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Patrick Honohan: Why I let bailout cat out of the bag


Patrick Honohan

Patrick Honohan

Patrick Honohan

By late August (2010), as the laborious process of NAMA valuations began to reveal the even larger haircuts required on the rest of the loans it was taking over, not only was the scale of prospective banking losses gaining more international attention, but the insufficiency of the fiscal adjustment was also becoming undeniable. Lenders in the financial markets were becoming doubtful.

Brian Lenihan knew well that September 2010 was going to be a testing month for the Irish banks, as they would have their work cut out to persuade lenders and depositors to rollover the large block of bank claims maturing in the last weeks of the original guarantee (which had been for two years only and, therefore, was due to expire at the end of September).

All of official Dublin knew that it was highly unlikely that a rollover would be successfully accomplished, leaving Anglo and, indeed, potentially other banks dependent on the Central Bank's Emergency Liquidity Assistance.

Already at the end of July, I had taken care to make the ECB fully aware of how this situation was shaping up, knowing that they would be uneasy about the prospect, as ELA is supposed to be a short-term facility. Nevertheless, it was the inexorable growth in ELA from the middle of September that would induce ECB staff and Council to press for Ireland's application for a programme of official financial assistance (ie. a bailout).

For a hammer, every problem is a nail, and most external official observers held fiscal hammers and assumed that fiscal tightening was the sole and necessary solution to the emerging Irish problem. By mid-September, Brian acknowledged that more fiscal action was going to be needed, even if it took several more weeks before official Dublin converged on a level of adjustment which would see the government's finances restored to a safe path. But fiscal adjustment was never going to solve the banks' problem if their funding continued to drain away.

While Brian fought a rear-guard battle against European fiscal hawks, in particular, resisting their pressure for an early budget, the Central Bank worked to persuade international colleagues to desist from market-destabilising statements that continued to fuel the deposit drain.

At the early-October IMF annual meetings, planning for a possible Irish funding application was already under way. At meetings with IMF officials, Brian asked what sort of conditions might a loan application entail and was reassured, by the tone conveyed by those on the other side - who would soon form the nucleus of the IMF Troika team for Ireland - and by their message, that the existing thrust of announced Irish fiscal and financial policy was broadly consistent with what would likely materialise. Still far from ready to make such an application, it seemed that Brian had mentally crossed a barrier.

In terms of market confidence, the die was cast by the Merkel-Sarkozy announcement on October 18 at Deauville to the effect that the holders of European government debt would have to contribute to any bailout. As the financial markets absorbed the implications of this new policy, interest rates on all peripheral government debt, but especially Ireland - now clearly seen as next-in-line for a bailout - jumped to insupportable levels. Now, Irish companies and individuals joined the external investors in removing their funds from the Irish banking system and the need for the protection of official external assistance became acute. Public and semi-public statements and briefings by senior Eurozone officials to that effect added fuel to the fire.

By Thursday, November 4, as the government announced the outline of its revised four-year budgetary plan, it was clear to Brian's Irish advisers that the game was likely up, and it did not take them long to convince Brian that it was time to talk to the Troika. I spoke to the relevant officials at the IMF and ECB and it was suggested that an early meeting be held in Brussels to see what might be available in the way of financial assistance.

By the middle of the following week, Brian had agreed that officials would conduct pre-negotiations on a programme - preferably precautionary in character. The IMF complained that it preferred to have a definite request before embarking on costly negotiations, but eventually agreed to proceed as if there had been a formal application. It was decided to hold the discussions in Brussels, as Brian did not want to have teams of negotiators in Dublin. The meeting was set for Sunday, November 14, and almost all of the 17-strong Irish team, led by the Department of Finance, flew over that morning.

Officials from the three agencies that made up the Troika had pre-negotiated, between themselves, much of what they had in mind, but their style in these initial negotiations with the Irish side was not to present demands, but instead to lay out what was legally possible in the terms of loans and the scale of financing they envisaged.

There were no surprises about the priorities. Fixing the banks and guaranteeing the fiscal adjustment were at the core of the Troika's agenda.

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The scale of the loan envisaged was even higher than we, on the Irish side, had anticipated, partly because the Troika wanted to provide for the eventuality of a very large capitalisation of the banks to a level which Irish officials thought would threaten debt sustainability of the sovereign. The Troika insisted, though, on two points: first, discussions could not go much further without a formal application, and second, the idea of a purely precautionary programme was out of the question.

Brian Lenihan was briefed by his officials on the two days of negotiations and was sufficiently convinced to agree that the negotiations should continue in Dublin on Thursday, November 18. Meanwhile, he came under much pressure from alarmed fellow ministers in the Eurogroup meeting on the Tuesday to make a formal application there and then.

I, too, was asked on Wednesday evening to let the Irish government know that the ECB Governing Council also wanted Ireland to apply in order to steady financial markets. I duly passed on the message by phone, but got a cross response from Brian, who rightly felt that all of the external actors were seeking to bounce him into formally making the application. He said he had no government approval to do so, but did not at all suggest that he was having second thoughts about the course that he had embarked upon. Instead, I assumed that he wanted to exploit the fact that no formal application had been made as a lever in the negotiations, which were scheduled to begin very visibly the following morning.

Noting the bewilderment evidenced in the European official circles, I became increasingly concerned that the financial market pressures, including the huge outflows from the banks, would cause lasting damage to the Irish economy.

Towards midnight that Wednesday, as the meeting I was attending broke up, I sounded out Frankfurt colleagues on whether they would support a statement by me indicating that the ECB was standing behind the Irish banking system, but in vain. Already, the following day's editorial in the Financial Times had appeared online, speaking of a bank run in Ireland.

Things had got to the point where, had it remained silent on the state of play, the Central Bank would have not only failed in its responsibility to use timely communication to steady confidence, but would also have dashed a legitimate public expectation in Ireland that it could be trusted not to deceive through omission.

Fortunately, this could be avoided, despite the lack of any application from Ireland for assistance. Thus, though by now all on the Irish side regarded a programme as inevitable and Brian's earlier hope that it could be a merely precautionary arrangement had now all but vanished, I made a point of explicitly leaving these two aspects -whether an application would be made and the possibility of a precautionary-only arrangement - open in the radio interview I undertook the following morning (Morning Ireland, Thursday, November 18).

The Troika remained in doubt about the government's intentions and the interview, if anything, improved the negotiating atmosphere somewhat to our advantage. What had not occurred to me was that Brian might not, even by that stage, have communicated to some of his senior ministerial colleagues how far down the road the discussions had already gone. Clearly, the interview was inconvenient for him, but he understood, as he confirmed to me then and later, that my sole aim was to work in the national interest.

Despite all this, the ECB - still not fully convinced that an application would be made - felt it necessary to write to Brian the following day, warning that continued emergency lending by the Central Bank to the Irish banks could not be assured unless there were to be an application.

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