In his last two columns, David McWilliams called for the introduction of a 100 per cent deposit guarantee. Now he explains what must happen next.

Ten years ago, while working in Moscow, I witnessed the collapse of the Russian banking system. I saw desperate people queuing outside main street banks. I witnessed investors losing all their wealth and I experienced what it was like to live in a society that was on the verge of psychological, as well as financial, collapse. We were a whisker away from that last week.

Make no mistake about it: last week, Ireland almost repeated the Russian experience of 1998.Had Brian Lenihan not intervened courageously to guarantee all deposits last Monday night, then at least one, if not two, Irish banks would have collapsed last Tuesday. By Thursday, we would have seen another bank fall and by Friday, the stock of the two big banks – Bank of Ireland and Allied Irish Bank – would have fallen to zero, rendering them effectively bankrupt.

There simply was no other choice. Over the past few days, commentators have queried the wisdom of Lenihan’s move, as if we had the luxury of a suite of options to pick from at our leisure. This was not the case. Ireland had run out of time, and only the most brazen and unexpected move could have prevailed.

We didn’t have time to consult our European neighbours, nor with whingeing Britain – which, incidentally, is not even in the same currency as us, let alone the same jurisdiction. The last time I checked, Gordon Brown was not the Taoiseach.

The choice was simple: either we wanted a banking system or we did not. Now that he has saved the system, the minister has to fix it. There are indeed risks, but they can be minimised. Last week, we saw phase one of this operation. Next week we will, hopefully, see the beginning of phase two.

Before we go on to phase two, it is important to deal with the moral hazard question, which many people have ‘rightly’ raised. It is legitimate to question the morality of bailing out bankers who have nearly bankrupted the country.

However, as this column has argued over the past few weeks, the time for recrimination is not now. The guilty must be punished, but this cleansing process should be planned in an orderly and logical manner. When dealing with the boards and senior management of the banks, a distinction must be made between those good people who made mistakes and the downright reckless cads, who put the country and an entire generation at risk. There are many people in the former category who deserve a second chance; there are some in the latter who don’t.

But this is not our concern today; we’ll come back to it when we have time. Our objective now is to keep up the momentum. Remember, the aim of state intervention in the financial system is not only to save the banks and prevent a catastrophe, but to make sure that the banks, as quickly as possible, re-emerge as stable providers of credit. This won’t happen on its own.

Amazingly, despite the abyss faced last week, there still seems to be a certain amount of delusion in the system. On the airwaves, the head of the Central Bank and the Regulator are suggesting that, because the Irish banks are not using their capital, there is sufficient capital in the system to legitimise asset values. This is nonsense because what they are describing is a frozen system, not a functioning system. While a frozen system might look from a distance to be healthy, it is in fact lifeless.

The only way to breathe life back into the banking system, and the economy in general, is to accept that asset values on the banks’ balance sheets are worth considerably less than what most bankers hope. You don’t have to be Einstein to figure this out. The dogs on the street know that Irish property prices are plummeting.

They were kept high by excessive bank lending and they are being driven down by excessive bank fear. We are nowhere near the floor yet. The quicker we get there, the quicker we can recover.

The minister has to accelerate this adjustment if he wants the crisis to be short and if he wants to get the full value from the stability which has been achieved by the guarantee.

If, on the other hand, he allows the political capital built up over the past four days to evaporate in indecision, then we could be facing a decade-long, Japanese-style depression.

So what do we have to do to get this over with quickly? The most important thing we must accept is that the Irish banking system is full of bad debts. The more quickly this is accepted, the better. Writing down bad debts means the banks will have to set aside enormous provisions. These have to be paid for by shareholders’ funds and this implies, at very least, that no dividends will be paid by Irish banks to shareholders for the next two years.

To make large provisions, banks need capital, and given that no one is willing to lend to the banks, the state might have to take the lead role in recapitalising the banking system.

There are many ways of doing this. However, the recent exchequer figures show that the state’s room to borrow is not enormous.

If the state decides to recapitalise the banking system using its own money, it needs to exact a very heavy price from the banks. Despite having saved the banks, history suggests that banks ‘‘don’t do grateful’’ – so the minister will have to force their hands on the terms of any recapitalisation. Expect sparks to fly in the weeks ahead, but the minister should realise that he is in the driving seat.

Lenihan has demonstrated courage. There were many options on the table last Monday night, but he took the best one. To get the full benefit of this move, he will need to wrest control of the banking system from those who nearly wrecked it. In this endeavour, he should be supported by every patriot in the country and all of us who are concerned about our future.

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