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Banking Crisis

Why is Anglo So Costly for the Taxpayer?

From today’s Sunday Times:

Brian Lenihan, the finance minister, said last week that the plight of Anglo Irish Bank was a reminder that nationalisation carried a heavy price for taxpayers.

Lenihan held up Anglo as a warning to academic economists who support the nationalisation of Ireland’s big two banks, Bank of Ireland and Allied Irish Banks.

A direct quote along these lines is reported in Saturday’s Irish Times. The Minister is quoted as saying that

Anglo’s need for capital “illustrates the point that, when nationalising a bank, there is an issue for the taxpayer”.

Ok then, perhaps I shouldn’t bother taking the bait at this point, but let’s think about this for a second.

Suppose Anglo had remained in private hands after last Autumn, perhaps with new management after Seanie and co were cleaned out.  Now they report losses that wipe out their capital base.

What would the government do at this point? No private investor would be willing to recapitalise Anglo. The government could decide to let Anglo be liquidated. However, the September 30 guarantee would then put the government on the hook for paying back Anglo’s liabilities and a disorderly asset firesale would probably only make things worse.  (Which is the government’s argument for not winding up Anglo right now.)

So, because of the September 30 guarantee, the government would be forced to re-capitalise Anglo now, whether the bank had previously been nationalised or not.  To blame the cost of re-capitalising Anglo on the decision to nationalise is putting the cart before the horse. The principle argument in favour of nationalising Anglo was that the government had guaranteed its liabilities and could not afford to keep a discredited management in place gambling with taxpayers money.

I would summarise the moral of the story here somewhat differently: When issuing blanket guarantees to troubled banks, there is an issue for the taxpayer.

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Uncategorized

Bryan Caplan’s Unemployment Wager

In response to a recent paper that was somewhat bullish about the benefits of the European employment model, Bryan Caplan proposes the following bet. It has since been taken up by John Quiggin.

“I’m going to offer the following bet to the authors of the CEPR report:

The average European unemployment rate for 2009-2018 (i.e., the next decade) will be at least 1% higher than U.S. unemployment rate. The bet will be resolved when Eurostat releases its final numbers for 2018.

I’m happy to bet each of the three authors $100 at even odds. Will they accept?

P.S. By 1% I of course meant 1 percentage-point.”

Categories
Banking Crisis Economic Performance Fiscal Policy

Banking Reform

Once we have banks that have been re-capitalised and apparently stable once more, where does our financial system go? In negative terms, how can we be assured that the financial system will not generate crises on the kind of scale that we are currently living through? In positive terms, how can we increase the chances that finance flows toward productive rather than speculative uses?

These critical questions are largely sidelined in the current debates on nationalization, which have focused largely on the (urgent and very important) questions of how to restore the stability of the banking system and who will end up stuck with the bill. But, even if this is achieved at the least possible cost to the taxpayer (and therefore with the least possible constraint on public investment into the future), this still leaves the questions of stability and productive investment. There is little reason to suppose that an unreconstructed banking system will deliver this on its own – the banking system provided neither stability nor productive investment before this crisis. Reform of banks themselves will be essential, although this has largely disappeared off the agenda in recent months.

There are five areas through which we can influence how banking practices are shaped by the wider system of financial governance (some of these are usefully reviewed in Stiglitz and Uy’s account of the ‘East Asian Miracle’). In each area, the system has left a great deal to be desired and requires reform.

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Banking Crisis Fiscal Policy

Anglo Irish bank: dealing with risk investors

Anglo Irish Bank has announced losses that bring its measured shareholders’ funds down to about 0.1 per cent of total assets — effectively zero.  It has also announced a further €3.4 billion in expected loan losses, little of which would be offset by operating income over the next year or so.

From a strict contractual point of view, the next in line for absorbing these losses are the subordinated debt holders.  There has already been some discussion on this site of the issues involved here.

Now we are at a crunch point because a recapitalization of Anglo cannot be long-delayed. Indeed, to continue trading, the bank presumably needed the assurance that was provided by the Government today that needed capital would be forthcoming.

There is €2.8 billion of unguaranteed sub-debt on Anglo’s books.  I am assuming that part of the Strategic Plan promised by the bank this morning will have to involve risk-sharing by sub-debt holders.  This could take the form of of a deeply-discounted buy-back (as indeed is already suggested in the Government’s statement). It could also take the form of a debt-equity swap. (This would parallel current discussions in the US around debt-equity swaps to recapitalize some of the larger US banks following their stress-tests).

Obviously none of this is easy, and these bondholders may want to play chicken.  In a liquidation they would be wiped out, but — absent modern bank insolvency legislation here — a messy liquidation could also inflict severe taxpayer and economic costs.

I admit that I am not sure of the most effective way of accomplishing it. There are some obvious options. Perhaps readers will have some further ideas. I am sure that officials are pondering these issues.

But difficult does not mean impossible.  The stakes here are evidently high. 

Urgent work to modernize bank insolvency procedures (as recently enacted in the UK post Northern Rock) could strengthen the Government’s hand. 

It might be argued that losses incurred even by sub-debt holders of a bank could damage the credit of the Irish government.  I disagree. 

First, it is really immaterial that the bank is Government-owned: eveyone knows that situation has only arisen as a result of the disastrous performance of the bank. No new subordinated debt has been issued since the nationalization. Besides, in his statement in the Dail on January 20, during the debate on the nationalization bill, the Minister removed any doubt about whether nationalization entailed an expansion of the guarantee.

More generally, even though there might be an immediate knee-jerk reaction in market prices of debt, mature reflection by the financial markets would recognize that a country honouring its debts and guarantees to the letter–and not beyond–was more creditworthy than one which handed over money lightly to unguaranteed risk investors.

Categories
Banking Crisis

PWC’s Stress Tests

Now that Anglo has officially blown through essentially all of its capital, and given that the government regularly cites PWC’s recent assessment of BOI and AIB’s likely capital needs, I thought it might be a good moment to remind folks of this excerpt from the PWC report on Anglo (released in February, fieldwork concluded on December 10):

Under the PwC highest stress scenario, Anglo’s core equity and tier 1 ratios are projected to exceed regulatory minima (Tier 1 – 4%) at 30 September 2010 after taking account of operating profits and stressed impairments … We used an independent firm of property valuers (Jones Lang LaSalle) to value a sample of 160 properties held as security in relation to the top 20 land & development exposures on Anglo’s books as identified in our Phase II review and report. The results of this work indicated that impairment charges over the period FY09 to FY11 would fall in a range between the two PwC impairment scenarios but closer PwC’s lower impairment scenario.

Hoocoodanode?