BACKGROUND:Advisers warned that a blanket guarantee could involve over €500bn and raise credibility issues, writes SIMON CARSWELL, Finance Correspondent

THE 54 records released by the Department of Finance on the events leading up to the Government guarantee on September 30th, 2008, reveal the frantic backroom manoeuvres to deal with the issue of cash flooding out of the banks.

Reading the documents, you can feel a little sympathy for the Government in trying to deal with a fast-deteriorating crisis situation.

Matters were both helped and complicated by the intervention of investment bank Merrill Lynch, which was hired as advisers on September 24th, just five days before the Government plumped for the blanket bank guarantee.

Merrill Lynch drafted a series of crisis management options from which the Government could pick and choose, outlining the pros and cons of each.

Ultimately, decisions rested with the Taoiseach and the Minister for Finance – the ones with their fingers over the button.

The only option Merrill did not back was the failure of any bank.

What’s clear is that no one believed they were dealing with a solvency crisis at this stage; the problem was a liquidity issue – the banks were running out of cash to fund their day-to-day operations.

“Liquidity issues aside, all of the Irish banks are profitable and well capitalised,” Merrill said in a memo dated September 28th.

The bank even said the commercial loan book at Irish Nationwide was “regarded as being generally good”. (The same institution has since written off almost a third of its €10 billion loan book.)

Ten days previously, in a presentation to the department, Anglo said it needed no external capital, and was projecting profits of more than €1 billion for 2009.

But Merrill conceded that Irish Nationwide, Anglo and Irish Life & Permanent were haemorrhaging cash. On September 28th, the advisers said Anglo would run out of money in two days and that the bank was heading for a deficit of €4.9 billion by October 24th.

The bank had exhausted its collateral to secure outside funding.

Curiously, in one memo, Merrill noted the major shareholding held by Seán Quinn in Anglo, the bank’s biggest investor. No other shareholders are mentioned in relation to the other banks.

On Friday, September 26th, Merrill executives said in a presentation that a blanket guarantee of the banking system was the “best, most decisive, most impactful” option from a market perspective.

However, the advisers warned that a blanket guarantee “may not add up”, and could damage the credibility of weak institutions.

They felt that it could be a mistake and would “hit national rating and allow poorer banks to continue”.

Such a guarantee could involve more than €500 billion, and raise issues about its credibility. “The wider market will be aware that Ireland could not afford to cover the full amount if required,” the advisers said.

As an alternative, Merrill recommended a secured lending scheme (SLS), where the six domestic lenders could use commercial loans as collateral to borrow loans from a special €20 billion pool to fund themselves.

“The SLS scheme is recommended because it would offer immediate liquidity and stabilise the sector,” said Merrill in a note on September 28th. “The option to subsequently own or separate assets out of the banks into State ownership or to stronger banks will be preserved, and can be done with full market support.”

Merrill said the SLS didn’t solve the problem banks – Anglo and Irish Nationwide – which were heavily concentrated in property.

Summarising all the options, the advisers said: “There is no right or wrong answer and the situation is very fluid, with financial institutions experiencing difficulty and being supported by governments on a daily basis.”

Significant events on Monday, September 29th, ultimately played a key role in determining the Government’s final approach.

The rescues of British lender Bradford Bingley, German commercial property bank Hypo Real Estate and Benelux group Fortis that day showed that bank-specific measures internationally were proving insufficient. This led the Government to adopt a catch-all, no-bank-left-behind approach early on the night of September 29th-30th.

The fear was that if a solution was chosen to save the weakest bank, the market would simply turn on the next weakest.

The records are important in helping to understand the options the Government faced, but the final decision rested with the Taoiseach and Minister for Finance Brian Lenihan.

The difficulty is that there are no memos on their mindsets at what was a time of extreme crisis.