The Irish Bank Guarantee

The roots of the Irish financial crisis lie with the property boom, which originated sometime around 2001. Charles Kindleberger, using the work of Minsky, has shown the five stages of each bubble. First there is Displacement; an exogenous shock that makes one sector of the economy more profitable than the others. This is fed by a Credit Expansion, followed by Euphoria, as irrational trading and speculation lead to over-trading and an overestimate of prospective returns. However, some event occurs which changes the psychology of the market, leading to Financial distress, before there is a widespread Revulsion against the assets.

A phrase often used in conjunction with a Bubble, is ‘Minsky moment’. A Minsky moment is a sudden major collapse of asset values which is part of the credit cycle or business cycle. Such moments occur because long periods of prosperity and increasing value of investments lead to increasing speculation using borrowed money. The spiraling debt incurred in financing speculative investments leads to cash flow problems for investors. The cash generated by their assets no longer is sufficient to pay off the debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. This is likely to lead to a collapse of asset values. Meanwhile, the over-indebted investors are forced to sell even their less-speculative positions to make good on their loans. However, at this point no counterparty can be found to bid at the high asking prices previously quoted. This starts a major sell-off, leading to a sudden and precipitous collapse in market-clearing asset prices, a sharp drop in market liquidity, and a severe demand for cash.

In Ireland, economic and population growth led to a surge in house prices. This was coupled with a huge increase in tax revenues, which led to public sector investment in property, thus further feeding the boom. The single European Monetary Union gave Irish banks access to huge amounts of capital at very low interest rates. Foremost among these was Anglo Irish which grew enormously in this time, and whose bonds were held by hundreds of major financial institutions across the globe. Reckless lending to property developers was a common occurrence.

However, the failure of the banks to properly assess their loans was met with an equal dereliction of duties by the Irish government. There was little regulation and all commentary by government officials in the lead up to the crash indicated that that nothing was amiss. Indeed Morgan Kelly, Professor of Economics at UCD was told that he should commit suicide by then Taoiseach (prime minister) Bertie Ahern, after he warned of impending doom.

The sub-prime mortgage market led to a collapse of Bear Stearns, followed six months later by Lehman brothers. As all financial institutions began to feel the pressure , interbank lending dried up. A deposit flight on Irish banks led to €1.8 billion being withdrawn from Anglo Irish bank on one day alone, the 29^th of September 2008. Fearful for the future, David Drumm and Sean Fitzpatrick, CEO’s of Anglo sought a €900 million loan. They approached Bank of Ireland, Allied Irish Banks (AIB) and the Irish Central Bank; however, each rejected them.

Eugene Sheehy, CEO of AIB and Brian Goggin, CEO of Bank of Ireland, sought an urgent meeting with the Irish government, as there was real concern that banks would be unable to open for business the next morning.  The banks wanted the government to nationalise Anglo Irish while guaranteeing the liabilities of all the other banks. It was believed that as the worst case scenario, it would cost the state €2 billion. Brian Cowen, the Taoiseach, decided that the best option was to guarantee all deposits and most bonds in the six main Irish banks. They thought that the main problem would be the loss of market liquidity. They failed to account for the huge property losses which would occur.

It is interesting to note that of the people in the room who decided to create this wide ranging bank guarantee, not one was an economist by training. They were as follows; Taoiseach Brian Cowen (Lawyer), Minister for Finance Brian Lenihan (Lawyer), Attorney General Paul Gallagher (Lawyer), Secretary  to the Government Dermot McCarthy (Public Servant), Secretary General at the Department of Finance David Doyle (Public Servant), Department of Finance Kevin Cardiff (Sociology and Anthropolgy), Governor of the Irish Central Bank John Hurley (Classics), and Financial regulator Patrick Neary (Classics)

The guarantee was over inclusive in two ways. First it covered far too many institutions, but in particular Anglo Irish, which had no hope of being rescued. In addition the fact that it included all bondholders and creditors led to an enormous increase in the cost to the taxpayer. Thus the guarantee did not work. Angle was nationalised three months later, other banks had to be rescued by using taxpayer money and this eventually led to the arrival of the Troika; the IMF, ECB and EU, and the loss of Ireland’s Economic Sovereignty.

In January 2015 at the Banking Inquiry, the current head of the Irish Central Bank, Professor Patrick Honohan was asked whether Angle should have been allowed to fail in Septemeber. He said that the best course of action would have been to supply the banks with enough emergency capital to allow them to get through the weekend and Anglo should have been allowed to fail after. The other banks have not fared better, AIB went from €22 a share in January 2007 to €0 a share in January 2012- it is now for all intents and purposes owned by the Irish government.