The collapse of Lehman Brothers in the autumn of 2008 was a "shot heard round the world". But it was met initially with a sense of complacency by the Government and authorities in Ireland. As late as September 18th, 2008, the financial regulator Patrick Neary was making soothing noises.

New liquidity requirements introduced the previous year gave Irish banks “a solid base” for when the “turmoil hit”, he said. “Irish banks have only very limited exposures to US subprime losses and related structured credit products,” he said. “Irish banks are resilient and have good shock-absorption capacity to cope with the current situation.”

The government was not quite so upbeat that month. In early September, then taoiseach Brian Cowen had warned that there were tougher times ahead and was gloomy about the prognosis for the economy – CSO figures released on September 25th showed the country was in recession for the first time in almost two decades.

“No one should underestimate the scale of the challenge that faces us,” said Cowen. “We are in new economic territory. No one should think that it will be easy to overcome, and no one should think that any politician, any economist or any leading figure in business has the easy solution,” he said at the Fianna Fáil think-in.

The thinking of the State authorities at this time followed two tracks, both wrong. The first was that the Irish banks remained solid and had been subjected to the most rigorous stress tests. Any problems they had were due to liquidity problems. The second was that Ireland was feeling the effects of a global phenomenon and that its problems had nothing to do with overheating in the domestic economy.

By the end of the month, the truth began to manifest itself. The bank guarantee was the first of a series of desperate measures by the government to shore up the economy and the banks.

Within three months chairman Seán Fitzpatrick and chief executive David Drumm had left Anglo Irish Bank. It was nationalised in January 2009. Later that year the National Asset Management Agency was established to take over the loans of the country’s biggest developers.

The Government brought the budget forward from December to October to deal with the widening gap between public expenditure and revenue. Already Fianna Fáil had fallen to 34 per cent in opinion polls; the budget-day decision to charge over-70s for medical cards led to a policy U-turn and a further tumble in the polls.

Political quicksand
Cowen was right that the government was in new economic territory. And that territory was quicksand. The collapse of Lehman Brothers set Cowen and his government colleagues into a downward spiral from which they would never recover. Support for Fianna Fáil collapsed.

Within 18 months it became clear that the cost of salvaging the banks would run into tens of billions of euro and that brought the wider economy, itself in terrible straits, to its knees. During 2010, the government struggled to contain the crisis, and the IMF and European Union intervened late that year.

In the short term, the political repercussions were electoral. Cowen’s final months as taoiseach were farcical, culminating in a disastrous attempt to reshuffle the cabinet. By this time the Greens had already signalled they were departing government. It made little difference.

The two coalition parties were trounced in the election. It seemed clear that the populist political culture of the previous decade needed to be transformed. Many of the more radical reforms promised by the new Coalition have not happened or have been diluted. Governments tend to be more tentative about reform than opposition.

Some of these changes did not occur because of intervening events. One of the key promises that emerged indirectly from the Lehman collapse was the promise to hold a full inquiry into the banking sector, requiring a change in the Constitution to allow parliament more powers. That referendum was defeated, putting paid to the inquisitorial inquiry many members of the public had expected.

Now, new legislation will allow an inquiry but more limited in scope and in ambition. That said, it may answer some of the key questions about the fundamental flaws in Irish banking operations and regulations that were ignored by virtually every player until the Lehmans collapse.