IT Piece on Bad Banks and Risk Insurance

Here‘s me in today’s Irish Times arguing against the current bad bank and risk insurance proposals.

9 replies on “IT Piece on Bad Banks and Risk Insurance”

Hard to disagree with this, Karl. One nitpick is that you don’t address whether it might be possible to use warrants and other conditions attached to the purchase of impaired assets by a state AMC to avoid a back-door recap of private banks.

Regarding nationalisation, there may be an issue of timing. Patrick Honohan provided evidence in a post earlier this month that the nationalisation of Anglo was associated with a jump in spreads on Irish government bonds. If circumstances allow, might it be safer to wait until the US has nationalised Citi, BoA, etc., and something similar has happened in the UK and most of continental Europe, before moving to nationalise the entire system here? Safely in numbers, keeping one’s head below the parapet, and those type of reasons.

Nice piece Karl.

@Alan: I understand the ‘keeping your head down’ argument. The real dilemma though would be: what if our nearest neighbours and perhaps other governments as well decide to do the wrong thing, under pressure from their bankers?

I think this article is spot-on and one of the most lucid on the subject the Irish banking system.

But I wonder, in my own uninformed way, whether the Irish government truly is a sufficient source of capital to undertake the daunting enterprise of fully writing down all the losses.

After all, borrowing to pay for bank write-offs is effectively like asking private lenders to buy Irish government bonds which will be used to buy rubbish paper from the commercial banks. Those same private lenders are unwilling to lend to the commercial banks directly, aren’t they?

The only difference between the Irish 3-year bond coming on the market next week and a corporate bond from, say, AIB is the sovereign guarantee of a state which is teetering on bankruptcy itself.

Perhaps people could enlighten me on why this logic is false?

Regarding the Swedish example, current US policy, the TARP and Bernanke’s comments, I think that the US is continuing to opt for the most damaging solution for their economy which we must not imitate in any way.

Bernanke’s comments imply a reflation of the asset price bubble, including stocks*. If this happens it again puts asset prices out of kilter with the general price level. In this case the general price level has to rise because they won’t let asset prices fall. Therefore inflation becomes their solution. So the cure is worse than the disease. They want joe public to pay for this by both taking their tax dollars through TARP to prop up asset prices and then again through inflation. This is incredible and unjust.

Surely we cannot engage in anything like the same practice of taking the toxic assets from our banks. They must be left with them to deal with and new banks created with public money. This avoids the moral hazard issue and punishes bad investment decisions. The importance of allowing failure in a capitalist system is surely of great value in redirecting investment away from those with a bad record.

* Apparently an S&P 500 at 800 is considered fair value based on long-term price/earnings ratios. So the stock market is priced correctly although below mean trend prices must be inevitable for an extended period.

I thought this was a great piece Karl – clearly articulated what I’ve been thinking about what are often very vague “bad bank” proposals.

However, nationalisation advocate John Quiggin has made the point that the fundamental and global nature of the present financial crisis may make a quick re-privitization more problematic than in previous cases like Sweden in the early nineties or the RTC in the US in the late eighties:

It is hard to avoid generalities in a newspaper article. There are fewer difficulties here.

Nationalisation is a broad brush concept. To make it useful for policy-makers and the public, you need to work down to the nitty gritty. There is quite a difference between nationalising Anglo and BoI/AIB, and that is quite different again from nationalising BoA/Citi.

There has to be a general presumption against nationalistion. For a chilling reality check, read Isaac’s WSJ op-ed here . William Isaac says he’s the only person in America who has ever nationalised a bank (Isaac led the FDIC during the Savings and Loan crisis of the 1980s, and “saved” Continental Illinois). Even more chilling, listen here .

Bad nationalisation weakens sovereign credit ratings for reasons that I think are obvious. You don’t need to look beyond what the rating agencies say. That is why bad policy decisions are met with wider yield spreads.

We, like at least some other bankers, have argued that the bad bank and risk insurance proposals are not good solutions in many contexts (notably as regards large US banks). That said, we are aware of some of the nuances.

So I wouldn’t tar all bankers with the same brush. All the more so as there will be no recovery in the economy until banks are healthier, and the public is reconciled with the idea that banks can make profits once again. Economists can help the public interest by explaining why strong banks are so vital. And “banker” has to become less of a dirty word.

An interesting nuance you introduce is the difference between temporary and permanent nationalisation. This is key. What practical steps can be taken to ensure that nationalisation is “temporary”. The devil is very much in the detail (although of course, you did not have space to elucidate). As Issac illustrates, day to day management is key.

You say a state asset management company is a more accurate and useful term than bad bank. Effectively. Indeed the difference between the two – and even a nationalised bank, quickly dismembered – could be zilch. The debate ought not be centred on bad bank, insurance and nationalisation, as if these are somehow conflicting alternatives. They aren’t.

More simply put (if not too simply), there are large losses on many bank balance sheets. So how big are they? And who pays?

More clarity would lift the uncertainty over Ireland’s sovereign ratings. Fear of contingent liabilities is rampant. Clarity might come through either nationalisation and quick sale, or an asset management solution, etc… Whatever. We need to talk euros and pennies. Ideology and broad brush principles do not help lift the clouds.

Some realities here.

The government is going to have to make sure the bad banks are taken off the bad bankers. This could be done by nationalizing or by some other means.

The government is then going to have to get the bad banks into good hands. It will have to try to sell these banks to ‘good bankers’.

The good bankers will not want to take on the bad loans. If there are bankers willing to take on bad loans in return for a lower price, then the government will know it has found a crowd of rip-off artists and will immediately realise that it has found a crowd of blackguards. No banker you would want to have anything to do with would be prepared to take on risk that is so fraught and so large.

Eventually the losses on these loans will be crystallized in one form or another, to a greater or lesser extent. When that happens, the government is just going to have to swallow it. The trick is to make sure not to do anything that makes these bad loans even badder, and to recover whatever can be recovered. Some loans might be partly or wholly collected directly by selling the underlying land, or some might be best dealt with by taking the land into public ownership if there is something useful that can be done with it to promote the common good.

Is this going to screw up the country’s credit rating? For sure. This can’t be avoided. Whether we like it or not, the government has to pick up the pieces now.

So for me, this is not the same as recapitalizing the banks. It is just freeing the banks of bad debt, so they can be put under new leadership and ownership. (Of course, any arrangement where the same owners and/or the same management ends up in control of the bank is not acceptable in my mind.)

This comment is coming from a person who is dealing with the reality of running a small business in this country in the current economic climate. I travel quite a bit in my business and have direct contact with other businessmen/women who have all hit this brick wall of falling revenue combined with an inability to substantially cut their cost base.
This is real for all of us and the blame game has got to stop. Banks and bankers have always been self-serving, but each and every-one of us who looked for loans from them in the “good-times” did so to enhance our own wealth and if one bank refused us we`d just head to the next one with our proposal. Anyone with a buy-to-let mortgage is a developer and for the general public and the media to put the blame for all this on the banks and the big developers is not fair and is not helpful. I`ve no vested interest here as I`m just one of the many who jumped on the band-wagon and took out a second mortgage, bought a house and rented it out. I did so because every-one else was doing it and let`s be honest we laughed at the “fools” who were too “chicken” to take the risk. We rubbed our s.u.vs and our 3 foreign holidays a year in their faces.
Builders bought some land with backing from the banks. These ordinary builders became the developers that we all seem to loathe now. What must be remembered that each one of these developers employed teams of skilled labourers and as they came near the completion of one site, had to look to the next opportunity in order to keep their business going. Whilst big profits were being made on one site the price of the next site was being driven up so that all the money after costs and tax would have to be put with the bank to secure the larger loan. This was then replicated time after time during the boom with developers eventually paying for example €150million for land (probably €30million of company profit as collateral and €120m from a bank) This land is sitting idle now and probably won`t reach that valuation again for 25 years. The developer has lost his €30m…..not hoarded it away. The banks have €120m sunk into a non-producing asset. We can continue to vilify the decision-makers or we can admit that it was a collective greed that brought us to this point. It was as self-propelling as it has been self-destructive.
Back to basics, with lessons learned is the only way forward for this country and the risk-takers, the entrepreneurs, have got to be supported in their enterprise. These are the life-blood of the economy. The businessmen and women who employ 5,6,7 people are the ones who should get tax breaks offered to multi-nationals. Why put all your eggs in one basket by giving incentives to companies employing 9000 people. Give the same breaks to 1000 companies employing 9 people and if one of these companies decides to re-locate to Poland it doesn`t devastate a whole community.
We will never see the hard-ships that our ancestors had to endure, but the strength of the Irish resolve in coursing through our veins because of the daily life and death struggle they had to contend with.

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