by Shane Ross
Northern Rock ran an operation in Ireland and had succeeded in raising €2.4 billion in deposits from Irish savers. As the crisis unfolded, Irish customers saw television pictures of fellow depositors queuing in the UK to draw their savings out of Northern Rock branches there. Queues began to form outside Northern Rock’s offices in Dublin’s Harcourt Street.
The British government was soon forced to guarantee all Northern Rock deposits in the UK. British depositors’ nerves were soothed, but clients in Ireland remained nervous that their savings would not be covered by the Bank of England’s promise. Cowen moved fast to secure an assurance from British Chancellor Alistair Darling that the Bank of England guarantee was extended to Irish savers.
In the same month that Northern Rock had to be rescued, September 2007, the International Monetary Fund wagged a finger at Ireland, forecasting a sharp reverse in Irish growth during 2008. In December, just four days before Cowen’s fourth and final Budget as Finance Minister, it emerged that stamp duty receipts, a measure of activity in the property market, were projected to dive by €730 million. Total tax revenue was projected to drop by €1.75 billion. For the first time as Finance Minister, Cowen was short of cash.
Cowen appeared to be in denial. In his budget speech he admitted that the ‘backdrop is challenging’ but went on to insist that the ‘fundamentals of the economy are still good – a point often lost by some’. He promised that ‘growth will be sustained into the future’.
Such misplaced optimism allowed him to increase public expenditure by over €1.7 billion.
Cowen was in denial, and so, as 2008 unfolded, were Irish bankers.
Responding to news of the 7.3 per cent decline in property prices in 2007, Niall O’Grady, head of marketing at Permanent TSB, parroted Cowen’s line:
After a decade of phenomenal growth the market finally came off the boil in 2007. However, prices today are pretty close to where they were at the start of 2006 and the fundamentals behind the market remain strong – as evidenced by rising rents. There is clearly demand for new houses albeit at reduced levels. The question is at what point buyers will take confidence that we’re at the top of the interest rate cycle and return to buy.
In early February Irish Life & Permanent’s normally low-profile chief executive Denis Casey rashly claimed that the falls in the share prices of Irish banks were an ‘overreaction’. Even in spring 2008, two of the biggest ostriches in the business were prescribing the Cowen medicine. AIB’s chairman Dermot Gleeson and his chief executive Eugene Sheehy took the opportunity of their annual report to mimic the Taoiseach’s myopia.
In his chairman’s statement accompanying the publication of AIB’s 2007 annual report in March 2008, Dermot Gleeson conceded that ‘short-term prospects are somewhat mixed’ but used the f-word again, insisting that ‘economic fundamentals remain solid and growth is expected to pick up again in 2009 and beyond’.
The script could have been written in the Department of Finance.
In the same report AIB chief executive Eugene Sheehy admitted that ‘our bad debt provisions will rise from the very low levels of 2007’. But he asserted: ‘Our lending policies and practices remain prudent.’
Within months AIB was facing bankruptcy, rescue or nationalization due to years of imprudent lending to property developers.
Meanwhile, Anglo was issuing some dodgy figures. In May 2008 it reported a 15 per cent rise in profits for the half year and made some ritually optimistic noises. In the same month Bank of Ireland hinted at profit falls for the year but proceeded to offer a dividend hike. On the last day of July AIB chief executive Eugene Sheehy followed suit, announcing that despite a profit fall of 4 per cent the bank would be paying an extra 10 per cent to its shareholders. The promise of higher dividends smelled of pure bravado. The instinct of Ireland’s bankers was to brazen it out. Sheehy insisted that, ‘We are not in any way concerned about capital.’ This was an absurd statement, as AIB’s bad-loan provisions were rocketing.
Two months later Sheehy would dismiss suggestions that AIB might seek support from the government or anywhere else, saying, ‘We’d rather die than raise equity.’
Investors around the world stared in wonder. Here were three banks – Anglo, Bank of Ireland and AIB – deeply mired in a property slump, hurling their disintegrating reserves at their shareholders.
After the world’s market traders had stopped wondering what pills these Irish guys were taking, they did what they knew best: they sold Irish banking shares with a vengeance. Short selling in Anglo Irish shares peaked around the St Patrick’s Day bank holiday. Dealers saw a one-way bet and sank the shares by 15 per cent. On the same day the UK’s HBOS, with a weakness for property lending almost equal to Anglo’s, came under fire from hedge funds.
Anglo never recovered. The market simply did not believe a word coming out of its St Stephen’s Green headquarters. Sean FitzPatrick and David Drumm tried to stem the flood of disbelief, but it was overwhelming. An incensed Drumm persuaded the obliging Financial Regulator to probe the short selling activities of certain brokers, but the inquiry came to nought. An Anglo public-relations offensive flopped. Even analysts from some of the top Irish firms became non-believers.
Anglo’s principal problem in the first six months of 2008 was the relentless distrust of its published figures. It was clear that Anglo was insanely overexposed to property developers, and that the property developers were getting into very deep trouble. Yet Anglo’s figures assumed an implausibly low rate of loan default. The markets judged the top brass guilty of bad banking, and of gilding the lily with optimistic valuations in Anglo’s scary property book.
One of the central figures in the swirl of rumours about Anglo’s customers was Ireland’s richest man, Sean Quinn.
Quinn, from Derrylin in Co. Fermanagh, made billions from nothing. He borrowed £100 in 1973 to extract gravel from his 23-acre family farm. Thinking big from the start, Quinn – often referred to as ‘the Sandman’ – founded the Quinn Group in that same year as a vehicle for what would become an extraordinarily diverse range of business interests, including cement, hotels, glass, plastics and property.
In 1996 Quinn founded Quinn Financial Services and took the staid Irish insurance world by storm, undercutting the established companies’ rates through Quinn Direct. Punters learned to love the fledgling insurance company as it played the role of a giant killer. Some of the enthusiasm for the Quinn Group’s aggressive style transformed into an affection for Quinn himself.
In 2003 Quinn purchased a 20 per cent stake (later to become 25 per cent) in NCB, Ireland’s third biggest stockbrokers. The quiet Quinn had big, big ideas. In 2005 a rare vanity project saw him purchase the Belfry hotel and golf course in England. He sponsored the British Masters tournament there in 2006.
By 2008 Quinn was a financial services giant; but he was also an enigma. Quinn Group was a private business; Sean Quinn was a private man. Few wealthy Irishmen have ever been able to hide so successfully from the national media. He has never owned a public company, which means that his operations have not been subjected to the reporting requirements of such companies. As he had never shown much interest in the trappings of wealth, few knew much about his tastes or his personal life. The outside world was carefully briefed that he regularly played poker with his old pals for a maximum loss of €10 a night. They knew too that he was a fiercely committed family man but, apart from that, he was an unfamiliar character. He surrounded himself with well-paid protectors from PR firm Wilson Hartnell, intent on keeping the media at arm’s length. But he could not hide completely: that year Forbes magazine named him as 164th in its worldwide mega-rich league.
In the first six months of 2006 Quinn Direct reported profits of €123 million. A year later Quinn enhanced his popularity as the champion of competition in the insurance market when he bought Bupa (Ireland), a subsidiary of the UK health insurer, for €150 million. Bupa, which had broken into the Irish market as the first challenger to the state
-owned VHI monopoly, was on the point of leaving Ireland after losing a court case over the terms on which the two insurers could compete. Quinn successfully appealed the decision to the Supreme Court and rebranded Bupa (Ireland) as Quinn Healthcare.
In early 2007 Quinn started building up a stake in Anglo Irish Bank. Normally a buyer of shares in a public company must declare his stake when it hits 3 per cent, but Quinn protected his anonymity by buying through ‘contracts for difference’ (CFDs). A buyer of a CFD in a block of shares does not purchase the shares themselves, but rather purchases the right to benefit from an increase in their price; by the same token, the holder of the CFD loses if the share price drops. Because CFD investments tend to be heavily funded by debt – most of the money involved is borrowed – gains and losses are magnified as a percentage of the investor’s stake.
Anglo’s falling share price in 2007 and 2008 meant that Quinn faced massive paper losses on his 25 per cent CFD position in the bank’s shares. By July 2008 the Financial Regulator was concerned that Quinn, looking at huge paper losses that risked becoming even bigger if Anglo shares continued to tank, might decide to cut his losses by letting his CFDs lapse, causing a vast quantity of Anglo shares to flood the market and thereby causing the share price to plummet further. Quinn converted three-fifths of his Anglo CFD stake – 15 per cent of the company’s shares – into a direct shareholding, taking a loss that Quinn himself says was more than a billion euros. Presumably Quinn could not afford to convert his entire CFD stake in this fashion, which meant the other 10 per cent of Anglo shares would be sold off – with potentially disastrous implications for the share price.
Sean Quinn was landing Anglo in the soup. No obvious buyer of 10 per cent of a sick bank on a downward spiral was in evidence.
The Anglo top brass caught an early whiff of Sean’s intentions. The senior ranks are said to have freaked when they realized that Sean’s 10 per cent of the bank would be under the hammer. Such a threat could be the final kiss of death to the dying bank, already savaged by short sellers, huge loans to property developers and rapidly escalating funding problems.
But Anglo still had its supporters. Some were battle-hardened veterans of the property war. At the height of the summer of 2008 Anglo insiders secretly assembled ten true Anglo loyalists and persuaded them to take up Sean’s shares between them. Anglo arranged to lend the ten saviours the €451 million needed to buy up the shares. Three-quarters of the €451 million was secured against the Anglo shares themselves, with the remaining 25 per cent secured against the individual investors’ personal assets. The Golden Circle was born.
Anglo was now treading a dangerous path. It was lending money to clients to buy shares in itself. The whole operation looked like a share-support scheme. Anglo was misleading the market.
In March 2008 the collapse of Bear Stearns, the fifth largest investment bank in the United States, set the stage for a series of events that would leave global markets in a state of near-permanent panic. The Bear Stearns crisis had immediate consequences for Irish bank shares.
Back in Ireland the markets were technically open, but deadly quiet, on St Patrick’s Day, the day after JPMorgan Chase offered to take Bear over at a price of $2 per share – less than one tenth of the share price two days earlier. Most Irish traders were not at their desks. This was an ideal time for the smarter hedge fund managers and opportunist dealers in Irish shares. The London Stock Exchange was open. Irish shares heavily traded in London included Irish Life & Permanent and Anglo. Anglo lost 15 per cent of its value.
Anglo had been rumbled by none other than the most influential financial column in the UK. The Financial Times’s Lex fingered Anglo as vulnerable to its high-wire commercial property gambles in Ireland and the UK. It bracketed the Irish bank with HBOS, widely considered the UK bank in the greatest danger. It decoupled both these banks from the US disease – sub-prime and mortgage-backed securities – and noted that on this side of the Atlantic we had our own chronic home-grown diseases. Lex was right.
Anglo reacted angrily. It protested to anyone who would listen, including the sleepiest financial regulators in Europe. Ireland’s watchdog launched an investigation into dealings on St Patrick’s Day, but not until the UK had given a lead by announcing its own probe into trading in HBOS, whose shares had tanked that day. It was not the first time that Ireland’s regulators had played follow my leader. The investigation came to nothing, but Anglo was on the global radar: not the best place to be.
Back in the United States they waited for their next catastrophe. It came soon enough.
Fannie Mae and Freddie Mac were the two largest mortgage finance companies in the US, estimated to have a 50 per cent slice of the $12 trillion US mortgage market. By July 2008 defaulting homeowners had left the two giants virtually insolvent. The US government regarded them as an integral part of the financial system: they were a proxy for confidence in the American economy, evidenced by their debt being held by several central banks around the world. Their failure was unthinkable. But failing they were.
Treasury Secretary Hank Paulson rammed a measure through Congress allowing the government to buy shares in the two behemoths and to underwrite their ballooning debts. Freddie and Fannie were saved by the American taxpayer and nationalized in all but name.
An ideological Rubicon had been crossed. The law of the free-market jungle had been broken. State subsidies were being used to prop up pillars of capitalism. In his dying days in office George Bush had become a pragmatist.
That was early September 2008. Elsewhere around the world governments were making efforts to ensure that no big banks went bust. Takeovers, mergers, emergency funding and bailouts were the order of the day. The unwritten, and unspoken, code appeared to be simple: governments were the guarantors of last resort. The nationalization weapon would be used if all else failed.
Until 15 September. The markets woke up that Monday morning to the stunning news that the US government had allowed the giant investment bank Lehman Brothers to collapse. Lehman was filing for bankruptcy.
The fourth biggest investment house in the US, even more exposed to risky assets than Bear Stearns, had spent much of the summer swanning around the world in search of a lifeboat. Hopes that it would clinch a deal with the Korean Development Bank lifted Lehman’s fortunes in early September. But on 9 September the talks with the Koreans broke down. Lehman’s shares fell by 40 per cent. The next day it recorded its worst quarter ever, with a loss of $3.9 billion, and announced that it was cutting its dividend. Another possible rescue merger, this time with the Bank of America, was dashed on 11 September.
The general expectation that George Bush would do for Lehman what he had done for Fannie and Freddie proved incorrect: the government had decided that they needed at least one example ‘pour encourager les autres’ and to prove its macho capitalist heart was still beating. On the same day, almost unnoticed, Bank of America bailed out Merrill Lynch with a $50 billion all-stock package.
A week later the insurance colossus AIG, fearing a liquidity meltdown, received US federal funds. Hank Paulson started talks with Congress on a possible $700 billion bailout package for the entire US banking system. On Friday 19 September Wall Street rallied strongly. Despite Lehman, AIG and Merrill Lynch, the Dow actually finished ahead on the week. The market felt that if the package was agreed, the worst would be over.
On the other side of the Atlantic, the UK was having its own problems. HBOS had acute difficulties not only with its lack of capital but also because of its heavy exposure to a fast-falling UK property market. Worse still, it was possibly the most dependent of all the UK banks on the wholesale funding market, which by now had seized up almost completely. Short sellers targeted HBOS. On Wednesday 17 September Lloyds TSB, under pressure from the British government, rescued HBOS with a £15 billion sterling bailout.
The British were in US-type doo-doo. They were anxious not to nationalize another bank after Northern Rock, but they were happy to see a mega-m
erger creating the largest retail operation in the UK. Size was safe. Competition law was hurled out the window to facilitate this huge transaction.
For the rest of the week the market steadied. A global relief rally provided a respite. HBOS shares rose 155 per cent from their low on Wednesday.
The relief rally barely lasted the weekend. The next week the fortunes of the Dow swung wildly in tandem with the volatile prospects for Paulson’s bailout. World markets followed suit. In the UK the government bit its tongue and was forced to nationalize another mortgage lender after Bradford & Bingley, which numbered ex-AIB chief Michael Buckley on its board, saw a run on deposits.
For Ireland’s nervous bankers, watching these events from a distance, mergermania suddenly became the only game in town. Big was beautiful. Size was safe. Mike Soden’s old idea of a Bank of Ireland–AIB marriage got a fresh outing. Others favoured the creation of a ‘third force’ in banking including Irish Life & Permanent, EBS and Irish Nationwide. Rumours sprouted by the hour.
Michael Fingleton’s building society became the first victim of the rumour machine. On 5 September the highly respected Reuters newsagency published a sensational story. It told how the building society ‘was in talks with its lenders to avoid insolvency’. Reuters posted the story on the wires at 6.14 p.m. on Friday evening, mercifully after the markets closed. Still, all hell broke loose in the Department of Finance, the bankers’ boardrooms and among the media. Even the Financial Regulator showed a bit of interest.
The story was wrong. Completely wrong. Fingleton emerged fuming. He had not even been asked for a response by the journalist. He dubbed it ‘an attempt to sabotage the society’. He did not try to identify the saboteur.
