The banks needed to be restructured, and so too did the system of banking regulation which had failed the country. Lenihan had no time for light-touch regulation of banks. He restructured the Central Bank and gave it new powers. He made an inspired choice in appointing Patrick Honohan as governor and brought in Matthew Elderfield from Bermuda as financial regulator to help restore much-needed credibility to the Central Bank. Honohan would later be central to securing a deal to restructure the IBRC promissory note. Lenihan also set up the Credit Review Office under John Trethowan to encourage more lending to the essential SME sector.
Lenihan was always eager to examine alternative policies and approaches. I recall a long conversation over the phone one weekend about a proposal by Citi Chief Economist Willem Buiter for a so-called ‘good bank/bad bank.’ Lenihan was open-minded about whether that model could be applied to Anglo. He eventually decided in autumn 2010 to wind down Anglo.
As the year 2009 drew toward a close, the cost of borrowing for the State declined and banks’ deposits stabilised. The global head- winds that were contributing to the recession began to abate, as world leaders delivered coordinated fiscal stimulus to the major economies. Ireland’s GNP bottomed out in the final quarter of 2009 and rose moderately in 2010. I recall Lenihan saying: ‘You know, I think this country has a future after all.’ But Lenihan knew that the improvements in sentiment were fragile. More gains in competitiveness were needed, the budget deficit was still large, and the economy was susceptible to international developments.
Moreover, bank losses were mounting, as the true extent of the reckless lending during the bubble was revealed. Lenihan wanted to spread the cost of the property crash over as long a period of time as possible. He recapitalised Anglo with a promissory note, not with cash borrowed on international markets. If he had injected cash, there would have been no scope at a later stage to renegotiate that arrangement.
He saw as a priority the need to reinforce international market confidence in the banking system, not least because the banks faced a funding cliff at the end of September 2010 when the blanket guarantee was due to expire. He introduced a scheme that guaranteed newly-issued (but not existing) bank debt for up to five years to help the banks to reduce this funding cliff as market sentiment gradually improved. Banks successfully issued new debt in the spring of 2010 and bank deposits began to rise again. In fact, during the first four months of 2010, funding to Irish banks rose around €500 million per week on average, compared with average weekly drops of €3,000 million during the first half of 2009.
EU/IMF BAILOUT
But events were conspiring against him. The scale of banks’ property-related losses continued to rise and rumours circulated in the markets that summer that the bailout of AIB could cost as much as Anglo. In a statement to the Dáil at the end of September 2010, Lenihan announced revised estimates of the cost of repairing the banking system. He wanted to provide reassurance to investors about the capacity of the Irish State to manage these costs. He began working on the four-year National Recovery Plan, which would later become the blueprint for the EU/IMF programme. He announced the first instalment of that plan would be a budgetary adjustment of €6 billion for 2011.
Abroad, fiscal stimulus was prematurely withdrawn from the world’s largest economies and analysts began to mark down their forecasts for global economic growth, including growth in Ireland. With slower growth forecast for the coming years, the task of closing the budget deficit began to look even more daunting. The euro area sovereign debt crisis exploded, with Greece entering a (failed) bailout programme in May, amid growing market anxiety about the prospects for peripheral euro-area economies. The country’s cost of borrowing rose to unsustainable levels, forcing the Government to withdraw from funding markets in September and rely on previously accumulated cash balances. The banks were unable to issue new bonds to address the funding cliff and relied instead on fresh borrowings from the ECB and the Central Bank of Ireland.
Angela Merkel and Nicolas Sarkozy’s disastrously timed agree- ment at Deauville in October (which they later tore up) to force a country that applied for a bailout programme to default on its sovereign debt was the straw that broke the camel’s back. Investors were now very concerned that the Irish State and its banks would default on their debts.
On the plane to Washington D.C. that month for the annual IMF/World Bank meetings, Lenihan and I discussed at length the pros and cons of exiting the euro area. He was always willing to investigate alternative strategies. Lenihan concluded that an exit would be disastrous for the people of Ireland. He recognised that the European Central Bank was providing invaluable support to the Irish banking system, but he wanted the ECB to do more. He pointed out that if Ireland were a state in the United States, the Federal Reserve would be offering unconditional support. He admired the Fed as a genuine lender of last resort.
Instead, the ECB was pressurising Ireland to reduce the amount of emergency loans that the Eurosystem had extended to Irish banks. In frustration, Lenihan sometimes referred to the ECB as ‘that bank in Frankfurt.’ He became aware that senior people at the ECB were briefing market investors that the bank was considering the withdrawal of financial support to parts of the Irish banking system. Investors were alarmed. By now, funding in debt markets for the Irish banks had dried up and they were haemorrhaging deposits.
As the financial pressure on Ireland intensified, the Government hoped that the ECB would step up its purchases of Irish bonds under the Securities Markets Programme. These hopes were dashed. One-and-a-half years later, with Italy and Spain under severe financial pressure, the ECB, under new boss Mario Draghi, belatedly introduced a potentially limitless bond-buying programme. In response, market confidence in Italy and Spain improved dramatically.
In early November, Lenihan came up with a plan which he hoped would keep Ireland out of a formal EU/IMF programme. He pointed out that, unlike Greece months earlier, the Irish State was not about to run out of cash. In fact, Ireland was fully funded until the middle of 2011. Lenihan wanted the European Commission to endorse the National Recovery Plan and the ECB to provide unequivocal liquidity support to the Irish banks. He believed that such European support would boost investor confidence in Ireland and quell the financial panic. In return, he would agree to increased surveillance by the European authorities – including quarterly surveillance if necessary – and that Ireland would enter a formal bailout programme in 2012 if things hadn’t turned around by then. He intended to discuss the plan with the French Finance Minister, Christine Lagarde, and the German Finance Minister, Wolfgang Schäuble.
But towards the end of the second week of November, a long-distance phone call from Olli Rehn, who had visited Dublin a few days earlier, confirmed that Lenihan’s bespoke plan for Ireland was not going to work. Under pressure from the ECB, the Government shortly afterwards applied for a financial assistance programme from the EU/IMF. In the negotiations, Lenihan, supported by the IMF staff, wanted to reduce the cost to the State of recapitalising the banks by imposing losses on the banks’ senior bonds. But the ECB would not countenance such a move. In fact, there was considerable opposition to bailing in bondholders in finance ministries across Europe and in the G7 group of countries. In the end, the Troika ruled out imposing losses on senior bank bonds. When the issue of burden sharing came up during the general election campaign in early 2011, Lenihan remarked that the new government would probably have more success pursuing other approaches at European level to reduce the cost to the State of rescuing the banks.
Europe’s evolving response to the euro crisis was at times chaotic. Lenihan described a meeting of euro area finance ministers around that time in which the Finnish ministry wanted Ireland to offer the state-owned ESB as collateral for loans from the European rescue funds.
The measures for ending the banking crisis contained in the EU/IMF programme built upon Lenihan’s efforts. As he put it himself, the programme meant ‘more capital and more NAMA.’ Lenihan had long wanted more support from Europe to repair the banks. ‘A small sovereign like Ireland faced with an
