Cowen on the 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. As I mentioned earlier, there were no euro-area wide mechanisms to stabilise stressed banks and protect deposits, so it fell to the Irish government to step in with an impactful initiative to try to stabilise the situation. In the event, in the months 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 (one of the few studies to have done so) 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 in the scheme, 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 clear and 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 that 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.
Regarding the scope of the guarantee, it is true that some types of junior bonds were included in the scheme. But it is important to note that we set a limited duration of two years on this broad guarantee. That scheme expired in September 2010 and junior bonds were no longer guaranteed by the State after that date. Critically, the bulk of the junior bonds covered by the Guarantee were scheduled to mature, that is, to be repaid, after September 2010. They did not mature during the period of the guarantee. Their inclusion in the scheme did not preclude the bonds eventually sharing in the burden of the banks losses. And in the event, when the true scale of bank losses had been revealed, these junior bonds did take their share of the losses. There was about €20 billion of junior bank bonds outstanding in September 2008 and average discounts of between 80-90 percent were eventually applied to these bonds under legislation introduced by my government.
It is the case that no discounts were applied to senior bonds, which raises the question as to whether the State could have reduced the bill for the banks by excluding senior bonds from the guarantee, either at the beginning or subsequently. The extent to which losses could be imposed on senior bonds of European banks is limited by the legal framework that requires equal treatment of all senior bank creditors, including senior bondholders and depositors. This state of affairs is very different from the US, where senior bonds and depositors can be treated differently.
Notwithstanding these legal issues, what the passage of time has shown is that, in reality, as a member of the euro area, the senior bonds of Irish banks had to be repaid in full, even if there had been no guarantee. At no stage during the crisis would the European authorities, especially the European Central Bank, have countenanced the dishonouring of senior bank bonds. The euro area policy of “No bank failures and no burning of senior bank creditors” has been a constant during the crisis. And as a member of the euro area, Ireland must play by the rules.
>>> 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.
The view of the European Central Bank at the time of the introduction of the guarantee was that it was up to governments in each Member State to stabilise their own banking systems. Only in October 2008 could one say that there was the start of a European approach to the crisis. The first summit of the Heads of State of the Eurogroup, which I attended, took place in Paris in the middle of that month. It was only at this stage that there was a sort of common prescription for how to deal with banks in crisis. The prescription included better mechanisms for coordination of policy responses by Member States. There was a belated recognition that up until that point, each Member State had been left to fight its own battles using principally its own resources and that this state of affairs was not satisfactory. In the months that followed, there was a marked step up in the level of activity at a European level, including enhanced regulatory coordination, development of new legislation for banks, and better systems for communication in relation to distressed banks.
In Ireland, having given a broad bank guarantee, we turned our attention to banks balance sheets and governance. By the end of 2008 we were developing recapitalisation plans and in 2009 we announced and commenced work on setting up an asset management company, the National Asset Management Agency (NAMA), to clean up bank balance sheets by purchasing from the bank at a discount the most difficult types of loans, mostly development and commercial property. Anglo Irish Bank was nationalised early in the year in January 2009.
Other European countries were looking at similar approaches. In the UK, the approach was to offer insurance to the banks against loans losses, while the German government also adopted a bad bank approach in relation to, for example, assets of Hypo Real Estate.
For us, despite enormous efforts and a heavy commitment of taxpayer money, it was hard to get ahead of the banking problems. There was a cycle of falling property prices adversely affecting banks’ balance sheets, leading to greater demand for capital. But we did seem to be making progress, and markets seemed to be turning our way, at last, in the spring of 2010
But we were increasingly concerned that the same types of funding shortages and solvency concerns that had proved so disastrous for the banking system were now spreading to sovereigns.
In Europe, we were developing a response to this in the form of the European Financial Stability Facility (EFSF) which was established in May 2010 as a precaution against sovereign difficulties. Markets were increasingly worried about Greece in particular, but this seemed to open up new concerns about sovereigns more generally, particularly those which were heavily indebted or might become so. And because of the costs of bank interventions, Ireland was now seen as being in that camp. The continuing threat from the banking costs, the deteriorating Greek situation, and a growing sense that despite the establishment of the EFSF, European systems might not cope well with a sovereign crisis lead to a jump in bond yields for Ireland and other Member States. The Deauville Declaration, which threatened to put losses on to bondholders in the event of a sovereign crisis, proved especially damaging for sovereign bond markets in Europe.
We have seen the implications of that policy effectively reversed over a period of time and European heads of government have been in almost constant session, meeting nearly once a month, seeking to further develop this framework.
By October 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 November 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 formally apply for external support.
In signing up the EU/IMF programme, we were aware that the 5.8 per cent average interest rate attached to the loans was high. It was, however, the best rate on offer at the time, as some Member States were anxious to dissuade countries from borrowing from the EFSF. 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. These cuts were very welcome and Irish bonds yields have eased markedly since.
Ireland has had an extraordinary high level of compliance with the programme, which in turn has boosted international confidence in the country’s prospects.
http://cges.georgetown.edu/files/3.2...n%20Speech.pdf
(you can open your mouth now)
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Originally Posted by Dr. FIVE
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