Monthly Archives: August 2013

It’s time for business to stop free riding and start engaging with Universities

This is an expanded version of an opinion piece which I have authored in the Irish Times Wednesday 14 August 2013

gdp spend students

Troubles, they tell us, comes in threes. For Irish universities this week shows that in spades. On one day we see a number of threads which taken together should give us some significant concern. These three threads are the proposed new funding model for third level (a classic curates egg), the issue of revenue auditing research and development tax credits and the issue of how much or little businesses worldwide engage with universities.

Before we delve into these its perhaps worth reminding ourselves of a few issues.

First, Ireland has an excellent third and fourth level system, with still surprisingly low levels of graduate unemployment and with significant pockets of world-class research.

Second, we have less state involvement than is commonly thought. Of the 1.5b per annum a large part of this is a subsidy for free fees. There is little appetite in the wider population for this to be abolished.

Third, we spend, over the tertiary sector cycle, less on average than the rest of the OECD (Which includes many countries much less well off than us).

Fourth, we have had no national open debate on what we want from our third and fourth level education system. The changes that are coming are led from the center, reflecting an ongoing tussle between the department of Education and Skills and the HEA. There has been little effort and perhaps exists less appetite to engage a debate amongst all stakeholders on what we want from our higher education sector.

Fifth, there is a genuine confusion in the debates, muted as they are,  about what we want from universities and what they do. Universities coproduce public and private goods. The public good is an educated reflective society and an independent critical thinking academy; the market will not provide this and so it falls to society to fund same. The private goods are the enhanced skills (over non graduates) which graduates attain. These, in principle, should give enhanced earnings which can be taxed and thus defray part of the public good cost as well as attracting some cofunding from the recipient in the form of fees.   This is rarely outlined with state funding seen as wasteful, luxurious, and profligate and tax seen as something intrinsically evil to be avoided at all costs. And therefore the debate revolves around funding – how much to whom how and at what benefit.

Sixth, we are already well on the way to a corporate led university sector – the Irish League of Credit Unions latest survey on third levle suggests that 1/2 of all third level entrants choose a place not based on what they like or feel they are competent to do but instead on the basis of current labour market vacancies. If this is the case then already universities have become training camps for the business sector.

As a state Ireland is broke and every single sector must both contract in terms of state involvement and show value for money. The promised funding model is as I state a curates egg. It suggests a series of key performance indicators that will determine the funding allocation. It is unclear from where these emerged. It is also the case that the more KPI’s one has the less each mean and the less credibility the entire set has.

These are reported to be the following : engagement in regional clusters, co-operation between individual colleges, student retention rates and inclusion of disadvantaged groups, teaching and learning excellence, research and increased commercialization, meeting regional labour market needs and enhanced internationalization, including more non-EU students.

It is not clear how these KPI’s  will be measured or even whether they can be measured. Nor is it clear why these and not others were chosen. What is also startling is the absence whatsoever of the things that students actually need : broad transferable skills. The KPIs are top down dirigisme, institutional focused rather than student focused and in many cases either liable to being gamed or to being irrelevant.

For example, what evidence is there that increased engagement in regional clusters will actually benefit either enhanced student learning or generate greater and more impactful research? Given that we don’t bother to measure research activity how will we measure research impact, or will it be the usual dreary rhetoric of commercialization patents and shortterm jobs created. How will be ensure that we deal with the output of arts, humanities and social science in that model? While it is tempting to call for a research analysis framework like the Research Assessment Exercise (now REF) in the UK, the costs of such a system need to be balanced against its beneficial effects. The REF has many rules, much paperwork and little flexibility to improve the engagement of academics with business. Similarity with cooperation – the KPI reeks of an unwillingness to accept that there will be some good and some less so institutions, departments and faculties and is a mechanism to hide failure under the carpet of excellence by merging strength and weakness to achieve adequacy.

How can we ensure that universities do not increase retention rates by dumbing down, and why is it the fault of universities and institutes of technology if students are ill prepared to cope with the academic and interpersonal demands of students emerging from the sausage factory of the second level? Today the leaving cert results come out ; tomorrow we will see the newspapers filled with adverts for grind and cram schools who will grind and cram young minds to one aim – pass the examination next year. Combined with a strong suspicion and perhaps societal desire for grade inflation in the same examination is it any surprise that even the best students falter when they are asked to engage with unbounded and freeform tasks at a high level in third level?

How does a thrust on Internationalization square with the need to be focused on regional labor market needs? And why is that a proximate and pertinent role for universities in any case? How local is local? How can we attract more non EU Students when the visa regime is archaic and our facilities poor compared to competing countries? Non EU students paying full economic cost cannot simply be lumped into already crowded lecture halls and be expected to act as goodwill ambassadors for Ireland in the future. The days when we could implicitly assume that they were lucky to get into a real university are gone, with world class facilities abounding elsewhere. We can’t charge more to deliver the same in worse conditions.

The issue on commercialization is one that goes to the second and third threads. It is often touted that we need more university-business engagement and that Irish business also needs to increase its research and development profile. To achieve that businesses have been given increasing tax breaks with long lifespans (on top of an already generous corporate tax regime) for research. In 2010 this amounted to 225m, nearly a quarter of the total state budget for third level. Revenue audits now suggest a high level of suspected abuse of this. And yet, not content with this generous tax break we also find that Irish business is amongst the least likely to engage with the third level. A survey in the times higher education on Monday suggested that Irish business invests only $8300 per annum per scholar in third level on research and innovation. This is less than 1/10 the amount spent by Korean or Singaporean, 1/9th the amount of Dutch and 1/8th the amount south African businesses invest. On the face of it this is startling.

There is an argument of course that this undervalues the amount of money put in by industry, as many courses at postgraduate level contain significant numbers of business executives. This however is also the case for other countries. Its also the case that other critiques can be made of the survey, notably its drawing from a relatively restricted sample (again however this is the case in all countries surveyed). While we might quibble with the exact numbers it would be reasonable to assume that the relative rankings are broadly correct. In any case nothing beats cold hard cash, and this is not and has not been forthcoming from Irish business in anything like the amounts indicated is the case in other jurisdictions. While Irish business persons have been generous (but not nearly as much as is thought and not even in the same dimension as some of the exiles children) when was the last time a corporation endowed a chair or a library or a lecture hall or sports stadium? Where are the corporate sponsored buildings, the corporate sponsored symposia and doctoral programmes? They are as scarce as actual green shoots in the economy.
Look around – how many chairs, centers, institutes have been funded by Irish business? While some exist, they are in fact few and far between. Compare that to even the lower tier universities in the USA or Canada, where there is a palpable engagement of business with academia running both ways to the benefit of both sides.

Lets stand back – Business in South Africa with a GDP per capita 5 times smaller than Ireland invests 8 times more per student per annum in research and development. And somehow this is spun in all the media as “Irish universities fail to engage business” . Israel and the UK, even Hong Kong whose funding models are seen as the exemplars we should aim for, are also very low in terms of business r&d to the third level, and this includes two countries with massive military industrial complexes. It is hard to not conclude from the two issues, business involvement and the R&D tax issue, that Irish business is all too often happy to take from the state and society and is not that keen to give back. For sure universities and IoTs need to engage more with them but it is a two way street. Engagement is not simply giving a few PCs or the odd bit of a chat, it is about business proactively funding PhD and postdoctoral students, about they endowing centers and developing longterm research, about ensuring that thought is put into industrial and commercial issues and that the needs of industry as a stakeholder in society are interwoven with academia. It is not chasing after rapid commercialization of the latest whizzbang nor about accelerating the undergraduate cycle to two years to produce inputs to industry.

We also need to re-evaluate how our MNC sector knits into the Irish economy and society. As the OECD and G8 made clear the friendly, Dublin as a friendly tax port of ease is over.  While much has been made of Apple’s tax arrangements with Ireland, little was discussed of what this meant for how MNCs do business in Ireland. It begs the question, if you are only around for the taxes why get entangled with the locals beyond coffee and sandwiches? For sure you will not be that   interested in fostering longterm intellectual relationships if the main driver is a tax loophole.

We need a debate on universities a and their role in society. They are not businesses. That is not to say that they should not be run in a professional, business like fashion with transparent budgeting and meaningful and appropriate professional management. Universities in particular exist to first and foremost provide educated engaged members of society. They do not exist simply to train people for industry. Industry has been good at outsourcing its basic skills training to the state, in effect free riding. Perhaps its time to think about giving something back?

Ultimately, the THES shows that aping one country will not work. Israel is one of the powerhouses of innovation and academic excellence but does poorly in this survey. Denmark, also a powerhouse of innovation, does well. They both have strong academic, entrepreneurial and innovation backgrounds but have different approaches to how they manage. The risk is that government policy tries to pick a country to follow as a model. Ireland needs to follow a mix of models and accept that these things must progress organically. Organic means bottom up – it does not mean being kept in the dark and fed manure

Advertisements

Ireland – its all goood…its alll gooooodddd

keep-calm-and-drink-the-kool-aidNo, really it is apparently all good. So sez a report by Euroweek. Mind you this is sponsored by a bunch of banks with significant exposure to Irish debt/bonds/interests so they are hardly likely to say “RUN RUN FOR THE HILLS” even if that were (which it probably isnt) warranted. Still. The centerpiece is a transcript of a roundtable on ireland. Whats astounding is NOT A SINGLE contrarian voice is to be heard. The herd thunders on. Feel free to read. There are some gems.

Some I particularly like :

 

if you offered the Spanish or the Greeks an
unemployment rate of 13.7%, they’d bite your hand
off, wouldn’t they

……

Public sector pay will be further reduced.

……

“given  healthy nominal GDP growth of 3%-4%
and interest rates of 4%-5%, the debt
trajectory looks sustainable.” [ and a puppy..my edit]

……

the increase in the population over the last 25 years means that as a percentage the gross number of emigrants is still down on the late 1980s. the second is ..ryanair …, which is allowing people to fly around the globe at a fraction of what it cost to do so in the 1980s.

……..

The economic situation in Ireland  has been quite stable over the last couple of years

……….

still, lets not be too negative. …

 

Realtime thoughts on the crisis 2008-10

hqYwsOver the last day or so I have posted a number of the opinion pieces which I had (mainly in the Irish Times) during the acute phase of the Irish banking crisis. For quick reference these are here. Its always interesting to look back at how one saw an issue in ‘real time’. I think the analyses stand up fairly well. I make no claim for prescience – for the most part these arose from discussions with bankers, academics, politicians and business people and represented my attempts to get to grips with what was going on.

So here they are with my ‘now/new’  titles

Enough, already, just pull the plug on Anglo before its too late ; September 2 2010

Id had it with the arguments that Anglo could be saved. Here is my oped in the Irish Times on 2 September 2010. Enough already…

OPINION:Ordinary folk have paid enough. Subordinated and senior debt holders should cover the rest

THE HORRENDOUS losses of Anglo Irish Bank come as no great surprise to informed analysts of the banking catastrophe. The Government s solutions amount to no more than insisting the taxpayer must, under all circumstances, bear all the losses Anglo will continue to create. This cannot be borne.

That there are significant additional losses to come from Anglo is undoubted. The Government and its proxies continue to assert, without placing in the public domain any detailed analyses, that the losses will be capped at EUR 25 billion. This is the same process that has successively asserted that the losses will be EUR 4.5 billion, EUR 12 billion, etc. Why are we expected to believe them now, when they have proven to be wildly inaccurate in the past? Analysts inside and outside Ireland believe Anglo s losses will be at least EUR 35 billion with potential for EUR 40 billion-plus.

Anglo, like all banks, is funded in five ways: deposits; borrowings /deposits of a short-term nature from other banks and central banks; longer-term borrowing (senior debt); longer-term borrowing with less protection (subordinated debt), and by shareholders. The question that arises is simple: which of these should be protected in full, and which in part? It is startling that, as of now, only the most junior party, the shareholders, have been asked to take the full consequences.

Some subordinated debt has been (voluntarily) renegotiated, but there remains some EUR 2.5 billion of subordinated debt in Anglo. This should now absorb the next EUR 2.5 billion of losses. It is unfortunate that the Government has guaranteed some of this, but this is a legislative act and can be unwound.

Beyond that, we are into the realm of senior debt holders. Anglo has borrowed some EUR 14 billion from such investors, of which some EUR 7 billion is repayable in September. It is now beyond time that these investors be informed that their investment is not fully payable. There is more than enough in the subordinated and senior bondholders to absorb even the most pessimistic estimates of losses to emerge from Anglo. We can, and I say we should, consider this.

We are told by the Government that to do so would be a sovereign default. This is palpable nonsense. Anglo Irish is a private institution, which has some elements of its capital structure guaranteed by the Government. It is not the State. The reason the guarantee was given was the fear that allowing Anglo to be wound down in 2008 would have precipitated a cascade of Irish bank failures. While this is debatable, we are now in 2010. The taxpayer has paid enough.

Governments have a genuine concern that if a state defaults, it may not be able to re-access bond markets. But even if we allow the fantasy that Anglo is the same as the State, assertions that this chimera would be locked out of the international bond markets are false, and are pedalled as a scare story to frighten the taxpayers and citizens into ponying up sovereign money to bail out private investors.

Bond investors look forward what they are interested in is the risk that they will not be repaid. A history of default will of course impact on the amount of money they will lend, and the price they will charge. But the evidence is that even serial defaulters can gain funds on an ongoing basis.

Academic evidence, including papers from the International Monetary Fund, indicates absolutely no evidence that sovereign investors are permanently excluded from the international capital markets after a default. Even in the rare cases of temporary exclusions, in the sense of not being able to issue bonds, this rarely lasts for more than two years. In addition, the evidence is that any increase in sovereign debt costs is short-lived and transitory. We have to decide: is the price for the taxpayer of any increased cost of lending if we discontinue support to Anglo, less than the cost of continued support?

There is in my mind no question now but that there is a moral, political, economic and social need for the subordinated and senior debt holders of Anglo Irish Bank to bear the remaining costs. There is a timing problem, however any announcement of the intention to force these losses on the senior bondholders would have to come prior to the renewal of the guarantee at the end of September. Thus, the next three weeks are critical.

There is an argument that this decision to withdraw the guarantee should be taken in conjunction with another. The State is now paying more for money than it would if it were to access the EU stability fund. The judgment of the bond markets is that the combined banking and fiscal crises are such that Ireland is no longer a sound bet. A very large part of this is the increasing concern that there is not the political will to deal with either of these problems, never mind both.

Pulling the plug on further taxpayer involvement in Anglo may best be done at the same time as announcing that we are to seek the assistance of the EU in restructuring our fiscal position.

It is time to seek to place ourselves in the hands of people who can run the State effectively and in the long-term interests of the citizens. Political or indeed national pride should not stand in the way of this.

Brian Lucey is associate professor of finance at Trinity College Dublin

We must deal with Mortgage debt to move on : November 11 2010

Another multisignatory oped in the Irish Times, this time on the need for mortgage debt, with some writeoffs, being needed.

 

Economists Constantin Gurdgiev, Brian Lucey, Stephen Kinsella, Ronan Lyons, Karl Deeter, Shane Whelan, David Madden, Brendan McElroy, Valerio Poti and John D Masson suggest a way to help mortgage defaulters

THE BURSTING of the boom has left tens of thousands with debts they will never be in a position to repay. These debts are poisoning the balance sheets of Ireland s banks, preventing the emergence of an economic recovery, as well as causing untold social misery. As a society, we must face up to this.

Two main problems exist: first, hundreds of thousands of people now find themselves in negative equity, where the value of their primary residence is less than the loan secured on it; and second, more than 100,000 also find themselves in difficulty paying the interest costs on their personal home loans.

With house prices continuing to fall, interest rates set to rise, after-tax disposable income falling and unemployment remaining high, there is a massive socioeconomic problem to be addressed.

Current asking prices suggest that 200,000 households are in negative equity, the majority of 270,000 people who bought between 2005 and 2008. Figures from June show 36,000 mortgages were in arrears of three months or more, with collective arrears of just over half a billion euro. These figures do not account for tens of thousands who have renegotiated, switched to interest-only repayments or obtained a reduced repayment schedule for a period of time.

If house prices fall by 55 per cent from the peak, half of buyers in 2004 and a quarter of those in 2003 would enter negative equity and 200,000 households would face negative equity of more than EUR 50,000 and there would more than likely be 60,000 households in arrears.

Their arrears of EUR 10 billion would compare to total mortgage debt outstanding in the Republic of EUR 115 billion. In the context of an overall bank bailout scheme of EUR 50 billion and rising, it is relatively small but at the individual level and, equally importantly, at the level of the real economy, it is a very large problem indeed. We suggest that this makes full or partial debt forgiveness a viable consideration. From an economic perspective the key question is: how would partial debt forgiveness affect the Irish economy?

Individual households in debt do not spend, they do not invest: they attempt to pay down debt when and where they can and they hoard cash. Arrears and negative equity lead to reduced entrepreneurship in the long run, as distressed households face both less wealth against which to borrow and more uncertainty about their income and safety-net savings.

In Ireland this is compounded by the draconian, outdated and entirely inappropriate laws on personal bankruptcy, the lack of non- recourse mortgages and the effect bankruptcy judgments have on an individual s ability to engage in business.

These cumulative economic effects can be tackled through a debt forgiveness mechanism. Banks must allow private home borrowers to revert to pre-crisis debt burdens. Ireland s banks must acknowledge that current debt levels are unrealistic and that timely write-offs are necessary.

Unable to control the external value of our currency, we need to replicate the effects of a devaluation internally to regain international competitiveness. The problem with deflation (and we are experiencing a brand of it) is that as price levels fall, the pain of the debt increases. Generally a policy choice is to inflate the debt away, but in Ireland, we typically do not issue loans on long fixed rates so, even if we could devalue our currency, borrowers would still be crippled as rates shot up. In the long run, socially and economically, debt forgiveness is the best option.

Internationally, more advanced menus for systemic mortgage default crises cover a wide range of options. Successful debt resolution regimes set the cost of restructuring at levels where households ability to pay preserves the value to lenders, in excess of what can be achieved in an immediate foreclosure.

In the case of Ireland, such a formula would most likely lead to an implicit writedown of at least 30 per cent of the more recent mortgage amounts on average, yielding an expected total cost to the entire system of circa EUR 37 billion to EUR 49 billion.

In Ireland, there were two initial responses to the crisis. The Government forced banks into signing, then extending to February 2011, a moratorium on repossessions, meaning lenders must wait at least a year from the time arrears first arise before applying to the courts for a repossession order.

Privately, people have been exhausting their savings, and that of family and close friends, to stave off slipping into arrears. Both of these are stop-gap measures and new approaches are emerging.

Publicly, the Expert Group on Mortgage Arrears has proposed reforming bankruptcy and introducing non-judicial debt settlement. Privately, Ireland is seeing more and more accidental landlords as people rent out their home and either move back in with parents or become tenants elsewhere. These are, in the end, only temporary and partial measures.

We suggest that as there are three parties to the problem the banks, the regulator (ie the State) and the individual these three must also be part of the solution.

For persons in negative equity, or where the loan is so large that it is becoming distressed, we suggest some degree of individual debt forgiveness and restructuring.

There is an argument of moral hazard that must be addressed if individuals do not suffer the consequences of their actions, then there is a reduced incentive for them and for others to behave in a sensible fashion. We argue that the existing levels of distress, plus the partial nature of the debt forgiveness help to mitigate this. People have already been burned and this lesson will not, it is to be hoped, be lost.

In addition, the banking and regulatory systems have collapsed and are in the process of being rebuilt. Central to the new systems must be a set of regulations, rigorously implemented, which prevent this problem from recurring and which will realign incentives properly to price risk in lending by shifting some of the burden off the shoulders of the borrowers and onto the lenders.

In order to implement this burden-sharing, a binding arbitration process needs to be put in place, to allocate the excess burden. In addition, we need urgent changes to the bankruptcy laws and to introduce the non-recourse mortgage option.

The request for entry into arbitration can be initiated by the borrower or lender. The arbitrators, which could be Mabs or some other independent organisation, would be empowered to determine either the allocation of any negative equity burden or to alter and adjust the mortgage terms.

For lenders who refuse to enter into arbitration, alterations to the mortgage code or ultimately the withdrawal of licence are appropriate responses. The public good is best served here by forcing the banks to take the great part of the losses for which they were responsible, not forcing the hard-pressed homeowners to take an unbearable burden into the future where they will inevitably buckle under the strain of repayment with disastrous social and economic consequences.

The losses that will be crystallised in the banks can be filled with additional Nama bonds now that we have Nama, we may as well make some use of it. This will increase the interest burden on the taxpayer, or in the end perhaps on the ECB but we argue that, in the overall socioeconomic context, debt forgiveness to the maximum feasible extent is a first step to restoring the economy and society.

Dr Constantin Gurdgiev, lecturer in finance, TCD;

Prof Brian Lucey, school of business, TCD;

Dr Stephen Kinsella, lecturer in economics, University of Limerick;

Ronan Lyons, Oxford University and Daft.ie;

Karl Deeter, Irish Mortgage Brokers;

Dr Shane Whelan, actuary, UCD school of mathematical sciences;

Prof David Madden, school of economics, UCD;

Dr Brendan McElroy, department of economics, UCC;

Dr Valerio Poti, lecturer in finance, DCU;

John D Masson, lecturer in economics, UCC.

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

 

The economics of Mr Micawber wont do : Feb 22 2010

the FF government stumbled and bumbled from crisis to crisis in the dreadful years of 2009-10. Here was my thinking at early 2010 in the Irish Times

Micawberish thinking on the problems in our banks means that, 18 months into the crisis, no effective repair action has taken place

ONE OF Dickens s great characters is Wilkins Micawber, in David Copperfield, who was wont to say something will turn up , and it appears as though such sentiments are at work still in Government thinking on the banks.

Eighteen months into the crisis in the Irish banking sector, and astonishing as it may seem, no real effective repair action has yet taken place. Not a single impaired loan has been taken off the books of the banks. Instead, Government handling of the banking system has been marked by an unwillingness to face up to this fundamental problem the banks are effectively bankrupted by the losses that they face on speculative lending.

The National Asset Management Agency (Nama), as structured, is designed to buy time for the market, somehow, to sort it out, as there is an ideological obsession at the heart of Government against the notion of the State as the majority shareholder in the banks, even if required and even if temporary. But events may force their hand.

Recall that Nama will in essence take off the banks the loans secured on now deflated bubble assets. The idea is that, in extremis, Nama can sell the assets for their long-term economic value and recoup some of its outlay. Nama is proposing to take over some EUR 33 billion of land and development loans in Ireland alone.

Recently it has been suggested that a major problem exists, in that in many cases of development land the title was not actually transferred to the developer; rather, they took out a licence to develop. This was, it seems, a scheme to minimise tax, but it leaves open the incredible scenario that rather than being secured on an asset, these loans were secured on what is technically a derivative whose value has now collapsed to zero. If the underlying assets are worth zero, the hole in the banking system is that much larger.

As if that was not enough, every day in the Commercial Court we see a parade of distressed loans secured on assets whose present prices are a small fraction of peak values. Nama is proposing to pay EUR 54 billion of taxpayers money to transfer EUR 77 billion worth of loans secured on assets worth some EUR 47 billion in mid-2009. This fall of over 35 per cent in asset values bears no resemblance whatsoever to reality. The Commercial Court sees falls of 70-80 per cent, and falls of over 95 per cent have occurred. Again, the hole in the system is much larger than Nama business plans suggested

The most public face of the creeping failure of Nama is the forced involvement of the State in Bank of Ireland. As part of the initial plan to prop up the banks the State issued AIB and BoI with EUR 3.5 billion in exchange for preference shares. While these did give voting rights and a warrant to take shares, they did not in and of themselves confer any direct ownership. The dividend on these was to be 8 per cent, some EUR 250 million.

However, the EU has stopped the banks from paying any forms of dividend when they are in receipt of State funds, as otherwise we would see a direct and transparent transfer of money from the State to private individuals. The effect of this was to force the State to take shares worth EUR 250 million, some 16 per cent of Bank of Ireland, in lieu.

As late as last week the State was still in Micawber mode, with the NTMA and the Department of Finance ignoring this and hoping that something would allow the State to take the money and/or defer payment and/or . . . something, anything, just not to become a shareholder in the bank.

The ideological obsession with non-State ownership has been driving the Nama plan all along; but the Rubicon has been passed the State is owner of a large chunk of Bank of Ireland. The Government hopes that by the time AIB has to pay its dividend in early May, something will turn up that will allow the State avoid taking shares. That something is hoped to be the EU finally approving Nama; but it is not at all clear that even then the EU will allow the banks to resume dividend payments. While the markets will have factored in some probability of the banks shares being diluted by the requirement to issue more shares to pay the dividend, the trajectory for Irish bank shares is probably downwards.

The market value of the two main banks has fluctuated around the EUR 1.2-1.5 billion mark. A minimum of EUR 3-4 billion extra is probably required in capital by each. With even more stringent international capital requirements looming, with the overhang of the warrants attached to the preference shares and with the banks toxic loans not yet cleaned, the likelihood of gaining this money from the private sector is slim. That will leave the State as the only source. Herein lies a bad joke the State, when it steps in further to take shares in the banks, will have to dilute its existing shareholdings gained by the share dividend payment. In saving the banks it will destroy the value it has now taken.

Two subsequent issues then emerge. First, where will the State obtain this money to recapitalise the banks (leaving aside the financial black hole that is Anglo, which may require EUR 10 billion more merely to stay in its present zombie state)? We face several years of fiscal stringency and it will be a hard sell for any minister for finance to say, in effect, that the taxpayer needs to bail out the banks further while themselves being taxed more for less services.

Second, throughout the banking crisis a deliberate and calculated rhetorical device has been employed: Iceland nationalised its banks; Iceland is in deep trouble. This is an argument known as post hoc, ergo propter hoc (a happened after b, therefore a was caused by b). Iceland was in such trouble that it had to nationalise its banks. If we are now forced  to nationalise the banks how can the Minister say we are not in massive trouble?

But how can we avoid this reality and should we? Micawber, we should recall from reading David Copperfield, ended up in the clink because he did not face reality. Nationalisation, or majority State-share ownership, is firmly back on the agenda. Something has turned up, but it s not what the Government wanted.

Brian Lucey is associate professor of finance in the school of business studies, Trinity College Dublin