Ethics and regulation: complements, not alternatives

Last week former Taoiseach and President of IFSC Ireland, John Bruton, said that the banking industry needed "to focus on ethics rather than regulation". As someone who strongly supports the idea of ethical codes and a more central role for ethics in business, I found this remark and the casual way it was accepted unhelpful on many levels. Ethics are not an alternative to regulation; rather regulation is needed to support ethical behaviour. 

First, what do we mean by ethics in business?  There are many approaches; to illustrate why ethics are not an alternative to regulation, consider just three. 

You can take a deontological approach, like that that of most religions, and impose an absolute moral code.  Something is either right or it is wrong, no exceptions. You can see aspects of this in some corporate codes of conduct: some things such as fraud, insider trading or forced labour are simply prohibited, regardless of the consequences at the time. These things are unethical – everything else is OK. Because of the inflexibility of prohibiting an action, the list tends to be a short one, and not very useful for complex “grey area” situations. 

In contrast, a utilitarian or consequentialist approach hinges on the idea that the morality of any action is completely determined by its consequences.  So in its purest form, faced with a decision, you could weigh up the impact on all parties and choose the course of action that minimises harm or maximises good. So while stealing might be “wrong” under a deontological approach, utilitarian ethics might allow it under some circumstances, such as the theft of food from a profitable business to save the life of a starving child. This is pragmatic and useful, but depends on the person making the decision having been really well trained; unless business schools and professional institutes put serious weight behind teaching the process of ethical decision-making, it is unreasonable to expect individual employees to respond in the best possible way when making snap decisions in a fast-moving and high-pressure environment.   

As a final example, a virtue-based approach to ethics comes from Aristotle’s ideas of how to be, rather than what to do.  A decision on a particular situation could be reached by asking, “Am I the sort of person who would ...?” or, “Are we the sort of organisation that ..?” This can work really well for individuals, but won’t work in business unless everyone in the organisation is aware of and supports the sorts of virtues or values that the firm as a whole espouses.  Since these values are not based on rules, they must be embodied by the leaders within the organisation – a kind of ethical role-modelling which be either positive or negative, depending on who’s in charge and how they behave. 

Now the question is: which of these approaches, bearing in mind that they are only three of a myriad of ways of describing and understanding business ethics, could credibly act as an alternative to regulation in an industry as cut-throat and prone to moral hazard as banking? 

The absolute moral code of deontological ethics is barely compatible with capitalism, and would be either limited or diluted by its application to profit-seeking financial innovation. The utilitarian approach is pragmatic but time-consuming, and depends heavily on training. Virtue-based ethics comes close to a personal ideal, but depends on individuals to an unsustainable degree.   

They are all good to have in an industry, but will never work alone.

The trouble with ethics in isolation is that unless they seem coherent with the overall climate in which an individual is working, he or she will lack the confidence to “do the right thing” even where the “right thing” is clear.  I might know that stealing is wrong, for example, but if all of my peers are routinely cleaning out the stationery cupboard and falsifying expense claims, then my personal belief is constantly challenged by the daily experience. This is where regulation – clear rules of law with penalties and consequences for non-compliance – will support ethical standards, reinforcing rather than replacing them.  

Of course regulation also has the happy advantage of being effective even for people who would never embrace an ethical code. Even sociopaths fear the law. In that sense, regulation has a wider impact than business ethics, and is a baseline if we are to expect better corporate behaviour. Without punishments, some people will never obey rules.  But most employees are not sociopaths, so training in ethical decision-making will also have a useful effect, enhancing the impact of regulation, and ensuring that it is implemented in spirit as well as in statute. 

What the industry needs is not "to focus on ethics rather than regulation," but to enforce regulation and resource ethical training. Then we might see the change we need. 

Sheila Killian

@islandtotheleft

What's a Euro anyway?

Is a euro in a Cypriot bank, locked down by withdrawal limits and capital controls, the same as a euro in an Irish or French bank? 

Is a euro sitting in, say, a payroll account in Laiki with a balance of more than €100,000 (and subject to an unspecified “haircut” on Thursday ) the same an “Irish euro”?

They’re both euro, both promises to pay the bearer, but honestly, do you have a preference? Of course you do. You’d prefer your money to be outside Cyprus. You’d prefer an Irish euro to a Cypriot one. So they’re not the same. Do we even have a single currency now, then? What does the Euro mean?

And how did this happen? At least in part, it happened because all the finance ministers of the Eurozone sat around earlier this month and let the Cypriots leave the room with a proposal to make depositors pay for bank losses, including insured depositors with balances of less than €100,000. They rowed back on that part, but you can’t undo the damage of their having taken it seriously to begin with.  Imagine a snowed-in family just once agreeing “if we get really hungry, we can eat the rabbit”. You can take that back all you like – everybody knows the rabbit’s not safe any more. He’s not just a pet, he’s protein. Depositors aren’t just protected customers now, they’re also a source of money to save the bank. 

We sat back and let that happen – all the Eurozone countries did. We let deposits in Cyprus undergo that subtle shift in meaning. We let their banks be closed for ages, with devastating impact on small firms and families. We let their tax rate be changed. We let them hang out there, hoping it would save us, the rest of this uneasy union. Where does that leave solidarity, in this European Project under our presidency?

Just now, you’d prefer an Irish euro to a Cypriot one. Remember that feeling, because, as Martin Niemöller might have written were he more interested in money, and living in more peaceful times, “First they came for the Cypriots ...”

Sheila Killian

@islandtotheleft

Guest post by Arthur Doohan: A perp walk for banks

Arthur Doohan: We all had a pleasantly salacious time some days ago watching various white-collar villains being hauled before the courts and given "good talking to's" by our esteemed judiciary. In the vernacular I believe this is referred to as the 'perp walk', where the fourth estate gets to harmlessly indulge our ancient tendencies to 'hue and cry' and 'witchhunt'.

All of which amounts to slamming the stable door on a horse whose cantering about the farmyard is still damaging this economy. Bad bankers and banking has caused huge current problems for everyone in the state. The same problems are afflicting most of the developed economies concurrently and concertedly.

Banking has seldom been an asset to the state or the economy in Ireland. It has had just as poor a history of labour disputes as other sectors and it has been sufficiently unfriendly to enterprise and innovation that the state has had to set up its own banks and to establish the global model for government agencies to stimulate investment, both foreign and domestic. And all this while the banks demanded the same privileges that obtained elsewhere such as depositor guarantees and light touch regulation.

So, if we are to avoid more of the same from our banks and to help us get out of this morass, I would ask you to consider a " 'purp' walk" for banking, that is, let us take out for a stroll the notion of the 'purpose' of banking. Specifically, what are banks for, what have they actually been doing, what are they doing now and what should they be doing in the future.

What we have
We, currently, have what are called 'universal banks', that is, they do 'everything' with respect to money and quite a few other things beside. Our banks borrow money, lend money, move money, convert money, 'invest' money and advise on all of the foregoing. For all of these services they charge fees as well as potentially profiting from 'exposures' or risk taking we inadvertently allow them to enter into with our money. About the only thing they don't do is print the damn stuff, despite what some 'theorists' will tell you.

This concentration of business models into a single conglomerate is a historic accident rather than a strategic decision. It is an accident waiting to happen which it does, repeatedly, as the history of banking shows. Further, it is an 'accident' that disregards the prudential structures that exist in all other financial markets.

Nowhere else are the risk takers allowed operate the risk transfer mechanism. In plain English, in every other financial market in the entire planet either there is an 'Exchange' which is an independent entity that carries no risk or risk transfer is done multilaterally from each to each other. Only in banking are the handful of big players, who carry the most risk, allowed to operate the 'clearing system'.

Out of this strategic oversight grows the risk that allows politicians to frighten us with threats of ATM shut downs and failures to pay wages and the like. The recent systemic problems at RBS/NatWest/Ulster have shown us that the 'clearing banks' are prone to failings in this.

There is, also, an embedded conflict of interest in the fact that banks are allowed to charge 'advice fees' for selling products that they will make profits on. Is there any legislation or regulation that forces bank officials to advise clients of their competitors products or services? If there is, I assume, it is 'enforced' to the usual standard of the Irish fiduciary authorities, says he pulling his lower eyelid to the floor….

A further issue is that its 'risk management tools' (derivatives principally) and risk transfer methodology (securitisation mainly) have proven to be ineffective and actually dangerous in many cases.

Added to all of this is a star system of employment leading overpayment for what amounts rewarding people for lucky gambling outcomes and encouraging doubling up of both good and bad bets.

Lastly, our banks insist on being given a Government guarantee for their 'raw material' (our deposits) so that they don't have to take responsibility for their profligacy. This exposes us to their 'moral hazard' and gives them a free embedded option, known, on Wall St., as the "trader's put" (the trader can 'put' you into trouble but walk away untouched himself). It has been amusing to watch them turn the notion of 'moral hazard' on its head in refusing to allow borrowers some relief from the bankers mistakes while they refuse to deal with their own moral bankruptcy; amusing in a very frustrating way, that is.

So, clearly, banking is a mess but our Government is in thrall to it even if the people no longer are. Clearly, also, it has been a mess for a very long time.

It is structurally unsound, overly complicated, morally deficient, professionally conflicted, technically overreaching and given to self-indulgent excess. In parenting terms, it's a spoilt child with a cocaine habit driving the family car.….with the family on board.

What we need
Anybody can lend money to anyone else and they can charge interest for it? So, why do we lend our money to bankers rather than directly to businesses or housebuyers? On the continent people do that, they buy bonds of (lend money to) businesses and housing associations they know. Yes, they have banks as well but 1) "not so much" and 2) "not so big".

In the 'Anglo-Saxon' world of business practice that we Irish have adopted by default (a word we must judiciously use), we do have a share buying culture but not a bond buying one. We use our banks as risk diversification mechanisms for our prudential investment strategy. That is, we let the bank manager invest our money in a pool of loans and we take a reduced return in exchange for a heretofore presumed safe one.

We need to preserve this function in banking and that is the only thing we need to keep.

Getting from here to there
Domestically, we have been witnesses to Lenihan's and Noonan's 'Frankenstein-ian' misadventures in attempting to create a viable banking system by assembling bits of dead institutions into facsimiles of living ones. Even the nomenclature of 'pillar banks' has been unfortunate in that instead of being strong and supportive they are seen as immobile, hard and old-fashioned.

Contrary to the assertions of those 'on the take' from the system, neither the Guarantee, the recapitalisations, NAMA or any other of the fudged reforms has created any institution capable of advancing new credit; as the closures, redundancies and shrinking debt levels attest.

Internationally, we have only seen the Vicker's Commission in the UK consider any changes to the structure and nature of banking. The concept of 'ringfencing' has a pleasant and well-meaning 'ring' to it but it has not been shown to be either 'organic' or concretely implementable. Further, the seven year implementation timetable seems unnecessarily long for such minor reforms and seems designed to allow for a sustained lobbying process to water down the provisions which has already got under way and already has the support of the Chancellor. Fortunately, the latest wave of scandals seems likely to consign Vickers to the dustbin of inadequacy and irrelevancy.

So, having dispensed with the current situation without reference to the classic Kerryman's 'directions' joke, we have to ask what road do we take to get to a stable safe banking system.

The prescription
There was nothing wrong with 'Glass-Steagall' apart from bankers not liking it which in itself seems a sufficient reason for bringing it back. The implied principle of having separate and single 'business lines' for operations with fiduciary duties would seem a sensible one and should be extended to the fullest degree. It would make real the concept of 'ringfencing'.

This would imply the creation of a utility clearing mechanism divested from the banks. If it was good enough for the gas and electricity networks here and abroad I don't see why it doesn't apply to the banks.

It would also imply the divestiture of the banks credit card businesses. Again, there is no reason why not to and there is no good reason why we should be tolerating financial 'conglomerates'. People already hold multiple cards from multiple operators, some of which are not bank affiliates and the banks already pool credit data into separate agencies to determine credit ratings. A further advantage to separating these 'business lines' is that the credit card system is in itself a form of clearing system and if completely independent of the banks would give a strength in depth through redundancy to the economy's need for payment clearing mechanisms.

Lastly, the banks should not be allowed to dispense advice for which they charge fees which puts them into conflicts of interest. This is the same objection in principle as saying that 'audit' and 'consultancy' should not be provided to businesses by the same firms.

For those who wish to cavil about the expense implied in these reforms, I can only point to the expense we are all being put to by not having these reforms and ask which you would rather go through again.

This leaves us with the problem of morally hazardous bankers. The operational difficulty is that we 'guarantee' the deposits but the problems come from the loans. How can one guarantee the loans? You can't in practice. What you can do in practice is constrain the guaranteed banks from lending offshore.

A particular problem with the Irish banking crisis was that German and British fundmanagers seeking higher yields lent money into Irish banks who lent it to their pet developers to overpay for German shopping malls and British hotels. It has not been explained why it is the moral duty of the Irish taxpayer to compensate these 'professionals' for their greedy mistakes. I understand why the Irish must pay for the hotels and shopping malls built in Ireland but I do not see why we are liable for those bought elsewhere.

I am not suggesting that banks should not be free to lend overseas…only that they should do it via distinct legal entities and that these should not be guaranteed by the State. If the bankers complain that the won't be able to do business overseas that is their problem not that of the State or its taxpayers.

In order to square the circle of competition and robustness and redundancy, I would want to see the 'mutual' sector restored to a position of health and strength. This could be done in many ways but perhaps the simplest would be to merge the EBS and PTSB and perhaps IL&P to give a fourth 'player' in the credit advance/banking sector.

As a final flourish to wrap up everything in a neat bow tie of robust redundancy, the PostBank should be reconstituted so as to provide a third clearing mechanism.

Conclusions
These reforms would leave us with a GDP appropriate banking industry robust to shocks with enhanced transparency and competition.

If the bankers say that they will be 'hamstrung', I say that they have 'hamstrung' the whole economy and that they should get used to suffering like the rest of us.

The Irish economy and the Irish people need working banks much more than it needs Irish owned banks and we need banks that won't get too big for our boots.

There is a quiet discussion being held right now in the Dept of Finance about the future shape of banking in Ireland. In that 'discussion' the civil servants are responding 'how high?' when the banks talk, in exactly the same way they did when the banks rewrote our bankruptcy legislation. We need to tell our politicians to get involved in that discussion and if they won't then we should get involved in it directly.

Recap
Those reforms in bullet form are;
- Create a utility clearing function to separate credit risk from payment transmission.
- Create single business line banks by divesting credit card businesses
- Forbid advice fees
- Remove the 'deposit guarantee' from funds lent overseas
- Reconstitute a fourth major lender from the old 'mutual' entities
- Reconstitute the PostBank

This is an edited version of a post which originally appeared on Arthur Doohan's blog

Guest post by Arthur Doohan: Don't complain - start repairing LIBOR

Arthur Doohan:LIBOR ‘structurally flawed’ says the ‘Fed’....

Power corrupts...even a little power corrupts quite a lot...as we have seen, down the millennia and at home and abroad. Expressing disgust at traders attempting to manipulate (and I stress the ‘attempting’) rates in their favour is as false and vacuous as expressing surprise at a shark attack or a pitbull bite.

The moral vacuum of having profit as an only goal and a highly linear and transparent process for achieving that target would affect anyone, and as the ‘Zimbardo prison experiment’ has shown most people are pliable in the appropriate environment. That the environment was as biased and extreme as having a cohort of young males of a very particular class and education only exacerbated the risks and tendencies for extreme behaviour. I am not condoning their behaviour. I am saying that it is a completely predictable byproduct of the system as it was designed.

LIBOR didn’t break,the market did and blaming LIBOR is very much like shooting the messenger. And ‘shooting the messenger’ and indulging in ‘distracting defenestrations’ of flamboyant CEOs is very much what the authorities and regulators are entirely about these days. They very much want you to believe that it was individual greed and corruption that is to blame for the mess we are in. What they don’t want you doing is questioning their ability and integrity. And above all, they don’t want you questioning the utility and value of the system that provides their ‘raison d’etre’.

If you need any further evidence, I would ask to you to witness the embarrassment of Charles Goodhart, formerly of the Bank of England, on the ‘Today’ programme on BBC R4 on Tuesday 17th July, 2012 admitting that the market was still dysfunctional and that when the crisis broke 'LIBOR fell between the cracks’. The regulators weren’t even looking at LIBOR, the flagship of liquidity and transparency in their ‘light touch’ dreamscape.

If there was no market during the height of the crisis (and there wasn’t and still now it is a shadow of its former self) then the regulators are as guilty for accepting ‘lies’ they knew to be such as the banks are for trying to tell those ‘lies’. But, in the same way the Catholic Church sought to cover up child sex abuse to protect its reputation, the financial regulators preferred to sought to hide the scale of the dysfunction to preserve the myth of ‘market capitalism’ and thereby the need for regulation of it.

We are quickly learning how easily we can live without the ‘universal church of Rome’. I think it is time to understand that ‘universal banking’ is as much an entirely predictable perversion of capitalism as ‘child abuse’ was a predictable outcome of the structures and strictures of Catholicism. Neither are good for the people they claim to serve, both have been perverted to suit the ‘operators’.The ‘Fed’ is the Federal Reserve Bank, the central bank of the USA. It and the Securities Exchange Commission and their UK counterparts, the Bank of England and the Financial Services Authority are the authorities charged by their governments to oversee and develop their national financial and capital markets.

Since the end of the Bretton Woods agreement and the subsequent lifting of capital controls this work has taken on greater levels of international coordination and cooperation.

Arising from the rigour of American tax law enforcement, in the 1970s the newly dollar-enriched oil exporting states found it more expedient to place their dollars on deposit in the Cayman Islands but to transact their business in London, due to a far greater extent to their trust in English courts than their admiration for London bankers. Thus was borne the original ‘Eurodollar’ and ‘Eurobond’ markets.

LIBOR predated this accidental flowering into a second coming for a post-imperial City of London as a major financial center. It had existed for a few decades by this stage. The volumes dependent on LIBOR settings went on an exponential growth binge, which accelerated even harder with the advent of the personal computer which allowed for the rapid and accurate pricing of derivatives.

Yet, despite all of the computerisation and all of the enhanced communications facilities and capablities that followed this boom in volumes and profitablity, LIBOR continued in its accustomed fashion as an honour-based voice-reported system with no formal legal standing, other than that which contracting parties chose to endow it with, and with no mechanism for appeal or redress.

Once again, it must be stressed that LIBOR is a private convention entered into by contracting parties utilising an unpaid-for voluntary service provided by a lobbying organisation. It is to the credit of the British Bankers Association that they did develop the system with expanded panels, greater outlier discounting and some level of historic transparency.

But for over sixty years the two globally most important sets of regulators looked at this private piece of ‘plumbing’ and decided on a daily basis that it was a suitable vehicle for pricing the underpinnings of all of the derivatives and the majority of the wholesale lending that they were charged with regulating.

And, now, they have the cheek to say that it is a “flawed mechanism”.

That the authorities are seeking to distract us from their failures with individual tales of venality and spectacular defenestrations is the true measure of their moral and practical failure and further proof that have no long term interest in reforming themselves or their systems
Arthur Doohan blogs here

Guest post by Arthur Doohan: The facts about LIBOR

Arthur Doohan: Personally, I love a good conspiracy theory even though most of them can’t take a rinse let alone a serious ‘spin-cycle’. But matters take on a different colour when the conspiracy theory feeds a hysteria that turns people into a lynch mob.

Much of the nonsense currently in the air about ‘LIBOR’ and attempts to manipulate it for personal gain is destructive, dangerous and will leave everyone feeling foolish and looking incompetent, which, no doubt, many are but it does neither them nor us much good to have the mask of dispassionate professionalism slip so far and reveal so much.

Let us start with a few facts and inconvenient truths.

The British Bankers Association which runs the ‘LIBOR fixings’ system is a private trade representation or lobby group. ‘LIBOR’ is not part of any legislatively enacted or governmentally sponsored program. ‘LIBOR’ is a bankers convention, created by bankers for their own and their counterparties convenience. ‘EurIBOR’ is the same thing but run by the European Bankers Federation. Both systems are operated by the so far un-impeached agency of Thomson-Reuters on behalf the sponsors. If someone created a better one (and several have tried) the world and its market-makers are free to move to it. It is a banker’s shorthand that for decades was a core component of the transparency and efficiency that made London such a global financial centre. It predates derivatives all types apart from options....

I do not seek to defend bankers or their practices. I personally left investment bank trading because I found it to be morally corrosive and no longer wished to be a ‘professional gambler with other people’s money’. But we are not going understand the mess we are in with ‘universal banking’ and hyper-liquid trading of assets, real or imaginary (sorry, that should be ‘derived’...) unless we ascertain the facts. As a former ‘LIBOR submitter’ and derivatives trader there are a few facts that need emphasising. Otherwise, the authorities and politicians will once again be in error as to the real problem and, as usual, with mis-diagnoses end up prescribing the wrong treatments.

Here’s another inconvenient truth.

It has not been proven that any submissions by Barclays to the BBA LIBOR panel have materially influenced the setting of a single rate on a single day to the demonstrable cost of any borrower or derivative counterparty.

Read that again.

It has not been proven that any submissions by Barclays to the BBA LIBOR panel have materially influenced the setting of a single rate on a single day to the demonstrable cost of any borrower or derivative counterparty.

Yes. That is the truth. I do not doubt that if they could have, the traders would have manipulated LIBOR for gain but it has not been shown that they did.

Here’s some others.

The FSA ‘final notice' to Barclays admits only that there was a ‘risk’ that the integrity of the ‘LIBOR’ settings would be compromised.

The fine is a number plucked from thin air and has no material basis of calculation against any putative gain arising from malfeasance on Barclay’s part because it would not be possible establish such a figure.

Some of the evidence is inconsistent, such as asking for submissions that were so skewed that they would not be included in the calculation. What evidence there is shows that submissions were ‘manipulated’ by the startling amount of 1 one-hundreth of a per cent. In one paragraph there is a request for a ‘low submission’ when the trader states that they are ‘long’ the asset class in question, which is nonsensical in that they are asking to have a lower return on something they have a lot of.

Some further facts to bear in mind.

These rates are for borrowings and derivatives only. They have no direct impact on deposit rates. Further, they have no direct impact on borrowing for mortgages, personal finance and small businesses which are set under different criteria and adjusted less frequently.

Lastly, given the commonly complained of reality that most derivative trading is a ‘casino’ indulged in by banks exclusively then for every ‘big boy’ with a ‘long position’ there must be another ‘big boy’ with the equivalent ‘short’ whose preference will be for the submissions and consequent settings to be the opposite way round.

This is why the system discounts the extremes and takes an average of the remainder.

There is a further long section of the ‘final notice’ that is concerned with Barclay’s behaviour during the ‘liquidity crunch’, the intense phase of the crisis when there was, in the FSA’s own words, ‘ a virtual standstill’ in the money markets, ie there was no market.

At a time when the markets were dysfunctional arising from over a decade’s worth of ‘light touch regulation’ the regulator now fines Barclays over the ‘truthiness’ of its quotes at a time when other regulators and authorities were in dialogue with Barclays for a percieved excess of ‘truthiness’ in those same quotes, which ‘truthiness’ was embarassing the authorities who wished to pretend to the electorate and populace that the crisis was less severe than it actually was.

The FSA did fine Barclays for breaches of FSA rules with respect to Barclays internal procedures in the conduct of FSA regulated business and it is entitled to do so. I don’t approve of trader’s trying to ‘game’ the system but that’s akin to complaining about cats catching mice.

Barclays suffered less trauma and imposed no burden on the taxpayer arising from the crisis and made an effort to be honest at a time when others were actively promoting fictions.

In simple English, you were being lied to by a bunch of banks about the seriousness of the crisis and the authorities are now seeking to punish them for a ‘story’ the authorities took an active hand in promoting and managing and they have started this ‘show trial’ with the bank that told the smallest lies.

There have been misjudgements aplenty by all concerned; Barclays, BoE, FSA, other banks, media and lots of people wanting to blame bankers for all our problems.

I don’t understand why Barclays did not resist this penalty more vigourously. I suspect that they wanted the annoying pompous gnat of the FSA to go away, that they wanted to subscribe to and support the fiction that FSA and other regulators are ‘in charge’ and that the cost would be less to them than to the other more guilty parties, whose fines and ‘final notices’ will be made public shortly.

I don’t think they or the authorities anticipated the degree of public reaction to this story. The fact that Barclays admitted the facts and collaborated with authorities meant that their story came out first and made them the public focus. Getting a ‘rebate’ on the fine only incensed the public further as opposed to the probable intent of rewarding Barclays and promoting them for ‘good citizenship’.

True to form, once the politicians saw the ‘mob’ forming, they egged them on rather than trying to stand up for generality, due process and principle.

The eggs are still flying....there’s going to be a hell of a mess, especially on the politicians faces.

Just remember this.

No one has shown that any class of citizen or consumer has suffered a material loss from the least egregious attempts at manipulating a purely private ‘contraption’ that forms a part of the ‘plumbing’ of the financial ‘casino’ at a time when the ‘casino’ was broken and all the ‘players’ were doing the same thing.

Finally, ‘LIBOR’ is a child of an information poor age. In a time before computers and when global communications were expensive and when banking and finance were a less central and fascinating business, a ‘shorthand’ was required in order to ‘benchmark’ loans. That the system was trusted for so long is a testament to its simple elegance. But in an age of ‘big data’ and cheap communications and financial crisis organising a robust, verifiable and real LIBOR should be a trivial exercise.

I suggest we focus on making the system work for the equal benefit of all rather fixing the blame, of which there is plenty to go around.

Arthur Doohan is a former banker currently promoting a public policy debate on alternative solutions to the debt crisis in Ireland and to bank restructuring.

Guest post by Martin O'Dea: A simple suggestion

Martin O'Dea: Forgetting banking debt and its link to sovereign debt and resolutions required around this issue and just dealing with excessive sovereign debt, if I might. Can blocks of sovereign debt, instead of just being subsumed into Euro Bonds, not be reconstituted so that they create some of what the fiscal treaty was attempting in terms of structural balance? In other words, could sovereign debt above perhaps 80% not be repaid (interest on same etc) until the country is running a current surplus? As the country's surplus increases the amount of repayment correspondingly goes up. The design would need to be long-term and equitable in its nature but should also leverage a short-term mechanism to bring sovereigns back from the brink of default and allow current deficits be addressed without the markets focusing on sovereign default potentials.

Draft heads of Personal Insolvency Bill out today- at long last!

Marie Sherlock: The long awaited heads of the Draft Personal Insolvency Bill was published today and at first glance, there is much to welcome.

For too long Ireland has stood far behind most other advanced industrial countries in not having a non-judicial framework in place to address contemporary problems of over- indebtedness, but Ireland will now move ahead of the curve by including not only unsecured, but also secured, typically mortgage debt in the new debt settlement institution. The problem of addressing the debt overhang problem could only ever be achieved by adopting a holistic approach to all forms of debt currently borne by Irish households, and I’m glad to say that today’s draft is a vital first step in the right direction.

There are three new forms of non-judicial debt resolution proposed (i) debt relief certificates to cater for unsecured debt under €20,000, (ii) debt settlement arrangements to cater for unsecured debts over the value of €20,001 and (iii) personal insolvency arrangements which will cover unsecured and secured debt up to a value of €3m.

Ultimately, it would seem that the success or failure of the non-judicial system to function as a less costly, more effective and more humane system for dealing with the problem of over-indebtedness in this country, will rest on five key measures.

The first is that debtors wishing to enter a non-judicial process will have access to appropriate advice and representation. The draft bill sets out clear guidelines for each of the three debt resolution processes on how the intermediary (for the debt relief certificate) or personal insolvency trustee (for the debt settlement and personal insolvency arrangements) will advise the debtors and mediate in the debt resolution process.

The only concern is that debtors should not be saddled with excessive costs for this service, but the draft bill states that other the initial fee, the debtor will not have to bear the costs of the process. There is some mention that the Insolvency service will “recover costs”, but does not state from whom. I would firmly share the view of the Law Reform Commission which was set out in their 2010 Report on Personal Debt Management in Ireland that the State should not be made bear these costs (for a task that if the Banks were doing correctly, there would be no need for these new processes) and that the creditors should be held liable.

The second key measure will be the success in forcing the banks to the negotiating table. There is some concern that the banks have an effective veto over their participation- the personal insolvency process depends on the agreement of 75% of “secured” creditors- which is typically the mortgage lender. Given what we know about the practises of some lenders in this country and that some 50% of those mortgages in arrears are with banks outside the “covered” institutions, there is a danger that some mortgage lenders will not engage. However it must also be noted that failure to participate in the non judicial process will be factored into consideration in the awarding of costs if a bankruptcy petition goes to the Courts.

The third measure is that a decent minimum level of income must be established for households who enter any of the three non judicial processes and to its credit the draft heads of Bill is very clear on this. But the detail has yet to be ironed out and will be set out by way of ministerial regulation. Imposing a new repayment schedule in a debt settlement/insolvency arrangement should not have the effect of forcing more households into a dependence on social welfare. Already, we have seen that the availability of the mortgage interest supplement has become an implicit subsidy to the Banks, while helping households’ repay some of their mortgage. The Social welfare system and the State must not be made take on any more of the costs of resolving the problems of the banks.

Fourthly, keeping people in their homes, where it is viable to do so will be a key measure of success, so that additional pressure in not loaded on an already over-subscribed social housing waiting list. Remember that as of the end of September 2011, over one in eight mortgages held in this country were either in arrears or had pre-empted arrears by restructuring the mortgage schedule or payment. Personal insolvency will not necessarily result in an individual having to surrender their home and the Bill details how the recommendations of the Keane report on mortgage arrears published last October, must be considered as part of the range of options for the debtor in terms of split mortgages, mortgage to rent and trade down mortgages, even though these proposals are not without their problems in terms of broad assumptions on rising incomes and increasing house values.

In terms of the balance sheet implications for the banks, the draft heads of bill specifies that no write down can be below the current value of the security, so if the bottom up stress testing exercise undertaken by Blackrock was done correctly last Spring, then the corresponding negative impact of a write down on the Bank’s balance sheet should be limited to the rolled up and future interest payments.

On a final note, this legislation has been long overdue but support for its introduction has taken time to gain traction and support, with plenty of doomsayers talking up the risks of moral hazard. Indeed, I remember sometime in late 2008 doing an radio debate against a certain economics professor from NUIG before he took up the role of Special Adviser to the Minister for Finance and was dismissed out of hand when putting forward our (hardly radical) proposals for distressed mortgage holders! But back to the draft heads of Bill, provision has been made for reform of the judicial bankruptcy procedures with the reduction in the discharge period from 12years down to 3years which opens up a significant difference in the discharge period between the judicial and non judicial procedures. Non judicial personal insolvency has a discharge period of 6-7 years. The terms of discharge for a bankrupt appear to be much more onerous, with 50% of all preferential creditors to be paid and a possible extension of the discharge period out to 8 years.

On a superficial level, the lack of a level playing pitch between the discharge periods for these two processes may appear unjust to a public dissatisfied with the pace in which delinquent bankers are being pursued and uneasy about salaries of €200,000 paid to developers co-operating with Nama. The Government will have a significant job to do in communicating its reasons for the distinction.

The data being sent to IMF and EU bodies should be public

Nat O'Connor: The latest IMF report on Ireland has an important annex: Annex 1. Provision of data (pages 81-82), which gives a list of "indicators and reports" that "shall be made available to the staff of the European Commission, the ECB and the IMF by the Irish authorities on a regular basis." A unit within the Department of Finance will "coordinate and collect" the relevant "data and information". (It is an update on a list that formed part of the original agreement with the IMF and EU bodies; pages 33-34 here).

A lot of this data is very valuable for understanding and analysing the Irish economy and the effects of Irish Government policy. It is reasonable for the IMF, EC and ECB to seek this data to monitor Ireland's ability to repay the money we borrowed from them. Indeed, it is valuable to have their expertise on what data is required to monitor our economy and national debt. However, now that this data is being collected, it should as a matter of course be made publicly available within Ireland as well.

For clarity, the entire Annex is repeated at the end of this post. There are 22 sets of data referred to: F1 to F11 are from the Departments of Finance and PER; N1 to N5 are from the NTMA; and C1 to C6 are from the Central Bank.

First of all, it should be noted that some of this data is already available, but the majority of it is not. Secondly, it is not clear that all of the required information will exist at the time when it is supposed to be submitted. Thirdly, it should be acknowledged that there may, in a limited number of cases, be legitimate reasons for not publicly releasing some of these datasets. For general principles on what might be legitimate reasons for not releasing data, I would refer to the guidelines given in the Freedom of Information Act 1997. However, just because the release of some information can be blocked, does not mean that it should be. Certainly, any refusal to publish a dataset should be explained by the relevant Minister to the Oireachtas.

Conversly, as part of the Government's announced reform of the national Budget process, it may well be their intention to publish this sort of data. Its release would certainly help the Oireachtas to hold the Government to account. Access to this data would also probably be necessary for the new Fiscal Advisory Council to be effective.

F6 is an example of good practice in relation to the budget. It requires the publication of revenue and expenditure plans for the next four years. This original requirement helped open up the Budget process and multi-annual budget planning will hopefully become standard practice even once the agreement with the IMF and EU concludes.

Much of the data being required refers to the national debt. The sustainability of Ireland's debt is crucial to whether or not the economy can recover, or whether a prolonged period of stagnation - or indeed some form of default - is inevitable. There are periods in the history of most states when political discourse is dominated by the debt and the deficit. This is certainly the case in Ireland today. There is a pressing need to ensure that this discussion is grounded in accurate facts and figures, and does not lead to wrong information being spread in public.

The implication of F10 is worrying. The data required here is "Assessment report of the management of activation policies and on the outcome of job seekers' search activities and participation in labour market programmes." One one level that is useful data. However, it is not balanced by other data in the list, and may give a distorted picture of the Irish economy. Labour activation is to be welcomed, but priority should be given to ensuring that jobs exist in the first place, before putting pressure on people who are unemployed.

The Government has signalled that we will make use of our crisis by improving our systems of oversight and scrutiny, to make sure that a similar crisis does not happen again. An important step in that direction would be the regular release of these datasets, on a single website, in machine readable format, at the same time (if not before) they are sent to the IMF and EU bodies. For example, the website of the Fiscal Advisory Council could be used for this purpose.

The extent of the national crisis requires the Government to repeatedly ask the public's patience and understanding for the difficult decisions it has to make. But confidence in those decisions is eroded when access to the relevant data on the economy and national debt is denied. Genuine reform of economic and budgetary policy should begin with a new openness in relation to data, including the full set of data currently being sent to the IMF and EU bodies.

...

Annex 1. Provision of data
During the programme, the following indicators and reports shall be made available to the staff of the European Commission, the ECB and the IMF by the Irish authorities on a regular basis. The External Programme Compliance Unit (EPCU) of the Department of Finance will coordinate and collect data and information and forward to all external programme partners.

Ref.
Report
Frequency

To be provided by the Department of Finance in consultation with the Department of Public Expenditure and Reform as appropriate

F.1
Monthly data on adherence to budget targets (Exchequer statement, details on Exchequer revenues and expenditure with information on Social Insurance Fund to follow as soon as practicable).
Monthly, 10 days after the end of each month

F.2
Updated monthly report on the Exchequer Balance and General Government Balance outlook for the remainder of the year which shows transition from the Exchequer Balance to the General Government Balance (using presentation in Table 1 and Table 2A of the EDP notification).
Monthly, 20 days after the end of each month

F.3
Quarterly data on main revenue and expenditure items of local Government.
Quarterly, 90 days after the end of each quarter

F.4
Quarterly data on the public service wage bill, number of employees and average wage (using the presentation of the Pay and Pension Bill with further details on pay and pension costs of local authorities).
Quarterly, 30 days after the end of each quarter

F.5
Quarterly data on general Government accounts, and general Government debt as per the relevant EU regulations on statistics.
Quarterly accrual data, 90 days after the end of each quarter

F.6
Updated annual plans of the general Government balance and its breakdown into revenue and expenditure components for the current year and the following four years, using presentation in the stability programme's standard table on general Government budgetary prospects.
30 days after EDP Notifications

F.7
Data on short- and medium- /long-term debt falling due (all instruments) over the next 36 months (interest and amortisation) for Non-Commercial State Agencies
Quarterly , 30 working days after the end of each quarter

F.8
Data on short- and medium- /long-term debt falling due (all instruments) over the next 36 months (interest and amortisation) for local authorities
Quarterly, 30 working days after the end of each quarter

F.9
Data on short- and medium- /long-term debt falling due (all instruments) over the next 36 months for State- owned commercial enterprises (interest and amortisation)
Quarterly, 30 working days after the end of each quarter

F.10
Assessment report of the management of activation policies and on the outcome of job seekers' search activities and participation in labour market programmes.
Quarterly, 30 working days after the end of each quarter.

F.11
Report on progress achieved towards interim PLAR targets and actual and planned asset disposals.
Quarterly, 10 working days after the end of each quarter.

To be provided by the NTMA

N.1
Monthly information on the Government's cash position with indication of sources as well of number of days covered
Monthly, three working days after the end of each Month

N.2
Data on below-the-line financing for central Government.
Monthly, no later than 15 days after the end of each month

N.3
Data on public debt and new guarantees issued by central Government to public enterprises and the private sector.
Monthly, 30 working days after the end of each month

N.4
Data on short-, medium- and long-term debt falling due (all instruments) over the next 36 months (interest and amortisation) for central Government.
Monthly , 30 working days after the end of each month

N.5
Updated estimates of financial sources (bonds issuance, other financing sources) for the banking and Government sectors in the next 12 months
Monthly, 30 working days after the end of each month

To be provided by the Central Bank of Ireland

C.1
The Central Bank of Ireland’s balance sheet.
Weekly, next working day

C.2
Individual maturity profiles (amortisation only) for each of the domestic banks will be provided as of the last Friday of each month.
Monthly, 30 working days after each month end.

C.3
Detailed financial and regulatory information (consolidated data) on domestic individual Irish banks and the banking sector in total especially regarding profitability (P&L), balance sheet, asset quality, regulatory capital; PLAR funding plan forecasts
Quarterly, 35 working days after the end of each quarter

C.4
Detailed information on deposits for the last Friday of each month.
Monthly, 30 working days after each month end.

C.5
Data on liabilities covered under the ELG Scheme for each of the Covered Institutions.
Monthly, 30 working days after each month end.

C.6
Deleveraging committee minutes and deleveraging sales progress sheets, detailing pricing, quantum, and other relevant result metrics.
Monthly, reflecting committee meetings held each month

State Investment Bank

Sean O Riain: Michael O’Sullivan and I have an article in today’s Irish Times arguing for a state investment bank. Some links to supporting materials are below.

Allocation of bank lending by sector and poor investment record is discussed here

Role of the state and the weakness of private sector in providing ‘productive investment’ from 2000-8 is documented by Rossa White of Davys here

Patrick Honohan's QEC article on the limited role of finance in Ireland’s economic success of the 1990s is here

Research on the effectiveness of grant aid:
Manufacturing in the 1980s:
O’Malley, E., K.A. Kennedy, and R. O’Donnell. 1992. Report to the Industrial Policy Review Group on the Impact of the Industrial Development Agencies Dublin, Stationery Office (not available online)

Software in the 1990s:
Ó Riain, S. 2004. The Politics of High Tech Growth: Developmental Network States in the Global Economy (Structural Analysis in the Social Sciences 23) New York/ Cambridge: Cambridge University Press. (this link to the most relevant parts vis google books may work)

Manufacturing in the 1990s:
Girma, S., H. Gorg, E. Strobl, F. Walsh, 2008. “Creating jobs through public subsidies: An empirical analysis” Labour Economics 15, 6, 1179-1199

Already noted above, this piece provides data on how state funding stimulated private investment funding in the late 1990s and after the dot.com bubble.

Martin Wolf's open letter to Mario Draghi

"You must choose between two paths: the orthodox one leads towards failure; the unorthodox one should lead towards success.

The eurozone confronts a set of complex longer-term challenges. But the members will not get the chance to make needed adjustments and implement required reforms if it does not survive. The immediate requirements include putting Greece on a sustainable path; avoiding a meltdown in public debt markets of several large countries; and preventing a collapse of banks. Of these, it is the last two that matter." You can read the rest of Martin Wolf's open letter to Mario Draghi here.

A long, long, long way to go

Michael Taft: A good step; but a very small step: the Finance Minister’s announcement that the Government will seek a substantial write-down of the €3.8 billion in senior unguaranteed unsecured debt in Anglo-Irish and Irish Nationwide will be welcomed. Some will legitimately complain that this should have been done after the Anglo nationalisation, when that debt stood at approximately €16 billion. But that was the fault of the previous government. Most of the debt has been paid off and we are left with the bill – a €31 billion promissory note which will cost the Exchequer €43 billion with interest over the next 15 years. So this first step on senior bondholders is the new government’s initiative. But let’s put it in perspective – the impact will be very small and even if successful we will be left with a staggering bill for winding down, what the Minister has called, this ‘warehouse’.

Currently, the Government is committed to paying off a promissory note of €31 billion (€25.3 billion to Anglo, €5.4 billion to INBS and €0.35 billion to the Educational Building Society). This will entail a cost of €3.060 billion borrowed in each year up to 2023, with a further payment of approximately €2.8 billion in 2024 and 2025.

This is an intolerable burden – equalling 2 percent of 2011 GDP; a burden that would not be accepted in any other EU country; and for a bank that isn’t even a bank. So what difference would it make if the Minister gets his way? Some, but not very much.

In putting forward his suggestion for burden sharing, the Minister referred to the current discount. This, therefore, doesn’t suggest a complete liquidation. The Irish Times reports that Anglo’s November 2011 bonds (€750 million) fell to 70 cents following the Minister’s announcement.

The following calculation, therefore, assesses the impact of writing down the €3.8 billion in senior unguaranteed debt by 50 percent. This would mean a write-down of €1.9 debt, or 6 percent of the current promissory note. This would result in the following difference in annual payments:

• Current Annual Payment: €3.060 billion
• New Annual Payment after Write-down: €2.870 billion

While the new annual payment is my own calculation, any revisions would be trivial.

So after a 50 percent write-down of the senior unguaranteed debt, we would see the annual payments fall by €190 million per year. We would still be pay close to €2.9 billion. This is no less an intolerable burden.

However, we may be into a ‘running-to-stand-still’ situation. The Department of Finance’s projections of the overall cost of the promissory note, including interest, is premised on long-term borrowing costs of 4.7 percent – a technical assumption ‘based on the weighted average cost of funds raised by the NTMA in the bond market in 2010’.

That technical assumption no longer holds. With ESFS borrowing rates at 5.8 percent, we should expect the overall cost of the promissory note to increase. So if we apply that new interest rate and apply it to the promissory note minus the 50 percent write-down of senior unguaranteed debt – we will find the level of payments rise again over the lifetime of the note. In other words, there is little if any net gain.

The Minister for Finance should be supported – as a first step, as an opening of the door. But the fiscal impact will be minimal and the state will still be under an unacceptable and irrational burden.

It is now time for a more radical, thorough-going approach to write-down, if not entirely eliminate, the public exposure to the costs of winding down Anglo and INBS. A starting point comes from the TASC document on banking, ‘The Debt and Banking Crisis’:

‘Insolvent banks should not be further supported by public funds and should be allowed to fail. In Ireland this means that, at the very least, Anglo Irish Bank and INBS should be allowed to fail. No further payments for Anglo Irish Bank’s promissory notes should be made.'

That’s a good starting point.

TASC launches discussion paper on debt and banking crisis

TASC today launched a discussion paper by TASC policy analyst (and PE blogger) Tom McDonnell, The Debt and Banking Crisis: Progressive Approaches for Europe and Ireland. You can download the document here. Comments?