FINANCIAL FRAGILITY & CORPORATE GOVERNANCEIN IRELAND

Dr Stephen Kinsella, UL

stephen.kinsella@ul.ie | stephenkinsella.net

“I DON'T THINK WE ARE ANYWHERE NEAR THE SITUATION THAT PREVAILED IN THE 1970'S.”— BEN BERNANKE, 2008

“THE CENTRAL PROBLEM OF DEPRESSION-PREVENTION HAS BEEN SOLVED, FOR ALL PRACTICAL PURPOSES.” ––ROBERT LUCAS, 2003

Eh, no Ted.

Changes in real GDP for Ireland, 1971–2008. Source: Central Statistics Office, Economic and Social Research Institute, and author's calculations. Note: 2007 and 2008 are estimates.

NOW.Corporate Governance & Financial Fragility in Ireland

Point of Talk: We should have made the rules tighter years ago.

WHAT I WANT YOU TO LEARN

1.Definition of Governance

2.History of Crises

3.Answer to Question: “Who does and who should regulate banks and financial intermediaries?”

4.History of Governance Structures in Ireland.

MINSKY

Minsky theory of the credit cyclecf. Minsky, Stabilising an Unstable Economy, (1986)

MINSKY MOMENTS1.Idea: Credit markets will breed their own reversal

2.How?

1.Cheap interest rates lead to increased lending.

2.This leads to increases in leverage (Loan/Deposit ratio).

3.Perverse incentives breed dodgy lending via financial innovations (Junk bonds/CDOS/etc) ensues.

4.Something changes, dodgy loans default, banks fail, unless they get bailed out by Big Bank/Big Govt.

MINSKY CYCLE

Five stages in Minsky’s model of the credit cycle:

1.displacement,

2.boom,

3.euphoria,

4.profit taking, and

5.panic.

3

Sectoral L ending ! March 2009

! PSC comprises two major components ! loans and holdings of securities. Holdings of

securities are an increasingly important component of credit, especially since the start of

2008, and mostly relate to credit extended to the financial intermediation category. This

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all sectors in Q1 2009 for the third consecutive quarter. Types of credit in this sector

include lending to non-bank credit providers, life insurance and pension funds, and

special-purpose vehicles (SPVs). The repurchase by credit institutions of residential or

commercial mortgage-backed securities issued by SPVs that are linked to individual

credit institutions is one of the factors behind the high growth rate of credit to financial

intermediation. However, a significant part of lending to the financial intermediation

sector is not associated with the domestic economy; this would include, for example,

lending to non-bank IFSC companies.

CORPORATE GOVERNANCE

WHAT IS GOVERNANCE?

Defini-tion

“Governance concerns the exercise of power through policies enacted by self- interested agents working within institutions”

ALL THIS HAS HAPPENED BEFORE, AND WILL HAPPEN

AGAIN

Latin American debt crisis of the 1980’s, US stock market crash of 1987,Japanese real estate and stock market crisis (and ensuing

liquidity trap) in the 1990’s, UK housing crash in 1991 and 1992, Mexican Peso crisis of 1994, Long-running Russian crisis of the mid-90s, East-Asian crisis of 1997/8, Bursting of the `dot com’ bubble in the US in 2000, Worldwide recession following the terrorist attacks of 9/11

in 2001, Argentinean currency crisis in 2002, Sub-prime crisis which began in the US in August 2007

Partial list of Crises 1980 - 2008

CAUTIONBanking is risky, must be regulated

BY WHOM?

• Since 2003, Financial Intermediaries licenced licensed in Ireland by the Financial Services Regulatory Authority (FSAI)

“Remit of the FSAI since its inception in May 2003 has been to license, liase with, and monitor the activities of licensed agents in the financial services sector, to ensure they act in the public interest according to legal strictures.”

WHO SHOULD LEND, AND WHY?

Lending by banks, for the most part, should be for productive, profit making activities

It is not clear that the practice of lending for investment in property, based on an expectation of ever-higher price increases in the value of that property, could be considered a productive activity.

It was, instead, a redistributive activity, where the future incomes of borrowers were transferred to the present to finance loans for mortgages on residential and commercial properties.

GOVERNANCE & REMUNERATION

• A Clear Principal-Agent Problem

GOVERNANCE & REMUNERATION

• “...the wave of corporate scandals that began in late 2001 shook confidence in the performance of public company boards and drew attention to potential flaws in their executive compensation packages. There is now recognition that many boards have employed compensation arrangements that do not service shareholders’ interests. But there is still substantial disagreement about the scope of such problems and, not surprisingly, how to address them. “

Bebchuk, L. and Fried, J. Pay without Performance: The Unfulfilled Promise of Executive Compensation, (Harvard University Press, Boston, 2004), p. ix.

STALL THE DIGGER.

US SUBPRIME LOANS

• Issued by FDIC

RECOMMENDATIONS FOR REFORM

• Speed up structural change

• Sponsor focused job creation programmes.

• Nationalise wayward Irish banks.

• Foster less procyclical leveraging

• Cede Regulatory control to EU.

• Encourage Transparency.

• Change the Rules

Excessive Regulation.

Sandin

the Gears

FINANCIAL FRAGILITY & CORPORATE GOVERNANCEIN IRELAND

Dr Stephen Kinsella, UL

stephen.kinsella@ul.ie | stephenkinsella.net