Tuesday, December 22, 2009


Prof. Patrick Honohan’s call for an investigation into the financial crisis is shocking only because it comes so late in the day. It is incredible that so much taxpayer money has been put at risk without a comprehensive examination into the causes of the crisis. Surely the Irish taxpayer deserves at least that much? Ireland is an outlier in this regard – the UK and the US have subjected those responsible for the crisis to searching scrutiny and investigations are ongoing. We need to follow suit immediately if we are to establish a firm foundation for undertaking the challenging task of regulatory reform. It is also essential to dispel the notion that crony capitalism is alive and well here.

An investigation is imperative, but not by the Oireachtas. That would be throwing good money after bad. There are good models that we can emulate from other jurisdictions. The starting point has to be the path-breaking inquiry that followed the Great Depression in the United States. The Senate investigation into the causes of the crisis cut through the lies and deception and paved the way for a slew of legislative advances like the Glass-Steagall Act (which established the Federal Deposit Insurance Corp.), the Securities Act of 1933, and the Securities Exchange Act of 1934 (which established the SEC). That investigation owed its success to the chief counsel, Ferdinand Pecora – an immigrant prosecutor who had been labeled a “dirty little Italian” -- a marked contrast to towering figures like JP Morgan Jr., who had to testify about the smoke and mirrors world of Wall Street banking in the early part of that century. Pecora’s team’s approach was described by one historian thus: "descend upon a banker or broker and go through his records, file drawer after file drawer, page by page, selecting and photostating documents. Staff lawyers and accountants would assemble this material to reconstruct the motivations, discrepancies, delinquencies, and frauds involved." The most important lesson from that investigation’s success for Ireland is that it must be led by those outside the corridors of power. A real investigation into the consequences of crony capitalism cannot be conducted by a group of insiders.

The current investigation in the US is much less colourful and has considerable differences in constitution, but is again manned from outside the Washington Beltway. The agency is created by statute (Fraud Enforcement and Recovery Act) and is called the Financial Crisis Inquiry Commission (FCIC). It is mandated to “submit on December 15, 2010 to the President and to the Congress a report containing the findings and conclusions of the Commission on the causes of the current financial and economic crisis in the United States.” The FCIC is a bi-partisan body chaired by Phil Angelides, a former California Treasurer, and includes a retired Senator, a couple of experienced Attorneys, and experts in economic policy. The statute expressly banned members of Congress and government employees from appointment as commissioners. The FCIC has the power to hold hearings, take testimony, and issue subpoenas. These subpoenas can be used to compel individuals to testify and are backed up by criminal sanctions. Significantly, the FCIC can also authorize its staff to take depositions; this should make its working more efficient by eliminating the need for the full commission to convene to hear testimony and allow it to take more depositions.

There are no illusions about the mammoth task given to the FCIC. Its charge includes an examination of every financial institution that failed, investigating whether federal and state regulators failed to enforce legal requirements, studying accounting practices, capital requirements and regulations on leverage and liquidity, credit rating agencies, lending practices and securitization, affiliations between insured depository institutions and securities, insurance, and other types of non-banking companies, corporate governance, compensation structures, legal structures in the financial industry, and derivatives. Another specific investigative assignment is the notion that some financial institutions are ‘too-big-to-fail.’ The FCIC also has the power to refer “any person that the Commission finds may have violated the laws of the United States in relation to such crisis” for prosecution.

An Irish Commission has to be similar only in terms of its constitution and the powers conferred. Luckily, its mandate does not have to be anywhere near as comprehensive as the FCIC’s in order to establish the causes of the crisis here, and to identify failures at various levels. At a minimum, it must be tasked with answering the following questions: What caused the credit bubble in Ireland? What was the role of financial institutions in creating the bubble? Were capital adequacy requirements at appropriate levels? Were the legal requirements followed? Was this a market failure, a regulatory failure, or an institutional failure? What is the role of information intermediaries? Did the regulators gloss over the risk exposure of financial institutions? Is there a way of limiting risk to tolerable levels through regulation? Did regulators have access to relevant information? Was there inadequate oversight and enforcement? Was there a failure of corporate governance? What ought to be the legal response to minimize the possibilities of a similar crisis in the future?

There has been support for Prof. Honohan’s proposal from entities like the Corporate Governance Association of Ireland (CGAI) and the Irish Banking Officials Union (IBOA), and some senators. These voices will only grow louder to reflect the zeitgeist. Those in power have to act now. Otherwise, we will move from bust to boom to bust again none the wiser.