Gormley On the Guarantee: The McWilliams Option

John Gormley on tonight’s Vincent Browne show:

Gormley: We had already discussed it for about a week on and off, we had discussed this. Some people, and I took the view too, that maybe nationalisation was the way forward. You have to remember the context.

Vincent Browne: You didn’t think that you as leader of the party that was in coalition government with Fianna Fail, you didn’t think that maybe you should get out of bed and go in to the Department of Finance where these discussions were going on.

Gormley: No because we had already discussed it Vincent. That’s the whole point

Vincent Browne: You went back to bed?

Gormley: Well, of course. I said “What is the option?” I remember speaking to Brian Lenihan and said “What option are we going for?” In fact, I can tell you what the exact words I used were “Are we going for the David McWilliams option?” That’s what I said on that particular evening. And he said yes. And as far as I was concerned that was the best option as I understood it at that time.

Vincent Browne: Because David McWilliams told you.

Gormley: Well, he is a person that I think a lot of people have respect for and we had discussed it. When I had mentioned nationalisation, he said “no, that’s not a good option at all.”

Vincent Browne: How come there was a bill presented to Brian Lenihan and Brian Cowen that night? There was a bill already drafted for the nationalisation of Anglo Irish Bank. How come that happened if nationalisation wasn’t on the table over the previous weeks or months?

Gormley: Well, that’s an interesting point because it’s the one that I have gone for myself, so I suppose the Department of Finance had just put that one in, just in case we didn’t decide for the guarantee.

The McWilliams Option might sound like a Robert Ludlum thriller. Unfortunately, this wasn’t fiction. This is a senior cabinet minister’s description of how the most important economic policy decision in the history of the state was made.

Cowen and Advice Relating to the Guarantee

As Fianna Fail deputies and the media debate the performance of Brian Cowen as Taoiseach over the next few days, the question of the September 2008 guarantee will come up time and again. The Taoiseach has defended himself strongly against accusations that any relationships he had with bankers led to his government’s decision to offer a near-blanket guarantee to the liabilities of the Irish banks. He has repeatedly argued that this decision was taken in the national interest.

This still leaves open the question of why it was considered in the national interest to offer such an extensive guarantee. On this subject, Mister Cowen has tended to answer that they took this decision based on the best advice available. The next few days would be a good time to provide evidence for this statement. As it stands, there is a lot of evidence that plenty of contrary advice was given. For example, as has been noted here on a number of occasions, the government’s expensively-hired outside advisers, Merrill Lynch, were not enthusiastic about such a guarantee.

In relation to the Department of Finance’s policy advice on this issue, a useful example of the Department’s stance is document 36 from the PAC collection. The document is a slide presentation from February 2008 titled “Overview of Financial Stability Resolution Issues”.  Page 11 states in bold:

As a matter of public policy to protect the interests of taxpayers any requirement to provide open-ended/legally binding State guarantees which would expose the Exchequer to the risk of very significant costs are not regarded as part of the toolkit for successful crisis management and resolution.

In bold and with “not” underlined. It certainly seems as though the Department officials were on the record as being against the form of guarantee provided. Evidence on who exactly proposed the form of guarantee that was provided would be welcome.

I also think it’s worth keeping in mind when government politicians condemn those who opposed the guarantee (i.e. the Labour Party) as having been irresponsible, as Peter Power did on the The Week in Politics last night, that this opposition was shared by the government’s own advisers.

Gormley Update: Guarantee Decision Not Taken Over Weekend

After claiming on RTE radio last weekend that the guarantee decision was taken “on the day before. It was a Sunday. We had a Cabinet meeting. We’d gone through it in quite a bit of detail” John Gormley is now stating that this was not, in fact, the case. Today’s Irish Times reports:

Mr Gormley said in a statement that a meeting of the Government was held on Sunday, September 28th, to discuss the budget for 2009.

“At the end of this meeting, the Minister for Finance briefed colleagues on problems experienced by Irish banks in context of international developments; that contingency arrangements were being prepared; that the situation was being closely monitored, and that the focus was on banking system stability.

“While no formal decision was taken, arising from the briefing there was a clear understanding some Government action would have to be taken if the situation deteriorated,” Mr Gormley said.

So, we’ve gone from “you couldn’t just make a decision on the spur of the moment. You’d have to discuss it for days in advance. Of course, not. No, you just can’t do it like that.”  to “some action had to be taken” with the specific action that was taken being done as follows:

The further deterioration in the situation on that Monday led on to the discussions and decision on the night of Monday and Tuesday, September 29th and September 30th, 2008.

i.e. they took the decision when Gormley was in bed.

Personally, I think Gormley would be better off sticking with “Wasn’t my idea, I was in bed” as a political strategy. More seriously, for the circumstances of such a momentous decision to be so murky more than two years afterwards is highly unsatisfactory.

Gormley on the September 2008 Guarantee Decision

One of the questions that has been raised time and again over the past few years is how exactly the government ended up taking the decision to provide an almost blanket guarantee to the banks. In an interview yesterday with Marian Finucane, Green Party leader, John Gormley, shed some new light on this decision. Here’s an excerpt (about twenty minutes in).

John Gormley: The arrangements had been made the previous Sunday, right, and we had gone into that in quite a bit of detail and said yes this was the expert advice, to go down the guarantee route.

Marian Finucane: When was that decision made?

John Gormley: That was on the day before. It was a Sunday. We had a Cabinet meeting. We’d gone through it in quite a bit of detail as I said.

Later there was this exchange:

Marian Finucane: Can I just ask you a question? I think the rest of us thought that the two Brians … that the decision was made that night.

John Gormley: Well, you couldn’t just make a decision on the spur of the moment. You’d have to discuss it for days in advance. Of course, not. No, you just can’t do it like that. Everybody had to be involved in what was the best thing to do in these circumstances.

Then when asked whether he understood at the time how momentous the guarantee decision was “nailing the sovereign to the banking difficulty” Gormley rolled out the following

You have to look at what Patrick Honohan has said. Again, as somehow who has been brought in, who has been quite an independent voice, the first outsider to be brought into that position. He did write a report. Again, it was a very thorough report. And he said very clearly in that report that while the bank guarantee may have been too broad, in that it included subordinated debt, that it was absolutely essential because of the systemic importance of some of these banks.

I’d make three points on this.

First, Minister Gormley tells us that the decision to give a blanket guarantee was made by the full Cabinet on the Sunday because this was the recommendation of expert advice. I think Minister Gormley should release this expert advice to the public and explain who it is that gave it. As of now, we know that the government’s very expensively recruited advisers Merrill Lynch (€7.33 million in fees) stated at a meeting on the previous Friday that they were against such a guarantee. Handwritten notes taken at a meeting involving the Minister for Finance and representatives from the Central Bank, Financial Regulator, Department of Finance contained the following:

On a blanket guarantee for all banks — ML felt could be a mistake and hit national rating and allow poorer banks to continue.

So what happened between the Friday and the Sunday?

Second, the continual rolling out of the talking point that “Honohan’s only objection was the inclusion of subdebt” does a disservice to all those who parrott it.

Here’s the most relevant section (8.39 in the report):

The scope of the Irish guarantee was exceptionally broad. Not only did it cover all deposits, including corporate and even interbank deposits, as well as certain asset backed bonds (covered bonds) and senior debt it also included, as noted already, certain subordinated debt. The inclusion of existing long-term bonds and some subordinated debt (which, as part of the capital structure of a bank is intended to act as a buffer against losses) was not necessary in order to protect the immediate liquidity position. These investments were in effect locked-in. Their inclusion complicated eventual loss allocation and resolution options. Arguments voiced in favour of this decision, namely, that many holders of these instruments were also holders of Irish bonds and that a guarantee in respect of them would help banks raise new bonds are open to question: after all, extending a Government guarantee to non-Government bonds has the effect of stressing the sovereign to the disadvantage of existing holders of Government bonds; besides, new bonds could have been guaranteed separately. The argument for simplicity also is weakened significantly by the fact that an actual dividing line between covered and non-covered liabilities was drawn at as least an equally arbitrary point; moreover, such instruments were held only by sophisticated investors.

The key point made here by Honohan is not, as Gormley and many other government politicians insist, that subordinated bonds were included (this decision is singled out in the short paragraph 8.40 that followed and later in 8.50 as “not easy to defend”). Rather the point was that the guarantee applied to existing bonds rather than new debt issues. 

Most likely, Gormley (and the others who make this point) haven’t read the report or have read it and don’t understand it. They are, most probably, simply repeating a talking point supplied to them by their spinners. And I suspect the Governor isn’t willing to request government politicians to cease-and-desist from misrepresenting his report, particularly given that his critical opinions on blanket guarantees were well flagged elsewhere. However, it would be nice to see interviewers refusing to accept this nonsense anymore.

Finally, I’d note that it appears that Gormley is more worried about the image of him not being consulted about the guarantee than he is with being considered responsible for it. This seems like poor politics. He’d be better off to have placards in Dublin South-East saying “Guarantee: Not My Idea” than “Guarantee: I Wasn’t In Bed”. But he’s entitled to make his own decisions on which message to get across. And, as he noted in his interview, politicians are ultimately made accountable at the ballot box. The public can soon show what they thought of Mister Gormley’s period in government.

Honohan-Supported-Guarantee Talking Point Still Going Strong

Stephen Collins writes in today’s Irish Times that “Fine Gael also had the courage to support the bank guarantee which, despite the Anglo shambles, was in principle the right thing to do as the governor of the Central Bank, Patrick Honohan, has repeatedly said.”

The guarantee was perhaps the most momentous policy decision in the history of the state. Unfortunately, the standard of commentary on this decision from prominent media columnists has, in general, been pretty lamentable. Here, Mr. Collins repeats a talking point that has been rolled out repeatedly by government TDs. Well, repetition of a talking point doesn’t make it true.

As I’ve noted here and elsewhere, there is a world of difference between Honohan’s support for a guarantee and the idea that he supported the guarantee that was actually put in place.

And again contrary to a widely repeated talking point, Honohan’s primary objection to the form of the guarantee was not the inclusion of subordinated debt but rather the inclusion of almost all existing long-term bonds. He argued that this inclusion “complicated eventual loss allocation and resolution options” and that it “pre-judged that all losses in any bank becoming insolvent during the guarantee period – beyond those absorbed by some of the providers of capital – would fall on the State.” In other words, it worsened the cost of what Collins calls “the Anglo shambles.”

These comments were consistent with Honohan’s previously-expressed opinions on this issue, as shown for example in this article published in the Economic and Social Review in 2009, published a few months before he was appointed Governor.

No public indication has been given that the authorities gave serious consideration to less systemically scene-shifting – and less costly – solutions. For example, they might have provided specific state guarantees for new borrowings or injections of preference or ordinary shares – approaches that were widely adopted across Europe and the US in the following weeks.

Footnote 15, placed after the word “costly” in the above paragraph, reads as follows:

Blanket guarantees are among the “accommodating” approaches to crisis policy shown by Honohan and Klingebiel (2003) to have added considerably to the fiscal costs of banking crises around the world.

The working paper version of this 2003 publication is available here.

We also know now from the documents released by the PAC, that the form of the guarantee that was given was not recommended by the government’s own advisors Merrill Lynch, nor is there evidence that senior civil servants were recommending this approach either. So, at this point, the last refuge for those who want to argue that the government’s approach on September 30 was the right decision is this misleading Honohan-supports-it talking point.

For what it’s worth, also, I think one could argue just as strongly that it was Labour who showed more courage in objecting to the guarantee: Indeed, to this day, Labour are still getting flak from government politicians and commentators like Collins for failing to fall in line with the consensus to support the guarantee. Moreover, my understanding of Fine Gael’s position at this point is that they consider themselves to have been essentially misled by the government into supporting the guarantee.

David Murphy: Hindsight Says Guarantee the Right Option

On the day that we found out that, contrary to the mantra of “everything was done on the basis of the best possible advice” the Irish government failed to follow the expert advice it received from Merrill Lynch when it decided to introduce a blanket guarantee, the state broadcaster brought on David Murphy to explain the implications. Viewers of the Six-One news were treated to the following exchange:

Sharon ni Bheolain: So with the benefit of hindsight and knowing now what we do know particularly about the value of those assets underpinning the loans, can we say that the blanket guarantee was the wrong way to go or is that an oversimplification?

David Murphy: I think in hindsight the guarantee probably was the right way to go and that’s exactly the conclusion that Patrick Honohan came to in his recent reports on the banks. The question though is “did they guaranteed too much?” and they did include subordinated debt in the guarantee. That was something that Merrill Lynch warned against. Merrill Lynch did make a number of warnings about introducing the guarantee. It said that Europe won’t be happy and that was right. It said that there will be a negative knock-on consequence for borrowing money in financial markets and that was right too. But it looks as if the government probably did choose the right option finally.

David reckons Patrick Honohan says that with hindsight the guarantee issued was the right way go. Let me turn the microphone over to Governor Honohan:

the extent of the cover provided (including to outstanding long-term bonds) can – even without the benefit of hindsight – be criticised inasmuch as it complicated and narrowed the eventual resolution options for the failing institutions and increased the State‘s potential share of the losses.

As I have discussed here before, Honohan’s arguments in favour of some sort of guarantee do not in any way mean his report backed the full blanket guarantee that was introduced. Rather than backing the guarantee with the benefit of hindsight, he opposes it even without this benefit!

So the only argument David Murphy can produce to defend the blanket guarantee is the claim that someone who opposed it (albeit in diplomatic language) was exactly in favour of it. Perhaps David had another argument and I have missed it.

More seriously, I heard An Taoiseach on the radio today defending the decision to introduce the blanket guarantee on the grounds that this was required to keep access to funding open for the Irish banks. Again, I’d defer to Governor Honohan, who argued in his report that the inclusion in the guarantee of existing long-term bonds “was not necessary in order to protect the immediate liquidity position. These investments were in effect locked-in.”

So, let’s recap. The government did not, in fact, follow the best possible advice that it paid for when introducing a blanket guarantee. Governor Honohan is not an advocate of blanket guarantees. And blanket guarantees are not necessary to deal with short-term liquidity problems.

Still, at least the government has David Murphy’s support.

Documents Relating to Bank Guarantee

The Oireachtas Public Accounts Committee has placed a number of documents online that were given to it by the Department of Finance in relation to the government’s deliberations prior to its decision to issue a guarantee on the liabilities of the Irish banks in September 2008. The documents can be found here. Section A has the most relevant but there’s also some interesting stuff in Section B, which has material from a joint Finance\Central Bank Standing Group on Financial Stability.

Update: There’s a lot of material in the documents and I haven’t looked at it all. However, thus far, my impression is that while the documents are useful in shedding light on the extent of the government’s lack of understanding of the scale of the solvency problem in the banks, they are not very useful in explaining why the government decided to issue such a blanket guarantee.

Take a look at document 5 from part A. This contains notes from a meeting on Friday September 26 involving the Minister for Finance and representatives from the Central Bank, Financial Regulator, Department of Finance and the government’s advisers, Merrill Lynch. The notes state: “On a blanket guarantee for all banks — ML felt could be a mistake and hit national rating and allow poorer banks to continue.”

Moving on a couple of days to document 3 from part A, a blanket guarantee is one of the options presented to the government by Merrill Lynch on Sunday, September 28. However, the note questions the credibility of this approach, again mentions the implications for sovereign debt ratings and also points to a negative reaction for other European countries. The document is a bit inconclusive but the blanket guarantee still does not appear to be the preferred option of the govenment’s advisers.

Then on September 29, the government decided to introduce an almost-blanket guarantee. These documents do not make it clear why this decision was taken.