A stroke of genius, perhaps, but don't bank on it just yet
Wednesday October 01 2008
The system had collapsed, and Anglo, Permanent TSB, Irish Nationwide and EBS,
could have gone down with it
NOT for the first time, in our exciting economic history, sheer desperation may have led us to a radical policy which will come to be admired, even copied, by others.
There was the Shannon duty-free zone; the zero corporation tax on export profits; the handing over of gigantic public debt to a semi-commercial agency, the NTMA. All were born out of crises and absence of choices, and many's the politician who afterwards took credit for these strokes of Irish genius.
Yet none was as radical as the decision to guarantee all the deposits and debt of the entire Irish-owned banking system. Nor was there any great loss if those previous schemes did not work. So we must all fervently hope that this also turns out to be an inspired piece of lateral thinking, however fraught its origins. The reaction of several reputable foreign observers yesterday was that it might be. The Government has taken an enormous bet on the great argument over the credit crisis -- whether it is essentially a crisis of confidence, where perfectly sound banks cannot raise the funds to conduct their normal business; or whether it is a crisis of solvency, where a lot of banks are actually unsound and incapable of doing normal business.
The answer to that question in Ireland will decide whether the taxpayer eventually faces some uncertain, but definitely large, bill to stand over some of the guarantee, or whether, for no cost, the Government has restored some semblance of normality to the banking system. What is not in doubt is that something had to be done. Government, banks and the central bank have spent weeks in secret talks trying, and failing, to reach agreement on how to cope with the deteriorating situation.
The Department of Finance was reluctant to expose the public finances to unknown liabilities. The banks were unwilling to raise large new amounts of capital, even from the Government, which they believed were not needed. Monday's events meant the game was up and time had run out.
Too much attention has been paid to bank share prices, largely because they are plain to see.
The real horrors have been on the opaque money markets. On 'Meltdown Monday', as the shares of the smaller Irish banks fell 40pc, across Europe, banks would lend to each other only at 1.25pc more than ECB rates. Last year, you could have got a tracker mortgage for far less than that.
In other words, banks would not lend to each other at all. The system had collapsed, and some of those smaller Irish lenders -- Anglo, Permanent TSB, Irish Nationwide and EBS, could have gone down with it. Indeed, all of them could have gone down with it.
It is up to the USA to put the system back on the rails. But waiting for that might have been too late. All the Irish banks insist that they are solvent. The Regulator has endorsed that. Their problem, they say, is the impossibility of raising the normal flow of borrowed funds in a collapsed market. If that is the case, it would clearly be utter folly to court the enormous cost and economic damage of letting sound banks fall.
The Government has looked at the figures and decided to believe the banks -- or at least most of them.
Banks can now go to the markets for routine funding (liquidity) with a state guarantee behind them. The idea -- and the hope -- is that the market will be willing to lend those funds. Collapse has been avoided -- as it had to be. In time, we will see if the Irish banks really are that sound, and whether the blanket guarantee really was a stroke of genius.
Irish banks do have problems, arising from their huge lending on property, especially commercial property and development land. Most analysts think they will have to write off about 1pc of their total loans -- which means nearly 2pc of their property loans. It may not sound a lot but, in banking terms, it is a big, big loss. In total, it could be more than €5bn.
Even so, in normal circumstances, one would expect the Irish banking system to be able to withstand that sort of loss. But circumstances are not normal. The purpose of the guarantee is to make conditions more normal for Irish banks, so that they can get on with the time-honoured process of bankrupting over-stretched customers, selling off their assets, writing off the resulting losses, and moving on.
AT which point, one can already see one of the dangers in the scheme. Within hours, there were calls for stressed-out borrowers to be cut some slack by their rapacious bankers, now that the raptors have sought the protection of the taxpayer. Ministers will have to be firm in their resolve that this is a way of restoring the normal functioning of banks, not its replacement by something kinder and more generous.
The Financial Regulator will have to keep a sharper eye than it did during the lending boom, to ensure that any bank that needs the guarantees is identified early, before the potential cost gets bigger. Last night's legislation is supposed to help in that scrutiny.
All the banks will have to be watched to ensure they do not abuse the guarantees by offering extra inducements to depositors or borrowing more than they need. Then there is the question of how the system will be brought to an end in two years' time, or whenever. As generals from Northern Ireland to Iraq have warned, it is always easier to go in than get out again.
The ultimate purpose, of course, is to minimise damage to the real economy. Yesterday's confidence survey suggests that Irish consumers will respond to good news if they get it. Unlike the Americans or British, they have significant savings, as well as their large mortgage debt. Irish companies, outside of property, also have strong balance sheets
If they start to feel that the Irish banking crisis has been solved, we could see results in improved spending and investment. If it really has been solved, the banks will be better able to lend to fund that spending. If other countries start copying us, the results might be dramatic.
