ANALYSIS:A sluggish bond market could cause problems later this year for the Government
THE DECISION on September 30th, 2008, to provide an almost blanket government guarantee for the liabilities of the Irish banks was perhaps the most momentous economic policy decision in the history of the State.
The decision has been the source of much controversy ever since with many economic commentators critical of the extent to which it made the taxpayer directly responsible for the mess made by our bankers.
I suspect that many people will have been surprised to hear the media report, time and again recently, that Central Bank governor Patrick Honohan, an international expert in banking matters, gave an almost complete endorsement to the bank guarantee, with his only quibble being the inclusion of subordinated debt.
In fact, this reporting has not been at all accurate. While the report does conclude that some kind of guarantee was required, it raises serious questions about the essential nature of the type of guarantee that was introduced.
The Irish banks faced a liquidity crisis in September 2008, prompted by worries about their solvency. Concerns about preventing a run on the banks certainly justified a blanket guarantee for deposits.
However, Honohan’s report strongly questions the decision to guarantee all existing bond debt.
At the time, the banks were having difficulty raising new funds to pay off existing debts as they matured.
A Government backing for new borrowing helped to deal with this problem and this approach was followed by many governments during this crisis period.
However, the Irish guarantee differed from the approach followed by almost every other country in also guaranteeing the full stock of existing debts for two years.
This part of the guarantee did not help deal with the crisis at hand. Honohan’s report notes that the “inclusion of existing long-term bonds and some subordinated debt . . . was not necessary in order to protect the immediate liquidity position. These investments were in effect locked-in.”
So the decision to guarantee all existing debt was unnecessary.
However, it had huge consequences for the State.
Overnight, the amount of debt backed by the Government surged and the cost of sovereign borrowing rose significantly as a result.
More importantly, the guarantee for existing debt made it almost impossible to reduce the costs to the taxpayer associated with failed financial institutions such as Anglo Irish Bank and Irish Nationwide.
Consider an alternative decision in September 2008 to guarantee new issues out to some maximum maturity, with the policy being reviewed every three or six months. Such a policy would have allowed for a review in early 2009 that could have deemed Anglo and INBS to be no longer covered by the guarantee.
The full stock of bond debt that these banks had run up would not have been the official responsibility of the Irish state.
One can argue that there may have been knock-on effects from a policy of having the bond holders of these banks lose all their investments. However, the approach taken went to the opposite extreme in completely ruling out the idea of these professional investors losing any money.
As Honohan’s report noted in a low-key but nevertheless damning passage: “In contrast to most of the interventions by other countries, in which more or less complicated risk-sharing mechanisms of one sort or another were introduced, the blanket cover offered by the Irish guarantee pre-judged that all losses in any bank becoming insolvent during the guarantee period – beyond those absorbed by some of the providers of capital – would fall on the State.”
The report also notes that “the extent of the cover provided (including to outstanding long-term bonds) can – even without the benefit of hindsight – be criticised inasmuch as it complicated and narrowed the eventual resolution options for the failing institutions and increased the State’s potential share of the losses”. These passages will be worth keeping in mind in the coming years as the costs of bailing out Anglo Irish Bank rise to ever more sickening levels (€22 billion and counting as we speak – almost €5,000 a head for every person in the Republic.)
The bottom line of Honohan’s report in relation to the guarantee is that it wasn’t necessary to guarantee all outstanding debt and the decision to do so played a crucial role in maximising the cost of the banking crisis for the taxpayer.
One problem not discussed in Honohan’s report is that the manner in which the guarantee was implemented is directly responsible for the serious risks that currently face the Irish banks and the State.
The Government were slow to introduce a new scheme that focused on guaranteeing new issues out to maturity.
The so-called ELG scheme was not passed until December 2009. In the meantime, the existing guarantee for all debt applied only up to September 2010.
For this reason, the banks issued very large amounts of debt after October 2008 that all mature before October of this year: €58 billion in senior debt falls due before that date and €16 billion in inter-bank deposits.
The assumption in passing the guarantee may have been that by 2010, international bond markets would have settled down and these debts would be easily rolled over.
Far from settling down, there is at present almost no bond issuance taking place.
If this situation does not improve, the final legacy of the guarantee may be a full-blown crisis later this year as banks struggle to pay off their maturing debts and the State struggles to honour its ill-starred guarantee.
-Karl Whelan is professor of economics at University College Dublin