We don’t have to pay a cent to the Anglo junior debtholders but we probably will. Below I walk through why the Government are either misled or misleading and opine on how we can avoid payment. We have a legal template, which could be tabled. FF should continue to drink its tall glass of STFU on Anglo, so it is down to the opposition. Sinn Fein are busy posturing on meaningless motions on the Taoiseach, the anti-austerity-unless-its-a-party-leaders-allowance-before-logic-party is doing whatever it does, so really its down to people like Shane Ross, Stephen Donnelly, Tom Pringle and so on, the (apparently ) concerned left and right, to table this. Continue reading
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.
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;
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.
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
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.
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.
the IMF weighed in in June 2009. It was spun as approval. It wasnt. Here is my Irish Times reaction piece
THE STATE of the Irish banking system remains parlous. This is particularly evident in its capital base. Notwithstanding the financial engineering of recent months, which has released capital through debt restructuring, Irish banks remain undercapitalised to meet regulatory and likely future losses.
Estimates by Oliver O Shea ( Restarting flow of credit the most immediate challenge facing main banks , The Irish Times, May 23rd) suggest that even under very optimistic scenarios total capital available to the main Irish banks is no more than EUR 50 billion. It is also useful to recognise that regulatory minimum ratios for capital are now significantly less than the market desired ratios. In plain language, although banks may well pass legal tests of being adequately capitalised, they may not pass market tests.
The present state of the Government s dealings with banks might best be described as piecemeal a smidgen of guarantee here, a dollop of preference shares over there, a bit of urging to restructure here, a nudge towards bolstering common stock elsewhere, and an overarching commitment to preserve the banks in as majority a public ownership as possible. Meanwhile, banks profit bases remain under stress and are unlikely to provide the tens of billions required to rebuild the balance sheets.
The International Monetary Fund (IMF), in its article IV consultation report just published, places the banking crisis front and centre. Its analysis of the response of the Government is damning. It is important to recognise the report is ultimately a political document and would have been drafted and redrafted. Thus any comments critical of the actions of the State must be read as having passed through several formal and informal filters prior to final publication.
The IMF starts its analysis with an estimate of bank losses of some EUR 35 billion. It is a massive indictment of the quality and competence of Irish economic governance that they state, on page 15, The authorities did not formally produce any estimate for aggregate bank losses.
In plain language, the Department of Finance either did not present or did not have any idea of the scale of the likely losses. It quite literally beggars belief that nine months into the crisis this could be the case. If the department does not have estimates, then it is grossly delinquent. If it does have estimates, and did not present them to the IMF, then one wonders what is being hidden. In any case, a loss of EUR 35 billion would render the Irish banks undercapitalised from a regulatory standpoint and most probably would result in their being economically insolvent.
The IMF report then examines the National Asset Management Agency (Nama) and emphasises over several paragraphs the importance of the new agency cleaning up the bank balance sheets swiftly and completely. Yet, we see (on page 19), They [the Department of Finance] agreed that piecemeal efforts could keep banks dependent on official support and unable to resume normal functioning. The Japanese experience is particularly cautionary.
This should chill the blood of any reader: the Department of Finance, which has led partial effort after partial effort to solve the banking crisis, and which is committed to more partial efforts, accepts that if these do not work, the economy faces a lost decade. Indeed, in that paragraph, the Department of Finance is reported as saying also: The authorities took note of these considerations for their further deliberations on setting up Nama.
Nine months into the crisis, five months after Nama was announced, and the department is considering further deliberations on Nama? No rush lads . . .
The IMF concludes with an analysis which echoes in all important elements the opinion in this newspaper (April 17th) of 20 economists (of whom I was one) that nationalisation plus Nama may be the way forward. The report states, Staff noted that nationalisation could become necessary but should be seen as complementary to Nama. Where the size of its impaired assets renders a bank critically undercapitalised or insolvent, the only real option may be temporary nationalisation . . . Having taken control of the bank, the shareholders would be fully diluted in the interest of protecting the taxpayer and thus preserving the political legitimacy of the initiative. The bad assets would still be carved out, but the thorny issue of purchase price would be less important, and the period of price discovery longer, since the transactions are between two Government-owned entities. The management of the full range of bad assets would proceed under the Nama structure. Nationalisation could also be used to effect needed mergers in the absence of more far-reaching resolution techniques.
Recall when reading this that the IMF has stated the losses are such as to leave the banks in a position of undercapitalisation at best. This argument from them echoes the almost unanimous consensus of academic finance observers. However, undaunted, the department (who, remember, don t seem to know the magnitude of the problem they are trying to solve) disagreed. However, their arguments (on page 19 of the report) are straw men the need for nationalised banks to operate under the same regulatory regimes as non-nationalised ones, the need for a clear exit strategy, the need for lack of politicisation of lending that have been discussed and to which solutions have been suggested in many forums including this newspaper.
So we are left with a Minister committed to incrementalism in solving a crisis the magnitude of which his department professes ignorance of, an incrementalism the department agrees runs the risk of a lost decade, and a determined if unargued rejection of all advice (internal and external) relating to the efficacy of the sole solution proposed.
And we wonder why the country is in crisis?
Recall FG proposed a state bank? Here was my reaction plus some thoughts on NAMA, in the Irish Times May 18 2009
NAMA IS dead in the water, moving only due to political inertia. It is drifting towards legal reefs and organisational shoals that were clearly visible on the charts.
Six weeks after its announcement in the Budget, nine months into the domestic banking crisis and the Government is reduced to pleas to trust them that the operational details will be revealed, eventually.
It is startling enough to see the Minister for Finance of a Eurozone country engaging on what is effectively a roadshow to sell bonds, a task more typically entrusted to mid-ranking corporate financers; it is surely unprecedented that on such a roadshow, the aim of which is to raise funds, the person doing the selling would cast such cold water, as he did, on the very concepts underpinning the sales concept.
To make matters worse, back at home, Michael Somers, the ultimate head of Nama (the National Asset Management Agency), more or less suggested to an Oireachtas committee that he had no idea how the organisation would or could work.
In this regard, Fine Gael s plan for the banking system is to be cautiously welcomed. It represents an attempt by that party to engage with the complexity of the banking crisis, and although in my view potentially flawed, is superior in almost every way to Nama.
The Fine Gael plan seeks to create a National Recovery Bank which would be capitalised by the State. This National Recovery Bank would underwrite or guarantee the SME (small and medium enterprise) lending of the existing banks via short-term Government-guaranteed borrowing from the European Central Bank.
The recovery bank would signal the end of the blanket guarantee on interbank and debt instruments after September 2010 in an effort to force the holders of those instruments to take a share of the losses on toxic lending; and it would create good and bad banks from the existing stock of banks the bad banks then remaining as workout vehicles to run themselves to liquidation.
The Fine Gael approach is conceptually similar to that of the Federal Deposit Insurance Corporation in the United States when they move to rescue or liquidate failed banks.
However, as Karl Whelan points out on irisheconomy.ie: The FDIC arrive secretly on a Friday afternoon they don t signal 16 months beforehand that they ll be shutting a bank down.
The reason for this is that a time period between announcement and effect allows for significant problems to emerge.
The Fine Gael plan would create a system which, at least for a while, is populated by undercapitalised or zombie banks, banks which are not be able to carry out their normal role in the economy. As well as undercapitalisation, the banks would be illiquid. As a consequence of the announced end of the guarantee, banks would not be able to source any funds that extended beyond September 2010 (when the guarantee ends) and so would be forced to rely only on the sluggish interbank markets, with the certainty that as the end of the guarantee looms, they would only be able to source short-term expensive funding.
The banks would not be able to extend new credit, nullifying the desire to pump credit to the SME sector.
Indeed, the effect of the drastic reductions in capital that would be a consequence of the banks having to, on their own, absorb toxic loans would be to reduce the banks to a state where they were unable to continue in business.
While it is proposed to rectify this at the end of the guarantee period by carving good banks out of bad, the plan would result in at best temporary zombification of the entire system and at worst a closure of the banks.
The consequences of this for the economy are well known and would be utterly disastrous. There is an issue common to both Nama and the Fine Gael plan: an assumption that they will, if implemented get credit moving . This is fallacious, as no plan thus far suggested can, in fact, increase credit.
A combination of a shrinking economy and shrinking capital bases of banks will inevitably result in shrinking lending. It cannot be otherwise.
The key issue is to manage the shrinkage, to ensure that the percentage of credit overall which extended to non-productive investment or overextending household leverage is drastically reduced.
Sectoral credit exposure management is properly the role of the financial regulator and the central bank.
Another issue with the Fine Gael plan is related to the period between announcement and implementation. Depositors would be told that deposits would be transferred to new, clean banks, when set up. In effect, the Fine Gael plan would be to say I m from the government, trust me .
In an environment where not only trust in the banking system but in the political system is broken, this is not in my view sufficiently strong to stop people moving deposits to other credit institutions. Politicisation of credit decisions is rarely a good idea. There is no guarantee whatsoever that the National Recovery Bank would not be politicised.
Indeed, the plan says that some banks would be provided with new guarantees to enable them to operate in the interim between announcement and implementation. This raises the questions of who decides what banks get which funds and on what criteria.
Finally, the Fine Gael plan contains within it, as does Nama, the acceptance that the State will end up the owner of the banks nationalisation. It states that if the new banks that are carved out are not able to raise funds, the State will provide.
It is certain that were any Irish bank, no matter how clean, to go to the international equity markets in late 2010 and seek funds, they would get a cold reception.
So nationalisation of the active bank system would be required. As all paths identified in the debate so far lead to the same end, nationalised banks, it is surprising that discussion on how to get there persists. It is only delaying the inevitable.
Published in the Irish Times May 12 2009
THE MOST important debate, declaration of war aside, in which the members of Dáil Éireann will ever participate is this week. The debate is the decision whether to bring the banks under the auspices of Nama or to nationalise them.
At stake is EUR 90 billion of taxpayers money three years tax revenue the international reputation of Ireland as a haven of cosy crony capitalism, the cost of international borrowing and the future health of the economy.
However, calling it a debate is wrong. Debate implies a sequence of informed speeches designed to sway the Opposition towards one s own position. The Dáil discussion s outcome is as predetermined as the course of the stars, with whipped vote fodder on all sides reiterating existing party positions before trooping loyally through the Tá or Níl gates, regardless of their own perspective or how persuasive they found the other side.
As an Oireachtas member noted to me last week on another issue: I will always vote with Fianna Fáil, regardless of my conscience.
The debate on Nama, the proposed National Asset Management Agency, and nationalisation has been ongoing for some time. My position is well-known that temporary nationalisation is a superior approach to the banks being under Nama s auspices on a semi-permanent basis.
There are as yet no serious, independent economic commentators in Ireland that have come out on economic grounds against temporary nationalisation. Where independent commentators have demurred it has been on the basis of managerial concerns regarding the politicisation of lending. Note that here I stress independent commentators bank and market employees are not, and cannot, be expected to be independent, and their comments should be weighted accordingly. This is not to ignore or denigrate these views, merely to contextualise them.
Nama, we are told over the weekend, is facing legal challenges, as was forecast. It has been warmly greeted by the Green Party and by commentators on the left who have suggested that the State as a significant landowner-landlord would allow direct State intervention in these markets. Thus those who oppose nationalisation on grounds of political interference find themselves sharing space with those that propose Nama as a vehicle for political interference.
We are also told that were it a private entity, Nama would require upwards of 700 specialist staff to operate, while plans suggest a staff of 30-40. Finally of course, there is the fact that any realistic asset management agency will require recapitalisation of such magnitude that the State will become the owner of at least 80 per cent and possibly much much more of the banks.
A persistent assertion against nationalisation is that nationalised banks will not gain access to the international interbank markets. The argument is logically flawed, but if true, contains the most dire portent of economic failure ever issued by a finance ministry. Banks, like all large operations, place and receive funds daily to smooth out peaks and troughs in their own financial requirements.
The Department of Finance asserts that a bank that is nationalised (as opposed to one that is merely 90 per cent State-owned) would simply be refused such funding from the international markets. There is no evidence or research findings that I or others can find that indicates that this is necessarily so.
Empirically, we find state-owned banks operating with interbank liquidity funding. Funds flow to the highest yielding lender for a given level of risk, the risk being the risk of the ultimate backer of the entity doing the borrowing. In a nationalised situation, this is the State. Banks also borrow to enable them to extend more funds than their deposits alone would allow.
This latter business model, of funding one s operations via wholesale money markets, is one that is no longer possible and to defend it is to defend as a model for the future banks such as Anglo, Northern Rock, Depfa and others who have failed. A version of the argument suggests that nationalisation, by imposing losses on the second-tier capital, bondholders, will cause them to shun banks seeking liquidity. Again this is asserted, not proven.
In any case, this second-tier capital is trading at a low percentage of face value, with many investors therein having already realised significant losses and being thus potentially amenable to accepting a mild premium on existing value to exit the market.
The only logical situation wherein a nationalised bank were to find itself unable to source interbank liquidity is one where the markets were doubtful of the repayment capacity of Ireland. We are also told that the only way in which the banks can operate at present is that they have the de facto backing of the State, de jure via the bank guarantee.
How nationalisation can weaken this situation is not clear. Apart from a treasury manager from a large international bank stating we will not lend to nationalised banks come what may , we must take this argument as being at best unproven. If, however, the department has had such advice, then that is equivalent to the international markets calling bankruptcy on the State, as they would be saying that they did not consider that the State could, with nationalised banks, meet its ongoing obligations. And we know that the State will have to in effect take on the banking system. So where does that leave us?
Regardless of the economic arguments, it is clear that the Government feel that they have such political capital invested in Nama that to retreat from their position now would be to show weakness. This does not bode well as it implies that politics will override economics when we are in an economic crisis.
Perhaps implementation of rational economic policies will have to await external forces with no political allegiance to the present State.
After the “nationalisation needed” oped the then economic advisor to the Minister for Finance penned a rebuttal. This is the re-rebuttal, published in the Irish Times April 27 2009
DR ALAN Ahearne argues (April 24th) that nationalisation of the banks is inappropriate and perhaps dangerous. As a senior adviser to the Department of Finance, his views presumably reflect official thinking and so bear analysis.
His arguments are in response to an earlier piece (April 17th) signed by 20 academic specialists in finance, wherein we urged nationalisation of the systemically-important elements of the Irish banking system. This would, we argued, provide a superior outcome for the taxpayer than a National Asset Management Agency (Nama)-only solution, and indeed could work in conjunction with a mini-Nama if desired. It is interesting that essentially the same arguments made by us have been articulated by Paul Krugman, a Nobel laureate for economics, and the International Monetary Funf (IMF).
Dr Ahearne s arguments are wrong. In forming this response I have spoken to many of the signatories of the April 17th article, and while I speak here only for myself I believe my views are representative.
Dr Ahearne makes five arguments: that nationalised banks would not get funding; that nationalising would be a stain on our economic reputation; that Nama is better for the taxpayer than nationalising; that nationalised banking systems retard economic growth; and that nationalisation is a one-way street.
It is worth noting that throughout the article Dr Ahearne represents the April 17th article as arguing for the entirety of the system to be nationalised. This is incorrect and represents a partial and surprising misreading as we suggested nationalising only those banks that were of systemic-importance.
Dr Ahearne suggests investors would surely give the Irish market a wide berth in the future not just in the banking sector if the State undertook such an extreme step .
Yet the decision to guarantee all liabilities of the banks, seen from the perspective of bondholders expectations on repayment, was de facto nationalisation, making the taxpayer responsible for all repayment.
The cost for the State in terms of its borrowing has been significant. Taking the important banks into State ownership now would reduce the contingent liability and thus reduce costs of funding. Perhaps Dr Ahearne is concerned that the markets would equate nationalisation with expropriation but this manifestly cannot be the case if fair value is paid.
That this fair value may be close to zero is another issue. The Minister on Budget night in discussing the allocation of losses across bank capital base and the taxpayer appeared to confuse inter-bank borrowings (the normal day-to-day borrowings all banks engage in to smooth out liquidity peaks and troughs) with capital borrowings (money lent to banks and which form part of the tier two capital required to be held as a buffer against losses).
Dr Ahearne now suggests that nationalised banks will not be able to secure access to the inter-bank market. A number of issues arise here. First, the excessive growth and over-reliance of banks on this source of funding was a key contributor to the Irish banks problem and, therefore, were there to be a reduction in same it would be welcomed.
Second, Dr Ahearne states it is naive to think that providers of funds do not differentiate between banks with a market presence and nationalised banks .
Again, this argument is hard to understand.
First, there is simply no evidence that state-owned financial institutions face greater problems than non-state-owned in sourcing inter-bank funding. Second, it is clear and has been admitted to by at least one bank covered by the guarantee the Irish Nationwide Building Society that the only way they can continue to source funding in this market is under the umbrella of the State. A nationalisation provides a far sturdier umbrella than a revocable guarantee.
Finally, large funders prefer to fund, on a short or long-term, entities that are backed by sovereigns (who have recourse to taxation to repay) than lower-rated speculative plays such as poorly-capitalised banks.
On the issue of Nama versus nationalisation on the taxpayer, Dr Ahearne confuses at least two distinct issues. The existing ownership which he lauds as providing an upside for the taxpayer is utterly separate from the Nama.
Second, while Nama provides for a further injection of equity capital, this will occur down the line when perhaps bank shares have recovered somewhat and thus be more expensive for the taxpayer. A benefit of nationalisation is that it would cost now merely EUR 2 billion to totally purchase the equity of the systemically-important banks. How paying EUR 2 billion for 100 per cent can be inferior to paying EUR 7 billion for 25 per cent is a mathematical conundrum. In essence, nationalisation now takes the entirety of the upside into the hands of the taxpayer.
The extent of recapitalisation that will be required is essentially the same under Nama as under nationalisation and will have to come from the State. It is a mystery as to why the Department of Finance considers that the suppliers of capital and the holders of the downside risk the taxpayer should not be also compensated with the upside potential.
Finally, on retardation of growth, the studies alluded to by Dr Ahearne relate to nationalisation of entire financial systems in developing countries. The concern is that nationalisation leads to politicisation of lending. It is a sign of a lack of faith in the political system as a whole that a senior adviser to Government can in effect muse that it cannot be trusted, for such is the logical outcome of his concerns. However, were the State to nationalise the systemically-important Irish-owned, guarantee-covered banks that would still leave significant competition from non-State owned.
We did, stating: If nationalised the taxpayer stands to get a return on their equity investment after the banks have been sold into private hands in a few years time, and this would substantially reduce the underlying cost to the taxpayer.
Such an opportunity could involve a voucher-style reprivatisation of the banks and also ignores the fact that Nama is set up explicitly to act for a medium-term.
No country facing economic problems of this magnitude has come out of recession until the banking system has been healed. The Department of Finance believes that starting this can wait. I do not. Waiting until Nama gets rolling, then waiting more until (if) its legal challenges have been overcome, is in effect writing an invitation to the IMF to write a prescription and our euro zone colleagues to force it upon us.
Brian M Lucey is associate professor of finance at the school of business studies, Trinity College