Patrick Honohan was the outsider brought in to run the Central Bank of Ireland during the great financial crisis. His memoir also tracks the country’s currency history in the century since independence

Academic economists are brainy types who for the most part spend their careers offering wise counsel form the sidelines. That was the case with Patrick Honohan, a UCD graduate who spent his career across the IMF, the World Bank and Trinity College Dublin. 

A few weeks short of his 60th birthday, Honohan (pictured) was plucked from ivory tower obscurity and appointed Governor of the Central Bank of Ireland. That was in September 2009, and in terms of being thrown into the thick of itthe timing could not have been better.

Until Prof Honohan’s elevation, the CBI top job had been the preserve of Department of Finance mandarins. Honohan secured the role because the late Brian Lenihan, finance minister at the time, had lost faith in the civil service and the Central Bank, as the Irish economy plunged deeper and deeper into crisis after the bursting of the property bubble in 2007/08.

Honohan got his big break after reaching out to Lenihan with unsolicited advice. He arrived in Dame Street a year after the seminal point in that meltdown, the blanket bank guarantee in September 2008. From the autumn of 2009, Honohan was at the coalface as the country slid inexorably towards bankruptcy and the Troika bailout in November 2010. 

In Association with

He remained in the CBI role for another five years, observing at close quarters the banks and their behaviours, and the mechanisms to repackage European Central Bank emergency liquidity assistance into long-term Irish national debt.

Policy Wonks

In retirement, Honohan has not been idle, writing Currency, Credit and Crisis: Central Banking in Ireland and Europe, for Cambridge University Press. At one level, the tome is aimed the central bank policy wonks whom Honohan used to mix with in Frankfurt. At another level, the book is Ireland’s Bust 101, with the author taking care to explain economic, banking and currency basics for readers. 

Stripped of the usual economist jargon and peer references, the book will sit well on the syllabus for economics students who need to know how and why Ireland got into the mess it did.

The 2008 bust and the 2010 bailout still loom large, with thousands of people suffering from the after-shocks. Another property bubble is in progress, though this time abundant credit is not the main driver. Private capital, much of it from overseas, is chasing Irish property assets in search of yield, driving prices ever higher. If and when that capital seeks a new home, the latest property bubble will burst and the impact on the economy and individuals will be severe. 

The Central Bank has attempted to rein in this new bubble with macro-prudential lending rules, to limited effect. Honohan has a low opinion of Irish banks and their growth culture, and he was instrumental in putting the lending curbs in place. Though property prices powered ahead after he handed over the governor role to fellow TCD academic Philip Lane, in his book Honohan doesn’t address how the latest bubble should be deflated.

In fairness, the issues addressed by Currency, Credit and Crisis are tackled through a central banker’s lens. If the Irish economy is becoming unbalanced again through a surfeit of construction investment, choking that back is the responsibility of arms of government outside the Central Bank.

Honohan has little faith in these policy makers too, bemoaning their short memories. In a lead-up to his account of the property crash and its aftermath, Honohan takes the reader through a potted history of Ireland’s currency, recalling that over the past century Ireland employed a foreign currency (sterling), a domestic currency pegged to sterling (the punt), the same punt linked to a multicurrency adjustable peg system (ERM), a free-floating punt, and finally the euro. 

Since independence, Honohan notes, almost every type of exchange rate regime has been tried in Ireland. “Irish governments were never sufficiently faced with the realisation that maintaining a currency regime that ensures stable prices involves discipline if it is not to have severe side effects,” he writes. “Neglect of this home truth was to have heavy consequences in the new century.”

Sterling Oscillations

The Free State started producing its own currency in 1927, exchangeable one for one with sterling. The sterling link shielded Ireland from speculative pressure, but not inflation. Honohan records that due to sterling oscillations average annual consumer price inflation from 1927 to 1978 was 4.8%. The peak was during the Labour Party’s mismanagement of the UK economy in the 1970s, when CPI peaked at 20.9%.

Ireland’s first attempt at escaping sterling’s shackles was the Exchange Rate Mechanism in 1979. This move broke the parity link with sterling and left the punt vulnerable to market speculators. Four years later the Central Bank was hiking wholesale interest rates to 17% to keep investors interested in the punt, deepening an already severe recession. That didn’t stave off an 8% ‘realignment’ of the currency value, and another devaluation followed in 1986, this time with Honohan egging on Taoiseach Garret FitzGerald.

The professor modestly notes: “The 1986 devaluation is often seen as having helped underpin the export-led recovery of the Irish economy from 1988, especially as the effect was boosted by a period of sterling strength.” On the downside, ERM was a disaster for price stability, with inflation averaging 7.7% per annum until the mechanism fell apart in 1993. 

Before that denouement, there was one more devaluation, in January 1993. When sterling crashed out of the ERM on Black Wednesday in September 1992, the punt was suddenly valued at £1.10. Speculators knew that was too good to last and the Central Bank spent £4bn trying to defend the punt’s value while also hoisting rates, at one point up to 100%. 

Finance minister Bertie Ahern faced up to the inevitable 10% devaluation the same week as the Central Bank celebrated its 50th birthday with a National Concert Hall bash. Honohan’s waggish pals dubbed the event the devaluation disco.

After 1993 and before the euro in 1999, the punt was allowed to float in a range of 15% plus or minus against Ireland’s main trading currencies. The author wonders: “Was it a coincidence that the years of exchange rate flexibility proved to coincide with the most successful years of Irish macroeconomic performance?” Honohan doesn’t really answer that question, preferring to emphasise the benign influence of the ‘great moderation’ and the start of globalisation.

The other factor at play in the 1990s was that punters knew the euro was coming down the tracks. The euro would mean mortgage rates set at German levels, so everyone decided to borrow more to fund their house purchase, and the great property boom was underway. 

When it arrived in 1999, the euro underpinned Ireland’s property bubble as Irish banks didn’t have to pay a currency risk premium to source wholesale funds. In Honohan’s view, Ireland staying outside the euro (never seriously contemplated by policy makers) would not have prevented the property bubble. 

“Given the euphoric global financial environment at the time, it is not hard to imagine an outsize property boom in a non-euro Ireland in the early 2000s,” Honohan opines, adding that UK banks such as Ulster Bank and Bank of Scotland were responsible for turbocharging the mortgage market with 100% mortgages and trackers.

“The lesson for me is not that the euro was fatally unsuitable for Ireland to join, but that its introduction was not accompanied by the necessary discipline in national policies,” Honohan writes. In his book, Honohan goes on to lament the shortcomings of the predecessors in the Central Bank and the Financial Regulator, while reassuring readers that oversight is now much improved.

Economic Implosion

How much euro membership was to blame for Ireland’s economic implosion is a subject of dispute. What’s clear from Honohan’s account is that ECB funding prevented the cash running out at the ATMs. As bank creditors and depositors withdrew their cash, despite a sovereign guarantee, the gap was being filled with emergency funding from Frankfurt. The Troika intervention became inevitable when the ECB ran out of patience.

A chunk of Honohan’s book is devoted to explaining the process of substituting national debt for the ECB funding. He also muses about possible alternative approaches by the ECB to the crisis. In later years, ECB governor Mario Draghi was much more relaxed about monetising national liabilities than his predecessor Jean-Claude Trichet. This has led to a renewed asset bubble in Ireland and elsewhere, with no end in sight. 

The Draghi policy has been hugely beneficial for Ireland, driving down the interest payable on the outsize national debt. The country’s net debt zoomed from €50bn in 2008 to €175bn in 2013, and is currently at €188bn. Honohan calculates that the net cost of the bank bailouts has been €36bn, or about 30% of the extra borrowing incurred in the crisis years. The rest of the borrowed money went to pay for social benefits, entitlements and public sector pay.

The Comptroller & Auditor General’s most recent tally is that the bail-out of Ireland’s banks during the financial crisis has cost the state €41.7bn, and that the ongoing cost is €1.1 bn to €1.3bn a year added to to the cost of servicing the national debt.

On the debt to GNI measure, Ireland is not the outlier it was, though it’s still way up there. When the next crunch comes, will the ECB be as steadfast in its support? Honohan isn’t so sure. 

“It is not at all clear that there is the political will for the needed intensification of shared sovereignty,” he writes. “The lack of collegiality that marked decision-making in the early years of the crisis is not entirely dispelled. Solidarity has not yet grown to the point where there is assurance of economic success of the system’s third decade.”