The genesis of the banking guarantee

The Indo are carrying an excerpt from David McWilliams new book (Follow the Money) that details a late night encounter with Brian Lenihan that lead to the Irish Banking Guarantee.

If something radical was not done and done quickly, it was crystal clear to me that the Irish banks would experience a traditional run, with depositors taking out their savings, and the banks would go bust. That one thing, at least, was certain.

The minister walked straight through the hall and headed directly into the kitchen as if he knew where he was going. Jaded, he sat down and turned off his phone.

Read the whole article..

  • Dave

    Very interesting article – and one that would scare the hell out of me if I hadn’t already come to the conclusion that my spare capital (modest as it is) would not be better protected by transferring it out of the Irish banking system. It’s clear that Lenihan didn’t have a clue what he was doing by making Irish taxpayers liable for the debts of private businesses, and neither did his unpaid adviser McWilliams.

    McWilliams seems to have assumed that the state could ‘rescue’ massively insolvent banks within the timescale of state guarantee, and assumed this could be organised by someone who McWilliams knew was out of his depth and drowning. What magic formula did McWilliams base this believe on? There was none that would restore value to devalued assets. McWilliams, despite his dire warnings, must simply have assumed that the banks were basically solvent and capable of successful restructuring. He was just as bewildered as the man he was advising.

    Incidentally, McWilliams seems too shy to point out that ‘ordinary’ depositors were already protected by state up to a limit of 100,000. Making the guarantee unlimited was not designed to protect the ordinary depositors (since ordinary depositors do not have funds anywhere near that amount), but was designed to reassure the large depositors (i.e. foreign fund managers who have multi-million deposits). In reality, making the guarantee unlimited screwed the ordinary depositors out of whatever limited funds the state would have available. Also, any ‘run’ on the banks would have been an abortion since the banks did not have the funds available.

    Really, I hope the next generation tells this generation to go fuck itself when they line up for state pensions. They should simply point out that this generation has dumped all its bad debts on the future generation, and that they paid their debts but no way are they going to pay their pensions and other freebies that they expect them to.

  • Issac Ball

    I have read David McWilliams’ writing for years. Some good stuff and with commonsense. But in reality nobody in government in the south have listened to anything he has said.Even when blatantly obvious that what they plan to do will end up creating further chaos.We are governed by political parties with selfish strategic interests at heart. Not the wellbeing of all the people. Survival of the party vote is all that matters, this was evident in the last election on Lisbon. The English have portrayed us Irish as thick for centuries. Now when you give them a chance to get rid of a corrupt and inept government,what happens ? They vote like lemmons.
    They swallowed up whole the fear mania generated that not to vote yes would have us lose out further billions of subsidies from Europe and voted to maintain the status quo. Now I have to agree with the jibe that they are thick.
    I suppose it’s like what Sinn Fein used to say years ago that they too would smash the status quo and we were just as thick believing that mantra. Funny old world ?

  • Scaramoosh

    Is there anybody out there who does not have an axe to grind?

    “MINISTER for Finance Brian Lenihan, reeling at reports that he had said officials in his Department did not grasp the scale of the financial crisis, yesterday hit back at the author of the assertion — celebrity economist David McWilliams — by claiming that McWilliams had sought but did not get a job as his “special adviser”.

  • Greenflag

    Thanks Mack for that very seasonal scary story . One wonders if Minister Lenihan was hoping somehow that chewing sufficient garlic would keep the vampires of Wall St at bay . Too many Dracula films as a teenager perhaps 😉

    But the story oddly enough shows Lenihan up in a slightly positive light . He ,admittedly after the event, did try to find out what was actually going on . The image of McWilliams being horrified at the Minister’s introductory reading of Greenspan’s ‘tales of the economic’ is one for some future edition of Langerland 😉

    Mr Lenihan was not the only politician who had’nt a clue . Mr Cowen had been the Finance Minister for the previous two terms so he should have been wised up but as we can see from McWilliam’s tale of garlic above, Cowan no doubt also allowed himself to be mesmerised by the mandarins and the ‘banking ‘ experts . Not much has changed in the world of politics in Ireland or the UK since the late Richard Crossman’s (British Government Minister -Labour ) diaries revealed all . Popularised later in the or hilarious TV series Yes Minister .

    There was not a Senator in the USA nor a Representative in the US Congress nor a Minister in Gordon Brown’s Cabinet nor a Shadow Minister in the Conservatie opposition who was any wiser than Lenihan and yes even those who had ‘economic degrees’ . Even Presidential candidate Senator McCain admitted a month or two before the election that ‘economics ‘ was not his strong point . The American people obviously agreed with him and voted in Mr Obama .

    Anyone who wants to see exactly how the USA Congress was ‘scared’ into the 700 billion dollar rescue plan should try to see Michael Moore’s
    ‘Capitalism a Love Story’ . Americans may not recall electing Goldman Sachs as their President back in 2000 but they might as well have .

    There is notmuch point in berating the politicians for their follies. We need to understand why this ‘crisis ‘ happened and what action could have been taken to avoid it . The answers are still emerging but it’s at least clear that it was 20 or more years in the making . The political groundwork and the ideology that could enable such a disaster to happen was laid down in the Reagan era, but it took the Clinton signing of the Glass Stiegel Act in 1998 to truly take the muzzles off the Wall St rottweilers, which enabled both them and the shadow banking fraternity to run riot and gamble with the world’s economy like an addictive gambler who has moved to Las Vegas for rehabilitation 🙁

  • Nic

    I think some of us are missing the point – McWilliams advocation of the extended guarantee was to shore up confidence for a limited period and prevent a run on the main banks. Such a run would have vaporized ordinary punters savings and the government would have had to find the money to compensate them. Step 2 should have been to wind down the delinquent banks with the government calling the shots. That, of course, is not what we got.

  • Greenflag

    Nic ,

    ‘and the government would have had to find the money to compensate them.’

    Where ? It’s not prudent economic policy to vaporize people’s savings or to emisserate large sections of the middle and working classes .

    In such circumstances the French have been known to seek the asssistance of Madame Guillotine while the Germans thought a funny little man given to hand waving histrionics with a penchant for art and racist ideology had the simple answer . Yes he had the simple answer and it took 55 million lives to prove that not only was it simple but certifiably insane 🙁

    It’s very easy to start a war much more difficult to stop one . In the financial wars it’s not different . Sheer terror pushed those at the top of the economic pyre to do what they did . The spectacle of tens of millions of newly impoverished and unemployed millions was enough to do the trick . Not that the high priests of neo conservatism ever gave a damn for such people – they were far more preoccupied with saving their own skins !

    As I write I read some 100 US banks have closed their doors in the past year . And the operation to close them down and transfer /sell off their assets and debts has been very low profile . Meanwhile at the top of the banking pyramid -Goldman Sachs and Bank of America among others continue their ‘devouring ‘ ways ;(

    The sharks of the ocean at least killed their prey immediately. The ‘land ‘sharks of Wall St and elsewhere like to keep their ‘prey’ solvent enough to be able to continue to feed off them !

  • Dave

    Nic, the uncomfortable reality is that your savings are “vaporized” the moment you deposit them in a bank. You do not, contrary to common misapprehension, give your savings to a bank for ‘safekeeping’ – you surrender legal title to your money to the bank and you become a creditor. That is a bank’s double entry bookkeeping system wherein your money becomes an asset of the bank. In effect, you enter into a commercial contract with them to invest your money, and in return they undertake to pay you a commercial return for your investment in the form of an interest payment. These banks are businesses that convert your cash into assets, usually retaining circa 5% of their net worth in the form of cash. So, the ‘run’ on cash will always stop when retained cash is exhausted, with the other 95% of depositors having to wait until the assets are liquidised. The problem with the Irish banks is that those assets are worth considerably less than what they paid for them, so their liabilities considerably exceed their assets. What did McWilliams propose to do about that? Nothing. But once the state guaranteed the banks, then the banks’ problems became the state’s problems and the state would then have devise a means avoid a realistic valuation of assets during the period of the guarantee. Hence it came up with NAMA, which is essentially a means to avoid selling assets that are worth less than the price paid for them, and thereby avoid realising the considerable loss. It is hoped that these assets will regain their value (i.e. that everything will sort itself out with another boom-and-bust cycle followed by another NAMA, ect). The banks always knew that the ‘moral hazard’ would ensure that the state would bail them out so they could be as reckless as EU regulations allowed them to be and as ECB expansionist monetary policies encouraged them to be. Once the banks got the state on the hook, it could then play the state for a sucker and slowly reveal the extent of the problem. McWilliams merely encouraged the minister to play into the bank’s hands, and the result of that is private business dumping its losses on the state. The true scale of the horror story has yet to emerge, but you’ll see it once interest rates rise in the eurozone (which they will do as other countries move out of recession) and folks who are losing their jobs at record rates realise that they have no hope for ever repaying a half million mortgage on a shoebox apartment that is now worth a quarter of what they paid for it. These banks are going to lose billions a year, and the taxpayer is going to pay for it. That’ll be interesting because business is being starved of cash by these banks, so these businesses are not going to be in a position to generate the wealth that the state needs to meet its debts. The state should not have interfered at all. It should have let failed banking business collapse, and it should have let successful banking business step in to fill the gap. I have no problem with the state guaranteeing your granny’s lifesavings up to a reasonable amount (as was always the case), but it was insanity to guarantee foreign depositors to the tune of an unlimited amount when these investors can (and do) take out insurance to cover such contingencies.

  • Greenflag

    Dave ,

    A nice simple intro there to banking 101. Not the whole story of course but hey when you are pursuing a neo con agenda that’s par for the course .

    ‘The state should not have interfered at all and it should have let successful banking business step in to fill the gap. ‘

    And which banks would they have been ? Bank of America ? Goldman Sachs ? Citgroup ? JP Morgan ? flush with American taxpayer’s bail out dosh ? . And now they are presently squeezing every penny of capital they can out of the US economy by NOT lending to small business and by paying out 1.5% on deposits while raking in three and four times as much at the other end while replenishing their self created capital ‘losses ‘ ?

    You have ignored as always the role of the entire shadow banking fraternity which was the prime mover of this economic mess and the daft neo conservative dogma of tearing up financial regulations while failing to implement even those regulations which were still extant .

    The supply of financial shite from Wall St is not yet finished . CIT group have bailed out with 2.3 billion of taxpayers money and retail business in the USA comin into the holiday season is set to experience an even further tightening of credit . Meanwhile BOA , Goldman et al continue to cream it .

    Authoritarian capitalism a.k.a rule by the Banks /Wall St now passes for what used to be a democracy .