for the market and for the public a picture of how we are going to progress over the next four or five years and perhaps that would produce some credibility to the Government's actions. So it was in the course of that summer, I can't remember exactly when, but I do recall taking aside one or two technically very able officials and saying "Guys, can we produce this, do we have the skills to do this?" They said "sure", so we said "Okay, well start." Then the Minister would have been much more involved in it because it was becoming more of a product into September and October. But we were talking about it with Europe and so forth a little bit, even in September so it was clearly in train by then.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Okay, so in today's hearing we are looking at the period from the beginning of 2009 onwards and of all the events that happened in 2009 and 2010, from nationalising Anglo to recapitalisation of the banks, the setting up of NAMA, the entering into the bailout programme in November 2010, I am sure in hindsight there are probably many issues you think could have been handled differently or better. But what stands out in your mind today, and with the benefit of hindsight, as to an example of what could have been done better?

Mr. Kevin Cardiff:

I think we unwittingly misled people in relation to NAMA. The 30% discount. It's not that ... you know, in a sense that was ... that was a problem. We might have been much better to say nothing about what the discount was going to be and just do the work because we ended up disappointing both the public and the market and it would have been, you know, in terms of a single thing, we were trying to create a credibility as to our actions, as well as, you know, as well as the impacts of the NAMA process itself, which were positive. We were trying to add to our credibility and our status in the market so as to be able to continue borrowing from it and, actually, the continuing ... continued worsening of the NAMA discounts over that year were actually sucking the credibility away from us rather than enhancing it. I got the opportunity a while ago to speak for about three minutes to a finance minister who was considering a bad bank and he said "what would you do different?" I said "Don't, for goodness sake, predict the loan values until you know what they are going to be."

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Yes, very finally, Chair, on 31 March 2011, the new Government's major statement on banking, it appears there was a very late change because of the ECB's position on burden sharing and you ... you give an account of it on page 203 of your composite statement. And I know you weren't directly involved in the telephone conversations that day with Frankfurt but what is your understanding of how far the ECB went on that day in conversation with the Taoiseach, with the Minster for Finance? You make reference to a statement from the ECB that they wouldn't come out subsequently and support the banking strategy if the Government had gone ahead and imposed losses on senior bondholders, but did they say that emergency support would be withdrawn? How far did they go, in your view, and what do you understand the position to be?

Mr. Kevin Cardiff:

No, no one said explicitly, that I recall, that emergency support would be withdrawn, but remember we had been negotiating for months with them for ... to get some sort of really positive statement that would say the ECB is behind us. Remember, a year or so later, when Draghi made his statement about the euro, the impact of the statement alone, when said by somebody credible with a real intent behind it ... and that's what we wanted for Ireland. We wanted that kind of positive statement with intent behind it. So, that was the prize, if you like.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Yes.

Mr. Kevin Cardiff:

And the ... the instruction from the ECB was that, if you want that prize, you do not burn anybody, any way senior, senior bonds, at all. And it was quite explicit. I had my own phone calls with Frankfurt that day and I got the same message. It was a very explicit message and I think I even attached an e-mail to my statement that shows how explicit it was. Remember-----

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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There would be no statement of support from the ECB-----

Mr. Kevin Cardiff:

Yes.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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-----following the Government announcement.

Mr. Kevin Cardiff:

As clear as that, yes.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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And that would have had very serious consequences?

Mr. Kevin Cardiff:

Well, it would have ... remember, this was the new Government trying to get a new initiative under way and it would have robbed it of much of its market significance, I think. Maybe we were overdoing that, but that was the view. Also, it would have started the new Government off in a very bad situation with one of its most important business relationships and so forth. So, anyway, I mean, I ... quite explicit. I think I said in my statement you can understand why they were thinking in those ways but we definitely got what was definitely an instruction that ... you could say it was just advice only in the sense that, you know, we could have done something differently but then the consequences would have been different.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Thank you.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you very much. Senator Sean Barrett.

Photo of Sean BarrettSean Barrett (Independent)
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Thank you, and welcome back, Mr. Cardiff. The ... when you said ... when you were here last week, you said, on page 36 of your evidence, "the actual supervision system they were working within wasn't designed that way ... because the political system ... had decided they wanted a different supervision system and ... they imposed that model". Given that the Department of Finance had ultimate responsibility for financial regulatory legislation, can you explain the suggestion that the political system imposed a model of regulatory supervision?

Mr. Kevin Cardiff:

We're going back to 2002, 2003.

Mr. Kevin Cardiff:

Okay. Well, I mean, the Department of Finance doesn't have ultimate responsibility, the Minister does, and there was strong political direction in relation to the shape of the regulator to the point that if I, as a relatively senior official, wanted to change the drafting of a few lines, it had to be cleared ... even relatively small amounts of technical change had to be cleared at a political level so, for example, I recall having to ring, having to telephone the ... you know, certain ministerial advisers to say, "We're ... we're thinking of changing this; is that all right?" So there was a lot of political ... not just input into the broad thread ... into the broad shape, which is the norm, but also into the ... into the technical detail, which is not.

Photo of Sean BarrettSean Barrett (Independent)
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Right. And that was political advisers, rather than Ministers, was it, that-----

Mr. Kevin Cardiff:

Well, I presume that they were closely ... closely advising their Minister, yes.

Photo of Sean BarrettSean Barrett (Independent)
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And did that affect your tenure as the Secretary General?

Mr. Kevin Cardiff:

Sorry, we're talking back in 2002, 2003, so I'm not sure how you mean did it affect my tenure.

Photo of Sean BarrettSean Barrett (Independent)
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No, I'm just seeing, in your evidence, that interference in the regulation of banks, which, as we know, caused so much problems in 2008 and afterwards, would you have any wider observation? What should have been done, instead of that kind of interference?

Mr. Kevin Cardiff:

Well, what ... what the Department of Finance, my predecessors and myself were concerned about was that in the event of prudential crises, we would have a ... quite a joined-up system that would not be governed by the kind of internal silo thinking, internal jealousies that happen when you set up institutions close together but separate. And we would have advocated ... I would have, had it been ... I mean, by the time I got to the job, it was fairly ... the policy line was fairly distinctly set out but we wanted, in what we were doing, to try and ensure that those silos would be capable of being overcome. So, even in the legislation, you'll see things like a requirement for staff exchange between the two sides of the new structure. You heard that they'd no economists in the regulator. Well, I'm a bit surprised because we set it up so that there could be people moving from side to side within the regulator. But every time we did something like that, there'd be a political instruction to do something else, so, you know, we did that but then ... I'm not sure is it directly in relation to that, but there's a political instruction to ensure that the chief executive of the regulator would have a legal entitlement to hire staff separately, off his own bat, separate from the overall organisation. So, quite a lot of involvement in the legislation itself but, in my tenure later as a Secretary General, I didn't come across anything like that so with the particular change of Minister or the particular Ministers or the particular issues, they weren't as ... as hands-on on legislative change as was the case for this. This was quite unusual.

Photo of Sean BarrettSean Barrett (Independent)
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In the case of the organisations which were subsequently nationalised, was it mentioned on the night of the guarantee that a quid pro quowould be the removal of the boards and the management of ... of those companies?

Mr. Kevin Cardiff:

I don't recall, no. No, I don't recall that.

Photo of Sean BarrettSean Barrett (Independent)
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Because money was lost between the guarantee and the nationalisation. I think it did go up by about €4 billion, I think, is that what Governor Honohan estimated was the extra cost of delaying the nationalisation?

Mr. Kevin Cardiff:

Excuse me. What you're saying is was there ... between the night and so on that, at the time of nationalisation-----

Mr. Kevin Cardiff:

-----was there ... well, by the time we nationalised Anglo, the chairman and chief executive were gone.

Photo of Sean BarrettSean Barrett (Independent)
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Would we have saved money if we'd asked them to go on the night of the guarantee?

Mr. Kevin Cardiff:

I'd like to say yes because it would make me look wiser, but I'm not sure we would have.

Photo of Sean BarrettSean Barrett (Independent)
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You mention, on page 6 of your larger document, "In [...] normal times, INBS should not have been a big problem to solve." Isn't there evidence from Nyberg, Honohan and so on that at least one of those banks had been a problem for eight years? I think it's called "Bank A" in one of ... one of the reports. So, why, in normal times, did we not say, "Look, there's a bank which is not fulfilling regulatory requirements"?

Mr. Kevin Cardiff:

You'll excuse my ignorance; Bank A being INBS?

Photo of Sean BarrettSean Barrett (Independent)
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I presume it does, yes. I think that, yes.

Mr. Kevin Cardiff:

From time to time ... because we'd be talking to them ... this was entirely their bailiwick but from time to time the regulator would say, "We're doing this" or, "We're doing that" and you did ... I did certainly hear that they had an issue, not so much with the policies within Bank A or INBS, but ... I'll talk about INBS, I know ... whatever Bank A is.

Mr. Kevin Cardiff:

They certainly had issues within that, not so much with the lending policy, though in retrospect they should have had, but with the management structure, which they regarded as extraordinarily focused on a single individual. And they seemed, though, to make some progress because there was a new and very experienced, apparently, individual brought into INBS at a particular point in time.

It was said at the time, I can't recall if I heard it from the regulator, but it was certainly said around at the time that this was more or less that they're under pressure from the regulator so they had some impact, if you like, and then that individual, I think, after some months or a year, left. So they were back at square one.

Photo of Sean BarrettSean Barrett (Independent)
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But it was taking eight years. Just in your shorter statement, you said to us, on page 6 I think ... sorry page 14, "There was real concern that the ECB should be kept 'in the loop'." And you criticised Mr. Trichet last week. How should that have operated, the relationship between the ECB and yourselves?

Mr. Kevin Cardiff:

Okay, just to be clear, I did criticise Mr. Trichet and I think it's true but I also said a lot of things ... talked about a lot about the things he did that were good for us. But, at that point and this is a different thing, this is not the bailout, this is not the burden sharing, this is something different, this is back in 2008. At that point we were anxious that the ECB would know that we had some stresses, because we wanted them to be positive in terms of the collateral they would accept from our banks. In particular that, and because we wanted them ... we wanted to use them as the bellwether for whether there was anything else going on around Europe that might be of use to us. So there was discussion, and I can say this quite explicitly because its ... I have notes to say so, explicitly there was discussion between a senior Central Bank official around about 17 September, and again around about the 28th, 29th ... the first case, Tony Grimes, who was the director general and at that point might still have been the acting governor, I'm not sure ... 28th, 29th the Governor. And of course there would have been discussion at different levels in between, but explicitly two points at which you can say that the Irish Central Bank system was talking to the ECB and explicitly my notes say, and of course I'm getting this back from the Irish central bankers, not from ... not from having been at the meetings. But explicitly, according to my notes, there was a discussion with Mr. Trichet on the 28th or 29th and he was told that in fact one of our banks was, you know, would be in difficulties within a matter of days.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Very short supplementary now Senator, I'm not allowing any questioning.

Photo of Sean BarrettSean Barrett (Independent)
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Yes. Just ... if ... did anything occur to you in the intervening week on the identity of Mr. DD that you mentioned last week?

Mr. Kevin Cardiff:

I'm still sure that I'm not sure, Deputy. Yes, I ... I think I know who it is, but if I say it and it's wrong then I've created a storm for somebody and that's not fair.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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And that's fair enough. Okay, I'm going to move on.

Photo of Sean BarrettSean Barrett (Independent)
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Thank you, Chairman.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I'm going to bring time to a wrap up. Thank you, Senator. Just a couple of matters. Earlier, when I was speaking to you about the nature, the structure of the design of the banking guarantee and how ... what bearing it had, if any, with the State entering the bailout programme two years later. Would it have possible to design the banking guarantee that would not have lead to a bailout?

Mr. Kevin Cardiff:

The bailout happened because the scale of our economic and fiscal difficulties, which were not caused by but seriously exasperated by our banking difficulties. And the real issue was the cost within the banks, the cost of losses within the banks rather than the guarantee itself. We could've designed the guarantee differently in the ways that Professor Honohan has talked about, to make it more possible within Irish circumstances to burn bondholders earlier, especially to burn the senior bondholders earlier. But from a policy point of view, and especially about what we learned later about the European reaction, that might not have been practically possible. So, one could only speculate, Chairman, one might have, you know ... one might have saved a small number of billions here and there according to Professor Honohan, I'm sure he's right, but you might not have, and then would a small number of billions made it difficult ... made a difference to whether we went into the bailout or not. Probably not. But every ... but you have to assume that everything else being equal over a period of years where they might not have been.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Mr. Cardiff, your period in the Department of Finance came to an end when you moved into the Court of Auditors. Did you apply for this position, were you headhunted for it and was there resistance from the Department of Finance for you ... from you leaving to go to the Court of Auditors?

Mr. Kevin Cardiff:

I received a phone call from the Taoiseach offering me the Government's nomination. I thought about it for a couple of days and I said "Yes". The Minister of the day, current Minister, told me that he had not ... this was not his suggestion or initiative. I suspect this because I had said to him some months before, not long after he joined the Department, I said to him, "Look, physically speaking, I'm not sure I can keep going for five more years", which would have been my term. In fact, I wasn't sure I could keep going for two more years at the current pace. I might have ceased to be effective, so I had said to him, "Look, you know, let's get you settled in, I'll stick with it for as long as you want, but you have to be aware that there's that issue."

So when the Taoiseach talked to me I thought maybe this was coming from the Minister, the Minister said "No", not from him. So ... but the timing, from my point of view, was reasonably good. The Government was in ... was bedding down, they'd been there for six months, I would be still in situfor another four or five months. The transition had happened, so it was, you know, it was positive. I was quite positive also to the idea that we would have a, you know, that the Department could have a new Secretary General that was based ... that was selected from the broad universe of people available, which is what happened in effect. In fact the job was thrown open worldwide and there was a real attempt globally to bring people into the, you know ... to have the best possible field. So that's what happened, there's nothing sinister that I'm aware of.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Cardiff, I'm going to move now to wrap up a ... I'll be allocating five minutes each to the members but I need questions and answers dealt with in that time. Deputy Murphy.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Thank you, Chairman, and thank you, Mr. Cardiff. Just a couple of brief questions. Why even think about a bailout in 2008? If you believed the banks were solvent, if profitable even, according to some reports, there was a fiscal correction to be made but there wasn't a funding problem. So why did it flash across your mind and then why did you act on it?

Mr. Kevin Cardiff:

Well, imagine the guarantee hadn't worked, Deputy, and in November of that month we were desperately trying to find someone to give us some money and no one had thought about it beforehand. Then I'd be answering a different question.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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So it was in case the guarantee hadn't have worked, we might have needed that programme from the IMF?

Mr. Kevin Cardiff:

Yes, well, as I said, it was ... while I was ... the first time we thought about it, was then. It was no more than a thought. I got a note, I think in October, saying more or less here's how its done, and we left it at that. We knew what the first step would be if we ever needed that avenue.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Moving back then ... or on to May 2010 and this offer from the IMF about maybe going to precautionary line. In April, the Governor of the Central Bank told the Minister that he thought we could be up next for a bailout. And earlier today, you said that the sovereign crisis began in April and exacerbated through May and June and into the summer. So, why wasn't that offer in May explored seriously?

Mr. Kevin Cardiff:

Okay, so are we talking ... well, I don't ... I doubt very much that the Governor was saying we might be next for a bailout in April 2010 because the first one was Greece, which was in May 2010.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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At the time, there were discussions about what support we might give to Greece as part of the bailout and in a conversation, this is according to what Patrick Honohan has written, he did say to the Minister that we should be involved because we could be next.

Mr. Kevin Cardiff:

Well, that's quite possible. Why didn't we react more quickly? Well, at the time, we were still funding quite well in the markets so we didn't need an additional funder at that moment, and we didn't have any difficulty in the funding markets really until the end of the summer. So, it would have been one you would file away as being potentially useful. Really, the great thing is so long as you know the facility is there if you need it, or could be there if you need it, you don't need to exercise it. The knowledge that it's there is very powerful in itself. So, I think that it would just be a matter of timing after that, Deputy.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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The question about ... and there's a view that ... the guarantee happens in September '08, Anglo gets nationalised at the beginning of '09 and NAMA gets to work, and then two years later you have this great movement as part of the bailout to finally bring a solution to the banking problem in Ireland. And you provided a memo to us written on 15 October 2008 in which you write to the NTMA, the regulator and Central Bank, the Attorney General and the Department, and you say:

I think we need to think about A. What recapitalisations might be required

B. What consolidations might be required

C. Whether any nationalisations might be required

You say that at the time, it was simply clear that the guarantee would need to be supplemented by other efforts and we may as well get started or restarted. And that was October 2008. And then when you go to the memorandum of understanding for the bailout, you have recapitalisations, consolidations and quasi-nationalisations and you've got a four-month timeline to complete those. So what was happening in the two years then from guarantee to bailout that prevented that work from happening that you then implemented very quickly once the bailout was agreed?

Mr. Kevin Cardiff:

Well, that work was happening. I mean, the ... excuse me, you ... the committee's request ... instruction to me to attend arrived before I'd done the capitalisation chapter but, basically, between 2000 and ... well, from ... okay, phases - and I'll go through them very quickly because I know you ... the second ... the last quarter of 2008, engagement with the banks - a lot of it - on whether and what capital they need and, more importantly, on whether there's private sector capital available, so ... and there was a lot of people around to claim they had money available but in the end none of them delivered. First half of ... first quarter of 2009, Anglo nationalisation, actual recap work going on and the first engagements on NAMA. The second half of ... second quarter and third quarter of 2009, great deal of effort on NAMA and more work on recap. That work ... work on NAMA, in particular, goes into the end of 2009. 2010 we're saying, "Look, time to take stock," big effort on stress tests and so forth, PCAR, and, again, just see ... and an effort to see if the recap effort is sufficient. For AIB, it turns out not. More work on Anglo as the Anglo book gets going. So 2010, April-May, two good months, April in particular. Work on private capital for Bank of Ireland, down to their own efforts as much as to the public effort. May, sovereign crisis starts - coping with that through the summer. Then implications of that four-year plan start. There wasn't a moment when we weren't working on it pretty hard. Maybe the consolidations was the only thing that you would accelerate because, remember, the recaps happened as the information became available. Consolidations could have happened earlier but I'm not sure it would have made much difference.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Senator MacSharry.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Thank you.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Thanks, Mr. Cardiff. I know you're anxious to get going, so just very briefly. You spoke there to Senator Barrett in relation to the nationalisation of Anglo, in particular, and why didn't it happen on the night. You had said to us that you had a preference for that - it didn't pan out. In his report, Mr. Honohan said, "it is hard to argue that the delay of five months in eventually nationalising Anglo had a major financial impact." Are you able to put a number on what cost you think would have been saved or is far too much made of this issue?

Mr. Kevin Cardiff:

Well, I think I said to you earlier, I didn't know that there was a number. It may be that too much is made of it, but what might have been saved is the ... I'd have to ... no, I'd have to go into areas that we're not supposed to go in. There was a reputational problem at the end of that year for Anglo. That caused a reputational problem for the whole country. That might have been saved.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. Just finally then, on the interest rate reduction, was there an understanding in Minister Lenihan's time that the interest rate would be revisited?

Mr. Kevin Cardiff:

It was explicit.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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That it would be?

Mr. Kevin Cardiff:

It was explicit in the memorandum for Government that the interest rate would be revisited.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Would be revisited. Okay, thanks very much.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay, thank you very much. Just one very final issue, and it's just to clear up with regard to your engagement with the inquiry last week. And on page 16 of the transcript of your engagement with us, you went on to say that "Anglo passed us in a document about themselves." Now, being mindful of matters that are taking place outside of this committee room and so forth, would it be possible for you to elaborate as to what the key message of that was and to elaborate as to when you actually received it, or not? And mindful of other matters, yes.

Mr. Kevin Cardiff:

Okay, I don't think it touches on other matters at all. It was received in the Department and I ... when I was talking to the PAC, I was a little bit confused about it so I surmised and then I turned out to be wrong, so I won't surmise. Certainly, it came in in the middle of September, maybe towards the 18th, 19th, 20th, in around then. The document itself is in the PAC records, so it's not ... it's available to you. I don't recall what's in it much except that it was a relatively upbeat view of their current position.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Thank you very much. Mr. Cardiff, I'm going to bring matters to conclusion. I do know that we do need to wrap up to facilitate matters. Is there anything you would like to add by means of a closing comment or additional commentary?

Mr. Kevin Cardiff:

Yes, just ... I mean, I don't envy your task. You are dealing with issues in which reputations, careers and billions and billions of euro are involved so, you know, there's so many agendas around that it's a really tough job for you to bring out the truth, so I hope you do. I wish you well with that and I'd just like ... as I said in private session, a lot of arrangement and co-ordination to ... for me coming from abroad to do this and I got a lot of courtesy and help from your staff, so I appreciate that.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much and those comments are certainly appreciated. So, with that said, Mr. Cardiff, I'd like to thank you for your participation with the inquiry today and also last week and for your extensive engagement with the inquiry. With that now said, I now formally excuse the witness and propose that we suspend until 3.50 p.m. when we will hear from further witnesses from the Department of Finance. Is that agreed? Agreed.

Sitting suspended at 3.07 p.m. and resumed at 3.50 p.m.

Department of Finance - Mr. William Beausang

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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We will go back into public session. Is that agreed? Agreed. In doing so, we will now move on to session 2 of today ... or the afternoon session, which is a public hearing with Mr. William Beausang, assistant secretary, Department of Finance. The Committee of Inquiry into the Banking Crisis is now resuming in public session and can I ask members and those in the public Gallery to ensure that their mobile devices are switched off? Today, we continue our hearings with the senior officials in the Department of Finance who had key roles during and after the crisis period. At our session this afternoon, we will hear from Mr. William Beausang, assistant secretary, Department of Finance. William Beausang joined the Civil Service in 1982, he was appointed assistant secretary in the banking, finance and international division of the Department of Finance in April 2005. He transferred to the government reform unit in the Department of Public Expenditure and Reform in July 2011. Mr. Beausang, you're very welcome before the inquiry this afternoon.

Before hearing from the witness, 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 you are directed by the Chairman to cease giving evidence in relation to a particular matter and you continue to do so, you are entitled thereafter only to a qualified privilege in respect of your evidence. You are directed that only evidence connected with the subject matter of these proceedings is to be given. I would remind members and those present that there are currently criminal proceedings ongoing and further criminal proceedings are scheduled during the lifetime of the inquiry, which overlap with the subject matter of the inquiry. Therefore, the utmost caution should be taken not to prejudice those proceedings.Members of the public are reminded that photography is prohibited in the committee room. To assist the smooth running of the inquiry, we will display certain documents on the screen here in the committee room. For those sitting in the Gallery, these documents will be displayed on the screen to your left and right. Members of the public and journalists are reminded that these documents are confidential and they should not publish any of the documents so displayed.

The witness has been directed to attend this meeting of the Joint Committee of Inquiry into the Banking Crisis. You have been furnished with booklets of core documents. They are before the committee and will be relied upon in questioning and form part of the evidence in the inquiry. So with that said, if I can now call on the clerk to administer the oath to Mr. Beausang, please.

The following witness was sworn in by the Clerk to the Committee:

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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So once again, Mr. Beausang, you're very welcome before the committee this afternoon and if I can invite you to make your opening remarks to the committee, please.

Mr. William Beausang:

With the committee's permission, in my opening statement I would like to summarise three key themes in my written evidence as follows: the Department of Finance's role in relation to financial regulation, the Department's relationship with the Financial Regulator and the Central Bank and financial stability planning carried out by the Department in the period preceding the onset of the crisis, up to August 2007 and thereafter.

From April 2005, I was responsible, at assistant secretary level in the Department of Finance, for policy and legislation for financial regulation. In essence, this related to putting in place, in the Statute Book, the regulatory framework applying to financial institutions. In practice, this primarily involved my unit participating in the negotiation and transposition into Irish law of what was at the time described as an avalanche of EU financial service directives, under the EU financial services action plan or FSAP. The FSAP was designed to put in place a common pan-EU framework for the regulation of the financial sector. This was considered essential to building a single market in financial services in the EU and promoting the provision of financial services on a cross-border basis. Each of the directives was the outcome of an extended period of expert analysis and debate at the EU level. The process involved in advanced ... in addition to finance ministries, the European Commission, committees of the EU financial supervisors and intensive consultation with industry representatives. The financial service directives were regarded and represented as embodying cutting-edge modern models and approaches to financial regulation, such as the state-of-the-art Basel II accord for banks, which I'll say a little bit more about later.

The existence and presumed full implementation of this detailed and comprehensive EU regulatory framework, endorsed at EU level by all member states and supervised domestically by the Financial Regulator, provided very substantial reassurance to the Department as to the safety and soundness of individual institutions and indeed, of the stability of the domestic financial system as a whole. Once this EU-determined regulatory framework had been put in place in legislation by the Department of Finance, the Financial Regulator was responsible for implementing and enforcing it and supervising the financial firms to which it applied. The legislation establishing the Central Bank and Financial Services Authority of Ireland and the EU regulatory framework did not provide the Minister of Finance with any statutory role in overseeing or scrutinising the Financial Regulator's performance or the exercise of its supervisory functions and responsibilities.

Strict supervisory independence was a key principle internationally, such as under the Basel core principles for effective banking supervision. The concept of supervisory independence was also central to the design of the EU framework for financial regulation. The authoritative expert consensus at the time was that banking supervisors should benefit from the same high degree of independence as central bankers. It was therefore integral to my area of the Department's relationship with the Financial Regulator that we should not take any significant action or step which could interfere or encroach on that strict supervisory independence. This was essential to rule out any scope for any perception of political interference in financial regulation and supervision, given the major conflicts of interest that might potentially arise. Any perceived breach of that principle would certainly have given rise to major concerns at regulatory authority level, given the authority's statutory mandate. In addition, the professional secrecy obligations under which the Financial Regulator operated, set out in EU and domestic law, prohibited the disclosure of information held by the Financial Regulator by virtue of the exercise of its statutory role and responsibilities. This was a very wide non-disclosure provision.

The strict independence conferred on the Central Bank under the CBFSAI legislation, and the EU treaties as part of the Eurosystem, created an identical dynamic in terms of my area's responsibilities vis-à-visthe Central Bank on financial stability matters. The stability of the financial system was a core function of the Central Bank under national legislation and the EU statute establishing the European system of central banks. My unit in the Department did not therefore have any legal mandate or statutory role which would have permitted it to seek to critically assess or second-guess the Central Bank's assessments of the financial conditions and the capital buffers available to the banks to deal with economic shocks, as set out in the Central Bank's financial stability reports during the relevant period.

Against this backdrop, the Basel II accord provided what proved to be entirely unwarranted reassurance to the Department that the supervisory, prudential and financial stability systems in the CBFSAI were operating effectively. Basel II was the detailed and comprehensive regulatory regime for determining capital requirements and carrying out bank supervision introduced under the EU capital requirements directive or CRD. The CRD was officially adopted by member states in June 2006 to enter into force from the start of 2007. The very substantial programme of work in both the Financial Regulator and the credit institutions involved in transitioning to compliance with the CRD is evidenced, for example, by the extensive consultation documentation issued by the Financial Regulator in October 2006. Basel II and the CRD were characterised as modernising and making capital requirements for banks more robust, comprehensive and risk-sensitive, fostering enhanced risk management in credit institutions, as well as strengthening financial stability overall. However, as early as February 2009 the high-level group on financial supervision in the EU, commissioned by the President of the Commission to make proposals to strengthen European supervisory arrangements, concluded that the international banking crisis heightened the need for a fundamental review of the Basel II CRD framework. The high-level group concluded that Basel II underestimated some important risks and overestimated banks' ability to handle them, that the Basel methodology seemed to have been disproportionately based on recent past economic data and good liquidity conditions and that these mistakes led to too little high-quality capital being held by the banks.

In summary, from my perspective the sophisticated and technically complex modelling of banks' risks and reliance on risk weightings based on assessments by external credit rating agencies to determine capital requirements under Basel II helped contribute to an entirely misplaced confidence in the capital adequacy of banks and the efficacy of bank supervision, even as the liquidity crisis intensified. Indeed one regulatory expert in his evidence to the UK parliamentary commission on banking standards characterised Basel II as "a complete waste of time". It contributed to a situation where bank supervision seems to have essentially comprised an administrative procedure to review systems and processes for the management of risk put in place by the banks themselves. According to the Nyberg report, prudential supervision comprised tick-box checks that formal procedures were in place, not checks on how they operated in practice. The false sense of security engendered by the CRD was compounded by the outcome of the stress tests reported in the Central Bank's financial stability reports. These extreme but plausible scenarios appeared to show that even if a hard rather than a soft landing occurred for the property market, capital buffers in the bank were adequate.

I turn now to contingency planning in the period 2005 to 2006. Financial stability planning carried out in my unit involved the development of contingency plans for any Government intervention required to resolve an individual financial institution in distress or stabilise the banking system as a whole. There are a number of distinct strands to this work stream in my area of the Department over the period from mid-2005 onwards and an important focus of our work, at least initially, was in reviewing the Central Bank's crisis management manual, the black or red book, and reviewing the case for putting in place a corresponding manual for the Department. It also encompassed a first assessment of the many legal issues that arose in relation to the successful resolution of a distressed financial institution. This included consideration in particular of the legal issues involved in facilitating a market solution, where a large overseas bank might be encouraged to take over a distressed, at risk, domestic institution. It also identified the need to review the legal framework for crisis management, and examine the legal powers that should comprise part of the public authority's toolbox where intervention was required to support an individual institution or the banking system as a whole. There was also a significant EU dimension to this work at the EU financial services committee, at which the Department of Finance was represented at second secretary general level, relating to arrangements for responding to the failure of a cross-border financial institution. A critical backdrop to this work throughout 2005 and 2006 was that the Financial Regulator consistently and strongly highlighted to the Minister and the Department that the credit union movement represented the most significant risk to financial stability in Ireland during ... at that time. In light of the Financial Regulator's assessment of national financial stability risk, in the Department we prioritised the assessment of the credit union sector and undertook and completed a major programme of work to review, assess and respond to the various issues and concerns raised. In parallel we continued to progress broader financial stability planning, tracking developments and recommendations at EU level.

Turning to financial stability planning in 2007 and 2008, in terms of broader financial stability planning, an important focus in 2007 was aligning national planning with developments at EU level, given the growth in the cross-border provision of financial services and following participation in the EU crisis simulation exercise in April 2006. A key next step flowing from deliberations at EU level was the establishment of a national ... of national domestic standing groups, on which work commenced in the Department in the last quarter of 2006. This led to the formal establishment of the DSG, comprising representatives of the Department, the Financial Regulator, and the Central Bank in July 2007. The DSG played a crucial role from August 2007 with the onset of the liquidity crisis, ensuring that the Minister was fully informed of the Financial Regulator's and Central Bank's assessment ... assessments of financial conditions and the funding pressures on the banking system. The stringent confidentiality requirements that I've already referred to would otherwise have seriously inhibited communication between the public authorities and this crucial information flow from Dame Street to Merrion Street. The DSG was a forum for communication and information exchange. It provided the basis for multiple reports to the Minister and Government on financial conditions, many of which are in the public domain. The DSG did not have a decision-making role, nor did it have any joint mandate in relation to the distinct and differentiated responsibilities of the organisations participating on it.

As the crisis intensified in 2008, and as foreseen by the governing documents for the DSG, management of the crisis migrated to the top management level in the Central Bank, Financial Regulator and the Department of Finance, with the NTMA involved from end-2007 and increasingly prominent. As set out in my written statement, from the autumn of 2007 we did seek to utilise the DSG to seek to develop the principles and agree a shared analysis and methodology that would better guide and inform crisis management on a co-ordinated basis among the public authorities. This work did not progress significantly beyond the Department's February 2008 scoping paper on financial stability planning on account of, for example, the important differences in emphasis with the Central Bank's assessment, as reflected in the Central Bank's comments on the Department's scoping paper, and its own paper on resolution options circulated in June 2008, the Financial Regulator's evident preoccupation over that time with the resolution of the CFD-related share overhang issue in one institution and the Central Bank and Financial Regulator's enduring assessment that the crisis was exclusively attributable to international liquidity situation, and the consequent sole focus on supporting bank funding.

The Department, therefore, continued to prioritise over the period, the preparation of draft emergency legislation to nationalise a bank. In early September 2008, this work was reorientated to taking a building society into public ownership on the basis of a major contribution from the office of the Attorney General, and, at a late stage, the Department's commercial legal advisers. By end September 2008, our contingency planning advanced to the point that legislation to do either could be finalised for publication and enactment at very short notice. The draft legislation also contained provisions to set aside competition law requirements to facilitate a market solution, provide financial assistance to credit institutions in the form of guarantees or capital, and provide the required legislative basis for the proposed secured liquidity scheme for bank funding.

In conclusion, my written statement and the supporting document I have submitted to the committee covers the foregoing issues, as well as those lines of inquiry which I have not referenced in this overview in considerably greater detail. Thank you. I am happy to answer any questions.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you very much, Mr. Beausang, again. If we can commence questioning, and, in doing so, if I can invite Senator Marc MacSharry, please. Senator, you've 25 minutes.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Thanks very much. Welcome, and thank you for your opening comments. Can you comment on the frequency of contacts with the ECB in 2008, and identify the level at which such contacts took place, to your memory, and the broad discussion content?

Mr. William Beausang:

The only information that I'd have on that, Senator, is really indirect information I would have obtained at the DSG, and back in the Department, and talking to more senior officials, David Doyle and Kevin Cardiff, where I would have had an awareness that the Governor, John Hurley, was in constant, or was, you know, in ongoing contact with the president of the ECB in keeping updated and briefed on developments and stresses in the Irish financial sector. I suppose as things intensified, as the crisis intensified into September 2008, as I think other witnesses have mentioned, there was a real impetus to ensuring that we really reinforced the difficulties that we were experiencing at that time at European level. Indeed, in work that I would have done, in a, sort of, scenario note that I would have done back in November 2007, I would have identified the possible requirement for an EU-level intervention to deal with the systemic difficulties that were arising in the Irish financial sector. I mean, this was, kind of, presented as something, you know, what could happen next, what could happen ultimately in terms of how things were moving at that point in time?

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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When was that roughly in 2008?

Mr. William Beausang:

That was in, if I can recall correctly, I think that note was done in November 2007. So even at that stage, and reflecting the discussions that I know the Governor would have had with the president, even in advance of that, there was awareness that what we might need to stabilise the Irish financial system was an EU-level response, dealing with all the difficulties that were emerging.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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So in late 2007, it was clearly on the ECB's agenda, at least, that a pan-European solution may have to be considered?

Mr. William Beausang:

Just to make sure that I haven't over-stressed that point, I mean, that would have been a report that I would have done, or a note I would have done up the line in the Department. I mean, you would have to ask the Governor, I suppose, at what stage, or look at his evidence as to what point he might have made that argument to the president, or indeed, did he ever make that point to the president? I know at a much later stage, and I think I enclosed the document with my written statement, around 17 September or so, we had a meeting of the DSG, and one of the specific action points from the DSG was to alert the European authorities, the authorities in the ECB, as to our difficulties, and the significance of our difficulties at that time.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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This is September 2007.

Mr. William Beausang:

Sorry, that's September 2008, now. That was at a much later stage, Senator.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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But specifically, when you were asked to prepare this document, to look at a European resolution, was it the Governor that was asking you to do that or-----

Mr. William Beausang:

No, that was an exercise, an internal report or note that I prepared on the basis of a request for a, kind of, "What's happening now, what could happen next, what might ultimately happen?", a sort of ... a forward-looking piece.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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And was it the DSG that asked for that-----

Mr. William Beausang:

No, I think it was a request that came from, if I recall correctly, from the Secretary General at the time.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. To your knowledge, throughout 2008 was there any joint plans agreed to mitigate the crisis? Were the ECB, through John Hurley, telling the Department, "Look, do this, do that"?

Mr. William Beausang:

No, I mean, the sense was reflecting two factors, reflecting the fact that there was, as you can imagine, a huge level of confidentiality and secrecy around these issues, so that would be a major concern that if we, outside of the, kind of, Central Bank confidentiality, if information leaked out, that we were ... that our banks were under significant funding pressures, that, you know, calls would go out to banks and other institutions in other jurisdictions, and that would intensify our difficulties. So there was a high degree of sensitivity and secrecy around our own work. But more than that, I mean, there was a strong sense, and this probably reflected the work that had been done at EU level up to then, in looking at the issues that would arise if there was a failure in a cross-border financial institution, that there was a major ... I mean, all of the crisis management done at EU level related to this issue of, "Well, what about if a major European cross-border bank got into difficulties", and what arrangements would need to be put in place for what they used to, what was referred to, and what I'm sure is still referred to as "burden-sharing", where governments in different member states where that bank operated would get involved in resolving that, those issues. So that was the focus of work at, kind of, in the, sort of, the EFC, that is the economic and financial committee, and the FSC, two high level European committees. There was no sense of there, I mean, that was as far as that, there was a sense of any kind of EU response to difficulties in any particular member state, and that would arise if you were talking about a cross-border bank. And it's interesting to make the point that, I mean, those kind of, that work stream I won't say broke down, but where it really got into difficulties was getting to a point with member states where there was any sense the member states were willing to agree, kind of, burden-sharing arrangements. That was a step too far for most member states at that time.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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And did your paper advocate that?

Mr. William Beausang:

The paper, I mean, the paper I'm talking about, it was a scenario analysis internal to the Department of Finance, so it wasn't related to the EU work stream on crisis management.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. In terms of the guarantee, in your e-mail to Brendan McDonagh of the NTMA, you refer to, "In the event the State provides a guarantee for all deposits and credits, of the domestic banking system...", and it goes on later, "...Minister confirms intention to provide guarantee, if required." It would appear that a pre-determined position may have been agreed by 26 September. Can you advise on the discussions and analysis provided by the NTMA in response to your e-mail, and discussions with the Secretary General on the same-----

Mr. William Beausang:

Is that e-mail available, just so that I can look at it?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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It's coming up. It should be on your screen there now, Mr. Beausang.

Mr. William Beausang:

Just while I'm waiting for it to come up, I certainly had no sense of a predetermined outcome on 26 September. I think what the Secretary General was asking me to do was make sure that we had more information on an option that was increasingly emerging as one of the options that would be put on the table whenever this thing came to a head. I mean, I was reviewing, obviously, the paper trail myself, and what I established was that the power to actually provide a blanket guarantee in the contingency legislation only went in around then, around 25 or 26 September. Up to then, there was a power to provide financial support to a distressed institution, but just a single institution, there wasn't a sense of that we were providing a power that could provide a broad blanket guarantee across the whole of the financial system. So that gives some indication, I suppose, as to the point that the guarantee came very clearly, you know, was very formally on our radar or in our planning in terms of it being in the contingency legislation that was being developed at that time. Up to then, it wasn't in the Bill.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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At that stage, there was nationalisation legislation already in existence, was there?

Mr. William Beausang:

Well, I mean ... at the point ... you know, let's say at end September, we'd a piece of legislation that, you know, at short notice could be finalised to nationalise a bank, nationalise a building society, set aside competition rules in case anybody was interested in coming in and taking over the stressed institution and also in providing a guarantee or capital support to an institution, you know, the broad power to provide financial assistance under the legislation as it ultimately turned out to be. So there was a nationalisation Bill prepared and more or less ready to go. I mean, there would have been some ... some finalisation required if the Government decision had been to nationalise the ... any institution but the legislation was essentially ready.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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What preparations were made, if any, to facilitate the wind-down of a financial institution or allowing a bank to fail?

Mr. William Beausang:

What ... well, I mean, I think it's ... it's quite clear that the ... given the systemic nature of the crisis that we were facing - and I think it's borne out in, certainly, the Nyberg report and the Honohan report - that allowing an institution to fail in those circumstances would have been catastrophic. So ... obviously, in our planning we had looked, at different times, at the whole issue of winding down of a financial institution, at a special resolution ... a special resolution regime for the banks. What we concluded was that there was huge, you know, technical, legal, policy, potentially constitutional difficulties in putting such a regime in place. But, in any event, I think it's very important to make the point that, you know, the SS ... the SRR that's now in place - the Credit Institutions (Resolution) Act - it's explicitly set up on the basis that the resolution powers only ... only play out - are only available to be implemented - in a situation where the decision has been taken not to wind down the bank. So the special resolution regime that we have from 2011 is explicit that the resolution powers - things like bridge banks, the transfer of liabilities and special manager and all that - those things only happen if the decision is made that the bank shouldn't be subject to an orderly wind-down. So, I mean, that's important to, kind of, feed in to the discussion on the special resolution regime and proposals for orderly wind-down.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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As you'll be aware, Patrick Honohan, the Governor, is of the view - and it's in the public domain - that the two banks "ought to have been intervened" , to quote his words, for a period of days and that that would have given an opportunity for a Europe-wide regime to be put in place, which may have been more beneficial to Ireland. What's your view on that?

Mr. William Beausang:

Well, considering that the full kind of European-wide SRR model with kind of bail-in ... bailing-in of creditors and so on is only in place, I understand, from the beginning of this year, so I'd be quite sceptical that it would have been possible - at that time and in that environment - to move more quickly. I mean, in talking about ... I mean, the fundamental issue and, I mean ... it's ... like, there's nothing new here, it's in the Nyberg report ... the fundamental issue, when you're looking at other options and whatever options were availed of, was senior bondholders, you know, the bail-in mechanisms and, I mean, as Nyberg himself said, you know, a special resolution regime, for example, that wouldn't have been a panacea at the time, unless costs are ... there was burden-sharing going to be achieved under that special resolution regime and, I mean, I don't need to go in with the committee all of the issues that have arisen around the non-availability of that option up until the new SRR or the new ... sorry, I won't remember offhand, but the new European-wide regime for banking resolution that came into effect relatively recently. And, of course, as things stand, it's currently untested, so it remains to be seen how effective that kind of model will be or the impact it will have - once it is implemented - in terms of the cost of bank funding and so on. So, it's a ... it's a very broad issue, I suppose, to consider.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Can you advise what discussions took place with Merrill Lynch and the NTMA or, indeed, other advisers on the issue of subordinated debt and the rationale for including subordinated debt in the guarantee?

Mr. William Beausang:

Well, I don't think I can add anything more than what is in the Merrill Lynch memorandum. I'd no direct discussions with Merrill Lynch or with the NTMA, I think, in advance of the guarantee coming into effect.

I mean, you know, personally at the time the guarantee was introduced, I wouldn't have had a kind of a deep knowledge or awareness of, let's say, the distinction between dated and undated subordinated debt. And indeed, it was only subsequently when I was reporting to the European Commission to DG Competition in the context of our state aid application that I gathered information from the NTMA from an e-mail from Brendan McDonagh that I think I submitted with my written evidence and also presumably an oral briefing from Merrill Lynch that explained, I suppose, the market reason, the funding reason the sovereign reason why dated subordinated debt should be included and why that case should be made to the Commission for the inclusion of dated subordinated debt. I wasn't present at any discussions on the 29-30 September where this was discussed. If they were discussed at that meeting.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Have you a view on it? Whether it would have been worthwhile that it would have been a good thing to do?

Mr. William Beausang:

Well, I'm ... I suppose there was a sense that there was one opportunity to take a, you know, whatever step that might be to try to create greater confidence in the Irish financial system. What I think, just to elaborate on that a little bit more. I would have been conscious myself that at the time, the UK authorities provided guarantees for Northern Rock. The guarantees over time extended into their capital structure. Now they didn't extend as far as our guarantee did, but they did find themselves in a situation where they guaranteed the deposits first and then they had to move into, you know, wholesale funding and beyond. So there was a sense that you wanted to avoid a situation with a guarantee. I mean, if you are going to ... if you're going to take that approach, you want that approach to be as impactful as possible and not find yourself in a situation where you are tweaking it at a later stage because that would obviously damage your credibility.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Can you describe for us the meetings that you would have been aware of or that you attended leading up to night of the guarantee, specific to the preparation?

Mr. William Beausang:

I think there was some significant meetings in the Central Bank, in the NTMA that I didn't attend. I was working on the legislation at that time so, you know, it's clear from the attendance list at those meetings I wasn't at them. So I wasn't party to discussion. I mean, one of those ... one of the meetings was a meeting where Merrill Lynch gave a presentation on resolution options or the state of the Irish financial ... the Irish banking system, whatever. I wasn't at that meeting and I think there was maybe another meeting in the Central Bank which obviously I have seen reports of subsequently but I wasn't present.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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And the night of the guarantee itself?

Mr. William Beausang:

The night of the guarantee itself. I was present for the first phase of the discussions. I think Kevin Cardiff's note, there's a sort of a segment of the meeting where Jim Farrell the chair of the Financial Regulator comes in and makes the case for the guarantee and then the discussion extended, you know, there was sort of a broader discussion about other options that were there. The nationalisation option being the main one, I suppose. And at that point, you know, looking at that hand written note at that phase of the meeting, I left the meeting because there was some preparation to be done. What was clear was that contingency arrangements needed to be put in place for the Central Bank, perhaps to provide ELA to the institutions the next day and that would only happen ... the Central Bank will only lend if they have a guarantee, a Government guarantee of that lending or, as it turned out because we wouldn't have had power to give a guarantee for that lending at that point, what they looked for was a letter of comfort saying that any losses on that lending would be made good by the State. So that's what I was involved in, in just putting together ... or perhaps talking to the director general of the bank as to what was the specific language required. But that was part of the contingency planning that was required at that point, Senator.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Did you take notes of any of the meetings that you attended?

Mr. William Beausang:

Well, are you talking about any particular meeting?

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Well, on the night of the guarantee.

Mr. William Beausang:

No, I didn't take notes at the meeting. I didn't take notes at that meeting.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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In meetings that you did attend of this nature around this time - and obviously we get the privacy and the secrecy that was required - were instructions ever issued with regard to the recording of a meeting not to take notes?

Mr. William Beausang:

No.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Okay. Can I ask, in your opening statement you mentioned Basel II framework was expected to foster stability in the EU, financial system by strengthening incentives for banks to conduct sound risk modelling and managing and by involving supervisors more directly in the review of banks' risk profiling, the risk management practice and risk bearing capacity. With the benefit of hindsight and everything that has happened, how did Basel II incentivise conduct in risk management practices?

Mr. William Beausang:

You see Basel II created a whole infrastructure, a whole industry, there was a Basel II industry around applying what was ... I mean maybe a good illustration of the complexity that was involved in Basel II; the original Basel I framework I think is described is 30 pages long, the second one is well over 300 and is, you know, hugely complex, technical, based on what was considered, at the time, best practice in terms of risk modelling, credit assessment and so on.

I think part of the difficulty was that from, obviously from the banks' perspective - to the extent that they paid any attention to this - but certainly from the regulator's, that as sometimes happens with all kinds of models, the model itself becomes the oracle in terms of whether something is working, is perceived to be working, or otherwise, rather than, as I'm sure people more expert to talk about Basel II would tell you, that it's meant to be just an aid to decision making or to the exercise of supervisory judgment.

But, I mean, it's important to make the point that when you talk about Basel II that it wasn't just a kind of technical modelling exercise. There was three pillars to it and one of the most ... the second pillar to it was what was called the supervisory review. It was characterised by the IMF in June 2008 as the heart and soul of the framework, which adds a solid layer of supervisory judgment to more rules-based approach of pillar 1. That's the modelling piste. It's built around principles that define roles and responsibilities of banks and their supervisors in the assessment of capital adequacy which include, as well as go beyond, the risk covered in pillar 1.

So, Basel I envisaged that you'd have this modelling and you'd have this sophisticated risk management systems but you'd also have supervisors assessing whether the modelling of risk was capturing all the risks in the institutions. But, I mean, it's absolutely clear, although I don't have direct knowledge of it, that the time, energy and resources in the Financial Regulator in just putting that model in place in a small country - you would have heard in talking to the people from the FR, you know, their staff resources, the limits on staff resources - it was a huge exercise, and in the banks themselves. And I think that point is made, either in the Honohan report or the Nyberg report that, as far as the banks were concerned, the risk management experts were taken off the day-to-day assessment of the risks the banks were carrying, to help create this infrastructure that the banks would need going forward to be competitive in capital markets, you know, under the Basel framework.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Was it the intention of Basel II that banks would supervise themselves?

Mr. William Beausang:

I think ... you know it ... it's a contentious issue and obviously, I mean,you will talk to people who will hold that ... that kind of, the Basel ... you know, that in moving from Basel I to Basel II there was an ... you know, there was an improvement, in principle, in terms of the design and the regulatory system. But certainly and ... I mean, it comes across very strongly from the work that the UK commissioned on banking standards did, that they concluded that ... and this was in their report on the failure of HBOS, they say, and this is a parliamentary committee:

The requirements of the Basel II framework not only weakened controls on capital adequacy by allowing banks to calculate their own risk-weightings, but they ... distracted supervisors from concerns about liquidity and credit; they may also have contributed to the appalling supervisory neglect of asset quality.

So that's in a bigger country with a much better-resourced supervisory body and that's the conclusion they're coming to in terms of the impact of Basel II on the efficacy of financial supervision over that period and in relation to the different supervisory approach that it encouraged, where as I said, supervisors were encouraged to review the model not to review the risks.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Just two last questions. In your time at the Department did you ever experience any major contrarian views to fiscal or banking decisions being taken?

Mr. William Beausang:

I mean, from my experience, Deputy, there was a lot of contrarian views in the Department of Finance on a whole range of issues. I mean, you know, in terms of what the Department ultimately has to do, which is advise Minister and advise Government, that works through the hierarchy, the management system, and those views are then represented, or those options are then represented, to the Minister. I mean, in terms of my area of responsibilities in the Department, I'd no direct interaction with any individual in the Department, or, indeed, in the Central Bank or the Financial Regulator, that was articulating strongly very contrarian views around where the banking system was or where the economy was, more generally. But, I mean, in terms of my responsibilities, my focus was very much on financial regulation and the stability of the banks rather than the broader macroeconomic framework, which was the responsibility of another area of the Department.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Earlier on we had John McCarthy who quoted from John FitzGerald's evidence here some time back, where he made reference to the politicisation of the advice of the economics unit. In your time, have you ever experienced, or during this critical period, was there an undue political influence which determined the direction of policy?

Mr. William Beausang:

No, I wouldn't say that I had ever any experience of that. I mean, I think, in the Department ... I mean, because I had worked as an economist on the economic side in the late 90s, and, at that time, we were writing papers warning about the risk of a hard landing. So you could imagine that there was a, sort of, I think, a loss of credibility in the ability of the Department, and certainly ... and I can't say because I'm not part of the political system, but I mean, in a scenario where, at that point in the economic cycle, the Department is saying there's big risks here now, house prices are taking off, credit is taking off, the fact that then the economy rolls forward and performs very strongly and shows ... and demonstrates a capacity to grow, you know, into the early 2000s, you know, quite sustainably, at a rapid pace, you can imagine that there was a certain scepticism around the Department's ability to call the economy correctly, even maybe within the Department itself.

Maybe to elaborate on that a bit more, I mean, when I first joined the Department in 1990, there was a designated economic service, and part of that work would have looked at things like, you know, longer term or medium-term economic forecasts, but, as we moved towards EMU, and moved into EMU, that kind of resource, increasingly, was looking at meeting the, kind of, governance requirements around our membership of EMU, things like the Stability and Growth Pact, and the kind of fiscal forecasting that was involved in ... that was required in that context. So, I mean, you know, at a point in time in the Department, there was ... it was somebody's job to worry about the current account of the balance of payments, which would have reflected the flows of finance into the State. You know, by the time the new century came around, and with our membership of EMU, and the fact that the monetary policy division of the Department, that would have been very involved in looking at monetary factors in the run-up team, you know, the fact that that had been recast as what, essentially, was my area, the financial regulation area, meant that there was a significant diminution of expertise in the Department at that ... you know, like, at that time, and it's ability to maybe call issues. As you know, more generally, as you probably heard from other witnesses ... I mean, kind of, macroeconomic modelling or forecasting ... I mean, the financial sector was, kind of, ignored in that work in a lot of instances, and that there wasn't a realisation maybe more broadly amongst the economics profession of the importance of monetary factors in assessing, you know, the current economic state.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you. Senator D'Arcy.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Thank you, Chairman. Mr. Beausang, you're welcome. On page 3 of your opening statement, Mr. Beausang, you state, "The model of 'principles-led' 'risk-based' supervision was set out in IFSRA's Strategic Plan." Section 5.4, you also state, "We knew that IFSRA’s supervisory approach was, therefore, strongly underpinned by a comprehensive system of technical regulation encompassing specific rules, regulations, codes and the supervisory powers necessary for their implementation." And this is a question that I put to other witnesses, Mr. Beausang. Why did the Irish principles/rules-based regulation, which was similar to other EU countries' rules-based regulation, fail so much worse than those other countries who had similar regulatory systems?

This is a question I have put to other witnesses Mr. Beausang. Why did the Irish principles rules-based regulation, which were similar to other EU countries rules-based regulation, fail so much worse than those other countries who had similar regulatory systems?

Mr. William Beausang:

I think you have to bring it back to the way in which those rules were implemented. We put in place those rules, that was our job. As I outlined in my witness statement and in my overview, we took, as far as prudential regulations were concerned, consumer protection legislation was done and it was obviously a domestic initiative but we took these models of financial regulation. They were carefully worked through by experts in Brussels, committees of financial supervisors, significant consultation with industry. We took those models, having negotiated those models and those models had been agreed by all member states and put them in place. It was then the responsibility of the Financial Regulator to implement the regulation and to supervise the banks in the manner that those regulations suggested. So the contrast that is often drawn is between the approach taken in Ireland and let's say the approach taken in Spain. Although I couldn't say this definitively, in broad terms they were operating the same framework, they were operating the same pan-EU framework of financial regulation. Of course they had their own difficulties in Spain eventually but the Spanish regulator is seen and the Spanish central bank is seen to have been more intrusive and having people on the ground in the banks rather than as occurred in Ireland. So that is the conclusion I would come to as to why things were disproportionately worse here. Apart from the conduct of the banks which is a separate iss