September 30, 2013
This day five years ago, the bosses of Ireland’s big banks came to the government with an ultimatum that went more or less like this: “We have run out of money, what are you going to do about it?”.
Of course this day could have been avoided if at some stage during the beginning of the credit boom in 2000-2002, the banks had been policed by the regulator. But they were allowed to do whatever they liked – endangering the entire economy. The state didn’t listen to any warnings in the period when something could have been done. By September 2008 it was all over.
The very real threat was that the banks, having mismanaged their affairs on a monumental basis, wouldn’t open the next day because they had no money. Of course, the minute they didn’t open, depositors – as in Cyprus – would be queuing to get their money out.
It is a hostage situation.
The banks (the hostage takers) threaten to kill the hostage (the economy) if the government won’t pay the ransom (a bailout of some sort).
The government’s watchdog – the regulator and the Central Bank – were on the telly a few days before, saying all was grand and that Irish banks had loads of money.
But why did the banks run out of money?
They had borrowed and borrowed wherever they could in order to lend out. The difference between the interest rate the banks paid to borrow and the rate of interest they charged on the loans they made to their customers was their profit.
As long as there were enough people who wanted to borrow from them and lend to them, the banks looked super-profitable. This was the case throughout the bubble years of 2000-2007. And as their bonuses were related to the share price, they were hardly going to stop the circus.
To put the banks’ borrowings in context, AIB and Bank of Ireland doubled their total loan books in three years. Bank of Ireland took more than a century to build a loan book of €63 billion and then, in three years from 2003 to 2006, it doubled it.
Ultimately, the scam becomes a pyramid scheme, where the value of the assets at the top of the pyramid is dependent on the amount of money coming in at the bottom.
If that money stops coming in, the banks are in trouble, because the assets that have been financed in the real economy are long-term assets like loans to developers or mortgages.
However, the money the banks have borrowed in order to lend out can be called in at any moment. Therefore the banks are involved in a calamitous balancing act, trying to pretend to their creditors that everything is OK and there is enough money coming in from interest payments on these long-term loans to finance the interest rates on the banks’ short-term borrowings.
Obviously the more reliant the banks are on short-term loans, the more precarious the position and the more at risk are the short-term loans – of which ordinary people’s deposits and companies’ deposits are a major component.
Over-lending and too much borrowing wasn’t making people and the banks richer, it was making them poorer. After all, the man who owes nothing is by definition richer than the man who owes something.
The banking crisis started in 2000, not 2008 as is often stated. It is still crippling us, as evidenced by the mortgage arrears debacle.
In the period 2000-2008, the banks behaved like pyromaniacs in a forest, playing with fire and laughing at anyone who warned of the dangers of a contagious inferno. Once the market peaked and reversed, the banking system’s implosion would be a financial forest fire that would engulf all around it.
The government – which should have been on top of this via the regulator and the Central Bank – had a choice: either to put it out using everything it could or to let the fire burn (let the banks go) and see what happened.
The recent evisceration of Cypriot deposits, or the total collapse of economies in the 1930s, or the fallout from the Asian crisis, all followed the decision to let banks go bust in an uncontrolled fashion. Anyone looking at such examples knows that the authorities have to act to prevent a contagious bank run.
Today, there are many who argue that we should have let them all go under, or that we could have isolated the bad banks and let others go. But they were all bad; every single Irish bank needed money to keep the doors open in 2008.
Those who started the fire continued to obscure the extent of the damage, and the firefighters – the regulators and central bankers – who were supposed to be in control sided with the pyromaniacs until it was far too late. People will say it was reckless borrowing as much as reckless lending that caused the bubble. That may be true but if I am the lender rather than the borrower, I should be concerned about the quality of debtor I am lending to, rather than the other way around.
In the middle of a bank run, the authorities have a choice: do something or do nothing. It had to stop the panic first, and assess the damage second.
The government had to act to protect deposits. It couldn’t do this by merging bad banks with good ones in a panic, because there were no good banks in Ireland. The state could have nationalised the banks there and then – but that wouldn’t have protected taxpayers.
The government could have let them go bust, which would be like a fireman allowing a forest fire to burn itself out and just hope for the best. The state could have let toxic banks go, but AIB, the biggest bank in the country, was on the verge of bankruptcy. Would letting AIB go have been a good idea? The government could have grabbed deposits, as they did in Cyprus.
Another option that is now bandied about was that the state could have just guaranteed all future bank borrowings not past ones. It is suggested as an elegant and clean way of dealing with an imploding banking system.
But let’s just think about that for a minute. Imagine AIB owes a lender – another bank – €100 million and this is about to mature but, as it is an old loan, it is not guaranteed under the new scheme. Then all the treasurer of AIB has to do is borrow a new €100 million which is now guaranteed and use the money to pay the old loan and in effect the ‘old’ loan is now guaranteed but it is just called a ‘new’ one.
There is a narrative in Ireland that blames the bank guarantee for everything, as if there was some other easy, painless option. We didn’t even have a bank resolution mechanism in place, and amazingly still don’t.
It ought to have been temporary, used to stop the panic, and then, following careful assessment of the situation, led to the introduction of a bank resolution law. This would have allowed for a negotiation with the bondholders in a calm way, which is the way the Americans dealt with their banks’ creditors in the savings and loans crisis of the 1980s-1990s.
But, for some reason, the guarantee was extended and extended.
It is important to understand that the guarantee and the bailouts were the consequences of reckless lending, too much borrowing and total lack of banking regulation. They were the consequence of the Irish banking/housing/credit collapse, not the cause.
If there had been no reckless lending, there wouldn’t have been a crash and no need for any remedial action to protect depositors.