Lessons from Ireland's failed bank guarantee
On 30 September 2008 the Irish government announced it will guarantee all banks, their loans and deposits to the tune of €440 billion - three times the size of the country's economy.
It was two weeks into the global crisis caused by the collapse of US-based Lehman Brothers investment bank. Banks were struggling to get cash. Panic had spread throughout the financial markets.
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Ireland's decision was heavily influenced by its eurozone peers, who were afraid that letting a bank fail in one euro-country could trigger a domino effect throughout the entire European banking sector.
The then president of the European Central Bank, Jean-Claude Trichet, rang up the Irish finance minister the weekend before the decision to tell him: "you must save your banks at all costs.”
IMF chief Christine Lagarde, at the time French finance minister, recalled two years after the decision that "we were very concerned about a bank run." They were also trying to avoid getting to the stage where tv sets were showing images of "people queuing outside banks."
"That would have been a complete disaster," she said.
The Irish decision-makers went however further than their eurozone peers expected.
The blanket guarantee was heavily criticised by the ECB who warned at the time that the Irish state may not have enough money to cover the financial gap in the country's banks, a sum which was unknown to the Irish government.
As it turned out later, the scheme was also heavily abused by bankers. It ended up costing taxpayers some €64 billion, forcing the country into an EU-IMF bailout.
"The date of Tuesday, 30 September 2008 will go down in history as the blackest day in Ireland since the Civil War broke out," current finance minister Michael Noonan said, according to The Journal.
A similar blanket guarantee was tried in Sweden, in 1991-1992, after a housing bubble burst, similar to Ireland.
But Sweden did not guarantee its banks in the middle of a global financial crisis. The country was not part of a currency union. And the government imposed much harsher requirements on the banks.
Secret recordings of meetings of the Anglo Irish Bank board members published over the summer revealed the extent to which bankers abused the state guarantee.
“We won’t do anything blatant, but we have to get the money in,” David Drumm, the head of Anglo Irish, told a senior manager at the bank two weeks before the state guarantee was issued.
In another transcript, two senior managers talk to each other about how not to scare off the government about how much the bank really needs. Anglo Irish first asked for €7 billion from the Central Bank, but in the end received a total of €28 billion.
To pay for all this, the Irish people had to stomach drastic wage cuts, tax hikes and slashed social programmes.
The Irish guarantee ended in March this year. The country is expected to return to the markets early next year and pay back its debt on the EU-IMF loans over the next few decades.
The end of the Irish experiment coincides with Cyprus being forced to impose losses on deposits above €100,000 as part of its own bailout. With its new "bail-in" rule, the EU now expects bank shareholders to contribute before taxpayers are burdened with the tab of a failing bank.
A single supervisor for the eurozone's 130 largest banks - to be up and running next year - should have a more objective view than national supervisors often under economic or political influence.
But the supervisor, hosted in the European Central Bank, will have little impact without a so-called resolution mechanism - an authority able to tell banks to close down and a fund to pay for these failed banks.
Germany has been opposing the creation of the resolution mechanism, citing legal concerns, but fearing another form of transferring bad loans from Spanish or French banks to German ones.
Yet even with all the new institutions in place, ultimately it will be the taxpayer bailing out banks.
"Much is put in place, yes, but it's still sub-optimal," says Carsten Brzeski, senior economist with ING Bank.
"Eventually it's still national government to pay the price - perhaps smaller than in Ireland's case, but they are still not exempt," he told this website.
This article was altered on 2 October to include ECB's criticism to the Irish guarantee.