How do we ensure a smaller, healthier banking sector?

Let’s amalgamate some of the credit unions? Build on what is regarded as sound and the rate of growth may be surprizing. But it does require a government licence.

Yes, that’s a fair summary of my concerns. More specifically, one of the reasons I’m concerned that we will end up overpaying is that even those involved in the process who understand perfectly well that the arguments cited in my piece are without merit, may still be willing to run a scheme which overpays because they are convinced that nationalisation is A Very Bad Thing.

Part of what I’m trying to do with these posts is help convince people that, while hardly desirable in normal times, nationalisation may just be the best of a set of bad options, and that — properly managed — it can produce an efficient outcome that minimises cost for the taxpayer.

If the government is willing to really consider nationalisation, then it may run a fair NAMA valuation process. If they are determined to rule out nationalisation, then there are lots of accountancy tricks that can be used to price these loans at far more than they are worth (Remember the PWC report’s claims that all of the Irish banks were well capitalised?)

First off, you win the argument with Rankin hands down: Backdoor recapitalisation through overpayment is indeed a terrible idea for the taxpayer.

I now see you are making the empirical claim, in part informed by very the existence of arguments such as Rankin’s, that the government is likely to overpay outside a nationalisation context. In that case, my proposed separation — pay expected value and then take fair compensation for recapitalisation — does not work.

Can you envision any mechanism for setting the asset transfer prices that would reduce your expectation of overpayment?

Another supporting argument for nationalisation is set out in a thought provoking note by Paul de Grauwe (writing about the ‘four deflations’ we now face - over at Euro Intelligence http://www.eurointelligence.com/article.581+M5a44f3fb3ec.0.html). He makes the point that the good bank/bad bank arrangement (similar to the NAMA approach) assumes that the privately owned ‘good bank’ will start lending ‘normally’. But what if they don’t? What if their incentives are to curb lending (and the risks that go with it in a still moribund economy) in order to appease risk averse shareholders?

In such a scenario the taxpayer has been left holding the baby … without any alimony. Seems like another reason for the nationalisation-then-privatisation model you propose.

If the public at large are not subsumed into this dialogue soon by the Government there will be a very confused and angry electorate awating them in June. The scale of what is being considered is awesome (50% of GDP) and even more awesome for individuals and families traumatised by the further confiscation of income in the Budget, recently unemployment or otherwise economically threatened. Indiciative results need to be evident quickly enough to demonstrate the credibility of the chosen approach.

When the true extent of the incidence of toxic loans at each of these banks is ascertained, surely the approach would be to reduce the exisitng equity to the extent of these losses, which in some instances could be zero, or greatly below zero.

The existing shareholders could be offered the opportunity of raising new capital privately and if they succeed they bank remains a PLC. This would mean that the State is not, at the outset, approaching this matter on the basis of ‘one size fits all’.

This was the case with respect to at least one Scandinavian bank in the 1990’s crisis. But if they fail to raise new equity, then the Government ought to obtain equity for its contribution and, if it is the sole shareholder, the bank is nationalised. Perhaps this approach would facilitate the sale of Government equity (privatisation) more quickly than would be the case of a business that suffered the institutional consequences of long-term nationalisation.

Another matter that needs an airing is the capacity of these banks to return to profitability within an acceptable timeframe and otherwise, merged, disposed of or closed. It would be outrageous to maintain a no-hoper on tax-payer life support for longer than is reasonable.

The existing boards of these banks need to be vigorously overhauled as a feature of this bailout.

A further point that I am curious about concerns the impact of the personal mortgagees’. The perception that I have is that the focus of attention is on the very large amounts owing by developers (speculators). But the consequences of lending to individuals amounts of money that are far greater than their sustainable income can service and lending sums greater than the initial value of the mortgaged property must be about to haunt the economic system. Commentators frequently mention that Ireland is untainted by the US inspired sub-prime lending debacle but the utter breakdown of financial law and order over the past several years must almost mimic sub-prime. Our GDP grew by 26% between 2004 and 2008, even allowing for its tapering last year. But private sector credit grew by 97% to almost €400 billion when the party was in full swing, dungarees were exchanged for pin-stripe suits and and Hiace vans for Aston Martins!

The purpose of the example is to illustrate that, conceptually, this position requires those that adopt it to also say that there is no difference between (a) and (b). Stylized examples like this are one way of illustrating general principles that sometimes get obscured by the bells and whistles associated with realistic discussion.

What reason could the government have for not using all of these funds to absorb the first tranche of losses though a full nationalization and restructure of the banks.

But I think your example here is a distraction. As you say, nobody has proposed recapitalising without compensation to the government. You are absolutely right that closest possbile attention has to be paid to ensure the government does not overpay for the assets — I don’t think anyone disagrees. (I include Patrick’s propsal here with Philip’s proposed modeification of terminology.)

From that point on, I think the debate is best served if we proceed on the assumption that the government pays expected value and then ask which arrangement has better incentive and risk properties from the public interest point of view. Otherwise, the bail out and organisational questions get tangled.

At present, the market value of bank equity is close to zero. If after the asset purchases (and presumably the government taking a majority equity stake) the market value of the remaining stake owned by the original owners is still close to zero, then I do not see how the government has bailed the bank owners out. Repeating myself, we can then focus on the relative governance, diverstiture and risk advantages of the contending alternatives.