Disaster may have been delayed rather than averted, but the government’s brave
rescue of the banking sector last Tuesday morning means that Brian Cowen’s
beleaguered administration has banked some credit for the first time.
Unfortunately, as Cowen and Brian Lenihan, his finance minister, know only
too well, credit can easily evaporate and is sometimes purchased at too high
a price.
There are massive risks, both political and economic, attached to the €400
billion in state guarantees given to the six named beneficiaries, and much
more if the Irish subsidiaries of foreign banks are included in this
insurance scheme for deposits and debts. If Cowen and Lenihan have taken the
wrong action, their careers are finished. But more importantly the country
will be bankrupted and we will all suffer. The consequences could be worse
than if they had let one or more banks or building societies go bankrupt
last week.
Yet, on balance, they did the right thing. Had they not acted, there could
have been a costly disaster for the entire economy. There may still be a
catastrophe, but the chances of that appear reasonably slim. It can be
reduced further if the banks are forced to behave in a correct fashion over
the next two years as a prelude to the guarantees being removed.
Indeed, the state could even make big profits from providing insurance, as
well as ensuring that adequate amounts of finance are available to consumers
and businesses over the next couple of years. But that’s probably hoping for
too much.
It’s possible things were not as serious last Monday evening and Tuesday
morning as we have been led to believe, and that the government’s response
was not proportionate. Commercial sensitivities mean we may never discover
the full details of what went on but there are times when we have to take
things on trust, even when they involve bankers and politicians. We have to
assume that the country’s biggest banks genuinely believed they were on the
verge of disaster. It may emerge that they exaggerated — just as they lied
previously in the face of considerable evidence that their lending was
unsafe — but the government couldn’t take a chance on that.
Many people have argued that market forces should have been obeyed and that
one or more banks should have been allowed to collapse. But how would all of
these experts have reacted if they had been in the room making the decision?
This was a time for what would work in practice and not in theory. Had just
one bank failed, then a domino effect would have taken hold, with other
corporate deposits fleeing the country, exacerbating the weakness of the
banks’ balance sheets. Borrowing would have been further restricted and if
banks cannot get funds, the public and businesses can’t get money. Quite
quickly, the banks would have failed.
This was too big an experiment for the government to consider. The costs
involved would have been unbearable for an exchequer already staring into an
abyss. Next Tuesday week’s budget is going to be bad enough, given the
massive deficit in tax revenues and the added social welfare bill because of
soaring unemployment, without having to pay for bailing out a bank too.
The government has bought one essential commodity with its actions: time. The
solution isn’t perfect, but how in the circumstances could it possibly have
been? The question now is what the government forces the banks to do in the
two-year period of this insurance.
The banks have to be punished for their recklessness. In the race for profits,
they lent more money than they had safely available to them and participated
eagerly in the fiction that property and land values would continue to rise.
Dodgy security on loans was the reason other international banks were
unwilling to forward sufficient liquidity to some of our institutions. They
felt the risk of lending to our undercapitalised banks was too great.
Unfortunately, Pat Neary, the Financial Regulator, does not seem to have
worked out that equation, and by denying it in television interviews, he has
destroyed much of his remaining credibility.
Neary’s office was supine in policing the reckless lending of the banks in
recent years — and I don’t just say this with the benefit of hindsight,
having argued it many times previously. The fear must be that Neary is not
sufficiently informed or strong enough to make the right judgment calls now,
especially since he believes what happened last week was due solely to the
international credit crunch.
Confronted with a weak Financial Regulator, the banks may be tempted not to
undertake the reforms essential for putting themselves back on a sound
commercial footing. It is clear the only way to save at least one
institution covered is to merge it with a stronger party. New capital will
have to be raised at all the remaining banks to cover the as-yet-undeclared
bad debts that have arisen from reckless lending to property developers.
More importantly, the government will have to insist on mergers and new
capital on balance sheets if its guarantees are not to be invoked. This
won’t be possible unless banks punish those who borrowed recklessly,
particularly for property speculation.
The good news is that the existence of the guarantee has attracted billions of
new deposits to Irish banks, greatly strengthening their balance sheets. It
means that the banks will be able to sell bonds and preference shares easily
to rebuild their balance sheets, and may not have to tap the state when they
seek to raise ordinary equity.
The bad news is that the banks may have to be stopped from packaging their own
toxic debts and selling them cheaply to investors under the banner of the
state guarantee. The Irish government is unpopular enough with its
international counterparts — who must envy the speed and decisiveness of
Lenihan’s actions — without that happening.
Lenihan insisted to me during an interview on Thursday that the charges to the
banks for the insurance cannot be returned to customers by way of more
expensive interest rates, fees and charges. How he’ll manage to prevent that
will be interesting to behold. He may not be in a legal position to restrict
the pay packets of bank bosses, but his moral authority to do so is strong
should he use it.
This crisis may prove a turning point for Cowen, Lenihan and the rest of the
cabinet and give them the backbone for the rest of what they have to do now.
Our government also struck a blow for national sovereignty last Tuesday
morning. Rather than asking for permission to act, it told the European
Central Bank and European Commission that it was becoming the first western
economy to underwrite its entire banking system. After all the post-Lisbon
treaty agonising, a display of nationalism was welcome.
But ministers have much to do if they are not to squander the newly acquired
credit. They must stop blaming international conditions for our economic
fiasco and accept domestic mistakes played a large part. The forthcoming
budget is among the most critical in history. It is our state, not the
financial system, that’s heading for financial meltdown if tough decisions
are not made. Hopefully, last week’s experience will have emboldened Cowen
and Lenihan to act decisively again.
matt.cooper@sunday-times.ie
