‘I prefer to let history in time to judge on the issues’
Economic developments and policies in the run up to the crisis:
The recession had a devastating effect on Ireland’s public finances. Economists today say that budgetary policy in the years preceding the crisis was not sufficiently counter-cyclical.
With the benefit of hindsight, budgetary policy should have leaned more heavily against the wind. But let’s be clear about what that would have meant.
It would have meant higher income taxes, lower levels of employment, and higher unemployment. It would have meant less spending on education, healthcare, research and development, infrastructure, and social welfare. These expenditures at the time were widely seen as highly desirable…
Ireland was hit in 2008 not just by a fiscal crisis, but also by a banking crisis…
Banking regulation and supervision in Ireland was on the surface compliant with international standards, but turned out to be complacent and permissive. This so-called “light touch” approach to regulation was fatally flawed because it put the emphasis on regulatory process rather than outcomes. We have taken these lessons on board in Ireland and have transformed the regulatory regime to guard against something similar happening again.
What were the causes of the euro crisis?
Some analysts have focused on the international crisis in financial markets following the collapse of Lehman Bros and have argued that this was the main factor which precipitated the euro crisis. Others have suggested the crisis was primarily or exclusively due to policy errors or structural problems in individual European countries. Yet others have suggested there was an overall design defect in the creation of the euro single currency which resulted in the widespread availability of very cheap and abundant credit without any international control mechanisms.
Like many such arguments, I believe there is some truth in all of these views…
There is… an understandable need to try and find somebody to blame, when a crisis of this magnitude occurs which has caused such damage to people’s lives and ambitions. This often means a simplification of the complexities involved...
In a major independent report by a Commission of Investigation into the Banking Sector in Ireland which examined the cause of the banking crisis in our country they noted that “systemic financial crises require a great number of institutions, enterprises and individuals to simultaneously follow unsound policies or practices”.
I think this applies also to all the countries impacted by the euro crisis. I would add to this the special responsibilities and indeed mistakes made by governments and by international institutions.
However, if we are to learn from the crisis it is necessary to understand why many of the actions taken seemed sensible at the time. This is not as a basis for defence but as a guide to understanding and all involved need to approach this in an open way.
With hindsight, mistakes were made prior to the crisis
Given what we now know, it is clear that serious mistakes were made in individual European countries including in Ireland, prior to the euro crisis and these all go back to a fundamental misjudgement of risk. Mistakes were also made at an international level.
Six mistakes which I believe were particularly relevant to the euro crisis include the following:
(1) First, fundamental errors were made within the management of individual banks which led to excessive risk taking.
(2) Banks in individual European countries particularly in fast growing economies like Ireland became too dependent on wholesale funding which, when the international credit market froze, left European banks vulnerable.
(3) There were inadequate financial regulatory controls in both the EU and in the US based on mistaken views of governance within banks and the adequacy of existing controls and the extent of the risk. This included deficiencies in the regulation of those financial institutions which were too big to fail, and I believe that auditors, regulators and governments and international agencies all share part of this responsibility.
(4) There was failure internationally to impose adequate international stability risk assessments and protection systems which took account of the interaction of international financial systems.
(5) As we now know many countries in Europe have been faced with the terrible combination of both fiscal and banking crises. This was in part because insufficient fiscal surpluses were accumulated in the good times to deal with the depth of the downturn. Based on a belief that growth would continue albeit at more modest levels, public expenditure and public investments were made at a level which assumed incorrectly that there would not be a dramatic collapse in government revenues in a short period…
(6) Finally, there was an absence of any adequate European wide structures to deal with the emerging crisis. When the crisis happened both Europe, at a central level, and individual countries were left floundering to try and design appropriate and adequate policy responses. Europe has, to some extent, attempted ever since to play catch up although increasingly the responses have been more significant.
All of these mistakes were made because of an underestimation of risk and a belief in the stability of financial markets. Both of these pillars have now been seen as built on clay.
What are lessons which must be learned?
The dramatic and ongoing unprecedented turmoil and crisis in the euro raises a number of important lessons which must be learned and which I hope will guide future policy for the next century. The key lessons in my view which should be accepted are as follows:
* Governments must in good times build greater fiscal surpluses to deal with unexpected downturns, although the scale of what would have been required would have seen remarkable levels of surpluses being accumulated in individual countries…
* Another lesson is that the regulation and supervisory rules for the financial institutions must have a much greater international element which would prevent contagion from developments in one country and prevent the need for small countries to take unilateral actions in times of crisis.
* The regulation of banks must reflect more fundamentally the absorptive capacity of the banks to respond to losses arising not only from any unexpected downturn in the individual economies but from the contagion impact of any international financial crises.
* Bankers in institutions of systemic importance must never again be let set their remuneration policies in a manner which incentivises excessive risk-taking and short-term gain.
* The capital requirements on banks must be set to ensure that the need for the exceptional support of Governments is never again required.
The policy response in Ireland
The main sign of an emerging crisis in Europe in 2008 was that European banks were finding it increasingly difficult to borrow on wholesale markets…
In different ways, there was no broad co-ordinated response and a Europe-wide approach to possible bank failures was not developed…
By the first week or two of October, there had been major interventions in the banking sectors in many EU member states. In Ireland, we introduced a broad bank guarantee…
I’d like to spend some time discussing the bank guarantee as is it the subject of much criticism.
Indeed there appears to be a common narrative that Ireland’s problems began on the night that the guarantee was introduced. But this narrative fails to consider the counterfactual scenario. It completely ignores the question: What would have occurred in the absence of such a guarantee?
Had we not guaranteed the funding of the banks, we faced the real risk of a run on the banks with devastating consequences for the availability of credit, the payments system, jobs, the economy and peoples’ savings.
In the event, following the introduction of the guarantee, the Irish banks attracted tens of billions of fresh funding on foot of the guarantee, which kept them functioning and bought Ireland and Europe critically needed time.
I have often asked myself: What could we have done differently? The Honohan report on the banking crisis published in 2010 examined the guarantee in detail… and agreed that an extensive guarantee was needed, but questioned whether the scheme was too broad. In particular, the report questioned the inclusion of certain debt instruments, namely subordinated debt, or junior bonds, and existing long-term senior bonds issued by the banks.
Whether a narrower guarantee would have staved off an implosion of the banking system at a lower cost to the State is a matter for economic historians to ruminate on. We had to deal with this crisis in real time. Our view at the time was that we would get one shot at calming the markets.
If, for any reason, the extent and nature of the guarantee was unclear or considered inadequate, our fear was that the guarantee would not have the desired effect and there would be no opportunity to provide further clarification. We felt we should make the position as unambiguous as possible
We also believed that, given the interconnectedness of the banking system, the luxury of allowing one bank to fail and believing it would not impact on other banks did not exist.
At the time the guarantee was given, the advice was that the banks were solvent but were experiencing a liquidity problem. In those circumstances, it is difficult to see how any government would have experimented with allowing any one bank to fail or take any risk in that regard.
Of course, it subsequently transpired that the banks were insolvent but that was not known at the time of the guarantee and furthermore, much of this insolvency was due to the further deterioration in markets caused by world recession and the recession in Ireland which directly affected the value of property assets. This in turn reduced the banks’ assets which created the insolvency.
If Ireland had been dealing with the problem in a context other than that of deep world and domestic recession, then the outcome could have been different… A question that is sometimes asked is why Ireland didn’t renege on the guarantee when the true scale of the banking losses became apparent. The reality is that the guarantee was enacted by Ireland’s parliament by a huge majority and reneging on it would have amounted to a declaration that Ireland was a bankrupt state…
By Oct 2010, we decided that a tactical withdrawal from the bond markets was appropriate, given the high interest rates that lenders were demanding.
But the hammering by markets of vulnerable sovereigns continued and there was great anxiety in Europe about Ireland as the next target of the markets. There was a sense that Ireland had to be “dealt with” in some way. Ireland agreed on the terms of its participation in an EU/IMF support programme at the end of Nov 2010.
Before formally applying for the EU/IMF programme, we wanted to know what such a programme would entail. As the government of the day, we had a duty to protect the interests of the country and its taxpayers. Our agreement with the IMF/EU officials that the National Recovery Plan would form the basis of the programme provided us with reassurance about what we would be signing up for and this allowed us to apply for external support.
In signing up the EU/IMF programme, we were aware that the 5.8% average interest rate attached to the loans was high. It was, however, the best rate on offer at the time… The policy framework in Europe for troubled sovereigns was still evolving, and we were aware that any changes in the interest rate regime would be applicable to all borrowings from the EFSF. In the event, the principle of equal treatment meant that when the interest rate on loans to Greece was lowered in July 2010, both Ireland and Portugal also enjoyed interest rate cuts. Irish bonds yields have eased markedly since.
The future of the euro?
I… believe the balance of probability is that the euro and the eurozone will address its challenges and will remain as one of the most successful economic unions.
Future of Ireland within the euro
The adjustments that have been required in Ireland have been very painful for many citizens.
About €20 billion of budgetary adjustments during our time in office and almost €4bn in this government’s first budget. These adjustments eventually stabilised and then reversed the tide of rising budget deficits. The public recognise the budgetary position must be returned to balance; otherwise interest payments will command a greater share of tax revenues.
But the road ahead on the budgetary front remains challenging. Another €9bn in adjustments are planned for the next three years to reduce the deficit to 3% of GDP by 2015.
Ireland has also made impressive strides in improving competitiveness… But the priority has to be to return the economy to robust growth, because only sustainable growth will reduce the unemployment rate.
Ireland’s adjustment path and return to markets can be helped by continued restructuring of the banking system. The next reform must involve a deal on the Anglo Irish Bank promissory notes…
The Irish economy now has one of the best capitalised banking systems in the world and an improved business environment and enhanced competitiveness. It has world class infrastructure and a highly skilled population. Ireland was one of the first eurozone countries to take action early on recapitalising the banks and on reducing the fiscal deficit.
There are, however, major challenges for our people in tackling unemployment and the legacy of the euro crisis… All in authority have to take their share of responsibility for our present dilemma, and I, taoiseach at the time and a former minister for finance do so more than most.
Governments make mistakes in good times and in bad times and I and others have apologised for those made by my government and for previous governments led by my party. There have been attempts to cast everything we did as errors but I prefer to let history in time analyse the policies and decisions and with the benefit of a longer view to examine and judge on the issues.
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