The exchange of letters between the then president of the European Central Bank Jean-Claude Trichet and the late Brian Lenihan reveals the then finance minister came under extraordinary pressure to submit to the will of the European Central Bank (ECB) in the run-up to Ireland's bailout in the final weeks of 2010.
This was the culmination of a toxic confluence of events which led inexorably to a crippling loss of investor confidence in Ireland's ever-growing debt and, ultimately, to a humiliating international rescue by Europe and the IMF.
With that came the surrender of Irish economic sovereignty and the collapse of the Fianna Fáil-Green Party government.
By any standard, these were historic events.
So what exactly happened? And what do the letters tell us?
Two years previously, in the aftermath of the Lehman Brothers bankruptcy, the government administration had guaranteed the liabilities of the Irish banks. That fateful undertaking left the State in a perilous position as recession deepened, magnifying banking losses and driving the public finances further and further into disarray.
The banks became ever more reliant on emergency ECB support, intensifying concern in Europe and beyond that Ireland would not be able to survive the storm without external aid.
This is the essential backdrop to the exchange of correspondence between Lenihan and Trichet, the assertive Frenchman who had led the ECB since 2003.
Europe had spent the first half of 2010 in a funk over the collapse of the public finances in Greece, whose EU/IMF bailout followed months of discord and controversy. As summer turned to autumn, Ireland came to feel the heat of contagion in a big way.
Faced with ever-increasing pressure in September 2010, the government had already withdrawn from private debt markets. The objective was to cultivate investor confidence in time for a return to the markets in early 2011.
Irreversible pressure
However, it did not work out that way. As the rescue bill for Anglo Irish Bank and other Irish lenders expanded beyond all expectation, investors took fright. The ECB started buying up Irish sovereign bonds in September, support which could be withdrawn at any time because it called into question the ban on the central bank printing money for member states.
By the first week of October, the interest rate on Irish 10-year debt was already 6.5 per cent, a level that would be impossible to sustain.
Irreversible pressure was building, greatly increasing the strain on taoiseach Brian Cowen and all who served in his administration.
In the days before the first Trichet letter, on October 15th, Lenihan had a meeting with IMF officials at the fund's headquarters in Washington. Moreover, European Commission officials were also in Merrion Street examining plans for a four-year fiscal retrenchment, which would see the introduction of €6 billion in cuts and tax increases in the 2011 budget.
In this letter, Trichet addressed Lenihan both as "Minister for Finance" and "Tánaiste", the latter in error as the post was then held by Mary Coughlan. With emergency ECB bank funding for Ireland rising rapidly, the two men had already spoken by phone. Trichet welcomed Dublin's moves to develop a stringent financial plan to fix the public finances over the course of the following four years.
Yet he was also highly concerned about the “extraordinarily” large provision of ECB funding for Ireland’s banks in previous weeks. This brought the bank close to infringing its own rules against the printing of money for member states, a practice known as “monetary financing” in the parlance of economics.
Trichet’s anxieties
Hence a warning from Trichet that such support could not be relied on in perpetuity and his demand that a four-year fiscal plan should be based on “cautious” growth forecasts and a strong programme of fiscal reforms.
"I would like to re-emphasise that the current large provision of liquidity by the Eurosystem and the Central Bank of Ireland to entities such as Anglo Irish Bank should not be taken for granted as a long-term solution ... The Governing Council cannot commit to maintaining the size of its funding to these institutions on a permanent basis," wrote Trichet.
“Future decisions by the Governing Council of the ECB regarding the terms of the liquidity provision to Irish banks will thus need to take into account appropriate progress in the area of fiscal consolidation, structural reforms and financial sector restructuring.”
This was a crucial point. The bailout may still have been weeks away, but Trichet was already laying down the principle that further aid would have to be matched by significant, ongoing efforts in Dublin to repair the public finances and put the banks on a sounder footing.
Deauville setback
By the time Lenihan responded, on November 4th, the situation had worsened considerably. The immediate catalyst was a declaration on the structure of any future bailouts which was issued in Deauville,
France
, by German chancellor
Angela Merkel
and then French president
Nicolas Sarkozy
.
Unhappy that European taxpayers were on the hook for the Greek bailout, the “Merkozy” duo resolved that private creditors would have to make contributions to any further rescue of any other euro zone country.
The Deauville declaration spooked markets. Ireland was, by then, first in line in the danger zone.
Irish debt took an immediate hit, with the interest rate on 10-year bonds approaching 7 per cent. There was despair in Irish government circles, for the development meant it would be even more difficult for Dublin to succeed in its plan to make a smooth return to private debt markets at the start of 2011.
All of this weighed on Lenihan as he submitted his response to Trichet, with enclosures containing global and Irish media reports about the turmoil sparked by Deauville.
"You will no doubt have noted the very adverse developments in the markets in recent days in relation to the widening spread of Irish Government bonds against the German bund," the minister wrote.
“This issue gives rise to very serious concerns for the Irish Government particularly in relation to the potential impact on the credibility of the very significant budgetary adjustments which we have developed working closely with the European authorities. I know that this concern is one that is strongly shared by you.”
Citing the disruption on markets after Deauville, Lenihan said already difficult market conditions were being worsened.
“I am sure that you will agree that it [is] imperative that comments particularly from senior political figures within the euro zone are consistent in their content and do not, as an unintended consequence, undermine the efforts of member states such as Ireland to address the serious difficulties that they are continuing to confront.”
In the grip of uncertainty
Lenihan had unveiled the €6 billion adjustment target for the 2011 budget on the day this letter was sent. That same day, Trichet publicly welcomed moves to frontload retrenchment in the four-year plan and said the overall endeavour was “not insufficient”.
But the markets were unimpressed. The situation seemed to grow more uncertain by the day.
The public illustration of distress was the spike in bond yields. In private, Ireland’s banks were drawing down more and more emergency ECB funds. In January, the ECB’s exposure to domestic banks stood at €90 billion. By November, it stood at €140 billion. The ECB was increasingly anxious that this represented one quarter of its total lending, which it saw as an “unprecedented level of exposure” for a country such as Ireland.
After all, the State’s share capital in the central bank was less than 1 per cent.
Hope seemed to be evaporating.
Within the ECB and the European Commission, officials privately concluded that Ireland would not be able to avoid a bailout. In Dublin Lenihan authorised tentative contact with the IMF. As the situation worsened, however, the finance minister wondered whether a specific rescue package for the banks might be possible.
Cowen wanted the ECB to buy up more Irish bonds, which it refused to do. For all the promises from Dublin to do the right thing in the four-year plan, the argument was advanced in the ECB’s headquarters in Frankfurt that Ireland was not facing up to its problems.
Three points are relevant.
First, the European and global authorities were worried that a repeat of delays over the Greek rescue would result in contagion from Ireland to other weakened countries if a bailout was not quickly arranged.
Second, concern about the turmoil prompted by the Deauville declaration led to an intervention at a Group of 20 meeting in Seoul, South Korea, to dilute the commitment made by Merkel and Sarkozy.
Third, Anglo Irish Bank was now so enfeebled that there was even concern in the Obama administration that it might renege on financial obligations, triggering a new wave of instability in global markets.
By mid-November, informal contacts were under way between Brussels, Berlin and other capitals about preparations for an Irish rescue. All of this was denied by the government, although steps were by then in train for that inevitability.
A delegation of top Irish officials travelled on Sunday, November 14th for secret talks in Brussels, an engagement which continued the following day. Increasingly, implausible denials from Cowen and other government figures merely heightened the sense of chaos in Dublin. The government believed it could maximise its hand in the negotiation by delaying the formal application for aid.
This did not go down well in the outside world.
Even after euro zone finance ministers gave a discreet mandate for “short and focused” preparations for a rescue plan, Irish banks suffered their biggest one-day loss of retail deposits on Wednesday, November 17th.
The Trichet threat
The response was swift. Central Bank governor
Patrick Honohan
went on
RTÉ
radio early the next day to declare a rescue plan involving “tens of billions of euro” was in the works. As if to emphasise that the game was up, IMF mission chief to Ireland Ajai Chopra arrived in Dublin that very morning. A bailout could hardly be avoided at this point, yet still there was no formal application from the government.
Trichet’s second letter to Lenihan came the next day, Friday, November 19th.
Again addressing him as “Tánaiste”, Trichet issued the now infamous threat that emergency ECB support for Ireland’s banks was on the line. Not only that, but he made it clear that this was the position of the entire ECB governing council.
“It is only if we receive in writing a commitment from the Irish Government vis-à-vis the Eurosystem on the four following points that we can authorise further provisions of [emergency liquidity assistance] to Irish financial institutions,” wrote the ECB chief.
The first, rather salient condition was the required formal request from Dublin for financial support. The other conditions centred on a continuation of the effort to repair the public finances and a reinforcement of the banks. The ECB chief also sought a guarantee from the State on the repayment to the central bank of emergency funds given to the Irish banks.
The threat to ECB support for the Irish banks greatly aggrieved Lenihan, Cowen and the rest of the government. While only two days passed before Lenihan confirmed the application would be made in a return letter to Trichet, the minister made no mention of his sense of betrayal by the ECB chief. The rescue programme under discussion would be both workable and effective, he said.
“I hope that this will provide some reassurance to the Governing Council and that you will be able to reiterate in a public way the continuing practical support of the ECB for the liquidity position of the Irish banks, to help reassure the market on this crucial point,” Lenihan wrote.
“You know that we here will not be lacking in the will to do all that is necessary on our part to protect our economy and people and to play our role in the Eurosystem.”
The point of no return had already been reached by the time Trichet issued his threat, but his intervention illustrates just how weakened the government was as it entered the formal negotiation.
Another week passed before the deal was ultimately done, but not before the ECB refused permission for the government to impose losses on senior bank bondholders.
The antagonism between Dublin and Frankfurt was all too clear.
