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Central Bank Governor Patrick Honohan has given a considered response on the Government’s options before the bank guarantee
By Economics Correspondent Sean Whelan
Central Bank Governor Patrick Honohan has published a letter to the Oireachtas Banking Inquiry, following up a couple of points arising from his appearance there on 15 January.
After that event, he was asked if his views on what should have been done with Anglo Irish Bank in September 2008 have changed since he completed his report on the banking crisis in 2010.
The Governor says in his letter there hasn’t been much “evolution in my thinking on this”, but concedes that from reading the official record of the committee, a different impression may have been conveyed.
So he has decided to set out some of his thoughts on paper, to sharpen up what he is trying to convey about the night of the Guarantee.
He does this by way of three scenarios – two so-called “hindsight scenarios” and the actual events, which he uses to evaluate the decisions taken at the end of September 2008.
“SCENARIO 1 (Hindsight). Suppose the consultants from international investment banks had advised the Government in September 2008 that a blanket guarantee of Anglo and INBS would cost the Government €35 billion in the long run (of course they did not so advise).”
What would the Government’s best response have been if confronted with such advice? The Governor says a €35bn cost would, in his view, have made the two banks too expensive to guarantee, relative to the confidence and reputation damage that would have been caused to Ireland by a liquidation involving a bail-in.
If it had this information, he says, the Government would have done better to exclude these two banks from the guarantee. It could have advised the ECB and European Commission that it intended to liquidate the two banks and protect only insured depositors. At the same time it would have been wise to guarantee new senior liabilities of the other banks.
On hearing of the Government’s intentions, the Governor believes the European authorities would have been shocked, and might possibly have agreed to some form of risk sharing agreement to persuade the government not to go ahead with a bail-in, given its destabilising confidence effect beyond Ireland.
If they did not agree to a risk sharing agreement, the Governor is of the opinion that the Government should have bailed in bondholders (and uninsured depositors, presumably, under the pari passu rule, though the Governors note does not spell this out). This should have been done under this scenario despite the reputational damage to the country that would have followed.
“SCENARIO 2 (actual information) In reality the investment bank consultants’ advice was that the market had no confidence in the business model of Anglo and INBS, and that it was that lack of confidence that explained the liquidity crisis. They advised that loan losses could eat into the banks capital but their central estimates did not suggest that the banks had significant negative equity.”
Want was the Government’s best response given this limited information? In the Governors opinion the best response was to intervene in the running of the banks – probably by nationalisation – and immediately replace the top management (this corresponds, he says, to Finance Minister Brian Lenihan’s stated preference).
Emergency Liquidity Assistance should have been provided to allow time for consultations with European Officials (including on the potential for risk sharing). A more limited systemic guarantee should have been provided – i.e. no existing bonds, no subordinate debt at all.
What was the Government’s actual response to this limited information? They left the existing top management in place, creating a potential risk (though the Governor says in practice there has been no evidence of management looting of the two failed banks).
There was no prior consultation with European partners, resulting in annoyance on their part and no risk-sharing. The blanket guarantee included old existing debt and subordinate debt, increasing the net fiscal cost.
The guarantee also implied accelerated payments in case of an event of liquidation: this inhibited steps to a more extensive corporate restructuring of the two failed banks for two years because the Government couldn’t meet the large cash call that would have been triggered by a liquidation.
Governor Honohan concludes “none of the courses of action available at the end of September 2008 would have relieved the state of all of the costs that resulted from the bank failures.”