Today’s Irish Independent reports that Peter Bacon has delivered his report on bad bank and risk insurance proposals to the Minister for Finance:
The Government has been advised to set up a ‘toxic debt’ company to take over billions of euro worth of bad property loans from the banks.
I’ve written quite a few times about the bad bank proposal and don’t want to repeat myself. Still, it’s worth clarifying a couple of the nuances in the article because it likely illustrates the spin that the government would use to justify such a plan should it be adopted.
First, the article tells us that
Critical to any deal would be that the banks sufficiently write down existing bad loans before transferring them to a new state-operated company. It will be necessary to establish correct valuations for such assets to avoid perceptions of taxpayers having to foot the bill for rescuing the banking system.
The “correct valuation” stuff sounds sensible but, in reality, it’s a red herring. Think about this for a minute. What is the “correct valuation” for these assets if it’s not the value that a private-sector investor would pay? And is there any reason to think that the inherent value of these bad loans would be different to the government than to private investors?
Do not be fooled: The raison d’etre of these plans is for the government to pay more for these assets (perhaps a lot more) than private investors are currently willing to pay, i.e. to pay a lot more than they are worth. This could avoid the banks having to be re-capitalised again. With only the taxpayer available to re-capitalise and the market value of the banks being tiny, any further rounds of re-capitalisation would be taking the banks close to or into nationalisation.
Second, we are told that
Most commentators agree that the Government would find it virtually impossible to raise the necessary funding in the international market to buy the banks’ toxic assets. However, one solution being mooted involves the proposed new company issuing government-backed debt to the banks in exchange for these assets.
This sounds almost too easy. Print off some bonds, stick them in the banks and we’re done. Hey presto. It is indeed the case that the government can re-capitalise the banks by printing off some bonds and giving them to the banks in return for impaired assets. It can then set up the ‘toxic debt company’ to sell off the bad assets over time to attempt to come up with as much money as possible to pay off the bonds when they mature.
It should be clear, however, that this scheme will still have implications for the government’s ability to raise funding in international markets in the future. To the extent that the government overpays for these assets, the toxic debt company will come up short of covering the proceeds of the newly-issued bank bonds. This leaves the Irish taxpayer with a (potentially huge) contingent liability.