BACKGROUND:The extent of the cover meant bond holders could not be forced to accept losses
THE EXTENT of the bank guarantee issued by the Government at the end of September 2008 increased the potential cost to the State, the Governor of the Central Bank said in his report.
No other country has introduced a blanket, system-wide guarantee, Prof Patrick Honohan said. “The scope of the Irish guarantee was exceptionally broad.” It was hard to argue with the view that an extensive bank guarantee needed to be put in place in late September 2008, he said.
All participants in the guarantee decision rightly felt they faced the likely collapse of the Irish banking system within days in the absence of decisive, immediate action,
“Failure to avoid this outcome would have resulted in immediate and lasting damage to the economy and society.”
However, he said the extent of the cover provided, including outstanding long-term bonds, could, even without the benefit of hindsight, be criticised as it complicated and narrowed the eventual resolution options for the failing institutions and increased the State’s potential share of the losses.
The extent of the guarantee meant that certain bond holders could not then be forced to accept part of the losses of the failing institutions. At the time of the guarantee, the subordinated debt in the institutions was just less than €20 billion. Shareholders’ funds were €23.2 billion.
The guarantee decision was taken under pressure of events on the night of September 29th/30th, but was the culmination of an intensive series of inter-agency meetings that took place under the leadership of the Department of Finance.
While there was agreement on the guarantee scheme, the idea of nationalising Anglo Irish Bank (implying an associated change in management) was also on the table. Legislation had been drafted and it was felt by some that nationalising Anglo would “reduce the reputational damage it was causing to the Irish banking system”.
The bank’s model was thought by many to be irrevocably broken although “few participants were even beginning to think it might have actual solvency issues.”
Other options considered at the time were the use of emergency lending assistance from the Central Bank and/or the creation of a domestic fund using the National Treasury Management Agency.
The possibility of additional support from Bank of Ireland and AIB was also considered. These options would only have bought a few more days, “say until the following weekend”, Prof Honohan said.
On the night of the guarantee scheme being agreed some argued that an overnight nationalisation of Anglo could destabilise the markets. In a reference to Anglo and to Irish Nationwide, Prof Honohan said the “wisdom of leaving senior management in place while providing an open-ended guarantee to two institutions which – it should have been clear – were on the road to insolvency, does not seem to have been considered.”
Better preparations during the year running up to the guarantee could have reduced the cost to society and the State of the coming downturn but “the bulk of it was already unavoidable”, he said.
“Above all, the lending decisions that generated this huge cost were made long before the point was reached of the guarantee. The damage had already been done.”
The report details how discussions on how to deal with a banking crisis were ongoing through 2008, with different options being considered.
A paper discussed in June did not address whether subordinated debt should be covered by any guarantee.
“A later note, undated but understood to have been prepared in the last days of September, drew on the June paper. It added a small but significant detail on the guarantee, specifically envisaging that such a guarantee would cover both senior and subordinated debt.”
While concerned about a liquidity crisis, the authorities were also dealing with “the unravelling of the Quinn Anglo CFD affair”. This appeared to have been a major preoccupation for the regulatory authority at the time, Prof Honohan said.
As the crisis increased, a consensus view emerged that “no Irish bank should be allowed to fail”. This “strong view departed from the textbook idea that only systemically important institutions should be candidates for such protective treatment. But it was shared without reservation by all the key officials involved and, for good or ill, simplified the decision making process.”
By late September it would have also reflected the broader reaction at European level to what was thought to be an ill-judged decision in the US not to save Lehman Brothers.
Right up to the time of the guarantee, officials thought they were dealing with a liquidity crisis, as against a solvency crisis.