Sins of the Father

by Conor McCabe

  The same day, the independent senator Shane Ross stood up in the Seanad and said:

  Let’s forget about the fact that the depositors are being underwritten. The same problem is going to be there tomorrow and the banks are going to be just as insolvent tomorrow, with the same loans and the same property developers into them for huge amounts of money. How is that going to be tackled, because that’s going to come up and bite us next week when we have realised that the depositors are all right.79

  The problem was that while the expected income from these loans had collapsed – because of the commercial and residential property crash, coupled with the deepening recession in the economy – the money owed by banks to investors in bank debt was guaranteed. The gap between the money the banks could salvage from its loan portfolio and the money the banks owed to its external creditors was now the responsibility of the Irish taxpayer. This was not a case of too big to fail. It was now a case of too big to function. That which twenty-four hours previously had drowned in its own debt had been miraculously brought back to life. The Irish government had reanimated a corpse; it had created a zombie. The bank guarantee had nothing to do with ensuring liquidity in the economy and everything to do with protecting Irish banks from their creditors. Thanks to Brian Lenihan and the Fianna Fáil/Green coalition, the losses of the banks were now the losses of the people. The sins of the father had been laid upon the children.

  ‘ONE ARGUMENT AGAINST ANY SUCH BLANKET GUARANTEE IS THAT WHEN YOU INSURE EVERYTHING, YOU INSURE NOTHING’80

  Tom Petruno, Los Angeles Times, October 2008.

  The government, along with bank executives, continued to reassure the public that Irish banks were well capitalised with a solid business base. The problems, they said, came from outside the country, and the banks were the innocent victims of an international crisis in confidence. ‘The oxygen supply for Irish banks was being cut off and healthy banks were starting to gasp for breath,’ said Denis Casey, Chief Executive of Irish Life and Permanent, ‘This guarantee turns on the oxygen supply.’81 The Taoiseach, Brian Cowen told the Dáil that it was:

  … a question of looking at the situation that we are in, that has been caused by the turbulence of financial markets, what has been happening in Germany, the Netherlands, Belgium, the United Kingdom and the United States. A situation emerged and it was made clear to me that [the bank guarantee] was what was required.82

  John Gormley, the leader of the Greens, spoke with satisfaction about his party’s contribution to the guarantee:

  The Minister for Finance has brought forward a mechanism which minimises the cost to taxpayers but at the same time places a bedrock of State guarantee under our banking sector … This bold move has seen commentators from around the world look on with a degree of admiration. I am very proud of the role the Green Party was able to play in providing this innovative solution.83

  However, not everyone shared this view. There were a few who argued that the guarantee was counterproductive and that it contained within itself the seeds of its own failure.

  The UCD economist Colm McCarthy called the guarantee a blank cheque, adding that ‘it is entirely likely that one of the banks could have negative capital.’84 Professor Morgan Kelly of UCD, who had warned of the impending property crash and was vilified on national television and in the print media as a result, tried to outline to the public why the bank guarantee was already a failure. ‘This is the wrong solution to the wrong problem,’ he said. ‘It has put the Irish taxpayer at risk of considerable losses, and does nothing to solve the real problem of Irish banks, which is a shortage of capital.’85 He explained that the ‘difficulty the Irish banks had in raising funds was a symptom of the bad debts that foreign investors know have eaten up most of their capital. By treating the symptom, the Government has ignored the cause, which is the shortage of bank capital.’ The professor of international financial economics at TCD, Patrick Honohan, queried the rationale of the blanket guarantee, noting that it covered ‘even subordinated debt-holders, who had already been earning a premium for the explicit risks they were taking’.86 ‘There is also the somewhat worrying fact’, he added, ‘that official statements continue to deny any possibility of under-capitalisation of any Irish bank, despite market concern.’ Honohan pointed out that, as with Kelly, his key worry was how much equity capital was actually left in Irish banks. ‘If there is little or no equity left, a bank will effectively be paying the insurance premium out of the government-guaranteed deposit funds. This will increase the temptation for those controlling such a bank to gamble for resurrection.’

  Two weeks later, the financial regulator, Patrick Neary, told the Oireachtas Committee on Economic Regulatory Affairs that the banks had a regulatory capital buffer of €42 billion, but that he had ‘identified €15 billion of property loans as being vulnerable’.87 Nonetheless, he maintained the view (and that of the government) that the banks were well capitalised, that the bank guarantee had proven itself to have been successful, and that international confidence in the Irish banking system had returned. ‘The only people who have confidence in you are the banks and the property developers,’ replied Senator Shane Ross. This was no surprise, as they were the section of society for whom, it seems, the guarantee was designed to protect. The scale and depth of the crisis may have been new, but the attitude and approach was not. Ireland remained a place where bankers and builders wielded the most power.

  On 28 November 2008, the Central Bank and financial regulator submitted a report to Brian Lenihan on the financial position of the six institutions covered by the guarantee. It stated that the ‘capital position of each of the institutions reviewed is in excess of regulatory requirements as at 30 September 2008 [and] that even in certain stress scenarios the capital levels in the financial institutions will remain within regulatory requirements in the period to 2011’.88 Lenihan added to the optimism of the report, saying that the guarantee scheme had been successful in ‘safeguarding the stability of the Irish banking sector and in restoring its liquidity position’. He did concede, though, that in ‘certain institutions the need for additional capital may be very modest, whereas for others the need may be greater’. These capital funding needs would be provided by the markets, although ‘in certain circumstances it would be appropriate for the State, through the National Pensions Reserve Fund or otherwise, to consider supplementing private investment with State participation, where in doing so the aim of securing the financial system can be better met.’

  The message the Minister sent out was confused and contradictory. He said that the banks were fine and well capitalised up to at least 2011 – except in cases where they weren’t – but that was ok because private financiers will step in to provide the gaps in capital funding – which according to the Central Bank and financial regulator didn’t exist – but in any case the pension reserve fund could always be used to shore up the capital funding needs of the banks, if the banks needed shoring up – which they don’t – but if they did the money is there – but they don’t, so none of that matters – everything is ok.

  Not surprisingly, no one believed such a jumbled message. It was clear that behind the ‘nothing to see here’ waving of hands by Lenihan and the Taoiseach Brian Cowen the Irish banks were structurally unsound. It was only ten weeks old, and already the rationale of a guarantee for all deposits, covered bonds, senior debt and dated subordinated debt, was falling apart. The shock for many was not that the government’s plan was not working, but that it decided to keep on digging. The idea that the government’s response was an economic one (however ill thought out) still held sway among the majority of citizens, commentators and journalists. Here, as so often, Morgan Kelly proved to be the public exception. In late October 2008, he wrote:

  … three weeks ago … Brian Lenihan was faced with a choice between rescuing two banks [Anglo Irish Bank and Irish Nationwide Building Society] and the handful of developers through whom they placed real estate bets, or recapitalising the financial i
nfrastructure on which the other four million of us depend. He chose the former.89

  The obvious conclusion as to the reasons behind the government’s actions – that a tiny but powerful section of Irish society was doing everything it could to protect itself, even if that meant the financial collapse of the State – seemed almost impossible for most people to accept. It did not take long, however, for that sentiment to change.

  On 14 December 2008, after weeks of speculation, the government announced that it was supporting a recapitalisation programme of up to €10 billion for the State’s credit institutions. It was doing so because ‘in current market conditions even fundamentally sound banks may require additional capital to respond to widespread market perception that higher capital ratios are appropriate for the sector internationally’.90 The National Reserve Pension Fund was opened up to help finance the operation. In order to assuage any fears the public may have had on such a move, the government declared that it was committed to fully safeguarding the interests of the taxpayer:

  State investment will be assessed on a case-by-case basis in an objective and non-discriminatory manner, having regard to the systemic importance of the institution, the importance of maintaining the stability of the financial system of the State, and the most effective and economical use of resources available to the State and each credit institution’s particular requirement for capital.91

  It was reported that Irish banks had ‘lost more than €56 billion of their market capitalisation since the stock market peaked in February 2007’.92 At first, the banks were reluctant to support recapitalisation. However, with international financial investors demanding that banks hold more capital, this resistance soon dimmed. As Shane Ross put it:

  The alternative to State bailouts was a takeover by private equity groups, which were hovering over the carcasses of the Irish banks. If the private equity groups were allowed inside the door, the board, staff, and culture of the banks would have been filleted. Recapitalisation suddenly seemed a trifle more appetising.93

  Michael Casey, former chief economist with the Central Bank and a board member of the IMF, made a similar observation:

  Politicians and senior public officials (including former central bankers and regulators) are regularly invited on to the boards of banks. It is also the case that the children and other relatives of politicians and senior officials are employed by the banks via an inside track. If foreign banks took over, would these perks continue?94

  The government’s handling of the crisis had all the hallmarks of a state doing everything it could to save individuals within a broken system, rather than trying to fix the system itself.

  In its first round of recapitalisation, the government gave €2 billion each to AIB and Bank of Ireland. It also gave €1.5 billion to Anglo Irish. ‘The fact that Anglo Irish Bank is deemed to pose a systemic threat is surprising,’ wrote Michael Casey in The Irish Times, ‘clearly the government’s Christmas spirit knows no bounds’.95 The value of Anglo Irish shares in December 2008 amounted to €266 million; twelve months previously they were worth over €8 billion. In the days after the capitalisation was first announced, it was revealed that the chairman of Anglo Irish Bank, Seán Fitzpatrick, had temporarily transferred loans worth €87 million that were in his name to Irish Nationwide Building Society. This was done in the days before the group’s 30 September year-end audit, and was generally believed to have been undertaken in order to avoid disclosing the loans to the group’s shareholders. The loans were transferred back a few weeks later. Fitzpatrick had done this every September for the past eight years. He was forced to resign in light of the revelations.

  Anglo Irish Bank was not of systemic importance to the Irish economy. In January 2009, the Department of Finance, in a report to the EU Commission, said that the bank operated within a ‘niche market rather than [the] broad market’.96 That niche was property speculation. On 15 January 2009, Brian Lenihan announced that Anglo Irish Bank would be placed under public ownership. The financial management and advisory company Merrill Lynch, in a report that cost the government €7.4 million, said that the bank was ‘fundamentally sound’.97 ‘The proposed Anglo nationalisation marks a decisive watershed in Irish democracy’ wrote Morgan Kelly. ‘With it, an Irish government has coolly looked its citizens in the eye and said: “Sorry, but your priorities are not ours.”’98 This had always been the case, of course, going as far back as the 1927 Banking Commission. The scale and depth of the banking crisis was such that, for the first time in a generation, there were active, critical voices coming from within the mainstream. They were not used to being ignored, but then again, neither were they used to finding themselves out of step with the economic consensus. Aside from the occasional article in the socially liberal but economically right-wing Irish Times, and maybe a two-minute Q&A on Morning Ireland or Prime Time, they continued to be shouted down and marginalised.

  The creation of the National Assets Management Agency (NAMA) in 2009, in the face of almost unanimous opposition across the country, brought home to the educated, conservative, middle classes that, in spite of what they had been telling themselves for years, their opinion, quite frankly, did not matter. The Irish middle classes honestly believed that the country’s housing market had been driven by a property-owning gene unique to the Celts, one forged after the famine and shaped like a semi-detached in suburbia, instead of seeing it for what it was: a speculative bubble fuelled by deregulated finance and Section 23-induced tax havens. The myths about our history, culture and economic success, to which the middle classes had clung for so long, were now being eroded. And the middle classes were not happy.

  ‘PEOPLE ARE SITTING DOWN, I KNOW, AND SAYING HOW CAN WE ALL SHARE THIS BURDEN OF ADJUSTMENT?’99

  An Taoiseach Brian Cowen, 4 February 2009.

  On 18 February 2009, the National Treasury Management Agency (NTMA) appointed the economist Dr Peter Bacon as a special advisor reporting directly to the Minister for Finance. He was given a three-month contract and was hired in order to ‘enhance the agency’s team during the recapitalisation process’.100 His remit was to ‘access the possibility of creating a “bad bank” or risk insurance scheme to take so-called toxic debts off the banks’ balance sheets in a bid to free up new lending’.101

  The previous week, the Minister for Finance had announced a €7 billion recapitalisation of AIB and Bank of Ireland. He stressed that the government had no desire to take control of the banks, nor would it hold ordinary shares. ‘The Irish financial institutions have little or no exposure to the sort of complex financial instruments which are weighing on the balance sheets of many banks internationally,’ he said. ‘However, Irish institutions have engaged in lending for land and property development, which exposes them to specific risk at a time of falling property prices and difficult economic conditions.’102 (Lenihan neglected to mention that the complex financial instruments he talked about had allowed Irish banks to leverage their capital to the type of levels to which they were now exposed, ensuring that capitalisation was now a core issue.) He said that the government was prepared to discuss schemes for assessing and eliminating such risk, and Dr Bacon’s appointment was seen as part of this process.

  The news that the government was contemplating a ‘bad bank’ for toxic assets drew the attention of Karl Whelan. In an opinion piece for The Irish Times, published on 27 February, he said that the ‘removal of toxic assets is not the key issue: banks could remove these assets themselves by simply writing down these loans to zero’. Instead, Whelan explained, ‘The relevant question is: what price does the government pay for these assets?’ The government, and its advocates in the press, claimed that the ‘bad bank’ scenario was a tried and tested way of dealing with banking crises. However, the proposals talked about by the Department of Finance and NTMA differed in crucial ways from what had gone before. Whelan explained:

  Previous bad banks were state asset management companies that worked to obtain the best sales price for ass
ets that governments inherited from insolvent banks that had been nationalised. The current proposal, which involves paying over the odds for assets to keep insolvent banks in private hands, has not been tried before.

  The government wanted to recapitalise the banks by paying more for assets than they were worth. Not only that, it was entirely feasible ‘to imagine a scenario where banks struggled with weak capital bases even after a bad bank scheme has been put in place’. Whelan concluded that the bad bank and risk insurance proposals were ‘unlikely to produce a clean solution to the problem of undercapitalised banks’.

  The minister, however, wanted a solution which was unique to Ireland, one that would involve ‘moving impaired assets – property loans and the properties securing them – into a separate property company … which could be capitalised and attract investment in due course’.103 It was in order to explore the practicalities of this idea – a toxic property company rather than a bad bank – that the Minister hired Dr Bacon. On 8 April 2009, a press conference took place in Dublin, at which the result of these efforts, NAMA, was presented to the people. The minister said that although NAMA would not be a bank, it would be managed like a bank, ensuring that ‘optiminal value for money is obtained for the taxpayer’. It would purchase property portfolios from the banks at a discount, and these portfolios would consist of both good and bad loans. At this early stage it was estimated that NAMA would buy loans totalling €80 billion to €90 billion, at a price yet to be decided. It was reckoned that ‘among the loans to be transferred are about €60 billion of land and property loans. The remaining €20 to €30 billion of loans are secured on investment properties – office blocks, shops and hotels – which have been provided as security for the speculative loans drawn by developers.’104