The 2008 bank guarantee is not the cause of all our ills
The film 'The Guarantee' premiered last night. If it is as good as the play upon which it is based, it will be gripping and thought-provoking.
Although neither the movie nor the original play is reductionist or simplistic, the release of the film led to many predictable clichés about the "infamous"/"fateful" night of the bank guarantee and much reductionist hyperbole of the kind that "one decision changed Ireland's path".
The conventional wisdom now is that all our woes stem from that single decision made at a single moment.
The conventional wisdom is wrong.
Regardless of whatever decision was taken in September 2008, the damage had been done and the crash would not have been significantly less severe had there been no guarantee or even a more limited guarantee.
One reason to hold that view is because evidence from financial crises around the world shows that once financial systems are allowed to become bloated and then fail, there is very little governments can do to lessen the damage.
Most pertinent to the Irish case in recent times are two other small island economies which also allowed their financial systems to become much too big - Iceland and Cyprus - but took a different approach to their banks when they failed.
Iceland's financial bubble was even bigger than Ireland's. But it differed in that it was more closely linked to the mega bubble in the western financial system that inflated at the time (Iceland had no domestic construction/property frenzy).
While Ireland's bubble began deflating in the spring of 2007 as property prices began to go into reverse, Iceland's bubble burst much more suddenly when the international financial system went into meltdown after the collapse of Lehman Brothers in the middle of September 2008.
When the music stopped, the Icelandic government realised that even putting the full weight of the state behind the banks would not save them. Reykjavik never had the option of a guarantee. With no other option, the decision was taken to burn the banks' foreign creditors - from big bondholders to British and Dutch retail customers with on-line savings accounts in Icelandic banks.
Despite taking a very different course of action from Ireland, the Icelandic economy still went into freefall, as the chart shows. The domestic economy contracted by more than one quarter, an even more severe depression than Ireland's.
Now, more than six years on, what is striking in both the case of Iceland and Ireland is how similar trends in GDP and domestic demand have been in the two countries. Neither economy has yet recovered the ground lost, as measured by GDP. In both cases the size of the countries' domestic economies compared to their pre-crisis peaks in early 2008 are essentially identical.
While there are many factors and issues around the handling of their respective financial crises, the notion that Iceland's economy has performed better than Ireland's since 2008 is not supported by the facts. Claims frequently heard here in Ireland that our north Atlantic neighbour made some sort of miraculous and rapid recovery because it did not guarantee its banks, are simply false.
What about Cyprus? In Nicosia a different set of circumstances led to the authorities there to face a similar meltdown over the course of 2012, culminating in bank runs and a full shutdown of the banking system in early 2013.
This happened because Cypriot banks had become bloated with foreign deposits (mostly from rich Russians). Cypriot banks lent those deposits on. Much of their lending went to Greece. When the Greek economy crashed, big chunks of the Cypriot loans turned bad.
By the time the situation came to a head in early 2013, it was clear that if the Cypriot government guaranteed all the banks' liabilities, its public debt levels would go through the roof, causing it to go bust. Irish-style, state-backed support for the banks was therefore not an option. Without external assistance, which was not forthcoming, burning bank creditors was the only option left, just as it had been in Reykjavik four years earlier.
Anyone with deposits of more than €100,000, whether they were Cypriot families who had saved for retirement over a lifetime or Russian oligarchs, lost up to half their money. Banks closed for weeks. As in the case of Iceland, movement of cash out of the country was forbidden.
The shock of all this had a huge impact on the real economy. Again, as the chart shows, the plunge in both GDP and domestic demand since has been remarkably similar to the patterns in both Ireland and Iceland in the years after their respective meltdowns. GDP is down by almost one tenth (and still falling), while domestic demand is almost one fifth smaller than it was in 2011 when contagion from Greece made it clear that the Cypriot banks were done for.
One of the channels through which the Cypriot bank failure fed through into the real economy was via households becoming poorer overnight owing to loss of their deposits. Companies and organisations also lost fortunes, and their inability to access their accounts for weeks after the shutdown of the banks further exacerbated the crisis.
In the discussion of the Irish crisis, it is rarely mentioned that the most rotten of the banks - Anglo Irish - had €19bn in deposits from individuals in September 2008, and €32bn from organisations, including companies, charities, public sector bodies, pension funds and credit unions.
Had it been allowed to collapse, the direct cost to the State would have been reduced to the tune of around €30bn. But the additional direct shock to an economy already reeling from the collapse of the construction industry would have been huge. That in turn would have further depressed tax revenues and pushed up public spending.
The chances that such a widespread loss of deposits among Anglo customers would not have led to a run on the other banks is, frankly, fanciful. If that had happened the entire system would have shut, just as it did in Iceland and Cyprus. The guarantee prevented that, and prevented huge additional costs.
It will never be possible to tell whether the indirect costs of allowing Anglo to fail would have been less than or greater than the huge direct cost of preventing collapse. But one thing is sure: nothing that happened on the night of September 28, 2008, could have prevented a disaster that had been in the making for the previous five years.