Would Ireland still have failed if Lehman had not collapsed?

Ireland received a severe shock when the US government let Lehman Brothers fall into bankruptcy. But if the US investment bank hadn't failed, could we have avoided the death spiral that followed?

Ireland was already in a recession in early 2008, its first for 25 years. In the week before the bank guarantee, the looming shortfall in tax revenue was projected to be €7 billion, more than twice the €3 billion deficit forecast only three months previously, an illustration of the rapid shrinkage of the economy.

The construction slump had set in, industrial activity and consumer spending were down, and the growth in bank lending was in decline.

Even without a banking crisis, turning around the ship of State in these circumstances would have been a huge challenge, particularly when the answer to the tax shortfall was to cut spending and increase taxes, taking money out of the economy while it contracts.

The “credit crunch” had hit global banking markets a full year before Lehman’s demise. True, Irish banks had negligible direct exposure to the toxic US subprime market, but hardly a lender in the world could withstand the shutdown in interbank lending.

Our property bubble was also bursting. The market had been out of control for years, fuelled by gung-ho bankers, greedy developers, lax regulation and an indulgent government which used transaction taxes to buttress public finances.

In March 2007, house prices had dropped for the first time in five years, the beginning of a long but inexorable slide.

The decline in property prices and sales would make it increasingly difficult for developers to refinance their borrowing and expose banks to large losses. Even without Lehman, Ireland’s banks were in ever-deepening trouble.

Having reached their peak in February 2007, shares in the main Irish lenders fell sharply, and by the start of September 2008, had lost half their value and were still declining.

Lehman amplified the weakness of all weak economies as contagion took hold. The drastic loss of confidence was immediate, threatening dozens of stricken institutions with collapse and forcing remedial action from governments such as Ireland’s.

Might there have been no blanket guarantee if Lehman had been rescued?

Possibly, but not certainly. Irish banks were already under acute strain and seemed set for huge losses in a souring, recession-struck property market. That is what their share price said.

It is true that the pace of the global recession quickened following Lehman. While the banks would still have sought to hide their losses, they would have been smoked out eventually. In that event, private investors are unlikely to have stepped up to bridge the gap.

A slightly lighter recession, without the Lehman explosion, might have reduced the ultimate burden on taxpayers. However, given the rampant malpractice and dizzying accumulation of bad loans by the Irish banks, it’s hard to imagine there would have been no public bailout at all.

A rescue of Lehman by the US government might have delayed disaster and given Dublin more time to plan, but acute vulnerabilities were present.

Should matters have been brought to a head later via a separate shock, there was still no Plan B.