The Banks: It’s About Allocation of Losses

With an announcement coming from the government on Tuesday, I think the best that can be hoped for at this point concerning our banking problems is some sort of “kicking to touch” in which the Minister announces that further time is being taken to consider the available options. If this is indeed the case, then we are going to need a much better-informed debate about these options over the next few weeks than has been served up in recent months by the Irish media.

There are a number of possible ways that the government can solve the problems with our leading banks. However, the various plans being discussed differ greatly in terms of (a) How the losses associated with bad property loans are allocated between the taxpayer and bank shareholders and (b) Who owns and controls the cleaned-up banks. If the media were serving the public well, there would have been an extensive discussion of these issues. Unfortunately, this has not been the case.

As an example, consider today’s column in the Irish Times by John McManus. Note that my point here is not to pick on McManus, who I consider to be an excellent journalist often willing to be tough on the government on business issues, but to illustrate the weakness of the coverage from even our leading journalists.

The article is titled “Time for reality all round in dealing the banks’ bad debts” but, to my mind, it fails utterly as a reality check since it does not address the important issues.

The article presents the idea of a state asset management company as some sort of plan that the government has belatedly come around to and that the banks need to be convinced to agree to. However, as I discussed in my article on Friday, the issue is not whether we need an asset management company but how this is implemented. And the key issue is the price that the government pays for these assets.

On this issue, McManus’s column is not reassuring. The issue of how much the state pays for the assets isn’t referred to explicitly at all. However, he refers to €56 billion in problem loans and then later refers to state asset management company having “assets of €56 billion”. If this were the case, then the plan would involve purchasing of these impaired loans at their current book value, which would constitute a huge direct transfer of funds from the taxpayer to the banks. Rather than interpret this as the incredible deal for the banks that this would be, McManus describes the plan as one which the government needs to convince the reluctant banks to sign up to:

They have accepted the State’s help, both by way of the guarantee and the recapitalisation, but stubbornly refuse to do what the State wants them to do. In this case, it’s agreeing to a bad bank as a way of drawing some sort of line under their problems.

Of course, it is highly unlikely that the government would ever pay book value for these assets. No plan would ever be announced with the byline “government agrees to overpay for assets”. So some writing down of these assets relative to book value would be required for the government to stand any chance of selling the plan to the public. For instance, the illustrative figures for the Bacon-style “bad bank” plan in my piece on Friday suggested the banks would have to write the assets down by exactly the €7 billion provided in re-cap funds by the government. But this would still represent a great deal for the bank shareholders and a dreadful one for the taxpayer.

One might ask, if I’m right, “why haven’t the banks jumped at this deal?”. McManus’s article provides a useful clue. Somewhat remarkably, the banks—who owe their continued existence as private companies to the state liability guarantee—are still “negotiating” to get a risk insurance scheme instead a state asset management company. This scheme—which would keep the bad assets on the bank balance sheets but see the government cover the losses as the banks declared them over time—is, as I’ve described before, the worst possible plan for the taxpayer and the best possible plan for the bank management.

This Minister has repeatedly noted his concerns about the risk insurance idea, so hopefully there is little chance this will be adopted, which brings us back to the key issue—how will the loan losses be allocated between the government and the bank shareholders?