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?

10 replies on “The Banks: It’s About Allocation of Losses”

karl. On questions and answers last nite this was my point re the q ‘will we have a bad bank’.
Its hard to get the issues across in soundbite time but those of us who are commenting today can and should try.


Excellent post. The latest media reports suggest that Minister Lenihan will announce today some sort of asset management fund to be run by the NTMA. But, you’re right, the issue of the allocation of losses won’t go away.

It is difficult to avoid the conclusion that AIB and BoI are technically insolvent. In the absence of a speedy and effective insolvency procedure for banks of this size and importance the only viable alternative is nationalisation. But, similarly to the Obama administration in the US, the Government wishes to avoid this at all costs. (in addition to the link provided by Brian to Jeffrey Sachs’s piece, Paul Krugman and Joe Stiglitz have been equally scathing about the proposed public-private initiative to relieve banks of their toxic assets.)

The shareholders who, however unwittingly, sanctioned this excessive accumulation of property-related “assets” deserve to be wiped out – and bond-holder also need a haircut. Any other solution will penalise taxes payers unjustifiably.

The economy deparately needs “boring” banks to perform normal financial intermediation. Nationalisation, clean and privatisation seems the best route.

Amen to that post, couldn’t agree more. No doubt in the next few days there will a huge media fixation on income tax etc. but from next week it would be great if you guys could get on TV and start sounding alarm bells about the consequences of overpaying for assets & the consequences protecting already wiped out shareholders.

You all have written excellent articles on this. Keep hammering away, a few pieces in the FT might get their attention and if you could get on Prime Time, Newsnight, even Bloomberg & the like and other shows and start sounding the alarm bells about Irish banks, the government & the Irish public might engage with this issue and start showing an interest. We really need a debate on this issue. The Central Bank should be weighing in heavily in public too.

This issue is so critical to recovery that it can’t be ignored by the media any longer. If you could raise your media profiles like McWilliams & Lee have done for a few weeks it would probably do the world of good.

It’s kind of surreal how the country has been (and will no doubt continue for the coming years) tearing itself apart over how to get the public finances right, and yet seemingly similtaneously drifting unknowingly (thank you media!) into simply gifting unnecessary billions to bank shareholders so as to avoid nationalisation.

Or is it me?!

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