by David Malone
Now that Mr Cowen has lost control of his party, coalition and country, the Irish can expect to be bullied and hectored from all sides. It is more important than ever for Ireland to defend herself against the claims that she owes the rest of us. She doesn’t.
Every European bank exposed to Irish loans, every bond holder holding Irish debt – both band and sovereign – and every foreign central bank concerned for the solvency of its own banks will start to crank up a barrage of propaganda and threats. It will be top of everyone’s propaganda agenda to make sure the Irish election offers no choices that could destabilize the unexploded ordnance of European bank insolvency.
The European financial class will be desperate to ensure that the Irish have an election that is carefully constrained so as not to offer anything that might actually help them. As far as the banks, the European Central Bank (ECB) and all the leaders of nations whose banks would suffer losses if Ireland were to default or restructure, the Irish people are not to be exposed to ideas of default.
All parties must be told, and if that fails to convince, made to feel directly via the bond market, the consequences of any alteration of the course followed so far. And, of course, it has already started. Here is what senior ECB banker, Lorenzo Bini-Smaghi, said on January 15th regarding Ireland’s electoral choices.
“It would be dramatic for Ireland if just by changing government you renege on the promises that Ireland as a sovereign has made.”
Not that he would dream of making veiled threats to try to frighten Irish public opinion into choosing what would be best for the banks over what would be best for the Irish people.
“Look at those countries which defaulted, like Argentina, Pakistan, Ukraine, Zimbabwe, Cote d’Ivoire. Do the Irish people want to go through the same experience?”
No mention of Iceland there. Funny that.
The foreign press will run story after story about the dangers of ‘contagion’, of the need for responsibility and resolve. The Irish Central bank will step in to make grave pronouncements if the political parties seem not to be holding the line.
Foreign leaders such as Merkel, Olli Rehn, Barosso, Trichet and our British clowns, all with their own national interest, will give talks and be quoted in their papers about the need for steady fiscal responsibility and the unthinkable consequences of any wavering.
If there is any rumbling of popular discontent, then scapegoats will be found – people upon whom some anger can be harmlessly vented. But if that does not work then the rhetoric will get more pointed. Ireland will be reminded that ‘it’s their fault’ and they ‘have no one to blame but themselves’. In the German press any hint that Ireland may be thinking of restructuring will be met with dark reminders of how ‘Ireland’ in the form of Depfa had to be bailed out by Germany.
In short I don’t think the financial class is pleased that the politically unreliable (when it comes to European questions) Irish are going to have an election at this delicate time. I think the run up to the elections will involve a lot of propaganda designed to shout down any opposition to bail outs and debt payments.
So I thought this might be a good moment to get a few things on record regarding Depfa, Hypo Real Estate (HRE) and the banking crisis blame-game.
For those who aren’t already familiar with the Depfa and HRE story, here it is in a very small nut shell. Hypo Real Estate was the huge German bank which we were all suddenly told, back in 2008, had to be bailed out by the German State at vast cost. But, they said, they had no choice, because HRE was so large and its debts so huge that if it collapsed it would, at the very least, bring down German banking. It was Europe’s AIG – to big to be allowed to fail. Then the back story emerged. HRE had bought ‘Irish’ bank Depfa at the top of the market at almost the same time as RBS bought ABN Ambro. Both purchases were insane and both killed the purchasing bank.
It was then put about that the collapse of HRE was in fact due to a huge funding crisis at Depfa always referred to as ‘its Irish subsidiary’. From that came the notion that Depfa must have hidden its true state from HRE. Why else would HRE have bought a bank which couldn’t fund itself?
And that is how the story firmed up. Irish Depfa must have lied about its true state in an effort to sell itself to Hypo, so that when Depfa’s hidden financial problems surfaced, the cost of them killed Hypo and then fell upon the German rather than the Irish tax payer.
It is sometimes easy to forget with all the sordid and ruinous business of Anglo Irish, that the beginning of the whole crisis in Ireland and in Europe was intimately tied to Depfa and HRE. Thus I think it is worth reminding ourselves of some of the misinformation and perhaps offering a few less well known facts. Facts which might help the Irish defend themselves.
It was often said, particularly in the German press, that Depfa ‘brought down HRE’. Had HRE not bought Depfa when it did in 2007, then it would have been the Irish, who had incubated the problem, who would have had to pay for it, not the Germans. There is always this undertone that somehow Depfa must have lied to or misled HRE.
Was DEPFA really an Irish Bank which the Irish should have bailed out?
Less than 1% of Depfa’s business was Irish. Virtually no Irish banking money flowed into Depfa or its deals. Depfa was not a major employer in Ireland. A couple of hundred jobs at most. Few of its senior positions were held by Irish people. Thus in purely bloodless financial terms there was virtually no reason for Ireland to bail out Depfa. Depfa was not systemically important to Ireland or the rest of its banking sector. Depfa was, however, vital to the continued health of the German banking sector. Add to this that the size of any bail out of Depfa was quite beyond what Ireland as a nation could have done. Ireland’s total IMF bailout stands at €85 billion. All on its own the HRE/Depfa bail out has already cost Merkel well over €100billion. Depfa, like one or two other banks in Ireland, was simply too big for its host. It was a financial cuckoo in the nest.
The Germans, however, would I think have bailed out Depfa even if it had not been bought by HRE because Depfa’s failure would have crippled something essential to the entire German banking sector – the Pfandbrief business. The Pfandbrief is a German ‘covered bond’. A covered bond is simply a super safe kind of bond. It is considered as safe as Sovereign bonds but gives a higher return. Germany invented the Pfandbrief and its banks relied on it.
The Pfandbrief/covered bond is considered super safe because, unlike other bonds, the Pfandbrief is backed by a ring-fenced set of assets which cover the total value of the Pfandbrief/bond. So even if the bank issuing the Pfandbrief were to go under, the Pfandbriefs themselves would never default. And it has been the bed-rock of the Pfandbrief’s reputation that in 250 years no Pfandbrief has ever defaulted.
At the time of the Depfa bail out there were €806 Billion in Pfandbrief outstanding. The third largest chunk of the German bond market and the section that had been growing rapidly and which everyone wanted to be a part of. The German banking sector wanted to grow and compete with the British and the Americans on the international stage. They saw the Pfandbrief as an important part of their strategy. This article from 1999 gives a great feel for how the markets were then, as they stood on the cusp bubble years.
If Depfa had gone down, it would have taken the AAA rated dependability of the Pfandbrief with it. Ireland could let that happen, Germany could not. That is why, I think, Germany would have bailed out Depfa no matter who owned it.
Why did Depfa move to Ireland if it was still a ‘German’ bank?
Depfa was always a German bank it chose to locate itself in Ireland for funding and regulatory reasons. Does this mean that Ireland was stealing Germany’s banking sector? No. The best way to think of Ireland is as German’s off-shore tax haven banking centre with one significant feature – it was within the Euro zone. Every country has one. The UK has many. Germany needed one and Ireland was happy to oblige. Thus it suited Germany as much as it did Ireland. It was a partnership.
Of course Ireland made itself everyone’s honey. But I think it is fair to say that of her many customers she had a special relationship with Germany. Think about it. Depfa, HRE and HVB (Now UniCredit), Deutsche Bank, LBBW, DZ bank, Commerzbank, Bankgesellschaft Berlin, Landesbank Sachsen, WestLB all gravitated to Dublin.
The fact that this arrangement/partnership has fallen apart in acrimony doesn’t alter the fact that when the money was flowing the Germany banks, German bankers and all the politicians were every happy with what was going on in their Irish subsidiary. Ireland does not owe Germany an apology.
In fact I think Ireland should be asking Germany some hard questions over the sometimes abusive relationship German banks have had, and some still have, with Ireland. See here for how WestLB after it collapsed created an SPV called Phoenix, as a means for parking/dumping €23 billion of toxic ‘assets’ in Ireland. This, it seems to me, is the Toxic Debt Wasteland I wrote about, becoming real.
How did the Irish Funding work?
Depfa had always raised its cash through its own Pfandbrief bank. Its source of funding were the Landesbanks who in turn got the cash from the bottom of Germany’s banking system the Kasse, deposit banks. They had all the cash.
But there were limiting factors. German money was the spur to Depfa’s early growth but the bank wanted more. They wanted better access to international funding and international customers. Neither as more than one German banker has told me, was readily available in Germany.
Ireland made itself a meeting place for those with money in need of investing and those looking for loans. For Depfa in particular it was an attractive place. Depfa had decided to target Russian and East European public investments (investing in publicly funded works) and Ireland had made itself attractive to Russian and Eastern money. Money in various shades of shadiness flowed to Ireland. The timeline of German banks and for that matter all European banks (thinking of UniCredit here) going to Ireland runs parallel to East European and later Russian money beginning to flood out of the former Soviet states looking for a new home in the West. Ireland met that need. Ireland become the favourite investment destination for Russian money.
Money was placed in the East. Plenty of subsidiaries there who could pass it along to be funnelled westward through Austria (Bank Austria) onward to Ireland where it could find its way to the heart of European banking in Ireland.
Depfa set up a brand new bank Depfa ACS bank, specifically to tap into all this new money. It even got the Irish parliament in agreement with the European authorities and German banking sector to write a new law making it possible. Ireland created its own version of the Pfandbrief – the Asset Backed Security. This allowed lots of new money to join with the steady flow of Germany money from the Landesbanks to unite in Ireland to the benefit of Ireland and Germany.
Of course Europe has access to all sorts of offshore banking so what made Ireland special? Ireland was physically close, was already a corporate centre, was English speaking (good for the Americans), was low tax, used English Law (good for London) and had the same ‘we can do it for you’ attitude of Luxembourg. What gave Ireland the edge over Luxembourg was it offered faster turn arounds on setting up deals and far more lax regulation. Ireland was perfect.
Ireland and Luxembourg are banking competitors. But Luxembourg is not English speaking, is slower and worst of all has a regulator who occasionally regulates. The Luxembourg regulator has all his own teeth. Ireland’s had his removed along with his balls a long time ago.
As long ago as 2005, Charlie McCreevy, Ireland’s former Minister of Finance, (another Fianna Fáil man who was at the Ministry of Finance before Brian Cowen took over that job and showed everyone how it should really be done!) who then became European Commissioner for Internal Market and Services (nothing like failing at one job in order to get a better job …) addressed an esteemed EU/UN gathering in New York in 2005 in which he famously stated,
“As Finance Minister in Ireland I saw what great entrepreneurial energies that a “light touch” regulatory system can unleash. 25 years ago we were the sick man of Europe. Today we are among the richest countries in Europe. Ireland is indeed testimony to the fact that you don’t need to be rich in natural resources to generate real wealth.”
That was shortly before someone shouted iceberg!
For those of you whose German is better than mine you will enjoy this German television (ZDF) expose of German banking in Ireland and Depfa/HRE in particular. Apart for revealing interviews with senior people in the German banking world, it also contains a brief interview with David McWilliams who famously referred to the fact that the German bankers behaved in Ireland “like men in a brothel” – with the blind eye of the Irish Financial Regulator seeing no evil. WhistleblowerIRL’s roller coaster experience as UniCredit Ireland’s risk manager illustrates the extent of the Irish regulator’s incompetence and/or criminality, and refusal to actually enforce regulations.
You can find more on Ireland’s regulatory cesspit and WhistleblowerIRL’s story in Why Bank Regulation is a Joke, and Who Bankrupted Ireland. For more the details of WhistleblowerIRL’s very much ongoing story see his blog here.
Of course if you want no regulation why not just go to the Caribbean? The answer comes back to Germany again.
Much of the money flowing into Europe looking to be invested would end up in Special Purpose Entities/Vehicles (SPE, SPV). These are the legal containers which house and run the securities in a collateralized debt obligation. You securitize debts, you put them in a CDO, you house the CDO in an SPE/V and you need somewhere to set up and domicile the SPE. What Germany wanted was to have the dubious advantages of off shore combined with the above board respectability of Europe. German investors, the Landesbanks, wanted their money inside the OECD cordon of respectability while getting all the perks of off-shore. Ireland provided both.
A former, very senior banker from Depfa told me the Landesbanks could not buy Depfa’s debt/Asset Backed Securities fast enough. Any issue Depfa made would be pre-sold to and wolfed down by the landesbanks before the ink was dry. This was a partnership.
Now before I wrap this first part up, I would just like to note that, another banker, based in Germany, has recently pointed out to me that in all of the discussion about the Greek-Ireland-Spain/Portugal bailouts, the debate over the tax-payers’ money that was, and still is, being poured into the now-nationalised HRE/Depfa has mysteriously been silenced. I wonder why? The banker referred me to this documentary which raises some interesting questions about why and how HRE was bailed-out. It makes the important link to Akerman at Deutsche Bank and how he appears to have told, not advised, but told, Merkel what to do. Merkel might be more of a tin wind-up model of an Iron Lady rather than the real thing.
As I have very basic German language skills, I would welcome any comments readers might have about these documentaries. This would help me to learn more about the HRE/Depfa saga.
On that note I am going to break the story here to stop this becoming too large. I will continue in the next part with the question:
So what went wrong? And why did HRE buy Depfa when it was already going wrong?
In which we will meet once again our old adversaries AIG and Goldman Sachs.
David Malone is the author of the book Debt Generation. You can read and listen to excerpts from his book here: http://www.debtgeneration.org/index.php