ANALYSIS:When Honohan's polite words are stripped away, political responsibility for the banking crisis is laid firmly at the door of Cowen's government
A DAMNING indictment of the Government’s budgetary policy in the years running up to 2008 is contained in the two banking reports and that is something the Opposition will hang around the neck of Taoiseach Brian Cowen until the votes are counted in the next general election.
The good news for the Coalition in the reports is the acceptance that some form of extensive bank guarantee scheme was necessary to stop the country’s banking system from collapsing in October 2008 and bringing the entire economy down with it.
Whether the Government will get any thanks from the electorate for preventing the hole getting any deeper, having dug it in the first place, is doubtful. Still, the broad endorsement of the policy adopted since the crisis broke will at least give Fianna Fáil TDs a message to try to sell to a disillusioned and bitter electorate when the day of reckoning comes.
When the polite language is stripped away, the findings of Patrick Honohan’s report are stark. While the Central Bank, the Financial Regulator and the banks themselves come in for the strongest criticism, there is no disguising the political responsibility that lies at the door of the Taoiseach and the Government.
Honohan blames macroeconomic and budgetary policies that contributed significantly to the economic overheating and helped “create a climate of public opinion which was led to believe that the party could last forever”.
He calculates that the scale of the banking crisis in Ireland was worse than any other country, apart from Iceland, and that three-quarters of the problem was home-grown, with fiscal policy playing a large part in its creation.
“The increased reliance on taxes that could only generate sufficient revenue in a boom, made public finances highly vulnerable to a downturn. Specific tax incentives also boosted rather than restrained the overheated construction sector. And, with surging labour demand, wage rates in both the public and private sectors moved well ahead of what could protect international competitiveness.”
The Regling and Watson report is also clear that the Irish banking crisis was “home made” and it points to official policies as well as bank governance as the cause of the crisis.
Honohan points to the country’s current massive borrowing requirement as arising from the increase in Government spending after 2004 which became embedded in the system during Cowen’s watch. This unsustainable rise in public spending led directly to the borrowing surge in 2008/2009 when the tax base began to crumble. This surge in borrowing was more pronounced in Ireland than virtually any other country during the downturn, according to the report.
It pulls no punches in saying that it was not the collapse of Lehman Brothers, as the Taoiseach has often said, but rather domestic policy decisions that accounted for the scale of the crash here.
Observing that Government spending doubled in real terms between 1995 and 2007, Honohan remarks that “in a final twist, real expenditure rose by over 11 per cent in both 2007 and 2008, an unfortunate late burst of spending which boosted the underlying deficit at almost the worst possible time”.
The Regling and Watson report also deals with the collapse in tax revenue over the past two years and points to a change in the structure of tax revenue since the 1990s. It points to the Government policy of repeated tax cutting which narrowed the tax base, the way in which the tax system favours property and the large number of tax exemptions.
In response to this catalogue of policy errors, the Government can point to the findings in both reports that it was not alone in failing to read the warning signs. Nobody else, including the International Monetary Fund, spotted them and the mood in Ireland reflected an international flight from reality.
The Taoiseach cited this finding in his response to the reports yesterday. He also pointed out that the Opposition parties spent almost all of their time attacking the Government for spending too little rather than too much right through the boom, and that is something Fianna Fáil will continue to stress.
Where the Government will be on stronger ground is in defence of its actions since the storm finally broke in September, 2008. The bank guarantee has come in for a lot of criticism and was opposed by the Labour Party from the beginning but Honohan is clear on this issue.
“As regards the substance of the guarantee itself, it is hard to argue with the view that an extensive guarantee needed to be put in place, since all participants (rightly) felt that they faced the likely collapse of the Irish banking system within days in the absence of decisive immediate action. Given the hysterical state of global financial markets in those weeks, failure to avoid this outcome would have resulted in immediate and lasting damage to the economy and society.”
While he has difficulties with aspects of the guarantee, such as the inclusion of subordinated debt, his analysis broadly backs the Government’s approach to the banking crisis and he is also clear on the need to get the public finances into shape as quickly as possible. It is some consolation for an embattled Coalition.
Stephen Collins is Political Editor