This day five years ago, the bosses of Ireland’s big banks came to the government with an ultimatum that went more or less like this: “We have run out of money, what are you going to do about it?”.
Of course this day could have been avoided if at some stage during the beginning of the credit boom in 2000-2002, the banks had been policed by the regulator. But they were allowed to do whatever they liked – endangering the entire economy. The state didn’t listen to any warnings in the period when something could have been done. By September 2008 it was all over.
The very real threat was that the banks, having mismanaged their affairs on a monumental basis, wouldn’t open the next day because they had no money. Of course, the minute they didn’t open, depositors – as in Cyprus – would be queuing to get their money out.
It is a hostage situation.
The banks (the hostage takers) threaten to kill the hostage (the economy) if the government won’t pay the ransom (a bailout of some sort).
The government’s watchdog – the regulator and the Central Bank – were on the telly a few days before, saying all was grand and that Irish banks had loads of money.
But why did the banks run out of money?
They had borrowed and borrowed wherever they could in order to lend out. The difference between the interest rate the banks paid to borrow and the rate of interest they charged on the loans they made to their customers was their profit.
As long as there were enough people who wanted to borrow from them and lend to them, the banks looked super-profitable. This was the case throughout the bubble years of 2000-2007. And as their bonuses were related to the share price, they were hardly going to stop the circus.
To put the banks’ borrowings in context, AIB and Bank of Ireland doubled their total loan books in three years. Bank of Ireland took more than a century to build a loan book of €63 billion and then, in three years from 2003 to 2006, it doubled it.
Ultimately, the scam becomes a pyramid scheme, where the value of the assets at the top of the pyramid is dependent on the amount of money coming in at the bottom.
If that money stops coming in, the banks are in trouble, because the assets that have been financed in the real economy are long-term assets like loans to developers or mortgages.
However, the money the banks have borrowed in order to lend out can be called in at any moment. Therefore the banks are involved in a calamitous balancing act, trying to pretend to their creditors that everything is OK and there is enough money coming in from interest payments on these long-term loans to finance the interest rates on the banks’ short-term borrowings.
Obviously the more reliant the banks are on short-term loans, the more precarious the position and the more at risk are the short-term loans – of which ordinary people’s deposits and companies’ deposits are a major component.
Over-lending and too much borrowing wasn’t making people and the banks richer, it was making them poorer. After all, the man who owes nothing is by definition richer than the man who owes something.
The banking crisis started in 2000, not 2008 as is often stated. It is still crippling us, as evidenced by the mortgage arrears debacle.
In the period 2000-2008, the banks behaved like pyromaniacs in a forest, playing with fire and laughing at anyone who warned of the dangers of a contagious inferno. Once the market peaked and reversed, the banking system’s implosion would be a financial forest fire that would engulf all around it.
The government – which should have been on top of this via the regulator and the Central Bank – had a choice: either to put it out using everything it could or to let the fire burn (let the banks go) and see what happened.
The recent evisceration of Cypriot deposits, or the total collapse of economies in the 1930s, or the fallout from the Asian crisis, all followed the decision to let banks go bust in an uncontrolled fashion. Anyone looking at such examples knows that the authorities have to act to prevent a contagious bank run.
Today, there are many who argue that we should have let them all go under, or that we could have isolated the bad banks and let others go. But they were all bad; every single Irish bank needed money to keep the doors open in 2008.
Those who started the fire continued to obscure the extent of the damage, and the firefighters – the regulators and central bankers – who were supposed to be in control sided with the pyromaniacs until it was far too late. People will say it was reckless borrowing as much as reckless lending that caused the bubble. That may be true but if I am the lender rather than the borrower, I should be concerned about the quality of debtor I am lending to, rather than the other way around.
In the middle of a bank run, the authorities have a choice: do something or do nothing. It had to stop the panic first, and assess the damage second.
The government had to act to protect deposits. It couldn’t do this by merging bad banks with good ones in a panic, because there were no good banks in Ireland. The state could have nationalised the banks there and then – but that wouldn’t have protected taxpayers.
The government could have let them go bust, which would be like a fireman allowing a forest fire to burn itself out and just hope for the best. The state could have let toxic banks go, but AIB, the biggest bank in the country, was on the verge of bankruptcy. Would letting AIB go have been a good idea? The government could have grabbed deposits, as they did in Cyprus.
Another option that is now bandied about was that the state could have just guaranteed all future bank borrowings not past ones. It is suggested as an elegant and clean way of dealing with an imploding banking system.
But let’s just think about that for a minute. Imagine AIB owes a lender – another bank – €100 million and this is about to mature but, as it is an old loan, it is not guaranteed under the new scheme. Then all the treasurer of AIB has to do is borrow a new €100 million which is now guaranteed and use the money to pay the old loan and in effect the ‘old’ loan is now guaranteed but it is just called a ‘new’ one.
There is a narrative in Ireland that blames the bank guarantee for everything, as if there was some other easy, painless option. We didn’t even have a bank resolution mechanism in place, and amazingly still don’t.
It ought to have been temporary, used to stop the panic, and then, following careful assessment of the situation, led to the introduction of a bank resolution law. This would have allowed for a negotiation with the bondholders in a calm way, which is the way the Americans dealt with their banks’ creditors in the savings and loans crisis of the 1980s-1990s.
But, for some reason, the guarantee was extended and extended.
It is important to understand that the guarantee and the bailouts were the consequences of reckless lending, too much borrowing and total lack of banking regulation. They were the consequence of the Irish banking/housing/credit collapse, not the cause.
If there had been no reckless lending, there wouldn’t have been a crash and no need for any remedial action to protect depositors.
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First am I?
But didn’t you spin the story that it was all the German banks and bondholders fault? Why did you deliberately obfuscate the fact that most of the money for the Irish credit bubble came from UK banks? Was that too close to the truth? I hope the £ kickbacks kept you warm and cosy at night David.
“However, the money the banks have borrowed in order to lend out can be called in at any moment.” Why do you keep repeating that lie David? It is useless trying to explain securitization to you. You are the main source of this egregious banking misinformation that is crippling Ireland. What a shame.
Sometimes, now, seem that everyone that, for starting a business or muscle her/his business, wants to borrow money from a bank has to produce a very precise, compelling and highly able to engage and reassure business plan … and stick to it for the future medium term at least. On the contrary the impression about banks seem not really aligned regarding their way to run their own business! If it is just a bit near to reality it is a scary situation. But it just an impression. I remember to have followed the UK banks enquiring committee on BBC, and… Read more »
Securitization and the derivatives market are indeed a core issues that require addressing and a proper analysis. It moved banking and the accepted practice of lending and borrowing into entirely new sets of relationships where it became more important for a bank to increase the risk that its borrowers were handling rather than reduce it while at the same time fooling the same borrowers into believing the opposite that they were somehow lowering the risk of borrowing because of falling or preferential rates while in fact they were accepting the banks’s risks onto their own books. The true value of… Read more »
It is good to have a reminder of what happened that day 5 years ago. It is good to blame the banks and their regulators for the situation the Irish citizens are in now. I guess in five years time we have another reminder. But this article column talks about the banks, institutes, culture and systems. No names of people are mentioned – just the position of the regulator. Very easy to repeat in general terms what has happened and recycle and rehash old information. At this stage we all know what has happened unless you’re an alien from out… Read more »
I referred to this before. It is a great critique “The 86 Biggest Lies on Wall Street” by John R. Talbot (e10 paperback). The author demonstrates the systemic FLAWS in Banking that render it a recurring basket case. David refers in his article to the mismatch between the bank’s short term/long term loans/borrowings. Here is an excerpt that nails it on the head regarding Ireland. “The capitalist credo of survival of the fittest does not apply to long-lived assets (mortgages) vs short-term liabilities (inter-bank loans) due to time dilation. Imagine a scenario involving a cut-throat mortgage bank. The Kamikaze tactics… Read more »
Calling the Shoah in aid in a debate of this nature does not assist in my view. On the anniversary of the massacre at Babbi Yar when 33,771 people were murdered by the Germans and their Allies in two days “whacking Jews” is not a phrase that I would consider appropriate or helpful to the points being made. It is offensive in fact. Neither does conjuring up the ghost of Nazism assist in understanding the collapse of the financial system in recent years. If you mean to summarize the neo-con post Schumpeterian argument that destruction of existing systems is the… Read more »
For those interested in a readable and thoroughly accessible account of derivatives and their impact on the financial and investment world there is none better than Gillian Tett’s “Fools’ Gold”. She is an assistant editor at the Financial Times and far better informed than any other journalist I have encountered in the many years spent working in the law of derivatives, securitization and the other complex financial instruments whether in business or sovereign debt.
“After all, the man who owes nothing is by definition richer than the man who owes something”… Sums it all up really David. Debt per se is not bad – provided it’s good/smart debt, but bad/unsmart debt = fatal.
Debt is a sine qua non of the captialist economy and the extension of credit an inescapable necessity of expansion. To suggest that in some way debt is a moral issue is to adopt what those pursuing borrowers want to be believed as if it were a one way stream of people wanting desperately to borrow and a cabal of prudent bankers desperately trying to resist their blandishments. David is quite correct in originating the debacle in the late 90s or even earlier with the vast growth of riskier investments arising out of derivative trading. There was a huge rush… Read more »
[…] full article at source: http://www.davidmcwilliams.ie/2013/09/30/grim-reality-of-the-guarantee […]
Interesting debate. I certainly wouldn’t consider myself to be in a position to comment on Nazi rules/politics etc. However, I do have the experience to discuss how the liability side of a bank balance is managed and as this thread relates to the debt portion, I will make a few comments in respect of this. There is a focus on securitisation in the previous posts and it is true to say that securitisation was playing an increasing role in banks funding and capital management. But it was just a portion. The liability side of a bank balance sheet includes, retail… Read more »
Well hang on here just a second David! You appear to be far too forgiving for how the banking crisis was dealt with and as if to say there was no other alternative as to how we the people would pay for it. You indicate that the fault mostly lies with the lenders. Well indeed, as most ordinary citizens just borrowed to put a roof over their heads. Is there something wrong with that? So let’s accept that the crisis is indeed rooted in wreckless lending and bad regulation. Well then, let’s bring that to it’s logical conclusion. The crisis… Read more »
Well, whatever phase I am going through in life right now, but I am coming around to the view that a lot of what we seen in the years since the signing of the Treaty of Maastricht, is a journey of intellectual delusion, compromise and make believe. In other words, as a society we collectively lost our marbles. Of course there where dissenting voices. And there were individuals, and perhaps even communities who opted out. But the overall mainstream thrust of intellectual activity (if there even was any) has been towards the one big solution, that is very popular and… Read more »
From the article;
“But, for some reason, the guarantee was extended and extended”
And above;
“the dirty little secret of the Eurozone under the ECB is that everything has been done to help the banks”
Why did you ask the question when you know the answer?
chutzpah 1892, from Yiddish khutspe “impudence, gall” from Heb. hutspah. The classic definition is that given by LeoRosten: “that quality enshrined in a man who, having killed his mother and father, throws himself on the mercy of the court because he is an orphan.” (this has been copied from an online dictionary) Some don’t look for mercy – psychopaths they just keep taken from the plebs… Rules are there for plebs or so say the psychopaths they have been proved right – some call them heroes – fly-boys in the air business (Fly by Ryan) – consequences do not concern… Read more »
An elderly neighbour described the boom/bust succinctly. “All those houses were built on borrowed money, so all those building jobs were paid with borrowed money. But the government borrows money to pay its staff. So, in a roundabout way, the whole boom was like a huge Government Works Scheme.”
As to Michael above. I would not hold myself out has having the knowledge of the Irish situation that say David or you have or anyone posting on this site in fact. I read Irish papers and hear stories from Irish clients but all tales in the end are travellers’ tales if one doesn’t go there oneself. What has astonished me is the behaviour of lawyers and the political elite. From the outside they as significant players in the unwinding of the mess seem not to have a clue about what has happened and whatever explanation may be available they… Read more »
David, I’m actually amazed after everything we’ve spoken about and all the material I’ve forwarded to the contrary to read the line; “They [the banks] had borrowed and borrowed wherever they could in order to lend out.” This is not how banking actually works because banks create the money they lend. The need central-bank-money to settle debts which build up as we transfer bank-account-money between banks but this type of money cannot leave the central bank’s balance sheet. Hence they cannot borrow from another bank and lend this money to the public. I passed on Standard and Poor’s paper on… Read more »
As far as I can see the main article is full of half truths. There is a lot of informed comment above which is valid. One aspect of the banking alluded to a lot is the collateralization of performing loans. I am not and have never been involved in the banking industry so all my knowledge comes from reading and observation. As I understand collateralization. It is the gathering together of a banks assets, in this case mortgages, and selling to a third party investor. I believe there is nothing wrong with this as long as proper disclosure is made… Read more »
For the financial lawyers, apparently here :
JPMC and CEO Dimon are afraid of N.Y. A.G. Eric Schneidermann
NY Attorney General Schneidermann is effectively leading a Pecora Commission, setting the scene for re-in-statement of Glass-Steagall : 33 pages of legislation which worked till 1999 (even though savagely chipped away), compared to 700 pages of the Gramm-Leach-Bliley Act, Dodd-Frank, and somewhere no one is sure,the Volcker Rule.
Hellhound of Wall Street – For the New Banking Inquiry
The Hellhound of Wall Street : How Ferdinand Pecora’s Investigation of the Great Crash Forever Changed American Finance
by Michael Perino London: Penguin, 2010
The review here shows how to deal with the banking problem today.
[…] always going to have to be dealt with by the State, as in Cyprus, Spain etc. Cue McWilliams 2.0: Grim reality of the guarantee | David McWilliams Apparently, Golden Balls is now also of the view that the Guarantee is not the problem, and that […]
Good Morning Their are some great posts on this thread……. It is always difficult to write something you know you want to and transferring it down “on paper” can be difficult for me. Have you noticed something different in this financial War from conventional Wars..? No friendly fire..! No “blue on blue” incidents……No Bankers hurt by accident..The accuracy of E.U Finance Ministers is astonishing. The fines that have been imposed on Banks over the last several years for breaches or financial irregularities are not fines at all as they are factored in to P/L as the cost of doing business.… Read more »
REFORM THE SENATE – MAKE IRELAND A STRONGER REPUBLIC HOW? 1. GIVE IT REAL POWER TO BLOCK BILLS. 2. MAKE SENATE ELECTIONS OPEN TO ALL. 3. HAVE SENATE ELECTIONS AT MIDWAY OF DAIL TERM. -> SO VOTERS CAN KEEP ROGUE GOVT IN CHECK. NO WAY. INSTEAD WE GET: 1. GET RID OF THE SEANAD QUICK – SAVE 20 MILLION FOR JUNKETS 3. NEED NEW BANK BAILOUTS TO PASS INSTANTLY. 4. NO OVERSITE EXCEPT FROM SPUD IN THE PARK. 5. STRONGER WHIP SYSTEMS TO BULLY THE TDS – BECAUSE I KNOW BEST. 6. AT THE TOP OF IT -> THE ECONOMIC… Read more »
“Honesty and integrity are the two most important attributes to be successful. If you can fake them you have it made. ” Groucho Marx.
Lots of bankers seem to have grasped what Groucho was saying.
The Legal-Illegal Game Greetings Colm, there are some better informed people posting here from a legal point of view concerning international law I assume, also probably well aware about international contract law that could have found application in Ireland and other austerity imposed on countries, but was silentely washed aside. http://unctad.org/en/Docs/osgdp20074_en.pdf As for your astonishment concerning Ireland’s wigged class, well, allow me a small example of the two forked tounge speaking in Ireland. The Gaming and Lotteries Act of 1956 states that casinos are illegal in Ireland. Due to the existing loopholes in the law, the establishment of private clubs… Read more »
the grim reality of the guarantee…..the Irish establishment are rotten with gombeenism. And the entire EU relationship is now working towards the returning to the same way that the relationship existed with the Crown, in the British Empire years. The Castle Catholics have engineered a means to put leverage themselves and attain the nirvana that James Howard Kunstler warns as being the root of a decadent society. They have attained the position of “something for nothing”. The guarantee, the republic, representative democracy, socialism, capitalism, catholicism, all the other ideas were great in theory, and sometimes even highly beneficial in practice.… Read more »
Hi,
Very amusing. Karl Whelan was shipping some abuse on twitter following an appearance with Vinny Browne [[[and in stepped… THE IRISH MAMMY!!!
http://www.independent.ie/lifestyle/ThreeTrending/blog/vincent-browne-guest-defended-by-his-mam-on-twitter-29624808.html
How dare you badmouth my boy!
If the awesome power that is ‘The Irish Mammy’ could only be harnessed for the forces of good. . . Why the possibilities are practically endless!
We merely need to concentrate this unwieldy power source and direct it toward the dark lords who are passing themselves off as the present administration.
T.K.O. :D
You don’t understand. I coulda had class. I coulda been a contender. I coulda been somebody, instead of a bum, which is what I am, let’s face it. It was you, Charley. The quote above captures gombeen (conservative) ideology in a nutshell – always look to blame and massage your sense of inadequacy by terrorising people who can’t defend themselves. Welcome to the future. Fascist nut cases gaining ground in Greece and Britain is just the start. 400 British servicemen signing The Sash on the field at Ibrox last Saturday is about as openly fascist as you can get especially… Read more »
http://www.irisheconomy.ie/index.php/2013/09/26/david-mcwilliams-on-the-bank-guarantee-and-pre-crisis-regulation/
David McWilliams on the Bank Guarantee and Pre-Crisis Regulation poste on Irish Economy by Philip Lane. It’s the last article, this one hasn’t been posted under the title, although it’s more relevant.
I have to say that the quality of blog commentary was one of the best I have seen is a long while. Very educational and it is very obvious that the rules of engagement are very vague and shrouded in archaic language of legalize. I can see why the article is very loose and grey. There seems to be no systematic way of pointing the finger to the problem at all. All of this is a pity because it means nothing will change as a result of rational action. This means that social and market upheaval will be let do… Read more »
According to the Headline Analyser Tool on the Advanced Marketing Institute web site the headlines on this blog fluctuate somewhere between good and poor. For any of you who blog and/or use social media this free tool could be useful when you are crafting killer headlines that attract eyeballs. Headlines from the recent past: A quick nap doesn’t mean you’re lazy it’s key to being productive – 50% Growing old disgracefully Where elderly can never afford to retire – 40% Dark arts of the bankers – 40% An uncomfortable truth about eurozone growth – 16.67% The shocking truth about eurozone… Read more »