FOUR letters released by the ECB yesterday have added another piece to the jigsaw puzzle of exactly how and why Ireland suffered the biggest banking collapse and biggest bank bailout of bondholders by taxpayers in modern history.
The letters, and especially the final letter which had not been credibly revealed, in some way look tame now, setting out a set of circumstances that have become very much part of the bailout story.
The picture of Jean-Claude Trichet threatening Ireland with armageddon is not fully borne out by the letters’ contents. They point out that Irish banks held a quarter of the ECB’s total lending €145bn — 85% of Ireland’s GDP — and that there were limits.
The final letter unemotionally spells out what was seen as the guillotine for Ireland: Take a bailout and follow a programme approved by the lenders of the needed finance. In his reply of November 21, Brian Lenihan said he fully understood the concerns raised by the ECB’s governing council.
Sources close to the activity at the time said that what was worse was the steady drip of stories to the world’s media that increased the pressure in a very public way on the economy and the government. It showed a level of panic among senior ECB figures, afraid of the consequences of Ireland going into meltdown and the obvious fallout for the euro and for all those banks that held billions in Irish bonds.
It also showed scant regard for democracy, others said, as negotiations were going on with the troika in Dublin, Brussels, and Frankfurt at the time. In the end, the actions probably forced Ireland’s hand a few days ahead of when it would have happened otherwise.
However, the letters from the ECB, marked “secret”, assumed a life of their own and became part of the story of a conspiracy against Ireland. EU ombudsman Emily O’Reilly, who had asked the ECB earlier this year to publish the letters, pointed to this issue when she said the delay in releasing them led to speculation about the crisis and the role of the ECB and other EU institutions “in the determination of Ireland’s economic welfare”.
“It is hardly desirable that such an important debate should be shaped around the imagined contents of a letter,” she said.
However, the full story has not yet been revealed. The banking inquiry will help fill in some of the blanks.
The ECB is obviously sensitive about the huge criticism heaped on it over the years and issued a 2,000-word explainer about the sequence of events and the role played by the various actors. It talks about the “sheer scale of the domestic crisis”, spelling out its criticism of the government guarantee, saying it “triggered an intense negative spiralling effect between the banking sector and the sovereign”.
It firmly pins the blame for the crisis on the failure of the political system to manage the economy: n The government’s income was overly dependent on tax from property building and sales that disappeared when the crisis hit and the construction industry collapsed; n There were no adjustments nationally to balance the fact the low inflation rate, together with low interest rates on borrowing, pushed up borrowing; n The huge growth in the country’s banking sector and how they were achieving the growth went unchecked because the banking supervisor was lax; n labour costs had increased by 50% in a decade; n There was an unhealthy over-reliance on the construction sector.
The ECB accepts that some factors outside Ireland’s control made the crisis worse — including the fact that the euro as a currency had not been properly set up and what was there was not effective. This has been addressed since the crisis, it asserts.
At the time, advice was given that the liabilities amounted to only a few billion euro — but the decision was also taken not to contact the European Commission about something that was part of its business. The commission later said had it been consulted, it would have advised not to give such an open-ended guarantee.
Bondholders feared they would lose their money as the two-year guarantee drew to a close.
The then government began preparing a four-year economic strategy with the commission and later communicated this to the IMF when officials visited Dublin. It contained most of the actions that subsequently appeared in the troika document.
Mr Trichet said the ECB would take account of the progress made in implementing the four-year strategy in its monitoring of its ongoing support to the banks but warned that they were seriously over-extended.
Mr Lenihan told Mr Trichet in his reply of November 4, 2010, that the cost of borrowing on the open markets had started to increase. “This issue gives rise to very serious concerns for the Irish government,” he said. By now, the Irish banks held a quarter of the ECB’s total lending of €145bn — 85% of Ireland’s GDP. It was “an unprecedented level of exposure to a country such as Ireland, whose share in the capital of the ECB was less than 1%”. Mr Lenihan also warning that the country was being shut out of the markets.
Mr Trichet — needing to protect his institution and the euro system — wrote to Mr Lenihan two weeks later, on November 19, basically telling him the rollercoaster trip was coming to a stop. In the dry language of bankers, he “explained the conditions under which further provisions of ELA [emergency liquidity assistance] to Irish financial institutions could be authorised”.
Mr Trichet said the ECB had agreed to the latest request for more money for the Irish banks, but any more money would depend on the government requesting a bailout; and committing with the IMF, commission, and ECB to restructure the financial sector, structural reforms, and consolidation.
Mr Lenihan’s response two days later strikes a note of resignation, outlining all the actions the government had taken to try to stave off that day’s decision to seek a bailout. They included, he said, the bank guarantee; recapitalisation of banks, nationalisation of Anglo Irish Bank; establishment of Nama to remove the riskiest loans from the bank’s balance sheet; pledging some €32bn to recapitalise the banking system; budget cuts of €15bn; and another €15bn to come by 2014.
He reassured Mr Trichet that he “fully understood” his concerns and asked him to state publicly the ECB’s continuing support to provide liquidity to the banks, to reassure the markets.
The ECB also addressed the accusation that it refused to allow Ireland to bail-in or burn those who had shares or money in the banks to contribute towards the losses. It said subordinated bondholders were bailed in and reduced the total owned by €14bn. But the refusal to bail-in the others cost the Irish taxpayer €19bn. Nobody really knows whether this was the right decision, but certainly later, when there was just a few billion euro of debt left, mostly held by hedge funds who were not expecting to get their money back, Irish officials felt the ECB was unreasonable in refusing to allow them to be bailed-in.
This grievance about the bondholders, however, did help with the subsequent breaks in terms of reduced interest rates, increased borrowing times, and, most valuable of all, the promissory notes deal which the ECB may not have liked, but learned to live with.
Edited version of correspondence between Brian Lenihan and Jean-Claude Trichet in the run up to Ireland’s bailout:
Frankfurt, October 15, 2010
As you know, the ECB greatly appreciates the recent commitment of the Irish government to develop a multi-annual economic and fiscal adjustment strategy.
I would like to re-emphasise that the current large provision of liquidity by the Eurosystem and the Central Bank of Ireland to entities such as Anglo Irish Bank should not be taken for granted as a long-term solution. The Governing Council cannot commit to maintaining the size of its funding to these institutions on a permanent basis.
I trust that the four-year strategy will target a fiscal deficit of below 3% in 2014. Future decisions by the Governing Council of the ECB regarding the terms of liquidity provision to Irish banks will thus need to take into account appropriate progress in the areas of fiscal consolidation, structural reforms, and financial sector restructuring.
With my best regards,
Dublin, November 4, 2010
You will have no doubt have noted the very adverse developments in the markets in recent days in relation to the widening spread of Irish Government bonds against the German bund. This issue gives rise to very serious concerns for the Irish Government.
It is very noticeable that over recent days, the widening in spreads has accelerated on the basis of speculation on the conditions that may be necessary to apply to the debt of countries accessing the European Financial Stability Facility and reported policy comments from senior political figures.
I am sure you will agree that it is imperative that comments from senior figures within the eurozone are consistent in their content and do not, as an unintended consequence, undermine the efforts of member states such as Ireland to address the serious difficulties that they are continuing to confront.
Frankfurt, November 19, 2010
As I indicated at the recent Eurogroup meeting, the exposure of the Eurosystem and of the Central Bank of Ireland vis-a-vis Irish financial institutions has risen significantly over the past few months to levels we consider with great concern. Recent developments can only add to these concerns.
As Patrick Honohan knows, the Governing Council has been asked yesterday to authorise new liquidity assistance, which it did. But all these considerations have implications for the assessment of the solvency of the institutions which are currently receiving emergency liquidity assistance (ELA).
It is the position of the Governing Council that it is only if we receive in writing a commitment from the Irish government vis-a-vis the Eurosystem on the four following points that we can authorise further provisions of ELA to Irish financial institutions:
1) The Irish government shall send a request for financial support to the Eurogroup;
2) The request shall include the commitment to undertake decisive actions in the areas of fiscal consolidation, structural reforms, and financial sector restructuring, in agreement with the European Commission, IMF, and ECB;
3) The plan for the restructuring of the Irish financial sector shall include the provision of the necessary capital to those Irish banks needing it and will be funded by the financial resources provided at the European and international level to the Irish government as well as by financial means currently available to the lrish government, including existing cash reserves of the Irish government;
4) The repayment of the funds provided in the form of ELA shall be fully guaranteed by the Irish government, which would ensure the payment of immediate compensation to the Central Bank of Ireland in the event of missed payments on the side of the recipient institutions. I am sure that you are aware that a swift response is needed before markets open next week...
Dublin, November 21, 2010
I made comprehensive and detailed statements on banking at the end of September and outlined the actions being taken to provide certainty to the international markets on the scale of bank losses. While initially this information was well received, the credibility of projected bank loan losses was increasingly called into question by analysts and investors — there comes a point at which negative sentiment starts to feed on itself, even independently of underlying realities, and we are clearly at that point.
I would like to inform you that the Irish Government has decided today to seek access to external support from the European and international support mechanisms. This grave and serious decision has been taken in the light of the developments I have outlined above and informed by your recent communications, and the advice that you have conveyed to me personally and courteously in recent days.
I hope this will provide some reassurance to the Governing Council and that you will be able to reiterate in a public way the continuing practical support of the ECB for the liquidity position of the Irish banks, to help reassure the market at this crucial point. You know we are here and will not be lacking in the will to do all that is necessary on our part to protect our economy and people and to play our role in the Eurosystem.