Tag Archives: Anglo

NAMA/FG Plan just delaying the inevitable : May 18 2009

Recall FG proposed a state bank? Here was my reaction plus some thoughts on NAMA, in the Irish Times May 18 2009


OPINION:Fine Gael s bank plan makes more sense than Nama (whose ultimate head doesn t know what s going on anyway). All roads still lead to nationalisation, writes BRIAN LUCEY

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.

Brian Lucey is associate professor of finance at the School of Business Studies in Trinity College, Dublin


Rational economics will require external forces : May 12 2009

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?

In my view, the economic arguments against nationalisation are not as strong as those in favour. However, it is clear that we have moved from the economic to the political realm in this debate.

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.

Brian Lucey is associate professor of finance at Trinity College Dublin

Delay will lead to a bailout : April 27 2009

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.

Dr Ahearne also critiques nationalisation for lacking a credible exit strategy.

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.

Furthermore, nationalisation offers an opportunity, should the Government see such a need, to share directly with the taxpayers the upside in restoring banking sector health.

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.

Again nationalisation is a superior option in that it is advocated as an explicitly temporary measure as opposed to a Nama-quango which has no sunset clause inbuilt.

A further issue on timeliness is that Nama may take until the last quarter of this year to get up and running, while nationalisation can be done instantly.

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

Ok, the banks are fubar’d : April 17 2009

Here a bunch of us wade in suggesting that its time to call the ball. The banks are bust and will need to be taken into state care. Again this was published in the Irish Times

OVER THE last number of months extraordinary changes have occurred in the Irish banking and financial scene. We believe that we are now at a critical stage in Irish economic history and that it is crucial that the Government take the right course of action to deal with the problems in our banking sector.

The banking system is widely perceived to have seized in terms of lending, and whether correct or not this perception needs to be addressed. We believe that the correct action to take now is nationalisation of the banking system, or at least that part of it that is of systemic importance.

We do not make this recommendation from any ideological position. In normal circumstances, none of us would recommend a nationalised banking system. However, these are far from normal times and we believe that in the current circumstances, nationalisation has become the best option open to the Government.

Furthermore, we explicitly recommend nationalisation only as a temporary measure. Once cleaned up, recapitalised, reorganised with new managerial structures, and potentially rebranded, we recommend that the banks be returned to private ownership.

In introducing its proposals for the National Asset Management Agency (Nama), Government Ministers and Peter Bacon, the consultant who recommended this plan to the Government, have stressed that they see their current plan as likely to produce a superior outcome to nationalisation (though they concede that majority State ownership may be required).

We disagree strongly. We see nationalisation as being the inevitable consequence of a required recapitalisation of the banks done on terms that are fair for the taxpayer.

We can summarise our arguments in favour of nationalisation, and against the Government s current approach of limited recapitalisation and the introduction of an asset management agency, under four headings. We consider thatnationalisation will better protect taxpayers interests, produce a more efficient and longer lasting solution to our banking problems, be more transparent in relation to pricing of distressed assets, and be far more likely to produce a banking system free from the toxic reputation that our current financial institutions have deservedly earned.


Our banks have made an enormous quantity of bad loans, mainly to property developers, and realisation of these losses will see a substantial erosion of their capital base. International financial regulations require that banks maintain certain levels of capital to be allowed to stay in business.

In addition, as the recession mounts, so too will bad debts in consumer and other commercial loans, and so our banks need outside capital investment to make up the losses on these loans. The highest grade, and most desirable, form of capital is ordinary share capital, and in the current circumstances the Irish Government is the only conceivable investor willing to provide this capital.

The Government has put forward Nama as a vehicle to take these bad loans off the banks at a discounted rate. To the extent that the realisation of losses on these loans erodes the capital position of the banks, the Government has indicated that it is willing to supply equity capital in return for shares.

Crucially, however, the Government s current descriptions of the range of outcomes from this process suggest that they are badly underestimating the scale of losses at our banks, and as such may end up substantially overpaying for bad assets.

Take our two leading banks, AIB and Bank of Ireland. Analysts have repeatedly estimated the extent of bad loans at these banks to be of the order of at least EUR 20 billion. Losses of this sort would wipe out virtually the entire EUR 27 billion of Tier 1 capital of these banks. This means that if the Government purchases these loans at fair market value, it will end up having to provide funds to replenish fully the equity capital of these banks and, in consequence, would end up with essentially full ownership of these banks.

There is thus a fundamental internal contradiction in the Government s current position. The Government is claiming that it can simultaneously: (a) purchase the bad loans at a discount reflecting their true market value; (b) keep the banks well or adequately capitalised; and (c) keep them out of State ownership.

These three outcomes are simply mutually incompatible, and we are greatly concerned that the Nama process may operate to maintain the appearance that all three objectives have been achieved by failing to meet the first requirement. This would arise if Nama purchases the bad loans at a discount but still well above market value.

With EUR 90 billion in loans to be purchased, the consequences to the taxpayer of overpaying for bad assets by 10 to 30 per cent are truly appalling. To put these figures in perspective, the effect in a full year of the Budget measures taken last week was to save the exchequer EUR 5 billion.

Peter Bacon and others have argued in recent days that the question of who owns the banks does not matter, because the ownership structure does not change the underlying size of loan losses. Frankly, this is argumentation by distraction.

Nobody is claiming that nationalisation changes the underlying loan losses on the bank balance sheets. However, what it does change is who owns the equity and also who has first claim on any increase in value in the new banks after they have been recapitalised. 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.

Furthermore, nationalisation offers an opportunity, should the Government see such a need, to share directly with the taxpayers the upside in restoring banking sector health. Such an opportunity could involve a voucher-style reprivatisation of the banks and could be used to provide economic stimulus at a time of scarce resources, at no new cost to the exchequer.


With the Nama process charged with meeting the three mutually contradictory objectives above, it is also possible that objective (b), recapitalising, will not be fully met. In other words, a Government that needs to be seen to purchase the bad assets at a reasonable discount and that does not want to take too high an ownership share may end up skimping on the size of the recapitalisation programme. Thus, rather than create fully healthy banks capable of functioning without help from the State, this process may continue to leave us with zombie banks that still require the State-sponsored life-support machine that is the liability guarantee.

However, once nationalised and with the promise of future returns for the State, the incentive for the Government will be to create well-capitalised healthy banks that can be privatised and allowed to operate independently from the State, as quickly as possible. We believe that full nationalisation now will end up getting the State out of its involvement in the banking business faster than the current approach being taken by the Government.

In contrast, a circumstance where a drip-feed of recapitalisations is required would be the worst of all possible outcomes.


Peter Bacon and Government Ministers have stressed that it is necessary to keep the banks out of public hands so that the process is a transparent one.

The truth is exactly the opposite.

Every additional euro that the State pays for bad assets is an additional euro for the current bank capital holders and one euro less of valuable equity investment for the State. For this reason, the process by which Nama purchases the bad assets is going to be an extremely controversial one. Already, analysts are citing ranges from 15 per cent to 50 per cent as appropriate for the discount on these loans.

However the Government decides to price these assets, whether it be via accountancy firms, auctioneers or economic consultants, the process is going to have an element of arbitrariness to it and is unlikely to be one that will be widely seen as fair and transparent.

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.

However, the valuation process in this case would cease to be controversial, as the Government would own both the Nama and the banks, so the price would hardly matter. The Swedish bad bank experience (widely mis-reported in this country) involved an asset valuation board that set the price for assets transferred from nationalised banks, but the process was not a controversial one.

A related argument that Government officials have made against nationalisation is that it would remove the stock market listing and market monitoring function, rendering opaque the quality of the State-owned banks. However, the experience of recent years is one that would have to cast doubt on the ability of markets to effectively monitor financial institutions.


The Government s plans seem likely to keep in place the current management at our biggest banks.

For instance, the smaller discounts on bad loans being cited would, if paid, likely allow Bank of Ireland to maintain its recent levels of equity capital without taking more funds from the Government than the EUR 3.5 billion it has already taken (in return for preference shares which give an option for a 25 per cent State share.)

This type of incremental change will do little to restore the battered reputation of Irish banking. It would be difficult to avoid claims of crony capitalism and golden circles were billions of State monies to be placed into the banks with minimal changes in their governance structure.

Nationalisation provides the opportunity for a fresh start for Irish banking. The State should run the temporarily nationalised banks as independent semi-State operations headed by highly independent boards of senior figures of the utmost integrity. Executives for these banks should be sourced through an international search, and remunerated accordingly.

These executive boards should be charged with a clear mandate to improve risk management practices, restore the brand image of Irish banking and finance, and return the banks to private ownership in a reasonably short time frame, for as high a stock price as possible.

This would certainly see substantial changes in senior management and board members in these banks, and allow for a rebuilding of the reputational capital of these institutions.

To conclude, we consider that the Government s approach of limited recapitalisation supplemented by Nama represents only a partial solution to our banking problems, and one that is unlikely to protect the taxpayer. A nationalised banking system with a mandate to restructure and reprivatise would be a preferable approach at this time.

List of signatories

This commentary has been written by a group of Ireland s leading academic economists, several of whom have analysed and commented on the banking and financial crisis on these pages and elsewhere over the past year. They are:

Karl Whelan, professor of economics, dept of economics, UCD; John Cotter, associate professor of finance, Smurfit School, UCD; Don Bredin, senior lecturer in finance, Smurfit School, UCD; Elaine Hutson, lecturer in finance, Smurfit School, UCD; Cal Muckley, lecturer in finance, Smurfit School, UCD; Shane Whelan, senior lecturer in actuarial studies, school of mathematics, UCD; Kevin O Rourke, professor of economics, Trinity College Dublin; Frank Barry, professor of international business and development, school of business, Trinity College Dublin; Pearse Colbert, professor of accounting, school of business, Trinity College Dublin; Brian Lucey, associate professor of finance, school of business, Trinity College Dublin; Patrick McCabe, senior lecturer in accounting, school of business, Trinity College Dublin; Alex Sevic, lecturer in finance, school of business, Trinity College Dublin; Constantin Gurdgiev, lecturer in finance, school of business, Trinity College Dublin; Valerio Poti, lecturer in finance, DCU business school; Jennifer Berrill, lecturer in finance, DCU business school; Ciarán Mac an Bhaird, lecturer in finance, Fiontar, DCU; Gregory Connor, professor of finance, department of economics, finance and accounting, NUI Maynooth; Rowena Pecchenino, professor of economics, department of economics, finance and accounting, NUI Maynooth; James Deegan, professor of economics, Kemmy School of Business, Limerick; and Cormac Ó Gráda, professor of economics, UCD

Recapitalising the Banks : November 28 2008

Another oped for the Irish Times, from a similar group warning that unless we moved rapidly we would end up with credit crunches and zombie banks….


Only adequate recapitalisation of the banks is likely to stop them inflicting further pain on an already slowing economy, write Brian Lucey, Gregory Connor, Valerio Poti, Mark Hutchinson, Niall O’Sullivan, Patrick McCabeandCal Muckley

THE DEBATE on bank recapitalisation appears to have moved on in recent weeks. At first, bankers denied the need for it, now, there is a denial that it will be useful. The gist of the argument against recapitalisation is that it will not make credit more available. The argument is that companies, and the economy, will have to accept an indefinite credit famine from Irish banks. The main thrust of the argument is that lower lending will be determined by the need for lower loan-to-deposit ratios, so that increasing bank capital will not help.

Aiming for lower loan-to-deposit ratios is a sensible proposition, given the deterioration of the loan assets of the banks, itself a direct result of the over-rapid increase in housing and construction related loans.

It is true that the loan-to-deposit ratios of Irish institutions are uncomfortably high. According to a UBS survey of bank balance sheets published in April, Ireland’s average loan-to-deposit ratio is 163.1 per cent. The country’s largest mortgage lender, Irish Life Permanent (ILP), records a ratio of 277.4 per cent, one of the highest of any western financial institution.

The typical US commercial bank has a lower ratio, about 100 to 110 per cent. The average ratio in the euro zone was at last count an even healthier 86.6 per cent. So, there is a problem with Irish banks’ loan-deposit ratios and Irish banks are probably best advised to reduce them.

Banks are reluctant to accept new capital and thereby dilute the claims of existing shareholders. The banks’ preferred strategy is to rapidly reduce loans to Irish business to lower the loan-to-deposit ratio, and not accept any new capital injections. From a macro-economic perspective, we need to recapitalise banks, allowing for an orderly and minimally disruptive process so that banks can slowly decrease outstanding loans rather than engaging in a panic reduction.

Consider a simplified bank balance sheet, with loans that represent the sole asset, financed by debt (deposits and inter-bank borrowing) and equity. Assets and liabilities must balance, but the composition of the liability side of the balance sheet matters. Deposits represent relatively stable funding, whereas inter-bank borrowings can be very volatile. This is why prudent bank management would rather increase deposits and/or decrease loans. Equity is arguably the most stable form of funding, because the capital is tied up in a bank indefinitely. Deposits and equity capital therefore share a common desirable trait in that they represent stable sources of funding. Adequately capitalised banks will likely move to reduce the loan-deposit ratio more gradually, inflicting less pain on an already badly slowing economy.

There is also another consideration which reinforces the conclusion that recapitalisation would help reduce the recessionary effects of the banks’ efforts to reduce their loan-to-deposit ratios. This argument rests on the notion of the “money multiplier”. For every euro of extra capital injected into the banking system, the amount of deposits in the economy increases by a multiple, due to the chain of depositing and lending. A recapitalisation would inject more capital into the Irish banking system as a result of this multiplier effect. It is important, however, to note that if banks were to re-export the capital injection via lending outside the economy, the beneficial effect would be much reduced. Thus some element of contingency and oversight is required. The oversight would be a requirement that banks which receive the capital be encouraged to invest in loans to the domestic economy.

The Government could seek adequate remuneration for the risk it takes in buying bank shares. For example, if it was to buy preference shares, it could demand a dividend likely to be in excess of 10 per cent per annum (the figure for similar transactions in the UK is about 12 per cent) and the option to convert into ordinary equity so the taxpayer benefits from any recovery in bank share prices. Contrast that with the high teen returns that are required typically from private equity funds, an increased return that can only come from rationalisation of banks and from increased profit margins at the expense of an already deflating economy.

As the Japanese and Swedish experiences show, if this is done well, it could turn the economy around and end up as a good deal for the taxpayer. The Japanese economy recovered from the decade-long depression that followed the burst of the property bubble in the 1980s only after the Japanese government recapitalised troubled banks by subscribing substantial amounts of preference shares. This injection of equity capital started in 1998 and picked up momentum in 1999, when the Japanese government recapitalised over 30 banks.

The recapitalisation of troubled banks lifted Japan out of the long depression and turned out to be a profitable investment. A number of banks turned around early and bought back the shares faster than anticipated, at a large profit for the Japanese government.

More importantly, the injection of capital allowed banks to clean up their balance sheet. This was essential to restore confidence, while avoiding the credit squeeze that would have occurred if the clean-up exercise had taken place in the absence of recapitalisation.

In the Swedish case, the banks were recapitalised with government monies and again the government was able to eventually recoup a very large amount of the monies invested.

A foreign private equity component to the bank capital injection has the advantage of bringing fresh managerial expertise. However, too much foreign capital in the mix would mean handing over control of strategic assets. Given the current illiquidity of Irish business, it seems reasonable to think that the only domestic investor with sufficient financial resources is the Irish Government.

This does not need to be a Christmas present for bank managers and shareholders. Both management and shareholders failed in their duties. Managers have presided over a loss of wealth unprecedented in the modern economy. Shareholders failed in their duty to monitor and control management. Neither side should get away with this dereliction of duty. Nor should the recapitalisation be a bad bargain for the taxpayer. Structured in the right manner it should represent a good long-term investment.

Brian Lucey is associate professor of finance at TCD; Prof Gregory Connor lectures in risk management systems at NUI Maynooth; Dr Valerio Poti lectures in corporate treasury management at DCU; Dr Mark Hutchinson and Dr Niall O’Sullivan are co-directors of the Centre for Investment Research at UCC; Patrick McCabe is a senior lecturer in accounting at TCD; and Dr Cal Muckley is a lecturer in finance at UCD

Anglo, Politicians and the bogs…

I kinda like Joan Burton. No, not in strange way, but she always seemed (at least in 2008-9-10) to have a good solid handle on the banking calamity. It’s a pity she got the smeared end of the stick when labour went into government. Actually, when you think of it – labour got the ‘go away out foreign and don’t bother us’ Foreign Ministry post for its leader, the ‘minister for hardship’ for Howlin, the ‘minister for rolling back the welfare state’ for Burton and all for what?

Anyhow, I kinda like her.

I have no animus towards Billy Kelleher TD either. I have met the man once, over a coffee at a summer school and he seemed an affable enough version of FF V2.03, Haughey free and not too infected with the Bert virus.

That said, the interplay between the two of them on the RTE Saturday news show “Saturday with Claire Byrne”  (what used to be Saturday view when Rodney Rice ran it) was enough to cause me to begin to lose the will to live. In fact there were two episodes, either of which would cause one to lose hope in the ability of the Irish political system to take any form of action.

The first interplay was around the Anglo tapes. Claire Byrne asked both of them their reaction and also about  the allegations (which I note here) by the Taoiseach that the main thing from any inquiry was to uncover collaboration between FF and the bankers (because we didn’t know that they were close….). All round the country people are outraged at the arrogance and petulance of the anglo dudes and still, for we are a charmingly naieve people, look to the political class for leadership and some indication that there will be justice or even vengeance. Instead of a measured reaction from two intelligent people about the tapes, about the constitutional problems of the dail holding inquiries that apportion decisions and blame, about the nature of banking and finance, we got…squabbling. Political point scoring, squabbling, polite point scoring and name calling, and a degree of disconnect from the issues that was dispiriting. It’s a game. What we have in politics bears as much resemblance to the concerns of the ordinary world as Kabuki theatre does to the realities of modern day Japanese life.

The second spirit sapping discussion came at the end, neatly bookmarking a show that resembled a political sandwich with a policy vacuum as filling. We heard about the turf cutting standoff. Farmers had moved heavy machinery onto protected peat bogs and were engaging in strip-mining it.  Lets be clear – this wasn’t a few auld lads with sleans and bottles of tae but commercial contractors, doing to protected boglands the same as illegal mahogany loggers do in the rainforest .  This was being done on boglands that were designated special conservation areas under EU and Irish law. There were police present including a superintendent, a senior officer. The reporter noted that they were leaning over a ditch observing the law-breaking…observing it mind, not stopping it, not arresting those engaging in it, looking on at it. Again here was an opportunity for our political leaders to show leadership. During the show we had talked about the need for the Anglo issues to be dealt with, in criminal court if needed. We had talked about the legal aspects of the dail inquiry and on the need for forensic and detailed examinations of what happened when where and how. Then we moved onto flagrant, public, mass law-breaking in front of police….the two politicians hemmed and hawed, admitting that yes it was a breach of the law but there were circumstances, issues, complications etc.  I asked how many of those breaking the law on the bog would that evening be supping stout in the pub decrying the anglo chaps and urging the full rigor of the law to be applied, to silence.

If we don’t get leadership, if we cant get leadership, from two intelligent thoughtful politicians, if we cannot get them to urge on national radio that the law be respected fully and it be challenged by legal peaceful means only as we are a mature and peaceable democracy, then we wont be always. People will rightly despair that a state which allows open defiance of a senior police officer who is not then supported 100% by politicians, that that state can ever come to grips with as complex a catastrophe as the banking crisis that has engulfed us.


100 things Ireland could have got for the price of one Anglo Irish Bank…

With the #anglotapes this week it seemed to me a good time to recall those heady days of August 2010 when we had spent only 25b on Anglo. At that time Ronan Lyons and I penned this little piece in the Sunday Business Post…

This week, it was announced that the EU had approved a further injection of our taxpayer money into additional capital for Anglo-Irish Bank . This brings the total as of now to  almost €25bn. This is money going into a bank that is essentially in wind-down over the coming decade, money that the Irish citizens and taxpayers will not see again, as it is shoring up the balance sheet of a bank that had too much imaginary wealth. And that is not the end of the money, many fear.

So just how much is €25bn that we are having to borrow for Anglo? In one way, it’s small change, compared to what will possibly be €200bn in borrowings by the State to fund the non-banking deficit between the onset of the crisis and 2020. But to any rational mind €25bn is still a mind-bogglingly large amount of money. The State has limited borrowing capacity, limited by a combination of what the taxpayer can repay. In putting €25bn into Anglo, the government, on our behalf, has spent money that can not be used for other projects. Here is a list, then, of 100 things – grouped into various categories – that the government could have spent €25bn but chose not to.

Ireland could make a major contribution to Fight Global Poverty


€25bn would go a long way in the fight against global poverty. Here are a few suggestions:

100. Buy enough malaria nets to protect the entire malaria-affected population of the world (half a billion people) for 80 years (based on NothingButNets figures of $10 a net)

99. Completely fund the World Food Programme for five years

98. Repair twice over the damage done to Haiti in the recent earthquake

97. Fund enough clean water and infrastructure projects to meet the Milliennium Development Goals in those areas

96. Buy up and extinguish the national debt of Bangladesh

95. Fund the UNESCO “Information for All” Project for 1200 years

94. Provide food aid to Niger for 1000 years

93. Asphalt every trunk and regional road (110,000km) of substandard road in sub-Saharan Africa

Ireland could become a World Science & Technology Hub

leneyeMajor scientific and technological projects cost a lot of money. But rarely €25bn. Here are a few ways Ireland could have used the €25bn to become a global hub for major breakthroughs in science and technology.

92. Start our own space programme, with twenty €1.2bn space shuttles

91. Foot the bill for a century of global research into nuclear fusion (the current 30-year global ITER project is expected to cost €5-10bn)

90. Research & develop 5000 new drugs….one of em’s bound to be useful

89. Construct 6 Large Hadron Colliders – one for each Green Party TD

88. Build 5 James Webb Space Telescope (the successor to Hubble), and revolutionise astronomy

87. Build two magnetoplasma space vehicles which in theory could get to mars in 40 days

86. Build a space elevator

85. Build two ITER nuclear fusion reactors and provide the world with cheap, abundant energy..

We could decide to give ourselves a break

holidaysWhat about using the €25bn to give ourselves a break? Here are a number of things that €25bn could pay for, while we take a break.

84. Pay the interest on everyone’s mortgage for 4 years (€147bn of mortgages at 4% is €5.88bn a year)

83. Abolish income tax for two years (based on 2009 gov income tax receipts of €11.8bn)

82. Offer everyone on the live register €100,000 to emigrate (we could afford a 50% take-up by the 466,000 on the dole)

81. Abolish VAT for two and a half years (based on 2009 receipts of €10.8bn)

80. Remove exise duty from fuel, tobacco and alcohol until 2015 (based on exise receipts of €4.7bn a year)

79. Pay the grocery bills of everybody in the country for 2.5 years

78. Scrap all fares on all forms of public transport, intercity and commuter trains and buses for 33 years

We could just treat ourselves

scrooge-mcduck (1)We could just treat ourselves with the €25bn windfall. Here are some suggestions as to how.

77. Run the world’s best ever lottery – every Irish citizens is entered into a draw where 25,000 people become millionaires!

76. Give every OAP a pension of 55,000 for a year….

75. Fly the adult population of Ireland to Las Vegas, give everyone 10k to gamble with

74. Give every person in the country €5,555.56

73. Buy half a million ecofriendly Nissan Leaf cars and have enough for a 5GW nuclear power station with the cash left over

72. Provide a new laptop every year to every second level student for 147 years

71. Buy a 32GB iPhone, a 64GB iPad, a 13″ 2.13GHz MacBook Air and a 27-inch iMac for every man, woman and child living in Ireland

We could treat the world

icecreamTreating ourselves is probably a bit selfish. Here are some ways to make the rest of the world like us more!

70. Buy 6.7b copies (one for everybody in the world) of Joyce’s “portrait of the artist as a young man”

69. Buy a pint of guinness for everyone in the world to celebrate Arthurs Day (and it would count as exports)

68. Buy every child in the world a 99 ice-cream cone every day for a week

67. Send every adult in the world on an MSc in Social Media in NCI

66. Send 225,000 people to do the Harvard MBA

We could truly become the world’s biggest sports fan

10BestClubs_2012Sport is big business. But not that big. With €25bn, we could…

65. Buy the world’s 20 most valuable soccer clubs, worth €9.6bn, wipe their debt (€2.3bn) and move them to Ireland, building each a 75,000-seater stadium (€600m each, based off cost of Aviva stadium)

64. Host two Olympics games, based on the London 2012 cost of €11.2bn

63. Buy Tonga and Fiji, which would have obvious rugby advantages

62. Construct 25 Bertie-bowls (one for each county except Dublin!)

61. Buy 83,300 McLaren supercars

60. Buy the entire stock of tickets and merchandise for all premier league clubs for the next 12 years

We could decide to really become a major player on world markets

2374Banking and finance got us into this mess. Surely they can get us out?

59. Buy €600bn in Credit Default Swaps on Ireland (could pay off nicely in the next few years!)

58. Buy two of Asia’s largest banks – Bank Central Asia and Malayan Banking

57. Recapitalise ALL the banks in europe that failed the stress tests

56. Purchase Monsanto, as a present for the green party, or (buy Nokia as a present for Ivor Callely)

55. Give each one of the 10,000 most senior bankers a round of golf on old head kinsale, the most expensive course in europe, every day for 20 years, and hope that they come up with some ideas!

54. Subsidise the US postal service for ten years

53. Allow the Italian Government to not put in place its 3 year austerity plan

52. Pay the salaries of TCD and UCD academics for 100 years.

We could just do it  because we can…

Burj+Khalifa,+Dubai+-+828mWhile the Government says it’s not a waste of €25bn, many people believe it is. Here are ten ways to really spend €25bn.

51. Buy Steve Jobs (€25bn is actuarial value on his life) and get him to work for Ireland Inc.

50. Buy gold plating 1.75mm think for O’Connell Street

49. 25,00 carats of red diamond, enough to encrust a mercedes….

48. Build a shed 10k long by 4k wide and put it around Tullamore…

47. Buy every one of the 5.8m cattle in the country, and to keep their little feet cosy two pairs of jimmy choos each

46. Detach the People’s Republic of Cork from the Republic of Ireland, by constructing a 10-metre wide moat – the per-kilometre cost of the new Gothard Tunnel in Switzerland suggests this may cost €30bn but I’m sure we could haggle them down in a recession.

45. Cover the entire county of Dublin a foot deep in corn

44. Hire Bertie to speak for 95 years

43. Purchase carbon credits to allow us to burn 3000 sqmiles of hardwood forest

42. Build 20 copies of the Burj Khalifa Dubai, the worlds tallest building

We could just splash the cash

item0.size.queen-mary-2-100488-1When people win the lottery, there’s naturally a tendency to splash the cash. Winning a €25bn lottery would certainly allow us to splash the cash. Here are some ideas.

41. Buy 1,000 luxury yachts to kickstart the Upper Shannon Rural Renewal Scheme (78-footers, 2nd-tier Russian oligarch standard)

40. Buy over one third of Denmark, 10% of France or three Luxembourgs, based on 2008 land costs

39. Send 833 people into space (or perhaps just 1666 one way trips…)

38. Stay in the most expensive hotel room in the world for 3400 years (it’s the Atlantis resort, Bahamas in case you were wondering)

37. Build 50 ginormous cruise liners akin to Carnival Splendour or Queen Mary 2

36. Make 100 Avatar-type films, which lets remember made back its money x4 at the box office!

35. Buy every TD a boeing dreamliner, ideal for those trips to glenties

34. Purchase 35 of the world’s most expensive mobile phone (goldstriker iPhone 3GS supreme) for every member of the oireachtas!

33. Build four Libraries of Alexandia in each county

32. Endow one university to the level of Harvard

31. Tile Dun Laoghaire-Rathdown totally in nice porcelain

30. Buy five Nimitz Class Nuclear supercarriers to scare the bejaysus out of the Spanish trawlers

29. Or buy 17 Virginia Class nuclear attack submarines, if we wanted to sneak up on the Spanish Trawlers instead

28. Supply the water needs of Galway City, for a year…with Perrier water

27. Purchase four Birkin Hermes bags for every adult female in the country, one for each season’s wardrobe

26. Buy and install 100 sq yards of parquet flooring for every single dwelling in the country.

25. Fill the Jack Lynch Tunnel with Midelton Single Cask whiskey

24. Purchase 225,000 kg of the most expensive truffles in the world

23. Buy every house and apartment listed on DAFT.ie and still have 12bleft to refurbish them

We could transport ourselves  out of this mess

98962638.jpg.CROP.rectangle3-largeWith €25bn in our back pockets, all those pie-in-the-sky superprojects would no longer be pie in the sky! Here are ten ways Ireland could put itself on the global superproject map.

22. Construct our own “Channel Tunnel” from Rosslare to Pembroke (based on the cost of the Jack Lynch tunnel)

21. Build 1,000 km of high-speed rail, serving all major coastal cities on the island (based on recent costs in Spain)

20. Build 11,150 miles of dual carriageway

19. Put in place a 400 station metro (if we could build it for the cost of porto’s metro)

18. Put in place a Maglev train from Belfast to Cork via Dublin

17. Build our own Three Gorges Dam, complete with turbines

16. Put in place 12 new Luas lines

15. Build just short of two Hong Kong International Airport (€15 bn each)

14. Build 12 New York-style “Freedom Towers” at €2bn each

13. If we didnt want a tunnel we could five Oresund-style 20km long bridge (Denmark – Sweden, €5b)

We could pay for improved public services

childrenshospitalAnd lastly, ten slightly more practical ways to spend €25bn

12. Build 75 brand new 50-teacher schools and run them for 75 years

11. Build 35 new Children’s Hospitals (based on €700m cost of new Children’s Hospital in Dublin)

10. Pay for an extra 5,000 hospital consultants for 62.5 years, based on Finnish wage (or for 29 years based on Irish wages)

9. Pay for cervical cancer vaccines for every girl going into 1st year for the next 8333 years

8. Reduce the pupil teacher ratio in primary schools to 1 in 10 for the next 20 years

7. Given an ultra highspeed fiberoptic broadband connection to every single house (including ghost estates…)

6. Buy 8,500 years of private speech and language counselling and really help autistic and speech problematic children

5. Introduce free pre-schooling for 32 years, based on an average cost of €700 a month for two years of 10 months, for all 110,000 children in the country

4. Make education properly free – the current cost from primary school to degree graduation is €70,000 per child. €25bn would bring nearly 400,000 students through their entire education

3. Give medical cards to everyone, for 25 years based on €500m cost in 2009 to cover 1.5m people

2. We  could use the money to renew and replace the drainage and water system of all mains

1. Or we could buy one broken bank…oh, hang on…..

So, a mixture of the bizarre, the stupid, the deeply practical, the useful, all tinged with a sense of lost opportunity. A bit like the governments solution to the banking crisis really! What this list shows us is that choices matter. Its unlikely that any government would have #50, paving o’connell street in gold, as a priority (well, not perhaps unless its leader was from Dublin Central…), But wouldnt it be nice if we had a government with the courage and vision to do #18, a maglev on the east coast, which would catapult ireland into a world leading techological position and cement the all ireland economy? or decide  #96 to lift Bangladesh out of poverty? Or …the list goes on, a list of lost opportunities.  And when one considers the additional €100b that represents the structural element of the governent debt, well…While Colm McCarthy is correct, that anger is not a policy, its hard to be anything but enraged when one considers the sheer scale of wasted opportunities.

Note: Ronan and Brian would like to thank all the dwellers in Twitterland for suggesting these, and other more unprintable suggestions. Particular thanks to Lorcan Roche-Kelly and CG for good ideas well costed. We are open to more suggestions.

Brian Lucey and Ronan Lyons