Bertie

by Colm Keena

  Fig. 2: Foreign borrowing by Irish banks, 1999–2007 (€ billion)

  Source: Central Bank of Ireland.

  The first-half, second-half analysis of the Ahern era can be divided in a number of ways. There is the first and the second Governments. There is the treatment of income tax: rates were reduced significantly during the period to 2001, while credits and bands were extended significantly in the period thereafter. McCreevy was Minister for Finance for the first half, Cowen for the second. The banks’ reliance on funds from abroad was modest during the first half but grew rapidly during the second. The wealth of the country was earned during the first half but borrowed during the second. Ireland had its own currency in the first half but was part of the euro for the second.

  Half time does not fall at exactly the same moment for all these factors, but the structure of the narrative is fairly clear. It is not the intention here to go through all the factors in any detail, though one point deserves to be made: despite what Ahern would say later, he and his Government colleagues were warned about the dangers of the pro-cyclical budgetary stance they adopted for almost the entire Ahern period. Ahern did not respond to those warnings by having second thoughts about strategy or even by taking a breather and worrying for a bit before deciding to press on. Rather, he ignored what was being said and, if that didn’t work, reacted as if the warnings were threats to his political position, sometimes verbally assaulting those who had dared to speak. There is little evidence that any of his Government colleagues were opponents of what was going on.

  Fig. 3: Budget packages, 1999–2008

  Annual budgets exceeded the advice of the Department of Finance. Note the spikes just before the two general elections.

  Source: Rob Wright, report on performance of Department of Finance. Reproduced with permission.

  Growth rates such as 10.1 per cent and 8.7 per cent are phenomenal for a developed Western economy and are well above what economists would describe as sustainable. The collapse of the Irish economy at the end of the Ahern era was the largest for a Western economy in the period after the Second World War.

  In money terms, the growth equated to a gross national product of €83 billion in 1996, €161½ billion in 2007 and €139½ billion by 2010. GNP is a measure that tends to exclude the activities of multinationals, which export their profits.

  Fig. 4: GNP, annual change, 1996–2010

  Source: Central Statistics Office.

  As can be seen, the spectacular growth began before Ahern’s period in power and McCreevy’s cuts in tax rates and continued towards—but did not quite reach—the May 2002 general election. The economy then trod water until, at the first sign of green shoots, confidence returned. When the property market revived, reckless lending by the banks became a distorting factor in economic growth.

  The revived property boom soon turned into a bubble. House prices soared, and land prices soared even more. Property developers and speculators began to factor future expected increases in property prices into the price they were willing to pay for land. In other words, when estimating how much a field outside a town in Co. Leitrim might be worth, they would calculate how much could be made from selling houses built on that field in a year-and-a-half’s time, when house prices in the area would be a certain percentage higher than they were when the field was bought. Speculators in the main urban centres made similar calculations, and the banks issued loans based on these calculations. Builders turned into speculators and developers. Bankers, accountants, architects, doctors, dentists, gardaí, teachers and others joined in. At times it seemed that the whole state was involved, not least politicians such as the former Government minister Frank Fahey, from Galway, and the Fianna Fáil senator Francie O’Brien, from Monaghan. Behind the boom in asset prices was a wave of credit issued by the banks, who were in turn borrowing the money abroad. No-one outside the world of banking appears to have noticed; inside the world of banking regulation, no concerns arose that we know of, and no effort was made to clamp down on what was happening.

  One effect of the bubble was that the construction sector began to take over, or to account for more and more of the economy. At its peak it employed 13 per cent of the work force. Elements of the economy outside the construction sector suffered. Much of the multinational exporting sector has very high productivity and so is not so sensitive to wage increases; but for the Irish exporting sector this did not apply. Whereas the domestic and exporting parts of the economy were roughly equal in 2001, by 2006 exports were less than 15 per cent of the economy.

  In November 2008, when it was beginning to dawn on everyone what a hames had been made of the economy, the Society of Chartered Surveyors held its annual conference in UCD. Prof. John FitzGerald delivered an address, ‘Blowing Bubbles and Bursting Them’. He presented some astonishing figures: Ireland had about 570 dwellings per thousand of population, but only 477 of these per thousand were occupied (only Spain had a similar gulf between existing and occupied dwellings); in Ireland in 2005 housing had comprised 13.9 per cent of GDP, compared with 4.6 per cent for France and 3.9 per cent for Britain. The average for Ireland over the period 1970 to 2005 was 6.1 per cent.

  Before Honohan became governor of the Irish Central Bank, he said in a paper called ‘What Went Wrong in Ireland?’ (written for the World Bank in May 2009), that growth in Ireland up to 2000 had been on a secure, export-led basis, underpinned by wage restraint. However, from about then a property price and construction bubble took hold, which sustained employment and output growth until 2007. Property booms and easy credit were an international phenomenon in the first half of the new century, but Honohan pointed out that the Irish property boom had started much earlier, and lasted longer, than those in surrounding jurisdictions. The three-fold increase in prices in the period 1994–2006 was the highest boom in any advanced economy in recent times. ‘Long before it peaked, it looked unsustainable to most commentary.’ Nevertheless, from 2003 the banks continued to ease loan conditions such as loan-to-value ratios.

  Competitive pressure on the leading banks to protect market share came especially from reckless expansion by one bank, Anglo Irish Bank (whose market share among Irish-controlled retail banks jumped from 3 per cent to 18 per cent in a decade, as it increased its total portfolio by an average of 36 per cent real). Foreign-controlled banks, especially the local subsidiary of HBOS [Bank of Scotland (Ireland)], also contributed.

  For some reason, bank regulation was ‘complacent and permissive’. It failed to impede the growth of Anglo-Irish Bank and allowed the reckless lending practices to spread. By 2006 two-thirds of loans to first-time buyers had loan-to-value ratios of 90 per cent; one-third were getting 100 per cent loans. Banks funded the lending surge with huge borrowings of their own, and increasingly they got the money from abroad. By early 2008 net foreign borrowing by Irish banks had jumped to more than 60 per cent of GDP, having been just 10 per cent in 2003. Although many economists have pointed the finger at the euro as the cause of this, that argument does not stand up to examination, given that banks in many European countries that were not in the currency also borrowed wildly in the international markets. The international markets grew complacent about risk, and money was easily available.

  Blair Horan pointed out that early in the Ahern period the banks began assessing mortgage applications in accordance with affordability and the applicant’s take-home pay. The more conservative measure of two-and-a-half times salary was abandoned. This meant that each cut in income tax by the Government fed directly into house prices. It also meant that when tax rates had to be increased later, the borrowers were put under increased strain just as the economic circumstances they were operating in were deteriorating.

  The huge borrowing abroad by the banks went largely unnoticed in public debate. However, the price of property, the scale of the construction sector and the loss of international competitiveness were all factors remarked on by serious domestic and international economists from 2004 on. Given that ther
e was so much concern about the reality of the values being ascribed to housing and property generally, the banks’ views on loan-to-value ratios are all the more bizarre. The combination of high property prices, high loan-to-value ratios and short-term foreign borrowing by the banks was to prove calamitous for the Irish public. During the boom years the Government had rapidly reduced the national debt and also put large amounts of money into the National Pension Reserve Fund, which was created by McCreevy in 2001 to help pay social welfare benefits and public-service pensions from 2025. However, in the first decade of the new century private-sector Ireland was creating a pile of foreign debt that would in time, through the Government’s handling of the banking crisis, be converted into public debt and so undo the debt reduction that had occurred over the previous period.

  The general Government debt as a percentage of GDP stood at 95 per cent in 1993 but dropped to 74 per cent by 1997, 36 per cent by 2001 and 25 per cent by 2006. This was well below the European average and was one of the indicators used at the time, when many commentators stated that Ireland was one of the euro zone’s healthiest economies. By 2011 its debt-to-GDP ratio was back at the level of the late 1980s.

  It was not just house-buyers who were finding it easy to get money. Money was being handed out with gay abandon to an increasing number of people involved in property investment, speculation and development. For example, Bernard McNamara, a developer and former Fianna Fáil councillor in Co. Clare, appears to have gone on a spending spree funded by the banks in the later, most overblown years of the property boom. Originally a builder, he became heavily involved in a range of deals, usually in partnerships with other developers and investors. McNamara was involved in the purchase of a €416 million site in Ringsend in 2006, one of the largest transactions of the boom and one that turned a cash-rich Dublin Docklands Development Authority into a financial basket case. With others he bought the Shelbourne, Conrad, Montrose and Burlington Hotels in Dublin, the Great Southern Hotel in Co. Kerry and the Radisson Hotel in Galway, as well as the Superquinn Group. He was also involved in an elaborate scheme of purchasing property between Grafton Street and South Great George’s Street in Dublin with a view to building a new link between the two. A financial services firm that investigated McNamara’s affairs in 2009 estimated that he had borrowed more than €1.4 billion in the period since 2005.

  When the downturn came there was little surprise among those who were concerned with such matters that Anglo-Irish Bank and Irish Nationwide had been involved in a spectacular level of recklessness. Banking literature stipulates a limited number of classic reasons for bank failures, among which are the presence of a dominant individual within the institution and above-average rates of growth. Anglo-Irish had Seán FitzPatrick, a chief executive who went on to become chairman, against all rules of best practice. Nationwide had Michael Fingleton, a man who appears to have run the supposed building society as a personal fiefdom since the 1980s.

  Among the professions that got involved in property investment were the bankers themselves. Some senior executives and members of bank boards invested heavily in property and property development at the height of the bubble. Fingleton and FitzPatrick were serial investors. Some senior executives in different banks went into business together. John Hughes, head of business banking with AIB in Eyre Square, Galway, developed a substantial property portfolio in Galway with Tom Browne, a one-time contender for the top job at Anglo-Irish Bank and the head of Irish operations with that bank up to 2007. The properties included a substantial Galway office property built by McNamara where their tenants included the state. Hughes also had property dealings with Tommy Hopkins, a senior executive with AIB Bankcentre, Dublin. Their company, Banagher Investments Ltd, took out mortgages from Anglo-Irish on property in Stoneybatter, Dublin. Hughes was involved in property dealings in partnership with Galway businessmen who separately banked with AIB in Galway. When everything fell apart for McNamara he gave an interview to Mary Wilson on RTE radio’s ‘Drivetime’ in which he said that during the boom years the banks ‘sought out’ people like him.

  The level of reckless lending by AIB, one of the largest and most successful commercial institutions in Ireland, came as more of a shock to observers. It emerged that the bank, under the chairmanship of Dermot Gleeson sc, a former Attorney-General, had become concerned about the growth of Anglo-Irish and what it perceived to be the taking of its natural clients. A drive was initiated to win back many of the developers who had moved to Anglo-Irish, and in this effort to attract these customers the bank lowered its banking standards. It did so just as the bubble was about to burst, and the disastrous policies pursued resulted in the bank coming under majority state ownership. These developments involved an enormous loss of wealth for the banks’ shareholders and, eventually, for the population generally.

  At the core of the whole disaster was the astonishing failures of those who were charged with regulating the banks. Brian Patterson, who accepted a request from McCreevy and Harney to be the first chairperson of the Financial Regulatory Authority, which he chaired until 2008, later told RTE that the focus was very much on consumer protection and that insufficient attention was given to the robustness of the banks, because the idea that they might fail seemed outlandish. The chief executive of the authority during the bubble years was Pat Neary. What is clear is that the regulator knew about the reduction in lending standards, the greater reliance on property business and the increased borrowing from abroad.

  An interesting aspect of the whole affair is the way Michael Fingleton was left in de facto sole control of a financial institution. It was known that people could approach him and that he could personally approve a loan. Many business journalists over the years did so, especially back in the 1980s and early 1990s when it was difficult to secure a mortgage. Fingleton usually charged a high rate. It appears that his powerful position within Irish Nationwide was generally recognised in the political world also. Michael Lowry gave evidence to the Moriarty Tribunal about going to Fingleton when he was a Government minister in the mid-1990s and getting immediate approval for a 100 per cent loan on a house in Blackrock, Co. Dublin. In September 2006 McCreevy and his wife, Noeleen, were given a €1.6 million loan to buy a property valued on the Irish Nationwide files at €1.5 million. The property was in the K Club golf resort in Co. Kildare. Irish Nationwide documents later seen by Simon Carswell of the Irish Times showed that the loan was an interest-only one and was granted nine days before the Ryder Cup competition on the club grounds. A Fianna Fáil senator and former chairperson of Monaghan County Council, Francie O’Brien, borrowed millions from Irish Nationwide for his investment dealings. Fingleton was involved in approving the loans even though he personally later got involved in business dealings with O’Brien. Fingleton and O’Brien, along with two others, borrowed €13 million from Ulster Bank to buy fifty acres in Co. Cavan, near the border with Co. Monaghan, on which they hoped to build houses. When the Mahon Tribunal began inquiring in 2008 into the house in Phibsborough that Celia Larkin had bought in 1993 using money from the B/T account, Fingleton personally authorised the fast-track loan for €40,000 that Larkin used to repay the money she had been given to buy the house.

  One way of getting a handle on the scale of the economic mismanagement in the bubble years is to consider taxation. By 2007 stamp duty was accounting for €3.2 billion of the €47.3 billion taken in by the exchequer in taxes. A large amount of the VAT, income tax and capital gains tax going into the exchequer was also coming from the property sector. This inflow of tax money allowed for the reduction in income tax rates and the exclusion of many workers from the income tax system at the same time as the Government oversaw a rapid increase in public-sector expenditure. When the property bubble collapsed a lot of the tax take went with it. Stamp duty fell by two-thirds, to €1 billion by 2009. VAT, which was €14.5 billion in 2007, fell to €10.6 billion two years later. Capital gains fell from €3.1 billion to €500,000. A large amount of the fall in i
ncome tax also arose from the collapse of the construction and property sector. The state found itself trying to deal with the colossal losses of the banking sector while also facing the challenge created by a huge hole in the public finances.

  People had borrowed from the banks to buy housing or invest in property development and, when doing so, had factored in the cost of stamp duty and other taxes. This meant that a significant amount of the tax take during the bubble years came from people who had borrowed the money from banks that in turn had borrowed it abroad. When the market collapsed and people found themselves with debts that exceeded the value of their assets, the strain of dealing with the situation was added to by the need of the state to increase taxation. The excesses of the bubble years were literally being paid for in its wake.

  By late 2010 the state could no longer borrow abroad and had to seek recourse to the EU and the IMF. The mismanagement of the economy by the Ahern Governments was such that Ireland’s economic sovereignty had to be in part conceded.

  Prof. Laffan was on the board of the NESC during the period of the second Ahern Government.

  We produced a report on housing, and I sat through the discussions on housing week after week, because it takes months for a report to get through the system. Peter Bacon was there at the time. John FitzGerald. The whole issue was about affordability. No-one actually said, ‘Is there something going wrong here?’

  The report was published in December 2004. Laffan remained on the NESC board right through the heart of the bubble years. There was a lot of conversation about land speculation and what to do about windfall profits, but no-one mentioned the possibility that the size and rate of growth of the property sector might contain a danger for the banks.