Banking Crisis

Question 1

It has been called the "biggest financial decision in Irish history.... and arguably the biggest policy decision ever taken by an Irish government."

(a) Discuss the economic environment and policy that preceded the banking crisis and the government bank guarantee in September 2008. (60 Marks)

Ireland had been known for being a wealthy country during the 'Celtic tiger' in the early 2000's but after September 2008, Ireland joined many other countries in an 'economic meltdown'. There is not one reason alone that is the cause of this financial economic chaos as other astonishing actions of the Irish banks came to light after the demise of Lehman brothers. Some of the causes that have to be considered were the little financial supervision and fiscal policy which left the economy vulnerable. Ireland also saw the rate of public expenditure to GDP rise leading up to the banking crisis. For example with comparing Ireland to America, America's debt was 300% in in 2006 but Ireland's debt was 700%. A takeover of Lehman had been tried by Bank of America and Barclays PLC but it did not become successful and after the bankruptcy was announced, their stock had fallen by a dramatic 93%.

A main cause of this banking crisis was the 'reckless' lending from the banks especially for people who wanted to get onto the property ladder. Competition amongst banks resulted in many cutting the prices of their mortgages and interest rates due to the entry of Bank of Scotland into the Irish market. This was due to Ireland's low interest rates in Europe and the house prices in Ireland being higher than any other EU country. With cheaper mortgages, came easier ways to obtain a mortgage. The banks began to offer 40 year mortgages instead of the normal 20 years and even First Active introduced 100% mortgages. Throughout the 2000's, ordinary people were borrowing ten times their salaries although during the 80's people were only borrowing up to three times their salary. Unfortunately if people could not pay these back it would lead to default. Ireland's fiscal policy even created pension reserve funds for political reasons which meant selling debt down to a third party. Simply it was easier the loan, the higher the prices rose.

As Ireland became part of the EU, it allowed for them to enter key markets. Being part of the euro made it easier to gain cross-border funding and helped Ireland develop a better relationship with foreign institutions. Borrowing came easily to Ireland as with Europe's low interest rates they were was no exchange rate risk although in 2007 Ireland had a rise in exchange rates more than any other European member. Up until 2005, real interest rates were positive until short-term and long-term interest rates fell quite quickly.

In 2005, the construction industry accounted for 23% of the nation's annual wealth and it also had seen employment double from the 1990's. Between 2003 and 2007, lending for property increased from 50% to 67%. This is astonishing for such a short amount of time and it just shows that the more the banker's lent to customers, the more profit the banks made. This led to a higher profit for the men at the top of the banks of which some would make up to 80,000 euro a week. This included Sean Fitzpatrick and David Drum. They simply wanted to be awarded a high level of remuneration and large bonus and it didn't matter who got the loan as long as they were given out. Sean Fitzpatrick was head of one of the world's fastest growing banks, Anglo Irish bank. He was known for his high lending to the property market with some saying Anglo lent 80 million euro a day and also 80% of their loans on property. Soon, with the trouble Anglo was facing, the National treasury management stopped putting money into Anglo. With property loans in danger of not being repaid, banks allowed a number of property developers to roll over their loans onto their next big project and at this rate the cost was rising and rising. Ireland simply had an oversupply of credit for building and construction which was not very sustainable and which we were about to see.

One of the main reasons for Ireland's banking crisis was the lack of regulation and supervision by the supervisors and bank managers themselves. Governance failures were not taken into account and were not investigated before matters got worse. With no regulating occurring, the banks way of thinking was less regulating meant more business and less regulation on the market the better. With less regulation of the banks, they believed that more competition among the financial sector would be better for society as it led to more lender options for the public. If a regulator had been put in place they could have curtailed the bank's lending and put a stop to fatal consequences such as the government guaranteeing the banks. If inspections had been carried out, they would have seen that a lot of the banks didn't put loans on their books, inadequate documentation and research into whether people could even pay back their loans was not carried out. The banks didn't follow guidelines as to who was capable of getting a loan as they didn't want authorities putting limits on credit. Simply if banks were regulated, there could have been a chance of survival and risky lending might not have occurred leaving us in this financial mess. If policy measures has been taken much sooner, the softer landing that was talked about could have been possible.

An unusual move from the Irish economy was that they have tax deduct abilities from mortgages from income tax but not from property tax. This was due to the fiscal deficit during 2008 where income tax