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| Preasráitis
In this Chapter, we explore the state institutions that were accountable for the regulation and supervision of both the banking sector and the financial stability of the state during the period leading up to the financial crisis. We consider the institutions’ roles, powers and the choices that they made during this critical period. We also consider the role and contribution of both international and domestic agencies in flagging and highlighting the emerging risks and growing threats to the Irish economy. These will be covered in three sections:
The availability of accurate and independent analysis of macro-economic and systemic risk is crucial to the role of the Central Bank and the Department of Finance in assessing, communicating and responding to such risks. A key role is also played by non-state actors in providing review, analysis, forecasts and challenge in the area of risk. This includes international bodies such as the European Commission, the Organisation for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF), the ratings agencies and the relevant domestic non-government body, the Economic and Social Research Institute (ESRI).
We examined the extent to which the domestic institutions, namely the Central Bank and the Department of Finance, relied or purported to rely on such analysis in their own assessment of the risks.
In the years leading up to the crisis, multiple warning signals were given by domestic and foreign experts and economic institutes.1 These warnings highlighted concerns in respect of:
Not all warnings were robust enough and were mixed with positive comments and praise for the Irish economy. Most of these warnings were however, either discounted or ignored by both the Irish regulatory and governmental authorities and decision-makers until it was too late to avert the crisis.2
The evidence provided by a number of witnesses relating to this period confirmed that a high degree of reliance was placed by Government and state institutions on the reports of international organisations and economic committees regarding the Irish economy. They appeared to take comfort from these reports as they viewed them as independent.
Speaking about the impact of the views expressed by International institutions such as the European Commission, IMF, OECD and ratings agencies, former Taoiseach, Bertie Ahern, said:
“These organisations have the advantage of having international perspectives, and the insights they provide are especially valuable when considering economic conditions and prospects in a comparative context.”3
Former Governor of the Central Bank, John Hurley also said: “Given their cross-country perspectives and their experience of crises, the Central Bank regarded the views of the OECD and the IMF as very important.”4
Between 1994 and 2000, the average national house price increased by more than 150%.5 Between 1998 and 2000, a broad consensus had emerged that these increases were justified by the stronger domestic economy and lower interest rates resulting from the forthcoming entry to the Euro.6
In 2000 and 2001, concerns were evident that the international economic cooling after the bursting of the so-called ‘dotcom-bubble’ and other events would also negatively impact on Ireland’s economy.7 Although a slowdown in the Irish economy was noticeable, it did not last long, as the stronger domestic demand soon led to re-acceleration of GDP and house price growth.
Following the relatively short slowdown in 2001 – 2002, the economy resumed its upward momentum, with strong growth continuing from 2003 to 2007.
In his evidence to the Joint Committee, former Research Professor at the ESRI, John FitzGerald, described the economic background for the pre-crisis period. He noted the rapid decrease in productivity growth in the early years of the 21st century and the ensuing loss of competitiveness, the growth in house prices, a rate of house completions not justified by population growth, the rising current account deficit, increased borrowings from abroad raising the vulnerability of the banking system and a rapid increase in household indebtedness.8
In considering the extent to which the state institutions heeded and responded to the signals from economic forecasting institutes and other commentators in the pre-crisis period, two key questions arise:
The European Commission is an independent supranational authority. It is separate from governments and acts as the executive body of the European Union (EU). The European Commission is responsible for proposing legislation, implementing decisions, upholding the EU treaties and managing the day-to-day business of the EU, including drawing up the budget of the EU. Economic regulation is one of the key areas in which the European Commission has extensive legislative powers.
It is important to note that the assessments of external economic forecasters like the European Commission/ECOFIN, IMF or OECD were, to a certain degree, based on data and information provided by the Irish authorities, including the Department of Finance and the Central Bank.9
The first material warning from the European Commission was in 2001, when it recommended to the ECOFIN Council (known as ECOFIN) that there should be a censure to the Irish Government on the Irish economy. The Commission concluded in a published opinion by ECOFIN that the Irish Government’s planned 2001-2003 Stability Programme was not consistent with the European Council’s Broad Economic Policy Guidelines. While the Council acknowledged that Ireland had “fully and comfortably” fulfilled its obligations in relation to Debt to GDP, it nonetheless warned about the pro-cyclicality of planned cuts in indirect and direct taxes, describing them as “aggravating overheating and inflationary pressures.”10
ECOFIN also highlighted the threat posed by the Government’s expansionary fiscal policies:
“The Council recalls that it has repeatedly urged the Irish authorities…to ensure economic stability by means of fiscal policy. The Council regrets that this advice was not reflected in the budget for 2001, despite developments in the course of 2000 indicating an increasing extent of overheating. The Council considers that Irish fiscal policy in 2001 is not consistent with the broad guidelines of the economic policies as regards budgetary policy.”11
On a review of the minutes of the ECOFIN meeting of 6 November 2001, it is apparent that measures were taken to re-visit the recommendation of ECOFIN in light of the sudden cooling-off of the economy after “unexpected developments” (e.g. the slowdown in the US, the foot and mouth disease crisis and events of 11 September 2001). The minutes stated:
“…the inconsistency addressed in the Recommendation between the Irish budgetary plans and the goal of economic stability has lost part of its force for this year… However, the Commission argues that the experience of overheating in the Irish economy justifies continued vigilance regarding the evolution of the fiscal stance.”12
In his evidence, Marco Buti, Director General for Economic and Financial Affairs with the European Commission, confirmed that “the assessment no longer raised any major issues.”13
In their supervisory role, general commentary from the European Commission and IMF contained critical remarks in relation to pro-cyclical fiscal policies of the Irish Government during this period. However, there was no specific warning on the development of a potentially large fiscal structural deficit.14
Marco Buti said that “…the Commission regularly stressed the uncertainty surrounding estimates of the structural budget balance for the Irish economy” . He also mentioned that there was “the sense that the structural fiscal position was weaker than the official estimate suggested, but there was no way to substantiate this view,”15 and he confirmed that the European Commission was of the opinion that the Government’s targets for the budget balance were not regarded as “particularly ambitious” in view of the strong economy.16
Marco Buti explained that the European Commission recognised that the Irish Government relied increasingly on income from property taxes and housing taxes, but given that the country was in surplus, it was “very difficult to say it was not behaving according to the Stability and Growth Pact, because it did.”17 Marco Buti admitted that the European Commission did not signal the risks in a sufficiently strong way.
The models employed by economists in the European Commission and the IMF did not give an early or good indication of the structural deficit in the years before the crisis. However, this was only identified after the crisis. It was explained that the available tools to measure a structural deficit were harmonised for all EU member states, which impacted in different ways on larger and smaller countries/economies, making it more difficult to assess compliance. In addition the model methodologies assumed that high output levels of the Irish economy and the related booms in tax revenues were permanent structural features.18 In hindsight, this assumption was proven to be wrong.
There was an over reliance on Ireland’s compliance with the limits set out in the Stability and Growth Pact. As Marco Buti said in his evidence to the Joint Committee:
“As the Government deficit remained below the Maastricht limit of 3% of GDP, the post-2001 Council opinions did not identify any formal conflict with existing EU fiscal rules.”19
While the economic models in use at a European level have improved since the crisis,20 doubts still remain in the Department of Finance as to the effectiveness of such modified models, in a small open economic setting such as Ireland. John McCarthy, Chief Economist of the Department of Finance confirmed that the methodology being applied even today is: “… a methodology that is designed to fit France and Germany. Unfortunately, it is a one-size-fits-all approach. It does not work for Ireland and I can say that quite definitely”.
He confirmed that there “have been some minor improvements to the methodology but they are not game changers”.21
Between 2001 and 2007, no specific assessment of the Irish banking sector was required under the European Commission’s Irish Stability Programme updates.22 The European Commission focused instead on the key ratios of the Stability and Growth Pact.23 As these requirements were mainly adhered to until 2007, no further in-depth studies that could have identified additional risks to the macroeconomic financial stability were carried out. The then Minister for Finance, Brian Cowen, stressed Ireland’s adherence to the Stability and Growth Pact in responding to questions about his tenure.24
The European Commission identified the risks of a sharp downturn of house prices and of a sudden end to the construction boom in its 2005 update of the Irish Stability Programme. However, this provided only limited understanding of the extent to which these risks presented a challenge to overall macroeconomic stability.25
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