The substantive value of money (purchasing power) at any moment in time is the result of the economic ‘battle of man with man’ in which money is a weapon (Weber 1978: 92-3). It is not a ‘neutral veil’, or a ‘harmless voucher’. Any balance of money and goods is the expression of a temporary balance of economic power; it does not represent the achievement of the long-run equilibrium described by economic theory. Geoffrey Ingham – The nature of money (2004) – p71.
Hindsight provides 20-20 vision, but in light of more recent events political spin and a sense of justifiable grievance can cloud the popular understanding of what happened in the past. There is, of course, the accuracy of the historical record to correct the flawed collective memory.
One ‘flawed memory’ is that the bailout by the Troika was forced on Ireland in order to ensure that money from Irish tax revenue was used to pay back French and German banks, and that since the bailout was a consequence of the guarantee, that it too was forced on Ireland by the ECB to ensure that European banks got their money back. At the time that the bailout was announced, Brian Lenihan began the process of conflating the terms and conditions of the program with the guarantee:
“There is simply no way that this country, whose banks are so dependent on international investors, can unilaterally renege on senior bondholders against the wishes of the ECB. Those who think we could do so are living in fantasy land.”
But when Irish politicians provided an unlimited guarantee the credibility of the guarantee and therefore its effectiveness in upholding the banking system depended on the willingness of the ECB to prevent a country from defaulting on its sovereign debt.
This is not to say that the actions of the ECB, its rules and structures or even the way that the single currency is arranged and the orthodox thinking that underpins it in the interests of private banking is correct or just. Far from it. However, a clear order of cause and effect must be followed, and the ECB is not responsible for the far reaching consequences of providing an unlimited guarantee.
Indeed, the Irish government was warned of the dangers. In their published opinion on the guarantee issued on the 3rd of October 2008 it says:
While the ECB appreciates that any guarantees provided by the Minister under the draft law would be contingent in nature, given that the financial exposure of the Irish State under such guarantees is potentially very large, the Irish Government could be obliged to make significant payments in case these guarantees are called over the next two years. At a point in time when the Irish budgetary position is deteriorating and may risk exceeding the 3% of GDP reference value for public deficits, as specified under Community law, this is a cause for concern, even when the provision of financial support would, under the draft law, as far as possible ultimately have to be recouped from the credit institution or subsidiary in question.
But the idea that the ECB applied pressure on Ireland to take the decision is reinforced by the fact that ultimately the ECB approved the Irish guarantee and that other European countries brought in their own after Ireland’s declared its intention. It is informed by the breezy accounts that the ECB President phoned Central Bank governor John Hurley on Saturday the 28th of September and the bit in the documentary Freefall which aired on RTE in September 2010, where Brian Lenihan tells the story of how he got a voice mail message from Jean Claude Triche while out at a Fianna Fail event. The message apparently said: “You must save your banks at all costs.” This is not very strong evidence of ‘pressure’ from the ECB.
But looking back at the reaction to events in late September 2008 reveals a different picture.
At the time, the decision to increase a guarantee on deposits from 20,000 to 100,000 in the previous week had already put pressure on other European countries to match it. Nationalisations of banks were happening in the UK, The Netherland and Belgium and there was news that Germany was about to do the same for its second largest bank, Hypo Real Estate, mainly because of its acquisition of the Dublin-based Depfa bank.
Alastair Darling has said that he spoke with Brian Lenihan on Sunday the 29th and he “assured him the Government would not give a blanket guarantee to the banks” and that as had been agreed in the informal Ecofin meeting on the 12-13 of September not to act unilaterally, but to wait for the coordinated joint response. From the ECOFIN press release:
“EU economy and finance ministers and governors of the central banks agreed on a joint response to confront the economic slowdown and restore confidence in the financial markets. ECOFIN agreed to implement a consistent and coordinated response at European level.”
As Brian Lenihan told the Dail in answer to a parliamentary question in 2011, he did not phone any one on the night of “September 29th to “seek advice” on the guarantee or any other options for resolving the crisis” and as Alistair Darling wrote in his autobiography, that the first he heard of it was on the morning of the 30th of September when it was mentioned in a report on the BBC radio’s Today program at 6.30 in the morning.
It “smacks of panic rather than a plan”, said Darling remembering Lenihan’s account of how the decision was made at 2am on the morning of the 30th when they talked the next day. During the conversation he also accused the Government of “acting unilaterally and jeopardising the health of other banking systems”.
In his book Darling said:
“I knew full well that if the Irish government’s bluff was called they would be bankrupt. It was a promise on which they could never deliver.”
Reaction across Europe was equally as bad. An unlimited guarantee before an already discussed coordinated response meant that governments forced to nationalise and recapitalised their largest banks struck down by the credit crisis now also had to deal with them being potentially further undermined by the sudden movement of deposits from their banks to the ‘safer haven’ of Ireland’s guaranteed institutions. As Yves Smith at Naked Capitalism put it at the time:
“While the ECB coordinated rescue of Fortis was a positive sign, Ireland’s move to guarantee all bank deposits was a blow, since it is drawing funds from EU institutions to Irish ones.”
Because of the close connections between UK and Irish banks, the movement of deposits which had started with the increase of the Irish deposit guarantee to 100,000, now turned into a flood leading Darling to ask Ireland to include UK subsidiaries operating in Ireland under the scheme.
Reaction in Brussels was the same.
“…..it emerged that the EU is forcing Ireland to substantially change its plans to offer all savers and businesses an unlimited guarantee on their bank deposits.
Neelie Kroes, EU competition commissioner, said the Irish scheme, adopted without consulting either Brussels or other European governments, was discriminatory and would be modified. “A guarantee without limits is not allowed,” she told Dutch TV.”
Again, Ireland had first mover advantage. The Greek government also brought in an unlimited guarantee after Ireland’s one was announced, yet were forced to rescind it immediately.
“The Greek government, under pressure from Brussels rowed back from its decision to mimic the Irish.”
“The EU top four leaders, including Merkel, had slapped down Dublin’s go-it-alone approach at an emergency summit yesterday after the European commission had earlier forced Greece to row back on a similar plan to provide limitless guarantees for bank deposits.”
Why was Ireland not forced to change it? One reason could be simply the speed of events.
“The EU’s ambitious plans to mount a collective response to the global financial crisis were in tatters tonight after the German government said it would guarantee all private savings in a move to prevent panic withdrawals – just a day after slamming the Irish for doing the same.
Chancellor Angela Merkel said in Berlin: “We’re saying to savers that their deposits are secure.” Peet Steinbrueck, finance minister, added: “I’d like to stress that we’ll make sure that no German saver should fear losing a euro of their deposits.”
Other governments followed this ‘bold and innovative move’, not out of admiration, but necessity. The plan being put together by the ECB and the EU Commission for a collective response included a guarantee of deposits, but not an unlimited one, and not one that included dated subordinated bonds or interbank deposits. Similarly all the guarantee schemes brought in by other European governments covered only new debt created after the guarantee, not old.
As the European guarantee states, its purpose was to ensure that ‘solvent’ banks were able to maintain access to liquidity. This is the same reason given for the Irish guarantee.
“The framework for the granting of government guarantees on bank debt should aim at: (i) addressing the funding problems of liquidity-constrained solvent banks by improving the functioning of the market for bank debt of longer term maturities; (ii) preserving the level-playing field among financial institutions and avoiding market distortions; and (iii) ensuring consistency with the management of liquidity by the Eurosystem and with its operational framework, so as not to impair the implementation of the single monetary policy.”
But there is an important proviso in Recommendation 2:
“With regard to the scope of the bank debt guarantee scheme, government guarantees on interbank deposits should not be provided.”
At the EU Summit of 12th of October 2008, EU leaders agreed the following:
“With a view to complementing the actions taken by the ECB in the interbank money market, the Governments of the Euro Area are ready to take proper action in a concerted and coordinated manner to improve market functioning over longer term maturities. The objective of such initiatives should be to address funding problems of liquidity constrained solvent banks. […] To this aim, Governments would make available for an interim period and on appropriate commercial terms, directly or indirectly, a Government guarantee, insurance, or other similar arrangements of new medium-term (up to 5 years) bank senior debt issuance. Depending on domestic market conditions in each country, actions could be targeted at some specific and relevant types of debt issuance.” Emphasis mine.
There are two important things to note. Firstly, the problems around liquidity and the inter-bank market were being dealt with through the ECB, by providing liquidity directly to banks using asset swaps – giving them deposits and taking collateral, most of which was toxic paper. So it explicitly states countries should not guarantee interbank deposits. Secondly the basis of the guarantee should be for new debt only, not old and new, as it was for the Irish scheme. The reasons why are clearly explained by Patrick Honohan above – namely, old subordinated debt is ‘capital’ for the banks and the first to be called upon when losses occur. Also, to guarantee it is far more costly when trying to rescue banks.
So given this clear indication that old debt should not have been guaranteed, why did the Irish government do it?
One indication first surfaced in Michael Lewis’ Vanity Fair article when he talked about Phil Ingram and the Merrill Lynch’ market report on Irish banks which appeared very briefly in March 2008 before being retracted by the Merrill Lynch and rewritten. According to Lewis Ingram, a fan of Morgan Kelly’s articles on the state of Irish banks, decided not to believe what Irish banks wanted everyone to think.
“To Ingram’s eyes, there undoubtedly appeared to be a vast difference between what the Irish banks were saying and what was really happening. To get at it he ignored what they were saying and went looking for knowledgeable insiders in the commercial-property market. He interviewed them, as a journalist might. On March 13, 2008, six months before the Irish real-estate Ponzi scheme collapsed, Ingram published a report, in which he simply quoted verbatim what British market insiders had told him about various banks’ lending to commercial real estate. The Irish banks were making far riskier loans in Ireland than they were in Britain, but even in Britain, the report revealed, they were the nuttiest lenders around: in that category, Anglo Irish, Bank of Ireland, and A.I.B. came, in that order, first, second, and third.”
Since then more has been revealed, including the original report and details about why Merrill Lynch were willing to speedily retract it when Irish bankers reacted with fury, demanding it be changed or Merrill Lynch would ‘lose their business’. In June 2010 it was revealed that Merrill Lynch was one of a number of institutions involved in facilitating reciprocal back-to-back loans with Anglo Irish Bank. The report says that the loans were dressed up as customer deposits.
“Internal Anglo Irish Bank documentation reveals executives believed that the Central Bank and Financial Regulator were ‘positively disposed’ to back-to-back loans worth €7.45 billion provided by Irish Life and Permanent.
The report also shows that Anglo entered reciprocal deals with Merrill Lynch, Royal Bank of Scotland, AIG and Hypo Real Estate.
The back-to-back loans of €7.45 billion, dressed up as customer deposits, are under investigation by the corporate enforcer Paul Appleby.
Other Anglo management e-mails, seen by RTÉ News, comment on the back-to-back funding in March 2008 which provided liquidity to Irish Life and Permanent.” Emphasis mine.
But it is Ingram’s report which is just as revealing:
“Like the UK, Ireland has also seen a sharp fall in property yields because of overvaluation and the availability of cheap debt.
‘UK capital values have dropped by over 15% to date, but Irish values have only fallen by 3%, despite our belief that Irish commercial real estate is overvalued,’ said Ingram.
‘There are three reasons why we think Irish capital values are only just beginning to correct. Most importantly in our view, are ownership differences. The Irish market is dominated by private investors who are not required to mark to market and may not need to, or are reluctant to, realise losses.’
The biggest risk, Ingram said, was that 37% of commercial property debt outstanding at December 2007 needed to be refinanced in 2008 and 2009, which would be difficult given the credit crunch.
‘Refinancing on economic terms is likely to become harder for some borrowers and this may cause them to sell, giving reference points for valuers to rebase valuations,’ Ingram added.
He said the Irish market was hard to analyse because of the lack of standardised data, the limited disclosure requirements, the complexity of risk and historically very low impairments.
The risks to the property market mean there is increased downside risk for the three Irish lenders most exposed to the market: Anglo Irish, Allied Irish and Bank of Ireland. They have all been significant lenders to UK property over the last few years. Anglo Irish has a UK commercial property loan book of £17.2bn, said Ingram, while Bank of Ireland and Allied Irish have loan books of £14.8bn and £8bn respectively.” Emphasis mine.
In March 2008 Merrill Lynch retracted one of their own market analysts’ report which showed that Irish banks were engaged in very risky lending in a rapidly deflating UK market and indicated that it’s more than likely that they are facing far greater exposure in the even riskier Irish property market at the same time (the same month) that it is involved in propping up the bank that the analysts said was the nuttiest lender around with fake deposits.
More importantly however, is the revelation that 37% of commercial property debt outstanding at December 2007 needed to be refinanced in 2008 and 2009.
Six months later….
“[Mon 29 – Tues 30 Sept 08 ] At 6.37pm, Kevin Cardiff, a senior official at the Department of Finance, e-mails Merrill Lynch executive Henrietta Baldock, asking for an advisory document setting out “the pros and cons of guarantee a sap [sic]” as he is in a meeting with the Taoiseach. She e-mails the document to him six minutes later.” (Copyright: Simon Carswell, The Big Gamble: The Inside Story of the Bank Guarantee, The Irish Times – Saturday, September 25, 2010)
And we wonder why the government opted, unlike all of its European neighbours, to cover old debt.
Part 4 to follow.
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