The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (48 page)

For the previous few weeks, the Irish government had been reluctant to embark on a Troika programme. The ‘two Brians’ (finance minister Lenihan and Taioseach Cowen) felt that having funded their sovereign borrowing requirements until mid-2011 there was no need for the dead hand of the inspectors. If a programme was needed, they felt they had maximum bargaining power to limit their loss of sovereignty. That seemed to be mainly defined by keeping Ireland’s 12.5 per cent rate of corporation tax, the lowest in the Eurozone, and a totem of the Celtic Tiger. The policy had attracted tech giants such as Apple, Google and Microsoft, as well as Europe’s bankers. ‘Corporation tax had to be got off the agenda before we’d even start talking,’ said one Dublin official. ‘We made no bones about talking about being fully funded in mid-2011. With a bank run on, it wasn’t really in our interests to prolong it, but we could hold out for longer.’ Secret, plausibly deniable, negotiations had started with Brussels commissioner Olli Rehn in September 2010.

Frankfurt was the ultimate determinant of Dublin’s fate in three ways. First there was the intervention in Irish government bonds under the SMP (in the same manner that was to occur in Italy a year later). As market interest rates for Irish government debt spiked to nearly 9 per cent, Lenihan requested that Frankfurt continue purchases, eventually revealed at €14 billion. The ECB’s fiscal hawks wanted to see that Ireland’s deficits were under control, and proposed even bigger spending cuts and tax rises. Ireland had not had a property tax since Fianna Fáil’s Jack Lynch won a thumping landslide in 1977 after promising to abolish rates. Ireland managed to vote itself into a tax system where half its citizens paid no income tax. Irish people paid no direct charges for their water and sewerage. Ireland had raised entitlements, for example offering €535 a month in child benefit for families with three children, over double the level in the UK (£185). The Troika was puzzled to discover that neutral Ireland paid its military chief more than militarily busy Britain. All of this was made possible on the rotten fruit of an unsustainable property boom.

Second, and more importantly, was the question of Ireland’s ‘addict’ banks. The 2008 guarantee for Anglo Irish and other rescued Irish banks merely gave the opportunity for depositors and market funding to exit stage left. How did the banks pay for the real and electronic cash being withdrawn, given withered funding and apparent insolvency? Principally by recourse to funding from Ireland’s central bank, part of the eurosystem, and increasingly via ELA emergency funding (‘emergency liquidity assistance’ is the official name, although in Ireland officials rebranded ELA as ‘exceptional’ or ‘extraordinary’ after realising that the assistance was not going anywhere). In total the ECB funding was worth more than Ireland’s entire €160 billion GDP. The Irish economy made up less than 2 per cent of the Eurozone, but Ireland received 25 per cent of all loans made by central banks within the Eurozone. Emergency funds were designed to be advanced to solvent banks facing a liquidity problem under the centuries-old doctrine of ‘lender of last resort’. The precise parameters of solvency were, however, unclear under the policy of ‘constructive ambiguity’ designed to prevent moral hazard by banks. In other words, the central bankers would not identify in advance how they would rescue troubled banks, because, rightly, they feared bankers would abuse the privilege and indulge in risky funding, knowing they would be supported by their central bank. Unfortunately, the ambiguity was more destructive than constructive.

In October 2010 the ECB tightened its risk control framework (its rules on emergency funding), seemingly with Ireland in mind, which brings us to the third way in which Frankfurt defined Ireland’s fate. A series of letters, phone calls and faxes were sent from Frankfurt to Dublin expressing concern at the level of ECB funding. The ECB ‘were a little coy’ – there were no defined threats to withdraw funding, but the Irish Department of Finance was left with the clear impression that life could be made difficult, through changes to charges and collateral rules. In a secret letter Trichet let it be known that the ECB was exposed and Ireland needed to shape up. The general tone of the letter, one member of the ECB governing council told me, was ‘There’s got to be a programme or there’s going to be trouble.’ Two and a half years later, in Cyprus, the ECB were not so shy, and directly threatened to withdraw the emergency bank support in terse public declarations, following a Cypriot parliamentary vote against a Troika programme (see Chapter 13,
here
).

In Dublin back in November 2010, obliging a nation to take a ‘voluntary’ bailout was proving rather tricky. The crisis was beginning to affect other nations. Major financial newswires were briefed that Ireland was negotiating a bailout. Irish ministers insisted that this was ‘a fiction’. The by-lines of these reports tended to be Frankfurt. Other powerful European finance ministries, when asked about the source of the Irish bailout rumours, suggested ‘Try a city in Germany that is not Berlin.’ It wasn’t Leipzig either. Nor was it just Frankfurt. In a radio interview with the
Irish Times
journalist Dan O’Brien just a few weeks before his death, Brian Lenihan described arriving at a Eurogroup finance ministers meeting late on account of Brussels fog. The ministers proclaimed that ‘the functioning of the single currency was at stake’. At that point German finance minister Wolfgang Schäuble asked Lenihan to leave the meeting and announce that Ireland was seeking a bailout. Lenihan refused, saying he had no authority. Still Ireland resisted. At that Brussels meeting Irish journalists were asking German journalists what was happening in Ireland.

Two days later, something remarkable happened. Ireland’s central bank governor, Patrick Honohan, also a member of that ECB governing council, rang up Ireland’s main morning radio show and invited himself on air from Frankfurt. He revealed the likelihood of a bailout worth ‘tens of billions of euros’, and that teams from the ECB, IMF and EU were already in Dublin. In fact, Honohan was to chair a meeting with the officials within the hour. Honohan had consulted neither of the two Brians. It felt like a monetary coup d’état. He explained that he had been texted about a
Financial Times
leader article entitled ‘Europe heads back into the storm’, which suggested that preparations should be made ‘for a run on the Irish banks spreading’. The governor was talking in his financial-stability capacity to prevent concern about such media commentary resulting in actual bank runs. Ireland’s elected government felt that it was being bounced into applying for a bailout by the ECB’s man in Dublin. A large swathe of the Irish public felt that the truth was finally being revealed about what they regarded as a duplicitous and incompetent government. Indeed, days later the government collapsed. Senior Frankfurt figures say it is ‘absolutely not true’ that the ECB pushed Ireland. Yet the crucial letter remains secret. And in Cyprus, very nakedly, this is exactly what happened. In both cases, however, the ECB argues that the
really
extraordinary intervention was their toleration of huge emergency liquidity funding for months on end in the first place. Bankrupt banks should not get life support. The Troika programmes ensured that the ECB would be repaid.

Frankfurt undeniably
did
intervene in one matter. The Irish government was minded to burn those bondholders who held now unguaranteed Anglo Irish debt in late 2010. The IMF agreed that losses should not just be nationalised, but shared with bankers. ‘And at that stage,’ a senior Irish policymaker told me, ‘their hand was stayed by Europe and particularly by the European Central Bank. It made the cost-benefit analysis and said “This is not a good idea.”’ The ECB believed that fully honouring the outstanding debts of Anglo Irish was ‘the least damaging course’. The Irish government made the same cost-benefit analysis and concluded that it could not afford to throw around €5 billion or 3 per cent of GDP away. ‘So at that stage,’ my informant went on, ‘clearly Ireland did take a hit for Europe.’ The burden of paying Ireland’s bank debt, particularly the ECB emergency funds, (not just Anglo Irish, also the bankrupt Irish Nationwide) was transferred to the Irish state through a €31 billion promissory note. It always had the sniff of an accounting fiddle. The stream of annual payments of €3.1 billion or 2 per cent of Ireland’s GDP, was, however very real. It was to last a decade, with smaller payments afterwards, essentially to pay interest.

It was Ireland’s misfortune that it was the subject of the first experiment with a formal bailout facility. There was no form book, manual or real precedent. Much of the documentation developed by the Troika for Ireland was emailed over for a name-change and deployed again for Portugal six months later. Some of the experimental mistakes were later unwound. Brian Lenihan would remind his staff that ‘Every time you issue debt you lose sovereignty.’ But the island’s sovereignty was dripping away towards Frankfurt more than any Irish politician could have appreciated. Every time a decision needed to be made, it seemed to emphasise that it would be Irish taxpayers and their children and grandchildren who would pay the bill for obscene banking excess, rather than the international funders of the guilty banks. The ECB was a driving force behind this. And this was just the first instance of the ECB stepping into areas where it had little mandate.

‘It’s true the ECB was involving itself in things it never planned to do,’ one Eurozone central bank governor told me. ‘Anything it lends to a bank in a certain country, there’s a risk of default. That risk of default will be passed back to all seventeen other member countries. If it buys bonds of a government, same thing. Any losses will be carried by the taxpayers of those member states, who are otherwise expecting dividends from the central bank. So this is not something that is written into the mandate of the ECB. Nor did we ever imagine there would be issues of this type. So it gets drawn deeper and deeper into other types of policies.’

Putting specific conditionalities at a high level of its policy action ‘is way beyond what the ECB was imagined to do’. But not just that, now it is involved directly in the Troika teams devising the conditionality. Why? Because it has large teams of trained financial economists. The ECB is very close to the action and has been asked by the rest of Europe to get involved. So for all these reasons the ECB is getting into territory that it wasn’t designed for.

The Irish government and central banker Patrick Honohan did, in 2013, lighten the burden of the promissory note. By liquidating the company holding the remnants of Anglo Irish and Irish Nationwide, essentially the promissory note was swapped for a series of long-term government bonds of up to forty years. The principal, the stock of the loan, would essentially not be repaid until the 2040s. An odious debt had become merely abominable. However, the net burden on the Irish state had been slashed from €25 billion to €1.4 billion over the next decade. The net present value of the repayments had been cut by 35 per cent according to University College Dublin economics professor Karl Whelan. The flipside was that the costs of the debt crisis would still be being paid half a century on. Still, the Bundesbank was concerned that the deal violated Article 123 of the Maastricht Treaty, the famed prohibition on monetary financing. The ECB neither stopped, nor endorsed the deal, but released a neutral statement saying the Irish decision had been ‘noted’. The Bundesbank and other northern central banks vowed to check each year that the Irish deal was not a backdoor version of printing money.

There was one amusing, even bitter, irony at the end of all this. The shell of the totemic uncompleted headquarters of Anglo Irish on the Dublin dockside was eventually sold to a wealthy new tenant for a knockdown price. In the crazy years, it had been valued at €250 million. The new purchasers bought it off the National Asset Management Agency (NAMA) – Ireland’s ‘bad bank’ – for €7 million. From 2015 it will be the new headquarters of the Central Bank of Ireland, and, effectively, the embassy of the ECB in Dublin.

Back in the Eurotower, teams of economists run the slide rule over the economic metrics of existing and potential member states. Staff at the ECB – like northern donor-nation finance ministers and some officials in Brussels – describe the policies that programme nations are obliged to pursue as ‘homework’. (The word features in internal ECB presentations.) Latvia is held up as the poster boy of how ‘internal devaluation’ can work. In 2012, just three years after its austerity programme, the Latvian economy grew by 5 per cent. Latvia retained its peg to the euro, rather than devalue its currency. Yet it endured a brutal collapse, a 20 per cent shrinkage in the size of its economy. ‘Austerity’ does not really work as a description for a programme in which nearly a third of public-sector staff were fired, and the salaries of the lucky majority that kept their jobs were cut by 40 per cent. Taxes were hiked, and benefits slashed. One in ten Latvians have left the country since 2000, half of them after 2008. Yet in the Eurotower, Latvia is considered a grand success. The principal difference between it and, say, Greece, is that Latvia began the ‘adjustment’ with a debt that represented only 7 per cent of GDP, an extraordinarily low level. The programme left it with a merely normal debt level. The Latvian lessons may be rather limited. At the Eurotower, they at least now focus on the institutional structure of a nation. Latvia’s capacity for self-flagellation, and its acceptance of punishment from others, rather sets it apart.

As he started his new job in 2011, Mario Draghi was learning much larger lessons about the Eurozone. He set about managing the ECB’s unique political economy. He lavished praise on the Bundesbank, at the same time as cutting interest rates and pumping hundreds of billions of euros into the Eurozone banking system. The cut in Eurozone interest rates – at his second governing council meeting – was the first time that the ECB’s German chief economist, Jürgen Stark, had effectively been overruled. With inflation at 3 per cent, already well above the target level of 2 per cent, Stark had suggested waiting to see the impact of price pressures. For the German economic establishment, the euromark was turning into the eurolira. Every few days Draghi would offer a rhetorical sacrifice at the Teutonic monetary altar. Yet he was doing something rather less in keeping with German sensibilities. After that meeting in December 2011, I asked him why he did not simply do what was standard practice in London and Washington and ‘print money’ by buying government debt on a massive scale?