The policy pendulum looks set to swing back to dealing with credit flow in the banking system. With so many policy proposals floating around internationally, I would be very interested to hear current views on the best policy course for the government.
Taking it as given that there has been a severe contraction of new credit, how much is due to: (i) a collapse in the demand for credit as firms and households repair balance sheets; or (ii) a collapse in the supply of credit?
Under (ii), is the main reason for the decline in supply: (a) the declining creditworthiness of potential borrowers; or (b) the risk aversion of bankers as they teeter on the edge of insolvency?
It seems to me that if the contraction is mainly driven by some combination of (i) and (ii a), the government would be wise to limit the additional fiscal commitment. A large package would further tighten the fiscal solvency constraint and force a more rapid fiscal correction.
The case for a large package seems more compelling if the credit contraction is being driven by the caution of the bankers. Whatever the size of the package, what is the proper balance between re-capitalisation, insurance for new credit flows, troubled asset purchases, etc?
6 replies on “Back to the banks”
It is still unclear what the true scale of bad debts is on Irish bank balance sheets. Rather than making a decision now on how much to allocate to the two main banks it might be sensible to get a team of experts (not accountants) to realistically value the banks loan books. This should be a condition of a bank accessing funds for recapitalisation. Only once the true state of future bad debts is clear can we have any idea of how much they really need.
I understand that Sweden took an approach along these lines. It should help remove the one thing markets hate most – uncertainty.
John – coming at this as a small business owner (30 staff) who has talked to a lot of business owners about this, I can safely say that (i) AND (ii) apply and that both (a) AND (b) are explanations for the decline in supply.
As the budget (to the taxpayer) of bailing out insolvent banks keeps rising (and tens of thousands in the rest of the economy are losing their jobs), then I find myself reluctantly drawn towards Willem Buiter’s idea of creating a ‘Good Bank’. Just hire the experienced bankers without too much bad judgement in their CVs to run it.
Not the ideal outcome for a free market democracy: but possibly the only solution when the banks have effectively destroyed the global capitalist economy from the inside. I’m happy to be persuaded otherwise: but right now it looks like the least bad option.
State should set up a new on line bank, capitalise it, look for new depositors and start lending on a commerical basis.
Feeding money to the current crew is throwning good money after bad.
I found this post by Simon Johnson on the Baseline Scenario interesting:
It suggests my original framing might have a too short-term focus. A key paragraph is:
“The task is not so much to force lending to increase now, but rather to clean up the banking system so that, when the recovery begins in earnest, credit will be available on reasonable terms and subject to sensible lending standards.”
JP Morgan had an interesting research document a couple of weeks ago. With the usual skepticism regarding investment bank analysis, the figures on bad debts and the balance sheet are illuminating, and the figures they arrive at to repair the balance sheet (€10.3bn in total) are pretty hefty.
I had a look at the Danske Bank’s Annual Report. The figures provided for their NIB operation (page 33) suggest that the position may raise serious issues beyond just the banks’ own funding problems.
The tax implications are likely to provide for a “triple whammy” on the Exchequer. NIB made a loss excluding the write off of the goodwill of €157M. The report comments that the outlook in Ireland and the Baltics looks very bleak.
1) NIB is unlikely to make any profits in 2009 as it takes a bad debt hit, therefore will pay no preliminary tax in 2009
2) As it made a loss in 2008, then any preliminary tax paid in 2008 will be repaid as no tax is due.
3) The losses in 2008 may be offset against 2007 profits, creating an additional refund. A loss of €157M has a tax value of €20M approx.
NIB were (I assume) not as heavily involved as the others in property speculation. Further hits to the Exchequer arising from Anglo Irish, IL & P, AIB, Ulster Bank, B of I etc. must surely be on the way. The combined loss is going to leave one huge hole!