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Оглавление1 THE DOCTOR ON DUTY
ALAN AHEARNE
BY THE TIME BRIAN LENIHAN arrived at the Department of Finance in May 2008, the Irish banking system was doomed. Over the previous five years, the domestic Irish banks had ballooned their loan books to a staggering €400 billion from €150 billion in 2003. Most of this new credit was extended to the property sector, including a nine-fold increase in lending for speculative development and a doubling in mortgage lending. Lenihan remarked that unlike other capital cities around Europe, there were no foreign buyers of property in Dublin during the boom years – a tell-tale sign that real estate was overvalued.
The banks funded this lethal expansion in credit by borrowing on international money markets. They attracted corporate deposits from all over the world and sold large amounts of bonds and commercial paper. They pumped this money into the Irish economy, thereby fuelling a surge in consumer and government spending. Ireland’s banking bosses gambled everything on the expectation of a soft landing in the property sector and continued benign conditions in international funding markets. Few people shouted stop. The domestic property crash and international financial crisis revealed in the starkest terms the recklessness of the banks’ business models and the failures of those tasked with regulating the banking system.
Now the chickens were coming home to roost. Ireland’s banks were about to hit the wall. Lenihan would spend nearly the next three years performing radical surgery on the Irish banking system. The international experience with systemic banking crises provided some guidance, but the complexity of the emergency facing Lenihan was unparalleled. Ireland’s banks were unusually large, with loans standing at more than twice the country’s total annual income. They had grown exceptionally dependent on international funding markets, just as the global financial system plunged into the most severe crisis since the Great Depression. An additional dimension to Ireland’s crisis was the country’s membership of a poorly constructed – and at times dysfunctional – currency union. The external environment and the rules of the game were constantly changing. Decisive, courageous and difficult decisions would be required to stave off disaster.
THE BANK GUARANTEE
I first met Brian Lenihan at his office in the Department of Finance in August 2008. Property values were already falling, the construction sector had come to a ‘shuddering halt,’ and the banks were struggling to fund themselves on money markets. During a wide-ranging discussion, I found Lenihan remarkably frank. It was clear to me that he was working on a plan. Among other things, we discussed the pros and cons of using money from the National Pensions Reserve Fund to strengthen the banks’ balance sheets. We agreed it was crucial that Lenihan had an accurate picture of the financial condition of the banks. We spent some time discussing the prospects for Anglo Irish Bank and Irish Nationwide Building Society – the two financial institutions most exposed to the crumbling property sector.
We met again in Galway some weeks later, on 15 September. I had been invited, along with economist Philip Lane from Trinity, to speak at the Fianna Fáil Parliamentary Party meeting about the Irish economy. That same day, the US investment bank Lehman Brothers filed for bankruptcy, sending violent shockwaves through the global financial system. On the fringes of the meeting, Lenihan and I chatted again about the state of the banks. Lenihan mused whether it would be possible ‘to knock over two dominoes without knocking the other four.’ I assumed at the time that he was contemplating the closure of Anglo and INBS, but was concerned about the knock-on effects on the other banks of such a move. He was exploring a wide range of alternatives, which I later learned was his modus operandi in making decisions. (He himself would have described it as his method of operating, as he disliked the unnecessary use of Latin in popular speech.)
Two weeks later, with the banking system on the brink of running out of cash, the Government introduced a blanket guarantee of the debts of the six main domestically owned financial institutions. The guarantee was identical to a successful scheme introduced in Sweden in the early 1990s. The emergency measure was aimed squarely at helping the banks to retain and attract new funding. In signing the guarantee order, Lenihan said: ‘The guarantee has as its central objective the removal of any uncertainty on the part of counter parties and customers and gives absolute comfort to depositors and investors that they have the full protection of the State.’
European finance ministers on 7 October announced a coordinated response to the financial crisis, though undoubtedly a clear message had been sent out from Brussels and Frankfurt to European capitals weeks earlier that there was to be no repeat of the Lehman’s debacle in Europe.
Although in the public mind the guarantee is most closely associated with the two Brians, it is often forgotten that the scheme was overwhelmingly supported by the Oireachtas. The introduction of the guarantee was also widely welcomed in the media. Criticisms of the move at the time were few and far between.
Judged against its immediate objective of keeping enough cash in the banks to forestall a widespread closure of the financial system, the guarantee worked a treat. With repayment of debt guaranteed by the (then) AAA-rated Irish State, the banks were able to raise €40 billion in new funding within six weeks. Lenihan described the bank rescue scheme as ‘the cheapest bailout in the world so far,’ a phrase that later was thrown back in his face many times as the cost to the State of shoring up the banks mounted.
Lenihan did not believe that rescuing the banks would involve no outlays. He speculated some time later that the resolution of Anglo and INBS would cost the State about €5 billion, but that the State would, in time, profit by a similar amount from its investments in the other banks. He realised that the State would incur substantial up-front costs as a result of the intervention to save the banks, but he expected that most of this outlay would eventually be recouped.
Many others shared this assessment. The Financial Regulator, Patrick Neary, in late 2008 described the banks as well capitalised, though he acknowledged that the banks might need more capital if the economy deteriorated further. Outside commentators were also relatively sanguine about the prospects for the banks. Not long before the introduction of the guarantee, the ratings agency Fitch affirmed Anglo’s long-term rating at A+ and maintained its outlook on that bank as stable. Later, in an article in The Irish Times in November 2008, ten academics specialising in finance and banking recommended that the State inject €10 billion of capital into the banks to repair them. They predicted a ‘good prospective return’ for the State on this investment.
All of these projections proved optimistic. To be fair, the ultimate cost of a banking crisis is impossible to determine early on. In the end, the State would inject €64 billion into the banks, much of which will probably not be recouped.
The higher-than-expected cost of saving the banks in part reflected the greater-than-expected severity of the recession. In Budget 2009, which was announced two weeks after the introduction of the bank guarantee, the Department of Finance projected a small decline of 1 per cent in economic activity (measured by GNP) for 2009, followed by a rebound to positive growth of 2.5 per cent in 2010 and 3.5 per cent in 2011. The Department anticipated that the unemployment rate would peak at 7.3 per cent in 2009.
Other economic forecasters were also pencilling in a relatively soft landing for the economy. In the ESRI’s Quarterly Economic Commentary (QEC) for autumn 2008, released just before Budget 2009, the QEC team forecast a modest contraction of less than 1 per cent in GNP in 2009 and a small increase in consumer spending. The Central Bank of Ireland and the IMF published similar projections. In the event, GNP plummeted more than 9 per cent in 2009 and consumer spending slumped more than 5 per cent. By the end of 2013, the depth and length of the economic downturn was such that both these measures of economic activity were still far below their peak levels in 2008. Unemployment soared to roughly twice the rate that economists had forecast.
If the economy had performed as anticipated in late 2008, banks’ losses would have been contained. But the exorbitant cost of shoring up the banks was also due to another factor. Reckless lending practices by the banks during the bubble years meant that the underlying quality of the banks’ loan books was much worse than could be gleaned by reading the banks’ financial statements. The detailed loan-by-loan due diligence examinations of the banks’ loans carried out in late 2009 and 2010 as part of the NAMA valuation process revealed a disturbing picture of poor loan documentation, of loans not properly legally secured and of marked deficiencies in the banks’ measurement and management of risk. The banks’ books were laden with landmines hidden beneath the financial accounts.
The blanket bank guarantee covered some €440 billion of banks’ debt. Deposits and bonds that were scheduled to be repaid by the banks over the next two years were covered. If the banks were not in a financial position to meet these obligations, then the State promised to make good on the repayments. The scheme categorically ruled out imposing losses on senior bank bondholders – also known as burden sharing with or bailing in bondholders – for a period of two years. Contrary to claims from some quarters, the blanket scheme was not extended beyond September 2010. Two other bank guarantee schemes were still in operation at that time and were extended well beyond 2010, but neither covered bank bonds issued before 2010. The two-year duration of the scheme meant that there would be no opportunity to bail in bondholders until October 2010. By that time, however, most of the bonds had reached their maturity dates and had been repaid in full.
Some people have argued that a narrower guarantee scheme which excluded existing senior bonds would have allowed burden sharing and reduced the cost to the State of rescuing the banks. At an abstract level, this might be true. In practice, however, this argument ignores the European Central Bank’s entrenched position regarding burden sharing with senior bank creditors. The ECB vehemently opposed bailing in bondholders. The ECB’s stance on this issue would later frustrate Lenihan’s plans to impose losses on senior bonds after the blanket scheme expired. Although promises to burn the bondholders featured in the general election campaign in 2011, to date no losses have been imposed on senior bonds of any bank in the euro area. At this remove, it is clear that the State would have had to make good on senior bank bonds, even if they had been excluded from the blanket guarantee.
More generally, there are mixed views among observers today as to whether the blanket guarantee was a mistake. A well-researched book by Donal Donovan and Antoin Murphy concludes that the guarantee was the least-worst option and that critics have failed to supply evidence that other solutions would have worked. The former President of the European Central Bank, Jean Claude Trichet, recently described the decision by the Government as ‘justifiable given the situation it found itself.’ In contrast, European Commissioner for Economic and Monetary Affairs Olli Rehn recently said: ‘In retrospect I think it is quite easy to spot some mistakes like the blanket guarantee for banks.’ Rehn’s comment is puzzling since the European Commission approved the guarantee scheme for state-aid purposes. To conform to EU state-aid rules, government intervention in the banking system ‘has to be necessary, appropriate and proportionate.’ How can a policy that is deemed to be necessary, appropriate and proportionate be a mistake? Moreover, the Commission later sided with the ECB against Lenihan and the IMF staff in protecting senior bank bondholders. It is not clear how these apparent contradictions can be explained.
One cannot help feel that for many people it is convenient to blame the country’s entire economic woes on the blanket guarantee. Many people are uncomfortable discussing what they said and did – and in some cases what they did not say and did not do – during the years of the bubble. If the public can be convinced that our problems began on the night of the guarantee, then nearly everyone is off the hook. The simplistic narrative that the bank guarantee cost the State €64 billion and that we ended up in an EU/IMF bailout programme because of the guarantee is too often used to distort the truth.
BATTLE TO RESTORE MARKET CONFIDENCE
The introduction of the guarantee bought time for the banking system, but by early 2009 the banks’ funding position was becoming strained again. For sure, the banks were supported by the State, but investors were becoming concerned about the sustainability of the State’s finances. During the first quarter of 2009, the economy lost nearly 8,000 full-time jobs per week. The bulk of these jobs were in construction and other property-related sectors. Economic activity plunged, led by a collapse in new homebuilding, and the public finances deteriorated at an alarming pace. The economy was falling off a cliff. Ireland’s costs of borrowing on international markets rose steeply.
The deepening recession affected investor confidence in the banks. In turn, the weakening banking system further depressed the economy and damaged the public finances. The toxic inter-relationship between the State and the banking sector was threatening to bring both of them down. It would be another four years until European leaders would agree to begin to build a banking union in Europe to break the link between sovereigns and banks. In the future, we may see a common backstop for banks in the European Union. But during Lenihan’s tenure at Finance, each member state was responsible for stabilising its own banking system.
Lenihan believed that the battle to restore market confidence and stabilise the financial system had to be fought on three fronts. First, the public finances had to be put on a sustainable footing. The transient taxes of the boom had evaporated, revealing a huge structural gap between government spending and revenues. To that end, Lenihan ‘executed’ (as he put it himself) €21 billion of budgetary adjustments, pushing the enormous boulder of fiscal correction more than two-thirds the way up that particular mountain.
Second, the country had to regain international competitiveness to improve its potential for growth. As Lenihan put it: ‘Unless we regain our competitive edge, we will be unable to return to the tried and tested strategy of export-led growth that ushered in the boom in the early 1990s. We must be able to compete and win again in the international marketplace.’ To measure competitiveness, Lenihan put a great deal of stock in Ireland’s unit labour costs. He studied these data regularly and was encouraged by the marked drop in costs in Ireland relative to our main trading partners during 2009 and 2010.
Despite the tight constraints imposed by the need to reduce the fiscal deficit, Lenihan’s Budgets contained initiatives to boost the competitiveness of various sectors of the Irish economy, including tourism, agriculture and agri-food, forestry and bio-energy, cons- truction and the retail trade. He also enhanced the incentives for R&D and intellectual property to help the country to attract new business and new jobs.
Lenihan was an optimist. He was convinced that the Irish people could work their way through the crisis. Lenihan could see light at the end of the tunnel when many others could see nothing but unrelenting economic gloom. He often reminded those around him how important it was to give people hope of a better economic future, lest they give up the fight to restore order to the public finances. Some of his more positive public comments about the future reflected this view.
NAMA
The third set of actions to repair the banking system involved recapitalising, shrinking and restructuring the banks. Lenihan wanted to ensure that the banks had enough capital to enable them to make loans to support the real economy. Lenihan also recognised that because of their large and risky loan books, the banks would constantly struggle to attract badly needed funding and capital. He also knew that a return to sustainable economic growth in the medium term would require a functioning banking system. In response, Lenihan set up the National Asset Management Agency (NAMA) to help to deleverage and de-risk the banks.
The establishment of NAMA was strongly supported inter- nationally by those with experience in resolving banking crises. When the plan for NAMA was outlined to visiting officials from the IMF in April 2009, they responded by saying: ‘If you hadn’t suggested NAMA to us, we would have suggested it to you.’ International support was hardly surprising, as a ‘bad bank’ was a standard tool to assist in the resolution of troubled banks.
The domestic reaction to the announcement of NAMA was more sceptical, however. Ireland had never experienced a systemic banking crisis, and few people here were familiar with the resolution toolkit employed by policymakers in such circumstances. Lenihan welcomed and encouraged constructive debate about NAMA, but despaired at the opportunism and cheap point-scoring that sometimes poisoned the political and wider debate. He remarked on how casual and ill-informed some of the media commentary was about banking issues. Lenihan had hoped to achieve political consensus around NAMA in order to improve international confidence, but to no avail. Nonetheless he was buoyed by the public support given to NAMA by people such as Alan Dukes, Garret FitzGerald and Ray Mac Sharry. Lenihan more than once called for a united national effort to confront the difficulties the country faced.
The charge that NAMA was a bailout for developers and bankers was politically potent. At this remove, the charge seems absurd. Nowadays, critics accuse NAMA of being overzealous in dealing with debtors and it would be difficult to find a banker or bank shareholder who would claim to have been enriched by NAMA. But critics made a populist appeal by misrepresenting NAMA as a novel construct established by a crooked government to protect narrow sectional interests. The debate intensified in the weeks and days before the internal Green Party vote on the policy on 14 September 2009. Opponents reckoned that if the Greens voted against NAMA, the coalition government would collapse. They made a big effort to affect the vote, but were unsuccessful.
Others had different reasons to oppose the setting up of NAMA. Lenihan was annoyed when he learned that some people at AIB were covertly briefing the media against NAMA. The NAMA process would force the banks to face up to the reality of their property losses; some at AIB would doubtlessly have preferred if the unpalatable truth about the state of that bank’s loan book had remained concealed. Lenihan was also exercised by an article critical of NAMA by financier Dermot Desmond published by The Irish Times on 16 September 2009, the same day the Dáil commenced second-stage debate on the NAMA bill. During that debate, Lenihan provided estimates of how much NAMA would pay for the loans. It was not clear how useful these high-level estimates would be, since under EU law the actual purchase price would be determined by detailed loan-by-loan valuations. But the Opposition had demanded estimates, and in any event Lenihan believed it was wrong to ask the Oireachtas to vote on a bill without some indication of the potential up-front cost involved.
Lenihan believed that effective rebuttal of critics’ arguments was the key to winning the debate over NAMA. Time has proved Lenihan right and the critics wrong. No serious commentator today could claim that investor confidence in our banks has not benefitted from the transfer of loans to NAMA. One shudders to think how the banks would have managed their development property loans had they remained on their books, given how slowly they have tackled mortgage arrears. The Spanish government three years later established a bad bank identical to NAMA to aid recovery from that county’s property crash, and Slovenia took NAMA as a model in late 2013. In both cases, the bad banks were set up with little or no controversy.
REFORMING BANKING REGULATION
The banks needed to be restructured, and so too did the system of banking regulation which had failed the country. Lenihan had no time for light-touch regulation of banks. He restructured the Central Bank and gave it new powers. He made an inspired choice in appointing Patrick Honohan as governor and brought in Matthew Elderfield from Bermuda as financial regulator to help restore much-needed credibility to the Central Bank. Honohan would later be central to securing a deal to restructure the IBRC promissory note. Lenihan also set up the Credit Review Office under John Trethowan to encourage more lending to the essential SME sector.
Lenihan was always eager to examine alternative policies and approaches. I recall a long conversation over the phone one weekend about a proposal by Citi Chief Economist Willem Buiter for a so-called ‘good bank/bad bank.’ Lenihan was open-minded about whether that model could be applied to Anglo. He eventually decided in autumn 2010 to wind down Anglo.
As the year 2009 drew toward a close, the cost of borrowing for the State declined and banks’ deposits stabilised. The global head- winds that were contributing to the recession began to abate, as world leaders delivered coordinated fiscal stimulus to the major economies. Ireland’s GNP bottomed out in the final quarter of 2009 and rose moderately in 2010. I recall Lenihan saying: ‘You know, I think this country has a future after all.’ But Lenihan knew that the improvements in sentiment were fragile. More gains in competitiveness were needed, the budget deficit was still large, and the economy was susceptible to international developments.
Moreover, bank losses were mounting, as the true extent of the reckless lending during the bubble was revealed. Lenihan wanted to spread the cost of the property crash over as long a period of time as possible. He recapitalised Anglo with a promissory note, not with cash borrowed on international markets. If he had injected cash, there would have been no scope at a later stage to renegotiate that arrangement.
He saw as a priority the need to reinforce international market confidence in the banking system, not least because the banks faced a funding cliff at the end of September 2010 when the blanket guarantee was due to expire. He introduced a scheme that guaranteed newly-issued (but not existing) bank debt for up to five years to help the banks to reduce this funding cliff as market sentiment gradually improved. Banks successfully issued new debt in the spring of 2010 and bank deposits began to rise again. In fact, during the first four months of 2010, funding to Irish banks rose around €500 million per week on average, compared with average weekly drops of €3,000 million during the first half of 2009.
EU/IMF BAILOUT
But events were conspiring against him. The scale of banks’ property-related losses continued to rise and rumours circulated in the markets that summer that the bailout of AIB could cost as much as Anglo. In a statement to the Dáil at the end of September 2010, Lenihan announced revised estimates of the cost of repairing the banking system. He wanted to provide reassurance to investors about the capacity of the Irish State to manage these costs. He began working on the four-year National Recovery Plan, which would later become the blueprint for the EU/IMF programme. He announced the first instalment of that plan would be a budgetary adjustment of €6 billion for 2011.
Abroad, fiscal stimulus was prematurely withdrawn from the world’s largest economies and analysts began to mark down their forecasts for global economic growth, including growth in Ireland. With slower growth forecast for the coming years, the task of closing the budget deficit began to look even more daunting. The euro area sovereign debt crisis exploded, with Greece entering a (failed) bailout programme in May, amid growing market anxiety about the prospects for peripheral euro-area economies. The country’s cost of borrowing rose to unsustainable levels, forcing the Government to withdraw from funding markets in September and rely on previously accumulated cash balances. The banks were unable to issue new bonds to address the funding cliff and relied instead on fresh borrowings from the ECB and the Central Bank of Ireland.
Angela Merkel and Nicolas Sarkozy’s disastrously timed agree- ment at Deauville in October (which they later tore up) to force a country that applied for a bailout programme to default on its sovereign debt was the straw that broke the camel’s back. Investors were now very concerned that the Irish State and its banks would default on their debts.
On the plane to Washington D.C. that month for the annual IMF/World Bank meetings, Lenihan and I discussed at length the pros and cons of exiting the euro area. He was always willing to investigate alternative strategies. Lenihan concluded that an exit would be disastrous for the people of Ireland. He recognised that the European Central Bank was providing invaluable support to the Irish banking system, but he wanted the ECB to do more. He pointed out that if Ireland were a state in the United States, the Federal Reserve would be offering unconditional support. He admired the Fed as a genuine lender of last resort.
Instead, the ECB was pressurising Ireland to reduce the amount of emergency loans that the Eurosystem had extended to Irish banks. In frustration, Lenihan sometimes referred to the ECB as ‘that bank in Frankfurt.’ He became aware that senior people at the ECB were briefing market investors that the bank was considering the withdrawal of financial support to parts of the Irish banking system. Investors were alarmed. By now, funding in debt markets for the Irish banks had dried up and they were haemorrhaging deposits.
As the financial pressure on Ireland intensified, the Government hoped that the ECB would step up its purchases of Irish bonds under the Securities Markets Programme. These hopes were dashed. One-and-a-half years later, with Italy and Spain under severe financial pressure, the ECB, under new boss Mario Draghi, belatedly introduced a potentially limitless bond-buying programme. In response, market confidence in Italy and Spain improved dramatically.
In early November, Lenihan came up with a plan which he hoped would keep Ireland out of a formal EU/IMF programme. He pointed out that, unlike Greece months earlier, the Irish State was not about to run out of cash. In fact, Ireland was fully funded until the middle of 2011. Lenihan wanted the European Commission to endorse the National Recovery Plan and the ECB to provide unequivocal liquidity support to the Irish banks. He believed that such European support would boost investor confidence in Ireland and quell the financial panic. In return, he would agree to increased surveillance by the European authorities – including quarterly surveillance if necessary – and that Ireland would enter a formal bailout programme in 2012 if things hadn’t turned around by then. He intended to discuss the plan with the French Finance Minister, Christine Lagarde, and the German Finance Minister, Wolfgang Schäuble.
But towards the end of the second week of November, a long-distance phone call from Olli Rehn, who had visited Dublin a few days earlier, confirmed that Lenihan’s bespoke plan for Ireland was not going to work. Under pressure from the ECB, the Government shortly afterwards applied for a financial assistance programme from the EU/IMF. In the negotiations, Lenihan, supported by the IMF staff, wanted to reduce the cost to the State of recapitalising the banks by imposing losses on the banks’ senior bonds. But the ECB would not countenance such a move. In fact, there was considerable opposition to bailing in bondholders in finance ministries across Europe and in the G7 group of countries. In the end, the Troika ruled out imposing losses on senior bank bonds. When the issue of burden sharing came up during the general election campaign in early 2011, Lenihan remarked that the new government would probably have more success pursuing other approaches at European level to reduce the cost to the State of rescuing the banks.
Europe’s evolving response to the euro crisis was at times chaotic. Lenihan described a meeting of euro area finance ministers around that time in which the Finnish ministry wanted Ireland to offer the state-owned ESB as collateral for loans from the European rescue funds.
The measures for ending the banking crisis contained in the EU/IMF programme built upon Lenihan’s efforts. As he put it himself, the programme meant ‘more capital and more NAMA.’ Lenihan had long wanted more support from Europe to repair the banks. ‘A small sovereign like Ireland faced with an outsized problem that we have in our banking sector, cannot on its own address all those problems,’ he said. By the time he left office in March 2011, the institutional arrangements in Europe to address banking crises were still not fully in place. Things are still evolving in that regard. As the head of the European Stability Mechanism (Europe’s bailout fund), Klaus Regling, said in early 2014,the European-level responses to the crisis have evolved over time and that options that were not available to Ireland, Portugal or Greece have become available now, while new options may become available in the future.
CONCLUSION
Ireland’s property bubble was one of the largest on record internationally. For nearly three years as finance minister, Lenihan lived with the consequences of the bursting of that bubble. The international experience provides plenty of examples of banking crises less severe and less complicated than Ireland’s where bank depositors lost their life savings and businesses their working capital. Ireland did not suffer that fate.
Lenihan was the doctor on duty when the critically injured banks arrived at the A&E department. In working out the consequences of the property bubble, extraordinary measures were needed to meet extraordinary challenges. For sure, the Irish banks have not yet been restored to full health. History, however, will surely show that Brian Lenihan’s incredible hard work and courage during the most acute phase of the crisis put the banking system and the Irish economy on the road to recovery.
