More on Ireland in this month’s magazine:

Julian Gough on why the Irish should marry their daughters to the IMF

Colin Murphy on Irish migration

Steingrímur Sigfússon, Iceland’s finance minister, had been planning to visit Dublin on 1st December to deliver a lecture to students at Trinity College. The title of his paper was “Iceland and the International Monetary Fund: what lessons for Ireland?” By chance, the longstanding engagement happened to fall a few days after Ireland had agreed the terms of a humiliating €85bn bailout by the IMF and a 16-member eurozone group led by Germany, and including Britain, Sweden and Denmark. In the event, diplomatic sensitivities prevailed, and Sigfússon, clearly not wishing to add to Ireland’s trauma, cancelled his trip. Two years after Iceland’s crisis, Ireland faces a similar nightmare: its banks may collapse, and the government may be unable to make good on its loans from the rest of the world. A recent letter to the Irish Times joked darkly that the title of the EU anthem should be changed from “Ode to Joy” to “Owed to Germany.”

Irish disorientation has not been helped by the offer, in November, of financial help from Britain, the former colonial power—even though the £7bn put forward by Chancellor George Osborne was prompted by concerns that Irish banks could drag down their British counterparts. One Irish MP reported receiving texts from angry constituents warning him not to accept the “Queen’s shilling,” while a friend recently visiting her sister in England was surprised to be offered a discount at the checkout of one London store because she was Irish. “It was as if I needed a food parcel,” she says.

What went wrong? And who was to blame? Ireland’s crisis today is not only the fault of reckless bankers and greedy property developers over the long decade of the boom—although it is certainly that. It is also about politicians’ mishandling of the first crisis in late 2008, when the global credit crunch exposed the hollow finances of Irish lenders. That led to a mass withdrawal of deposits at Ireland’s third-largest bank, Anglo Irish. Two years on, and after a series of unprecedented and hugely controversial government interventions since then which have saddled Irish taxpayers with the bill for propping up the banks, there is still the threat of a run on deposits. “We went in a complete circle and the sum of the parts of our response to the crisis has brought us back to a deeper liquidity shock than when we started,” admits Pat Cox, former president of the European parliament. “That is some kind of perverse genius, which will certainly go down in monetary economics as a brilliant example of exactly what not to do.”

The events that led to November’s momentous European-IMF bailout for Ireland can be traced directly back to an emergency meeting at the department of finance in late September 2008. Finance minister Brian Lenihan called the heads of Bank of Ireland and Allied Irish Banks to his offices in Merrion Street to address the deteriorating situation at Anglo Irish Bank. That night, in a bid to stabilise the situation, he made a fateful decision: to offer a blanket guarantee over not just the deposits, but almost all the debts of Ireland’s five domestic lenders. This meant that if a bank became insolvent, the government would guarantee to pay—with taxpayer money—all the bank’s debts. Lenihan was advised that Anglo Irish was only facing a liquidity crisis, not the insolvency which later became evident when the bank had to be nationalised the following January. But it is still not clear why a full blanket guarantee was given. What is known is the government ignored the counsel of Merrill Lynch, the US bank it had appointed as financial adviser just five days earlier.

The state had, in effect, taken on a potential liability of some €440bn: two and half times bigger than the size of the national economy and equivalent to more than ten times the amount of tax the government raises in a year. As Paul Krugman, the Nobel laureate economist, put it, this decision turned “private losses into public obligations.”

At the time, Patrick Honohan, who a year later was to be appointed the central bank governor, wrote on the irisheconomy.ie blog that it was a mistake to include all classes of debt in the guarantee, arguing that Irish taxpayers should not be expected to guarantee creditors who had deliberately taken on risky investments. In truth, however, by September 2008 the government had few options. Nationalisation of Anglo Irish, the bank in the market’s crosshairs, might have risked a run on Bank of Ireland and Allied Irish Banks, the country’s two most important financial institutions. Good information was scarce. The markets were highly volatile in the wake of the Lehman Brothers collapse. It subsequently emerged that the Irish banks were also less than candid about the real state of their balance sheets—nor were the regulators equipped to probe them. As one leading Dublin lawyer put it: “Do you think the people in the department of finance knew what a regulatory capital instrument was back then? They certainly do now.”

On 30th September 2008, the day after the guarantee was introduced, Morgan Kelly, an economist at University College Dublin, whose warnings about the state of the Irish banks had been rubbished by the business community, predicted the property loan losses could easily hit €20bn. “All the ghost estates you can see around the place: that is the capital of the Irish banks right now. They’re going to make horrific losses,” he told the RTE television show Prime Time. Ireland’s housing stock had increased by a third during the ten years to 2005. But when the credit crunch hit, and banks would no longer provide mortgages, the landscape was left scarred with unoccupied and unfinished estates; many of which will now have to be bulldozed and the land returned to pasture.

The crisis called for bold measures, and the government’s next step was to assume the banks’ worst property loans—€74bn across five institutions—and transfer them to the National Asset Management Agency (Nama), the vehicle set up to buy the distressed assets. The transfer, however, involved Nama paying much less than the face value of the loans—to reflect the fall in the underlying property. As a result, the banks had to enter huge losses into their books. With little chance of raising equity on their own, the banks had to be recapitalised by the government—or rather, the taxpayer—a bill that has already reached close to €50bn.

The EU-IMF bailout will inject a further €10bn of capital into the banks, with an additional €25bn held in reserve as a contingency buffer for unforeseen losses. The authorities hope this will staunch the outflow of deposits, which has left the Irish banks dangerously dependent on the lifeline of the European Central Bank (ECB) for liquidity support. On the streets, the reaction to the bailout is one of anger towards the politicians and bankers, mixed with some relief that outside agencies are now overseeing the Irish economy. That relief—and at least a lukewarm welcome—must have been a pleasant change for IMF officials, used to walking into countries where they are seen as the villains who have come to cut public services. Ajai Chopra, deputy director of the IMF’s European department and the mission chief to Ireland, says he was addressed in the street by his first name and “patted on the back.” But whether the bailout is the cure for Ireland’s ills is unclear. In the short term it loads on further debt—like giving an alcoholic a drink, many have commented.

Scarred by haste: during the boom, house prices tripled and there was a rush to build; now many half-finished estates will have to be bulldozed

Some analysts believe Ireland is condemned to move to an even worse stage of disaster: defaulting on its sovereign debt, or telling the world that the government cannot make the payments due on the money it has borrowed from the world’s financial markets. Ireland still has a strong export economy. As one New York fund manager put it, “it’s not Argentina.” Before the bailout, the country’s gross public debt, as a proportion of national output, was projected to peak in 2012 at around 106 per cent, close to the EU average. Even if the IMF’s €25bn contingency capital is used, it will raise that proportion by only another ten percentage points—an uncomfortable level of debt, but hardly the worst by world standards after the past few years of recession and turmoil. But the ECB and European commission are in effect hobbling Ireland by forcing it to repay its bank creditors in full, to avoid creating panic in the debt markets across Europe. A debt default may prove unavoidable unless the hapless Irish taxpayer can shoulder almost the entire cost of the domestic property crash.

Who’s to blame? Jack O’Connor, president of the Irish Congress of Trade Unions and head of the Services, Industrial, Professional and Technical Union, believes it is a humiliating capitulation for Fianna Fáil, the “soldiers of destiny” party of Brian Cowen—prime minister throughout the crisis—which failed to defend Ireland’s economic sovereignty. “Our movement was at the forefront of the struggle for national independence for this country, and we’re in the unenviable position of having those who claim to be the inheritors of the legacy of the struggle of national independence having effectively forfeited it,” he said.

Among the political elite in Dublin, meanwhile, who are pro-European by instinct, there is a deep resentment at what is seen as the lack of solidarity by other EU states. Many feel Ireland has been bounced into accepting a bailout to save the euro; that the country is the sacrifice made to appease the wrath of the markets. “The ECB does not want a European bank to go under,” says Brigid Laffan, a vice president of University College Dublin and the former Jean Monnet professor of European affairs. “I think that’s wrong. You cannot support banks that are just black holes, and that’s what we’ve done in this country.” She is critical of the ECB for failing to plan for the crisis, and thinks it’s unlikely that the contagion can be stopped. “Portugal will now come under a lot of strain in the markets, and then the big question is Spain,” she warns. “You can handle the debt problems of small countries more easily than that of larger ones.”

Only a few years ago, the prospect of Ireland being bailed out by the IMF would have been laughable. The country was viewed by the rest of Europe as a model economy. It had low taxes—just 12.5 per cent for businesses—and traded extensively with the rest of Europe and the US. It was a shining example to the new accession states of eastern and central Europe; a nation that seemed to defy the fears that smaller, poorer countries on Europe’s fringe would always be a drain on the centre. Despite having few natural resources, it had established itself in the 1980s and 1990s as the location of choice for US multinationals seeking a foothold in the EU’s single market. The national finances appeared in rude good health, running surpluses in nine of the ten years up to 2007. When, in 2000, the European commission publicly reprimanded Ireland for dangerously stoking up the economy and urged the then finance minister Charlie McCreevy to put on the brakes, he scoffed at the idea. “How could you justify cuts in public expenditure and increased taxation when things are going well?” he asked. “It’s economically and politically daft.”

But the criticism wasn’t daft. The government’s policy was already dangerously magnifying the cycle of boom and bust. Tax breaks continued for property developers and homeowners long after the housing boom had peaked. Former Taoiseach Bertie Ahern famously once remarked that the “boom can only get boomier.” Brian Cowen, his successor, must also take some blame. When he was finance minister, policy magnified economic fluctuations in a manner that was popular with voters in elections. The IMF called Cowen’s 2006 spending plans “unfortunate”—in their terms, a damning indictment. Then, in December 2007, he again let go the reins with a splurge of public spending, ahead of the expected leadership battle to succeed Bertie Ahern. In the event, Ahern resigned amid accusations about his personal finances, which he has always denied, and Cowen was elected party leader and prime minister unopposed.

*****

It was not only the politicians who were profligate. Across the country, it was the age of excess. The Galway Races were said to resemble a scene from Apocalypse Now as rich builders and developers arrived in their helicopters. At one Dublin antiques auction a George III turf bucket—for holding peat logs for the fire—fetched €140,000, more than ten times the asking price, after a fierce bidding war between two property developers. At a city centre wine merchants, the local manager says it was not unusual for office workers to buy a €35 bottle of wine to have with their TV dinner.

Everyone in Ireland, it seemed, had become addicted to debt. Credit expanded at more than 20 per cent annually—Anglo Irish grew its loan book by an annual average of 36 per cent in the decade to 2006. Facilitated by euro membership, Irish banks were able to increase loan growth at a pace that far outstripped their ability to gather up deposits, as they could borrow in the inter-bank market without fear of currency risk.

Derek Quinlan, a tax inspector turned property developer, seemed to exemplify this relaxed attitude to debt. He first attracted international attention with his purchase of the Connaught, Berkeley and Claridges hotels in 2005. “I understood how the mathematics of debt work,” he said the same year. “You can get as much leverage as possible in a good covenant and a good location. And I always liked to take the biggest possible piece (of the investment) myself. You have to back yourself.” Today, many of his investments are in the hands of the Irish government, and his bank loans have been taken over by Nama, the agency set up to absorb bad bank debts.

With hindsight, it is easy to see Ireland was heading for a fall. Every Friday, the Irish Times property supplement reminded readers what US mansions and French châteaux they could buy for the same price that a terraced or modest semi-detached house cost at home. The average house price rose from €75,000 in 1996 to €280,000 ten years later. Dublin was judged one of the most expensive real estate markets in the world. Irrational exuberance—Alan Greenspan’s phrase to describe the phenomenon surrounding the dotcom bubble of 2001—might have been coined for Ireland. It was a classic asset-price bubble, in which easy money allowed participants to take on more debt. But the global credit crunch triggered the bust by making credit much harder to get. And Ireland’s membership of the single currency meant it had few tools to deal with this. The one-size fits all monetary policy of the euro meant Ireland enjoyed cheap money (in the form of low interest rates) when it needed to be dearer (to check unsustainable growth), and the EU’s stability and growth pact provided no scope for a Keynesian stimulus package.

*****

But if politicians, the EU and Irish consumers are all somewhat to blame, perhaps the greatest contributor of all was the actions of many of the banks themselves. As Matthew Elderfield, who was appointed regulator in the wake of the crisis, explained to a parliamentary committee in April: “The banks’ business models were, as we now know, fundamentally flawed. They were chasing unsustainable profits through risky property and development lending—profits that effectively subsidised aggressive campaigns for mortgage market share and unsustainably low interest rates.” The Scottish banks in particular—Halifax Bank of Scotland and Royal Bank of Scotland through its subsidiary Ulster Bank—saw an opportunity to take market share in Ireland, increasing the race to offer cheap mortgages.

Anglo Irish Bank, a specialist lender to property, is usually portrayed as one  of the most enthusiastic in this competition. But it is useful to remember that, in the deal to buy Jury’s Ballsbridge Hotel in 2005, one of the biggest transactions in central Dublin, it was Anglo Irish which judged it was overpriced, and backed away from the €240m deal. It was Ulster Bank, often seen as the most staid of the Irish lenders because of its Northern Irish Protestant roots, which financed Sean Dunne, the successful bidder. The deal marked the top of the market. Five years on, Dunne has still not secured planning permission for his redevelopment scheme.

Could the Irish regulator have done more to curb these excesses? Imposing stricter rules, say, on the amount of capital a bank was obliged to hold for a given level of loans, would merely have put Irish banks at a disadvantage to their foreign rivals. But governance standards could certainly have been better. Elderfield has acknowledged that over-dominant chief executives were part of the problem, as well as cosy board relationships and relaxed regulation.

It is Sean FitzPatrick, who ran Anglo Irish as chief executive for 18 years, and as chairman from 2005 to 2008, who is held up by the public for particular censure. His resignation in December 2008 followed his  admission that, for eight successive years, he had failed properly to disclose to auditors more than €80m of euros of personal loans made to him by the bank. He had temporarily transferred the loans to another bank before Anglo Irish’s year end. The loans themselves were not improper, and the bank, in a statement on his resignation, said that “the transfer of loans did not breach banking or legal regulations,” but noted that “it was inappropriate from a transparency point of view.” FitzPatrick also denies any breach of banking or legal regulations.

There is also an investigation into a deal in June 2008 in which Anglo Irish allegedly arranged to place a 10 per cent block of the bank’s shares with “ten longstanding clients,” without disclosing the information to other investors as the regulator normally requires. The stake was part of a 28 per cent interest built up by Sean Quinn, a county Cavan millionaire, who was Ireland’s richest man at the time according to Forbes magazine. He held the investment through a financial instrument called a contract for difference (CFD), which allows an investor to take a position without paying the full value of the underlying shares, and without disclosing it publicly. Quinn was taking a big bet on Anglo Irish shares rising. But with the property market in freefall, and rumours of his investment circulating, short sellers, who gamble that prices will fall, saw an opportunity to attack Anglo Irish. That drove the shares even lower, in what became known as the 2008 St Patrick’s day massacre.

Quinn admits he lost “more than a €1bn” in this ill-judged investment. There is no suggestion that he had done anything wrong, other than make a reckless investment; the focus is on the bank’s activities in trying to bring in new investors who might buy up Quinn’s stake without declaring it to the market. “We were too greedy,” Quinn told Irish television last year. “We shouldn’t have bought the shares. It’s not something I’ll forget in my lifetime”—although he added: “there’s no impropriety in anything we’ve done in that bank.”

Naturally, everyone who invested in Irish bank shares lost heavily. Patrick Honohan, Ireland’s central bank governor, calculates that shareholders absorbed about a third of the bank losses. In the absence of a default, or any deal to require the banks’ senior bondholders to share the costs, it is the Irish state and the Irish taxpayer who will pay most of the rest.

Jonathan McMahon, head of banking supervision at Ireland’s financial regulator, has a bar chart he likes to pull out at presentations. It shows that the cumulative profits of the Irish banks from 2000 to 2008 were wiped out in just one year of losses in 2009. It is almost as if, for Ireland, the decade never happened. Many Irish people must be wishing it never had.

More on Ireland in this month’s magazine:

Julian Gough on why the Irish should marry their daughters to the IMF

Colin Murphy on Irish migration

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