Ireland's Bailout: One Year On
Dick Roche was Ireland's Minister for European Affairs until March 2011. At this time, national elections resulted in a loss of the Fianna Fail party, which had been in power during the 2008-2011 Irish financial crisis. In this article, Dick Roche provides ECN with an exclusive, inside view of the state of public finances, the impact of bank lending to the real estate sector, and the negotiations which led to the Irish bailout.
This is part of a paper delivered to the "Quo Vadis Europe" conference organised by Suomen Keskusta, the Finnish Centre Party and the European Liberal Democrat and Reform Party (ELDR), held in Helsinki on Monday 14 November. Dick is Vice President of the ELDR and a member of ECN's Advisory Board.
A year on since the IMF and ECB arrived and the events of the first 3 weeks of November 2010 are still shrouded in something of a fog. It will take time before a full, dispassionate and objective history of all the events of those fateful November days is written. It is instructive none-the-less to look back a year later at the events that convulsed the nation and that brought about such a fundamental political change.
THE CREDIT CRUNCH: A DOUBLE WHAMMY
Between 1995 and 2006 the Irish economy boomed, fuelled in part by cheap capital raised in the interbank market. New operators arrived on the banking sector with ‘less restrictive’ policies an issuing loans. The ‘new competition’ and ‘greater flexibility’ in banking was widely welcomed at the time.
The massive inflow of cheap capital and the dumping of traditional banking standards fed a property bubble of historic proportions.
From the mid 1990s to 2007 property prices rose to astronomical levels. This in turn triggered an explosive expansion in the building industry, particularly home building.
In spite of record housing output, property prices continued to escalate: the ‘law’ of supply and demand was stood on its head – a classic property bubble.
Employment in the building industry rocketed. Tax take from that sector boomed so much so that there where demands for cuts in stamp duty.
The ‘Celtic tiger’ lost its stride in 2007. It came to a juddering halt in 2008. Following the Lehman debacle credit virtually disappeared. Banks that had been pushing loans would not part with a cent. Building projects were abandoned, property sales crashed, prices plummeted, major developers failed and tens of thousands of building workers lost their jobs.
State tax revenues went through the floor. Irish public finances that had been in a state of rude good health for years became terminally ill.
From mid 2007 the Irish banking system experienced serious difficulty financing day-to-day operations. Alarm amongst senior bankers grew and as the summer of 2008 drew to an end, turned to outright panic.
A final blow for the ‘Celtic tiger’ came in September 2008. Inadequate and lax supervision by the Irish regulatory bodies and criminally irresponsible behavior by some bankers had undermined the entire banking system. The Irish Government was asked to rescue the banks.
Faced with the prospect of a bank meltdown the Irish Government introduced its controversial, but later widely copied, bank guarantee scheme.
Two years later and Irish banking was still on life support, kept afloat through ECB intervention, state recapitalization, by selling off non core businesses and by being relieved of its assets (including some regarded as ‘toxic’) at written down prices by the creation of a state asset management agency. Non-Irish players were getting out of Irish banking.
On top of all the other woes Eurostat demanded a reclassification that had the effect of revising Ireland’s budget deficit upwards to 14.3 % from 11.7 %. The Finance Minister pointed out that "There is no additional borrowing associated with this technical reclassification” and that it would not deflect from reducing the deficit to below 3 percent of GDP by 2014," Lenihan said.
Dramatic and painful steps were also taken on public expenditure.
By October 2010, €15 billion in adjustments had already been implemented. A further €6 billion in spending adjustments were signaled for Budget 2011.
It was planned that by December 2011 Ireland would be 2/3 of the way to meeting the EU target of bringing our deficit below 3% of GDP by 2014, in spite of the Eurostat reclassification.
On the surface, things were beginning to look positive. Exchequer returns for end October showed tax take ahead (1%) of profile. Exchequer spending was below expectations. Ireland was fully funded until mid 2011. There was a cash balance of €22bn in NTMA and an additional €25bn in the National Pension reserve.
Work was underway on a four-year plan to map out a way forward to national recovery. There was even a degree of political consensus on what had to be done.
Ireland’s efforts to halt the slide were widely acknowledged.
Commissioner Olli Rehn pointed out that Ireland had formidable strengths; strong economic fundamentals; well-educated labour force, strong export growth and a strong private sector.
A communiqué issued by the EU Economic and Finance Council acknowledged the ‘significant efforts of Ireland’ to address our problems, welcomed the four year budgetary strategy, expressed ‘full confidence’ that it would ‘firmly anchor’ the 2014 date Ireland’s deficit.
The Council also approved Ireland’s intended frontloading a further €6billion in adjustments in 2011 and acknowledged that proposed ‘structural reforms’ would result in Ireland being able to ‘return to a strong and sustainable growth path’.
With the measures that were put in place on the public finances there was even talk that Ireland might be pulling out of the woods. The NTMA tested the water. A €1.5 billion bond issue was three times over-subscribed. An analyst from Forex.com commented in September "The successful bond auction from Ireland shows that the country can still fund itself and does not yet have to tap the IMF for funds as rumored last week.” Commissioner Rehn told the Irish Times that there was ‘no need to seek emergency aid’.
But the focus moved back to the banks. Deposits were flooding out ‘impaired’ assents were being transferred to NAMA. S&P downgraded Ireland’s rating in late August. An extension of the bank guarantee was deemed necessary and were enacted at the end of September.
Most importantly, the Eurozone narrative changed dramatically.
One of the background issues causing market jitters was talk about default.
The German Chancellor flagged concerns about ‘moral hazard’ and referred to the private sector carrying some bailout costs. The matter featured again in a much-criticised October meeting between President Sarkozy and Chancellor Merkel in Deauville and was raised at the G20 Summit of 11-12 November.
The fact that the Chancellor was talking in the context of future changes was largely overlooked, including in Ireland where talk of burning bondholders was politically popular.
Ireland and defaults were hot topics when G20 Finance Ministers met in Korea in late October at the Seoul G20 Summit of 11-12 November. At the summit US treasury secretary Geithner made clear his opposition to burden sharing.. EU Finance Ministers tried to dampen the speculation pointing out that current bondholders would not be involved in any ‘burden sharing.’
In so far as Ireland was concerned this was a vain effort the Irish 10 year bond yield was approaching 9% as the G20 ended.
The Whispering Campaign
Minister Lenihan, spoke on 11th November 2010 of “the continuing rise in the cost of borrowing for Ireland (due) to uncertainty surrounding European Union plans for future debt’.
Speculation about burden sharing was by no means the only factor in play, there was another, specifically Irish, issue. Throughout the summer there were huge outflows of funds from the Irish banks.
As these funds flowed out the ECB was pumping money in making Frankfurt understandably nervous.
Things took a sinister twist in early November. There was a round of ‘off the record briefings’ predicting that Ireland would have no choice but to apply for an IMF/ECB bailout. These were primarily from ECB ‘circles’
By the weekend of 13 – 14 November 2010 speculation was at fever pitch.
Media reports that an IMF/ECB/EU bailout ‘was on the way’ sent shockwaves through Irish society. Opposition and media accused the Government of lying, of saying that bailout talks were not underway when they in fact were. The fact that no decision to trigger a request had been taken was discounted.
The briefings ended whatever slim chance Ireland had of weathering the storm and avoid triggering a bailout application.
At the Ecofin meeting of 16th November pressure on Ireland intensified. The German minister urged Ireland to announce an application for aid.
Two days later the Governor of the Irish central bank told RTE that he ‘expected’ the IMF to loan the country ‘tens of billions’. "The intention is, and the expectation is - on [the IMF's] part - and personally on my part - that negotiations or discussions will be effective and that a loan will be made available as necessary." The IMF said it had not received a request for financial support from Ireland.
On the same day Brian Lenihan told the Dail that the establishment of a contingency fund would be a "very desirable outcome" but pointed out that a request had not yet been submitted.
On 21st November 2010 the Government announced that a request for financial assistance from the EU and International Monetary Fund had now been lodged.
The Reasons Why.
Two questions arise: -
- If things were improving – why was the Irish bailout needed?
- Why resist triggering a bailout request until 21 November?
The answer to the first question is straightforward: concerns about the extent of the ‘hole’ in the banking system had not been stilled.
Those concerns were most pronounced in the ECB. Deposits were flowing out as fast as the ECB was pumping money in: when would the hemorrhage stop?
It was to take some time until the full extent of the problem in the banks could be tied down – not least because of a lack of cooperation from banks and some of their clients and the extraordinarily complex not to say crooked deals that had been put together during the boom years.
By September 2010 the yield on government bonds was rising alarmingly. In October the yield went over the 7%. Ireland was priced out of the market: fear of an Irish default stalked the markets & haunted the ECB.
If, in spite of all the hard work, Ireland were to go under who would it drag down? What banks and in what countries would also go under?
National pride or sentiment counted for little with those–particularly in the ECB – who were determined that Irish concerns would not be allowed to stand in the way of protecting the Euro project. The conclusion was reached that like it or lump it Ireland would come into an IMF/ECB rescue.
Shortly before his death, Brian Lenihan told the BBC that it was at ECB insistence that Ireland accepted EU-IMF loans. He accused members of the ECB executive of "betrayal" and criticised some ECB governing board members for the "damaging" manner in which they briefed media about Ireland. In contrast the European Commission was more open-minded.
ECB intransigence was also blamed for preventing compulsory ‘burden sharing’ by bondholders. While the IMF was ‘relaxed’ on the issue the ECB that had been very actively buying up bonds in the markets insisted that bondholders would not ‘be burned.’
WHY DELAY THE INEVITABLE?
The question as to why the Government didn’t trigger the formal request for IMF/ECB/EU intervention is a little more complex – was it in denial or as political opponents accused was it simply lying.
At the time the Government felt that
- Ireland was in a different position than countries that called the IMF in.
- Ireland had shown willingness to take necessary tough decisions.
The big issue for Government was the conditions that would apply in any rescue package. Vital national interests were at stake. Ireland needed to know the negotiating position before discussions commenced.
Time was needed to explore fully what would be involved. Would, for example, Ireland’s taxation system be brought into the discussions – as hinted by the French Finance Minister.
IT’S NOT OVER YET
What is clear at this point is that some in the ECB, and in a number of member state governments, believed that by dealing with ‘the Irish problem’ contagion could be avoided: that was hopelessly optimistic.
The rot didn’t start nor was it ever going to end with Ireland.
The roots of the Eurozone crisis lie in the foundation of the Eurozone itself and in particular in the manner in which the ECB was established. The bank lacks the full range of instruments typically available to central banks.
The current crisis threatens not only the Eurozone but the very European Union itself. What the EU needs now is a short, sharp and focused Convention on the Future of the Euro where every Member State, not just the ‘big guys’ can have their say.
© Dick Roche 19112011.1986