June 14, 2010
The recent publication of Professor Patrick Honohan’s inquiry into the banking disaster reminds me of weekly scraps I had with lads when I was a boy.
Back then, I regularly ran the gauntlet of the local hard lads on the bus home from school.
Suffice to say that a Blackrock College uniform was considered to be a ‘legitimate target’ in Dun Laoghaire in the 1980s.The drill on the bus was always the same; some of the local shapers would get on and ask me for a smoke or some cash. It was always the same:
‘‘Hey Redser, any odds?”
Then the slap came, normally delivered by the weediest ones (they were always the most dangerous).Then they tried to steal my gear bag – for the craic.
‘‘Please stop, I don’t want any hassle. Leave me alone, leave my bag alone.”
‘‘What the f… are you going to do about it, Redser?”
Fair question, because they knew there was nothing I could have done about it, so there was no option but to take the hiding. Now – let’s go back to the banking report.
The ‘‘what are you going to do about it’’ question could also be legitimately asked of Professor Honohan. As governor of the Central Bank, he has the authority, both moral and executive, to follow up on his excellent report and actually change the banking game here, so that it never happens again.
Can you imagine if we did something to ensure that never again will our country be destroyed by the greed of bankers, and never again will the banks be used to speculate on land and houses? Can you imagine if our houses would never again be used as glorified ATMs to facilitate a credit frenzy?
In the 1930s, following the disastrous bank-led speculation on the stock markets, the US authorities broke up banks into investment banks and ordinary banks.
This move followed the realisation that banks couldn’t be trusted, so they needed to be broken up and regulated. We need to do the same here.
Apart from appalling management, the main reason the banks got themselves into such a mess was that their balance sheets played tricks on them. The more money they lent out to property, the more the price of property went up. So the price of property went up – and up.
And as it went up, it played tricks on the banks and they thought the value of the security was going up too. But it wasn’t. In fact, the quality of the collateral was falling and getting more risky.
So the key to avoiding a new property boom is to change the amount of collateral that is permissible against property lending, because this is the relationship that is fooling the banks and making them more likely to lower their balance sheets.
What if we were to back up the banking report with a new way of looking at collateral?
What if Honohan were to look at a backward-looking index of property, let’s say property values over 25 years, and introduce a new system whereby the bank could lend only 80 per cent of the average price of a property over the past 25 years?
By adopting such a backward-looking approach, there would be no risk of any more booms or busts, because using the average price would limit the amount of cash that could be lent against any property.
We would eliminate the risk of banks getting into a lending war at the top of a cycle because they wouldn’t be allowed to use the latest valuation to justify the latest mega loan.
We might also break up the banks, as Roosevelt did after the Great Depression.
How would you do this? And why?
Well, it could prevent banks from ever again getting involved in property and push some to move back to a building society model.
Remember, international banks had derivatives – complex financial products in which risk was carefully hidden.
Our equivalents were more prosaic – commercial property,100 per cent mortgages and speculative development land deals. It was, as the bank reports said, a ‘‘plain vanilla’’ property boom.
Using this logic, if we were to follow the recent US move of banning commercial banks getting involved in derivatives, we could ban ‘normal’ banks from getting involved in property investment plays again.
We could have land and property banks that simply lend to property buyers, but are governed by tight regulation and backward-looking indices to limit loans.
All these small changes can be made. The interesting thing about the banking collapse is that it gives us permission to change, it gives us the excuse we need to revolutionise the system.
This is what Honohan has on his side.
We, the people, are on his side as we have never been before with a Central Bank governor.
When I was a young economist in the Central Bank, Honohan dropped in occasionally. At the time, he was working at the World Bank.
He was always helpful with his time and was happy to explain difficult ideas to younger economists, using his clear mind and his wonderful teaching skills. But more than anything else, he had a deprecating sense of humour.
It was the same sense of humour that he used when I first saw him debate, when he deftly filleted the pompous British economist Dr Patrick Minford in the early 1990s in Trinity – without him even noticing.
Honohan is now deservedly in the most important economic position in the country, and power has shifted to him from the Department of Finance. Because of his open mind, we can expect more invaluable initiatives in the months ahead.
I expect that he will make bold moves when he feels it’s the right time.
Recreating our banking system to make sure that it functions properly will be one of the tasks. I don’t expect Professor Honohan to shrink from that challenge.
The report is only the beginning.
David McWilliams hosts the Dalkey Book Festival next weekend. Details can be found at www.dalkeybookfestival.org