I had a long conversation last weekend with the MD of a Financial Services company to see how closely his private-sector non-economist perspective accorded with my own (which is probably the consensus among public-sector economists), that Anglo should have been allowed to collapse and the developers bankrupted if necessary. There was little difference in our perspectives!
He thought the idea ludicrous that Anglo-Irish could regain the trust necessary to get back to “business as usual”. Also, he tells me that a receiver will not necessarily dump all distressed assets onto the market at once (which some might think of as a possible rationale for what the government has done) but can hold off in order to maximise their sale value. Anglo Irish staff, furthermore, would not have the skills to act as a receiver or even as a “bad” or “collection” bank. The only (theoretical) logic for nationalisation that he could see, since we were in agreement that Anglo is not of systemic importance, is that there might possibly be spillover effects in terms of job losses etc. associated with widespread concurrent bankruptcies.
Since virtually the entire economics community is agreed that Anglo should have been let go, the question arises as to who is providing the advice that the government is listening to these days? Not Patrick Honohan obviously, though he’s right on their doorstep and has been dealing with financial crises for the last two decades. Is it the same PWC (as Martin Mansergh suggested on radio) who gave the banking system a clean bill of health as recently as last Autumn? I googled PWC yesterday and found them to be amongst the “soft landing” merchants of recent years. Why would the Finance and Central Bank economists’ perspectives differ so dramatically from the consensus reached by the rest of the public-sector economics community?
A question that academics will ultimately have to revisit concerns the (few) academic analyses of recent years that found property prices to have been largely driven by fundamentals. I remember commenting on one such paper to make the following point. The real interest rate used in the analysis was the nominal rate minus recent house price inflation. But if the latter were a bubble, the real interest rate would be underestimated and the fundamentals exaggerated. I didn’t find the explanation offered to be convincing.
11 replies on “Nationalisation of Anglo-Irish Bank”
I agree that the Government’s handling of Anglo beggars belief, but I think you’ll find that it is the popular fetishes of microeconomics and portfolio theory that have robbed economics of intellectual rigour. Economists have long abandoned discussing the real economy, you know the dirty business of labour productivity and capital investment in infrastructure. I think we need an intellectual renaissance in economics to get to grips with the broader structural problems. This will not be achieved by rehashing economic models that obviously failed to inform analysis of the Great Moderation and seem totally implausible today.
As I see it, there are two possible interpretations of the Anglo bail-out. Either:
1) FF cynically used instruments of the state to bail out their mates,
2) The government, having initially honestly assessed the situation as not that bad, committed themselves to a course of action and then felt they would look incompetent if they backtracked in any way.
I am willing to give them the benefit of the doubt and accept the second scenario. If this is the case, I would urge them to heed the words of John Maynard Keynes: “When the facts change, I change my mind. What do you do, sir?”!
I think there are two aspects to the issue you raised in the last paragraph of your post about academic papers on the Irish housing market: (a) why did relatively few economists warn about a bubble in the housing market and (b) why was so little attention paid to the warnings?
Robert Schiller wrote an interesting column recently that touches on both of these questions – see http://www.nytimes.com/2008/11/02/business/02view.html?pagewanted=1&_r=1.
If somebody of Schiller’s stature felt shy about raising questions about bubbles then it is hardly surprising that most economists stayed away from the issue. The ‘fundamental’ problem about analysing bubbles is that we find it so hard to argue against anything that has a revealed preference aspect to it.
A vast number of people gained substantially from the housing market in Ireland in the past 15 years. As Frank has pointed out in an earlier post foremost among these were landowners. While some of these were undoubtedly large landowners and developers, it is also the case that the high price of land, its dispersed ownership, low capital gains tax, and relatively lax planning regulations meant that anybody with land adjoining a main, regional or minor road had a rare opportunity to get rich.
I really do not understand how anyone can believe that Anglo was not of ‘systemic importance’ and that it should have been ‘let go’.
Even from a historical perspective, it has been shown time and again that the benefits to be gained by allowing institutions to fail (eg as a deterrent to moral hazard) are far outweighed by the overall costs to the financial system resulting. The failure of Sanyo Securities in Japan in ’97 is a case in point; the failure of Lehman Bros being a more recent example.
What I can’t understand is the suggestion that the fall out from this would be limited to a the bankruptcy handful of Fianna Fail leaning property developers (not just in this article)..
(1) while Anglo may have underwritten many large loans in Ireland, it was also an active syndicator, the primary participants in this were the other Irish commercial banks. Therefore any impact of large scale writedowns of their loan books would have a collosal impact on the remaining listed Irish banks as they revised their bad debts.
(2) people are grossly over-estimating Anglo’s exposure to Irish development property (or prehaps underestimating the scale of their exposures elsewhere!). In my experience, it was the late comers to the Celtic Tiger party that wrote most of the big cheques for development deals in the previous two years..e.g. UB funding Sean Dunne’s purchase of Jury’s; BOSI funding Taggarts.
(3) while the focus is now on the quality of Anglo’s loan book, solvency and liquidity problems are not readily seperable. It was Anglos overreliance on the wholesale funding market and its inability to refinance its debts as the fell due that was the final nail in the coffin. If the Government were to let the company fail, the Government would have had to repay, on demand, all unsecured and sub debt – ie the part of the cap structure that would get crammed down if it let it fail. Persumably therefore, the taxpayer would have all the downside, i.e. taking all the losses with none of the potential benefits that ownership would bring.
What is clear from this is that the Anglo experience is not the cause of the Ireland’s economic demise, but rather the effect of (i) lack of regulation both at an EU level and a domestic level, (ii) lack of domestic oversight and general governmental incompetence. To wit:
Financial deregulation precipitated by EU membership allowed non-domestic banks to create hyper competition among banks resulting in the deteriorating quality of loan books.
Liberal access to international capital markets and lax domestic regulatory environment meant Irish financial institutions (not just banks, e.g. ISTC, the Frankenstein creation of Anglo) relied on short term wholesale funding more so than any other EU country meaning a greater susceptibility to liquidy shocks.
Lack of domestic oversight and general government incompetence resulted in the us stumbling through from crisis to crisis, from the knee jerk blanket government guarantee to the Sean Fitz loan scandals. Our reputation has been destroyed, built up over the last 10 years, has been destroyed in the matter of a few months.
So, from my “private-sector non-economist perspective”; the nationalisation of Anglo was not only necessary but in fact is a good thing. Nationalisation affords us an opportunity to tackle the crisis facing the irish banking system. As a public company, Anglo replaced its MD and Risk Officer with internal candidates and promoted the FC to the FD job. Surely, the only way to restore confidence is a wholesale replacement of the executive function in Anglo and to own up to their full bad debt exposure and begin an orderly wind down of the bank where possible. Conversely, the Government must use the bank to ensure that that viable businesses do not suffer as a result of the tightened credit conditions and resultant economic contraction. As a corollary, in adopting a ‘business as usual’ approach, the chances of recovering a greater proportion of its asset base will be substantially enhanced. In no scenario can I see the failure of Anglo as the optimal outcome…
Enrique’s first point is to me the most compelling. There is ample evidence on cascade effects that meant that anglo going would have simply precipitated a (share at least if not deposit) run on the others.
However, the governments silence on most matters related to the bad debt scenario, plus the frankly ludicrious reassersion of “business as usual” has led to the present situation where we have a run on the shares anyhow.
I don’t understand how anyone can trust PWC. Guess who were the auditors of AIB when they were busy fiddling their tax – PWC. The Chairman of Anglo Irish was managing partner of – PWC. Seán Quinn’s main advisor is Dermot Reilly, a partner in – PWC. (His auditors are Ernst & Young, who also audited Anglo Irish.) The cross directorships involved such as Gary McGann, a director of Anglo Irish and CEO where Seánie was Chairman. Ned Sullivan came from Greencore, where Seánie was also a director.
Over 30 years ago Sinn Féin Workers Party in their pamphlet The Irish Industrial Revolution pointed out these cross directorships and cross interests. Nothing has changed.
Indeed the Civil Service is now controlled by a similar form of cross interests. Many departments are now led by Dept. of Finance Mini Me’s We have seen that the Dept. of Finance is an empty vessel bereft of any ideas.
Externally we see various ex Finance staff such as Dermot Quigley used to prepare reports to ensure the role of the Dept. of Finance is protected.
I think our problems started with the blanket guarantee to all banks and all deposits and bonds. Turning limited liability companies into unlimited liability companies and then nationalizing them is bordering on insanity.
The mistakes that have been made are now irreversible. The real question now is what level of bad debts will emerge from the Irish banking sector in the next 5 years.
Are we talking about €10B, €25B, €50B or even more?
Nationalisation became inevitable once the State guaranteed all Anglo’s liabilities. Anglo would have collapsed immediately if it had been excluded from this guarantee. Whether or not this would have led to systemic collapse, the Government preferred to extend the guarantee rather than take responsibility for this collapse. Minister Lenihan told the Dail yesterday that nationalisation was considered on 29 September but the State guarantee scheme was preferred.
The opposition were utterly dissatisfied with the debates on the nationalisation bill. The Seanad debate ended in total confusion as is apparent from these links. As a result, the State owns a bank but the legislative framework governing the nationalised bank is unsatisfactory. The Minister will be held solely responsible for the future operation of Anglo even though the Minister may appoint a nominee under the Act, possibly the NTMA, to act on his behalf.
Enrique’s point about the effects on winding up Anglo on other banks via syndicated loans is often mentioned. It is a complete red herring. If other banks are forced to write down the inflated book value of assets to their true economic value, how could that possibly make the banks worse off? A set of accounts is supposed to reflect reality. You can’t change that reality by writing down false figures in the books. The share price and confidence of depositors and debt holders in the other banks reflects the economic reality, not what is recorded (largely on a historical cost basis) in the books.
On the PwC report, to be fair they probably drew up the report based on International Financial Reporting Standards. They are accountants after all! IFRS mean that banks cannot make provisions against losses that are fully expected but have not yet happened. A bank can only make a provision if a triggering event occurs, such as when a borrower misses an interest payment. This means that loan loss provisions are very low during the early stages of a downturn, as triggering events have yet to happen. So accounts based on IFRS will exaggerate banks’ capital position at the this stage of the cycle.
That’s a fair point Alan. I have no doubt the current weakness in the share prices of the banks reflects a very skeptical view by investors about announced bad debt provisions.
The issue for the big banks however is that under IAS39, if a fire sale of Anglo’s assets gives specific evidence of a diminution in value of these assets, they must be marked down accordingly. As a result, this creates a requirement under Balse II to increase the capital adequacy reserve by this amount, thus impinging on the banks liquidity position and tier one capital ratios further.
On top of this, your point implies that the market is insensitive to changes in accounting figures. You may recall the rally the investment banks enjoyed when the ‘mark to market’ rules were relaxed at the end of last year, allowing them to reclassify certain illiquid assets held for investment from market determined values to management determined values. There was no change in economic reality here – just a change in the valuation method. If the remaining listed banks marked their book to its realisable value, you can be assured that we would be left with no private sector banks; notwithstanding current investor skepticism about asset values.
Overall however, I agree with your basic argument; the Irish banks are sitting on unquantifiably large unrealised losses that we the taxpayer will ultimately end up carrying the can for and failure to address these will result in ‘zombie banks’ unable to operate commercially because of their weight of non performing loans, similar to Japan’s experience in the 90s.
I wonder if Alan Ahearne is entirely justified in dismissing Enrique DeLucas’ point as a red herring.
The price realised in a liquidation sale is not necessarily a valid yardstick for a valid “mark to market” exercise.