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       1 THE DOCTOR ON DUTY

      ALAN AHEARNE

      BY THE TIME BRIAN LENIHAN arrived at the Department of Finance in May 2008, the Irish banking system was doomed. Over the previous five years, the domestic Irish banks had ballooned their loan books to a staggering €400 billion from €150 billion in 2003. Most of this new credit was extended to the property sector, including a nine-fold increase in lending for speculative development and a doubling in mortgage lending. Lenihan remarked that unlike other capital cities around Europe, there were no foreign buyers of property in Dublin during the boom years – a tell-tale sign that real estate was overvalued.

      The banks funded this lethal expansion in credit by borrowing on international money markets. They attracted corporate deposits from all over the world and sold large amounts of bonds and commercial paper. They pumped this money into the Irish economy, thereby fuelling a surge in consumer and government spending. Ireland’s banking bosses gambled everything on the expectation of a soft landing in the property sector and continued benign conditions in international funding markets. Few people shouted stop. The domestic property crash and international financial crisis revealed in the starkest terms the recklessness of the banks’ business models and the failures of those tasked with regulating the banking system.

      Now the chickens were coming home to roost. Ireland’s banks were about to hit the wall. Lenihan would spend nearly the next three years performing radical surgery on the Irish banking system. The international experience with systemic banking crises provided some guidance, but the complexity of the emergency facing Lenihan was unparalleled. Ireland’s banks were unusually large, with loans standing at more than twice the country’s total annual income. They had grown exceptionally dependent on international funding markets, just as the global financial system plunged into the most severe crisis since the Great Depression. An additional dimension to Ireland’s crisis was the country’s membership of a poorly constructed – and at times dysfunctional – currency union. The external environment and the rules of the game were constantly changing. Decisive, courageous and difficult decisions would be required to stave off disaster.

      THE BANK GUARANTEE

      I first met Brian Lenihan at his office in the Department of Finance in August 2008. Property values were already falling, the construction sector had come to a ‘shuddering halt,’ and the banks were struggling to fund themselves on money markets. During a wide-ranging discussion, I found Lenihan remarkably frank. It was clear to me that he was working on a plan. Among other things, we discussed the pros and cons of using money from the National Pensions Reserve Fund to strengthen the banks’ balance sheets. We agreed it was crucial that Lenihan had an accurate picture of the financial condition of the banks. We spent some time discussing the prospects for Anglo Irish Bank and Irish Nationwide Building Society – the two financial institutions most exposed to the crumbling property sector.

      We met again in Galway some weeks later, on 15 September. I had been invited, along with economist Philip Lane from Trinity, to speak at the Fianna Fáil Parliamentary Party meeting about the Irish economy. That same day, the US investment bank Lehman Brothers filed for bankruptcy, sending violent shockwaves through the global financial system. On the fringes of the meeting, Lenihan and I chatted again about the state of the banks. Lenihan mused whether it would be possible ‘to knock over two dominoes without knocking the other four.’ I assumed at the time that he was contemplating the closure of Anglo and INBS, but was concerned about the knock-on effects on the other banks of such a move. He was exploring a wide range of alternatives, which I later learned was his modus operandi in making decisions. (He himself would have described it as his method of operating, as he disliked the unnecessary use of Latin in popular speech.)

      Two weeks later, with the banking system on the brink of running out of cash, the Government introduced a blanket guarantee of the debts of the six main domestically owned financial institutions. The guarantee was identical to a successful scheme introduced in Sweden in the early 1990s. The emergency measure was aimed squarely at helping the banks to retain and attract new funding. In signing the guarantee order, Lenihan said: ‘The guarantee has as its central objective the removal of any uncertainty on the part of counter parties and customers and gives absolute comfort to depositors and investors that they have the full protection of the State.’

      European finance ministers on 7 October announced a coordinated response to the financial crisis, though undoubtedly a clear message had been sent out from Brussels and Frankfurt to European capitals weeks earlier that there was to be no repeat of the Lehman’s debacle in Europe.

      Although in the public mind the guarantee is most closely associated with the two Brians, it is often forgotten that the scheme was overwhelmingly supported by the Oireachtas. The introduction of the guarantee was also widely welcomed in the media. Criticisms of the move at the time were few and far between.

      Judged against its immediate objective of keeping enough cash in the banks to forestall a widespread closure of the financial system, the guarantee worked a treat. With repayment of debt guaranteed by the (then) AAA-rated Irish State, the banks were able to raise €40 billion in new funding within six weeks. Lenihan described the bank rescue scheme as ‘the cheapest bailout in the world so far,’ a phrase that later was thrown back in his face many times as the cost to the State of shoring up the banks mounted.

      Lenihan did not believe that rescuing the banks would involve no outlays. He speculated some time later that the resolution of Anglo and INBS would cost the State about €5 billion, but that the State would, in time, profit by a similar amount from its investments in the other banks. He realised that the State would incur substantial up-front costs as a result of the intervention to save the banks, but he expected that most of this outlay would eventually be recouped.

      Many others shared this assessment. The Financial Regulator, Patrick Neary, in late 2008 described the banks as well capitalised, though he acknowledged that the banks might need more capital if the economy deteriorated further. Outside commentators were also relatively sanguine about the prospects for the banks. Not long before the introduction of the guarantee, the ratings agency Fitch affirmed Anglo’s long-term rating at A+ and maintained its outlook on that bank as stable. Later, in

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