Last night’s RTE news was full of breathless commentary from Brussels and Montrose to the effect that governments needed to do more than just re-capitalise the banks. From Brussels, Sean Whelan excitedly talked about “toxic assets” and how it was going to be necessary to “buy the toxic assets at a steep discount, leaving the banks to continue with the viable parts of their business. Simply re-capitalising the banks isn’t seen as enough.” Back in Montrose, David Murphy authoritatively informed us that “In terms of doing something else in addition to re-capitalisation, they have an option of setting up a bad bank or, for instance, insuring the banks against the some of the bad loans that are coming down the track. But it’s pretty clear that the re-capitalisation on its own won’t be enough. And if they do something that isn’t enough, the markets won’t like it one little bit and Ireland will be punished for that.”
Despite the confident tones in which this expert analysis was delivered, as far as I can see it doesn’t make any sense.
There is no logical distinction between the issue of undercapitalisation and the problems created by so-called toxic assets. Banks could get rid of all their toxic assets in an instant if they just wrote them down to zero. But then they would be undercapitalised—and that’s the problem with toxic assets. What appears to be going on is that the various re-capitalisation programs around the world have not managed to offset the likely losses from bad loans. However, this is a problem with the size of the re-capitalisation programs, not their nature. There is no logical argument for now augmenting these programs with a scheme to systematically overpay for impaired assets. (Sean Whelan may think the proposal is for buying assets “at a steep discount” but that discount is relative to what they were originally worth, not what they are worth now.)
What appears to be going on is that neither banks or governments want to inject more government equity capital because going any further than we are now requires effectively admitting that the banks need to be nationalised. Government concerns about nationalising banks are well-founded but it seems that, in many cases, we are well beyond that point. If the banks can’t find private equity to re-capitalise them and government is willing to do so, then that’s where we should end up.
As a final point, it’s worth noting that despite the constant commentary about toxic assets and all the problems created by the evils of structured finance (CDO-squared and all that), this stuff is essentially irrelevant to the Irish banks. Their toxic assets are largely plain old loans to bankrupt developers and rocket science isn’t required to come up with a guess at the size of the loan losses. As Colm McCarthy has joked “We didn’t import any toxic assets, we grew our own.”
As usual, I have the sneaking feeling that I’m missing something. Perhaps our team of commenting pundits can explain to me what I’ve got wrong.