by Shane Ross
Hurley’s November 2004 Financial Stability Report did, almost alone in the entire sector, sound alarm bells about the dangers lurking in the property boom. He did not mince his words:
The risk of an unanticipated and sudden fall in residential property prices, accompanied by an increase in the default rate among mortgage holders… is the risk that poses the greatest threat to the health of the banking system.
By November 2005 a slowdown in house-price increases had reassured the governor. In that year’s report he anticipated a soft landing but was still on alert in case property showed signs of a resurgence.
Hurley’s 2006 Financial Stability Report was again wary of the dangers of renewed property rises and warned of indebtedness as a result, but crucially the report gave the banks a clean bill of health: ‘The banking system is well placed to withstand the impact of any major adverse developments in the short to medium term.’ In November 2007 Hurley was more circumspect, acknowledging the difficulties faced by banks wishing to borrow in the tightening interbank markets. He also recognized the hostility of overseas investors towards Irish banking shares. But he concluded that the ‘current situation and outlook for Irish banks, based on an assessment of developments so far, is positive’. And in a final flourish he claimed that ‘Irish banks are solidly profitable and well-capitalized. In this context it is worth noting that they have one of the lowest rates of non-performing loans in Europe.’ The problem was that the figures on non-performing loans were unchallenged figments of bankers’ imaginations.
This was November 2007. By the end of 2008 profits from Irish banks had tanked. Dividends had been cancelled. Anglo Irish was probably insolvent. Far from being ‘well-capitalized’, Bank of Ireland and AIB were on the point of receiving a capital injection of €3.5 billion each.
Property developers were strangely a low priority in Hurley’s analysis and in Neary’s commentaries. Even the dogs in the street were worrying about the big-ticket property boys. Their huge bank borrowings were making headlines by the day. But the builders and developers hardly seemed to feature in the vision of the regulators.
The regulatory body’s earlier measures had simply bounced off the intended targets. Its limited attempts to restrict the banks’ scope to lend to house buyers were easily circumvented by the canny lenders. The watchdog failed to recognize the root of the problem: property, property, property. Ireland’s bankers had gone bonkers on one commodity. The amounts lent and the actual size of property loans as a proportion of the banks’ overall lending book was ballooning. This infatuation with property ensured that if there was ever a turndown in the sector, let alone a deep slump, Ireland’s banks would be out on a limb. The Financial Regulator failed to instruct them to bring property loans back to prudent levels, to reduce them as a proportion of their overall book. Unchecked, the banks heaped fuel on the inferno.
Not only did the Financial Regulator baulk at restricting the proportion that banks could lend to property, it put no ceiling on bonuses or bankers’ pay. Their staggering incentives pushed them towards bigger and bigger property loans and instant personal gratification. They steered the banks into 2008 on a wing and a prayer.
Neary’s first public appearance in 2008 was an attempt to reassure the Oireachtas Public Service and Finance Committee that the nation’s banks were in good shape and under prudent supervisors. He appeared with Hurley. Both men sang from the same hymn sheet. Hurley was the senior partner in a united front.
Neary again made much of the 2006 measures he had taken to compel the banks to set aside more capital to counteract the dangers of higher-risk property lending. He repeated the same defence that he had ordered precautionary measures. The committee chairman, Michael Finneran, thanked Neary and Hurley for their ‘reassuring reports’.
It was too late. They had been whistling past the graveyard.
Even more market turmoil was to follow in the next six weeks, culminating in the St Patrick’s Day massacre of Anglo Irish Bank’s shares in London. The price of its stock fell by 23 per cent in a single session. As a result Anglo’s top brass complained to the Financial Regulator that some Dublin stockbrokers were not playing ball. They particularly deplored the bearish noises of Davy and Merrion Capital towards their shares. They believed that brokers were spreading damaging rumours. Anglo even sent a solicitor’s letter to Merrion Capital threatening to sue. Merrion responded with a robust denial of any culpability, pointing out that the stock-market view of Anglo reflected their own. No legal action ever materialized.
Neary’s response to this spat was the instinctive reaction of a tame Central Banker, not an independent regulator: he launched an inquiry. Davy and Merrion received letters asking detailed questions about their dealings in Anglo’s shares. Nothing untoward was found, but Neary had stood up for Anglo.
When Neary next appeared before an Oireachtas committee, in April 2008, he faced a few tougher questions. Deputy Seán Ardagh of Fianna Fáil asked him about the probe into dealings in Anglo (though nobody named the bank). His reply betrayed an instinctive Central Banker’s attitude to markets.
On St Patrick’s Day we commenced an investigation. We spoke yesterday of the rumours in the market then, which reached a crescendo on that particular weekend. We felt there were unjustified stories about a leading financial institution in circulation and we were extremely concerned that well-capitalized, strong, profitable financial institutions could be severely and negatively impacted by unfounded and groundless rumours emanating from unknown sources.
Hostages to fortune were being scattered around like snuff at a wake. Anglo was neither well capitalized, nor strong, nor profitable. Nor were the other Irish banks. As it turned out, the rumours about Anglo were bang on.
Michael Casey, a former Central Bank chief economist, told me that there was plenty that could have been done: ‘They could have brought in the banks and offered to act as ringmaster. There was a race to the bottom in progress. The banks would have appreciated that.’
The banks needed a cool, independent and authoritative hand to guide them collectively out of the morass. Perhaps they would have welcomed an outsider telling them all together to reduce the levels of risk they were exposed to. The banks were on an uncontrolled roll, far beyond rescuing themselves, and the Financial Regulator did nothing about it.
On 18 September, after the markets closed, Neary followed the UK Financial Services Authority’s lead and banned short selling of financial stocks. It was a blatant attempt to protect Anglo’s and the other banks’ tumbling share prices. The market rally that followed was short-lived. Within days, even with short sellers off the pitch, bank shares began to slide again.
On 29 September Neary and Hurley were holed up in the Taoiseach’s office at the famous late-night emergency summit called to save the Irish banks. The government’s bank guarantee – agreed that night – was a tacit admission that at least one bank was on the point of collapse. Reports of the crisis meeting describe Neary as cool as a cucumber. Like Ireland’s bankers, he calmly blamed the outside world, the credit crunch, anything but domestic factors.
Within a week of the historic crisis meeting, Neary appeared before an Oireachtas committee for the last time. He saw it as his duty to reassure the nation that the banking system was secure. His rhetoric was suddenly more urgent, but his personal demeanour seemed strangely aloof. As a member of the committee, I called for his head, but received scant support.
Neary took the orthodox government/banker/regulator line. Ireland faced an unprecedented international financial crisis. Wholesale funding in the interbank market had dried up. Lehman Brothers was hauled into the Irish mix. So were Northern Rock, Bear Stearns, Freddie Mac and Fannie Mae. The kitchen sink was not far behind.
Neary had a point. All of those factors had played a part in the Irish banking crisis. But until that day the elephant in the room had been virtually ignored.
Suddenly the elephant became visible.
‘There will be losses,’
Neary admitted, ‘on property-related loans, and increased provisions and write-offs will be necessary. The potential difficulties in this regard are linked to how the economy unfolds.’ The game was up. Figures began to come spilling out. ‘Speculative lending to construction and property development in Ireland amounts to €39.1 billion,’ Neary revealed, ‘of which €24 billion is supported by additional collateral…’
Even hardened sceptics gasped.
After these words it was probably only a matter of time before Neary departed from his post. The international reputation of Ireland as a regulated financial centre was in tatters.
But Neary had a last hurrah. A few days later, still fancying his ability to calm the nation’s nerves, this strangely unconvincing figure headed for RTÉ’s Prime Time programme to cross swords with interviewer Mark Little.
That night, my telephone at home rang. At the other end of the line was the broadcaster Eamon Dunphy. There was fear in his voice, which may have reflected the mood of the entire population. ‘I have just seen Pat Neary, the financial regulator, on Prime Time,’ he whispered. ‘I am terrified. I am going to emigrate.’
Neary had sealed his own fate. Asked by Little about Irish banking’s exposure to property, he tried to fudge. Eventually, when Little challenged him with a direct question about the weakness of Irish banks being their exposure to property, he said that he ‘did not accept that at all’. He grudgingly admitted that there would be ‘certain levels of impairments’. He spoke of how well capitalized the banks were and how there was enough liquidity in the system. It was the denial of the bottomless pit facing Ireland’s banks because of their exposure to property that petrified Dunphy and the rest of the nation.
Neary was pictured at the end of the interview smiling happily, like everyone’s lovable old grandfather. It was a bizarre performance.
Neary limped on for a couple of months. Then, on 18 December, Sean FitzPatrick announced that he was resigning. He had doctored the year-end books at Anglo.
It was one undetected scam too many. Questions were asked of the auditors, the directors and the Financial Regulator about how Sean had managed to pull such a stunt without any of the watchdogs twigging. None answered satisfactorily. Nearly all Anglo’s non-executive directors departed within weeks. The auditors, Ernst & Young, clung on.
Minister for Finance Brian Lenihan was reputed to be furious with Neary. His lukewarm endorsement of Neary in the Dáil as early as October had made it clear that he wanted the chief bank regulator to fall on his sword.
It was confidently expected that Neary would resign after a meeting of the board of the Financial Regulator just before Christmas. But Neary was mounting a sturdy defence. He insisted that he knew nothing of FitzPatrick’s loans. No one had told him. Mary Burke, a senior staff member, was equally insistent that he had been informed verbally. There was a direct conflict of evidence.
An inquiry was set up by the board of the Financial Regulator. Politicians made it clear to the board that there was only one acceptable outcome. The inquiry carried out by Dermot Quigley, a former Revenue commissioner, and John Dunne, chairman of the IDA, failed to resolve the conflict of evidence, but the end was inevitable. Neary agreed to retire early with a golden handshake of €630,000 and a full pension. On 31 January 2009 he stepped down after a crowded farewell office party.
Patrick Neary was a failure as a regulator, but he was also a victim of a terrible system that he did not invent. The Central Bank and Irish commercial banks had been joined at the hip from their beginnings. Cross-directorships fuelled a culture of common purpose. ‘Principles-based’ regulation ensured the continuation of this warm, and ultimately destructive, relationship. The bankers accepted the laissez-faire camaraderie of the Financial Regulator. Anglo seized on it as an invitation to lend dangerously and excessively. Fired by fear and greed, the rest followed. They abused the opportunity offered in the sure knowledge that they had nothing to fear from the watchdog. And they found co-conspirators in Ireland’s rapidly rising band of property developers.
4. The Building Societies
One day in September 2000, Ethna Tinney was browsing through the Irish Times in her Limerick home. The 42-year-old horse lover, who had just landed a job as a producer at RTÉ Lyric FM, was happy with her lot. The last thing on her mind was another job. Suddenly she spotted an interesting advertisement.
The EBS building society had decided to embark on a great experiment: it had placed a newspaper advertisement seeking directors. Ordinary EBS members were encouraged to apply to sit on the Society’s board. Ethna Tinney was one of 300 EBS members who decided to go for it. In a matter of weeks she was among seven candidates shortlisted by the recruitment agency.
Tinney’s final interview took place in Dublin’s Jurys Hotel. Today she describes the encounter as a real ‘grilling’ from EBS chairman Brian Joyce, board member and TCD professor Yvonne Scannell, chief executive Ted McGovern and vice-chairman Ron Bolger.
Joyce was a taciturn type who had served as chairman of CIE and other state bodies. A graduate of University College Galway with a BComm, he became a management accountant. He worked in RTÉ from 1967 to 1969 and then moved to the Dairy Board, where he served as managing director from 1979 to 1989. After that he took to the boardrooms full-time, and made plenty of money, but never landed the plum positions – such as a director’s seat at the major banks or CRH.
His vice-chairman, Ron Bolger, was a former managing partner at the accountancy firm KPMG. Bolger had served on the board of Eircom when it was in state ownership but, like Joyce, had never quite made it as a director of one of the big prizes. He was always hovering around somewhere near the top of the second division.
Joyce and Bolger did not see eye to eye, but back in 2000 they agreed about Tinney. She was the outstanding candidate among the shortlisted applicants. She was given the job.
For the next two years there was relative harmony at the EBS. The building society lived on its reputation as being less cut-throat than its rivals, more humane in its methods and a genuine nurturer of its members.
But in the Ireland of 2005 there was little room left for the small building society in a mortgage market infested by banking sharks. In the early years of the millennium the EBS began to lose its edge. Its mortgages and deposit rates were not the most attractive in the market. The high moral tone of mutuality had worked wonders for decades, but the shine was rapidly coming off the society’s halo. Loyalty was wearing a bit thin as depositors tended to be old, and choosy young borrowers were shopping around for the best deal. EBS, a high-cost operation, found it hard to compete.
The chief executive, Ted McGovern, was fiercely ambitious. A solemn Scot, he hoped to attach the EBS to a foreign institution with size and muscle, and in 2004 he began merger talks with the giant Dutch co-operative Rabobank. Some board members backed McGovern’s plans; others saw them as a vainglorious attempt at expansion. Eventually the proposed merger fizzled out.
It was suspected that McGovern was jealously eyeing the huge profits earned by Michael Fingleton at the rival Irish Nationwide Building Society. Fingleton also took home a pay packet of more than double McGovern’s healthy €760,000. There was only one way to compete with the buccaneering Nationwide chief – form an alliance with a big partner or follow him into the danger zone: commercial property.
While Fingleton never had any trouble from his board, Ted McGovern’s was beginning to splinter under the strain of the new, but compelling, commercial demands. Chairman Joyce and his faction supported McGovern in most of his expansionary moves. Ron Bolger, Cathal Magee (a director of Eircom and the VHI) and Tinney were sceptical.
The growing tensions reached boiling point when in 2005 McGovern recruited PricewaterhouseCoopers accountant Alan Merriman to the post of finance director at a salary so high for a mutual that it shocked some of the independent board members. In his first full year (2006) Merriman’s total package fell just short of €700,000, more than twice that of his pre
decessor. EBS had not been one of the biggest sinners in the pay stakes, but the arrival of Merriman at a high salary was seen as having the potential to lift others, including McGovern himself, into the salary superleague.
Members of the remuneration committee, most vociferously Cathal Magee and Ron Bolger, were irate that the appointment had happened without their approval. Civil war broke out on the EBS board. Bypassing the remuneration committee was not the only cause of battle. A €5m payment into the senior managers’ pension fund without board approval sent Magee into anger orbit, while Bolger was constantly agitated by corporate governance issues. Bolger, Magee and Tinney frequently challenged Joyce. At one board meeting in the summer of 2006 heated words were exchanged when Joyce turned on both Magee and Bolger. Magee resisted McGovern’s hopes of a tie-up with Rabobank. Bolger demanded an audit of corporate governance at the society, a thinly veiled criticism of the way the board was run by Joyce and McGovern. The gloves were off.
Insiders now agree that the EBS had reached a crisis point, and not just at board level. The booming mortgage market of 2005–6 masked fundamental problems at the small building society. Its high costs and lax attitude to them were in contrast to the Irish Nationwide’s tight discipline: EBS’s cost-to-income ratio was running at three times the level of Fingleton’s. EBS was no longer the cheapest mortgage in the market. Its competitors in the banks, with lower cost bases, were able to undercut it.
Bolger had been tipped to succeed Joyce; but he was not Joyce’s choice. After months of squabbling the two adversaries eventually reached a devil’s pact. They would leave simultaneously. They could not trust each other enough to be sure that any staggered deal would be honoured, so they jumped together.
