Tag Archives: banks

Bail-In Research

There is an interesting op-ed in the Irish Times today, from Stephen Flood of Goldcore. This is on foot of a research note which they have produced (introduced by yrs trly) on the state of play on Bail Ins (where depositors become part of the solution to bank recapitalization, a la Cyprus) across europe.

The risk of such bail-in in Ireland is low. But then so too are interest rates. It might be useful for people, in saving, to consider not just yield but also liquidity risk. Irish banks are well capitalised – but then we have heard that before.

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Irish Banks : Arrears, Deposits, Bail-in and Interest Rate Editon

This is an edited and extended version of a column in The Irish Examiner 26 October 2013

There is a great book on marketing titled “the long tail” , which stresses that instead of trying to hit millions of customers at once its perhaps better to do millions of niches. Replete with examples it was and remains a deserved hit. The long tail refers to the distribution of something – a large bulk at one end quickly trailing off to smaller numbers but which go on for a long time. Another word for this is skewness. In very many skewed distributions it is common for the total amount in the long tail to be equal to or greater than the amount in the bulk. Another way of thinking of this is a power law. Many many things have been found to follow power laws – terrorism, population of cities, bibliometrics, income distribution… theres no reason to think Irish bank losses are different.

download (1)The long tail approach is worth considering as we move into the sixth year of this crisis.  Having dealt with the massive mess of the commercial property and developers loans via hiving them off to NAMA (which has yet to “get credit flowing” as its cheerleaders in the then government and some still prominent stockbrokers trumpeted) , the long tail of the mortgage and SME loans continue to erode the banks. We are moving down the tail with the average loss getting smaller but there are an awful lot of them. Today I spoke to a SME owner who runs a small distribution business. He had settled with a bank for a loan taken out in 2006 which resulted in the bank taking a loss of just under €1m. The business is still going, much reduced but “ticking over nicely”. This is as good as it gets – a viable business remains. Many many SME loans are for larger amounts and the banks will take a larger hit as there is nothing left. I think of someone  I know who purchased a house in 2006 for €450k, interest only of course, in a  not very fashionable holiday area, where similar homes are selling at €150k on a good day. These are the long tail and they are wagging the dogs of our banks as the banks chase them round in a circle.

Basel-IIIAt present Irish banks are well capitalized. Some might say that in a classic overreaction to the lack of adequate capital buffers in the past they are over capitalized. Bank capital is a two edged sword. On the one hand the more capital they have the greater a buffer exists to absorb losses. On the other, as capital is measured as a percentage of assets the more capital is required then all things considered the smaller will be the assets. A bank that has a 10% capital ratio will be able to make more loans (assets) than one that is required to hold a 15% ratio. The ECB has recently announced that it will conduct another round of stress tests. These are required, in essence, so that the final set of capital injections will be made prior to the ECB taking over full control of regulation. The political reality is that this step, a necessary requirement for a proper banking union, will require that individual states make or supervise any capital injections. In a banking union this will be the responsibility of the union, and thus the German taxpayer might be on the hook. But not this last time.

gpyugoWe have known for some time that the Irish banks will require additional capital. The state of the mortgage book is bad but the state of the SME loan book is also dire. Earlier this year we found out that  50% of the SME loan book was in distress.  There is a total of €70b in SME lending, of which an astounding €30b is still outstanding to real estate. A multibillion loss is an absolute certainty.   On the mortgages we have similar. The question that should raise its head is : who bears these losses. Traditionally the order of losses was deemed to be shareholders -> junior bondholders -> deposits and senior bonds. The taxpayer might then step in and recapitalize if the bank was deemed to be needed.  So in the Irish case 2008 saw some but not all junior bondholders and almost all equity destroyed, but the system balked at that and so in stepped Paddy with his chequebook. And we know how that ended. We saw in Cyrpus, and indeed have seen in the liquidation of IBRC that depositors can and in future will be “bailed in”. This is fine and dandy if all other sources of capital have been burned through. The problem is that recent statements by Mario Draghi suggest that bondholders might be spared in future, for fear that once burned they might not return. In other words the sovereign would be required to make a decision as to whether they would absorb losses or instead force bailins on depositors. There is zero willingness for the Irish state to add more taxpayer money into the banks. Thus the question becomes: do the banks hae sufficient buffers in place to absorb losses before the question of depositors comes into play?

hqdefaultOn a macro level they are good. AIB has shareholders funds of c 10b, BOI of 8b and PTSB 2.4b.  In the case of PTSB and AIB much of these shareholder funds are in fact state funds, so any erosion of these is an erosion of taxpayer funds. The problem is that as we noted they are required to hold funds at a certain level. This level is higher than the European requirements. Thus as losses get booked the banks will have to either raise additional funds. This, in sufficient amounts, is I submit unlikely. While they have had some success in raising limited amounts these have either been expensive or have required significant security. In addition, the banks face rollovers of existing issued debt. Bank of Ireland will need to roll over or pay off bonds of 9.5b in 2014-2015, AIB 7.5b and PTSB 5b n the same period. This will tax them significantly. If they face a requirement to otherwise increase capital from losses that will make the job that much more difficult. A large part of the outstanding bonds are senior notes, some 7b. A large part of the remaining is covered or asset backed. Only some 5b or so across the banks, mainly in Bank of Ireland, are unsecured or subordinated. Bank of Ireland has the largest “burnable” buffer but is the one least likely to require it. AIB has very little unsecured debt and less than 4b senior debt. We have seen that even the mention of senior debt being burned, where legally possible, has caused significant negative market reaction. Thus where there is no taxpayer backstop and either no bondholders or no willingness to burn them, inevitably deposits must come into play. In that context depositors should seek a higher rate than they are at present getting.

browseChartThe chart shows the deposit rate on new deposits for an agreed maturity, Ireland v Germany. Deposits that were ten years ago seen as close to riskless as it is possible to be are no longer so perceived. The difference between Irish and German deposits is not, I suggest, sufficient to reward for the relative risk differential. Although small, the risk of depositor bailin in Ireland is many many times larger than that in Germany. These risks are the worst sort- small probability large outcome risk. It is time that the banks begun to remunerate depositors  appropriately for the risk, small that it is, that they are being asked to bear.  We need to move away from a banking system that is dependent in large part on loan capital towards one that is dependent on deposits. In fact, in the last week we have seen the situation worsen. The increase in DIRT means that deposits are now paying less than the already paltry levels. Combined with the loss of ACC , closing after 86 years, this further erodes competition, even if ACC was a small player. Expect pressure on interest rates to be downward, relatively speaking, on deposits. Which are now risk capital and in the firing line.

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

The economics of Mr Micawber wont do : Feb 22 2010

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

 

Beware the long tail of non NAMA loans sinking the banks : Feb 3 2010

NAMA was hailed by many as a silver bullet. But it wasnt and couldnt be as I suggested in the Irish Times in February 3 2010
OPINION:GROWING UP beside the seaside, one becomes familiar with the sea and its actions. One thing that becomes clear is that while the first wave of a storm may do great damage, it is the subsequent waves that complete the destruction, writes BRIAN LUCEY

Irish banks are on the rocks, badly damaged by the wave of losses on commercial and speculative property lending. What is now evident is that a second wave of losses is heading towards them. While this is likely to be lesser in magnitude than the first wave, the system is so compromised that it is much less able to take a blow.

There are two interrelated problems. First, we have negative equity, where borrowers have outstanding a mortgage loan greater than the value of the property on which it is secured. A second problem is that of stressed mortgages, where individuals find it hard to meet the repayments on mortgages, whether they are in negative equity or not. Facing into at least another year of depressed economic activity, increases in unemployment, decreases in real wages and increases in interest rates, this problem will only grow.

So what is the extent of the problem of negative equity? Part of the problem is that we do not (officially) know. Despite the importance of property in the Irish psyche and economy, it is startling that there are no good property price indices available.

In a classic case of the law of unintended consequences, the Data Protection Act appears to prevent estate agents from supplying details of sales to third parties. No authoritative database of property transactions is available, which leads to inference being our only guide.

Two excellent works from different perspectives, using overlapping but distinct sources, have recently suggested that as of the third quarter of 2009, 130,000-150,000 households were in negative equity. Ronan Lyons suggests the lower figure, while David Duffy of the ESRI suggests the higher one. These figures are now almost certainly higher, so we could be looking at 200,000 borrowers whose mortgages are greater than the value of their homes. That is one in seven households. These papers point out two other issues the greatest problem is in first-time buyers who purchased from 2004 onwards and the problem is compounded for up to 50,000 people who face both negative equity and unemployment. It is heartening to see that the Government, or at least Eamon Ryan, is now suggesting that something must be done . What is clear is that the Government has no moral authority to ignore the issue.

Apart from its political duty, a Government that has presided over successive attempts to allow the providers of risk capital to the banks to escape the consequences of failure has no moral right to say to thousands of small-scale borrowers that they are less important and no help will be extended.

What appears from the musings of Ryan is that persons in stressed mortgages would be given some sort of payment holiday, or that a Nama arrangement for them, whereby Nama II would take over part of the loan, might be arranged. Laudable as this is, there are several interlinked problems that need to be sorted before any solution is put in place. Top of the list is a need for more timely and accurate data. Beyond that other issues lurk.

The first problem is one of moral hazard. Moral hazard is where an incentive is created for people to act imprudently. Borrowers took out mortgages that in many cases were far too high for them to repay under any realistic circumstance. While it is true that lax regulation, estate agent hyping, bank loan pushing and a general bubble mentality left many with a feeling that they had no choice but to so borrow, the fact remains that bailing them out causes problems.

Any bailout, no matter how socially desirable and no matter how structured, will involve transfers from persons who did not borrow excessively to those that did.

There is then less of an incentive for the prudent to remain prudent in future, as a precedent has been set. This is not to say that we can or should on economic or moral grounds ignore the massive looming plight, it is to recognise that we need to structure the rescue in such a way as to mitigate this and other issues.

A populist solution might be to say that the banks must take the pain. After all, they were the ones doing the lending and should have known better. As of the end of 2009, there was something of the order of EUR 75 billion outstanding in residential mortgages, the vast majority owed to the guaranteed banks. If only 10 per cent of this is ultimately likely to be lost, then that is another EUR 7.5 billion of losses that the Irish banking system will have to absorb. It cannot do this and face its other losses without massive State intervention, nationalisation in effect. And again there is a transfer issue.

A payment holiday or any other solution which interrupts the flow of income from the mortgages runs into other difficulties. First, it merely defers the problem.

Lurking in the mind of those that propose this may be a feeling that the housing market will turn up, and that the increased debt will eventually be eroded by increases in value of the housing stock. This assumption is subject to severe challenges, but a further problem may arise in regard to securitisation.

In December, a plan to offer Italian homeowners a payment holiday was queried by ratings agencies. Mortgages are typically pooled and the income stream used as collateral by the banks to obtain funding for other lending. Any move that resulted in the downgrading of these flows would impair the banks ability to raise this funding and further tighten borrowing conditions for business.

What then about people walking away from negative equity? Apart from the issues of the banks ability to bear the losses, the effect on securitisation and the social issues, this would ultimately result in the mortgagee becoming bankrupt.

It is generally recognised (without much being done about it) that our personal bankruptcy laws are archaic and unsuited to a modern economy. Without widescale reform, this option would result in a generation of persons unable to access credit and with a major stain on their personal record.

No easy solutions present themselves. It is good that Ryan is at least talking about the problem, but we have seen from this Government that recognition of a problem in banking and swift action is not its strong suit.

It is to be hoped that facing this second wave swifter action will be taken, before the third wave, of distressed personal non-mortgage credit, rolls over the hulk of the Irish banking system.

Brian Lucey is associate professor of finance at the school of business studies in Trinity College Dublin and a research associate at the TCD Institute for International Integration Studies

 

NAMA – good for developers, not so good for taxpayers and mortage payers : September 7 2009

Alan Ahearne again weighed in suggesting , after the ’46’ that NAMA was going to work. I wasnt so sure and said so September 7 2009

OPINION:THE ARTICLE by Dr Alan Ahearne in Saturday s Irish Times, (which we can presumably take as being a statement on Nama from the Department of Finance and the Government) contains much that can be agreed with. Few would disagree the banking system must be cleansed and positioned to again take a central place in the economy. What I and I suspect most other critical thinkers would find harder to agree with is the assertion that the only method of achieving this is Nama-as-is, writes BRIAN LUCEY

This, let us recall, involves a conscious decision to use taxpayers money to overpay banks for their toxic assets, thereby transferring billions of euro from the taxpayers to bank shareholders. That the Government s economic adviser would express surprise that there has been a heated debate about a strategy to overpay by billions at a time of fiscal crisis suggests that the mandarins of Merrion Street are totally out of touch with reality.

Barely one in four people supports Nama, and while people may not understand all the technicalities, they do see the core immorality and unfairness at the heart of Nama. Tens of thousands of people own their own toxic assets , houses in negative equity. Yet the Government is not suggesting that they should come along and pay us more than they are currently worth according to a vague, as yet secret, formula built on a pyramid of unrealistic assumptions. So why then are bank shareholders getting this deal?

Beyond this, the argument rests on a series of weak assumptions. Most startling, perhaps, of all of these is a call for Irish banks for Irish people , when Dr Ahearne states: For our economy to recover, we need clean Irish banks . This continues a line of rhetoric against foreign banks operating in the State best exemplified by Fianna Fáil TD Ned O Keeffe, who stated that the damage done to the economy was brought about by the foreign banks who came into the country .

One thing we know from economics and from painful experience in this State is that competition, while sometimes raw and painful, generally benefits the customer. The ghost of 1930s protectionist and corporatist economic policies of the majority party of Government are stirring again, it seems.

Dr Ahearne notes that Nama bonds will be traded on international markets. This ignores the difficulties any new issue of debt is likely to face in the next few years. With no track record, yielding a coupon rate well below that of State bonds, these bonds will almost certainly trade at well below face value. I assume the Nama bonds will be issued with a maturity which approximates assets of 10-year duration or longer. The assumption that the bond markets will swallow whatever amounts of Nama bonds are issued is untested and unbacked by anything other than hope or assertion.

A further assumption is crucial to the Nama debate that banks and property developers acted in a manner that was more restrained than the average household. We are asked to believe that in an era when young couples were getting 110 per cent mortgages, millionaire developers were only taking 75 per cent mortgages. It beggars belief to be asked to take this on trust.

The reality is that very little pure equity was used in the latter years of the bubble; a common practice was, it seems, to pledge the rise in previous developments as equity, to pledge stock market positions, to avail of tax shelters to generate tax savings then pledged, or to borrow elsewhere, unsecured on the new development. Dr Ahearne s arguments suggest that we are at or near the trough of property values, and that over the prospective and as yet mysterious lifetime of Nama, there will be a general uplift in property prices. Closely related is another, which seems to imply that the Government considers that contrary to all indications, we are near the peak (not the trough) of financing.

Values for some properties might reasonably be expected to experience some uplift when the current extremely high cost of financing purchases of property eases. The statement on costs of purchases is opaque, given that we are experiencing historically low rates of interest. A significant debate on property price paths has taken place over the last number of weeks. Significant evidence indicates that a decade or more can elapse with little upward movement in prices.

Last week this point was reiterated in court by Prof Morgan Kelly, and the Dutch Central Bank published research which indicates that Irish property prices are still well out of line with international norms. A plan B for Nama which lays out a scenario where property prices do not rise would be enormously helpful, and would be an essential part of any normal business plan.

Another assumption is that Nama will pay for itself Of course interest rates are expected to rise, but that will increase both Nama s income and outlays. This rests on two assumptions that the interest rates paid on the loans Nama will take over are floating, and that the assets which underpin these loans are sufficiently robust to continue servicing increased interest rates. Neither assumption, in my view, is reasonable. There is no rationale for assuming that over a 10-15 year period, interest rates and property yields move together, unless such a period includes a property boom. It would be good to see evidence that development loans were, in fact, floating rate rather than balloon or fixed loans. Information in aggregate cannot be commercially sensitive.

A new argument against nationalisation also emerges in the shape of the value of a stock market listing in providing monitoring and transparency. While a market listing is indeed useful, if the banks have to be nationalised then the relevant investor is the State, which, via the Central Bank, already knows what s going on in the banks with weekly detailed reports. Academic research indicates that it is corporate bonds, not equity markets, that are most efficient at monitoring corporate health.

The Government has set its face firmly against the non-senior bondholders taking any further hits, and thus we can suppose that the deep pool of traded debt of the Irish banks will remain traded, and thus transparency and monitoring can occur via this market.

Dr Ahearne also argues that nationalisation (after the banks realise any losses involved in Nama transfers) will not be required. He contends that the value of loans on the banks balance sheets already includes adequate provision for bad loans, and as such any further losses will not fully erode shareholders equity.

This begs the question that if the banks had made adequate provisions, then presumably Nama would not be required. It is precisely because they have not made these provisions that they wish to offload the toxic loans to the taxpayer. The circular logic continues with the Minister stating that the banks need not be nationalised, as doing so would mean the boards would have traded recklessly, and thus would have had to resign. As they have not resigned, the argument goes, the banks must be solvent.

Which again brings us to the question: why then do we need Nama with its accompanying transfers of billions of euro from the taxpayer to the shareholders?

A smack from the IMF : June 26 2009

the IMF weighed in in June 2009. It was spun as approval. It wasnt. Here is my Irish Times reaction piece

 

OPINION:The IMF report most certainly does not give Government banking policy the thumbs up, writes BRIAN LUCEY.

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?

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