A Fair and Efficient Plan for Fixing Our Banks

Here‘s an article I wrote for today’s Irish Times which outlines a plan for dealing with the problems at our two major banks.

13 replies on “A Fair and Efficient Plan for Fixing Our Banks”

This article represents the most succinct and accurate summary of banking clean-up I have read anywhere. Chapeau! (I just hope someone up there is listening!)

My only comment: The estimation of “fair value” for distressed property-related assets should be comprehensive enough to encompass all securitized lending (including performing loans). It should be based on asset pricing through imputed rental values, rather than any guess at market values. This method of accounting should also be enshrined in mortgage lending best-practice for all future asset valuation.

very persuasive!

One thought however

Does this plan abandon all hope of giving unsecured creditors a haircut?
Am I right in thinking that after the guarantee expires all bets are off – in hopefully calmer times it might be possible to let creditors bear some of the burdern. (maybe guarentee new borrowing by the banks in some shape and form after expiry)

This appears to me to be possible under Bacon but is it possible under this alterntive? Fairness demands that shareholders and bondholders bear the burden to the largest extent possible. At very least unsecured creditors should not get any premium over Irish national debt issued at the same time.

A thoughtful and well-argued plan that might be do-able. I would lned my support to it as a good solution. It is more expensive for the Irish Exchequer than my Euro-Geithner plan (which transferred the bailout costs on to the ECB) but MUCH less tax-expensive than the leaked outline of the Bacon plan which seems to involve an unaffordable overpayment by the Irish Exchequer for banks’ toxic assets. One way or another we need to prevent the Irish Exchequer from attempting to buy the banks’ toxic assets at a substantial premium without recompense. That is not appropriate in the current budget environment and policy makers need to be made clear on that. Either the ECB picks up the cost or the Irish state receives compensating financial claims, as in this plan.

It is important to note that the Irish government (Central Bank and Treasury) cannot function as a lender-of-last-resort without having a sovereign currency. The lender-of-last-resort for the Irish economy is the ECB. Similarly (perhaps this is the same point) the Irish government cannot ease long-term liquidity contraints on private agents since it does not have such liquidity itself.

Karl, In your article, you say “As reported, the approach recommended by Bacon is as follows. The Government agrees to pay more for the portfolio of troubled loans that it is currently worth.”

You must have read a different leak. In the first press report of the Bacon plan it was stated quite explicitly 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.” (Irish Independent, March 19)

Again: “The transfer value of moving the bad assets from the banks to the toxic debt company…is expected to involve sharp write-downs in property values that are equal to or even lower than the worst-case scenarios estimated by the banks.” (Irish Times, March 20).

If the property is written down before purchase, as is explicitly stated by these reports, shouldn’t that make it equivalent to your scheme in cost terms?

Of course, the key is getting the right valuation. I agree that nationalizing first means the government doesn’t have to fight the banks over this.

I agree. The bad bank idea means that the government will nationalise the bad loans while leaving the “good loans” to the banks that got us into this mess.

After the banks are nationalised, why not split them up into competing companies before privitising them? This will lead to better value for customers and permanently lower profits for banks. That is how to punish them.

Patrick: “Written down” does not necessarily mean “Written down to fair market value” — my example assumes the loans are written down by exactly the €7 billion the government invests in the re-capitalisation. My interpretation is that this element is only “critical to this deal” to the extent that the spin will require government and bank spokespeople to be able to say that the banks have taken “sharp writedowns” which will sound like they’re taking a serious hit.

The leaks make clear that “keeping the banks out of nationalisation” is a key aim of this plan and the Minister himself has presented Bacon’s role as being the exploration of plans that the government can implement in addition to the €7 billion re-capitalisation.

Perhaps Patrick can see how we can simultaneously have
(a) A write-down of these assets to fair market value.
(b) No more than €7 billion government investment
(c) The banks remaining adequately capitalised.

but I certainly cannot.

Beyond all that, this discussion shows the weakness of government-by-leak. It would have been far better to have the Bacon proposals made available in full to the public.

OK, on consideration I suppose I have been unfair. And, as we have discussed before on this blog, I do like your plan quite well. Indeed, there may be no better way to go.

In particular I share your concern that no more taxpayers’ money should go to subsidize shareholders or other providers of risk capital, and that, if poorly managed an asset purchase scheme could easily do just that. (An insurance scheme might be even worse on this dimension).

No problem Patrick. It’s easy to get wires crossed in these kind of exchanges. Perhaps my implication that you didn’t understand the incompatibility of (a) (b) and (c) above was also unfair. The substantive issue here is to avoid a poorly managed asset purchase scheme and it’s clear we agree on that.

Karl Whelan’s plan is a very timely contribution to a debate which is receiving insufficient public attention. I am disturbed by reports that the Government intend to announce plans for an “asset management company” on Tuesday. We haven’t seen the Bacon proposals and everyone is extremely tight-lipped even though the cost to the taxpayer may greatly exceed the total adjustments in the supplementary budget.

The key to the any such plan, of course, is relationship between the price the Government pays and the long-term value of the assets it receives in return.

If the Irish financial institutions transfer to the State nothing more than the real estate against which bad debts have been secured, the burden on the taxpayer will be enormous because
(a) the Government would pay a price sufficient to avoid nationalisation, but
(b) if we are to develop a sound economy, real estate must never again achieve valuations approaching those of recent years.

In Ireland, real estate lending normally involves personal recourse and the “bad bank” should have subrogated claims against the borrowers. Unfortunately, this will require (a) the political will to pursue speculators and developers and (b) effective means to extract money which, no doubt, they have already put beyond the reach of Irish courts.


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