Lucey on Bank Nationalisation Post author By Philip Lane Post date April 26, 2009 Brian gives a detailed response to Alan Ahearne in this article in Monday’s Irish Times. Categories In Banking Crisis Tags Bank nationalisation, NAMA 21 Comments on Lucey on Bank Nationalisation ← Economists and the Crisis → Calculated Risk on Liquidity and Solvency 21 replies on “Lucey on Bank Nationalisation” Many of my comments were sharpened by responses, private and public, to my early saturday musings here. This site is proving exceptionally useful as a sounding board and source of rapid feedback, and is a great example I think of how ICT can really aid productivity. Thanks to all It would be great if the rationality presented in this piece (following on from the widely supported piece of 17 April) were to prevail, but the Government has dug itself into this NAMA hole and seems determined to keep digging. It may also be happy to have this debate rumbling on. This jesuitical pursuit of the precise meaning of “nationalisation” echoes the struggle to define the mystic Republic that occupied much of Irish politics during the last century. And it’s rapidly leading to the classic “Irish solution to an Irish problem” – which means the worst of all possible worlds. To all intents and purposes, with the current blanket guarantee in place, the international capital markets and external investors are treating the Irish banking system as being effectively nationalised. In the Irish context this will become even more real when the Government will be obliged to inject equity to compensate for any write-down of the property asset loan books when these are transferred to NAMA – and to compensate for any provisions the banks may have to make for future levies if the write-downs are insufficient. The State will be the major, if not dominant, shareholder, but the Government, in its narrow self-serving view, will be able to avoid the hassle of going through the formalities of nationalisation, of appointing new more effective management, of restructuring the sector and of arranging a subsequent sell-off. I expect the ECB and the IMF will let Ireland stew. Apart from some Japanese input, the IMF has received only the promises of the funding required to treble its lending facility and there are far more deserving cases. They will find it hard to over-rule the cloud-cuckoo land rhetoric being spouted by the two Brians and a Mary until the wheels start to come off. And come off they will, unless the cost base of the regulated and sheltered sectors is tackled, the semi-states are sold off and a major programme of public investment in fixed and human capital is initiated. “Here we go round the Mulberry Bush “–again.! Both sides of debate have made their points and are very entrenched in their views—and not open to changing in any way. There is no point in this continuous loop of repeating and repeating same arguments—as if hoping that if one says something often enough it becomes fact. @Tadgh Sorry if I give that impression but let me assure you that I am completely open to changing my mind IF persuaded strongly enough. For example, over the weekend Brian L came on RTE and more or less said the same thign as Alan (no surprise there tg) that the state could not afford to nationalise the banks as it would be too expensive in sovereign debt terms. Now, this tells me that DoF have gotten indications that the markets wont fund much more. That tallies somewhat with the lowish cover on the bond auction last week. So, while that doesnt help either NAMA or nationalisation, its useful information that I suspect may have come later if at all without this discussion Unlike DoF i try to use evidence for my arguments; it would be helpful if the DoF were to show a little more humility and less doctranaire hubris and give some evidence. @ Brian Lucey. Have you committed the cardinal sin of ‘talking down the market’? Bloomberg this morning have this: (with Brian Lucey quoted) http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a6ccv4Zxirag @LorcanRK Yes : me bad. 😉 The lowish cover on the bond auction last week has generally been ascribed to a lack of interest in Irish government debt. Would higher cover have meant an opportunity was lost to place more bonds or that the coupon was higher than it need have been? Are there rules of thumb about a “good” cover level or elasticity of volume v. coupon? Brian, great response piece to Mr.Ahearne in the Times today. I agree that nationalizing the two main banks is the best way forward (and its probably going to happen anyway in a roundabout way through NAMA + recapitilisation etc). I found Mr.Ahearne’s argument extremely ropey in the Times on Sat. Essentially – whether we like or not the blanket guarantee nationalised the banks, 99%, in all but name – and thats how the outside views it. This isn’t a strictly economic question (more of a political one) but how do you recommend we ensure that if the main banks do become nationalised, by legislation, that they dont become politicised – and are there for the public good. As opposed to their own pockets. Because I presume that running the banks out of the Dept. of Finance, whether thats in control of FF/FG/Labour or coalition, means that political manipulation of the big banking decisions are made with party politics in mind (or maybe I am so innocent to think thats not going on already 🙂 could happen….i.e. FG/Labour screw over Anglo Irish because they helped FF for the last decade. Im not justiyfing Anglo’s (nor FF’s) action – in fact the exact opposite – but internal political feuding manifesting itself on the crumbling Irish banking sector cant be good. And its the last thing the Irish people need now. The guarantee transferred bank risk to sovereign risk. Hence the progressive downgrading by the rating agencies. Market failure has resulted in NAMA. The questions now are: How to price the impaired loans, how much is required for re-capitalization, and who pays. To state the obvious, these questions will be answered by whoever has the power to decide. Neither power, nor value/price deviations, exist in contemporary economics. So its difficult to see what role economics plays in resolving this debacle. @Ed One way might be to set up a “state banking commission” to run them. The absolutely cannot be under direct or indirect political control @Brian Lucy, if banks were lending at c.30% equity on deals (borrowers LTV would be 70%) then a 50% writedown on them would mean the market would have fallen 65% (50% on the 70% loan would be 35% – because the discount is going on the loan provision, not on original valuations.) So would you share the calculations you used in coming to those figures? I am of an open mind once I see the figures but 50% doesn’t sound accurate to me, and in particular a disparity of 30% up to 50% on 90bn is worrisome. Brian Lucey Thank you! Like Ed, I would be very concerned about giving the government so much control over our banking industry. If we have to nationalise the banks, we should look for ways to limit the potential for political interference. One solution might be for the government to work in partnership with the private sector. Perhaps a joint venture where the government holds a majority stake but leaves the management of the banks to the minority stakeholder(s) – Private equity groups Once a bank gets sweetheart deals going, then it has compromised the directors and is fully in the grasp of those who know where the bodies are buried. This will in some cases, continue into the new entity whatever it may be. This is what happened in AngIB. It became public knowledge. AngIB had to go for the sake of the others… It is an effective tactic to destroy a competitor….. But do Irish banks compete in all areas? Conversely, ripping up those deals, as with a completely honest even naive, NAMA management, may have unforeseen complications. BCCI for example. Academics are fond of stripping out such noise from their models, but this is a real world problem, guys. For example, whose secured assets are sold off first? Will they benefit more than those later in the queue? Who is going to deal with the law suits when paper comes into court from the borrower to suggest that the apparent security was non-recourse? Or linked to a deal that is ultra vires the bank? “Practical people” will not open such cases unless they have an infinite budget. Lobbyists will ensure that those in control get the tip off that their client will be difficult and embarrassing etc. So priority matters. It is a policy matter. Policy is omnipresent. To suggest that only the government is corrupt is wrong as there must be another party to benefit. They will also be lobbying the management, whomever they might be. Long term 40 year civil servants are loyal to their pension. The problem is a lack of accountability of their actions. The Constitution sets out that this is the primary responsibility of the C&AG, who is supposed to be a competent accountant and immune from sack by government. An example from my own experience that the Irish Times reports will vindicate. In the DIRT enquiry, the C&AG made the charge after is investigation that Investigation Branch in Taxes had failed to investigate DIRT. (And there were suggestions that the banks knew this was to happen and that they encouraged evasion thereby.) The C&AG had been led up the garden path by an official who had been appointed, as his liaison, to IB a week after his enquiry was announced. That person had never previously worked in IB. But he was close to very senior people in Dublin Castle …… Anyway, I was the only person to contradict the C&AG. He shook my hand at the hearings. I had produced the written instruction, over 10 years old, published to every inspector of Taxes, but which was not found by him. This situation can arise in any organization, but the fact of the matter was that the Revenue had officially told its servants not to use their powers to check on what was going on in the banks. This came to light after the fact. But it was known by those in Taxes who bothered to read their instructions, those directly involved in the areas that should have been doing this. It took the public invitation of the Dail to prompt me to come forward. I was the only one. My career did not prosper and neither did my health. There is no effective watch dog of the public service. But there are honest members of the public service. Only insiders can know them, but even then, there are no guarantees. The only guarantee is genuine competition. There has to be a clearing of the decks, allowing what banks remain to set the system in motion. There should also be at least one new bank founded by Irish shareholders. As soon as possible. There will be many people available soon with depth of experience etc etc They will not have massive overheads but access to the ATM system will be vital. It will be set up to swallow the other banks, by taking on the best customers. I fear that the decades of dodgy deals by banks will make it impossible to sort out this mess and Brian Lucey’s point about time is well taken. There is only so much time left before events render further discussion very academic indeed. Delaying the inevitable liquidations makes the use of the productive assets of the banking system as opposed to individual banks, more difficult. This is where reform of the credit industry should be addressed, as a whole, by action, not by committee. Remember Iceland. @Ed: “how do you recommend we ensure that if the main banks do become nationalised, by legislation, that they dont become politicised – and are there for the public good. As opposed to their own pockets.” I think people are forgetting that this state has a long tradition of public sector ownership and management of strategic industries in energy, transport, natural resources, food and even seaweed. Many of those industries were set up when the private sector was either unable or unwilling to do the job. Yes, they were probably subject to high-level political direction (which is legitimate in a democracy) and to a certain amount of low-level interference (“I’m a TD. Give my constituent a job”), but given the distortions, disasters and self-serving decisions introduced under private ownership, I see no reason to panic at the prospect of public ownership per se. bjg “Second, while Nama provides for a further injection of equity capital, this will occur down the line when perhaps bank shares have recovered somewhat and thus be more expensive for the taxpayer” – the state have purchase options (for instance) on BOI Shares at reduced rates, if bank shares recover it will actually be a windfall for the tax payer. ———————————- “we suggested nationalising only those banks that were of systemic-importance.” – the banks of systemic importance (AIB & BOI), are, when added to anglo are in excess of 2/3rds of our banking system. There has been no example of this having worked historically in a country that didn’t control its own currency as the currency markets were part of the general recovery plan in every example. (you’d need an example of an individual state in the US for this belief to hold) ———————————– “Dr Ahearne now suggests that nationalised banks will not be able to secure access to the inter-bank market. A number of issues arise here. First, the excessive growth and over-reliance of banks on this source of funding was a key contributor to the Irish banks problem and, therefore, were there to be a reduction in same it would be welcomed.” -Where else is the funding going to come from? It sounds to me like you just called for wholesale delveraging of both banks (via reduction in interbank funding) and thus the wider market, the paradox of deleveraging in this example would ensure we grind through the bottom of the present hold and into an even deeper one. We still need money for the market to operate, where will it come from if we DON’T use interbank markets any more? ———————————— “it is naive to think that providers of funds do not differentiate between banks with a market presence and nationalised banks – First, there is simply no evidence that state-owned financial institutions face greater problems than non-state-owned in sourcing inter-bank funding.” –Sovereign debt is of course easier to raise, it is ireland as an investment opportunity that starts to look less attractive, -wiping shareholders is news that travels! Where is the opinion on 1. market sentiment and 2. market flow of information? We can’t lay out our stall then chop and change continuously,some plan in action is better than stagnation and the long term exit plan for nationalised banks is totally unclear in the Euro rather than Punt context. The sad reality is that this country – in the international market context, is a wet rock out in the Atlantic with lots of problems, we need to show that we can fix those problems on our own and rapidly, of course the IMF want nationalised banks, that way if they come in they can effect instant control over the whole financial system, I’d rather see them out of the picture and a bit of cohesion in financial circles as well as the wider irish society so we can get the job at hand underway and do the heavy lifting. Krugman is a nobel laureate, as was Friedman, the reality is that his for all of his publicity the Obama administration aren’t really listening to the guy, and there is a reason for it. —————————————— ”Second, it is clear and has been admitted to by at least one bank covered by the guarantee – the Irish Nationwide Building Society – that the only way they can continue to source funding in this market is under the umbrella of the State. A nationalisation provides a far sturdier umbrella than a revocable guarantee.” NOTE: Revocable… At least there is a life raft off the ship in the case of some institutions, if they all fall under state ownership (and your example is perhaps the worst of all for the taxpayer) then there is not bullet left in the gun, no wiping of shareholders, no wiping of debt down the line, you want your fix today. Sadly, no plan one side or the other will get us out of this in jig-time, what we can do is minimise the damage, and state control of our entire national credit market would be a mistake, I don’t know where people found such sudden faith in all things state controlled… If the toxic elements are removed the remaining parts of the bank can still be profitable, if you nationalise the institution then the whole bank will likely go bad and turn inefficient. If the state was efficient to begin with then our public systems on all fronts should be leading examples of efficiency right? The fact that they aren’t should really tell you something, and if you need me to explain it then you just don’t get it. ——————————————– Finally, large funders prefer to fund, on a short or long-term, entities that are backed by sovereigns (who have recourse to taxation to repay) than lower-rated speculative plays such as poorly-capitalised banks. True as a statement, but the working element of this is that nationalisation would result in a further sovereign write-down, thus the deficit costs we are carrying would rise when we issue further debt, we did have an implied pricing before our actual write-down, but nationalisation would probably carry us to the next rung down. And when you add that on top of the existing debt you have a problem. Not only that, you can’t just ‘divest’ banks in order to rectify the situation overnight, the weight of the additional debt would drive the state to further spending cuts and revenue raising. ———————————————- “On the issue of Nama versus nationalisation on the taxpayer, Dr Ahearne confuses at least two distinct issues. The existing ownership which he lauds as providing an upside for the taxpayer is utterly separate from the Nama.” – the share options and 8% interest charge are upsides, if losses are realised in NAMA then the banks will have to pay, it will be amortized with interest. On the nationalisation front you might get an academic win in the short term, the ‘blood letting’ the public are crying out for, but for all the talk of how nationalisation is the answer there is nobody shouting out the obvious long term downsides. If NAMA fails it would be bad, but if a nationalised bank failed it would be calamitous… http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/5220118/The-capital-well-is-running-dry-and-some-economies-will-wither.html Ambrose encapsulating what has been known for some time. If the MSM have it it can only be months away. The spelling mistakes are a hoot! Remember Iceland! http://www.bloomberg.com/apps/news?pid=20601039&sid=aColIYAe.RaU&refer=home Another good article and again as MSM as possible. Time to drop the masks everyone? Or will we still play the game? Save the credit system now! @ Karl Deeter A good analysis and I agree with your points, Karl, but aren’t you a little behind the times? You speak of a bank system. That has been dead for a while now. We are trying the Japanese non-solution. But the actual system is now similar to that of India. Local savers and local borrowers. It may be time to ban loans for non-productive purposes. This to include land development of any kind. Instead there will have to be ma return to true capitalism. One of the problems that holds us back is the requirement of horizontal development. Laying concrete. One of the sources of the corruption makes profit from this but it is no longer efficient. We must be more efficient and prepare for the disaster as it unfolds. The functioning bank system is now much smaller than it was. Only by going onto a war footing will we come through this with an optimal result. What capital still exists must come to regard Ireland as ruthless. We must not continue to neglect large parts of our society but must mobilize them in return for dole and better housing. Merely repairing the property that we have is a very positive step, which will increase our true wealth. Much international capital, not laundered from domestic sources, is tied to reciprocal spending by the recipient. That will cease altogether in this financial storm. Imports are going to drop off the map for lack of demand and due to the failure of the credit for goods in transit, bill of lading lending that has collapsed recently. We can concentrate on “making do” as never before. We must. @pat donnelly You raised some thought provoking ideas, the only issue I would have is that of saying that the banking system is dead. You see, the issue I have with that is that I make a living from the banking system and if it was dead I would have ceased trading long ago too, particularly in the intermediary market. the reality is that our company is weathering the storm quite well all things considered, and its not the ‘system’ that is dead or we would have ceased trading. rather it is the ‘old system’ that is dead, and good riddance! credit needs to return to the historical role it played and be curtailed to a degree in the historical way that it always was, strong underwriting, stiff criteria, based on good collateral and at high margins. (obligatory) The banking system’s not dead, it’s resting… Comments are closed.