The report into the financial crisis by Central Bank governor Patrick Honohan has finally revealed many of the key details of the events nearly two years ago that put the state on the hook for bank liabilities of about €400bn. It has also revealed that, in the run-up to the guarantee being put in place, the state's crisis command committee and its 'Black Book' on how to deal with financial instability became irrelevant and ignored.
The Domestic Standing Group (DSG), the committee made up of senior officials from the Central Bank, Financial Regulator and Department of Finance, stepped up its monitoring of the financial system from 2007 onwards as concern about the health of the banks deepened in the wake of the implosion of the US subprime mortgage market and the growing liquidity crisis as banks refused to lend to each other.
Crucial to the DSG's response to any situation was the Central Bank's crisis management manual, also known as the 'Black Book', which was drawn up in 2001. Among the manual's options for helping banks or building societies in difficulty was the provision of so-called "emergency liquidity assistance" (ELA) – essentially the Central Bank fulfilling its role as lender of last resort. The manual also detailed how to prepare for advancing state aid to failing banks or for the bankruptcy of an insolvent institution. The DSG and the 'Black Book' were there to ensure that policy in an emergency wasn't made on the hoof.
"Although a large amount of resources had been devoted to preparation of the crisis management manual, it was not employed to any significant extent during the crisis," Honohan said in his report, which runs to 177 pages. The manual was thought to be "too cumbersome" and events were moving far too quickly to follow it. And as the crisis spread in the summer of 2008, reaching its peak with the announcement of the guarantee on 30 September, the manual was completely thrown out the window as ad hoc meetings took place to devise a solution to prevent the meltdown of the banking system.
According to Honohan, some of the facts of what happened will never be known as there are only "sketchy records" of the "intensive round of informal meetings" that took place in the run-up to the guarantee. But he has been able to piece together how the guarantee emerged from the various options that were being considered by the Financial Regulator, Central Bank and the Department of Finance.
In June 2008 it was clear to the DSG that action would have to be taken. As well as the emergency liquidity facility, other options were also on the table, Honohan says, including "assisted private sector acquisition and nationalisation" of banks and building societies and the deposit guarantee. At that stage, Honohan says, there was no question of subordinated debt being protected by the guarantee. Another plan involved a "secured lending scheme" of some €20bn being made available by the Central Bank, the National Treasury Management Agency and the National Pension Reserve Fund.
By September, with the situation deteriorating, the DSG committee took on a lesser role as the Department of Finance took control and the Central Bank and Financial Regulator ended up "playing a less central role than might have been expected", Honohan says.
It was around this time that the most important policy to emerge was that "no Irish bank should be allowed to fail", Honohan reports. Once that was established the outcome was that Anglo Irish Bank and Irish Nationwide Building Society – cited in the report as two most likely to collapse – would be protected. It also became clear that some of the measures being considered by the department, such as nationalisation and providing liquidity assistance, would not be successful.
"It was observed that the ELA was normally intended to be availed of in the case of a single institution facing difficulties. Using ELA to support the entire banking system – which might end up being necessary – could, it was thought, have had a major reputational impact on the Irish banking system. More generally there was uncertainty whether use of ELA, if publicly disclosed or detected, would boost or detract from market confidence," Honohan says.
According to Honohan, over the last weekend in September, "intense" discussions took place about what to do. The 'blanket guarantee' option emerged. On Monday 29 September, Anglo's share price crumbled and "decisive action that evening was inevitable". The chief executives and chairmen of AIB and Bank of Ireland were brought into the loop by the Department of Finance. Dozens of meetings were held late into the night and early the next day. According to Honohan, then Central Bank governor John Hurley, along with the chairman and chief executive of the regulator, came to the conclusion, "with varying degrees of enthusiasm", that a general deposit guarantee was necessary. Both AIB and Bank of Ireland were in favour of the guarantee and also urged the government to nationalise Anglo Irish and Irish Nationwide.
According to the governor's report, the now-controversial idea of guaranteeing subordinated debt emerged once the decision to offer the guarantee was made. Merrill Lynch, the US investment bank hired by the Department of Finance to provide it with expert advice, "explicitly envisaged exclusion of dated subordinated debt" from the guarantee. However, it was decided that the holders of subordinated debt couldn't be cut loose as these were the same investors purchasing sovereign debt and that the government needed an all-encompassing and simple solution to shore up the financial system. Honohan found the arguments for including subordinated debt in the guarantee "weak" and said its inclusion "increased the potential share of losses borne by the state".
While accepting that all those involved in finding a solution to the crisis were under extreme pressure, especially on those fateful few days at the end of September 2008, Honohan was critical of the institution he now heads for failing to undertake "comprehensive preparatory work" to develop policy options in the event the "unthinkable might transpire". The decision that no institution could be allowed to fail – a policy that was not initiated by either the bank or the regulator – deserved much more scrutiny and could never be a permanent standpoint.
"In contrast to most of the interventions by other countries, in which more or less complicated risk-sharing mechanisms of one sort or another were introduced, the blanket cover offered by the Irish guarantee pre-judged that all losses in any bank becoming insolvent during the guarantee period – beyond those absorbed by some of the providers of capital – would fall on the state. Given the 'no failure' policy, a guarantee with its costs were inevitable."