Note: This oral testimony was delivered on February 5, 2015 in Dublin, Ireland before the Oireachtas' Joint Committee of Inquiry into the Banking Crisis. These are my prepared remarks. My actual oral testimony differed considerably. A transcript is available from the Inquiry, as is complete video.
To: Joint Committee of Inquiry into the Banking Crisis
From: William K. Black
Date: February 3, 2015
Oral Testimony of William K. Black
Thank you for the invitation to assist Ireland as you face among the most important questions Ireland and many other nations must answer correctly if we are to put a stop to our recurrent, intensifying financial crises. I am William K. Black and I come to you wearing four disciplinary and three institutional "hats." My primary appointment is in economics with a joint appointment in law at the University of Missouri-Kansas City. I am a white-collar criminologist and a former senior financial regulator. My research specialties include elite white-collar crime and corruption, regulation, and financial crises. I am the Distinguished Scholar in Residence for Financial Regulation at the University of Minnesota's Law School. I am a professor at the Instituto de Altos Estudios Nacionales es la Universidad de Posgrado del Estado in Quito, Ecuador. My testimony, of course, is solely my personal views rather than the official position of any of these universities.
There is Nothing More Expensive than Failed Banking Regulation
There is nothing a nation does in the domestic sphere that is more expensive than ineffective regulation. Bankers cause bank losses. Bank regulators can reduce bank losses dramatically and prevent the hyper-inflation of the bubble and the resultant financial crisis. Bank regulators do not require super powers to succeed. They do not have to be able to foresee the crisis or even realize that there is a bubble to succeed.
The Three Maladies
To prevent the most common and severe form of bank crises, bank regulators need to understand, and act vigorously and promptly to stop, three maladies -- the "recipe," indefensible loan underwriting (leading to "adverse selection"), and the Gresham's dynamic. Each of those maladies is profoundly harmful, so acting promptly and vigorously to stem them is highly desirable. Acting to block these three maladies unambiguously aids honest bankers' banks and their shareholders, creditors, and customers. Each of these maladies had been in the relevant literature for decades prior to the Irish bank crisis.
A Caution on Interpreting my Use of the Word "CEO"
For reasons solely of brevity, I use the term "CEO" rather than the phrase "the persons controlling the bank." When I use the term "CEO" I am NOT referring to any individual who may have held that title at a particular Irish bank at a particular time. I am using the term generically and collectively to mean whatever officials exerted control over the strategic decisions of the non-Irish banks. I do not refer in my testimony to any Irish bank CEOs.
My testimony does not directly address the causes of the current Irish banking crisis. My testimony focusses on what causes the worst and the most common banking crises in other nations. Those factors are also the most likely to cause future severe banking crises in Ireland and other nations. Preventing and minimizing future banking crises is my focus.
Countering "Criminogenic" Environments
Bank regulators who understood these three maladies have demonstrated the ability to regulate effectively and prevent systemic financial crises. They have figured out what policies make an environment "criminogenic." A criminogenic environment is one in which the incentive structures are so perverse that they produce widespread crime. The primary means by which bank CEOs create these perverse incentives is through compensation, retention, and promotion systems. Irish bank regulators can learn to identify and counter these perverse incentives, preventing and limiting the three maladies in the future and holding even elite individuals personally accountable for their misconduct in future failures.
My description of the need to counter these perverse incentives that make the three maladies widespread is not the only function of good bank regulators, but it is the paramount function. Preventing future criminogenic environment in banking would not simply accomplish the paramount function of banking regulators, but also greatly reduce the frequency and severity of future abuses by bankers such as the massive sales of inappropriate financial products to customers. The same type of perverse compensation/reward systems that produce the three maladies also produce endemic product sale abuses by bankers.