Ship of Fools (16 page)

The effects on an economy dangerously dependent on construction would, he warned, be catastrophic: ‘We could see a collapse of government revenue and unemployment back above 15 per cent.'

Bertie Ahern's response to Kelly's (entirely accurate) predictions was to urge him and his ilk to kill themselves. ‘Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don't know how people who engage in that don't commit suicide.' Ahern got strong support from his main media cheerleader, the bestselling Sunday newspaper the
Sunday Independent
, whose deputy editor Liam Collins wrote that ‘Bertie Ahern got it absolutely right' and attacked
the Economic and Social Research Institute for having the bad taste even to publish Kelly's paper: ‘The state-funded Economic & Social Research Institute set the stalled ball rolling again last week when it regurgitated a hysterical rant from an academic who had the audacity to accuse those in the property business of “wishful thinking” because they remained optimistic about the future of house prices. Professor Morgan Kelly, from the bloated campus of University College Dublin, first jumped on the property bandwagon on December 21, 2006, with his paper,
Irish House Prices: Gliding into the Abyss?
When not too many people paid much attention to his thesis, the state “think tank” reissued his gloom-laden forecast under the new guise of academic research. It came with complicated formulae, big words and long, hard-to-read paragraphs - but the same dismal conclusions. ' Collins accused Kelly of ‘tabloid scholarship'.

What was remarkable, however, was how few mainstream economists came to Kelly's defence. Every historically literate economist knew for sure that the Irish property boom was going to crash. As early as August 2000, the International Monetary Fund put the Irish bubble in the context of all known modern property booms and concluded that ‘there has not been a single experience of price inflation on the scale of Ireland's which did not end in prices falling'. Given that prices actually doubled in the six years after that warning, the scale of the crash was even more predictable. Yet the overwhelming majority of Irish economists either contented themselves with timid and carefully couched murmurs of unease or, in the case of most of those who worked for stockbrokers, banks and building societies and who dominated media discussions of the issue, joined in the reassurances about soft landings.

In effect, the cheerleaders for the Celtic Tiger had constructed an impregnable but entirely fictional reality. It was an unquestionable certainty as secure as the Tsar's conviction that there could be no revolution in Russia or Donald Rumsfeld's conviction that there were weapons of mass destruction in Iraq. In a country that was losing its religion, the indestructibility of the property market was the remaining one true faith. Were it not for the unfortunate restrictions of modern civility, heretics like Kelly would have been burned at the stake in O'Connell Street. Unreality was now the place where Ireland lived.

‘Don't try to protect everyone from every possible accident'

- Charlie McCreevy

 

 

 

If, at the height of the Irish boom, you stopped virtually anyone in the street in Dublin and asked them the following questions, you could be pretty sure of the answers they would give:

The answers were common knowledge. Most of the investment came from the United States of America. Most of it went into either information technology (Intel, Microsoft, IBM) or pharmaceuticals (Pfizer, Eli Lilly, Merck). And Ireland's largest bank was Allied Irish.

In fact, these obvious answers were all wrong. From 2002 onwards, the largest source of foreign direct investment into Ireland was the Netherlands (€10.7 billion that year, compared to €7.9 billion from the USA). In 2003, €8.6 billion came from the Netherlands, while flows from the US were actually negative, with more going out in repatriated profits than came in through investment. Even in 2007, when North American investment doubled to €31 billion, it was still less than the €33 billion that came from the Netherlands.

Where was this vast Dutch investment coming from? Was
Shell oil buying up the entire country? Were the Dutch rat-race refuseniks who set up smallholdings in rural Ireland in the 1970s planning an unimaginable expansion of their organic cheese-making operations? In fact the money was mostly connected to high-level financial juggling by American-owned transnational corporations, with their Dutch-based treasury-management subsidiaries routing capital flows through Dublin.

The answer to the second question was equally surprising. The largest single component of the stock of foreign-owned assets in Ireland was not in either information technology or pharmaceuticals, it was in the International Financial Services Centre (IFSC) in Dublin, which is essentially a tax haven for global finance. The prominence of world-leading transnational firms like Intel or Pfizer may have defined the Irish economic landscape. Their presence was solid and reassuring - whatever anyone thought of them, however much we knew about their repatriation of vast profits every year, they were global industrial titans, producing real products for real export markets. But they were dwarfed by the sheer scale of money that was pumped through the IFSC. In 2005, for example, the IFSC accounted for approximately 75 per cent of all foreign investment in Ireland. Yet it was not particularly surprising that most Irish people would not have known this, for it was not easy to understand exactly what many of the companies in the IFSC were up to.

And, to answer the third question, the largest Irish bank was not AIB, but the giant German operation Depfa (short for Deutsche Pfandbriefanstalt), a specialist lender to governments and municipalities that transferred its global headquarters to the IFSC in Dublin in 2002. Its global centre at Harbourmaster Place on the River Liffey had just 319 employees,
but claimed assets in 2003 of $218 billion. Depfa had been as German as sauerkraut - it was founded by the Prussian government in 1922 and it was still listed on the Frankfurt stock exchange. But it was now as Irish as bacon and cabbage.

 

The IFSC was established in 1987 by Charles Haughey, at the suggestion of one his financial backers, Dermot Desmond, specifically to persuade international finance companies to set up offices in a new, American-designed development at Custom House Docks on the Liffey, just a few minutes east of Dublin's city centre. The incentive was simple: a 10 per cent rate of corporation tax. (The IFSC moved in 2005 to a 12.5 per cent tax rate and companies were allowed to locate themselves outside the Custom House Docks centre.)

The IFSC worked. It attracted half of the world's top fifty banks and top twenty insurance companies, alongside another 1,200 operations of various sizes. By 2003, Ireland was the main global location for money market mutual funds (a total of $125 billion in these funds was domiciled in Dublin), overtaking its old spiritual hinterland of the Cayman Islands. In the same year, Dublin's investment funds industry (valued at $480 billion) surpassed London's. Hedge fund managers liked the place: by 2004, over $200 billion in hedge fund assets were being serviced in Dublin.

The IFSC eventually employed 25,000 people, many of them on high salaries. In spite of the low tax rate, it contributed, at its height in 2006, €1.2 billion in taxes to the government. But there was a price to pay for these blessings. The attraction of the IFSC for the global finance industry was not just low taxation. It was also lax, and in some cases virtually non-existent, regulation. The Irish state acquired an incentive to keep banking supervision to a minimum.

Any urge to beef up regulation after the DIRT and Ansbacher scandals was outweighed by the belief that the Irish tradition of looking the other way while banks passed funny money around was actually an economic asset. Ethitical banking went global. While the embodiment of Irish banking culture had been the bogus non-resident, now it became the bogus resident. The unreality of Irish people pretending to be elsewhere was replaced by the unreality of foreign people pretending to be in Ireland.

In February 2009, the
Guardian
newspaper sent reporters to Dublin to check out the ‘head offices' of British companies that were now ‘domiciled' in Ireland: ‘One such “headquarters” turned out to be merely the premises of the company's accountants. Other multi-nationals had just a handful of staff at work, no nameplates outside, or occupied the premises only sporadically . . . Tarsus, a business media group, says its new Irish headquarters is in a redeveloped Dublin dock by the river Liffey. But when we went there, it appeared to be merely the premises of their tax advisers, PWC [Price Waterhouse Coopers]. Henderson Global Investors has only three staff at its Dublin suite of off-the-shelf rental offices, compared with 550 who continue to work at its main London office. A receptionist in Ireland said: ‘They are not here a lot of the time.' Charter Engineers has no nameplate on its temporary offices, and the company secretary - one of only five staff - flies in on Monday and home again on Friday.'

Under Irish tax law, a corporation can pay its entire tax bill in Ireland if ‘its central management and control are located in the state'. The ghostly presences traced by the
Guardian
are the ciphers of ‘central management and control' that allow companies to pay tax at generous Irish rates
rather than more stringent British ones. The
Guardian
revelations prompted the Treasury spokesman of the Liberal Democrats to call Dublin ‘Lichtenstein on the Liffey'.

If the Irish had a right to be insulted by this description, it was only because we tended to prefer warmer, Caribbean climes. The Cayman Islands, as we have seen, was a virtual fifth province in the 1980s. And in fact, the official equivalent that the IFSC was seeking was also West Indian: in 2003, referring to the IFSC, the state's Industrial Development Agency (IDA) actually boasted that ‘There has been rapid growth in the Irish insurance and reinsurance industries in recent years, with Dublin fast becoming the Bermuda of Europe.'

While much relatively straightforward banking business was done at the IFSC, two aspects of what went on there were fraught with long-term danger for Ireland. The first was the construction of this outlandish volume of fictions, the creation of a parallel universe of apparently vast financial operations with huge paper assets but almost no substance. Dublin became the Potemkin village of global finance.

The main force behind the creation of this shadow economy was the attraction to Dublin of the treasury management arms of transnational corporations (TNCs). The purpose of these companies is to rationalise the flows of capital between different parts of a global group and, of course, to ensure that the overall tax bill is as meagre as the magic of financial wizardry can make it. The IFSC, with its low corporation tax rates, tax exemptions on dividends and interest payments, and access to Ireland's large range of bilateral tax treaties, was attractive in this light. The 12.5 per cent tax rate was a little over a third of that prevailing in the US and most of Western Europe. By 2002, Ireland had become the single
largest location of declared pre-tax profits for US firms (followed, aptly, by Bermuda).

The other attraction, though, was the lack of regulation, or what the IDA called ‘a flexible and business focused tax and regulatory system'. In the case of treasury management operations, the business-focused regulatory system had two aspects. Firstly, these treasury arms of TNCs were allowed to set themselves up as banks. And secondly, the Central Bank and its supervisory arm (known firstly as the Irish Financial Services Authority and then as the Financial Regulator) agreed not to regulate them.

As the IDA put it for the benefit of potential clients: ‘In 1998, the Regulator revised its Bank licensing regulations and it may now accept, under certain circumstances, applications from corporate entities to be licensed as Banks. In the case of most group treasury and asset financing operations the Regulator has disapplied its powers of supervision.' The word ‘disapplied' was a wonderful Irish coinage. Global corporations, in other words, could establish unsupervised banks in Dublin. At the height of the boom, there were over 400 of these firms at the IFSC - there are now around 350.

These entities were usually subsidiaries of subsidiaries, owned by companies that the corporations had already established in other countries, many of them tax havens or low-tax jurisdictions. (In thirty-two of the forty-six cases that Trinity College Dublin economist Jim Stewart studied, the parent company of the Irish operation was located in a tax haven.) Thus, 3Com IFSC, the Irish affiliate of 3Com, is registered in the Cayman Islands; Kinsale Financial Services, the IFSC offshoot of Eli Lilly, is registered in Switzerland; Pfizer International Bank Europe is registered in the Isle of Man, and Brangate, the IFSC arm of Tyco, is registered in
Luxembourg. Some of these companies were like Babushka dolls: Xerox Leasing is the Irish subsidiary of a Jersey subsidiary of a Greek subsidiary of the US photocopy machine manufacturer.

These convoluted structures were not accidental. One of the measures proposed by the Obama presidency in the US in 2009, for example, was to permit transnational corporations to have only one layer of subsidiary ownership for tax purposes. The accompanying Congressional memorandum on tax havens specifically cited Ireland: ‘Thus, a U.S. parent with a subsidiary in Ireland could treat that subsidiary as a branch (disregard it as a separate entity). The Irish subsidiary, however, could not treat its German subsidiary as a disregarded entity.' The amount of money at stake is obvious from the amount of tax the US authorities expected to raise in a single year from this one measure: $86.5 billion.