Ahearne on Bank Nationalisation Post author By Philip Lane Post date April 25, 2009 In today’s Irish Times, Alan makes the case against nationalisation: you can read it here. Categories In Banking Crisis Tags NAMA 42 Comments on Ahearne on Bank Nationalisation ← Unemployment among the Young → Economists and the Crisis 42 replies on “Ahearne on Bank Nationalisation” Alans arguments are , on the face of it, wrong and known to be so. There are four made : That banks would not get funding, that nationalising would be a stain on our economic reputation, that NAMA is better for the taxpayer! and that nationalised banks retard economic growth. Its a classic political economy piece, emphasis on te political and to me dispels hopes I may have had that the appointment of a competent economist to the dept would result in sensible advice. Alan has, alas, been captured. The arguments on the international reputation are opinion and illgrounded. We did not , as was alluded, suggest nationalising the entire syste, just that part which was important. To suggest otherwise is not to have read the article. Alan (or whoever wrote the piece : these arguments have been floating about the political sphere for a week now) suggests “Investors would surely give the Irish market a wide berth in the future – not just in the banking sector – if the State undertook such an extreme step”. But the guarantee, in bond market land, was seen as such and acted upon. In fact, taking the important into the state would reduce the contingent liability and I would argue reduce costs of funding. As I have said before, I do not think the dept of finance understand the bond markets. Second, the funding issue. Its not clear here whether this is in relation to interbank funding or capital funding. It seems to be on interbank funding (the excessive growth of which btw is now seen as a key comtributor to the irish banks problem and a reduction in which should therefore be welcomed) but to suggest “it is naïve to think that providers of funds do not differentiate between banks with a market presence and nationalised banks” is to fly in the face of reality. Is anglo facing interbank liqudity problems? Is any chinese bank? Or any large corporate treasury of a stateowned company, such as EBS? More accurately perhaps, are the finding any more trouble than their non state counterparts. On the taxpayer, it shows enormous faith, to put it mildly, to consider that an investment with 25 or 45 percent ownership stake will return the same to the person that owns 100% when the assets are identical. Alan, dont teach investments….. Finally, on retardation of growth ; the vast majority of the studies inferred as relevant relate to systems nationalisation in developing countries. If the state were to nationalise the systemically important irish owned guarantee covered banks that would still leave ample an sufficient competititon from non state owned banks in ireland. Overall, this is a set of arguments that are wrong, politicisised, incorrect and or disingenous. from the april 17th article : ‘Twenty of Ireland’s leading academic economists argue that the Government has got it badly wrong.’ Sometimes I have to wonder why there is such a divide between academics and practitioners. The real life issues being brought up by Alan don’t factor into the paradigm of many on this site, and on one hand that means there is a glaring disparity between the scholars who study the situation and the scribes who write the rules. I’d like to hear anybody’s thoughts on this. karl. Can you elaborate? simply put: there are two types of people in the market, those who are academic and those who are out for profit. I think academics believe that practitioners are about greed etc. – I’d believe its more about utility, and the practitioners reckon academics don’t know how to operate ‘in the real world’. and neither side seems to see eye to eye, hence you get this divide of nationalisation/non-nationalisation etc. take any financial argument and you’ll find that the opposite sides can often be grouped not by their political ideology but by their place in the market, ahearne (having worked with the fed) is as much a practitioner now. there is no set acid test but as a rule I’d say that once you work to create profit (I don’t mean wages- educators are not there for profit in this sense) then you are leaning towards the practitioner side. and if your work is primarily that of research/study/education then you are leaning towards the academic side. thus you don’t see the likes of stockbrokers, bankers, intermediaries (schmucks like me) or other market practitioners clamouring for nationalisation, and equally you do see those who are academic showing much more support for it. so with that in mind, do we have the decision making mix of power wrong? should it have more or less of one or the other? do people even feel that there is this divide in the financial sphere? @brian lucy – as a side note– the cost of funding (if we nationalised over 60% of our banks which is what doing the big two would do) would indeed fall for the banks themselves, but not for the state, our sovereign debt costs would rise and we would likely get another writedown, in a deleveraging world where money is no longer infinite would investors chase our bonds for the extra spread (with extra risk) or accept less for the benchmark bund prices? as an adviser I’d have to go with the latter. :Karl Deeter Karl Not sure that I see that there needs to be such disparity in policy suggestions between the two sides. Not sure that there are two sides indeed. Re the bank costs : the cost of debt rose when we took on the guarantee. So reducing the amount guaranteed should reduce the costs. Just a few comments on the escalation of this current vital debate on NAMA: 1. The orginal contribution published in the IT in the names of many contributors to this site (and others) was brave , bold, and badly required. However, in the words of the French Marshal commenting on the Charge of the Light Brigade “C’est magnifique, mais ce n’est pas la guerre.” I am reminded of the 364 economists who collectively condemned Margaret Thathcher’s policies in 1981 – and of her subsequent guest appearance in “Yes, Prime Minister” when, perhaps half in jest, she proposed the abolition of economists. I suspect there are some among us who are aware of the shambolic funding of higher level education in Britain during the 1980s and early to mid 1990s. A vengeful Government pursuing cutbacks is a nasty beast. This, however, should not provide cover for a pussilanimous retreat; the case being made, and supporting argumenation, should be strengthened further 2. We should not be too hard on Alan Ahearne. Today’s piece in the IT deserves parsing and deconstruction. One should never underestimate the slipperiness of Irish public servants to obfuscate and to avoid consideration of the obvious. This piece may have appeared in Alan’s name, but it has all the features of similar communications I have received over the years from Governmenat Departments and agencies. I expect Alan has been confronted with a very simple choice: stay, swallow some of the garbage and hope against hope to be able to insert some modicum of rationality or walk, with his integrity intact, but then be consigned to shout, powerlessly, from the sidelines. 3. Brian Lucey is correct. This is a political, not an economic, issue. Nationalising key banks, cleaning out the managements and restructuring the businesses would simply highlight the requirement for similar surgery on the Government, policy and regulation. This is an absolute no-no. There will be no effective resoltion of these problems until the Dail arithmetic crumbles or the Government simply runs its course. B|ut it remains vitally important to keep developing a coherent case for comprehensive reform. 4. We also need to keep the “big picture” in mind. Obviously the initial focus has to be on the banks – without them functioning nothing much will happen in the wider economy, but there is a broader agenda for institutional reform and fixed and human capital investment that needs to be pursued. The failure of financial sector regulation is being replicated in all other regulated sectors. Accompanying failures in competition and consumer protection policies have contributed. If the Government is so worried about the message selective bank nationalsiation might send out, it should think about selling off the existing semi-state businesses to restructure its balance sheet and to part-fund badly required fixed and human capital investment. Apart from hoping that an upturn in the international company will come to Ireland’s rescue, the Government has no idea how to facilitate the future flows of revenue that will be needed to finance large-scale borrowings. It is in this area that the international capital markets have genuine grounds for concern. Ireland has the scale and cohesiveness to pursue radical reforms – much as the Scandinavian countries did during the 1980s and ’90s – but only if the political will, imagination and intelligence exists. All, unfortunately, are currently absent. While admittedly somewhat simplistic, it appears in essence that the relative nationalisation or NAMA arguments boil down to the trade off between efficiency and equity. No matter what Alan Ahearne says, any resolution to the problem where current shareholders whose equity is in reality worth 0 ends up not being worth 0 is a subsidy/ transfer from taxpayers to shareholders. That said, the likely inefficiencies of government ownership are there for all to see in the Irish case. The private sector may have had one banking crisis, but the health and public transport systems, as well as to a lesser extent education systems have been in crisis for some time now, despite their unprecedentedly high levels of funding. As such, @Karl I don’t believe the difference between practitioners and theorists refers to capture, pragmatism or ideological differences. However it is interesting that in this case the theorists are in favour of … state control, while the person close to the government has little faith! maybe we should trust his informational advantage! – Karl D I’m a practitioner in this area and I think your arguments against Nationalization are wafer thin Karl. Through the guarantee the Irish government has already exposed you to all the downside risks in the Irish banking sector. Nationalization prior to NAMA will not increase these risks and if it could possibly reduce your cost of sovereign funding. NAMA as currently envisaged is a direct subsidy to existing bank shareholders from taxpayers to the tune of €20B. This should already be discounted by the markets and factored into Ireland’s bond spreads. If the Irish government reverses course there should be an improvement in your funding position as investors see that the governments balance sheet has just improved by €20B at the expense of shareholders. After that all the other issues are just a distraction. They reasons may have some merit but they are never going to outweigh a €20B positive from nationalization. I’d like to see a list of practitioners who believe that Nationalization is the wrong way to go for Ireland and reasons with a little nit more substance. Karl D, are you a shareholder in any of the Irish banks? “No matter what Alan Ahearne says, any resolution to the problem where current shareholders whose equity is in reality worth 0 ends up not being worth 0 is a subsidy/ transfer from taxpayers to shareholders. ” exactly! this is a simple point and choosing to not face up to it is dishonest. @ Michael L: The state balance sheet will be €20bn better off at the expense of shareholders? That’s interesting, because the banks are not even valued at anywhere close to 20bn so where will that savings come from? – given that nationalised banks will STILL have to work through the debts one way or the other and the money will be spent either way. And for the sake of clarity – yes, I do hold shares in irish banks, us banks, water companies, oil co’s etc. as a person in the financial field it is quite natural for me to buy equities, equally I take my losses in an adult fashion – so I hope you are not so cynical as to think that any minor shareholding would actually shape an adults world view! Karl D., The preferreds and the bondholders need to take a haircut too. That is where the 20B will come from. The only way to avoid this massive subsidy from the taxpayer is to do a capital restructuring. Also as has already been pointed out, Irish government debt ratings and CDS’s already took a hit after the horrible guarantee scheme. Taxpayers are already paying higher rates of interest/ Money that could have gone into the real economy – through lesser tax increases, job creation schemes, VAT increase reversal or what ever. Any of these would be a better use of money than higher interest payments. Prof Lucy, Be interested on your views on HOW debt is to be paid down: future income stream (and what this implies)?, default or Jubilee?, bankruptcy? Printing press? Econ 101 is quite shy on the problem of debt, its missing from PAE. I would also be interested to learn about your current economic Model-in-Use. It is not possible to have a meaningful intellectual engagement about the current economic and financial disaster if contributors cannot articulate what their economic Model-in-Use is. Whether these models are valid, appropriate, useful, or not, is entirely another matter. Mine is Sustainability, (annual, incremental declension in economic activity). Brian P @ Karl D Does your opposition to nationalisation constitute support for the proposed NAMA? If not, hat would you propose as an alternative? I would have assumed that at this stage the markets would treat the state and the banks as one (or identical) entity(/entities) when calculating risk? I mean it appears that the more risky of the two parties can pass losses on to the less risky one anyway… @brian woods Sorry Brian . Dont really understand your questions. cam you be more specific? Sorry to change the subject ,but wheres the coverage of yet another brilliant article by Paul Gillespie in todays times.?His analysis of the communal blindness and indeed collective madness which led to the crisis is worthy of mention.Gillespie groups together Journalists, Economists, politicians,business leaders who failed to see the warning signs of economic meltdown or the inherent weaknesses in the system.The detailed and statistical evaluations of economic reality in this Blog are competent and well researched ,but I feel sometimes we are failing to see the wood for the trees? Brian Lucey laments that its “political economy”. Always was, always will be. Its called the real world. And its study was once called,-Political Economy. The Alan Ahern article contains plenty of double-speak and theoretical legerdemain. AA: “First, would international confidence in Ireland be sustained in circumstances where the whole of the banking sector was under the wing of the State?” The canard of ‘international confidence’ in Ireland really should be knocked. The chorus of international voices that have decided that Ireland is the next developed economy to go down has been rising steadily since the middle of last year. To talk of sustaining that what is already lost is disingenuous. AA: “would wholesale international money markets be prepared to fund a nationalised banking sector? Banks in Ireland, as elsewhere, remain very dependent on their continuing ability to raise funds from abroad to finance their activities and meet the economy’s needs. Banks with a continuing market presence and operating subject to market disciplines and constraints are best equipped to compete for funds in the international marketplace.” Why wouldn’t they be willing to fund a nationalised banking system? Would international funds not be more willing to deal with a bank who’s position and ownership is understood, and one where the chance of insolvency is curtailed by a sovereign owner, rather than the current situation where the bank’s future is both unknown and politicised? The market presence of the Irish banks only serves to highlight their weakness at the moment. And ‘market disciplines and constraints’??? Please.. This also ignores the fact that the Irish banks have become over reliant on international funding for their balance sheets. Is there not a very strong argument for a limit on the loan/deposit ratios of the banks, considering that the levels of credit this funding model allowed into the Irish market in the past decade has been a major driver of the ‘bubble’? But perhaps an argument for another day. AA “The simple truth is that nationalisation creates a significant risk of a political rather than a commercial allocation of credit. This would be bad for the banks but even worse for the country.” I had to read this line a few times to make sure I wasn’t seeing things. Alan’s argument seems to be that we should not nationalise the banks because the government does not have the ability to allow the banks to be run properly. If they are so bereft of talent, then why should we listen to them when they tell us that they know what is the best future for the banks? Overall I am reminded of this quote “We are all entitled to our own opinions, but we are not entitled to our own facts” there is actually a lot of agreement. Everyone agrees we are in a bad situation, with undercapitalized, unviable banks. Everyone agrees that we need a strong private banking sector. The debate is about how to get from A to Z. Some people want to go the short, sharp, fast route, moving to nationalization, rationalization and the privatization. The people who are driving want to go a slower, longer more circuitous route, avoiding sudden, sharp shocks. They are also unwilling to abandon the extra passengers that we are carrying in the form of shareholders This is considered a ‘safer’ route. The objection to this is that the long route may be too long. We will simply have run out of petrol before we get to the destination. calan. Not lamenting at all. Its time we rememberd our roots. As a non-academic who worked in International Debt Capital Markets, Alan Ahearne is totally wrong. For the record the credit rating of Republic of Ireland is (S&P AA+/Fitch AA+/ Moody’s Aaa W/L -ve). Even assuming that Moody’s downgrades Ireland’s rating to high-AA (Aa1) or mid-AA (Aa2) it will still be several notches higher than either AIB or Bank of Ireland. For the record, bond investors prefer higher rated entities. I would suggest that Alan read up on CAPM. Central Banks, Pension, Life & Insurance funds would always prefer to purchase securities issued by a AA+ rated Sovereign (with Recourse to Taxation => non-credit) than a financially strapped poorly run A- rated Irish bank where NO CLEAN OUT of senior staff who wilfully followed the asset growth for asset growth’s sake policy set by Anglo Irish i.e. reckless lending. Are we to give the same eejits a second run at it by recapitalising the banks in return for a minority interest? Temporary means 2-3 years. Temporary Nationalisation Politicisation. It is still possible for the State to take ownership of the banks, restructure them, hire international executives with banking experience to run them at arms length. @LorcanRK it was former Speaker of the US House of Representatives Pat Moynihan who coined (at least used) the phrase: “Everyone is entitled to their own opinion, they’re not entitled to their own facts”. AA is now an economic advisor to Brian, Brian & Mary. That makes him vested interest. As we all are now fully aware of the Political Aversion to full nationalisation of the Irish banks persists, Alan has merely articulated the governments present position. The case for complete nationalisation remains. @anurag you can’t just ‘haircut’ bond holders, you see, equity investors can be wiped whenever you want, its not nice but it can be done, but you miss even a euro in your bond payments and the money will literally go out like the tide does but it won’t come back. @derek brawn – erm… obviously every nation is always going to be higher rated than any institution in that nation? banks being no different. if you were giving advice would you really say ‘go for irish sovereign debt rather than bund’ if the country got a further writedown on the back of nationalisation? the country, not the banks needs to come first and nationalisation will drag down our sovereign credit rating. btw: if you would suggest lower rated bonds would you still be standing over that from an advisory position? I wouldn’t. @Karl Deeter Nationalization wouldn’t on its own would not lead to a additional downgrades of the sovereign debt. Through the guarantee we are already exposed to 100% of the downside risk. In reality we have an exposure that is already greater than a normal equity investor as their losses are limited to the amount they put it while we have guaranteed to make good any shortfall between the banks assets and liabilities. Nationalization does however ensure that the government gets 100% of the upside through owning 100% of the shares. This will make the overall burden on the taxpayer less and should feed positively into the sovereign debt market. @dreaded estate ‘Nationalization wouldn’t on its own would not lead to a additional downgrades of the sovereign debt.’ – upon what do you form that opinion? Is it an assumption? The divisions among economists on this fundamental question raises broader issues about economics as an academic discipline and its scientific basis. I would support nationalisation as the only way to protect the taxpayer from overpaying for assets under NAMA but I recognise the grave risks which nationalisation entails. The key challenge is to design a structure for nationalisation which would protect the taxpayer and facilitate re-privatisation. Above all, the structure should be insulated from political pressures and from the banks/developers. Putting Peter Bacon in charge would be a catastrophic mis-step. My blog has further comments about the role of economics in the present crisis. @Karl Deeter Yes it is an assumption but it is based on the fact that the state is already shouldering 100% of the risks through the guarantee. No new risks would be added to our balance sheet so there would be no change in our underlying creditworthiness. If there is already an equivalence between soverign and bank debt why are they given different credit ratings – is the guarentee not entirely watertight? Alan Ahearne makes a good point about the risk of political interference with the banks after nationalisation. The basic problem with any solution short of nationalisation is the large proportion of capital needed to solve the banks’ problem and leave them in a situation where they will be motivated to lend wisely but liberally. Short-term nationalisatio (perhaps two year? partly depends upon the market for secondary bank offerings) with strict controls preventing political interference (yes this is still a risk) might save the Irish taxpayer ten billion Euros relative to a NAMA-plus-capital-injection plan designed to leave the current shareholders with the common equity. Prof Lucy, I have a significant difficulty understanding HOW a future income stream, heavily burdened by debt will be sufficient to both sustain ourselves, AND, pay-down the debt we are taking on with such abandon. The Law of Exponents forbids this. Your income stream must of necessity increment itself in excess of the incremental increase in the value of the debt burden. Hence an inflection point will be reached – and down we go! There is also the unpleasant little matter of the Second Law of Thermodynamics and its relationship to our dependence on liquid fossil fuels – hence economic activity. In essence, I cannot understand how we can possibly escape from the debt trap – [you have a legal obligation to repay your debts] – absent some miraculous episode of Quantitative Easing. My question about economic Models-in-Use is critical. Your responses are framed by your Model-in-Use (your belief system). All that I am reading about the present mess leads me to form the opinion that commentators are using the Permagrowth Model. This model must fail as it contradicts both the Law of Exponents and The Second Law. So whats’ left? Brian P Obviously Professor Lucy (sic) never heard of the law of exponents. me neither, is it one of Jim Corr’s? As for the second law, I am reminded of the Simpsons episode where Lisa invents a perpetual motion machine; in fact it proceeds to accelerate. Suitably outraged, Homer upbraids her “In this house, we obey the second law of thermodynamics”. Ahearne is worried that nationalisation would lead to political influence on the allocation of credit. Such influence might well be an improvement on the market allocation that led to the current economic debacle. Prof. Lucey,- glad to hear you’re interested in going back to the roots of economic thought. Understanding the thought of such financial technicians as Samuelson, Merton, Markowitz, Scholes, Fischer Black and Eugene Fama, and others, is certainly crucial if we are to understand how this global financial crisis developed. What were the main intellectual, and ideological, influences on the development of their thinking? Why did these strands of thought and the financial engineering based on them lead to the current meltdown? Taking refuge in the current fad of ‘behavioral’ finance won’t do. But all this is a subject for another day…. maybe several. @karl deeter: I would submit that money for Irish banks already went out like the tide. If it wasn’t for the government’s guarantee there was no money from the bond markets anyway. So the haircut was completely on the table. What the government should have done in September was force the banks to realize losses/increase loss provisions, wipe common and preferred, force bondholders to take haircuts and/or equity conversions and THEN guarantee future liabilities. Of course Irish banks are over-reliant on foreign capital as well but that is another discussion. Just an addendum to my previous comment: There is a big difference between missing a bond payment – default – and forcing a haircut/conversion to equity. However, my main argument remains that there was no money for Irish banks from the bond market anyway. Am I incorrect in recalling that there were large very temporary loans made by ILP to AngIB? They were made to fool the regulators, who may have had actual knowledge nonetheless? And that this was normal practice? That it had taken place some times before? Are we then irrational to assume that this has become an industry practice? The institutions are competitors, theoretically. They nonetheless engage in anti-competitive behaviour. There are other practices set out in my earlier posts on this site, which would call all ratings into question, for the banks at least. AA appears to have been captured indeed. He is now concerned that the government which employs him, might direct credit for its own ends. Really? Not logical. Using the possibility! of corruption to deny a sensible course of action by the same corrupt body is amazing but totally Irish! The best solution is liquidation of these and bury the bodies deep! The next best is nationalization and blackmail those who have committed offences into acts of altruism or disclosure of assets. Much so called international funding is pure shadow banking. RIP. There is a shortage of such capital, not surprizingly. With the wsj a shitty rag, pushing Irelands debts as 800% of gdp, we will only attract funds at a huge cost. Remember we have to repay, in a deflating environment! Remember Iceland! I have to say I was singularly unimpressed with Alan Ahearne’s contribution on this issue. As Brian Lucey has already pointed out, the main argument of the piece – that investors would shy away from Irish bonds which represented investments in our two main banks – is not founded on anything but pure spin and opinion. In fact, the performance of Irish sovereign paper in the wake of the Bank Guarantee Scheme provides compelling evidence that this is not the case. In effect, we have already announced to the world that we have assumed an open-ended liability vis-a-vis the stakeholders of banks here chartered. And yet they keep buying our bonds. (Maybe they’re counting on the German Eurozone Guarantee Scheme) So we are already carrying the costs of nationalisation in our bonds. Now, I happen to also think that we are closer to sovereign insolvency that a lot of people appreciate, but the best way to pull back from this brink is to contain the liabilities implied by the current arrangement. This in turn can be done by nationalising, wiping out existing shareholder claims and reforging the various balance sheet scraps into something resembling new banks. As for Alan Ahearne’s claim that we are well-positioned to benefit from the upside due to the share options arising from recapitalisaiton. This is really cheap used-car-salesman tactics, and quite unworthy of the debate: Obviously share ownership in whatever remains of the banks is a zero-sum game. If current shareholders escape with anything more than zero, this represents an unequivocal loss to the taxpayer. […] the politicians or the mainstream media, it’s happening among economists on irisheconomy.ie here (see comments also) and in previous posts on that […] @Kevin.j.denny Not sure what your saying there kevin… One thing that hasn’t really been addressed so far is which banks exactly ought to be nationalised. Which ones are of “systemic importance”, which can be left to fend for themselves (with the guarentee of course)? @James Ok – AIB and BOI are of systemic importance. the life part of ILP needs to be saved. The rest are not and can be dealt with on a case by case / political basis. IMHO. Note : none can , again IMHO, fend for themselves. @Dreaded Estate: “Yes it is an assumption but it is based on the fact that the state is already shouldering 100% of the risks through the guarantee. No new risks would be added to our balance sheet so there would be no change in our underlying creditworthiness.” I don’t have another way to say this other than ‘you assumed wrong’. The market reaction was that we got a down grade largely on the back of the guarantee and our banking situation, but that is a separate proposal to that of actually nationalising the banks which would mean that the banks actually come under the national rating. Think of it like this – If you were to credit rate me, and I was a guarantor on a mortgage, you’d think of if differently than you would if I actually held the mortgage myself. End game – the sovereign rating drops towards that of the banks rather than the banks rising toward the sovereign, although comparatively the gap would decrease it’s no the kind of margin gain one really wants. Comments are closed.