Four years ago today, it emerged that nobody would lend to Anglo Irish Bank in the wholesale markets.
The bank faced imminent collapse. The Government announced that almost all the existing liabilities of the domestic Irish banks were to be guaranteed immediately by the Irish Exchequer, as well as future liabilities contracted over a two-year period to end-September 2010.
The Government had been advised by the banks and their regulator that Anglo's problems were confined to a shortage of liquidity arising from the international credit squeeze. The Lehman Brothers bank in New York had been allowed to go under by US authorities two weeks earlier. The public were assured that all Irish banks were solvent and were innocently suffering collateral damage from somebody else's banking crisis.
This rosy assessment was confirmed in a report from PricewaterhouseCoopers commissioned shortly thereafter and released in February 2009. The assessment supporting this bet-the-ranch decision was about as wrong as it is possible to be.
Not just Anglo, but every other bank operating in Ireland, including foreign-owned banks, had experienced catastrophic loan losses. Every one of the Irish banks would have failed without State support. Anglo has already provided for loan losses exceeding eight times its capital and every single domestic bank has been eating prodigious quantities of Exchequer funds ever since.
The banking system which the State so blithely guaranteed on that misfortunate weekend four years ago went down in one of the biggest banking busts there has ever been anywhere in the world. State support for the banks has been ruinous and the State itself effectively went bust in the autumn of 2010, driven from the bond market under the weight of debt. The State now relies, in Morgan Kelly's phrase, on the kindness of strangers, in the form of emergency loans from the EU and the IMF.
Most of the Irish banking losses relate to loans already made by September 2008 when the guarantee was announced. How the bank boards and managements, the Central Bank, the Financial Regulator and the Department of Finance, not to mention PricewaterhouseCoopers, got it so badly wrong has yet to be satisfactorily explained.
Eventually in March 2010, the Central Bank, under new
leadership, released a comprehensive estimate of bank loan losses and the full extent of the disaster was acknowledged. In addition to the utter bankruptcy of both Anglo and Irish Nationwide, appalling losses had been incurred at AIB, which was nationalised, and huge losses at all of the other Irish banks.
Prior to the crisis of September 2008, Irish bank share prices had been falling rapidly for more than a year and it was public knowledge that several banks had encountered problems raising funds in the wholesale markets. The State nonetheless assumed liabilities well in excess of its financial capacity, despite clear grounds for caution.
The price of commercial property, the collateral for much of the bank lending, had been falling for 18 months. Numerous commentators expressed instant alarm at the blanket-guarantee decision and events unfortunately have vindicated their alarm. To their credit, the Labour Party deputies opposed the bank guarantee in the Dail, the only deputies to do so.
The guarantee was extraordinarily broad, even allowing for the hurried decision-making timetable. Pre-existing bonds issued by banks as well as new ones were guaranteed, precluding the subsequent imposition of losses on legacy bondholders.
Remarkably some categories of subordinated (junior) bonds were also guaranteed. Holders of these bonds would have expected exposure to losses immediately after the equity shareholders, all of whom were wiped out. Instead they were elevated to the superior status of sovereign creditors in a move which has puzzled observers ever since and which has never been explained.
Since the Irish banking system had grown enormously through the bubble, the volume of liabilities assumed under the guarantee was a large multiple of annual national income. Thus there was always a risk that the State's finances would suffer badly if things went wrong, as well as good reasons for fearing that they would.
The responsibility for the Irish Exchequer's bank-related debt (about €64bn, more than 50 per cent of national income) does not however reside entirely in Ireland. Once the Irish authorities realised, in the early months of 2010, that continued payouts to creditors of bust banks would quickly threaten the solvency of the State, they sought to break the link between banks and sovereigns through discontinuing the guarantee arrangements.
Breaking this link became EU and European Central Bank (ECB) policy only recently, as the Spanish crisis intensified. The Irish Government was inhibited from pioneering this policy in the eurozone as a result of threats from the same ECB, on which the Irish banks were reliant for liquidity provision.
Whether the ECB was acting outside its mandate in making these threats has not as yet been tested at the European Court. The protection of categories of unsecured bank creditors at the expense of sovereigns is not a power vested explicitly in the ECB, or in any European institution, under the treaties. Had such a provision been proposed, no country would have agreed to it.
On June 29 last, the European Council, to considerable relief in the eurozone's peripheral bond markets, announced a series of agreements designed to address the interlinked banking and sovereign debt crises. These included the use of the European Stability Mechanism (ESM) rescue fund to recapitalise banks directly. The ECB, under its new president Mario Draghi, followed up with a proposal for direct ECB purchases of eurozone government bonds in the secondary market.
The backsliding commenced straight away, led by Bundesbank president Jens Weidmann who dissented publicly from the decision of the ECB governing council, while choosing to remain a member. German Finance Minister Wolfgang Schauble attended a meeting with his Dutch and Finnish counterparts in Helsinki on Tuesday last and the three released a communique decisively at odds with the June European Council commitments. They state: "We discussed basic principles for enabling direct ESM bank recapitalisation, which can only take place once the single supervisory mechanism is established and its effectiveness has been determined," (my italics). Even if there was unanimity on the new Europe-wide bank supervision arrangements, it is a huge task to create the new supervisory structure. Schauble insists that it should cover only 25 or 30 of Europe's largest banks, a list that would have excluded the ones that have caused most of the problems and a view at odds with most other finance ministers.
But the Helsinki Three would also delay ESM recapitalisation of troubled banks not merely until the supervision body is established, but also until "its effectiveness has been determined". That could mean never -- there is no bank supervision body in the world whose effectiveness is universally accepted.
The communique continues: "The ESM can take direct responsibility of problems that occur under the new supervision, but legacy assets should be under the responsibility of national authorities," and finally "direct bank recapitalisation by the ESM should take place based on an approach that adheres to the basic order of first using private capital, then national public capital and only as a last resort the ESM".
The drafters presumably meant liabilities rather than assets in the first part quoted. These statements taken together, as well as seeking to row back on the commitments entered into by the prime ministers of Finland, Germany and the Netherlands last June, constitute an extraordinarily naive formula for dealing with banking busts in a monetary union. The implication is that when private banks are in trouble, first resort is to new private capital, of which there will be none in the most serious cases. Next up is national public capital. Only when this is exhausted could there be resort to institutions at the level of the monetary union. Aside from the sheer inconsistency (these people would all say 'no' if asked to endorse moral hazard for banks), the implication is that each component state in a monetary union is to be fully exposed, up to the point of national insolvency, for bailing out private banks. The effect would be to institutionalise the bank-sovereign doom-loop.
The Helsinki Three should put the following proposition to the electorates of Finland, Germany and the Netherlands: "We, the citizens, agree to bail out the creditors, foreign and domestic, of any Finnish/German/Dutch banks that fail, up to the point where the state becomes insolvent." Surely the citizens would understand.