Sins of the Father (23 page)

Such was the strength of this type of comprador business and tax avoidance speculation within the Republic, that social and political resistance to its struggle for survival were frustratingly weak and ineffective. With the mainstream media and political parties on board, the only tangible forms of protest open to the Republic’s citizens were street protests and the ballot box, which resulted in the collapse in support for Fianna Fáil, and its coalition partner, the Irish Green Party.

It was only in the final weeks of the government, after the arrival of an EU/IMF team in November 2010 and the imposition of a bailout package designed to support Irish bank bondholders in Europe, that the leadership of Fianna Fáil turned its attention to the survival of the party. The reasons why Brian Cowen and his cabinet took such a stance are not entirely certain, but what is known is that for decades Fianna Fáil was a party with two faces. It was a populist party with a strong working-class and public-sector base, but one that was funded by particular banking and business interests. Normally, such contradictions can co-exist once there is sufficient room for manoeuvre. With the 2008 bank crisis, however, the party’s options contracted to almost zero. It could no longer sugarcoat its business-led economic policies with political gestures and tax breaks for PRSI workers. In order to get the country through the crisis, the State needed to quarantine the loans which had been used for tax avoidance measures, such as Section 23, while at the same time guaranteeing deposits. Instead, it decided to transfer responsibility for the loans onto the shoulders of the State, to cut back on funding for education, health, pensions and welfare, increase tax on personal income and expenditure, and appeal to patriotism and sense of duty. Its decision to borrow tens of billions of euros to prop up dead banks and Section 23 loans consigned the rest of the economy to freefall – the part of the economy where the jobs lay – and the party lost support as a result. It could not bail out its financial backers
and
keep its working-class and public-sector vote on board. The economic situation just wouldn’t allow for such an option.

The two-year period between the bank guarantee and the EU/IMF intervention was a time when the controlling forces within Irish society revealed themselves in a way that had not been seen for decades. The scale and depth of the crisis made it impossible for the nature of their wealth to remain under the radar. The crisis brought clarity to the actual focus of the State’s economic and political system. What we see during those two years are the consequences of the empowerment of financial dealers and property developers, the glorified
Maître d
’s who meet and greet multinationals as they arrive on our shores, aided and abetted by the main political parties, who are unable, or unwilling, to see any alternative.

The financial crisis was global in nature, but Ireland’s almost fatal exposure to it was not a fluke or simple bad luck. Similarly, the reaction of the government was not because of moral failings, alcoholism, dysfunctional leaders, a lack of interest in the media or a lack of an ‘ear for strategic political advice’.
¹
On the contrary, the government’s reaction to the bank crisis made sense – when viewed from the perspective that the logic was to cushion Ireland’s financial vested interests from the fall, with the bank guarantee the most direct and secure way of providing that protection. At the same time, the economic and social myths which had built up over the previous fifteen years, of a prosperous land and a classless people, simply vanished. Ireland was a democracy, to be sure, with open and free elections, but it was far from governed in the interests of its people.

Sheila Bair, Federal Deposit Insurance Corporation, December 2007.

The general explanation for the 2008 global financial crisis is that its roots lay with the American housing market – more specifically with subprime mortgages, the shadow banking system, securities, and the complex, opaque system of over-the-counter derivatives.
The Irish Times
wrote that in the US, ‘The combination of reckless borrowing by house purchasers and imprudent lending practices by banks and financial institutions, when set against the background of rising interest rates and falling property prices … proved to be a lethal mixture’.
³
The Fianna Fáil TD Seán Ardagh told the Dáil in July 2008 that it began ‘with subprime mortgages in the United States … Many of these subprime mortgages suddenly became bad and thereby all of the securities based on them became bad.’
⁴
The monthly financial newspaper
The Banker
wrote that ‘The credit crisis, triggered by the subprime mortgage meltdown in the US, produced devastating repercussions’.
⁵
The
Guardian
said that ‘The global financial crisis has its roots in the US mortgage industry, where the sheer scale of liabilities on subprime loans is gradually becoming clear’,
⁶
while Fiona Walsh of
The Irish Times
said that 2008 was the year when ‘The credit crunch hit the high street, as the financial contagion that sprang from the subprime mortgage market in America finally spilled over into the real economy’.
⁷

The destabilising effect of the subprime loan market on the wider economy was two-fold: it added to an already-expanded housing bubble, while the loans themselves entered the global bloodstream through the proliferation of Mortgage-Backed Securities (MBS). MBSs are bonds which are essentially pools of mortgages. An investor buys a share in the MBS and receives a fixed payment for the investment. There were three US government-sponsored agencies – Fannie Mae, Freddie Mac and Ginnie Mae – that used them as a way of funding the US mortgage market and expanding home ownership. The securities issued by Ginnie Mae were backed ‘by the full faith and credit of the US government, [which] guarantees that investors receive timely payments’,
⁸
whereas those issued by Fannie Mae and Freddie Mac did not have full federal backing. However, both enterprises benefited from what was called ‘an implicit federal guarantee … investors perceive a government guarantee’.
⁹

In 1999, the Clinton administration put pressure on Fannie Mae to ease ‘The credit requirements on loans that it will purchase from banks and other lenders’.
¹⁰
The government wanted to encourage banks ‘to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans’, and it used Fannie Mae and MBSs to do so. Essentially, Fannie Mae, the main underwriter of home mortgages in the US, was moving into subprime lending. ‘In moving, even tentatively, into this new area of lending,’ wrote
The New York Times
in 1999, ‘Fannie May is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.’
¹¹
In February 2004, the chairman of the Federal Reserve, Alan Greenspan, explained to
The New York Times
that the sizes of Fannie Mae and Freddie Mac, and the fact that they were government-sponsored enterprises, made it ‘difficult for Congress to avoid a bailout in the event of a financial calamity’. ‘It’s basically creating an abnormality,’ he said, ‘which the system cannot close around, and the potential of that is a systemic risk sometime in the future, if they continue to increase at the rate at which they are.’
¹²
Greenspan’s concerns were not with MBSs as such, but with the fact that they were concentrated within federal-protected financial institutions. His preferred solution was not the oversight of such potentially risky ventures, but the further deregulation of mortgage securities in order to let the dynamics of the free market – and its invisible hand – set the parameters of risk and, of course, to profit from that risk.

In the late 1990s, new types of MBSs were developed, this time for private banks. They were called private-label mortgage-backed securities. They lacked any form of a government guarantee – implicit or otherwise – and as such they carried greater risk. The absence of a government guarantee also meant that banks relied on private credit-rating agencies to enhance confidence in these new securities and to encourage investors. These were freely given. As one commentator put it:

Debt holders relied on credit rating agencies such as Moody’s, Standard & Poor’s, and Fitch to prescribe the amount of risk associated with private label securities. These private label securities earned great ratings from the credit agencies. In fact, the vast majority of private label debt was rated AAA, the highest rating achievable, second only to debt that was government insured. The appeal to investors was a higher return as to the comparable government insured securities.
¹³

The rise of these private-label mortgage-back securities, coupled with the liberalisation of lending practices in Freddie Mac and Fannie Mae, meant that ‘most subprime lenders were [now] financed by investors on Wall Street’ rather than ‘traditional banks and thrifts, which traditionally financed their loans with deposits’.
¹⁴
Furthermore, the transactions surrounding these products were highly complex and required a strong degree of mathematical fluency to decipher them, so much so that many of the bank executives and regulators who traded and regulated the securities simply did not understand the mechanics. Such were the wage bonuses and profits generated by these products, however, that there was little desire on the part of the financial markets to question the process. Accordingly, there was an increasing reliance on computer software packages to compensate for the lack of detailed knowledge. In the words of the 2011 Financial Crisis Inquiry Commission Report:

Financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk.
¹⁵

Furthermore:

… while the vulnerabilities that created the potential for crisis were years in the making, it was the collapse of the housing bubble – fuelled by low interest rates, easy and available credit, scant regulation, and toxic mortgages – that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of 2008.

Trillions of dollars in risky mortgages had become embedded throughout the financial system, as mortgage-related securities were packaged, repackaged, and sold to investors around the world.

When the bubble burst, hundreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them.

This happened not just in the United States but around the world. The losses were magnified by derivatives such as synthetic securities.
¹⁶

The slowdown in the US housing market in 2006 took place alongside a rise in mortgage defaults. The securitisation of mortgages, however, had become a key element of the world’s financial markets. The route by which bad loans in Chicago ended up on the balance sheets of ILB Deutsche in Düsseldorf was ‘opaque and laden with short-term debt’, and was facilitated by the development of the shadow banking system.
¹⁷

Paul Volcker, former Chairman of the Federal Reserve, 11 October 2010.

The authors of the Financial Crisis Inquiry Commission Report found that the US financial system of 2008 bore little resemblance to that of their parents’ generation; ‘The changes in the past three decades alone,’ they concluded, ‘have been remarkable.’
¹⁹
In 1933, in the wake of the Wall Street Crash and Great Depression, the US legislature passed the Glass-Steagall Act. This established the Federal Deposit Insurance Corporation (FDIC), which was set up in order to avert banks runs and sharp contractions in the finance markets. It meant that ‘if banks were short of cash, they could now borrow from the Federal Reserve, even when they could borrow nowhere else. The Fed, acting as lender of last resort, would ensure that banks would not fail simply from a lack of liquidity.’
²⁰
The price of this bank guarantee was regulation. In order to lessen the chances of a bank failure, the Fed insisted on measures to avoid excessive risk. The 1933 and 1935 Banking Acts ‘prohibited the payment of interest on demand deposits and authorized the Federal Reserve to set interest rates on time and savings deposits paid banks and savings and loans associations’ (S&Ls or thrifts).
²¹
Congress moved to limit the competition for deposits, as it felt that ‘competition for deposits not only reduced bank profits by raising interest expenses, but also might cause banks to acquire riskier assets with higher expected returns in attempts to limit the erosion of their profits’.
²²

The cap on interest rates came under increasing pressure in the late 1960s and early 1970s, as inflation grew and institutions such as ‘Merrill Lynch, Fidelity, Vanguard and others persuaded consumers and businesses to abandon banks and thrifts for higher returns’.
²³
‘These firms,’ said the Financial Crisis Inquiry Report:

…created money market mutual funds that invested these depositors’ money in short-term, safe securities such as Treasury bonds and highly rated corporate debt, and the funds paid higher interest rates than banks and thrifts were allowed to pay. The funds functioned like bank accounts, although with a different mechanism: customers bought shares redeemable daily at a stable value. In 1977, Merrill Lynch introduced something even more like a bank account: ‘cash management accounts’ allowed customers to write checks. Other money market mutual funds quickly followed.