Ireland’s rugby team has a fighting chance against New Zealand’s mighty All Blacks in this afternoon’s test match in Dublin. But the republic’s battered government and bust banks never had a prayer once eurozone partners decided that its insolvency, real or perceived, was jeopardising other members of the euro and therefore the future of the single currency itself.
Brian Lenihan, finance minister, has this week repeated almost hourly that the exchequer was fully funded into the middle of next year. All for naught. Mr Lenihan and the Fianna Fáil-led coalition government of Brian Cowen, prime minister, on Friday looked set to capitulate, bullied into a bail-out. As Brian Lucey, a Trinity College economist, put it in a much circulated blog: “This is geopolitical hardball: Brian Lenihan from Castleknock versus the heirs of Bismarck and Cardinal Richelieu.”
In September, Mr Lenihan had sought to draw a line under the banking crisis – the overhang of toxic debt accumulated after a decade in which Irish banks borrowed gaily in the international wholesale markets to finance a property development bubble that at its peak amounted to more than one-fifth of the country’s economic output. Already the government had committed €50bn of taxpayers’ money – almost one-third of gross domestic product – to fill the hole.
Although the heart of the problem was not government finances but the untenable condition of the banks, most of them had come under at least partial state control. Back in 2008, the government gave a blanket guarantee on all their deposits and most of their debts – thereby turning the state and the banks into one entity from the viewpoint of financial markets.
Just how serious a liability this had become was revealed on Monday, when officials disclosed that the Irish central bank had extended €20bn ($27bn) of exceptional liquidity to the banks in September and October – over and above the €130bn they had been lent by the European Central Bank, which itself was one-quarter of all ECB lending to eurozone banks.
Bond markets sensed this extra aid meant one or two Irish banks might be close to using up all the assets they could put up to tap ECB liquidity. When Bank of Ireland, the most robust of those left standing, was last week revealed to have haemorrhaged €10bn in corporate deposits in September, that sense hardened into certainty. As Ireland’s cost of borrowing spiked by a further two percentage points in comparison with that of Germany, it began to look as though the game was up. In late September, officials at the National Treasury Management Agency were basing their cash-flow calculations on future borrowing rates of 5.5-5.75 per cent – not way over 8 per cent. Asked then what would happen if they were out by, say, two percentage points, one said: “Then we’re fucked, so we are.”
While the responsibility for reducing Ireland to this state of prostration undoubtedly lies with the covens of politicians, bankers and builders who alchemically prolonged the Celtic Tiger boom of the 1990s well beyond the millennium, the heirs of Bismarck and Richelieu had a hand in tipping things over.
That part of the story begins in Deauville in mid-October. At the resort town on the Normandy coast Angela Merkel, German chancellor, did a deal with President Nicolas Sarkozy of France that took European Union finance ministers and the financial markets equally by surprise.
In essence, the chancellor gave up German insistence on sanctions against profligate eurozone members in exchange for Mr Sarkozy’s assent to a “crisis resolution mechanism” that would share the cost between private creditors and taxpayers of cleaning up after any future implosion such as Greece had undergone.
On the day of that thunderbolt, Herman Van Rompuy, the EU’s permanent president, was locked in negotiations with finance ministers from all 27 member states in Luxembourg to put the final touches on a hard-fought package of economic and budget reforms. The Franco-German side-deal left egos bruised and anger at Ms Merkel began to rise, particularly among a group of northern, fiscally prudent countries that had been backing Berlin on tough penalties.
Berlin said it was following a “script” drawn up after the Greek crisis in order to ensure future bail-outs would not fall disproportionately on German taxpayers. Wolfgang Schäuble, finance minister, in a tartly worded letter to his counterparts obtained by the FT, acknowledged “a lot of critical public reactions” to the Deauville deal. But the letter, dated October 26 – just days before an EU summit in Brussels to debate the budget sanction proposals – accused other countries of being unrealistic.
“Many other governments like to hide themselves behind the French government and now behind the Federal government of Germany,” Mr Schäuble wrote. “Wishful thinking is not sufficient for pragmatic and realistic decisionmaking.” The stage was set for a very tense summit.
As far as Germany was concerned, the prize of getting France to agree to treaty change to establish a mechanism for crisis resolution was well worth the compromise. In exchange, Ms Merkel agreed that finance ministers – not bureaucrats – would have the last say on imposing sanctions on member states that broke budget rules. German officials admitted that the chancellor could not persuade Mr Sarkozy to accept automatic sanctions. That would mean too big a shift of power from the European Council – representing member states – to the European Commission, the executive.
As a former German diplomat said later, persuading the French to give up political control “would have been like castrating Colbert [France’s controller general of finance in the 17th century] 300 years late”. When it was suggested to a German official that Jean-Claude Trichet, ECB president, would be angry about this compromise, he retorted: “This is not a university class. You have to have a political agreement.”
At the Brussels summit dinner of October 28, Mr Trichet warned Ms Merkel bluntly that her insistence on more pain for private investors in future eurozone bail-outs would simply send up short-term borrowing costs, deepening the crisis. That is exactly what happened.
The ECB knew more than any other institution just how dire it had become for Irish banks. It had lent them €40bn in the latest three months alone. Such dependency was clearly not sustainable, the ECB believed. Temporary liquidity was beginning to look like long-term funding at heavily subsidised rates. The Frankfurt-based 16-country central bank was also worried that its support had reduced the incentives for politicians to take corrective action. Dublin was assuming unlimited ECB liquidity could continue indefinitely. The ECB could find its monetary policy being determined by Ireland rather than, as expected next month, taking the next steps to unwind the exceptional measures it had put in place after the collapse of Lehman Brothers in September 2008.
But Mr Trichet was also increasingly concerned that the Germans’ push to lean on private investors in a new bail-out system was going to scare the bond market. The day before the summit he called José Manuel Barroso, Commission president, to argue his case. Mr Barroso agreed: this really was not the time to start a debate on the shape of a future bailout – and particularly on the extent to which bondholders would have to share the burden with taxpayers.
As leaders gathered, there seemed to be growing resistance to Ms Merkel’s plans – especially among German allies seething at how she had behaved in Deauville. Fredrik Reinfeldt, the prime minister of Sweden, put it bluntly: “To solve Germany’s problem, we shouldn’t create problems for everyone else.”
But once the summit began, opposition began to fold. No president or prime minister spoke up against Ms Merkel, who was pushing the bail-out measures with her characteristic grasp of policy minutiae, according to people who were in the room. It was left to Mr Trichet to defend his position, with only Mr Barroso on his side. “I have the impression that people don’t really realise what the reality of the situation is,” Mr Trichet is understood to have said.
Mr Sarkozy could stand no more. He cut off his fellow Frenchman and issued a stinging rebuke: heads of state were accountable to their people; central bank presidents only to a board of governors. With Mr Sarkozy’s backing, Ms Merkel won the day. Treaty change would come. But when the markets opened the following week, it was Mr Trichet who was proved right.
By the time European leaders arrived for the Group of 20 summit of November 11-12, the bond market was falling through the floor and talk was rising of another Greece. Mr Barroso buttonholed EU leaders including Ms Merkel on the need to reassure the markets. “Either the markets do not understand what we mean, or there were other factors,” says one German official. The mechanism that Berlin wants “only affects new emissions of sovereign bonds, and therefore has no direct influence on the bonds traded today. Logically, there should not be any effect on the bond markets.”
But Berlin began to recognise that the hardline stance was sowing confusion and fear. It began to backpedal. Before markets opened on Friday last week, the finance ministers of Germany, France, Britain, Italy and Spain had issued a statement assuring all current debt holders that they would not be on the hook to pay for any new bail-out. Irish bonds staged their biggest single-day rally since the Greek rescue six months earlier.
Just days before the G20, Olli Rehn, the EU’s economic and monetary affairs commissioner, had been in Dublin, where he and Mr Lenihan had huddled over how the country’s four-year budget programme – due to be unveiled next week – could claim that it would bring down the budget deficit to affordable levels by 2014.
Now back in Brussels after Seoul, Mr Rehn headed to the Commission’s headquarters on Sunday and was joined by Mr Barroso. For hours, the two men and their staffs weighed EU strategy and options. By the time the meeting broke up that night, they appeared to be in agreement with the International Monetary Fund and the ECB on how to proceed.
Last weekend it emerged that the ECB had launched a fierce behind-the-scenes lobbying campaign to persuade Dublin it had to do something to shore up confidence in its banks – and fast. Public confirmation of the ECB’s concern came early on Monday. Vítor Constâncio, its vice-president, surprised journalists in Vienna with an impromptu briefing, unusual for the usually communication-shy central bank. The European Financial Stability Facility – the €440bn war-chest set up after the Greek crisis to deal with future euro-emergencies – could be used by Ireland to prop up its banks, Mr Constâncio suggested. Asked whether the ECB would back an application by Dublin to draw on the facility, he replied: “Yes, of course.”
When eurozone finance ministers met in Brussels on Tuesday amid febrile expectation, it was quickly decided that a team of IMF, Commission and ECB officials would be sent to Dublin to dig into Ireland’s books, measure the black hole in the banks and prepare for a bail-out. Mr Lenihan accepted the consensus. The deal had largely been pre-cooked, with little drama. As Finland’s Jyrki Katainen put it: “Pragmatic is not that sexy, but it was pragmatic.”
Ireland appeared to be heading for the quasi-protectorate status of Greece, under the tutelage of the IMF-ECB-Commission troika.
As Mr Sarkozy haughtily remarked in dismissing Mr Trichet’s concerns, and Mr Cowen can attest, heads of government are accountable to their people. The Taioseach was in defiant mood when he addressed parliament on Tuesday. “The measures we have taken are working,” he declared. But Mr Cowen had to acknowledge that it no longer made sense to camouflage the connection between the banks’ sickness and the economy as a whole. “Costs of borrowing are very high and are at a level that would make it difficult for banks here to operate as engines of recovery.”
The turning point was reached on Wednesday, when the Irish government announced that an IMF-European team would arrive in Dublin the next day. In a fevered political atmosphere, Mr Cowen and his colleagues found themselves accused of jeopardising Ireland’s sovereignty– a deadly charge, given the self-image of Fianna Fáil as the embodiment of Irish independence.
A stinging editorial in the Irish Times on Thursday captured the mood, referring to the Easter Rising against British rule and asking whether this “was what the men of 1916 died for: a bail-out from the German chancellor with a few shillings of sympathy from the British chancellor on the side”.
Confirmation that Ireland would indeed seek assistance finally arrived on Thursday when Patrick Honohan, the central bank governor, told Irish radio it was likely that a package involving “tens of billions” of euros would be arranged. Whether, as he suggested, this is “contingent capital funding that can be shown but not used” may now be up to the troika.
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