Holding up an Irish mirror

 Everyone has a theory about the financial crisis in the United States. These theories range from the absurd to the plausible — from claims that liberal Democrats somehow forced banks to lend to the undeserving poor (even though Republicans controlled Congress) to the belief that exotic financial instruments fostered confusion and fraud. But what do we really know?
         Well, in a way the sheer scale of the crisis — the way it affected much, though not all, of the world — is helpful, for research if nothing else. We can look at countries that avoided the worst, like Canada, and ask what they did right — such as limiting leverage, protecting consumers and, above all, avoiding getting caught up in an ideology that denies any need for regulation. We can also look at countries whose financial institutions and policies seemed very different from those in the United States, yet which cracked up just as badly, and try to discern common causes.
         So let’s talk about Ireland.
         As a new research paper by the Irish economists Gregory Connor, Thomas Flavin and Brian O’Kelly points out, “Almost all the apparent causal factors of the U.S. crisis are missing in the Irish case,” and vice versa. Yet the shape of Ireland’s crisis was very similar: a huge real estate bubble — prices rose more in Dublin than in Los Angeles or Miami — followed by a severe banking bust that was contained only via an expensive bailout.
         Ireland’s bust wasn’t a tale of collateralized debt obligations and credit default swaps; it was an old-fashioned, plain-vanilla case of excess, in which banks made big loans to questionable borrowers, and taxpayers ended up holding the bag.
         So what did we have in common? The authors of the new study suggest four ” ‘deep’ causal factors.”
         First, there was irrational exuberance: In both countries buyers and lenders convinced themselves that real estate prices, although sky-high by historical standards, would continue to rise.
         Second, there was a huge inflow of cheap money. In America’s case, much of the cheap money came from China; in Ireland’s case, it came mainly from the rest of the euro zone, where Germany became a gigantic capital exporter.
         Third, key players had an incentive to take big risks. In Ireland, “rogue-bank heads retired with their large fortunes intact.” There was a lot of this in the United States, too: as Harvard’s Lucian Bebchuk and others have pointed out, top executives at failed United States financial companies received billions in “performance-related” pay before their firms went belly-up.
         But the most striking similarity between Ireland and America was “regulatory imprudence”: the people charged with keeping banks safe didn’t do their jobs. In Ireland, regulators looked the other way in part because the country was trying to attract foreign business, in part because of cronyism: Bankers and property developers had close ties to the ruling party.
         So what can we learn from the way Ireland had a United States-type financial crisis with very different institutions? Mainly, that we have to focus as much on the regulators as on the regulations. By all means, let’s limit both leverage and the use of securitization — which were part of what Canada did right. But such measures won’t matter unless they’re enforced by people who see it as their duty to say no to powerful bankers.
         That’s why the United States needs an independent agency protecting financial consumers — again, something Canada did right — rather than leaving the job to agencies that have other priorities. And beyond that, the United States needs a sea change in attitudes, a recognition that letting bankers do what they want is a recipe for disaster.