This is a bondholder bailout which will sink us ; October 5 2010

In a desperate attempt to stave off the inevitable the government laid forth a series of plans, and plans for plans, for Anglo in particular. Here is my opinion as of early October 2010

 

There is no State scheme to remunerate private investors when banks are in distress, writes BRIAN LUCEY

IN 1968, Robert Conquest, the historian, published the first edition of a classic study of the purges under Stalin. Called The Great Terror, it was of course reviled by the Soviet state and its fellow travellers for its suggestions of tens of millions of innocents sent to the gulags. In 1990, he published a second edition, this time with assistance from the state archives, in which he substantiated his claim. His publishers asked if he wanted a new title, and he is reputed to have said how about I told you so, you f*****g fools ? . While we can in no way equate the meltdown of the Irish banking system with Stalinist purges, the same cycle independent analysts warn, they get reviled and attacked, and belatedly the official line eventually shows that they were if anything overoptimistic has been at work on this issue. The reality is the external critics and commentators have been proven substantively more correct than Government in our fears about the cost of the banking crisis.

The events of the last couple of weeks smack of increasing desperation by the Government. First we had the farrago of the announcement of Anglo being split into a bad and a worse bank, with conflicting statements issued on its operation. It is worth noting, by the by, that three weeks on, the Government has not yet seen fit to formally send details of the plan to the European Commission either a sign of incredible sloppiness or an indication that it was all smoke and mirrors.

The Anglo split, we eventually discovered, involves the exact same situation then Anglo deposits funding Anglo loans as now, but with two banks involved instead of one. When it became clear that this was not a solution but a demonstration of the ineptitude of policy, the markets reacted as was predictable on September 6th, our 10-year bond yield was 5.8 per cent and three weeks later, it was 6.9 per cent. The increasing yield appears to have been the catalyst for the announcements on Thursday, in another attempt to calm the markets. So what do we know from these?

There has been a massive change in the operation and scope of Nama. It will now not take over EUR 7 billion worth of loans from AIB and Bank of Ireland that are EUR 5-20 million, these loans instead remaining with the banks. Indicative figures from the banks suggest these loans would have attracted discounts at or near 70 per cent. It appears that this is being done in large part to facilitate the transfer to Nama of EUR 19 billion of Anglo loans.

The consequence is that these deeply impaired loans will remain on the books of AIB and BoI. This will do nothing other than to further impede the ability of the banks to recover. Let us not even begin to consider the tens of billions of losses that will emerge from the loans that were never going to Nama.

The banks remain deeply damaged, and the Government has scuttled its own plan for their solution. In a desire to reduce uncertainty around the Nama process and to have it completed (after which happy event we were constantly told credit will flow ) by the end of October, Nama will have to complete due diligence and valuation of EUR 19 billion worth of Anglo loans within one month. Given that these loans are in all probability those with poorer documentation and security, this is an enormous ask. In effect, the Government is transferring loans from one State institution to another without detailed transfer valuation.

This is exactly what was done in Sweden and what was urged by me and others in April 2009. By contrast, nationalisation per se requires no such controversial asset-pricing process. Nationalisation can still involve a Nama if the Government believes that reprivatisation of the banks would proceed best if certain of the most toxic and compromised assets have to be taken off the bank books altogether rather than just written down to market price.

It is important to realise that, had the State nationalised the banks, this would have happened only after it had forced them to recognise the true state of their losses. Nationalisation would have been a consequence of the State injecting the needed capital, as will now happen with AIB.

It is instructive to examine the case of AIB. AIB has an asset value on the market now of just about EUR 600 million. The taxpayer will have to inject some billions in additional capital, taking our stake towards 90 per cent. We will be purchasing, however, the carcass of AIB. Its valuable assets, in Poland, the UK and the US, which would over the next number of years have provided valuable cash flow, have been or will be sold. The State will in effect pay billions for an asset worth millions, an asset that will moreover not likely recover in value for decades.

On March 19th in this newspaper, I suggested that the policy of asset disposal by AIB was folly. I stand by that statement. While some asset disposal may be required as a token to the commission, selling the crown jewels leaves the organisation weaker.

Again, had a realistic loss assessment been forced on the banks in early 2009, and such assessments were in the public domain from independent analysts, we could now be moving towards refloating AIB as a medium-sized international bank rather than purchasing the AIB that existed pre-1970.

This takes place against the backdrop of a tocsin from the markets spelling their gloomy view of Ireland Inc. The Government, when not complaining that the markets are irrational or incorrect, has been adamant that bond yields are high due to uncertainty around the banks, without taking responsibility for the continuation and deepening of that very uncertainty. This is in some degree true markets don t like uncertainty, defined as not being able to put a probabilistic outcome on an asset, but quite like dealing with probabilistic risk. Diminution of uncertainty will, I fear, not bring significant relief in the bond markets.

The main determinants of sovereign bond yields, in the medium and long run, are well understood, at least in academia and by the markets. Researchers have demonstrated clearly, over time and across countries, that it is public debt that drives spreads. Having locked itself out of the markets, the NTMA is clearly betting that in early spring there will be a radically different perception of our fiscal position. All is therefore staked on the budgetary process delivering a credible plan. Another magic bullet is being sought.

A further problem with the bond markets has revealed itself with the realisation that while the Minister expects the subordinated bondholders to carry some pain, they are not playing nice. People like Roman Abramovitch do not get to own 300ft yachts and Premiership football teams by giving money away unnecessarily. It now appears that, in some cases, the subordinated bonds cannot be subject to a haircut unless the senior bonds are in default. And the Minister has stated, in cataclysmic and apocalyptic terms, that this will not happen.

What is missing here is that in most modern states there is a banking resolution mechanism, a special form of bankruptcy proceedings for banks, which can set the terms of how, and if, and in what way, bondholders are remunerated when the banks are in distress. It is negligence beyond the normal sclerosis of the Irish political system that three years after the Northern Rock collapse, we do not have such a mechanism. The effect of this is to protect the subordinated and senior bondholders. One has to ask why has such a mechanism not been put in place, and to whose benefit is it that it is not? It s clearly not in the taxpayers best interests. But then very little of the Government s policy on the banking crisis has been. While a resolution scheme may yet emerge from the slough of despond that is the Dáil, it will be too late to prevent the transfer of tens of billions of euro from taxpayers to wealthy private individuals, some of whom are certain to be domestic. We must find out why that is being allowed to happen and who benefits.

Brian Lucey is editor of Research in International Business and Finance and associate professor of finance at TCD

 

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