Last night on The Week in Politics, Fine Gael’s Leo Varadkar criticised proposals for nationalisation of the banks on a couple of grounds, one of which was that it “wipes out 300,000 small shareholders.” Later, in describing FG’s plan he said that the new banks created as part of this plan “would buy the good loans off the banks, take the good loans off the banks and set up a clean bank and, by doing that, you then create capital for the old banks and give them some chance of survival.”
Those watching would probably interpret these comments to imply that Fine Gael’s plan does not involve nationalisation and that it would be better for bank shareholders than what has been proposed under nationalisation. In my opinion, neither of these positions are correct.
First, let’s look at what happens to the shareholdings in the current banks under the FG plan. Here’s the relevant section:
11. The “legacy banks” left behind would remain in private ownership. Their banking licences would be withdrawn and they would no longer engage in any new lending (beyond what is needed to facilitate work-outs of their loan-books). Their shares might continue to be quoted on the stock exchange.
12. The purpose of the legacy banks would solely be to work down the remainder of the loan book (mostly the distressed developer-related debts and associated collateral) and recoup maximum value from it over time. It would be managed in the interests of the existing capital owners and other creditors. If enough money is recovered over time from property developers, they would be fully repaid (any Government debt would be repaid first).
13. If the legacy banks prove to be insolvent, at some point they will be unable to service their obligations. At this point, normal bankruptcy proceedings would apply. This may involve significant haircuts for unsecured creditors, and / or debt-to-equity swaps.
Leo may think that this scheme is giving the legacy banks “a chance of survival” but with banking licences withdrawn and their only role being to manage bad debts, this looks more like a temporary period of living death. Clearly, the shares in these banks will be worthless. This is, of course, the essential idea of the FG plan: Providers of risk capital should take the hit and equity is the riskiest form of capital. Legally, you can’t clean out bond holders without wiping out equity first.
[Before my FG friends start complaining, I am aware of the offer of discounted shares in the new banks for existing shareholders. More on that below.]
But what about the new banks—who’s going to own them? The FG plan is not too clear about this but Willem Buiter (whose plan FG are essentially following) has described pretty clearly how this works with this kind of plan. He proposes that the new banks are capitalised by the state.
If the new bank takes on a higher level of assets than liabilities, then the government will pay the old banks the difference, so that it has provided the equity capital for the new banks (you can’t simply strip assets greater than liabilities out of a privately-owned listed company with debt obligations, though note that Leo is not correct that this process is “creating capital” for the old bank.) In the (unlikely) case that a new bank’s good assets are less than liabilities, the government can provide the difference required to recapitalise (FG optimistically propose that the old bank could owe the difference to the state-owned new bank with this obligation being senior to other debt.)
So, as proposed by Buiter, the new-bank-old-bank plan clearly involves nationalisation of the good parts of the banking system. FG are a bit coy about this. They discuss the idea of raising new capital from “private investors, including shareholders of the legacy banks at discounted prices” but this process would undoubtedly take time. Most likely, the good banks would need a period of stability in state ownership to appoint new management and set out a clear business strategy
As for the shareholders, whether the opportunity to buy new shares in a good bank at a discount at some point in the future proves to be any kind of compensation would depend on the size of the discount, which has not been specified. Certainly, there is no reason to assume the shareholders would do better under the FG plan than under some of the proposals associated with advocates of nationalisation (such as paying current market value). Indeed some advocates of nationalisation have proposed giving shareholders in the old banks an ownership share in the banks once they have been privatised again.
The real differences between the FG plan and the various nationalisation proposals are twofold:
- FG want to wait 16 months before nationalising most of the banking system, hoping that a National Recovery Bank will somehow keep credit flowing.
- FG want holders of longer-dated bank debt to absorb losses. The advocates of nationalisation have, by and large, kept the debate within the government’s terms of reference, which assume that guaranteed bondholders to not lose out. However, one could debate whether or not further nationalisation needs to follow the Anglo model and be accompanied by assurances that all debt will be paid back. Legally, I believe the banks will still be limited liability companies and one can debate whether or not financial markets would indeed see such a default as equivalent to a sovereign default.
My scepticism about the FG plan relates to the weakness of Point 1. I don’t think their proposed resolution would work and I don’t think we can afford to wait 16 months.
Point 2 is to my mind, the attractive part of the FG plan. If the loan losses turn out to be a lot larger than the current equity capital of the banks, then the loss of longer dated bond debt as a cushion could greatly increase the cost of the banking crisis for the taxpayer. That said, one can debate whether such defaults would have negative implications for the future funding of the Irish financial system. Opposing Varakar on the The Week in Politics, Michael Martin was fairly explicit that he saw this as a problem with the FG plan. In any case, FG are to be congratulated for getting a proper debate on this issue going.
22 replies on “FG, Bank Shareholders and Nationalisation”
@Karl
the political classes dont want to admit that the outcome set is closing ontemporary natiionalisation. The debate however has moved perceptibly from if to when/how/how much of the system will be in state care.
Karl
You quote selectively from the Fine Gael document to suit your ends. You ignore the previous sections that make it clear that the banks are only broken up into “legacy” banks and “good” banks in the event that they fail a stress test at the end of the Guarantee period.
This provides the possibility (oerhaps slim, but none of us really know) that they may be able to recapitalise sufficiently in the interim period, in part by renegotiating their obligations to owners of subordinated debt and other long dated securities that will remain locked into the banks at the expiration of the Guarantee>
I understand the reasonable and well-motivated people can disagree on the best way forward on this issue, but at least do the readers the service of representing the ideas fully and fairly.
Proponents of nationalisation have to date, in my view, failed to persuade that nationalisation is just another way of buying assets that may well end up at considerably lower value than the banks’ liabilities, but without any realistic way of ensuring that taxpayers are not first in line for losses beyond those taken by shareholders (and we wouldn’t even know what these would be until the five years of court battles have finished).
It would be useful to describe what you mean by an alternative to the Anglo model of nationalisation that would extend loss absorption beyond the shareholders. What other model would make it more acceptable for a state-owned bank to default on its debts?
Andrew
“This provides the possibility (oerhaps slim, but none of us really know) that they may be able to recapitalise sufficiently in the interim period,”
So on a slim chance we create a zombie set….?
“and we wouldn’t even know what these would be until the five years of court battles have finished”
According to three consitutional/contract professors of law, nationalisation if done administrativly correctly is not legally any problem. But maybe FG have advice that it would be, so lets see it and have that debate Andrew.
WHY are FF and FG so intent on keeping some minor float alive….?
Andrew, it’s simply not possible to quote the whole document in a blog post! I wrote about the stress tests in my last post on the FG plan and didn’t in any way think that not mentioning this in the current post was some kind of strategic omission.
As regards the point I omitted, you call the possibility that these banks could re-capitalise themselves without any further state help “slim”–I would call this possibility “nonexistent.” So why waste time writing about things that can’t happen? (we’re already off in never-never land here to a large extent anyway since the government isn’t going to adopt your plan.)
I agree that your second last paragaph focuses on a point (loss protection for taxpayers) in which your plan is superior. This is very important (I have spent a lot of time writing about the importance of this issue) but there are other considerations right now.
On other methods for loss absorbtion, I’m open to any good ideas people have. How about the following? The government could announce tomorrow that it’s not going to renew the guarantee and then negotiate a debt-for-equity swap combined with recapitalisation from the state. Something like this could perhaps keep the banks out of full nationalisation (contrary to my public image, I’m not dogmatic about nationalistion — I’m willing to consider any proposal that can work to fix the banks quickly at minimum cost to the taxpayer.) And you wouldn’t have to wait 16 months.
My point here is that, while I’m sympathetic to what you want to achieve, I don’t think the National Recovery Bank thing is going to work.
Karl
If my last missive sounded overly combative, allow me to put it down to the end of a long, stressful day! I enjoy engaging in the debate and welcome the robust criticism.
Andrew
@ Karl and Brian.
On the previous thread concerning the Fine Gael proposal, I suggested (in a link, reproduced below) a possible list of additional costs that could result from nationalisation as of today. These came to roughly 20 billion euro and were comprised of 3 components:
1) Losses that will be borne by the State instead of subordinated debt holders (who as you pointed out yesterday Karl, are guaranteed until September 2010) of 11 billion euros (based on IMF assumptions concerning total losses)
2) Indemnification of existing shareholders (in one form or another, either cash or a free ride on state recapitalisation). I think an estimate of 5 billion here, barely more than 20% of pre-nationalisation audited net equity may not be excessive.
3) Costs arising from government inefficiencies (your point Karl concerning the Greens wanting to turn development land into fields. Cronyism. Conflict of interests between government departments making banks easiest place to raid. Job security demotivating bankers) which I arbitrarily estimated as 5 billion euros (the alternative to nationalisation and a civil service mentality being highly motivated and intelligent bankers fighting for their jobs).
If losses were to be higher that IMF estimates, this cost of nationalisation could rise above 20 billion euros.
Against this, I understand that your principal argument is that the banks will be run out of business because of liquidity problems if we don’t take them under the public wing.
These Irish banks have 540 billion (or so) of net banking assets. They have long term funding of over 70 billion euros (equity + subordinated debt + post 2010 senior debt), deposits of 250 billion euros and additional short-term non-financing liabilities of approximately 50 billion (this figure is harder to estimate). They thus need financing from capital markets and the ECB of approximately 170 billion (remembering that this figure would decrease massively if they could divest themselves of their 130 to 140 billion of non-Irish assets without taking major losses). They have a potential 540 billion of collateral to raise this financing (I suggest that all these assets are potentially collateral – the only arguable upside of NAMA is that it gets ECB funding for 90 billion euros of trash).
They are thus “overcollateralised” by almost 3 to 1 (say 510 to 170, allowing 30 billion of “other” assets). The ECB already funds these institutions (by how much?) and is clearly willing to give at least 75 billion more for the NAMA bonds, ignoring all the other assets above BBB- that would qualify for the ECB discount window.
Is it really a certainty, given these broad figures, that we can’t obtain sufficient liquidity with ECB support given the extent to which they already appear to be willing to provide funding.
The cost of assuming that we can’t get this liquidity is arguably 20 billion euros. It’s a big call.
I firmly believe that the banks have been bullying the taxpayer to obtain equity investments in many shapes and forms (non-interest bearing preference shares, coverage of all of Anglo’s liabilities, and most recently potential overpayment for NAMA assets as its the only way that the MOF can make the figures stack up) using this liquidity threat and that we need to genuinely hestitate before we finally plunge into taking all of their losses (through nationalisation or, worse, NAMA) because we’re afraid of them.
My accountant mullings are on a newly created blog
http://escapefromnama.blogspot.com/
I dont understand when Michael martin was saying how different FG and Labour were, why Leo didnt just say ditto you and the PDs or You and the Greens.
I am caught in two minds as to what would be the best form of action re the banking crisis.
Obviously I would like a Delorian, to go back to 29th of Sept and let Anglo go to the wall.
One has to wonder if the government was under severe pressure from Anglo’s financial backers or did they even know?
So should we A nationalise now and act like grown ups but risk bankrupting the country or B wait till the guarantee is over, then once the banks are back being Ltd. company’s let them go to the wall and default risking our future loan capacity at a time we are running 20 billion + deficits?
As a kerry man might say to a tourist looking for directions ‘well I wouldnt star from here’
The banks are now a danger to persons in power and behind those in power. There is too much information that may be published if control of the banks is lost. There is a concerted attempt to prevent this.
A true concern is the issue of regulatory capture. Can the State really afford to kill off the lending power of one of its biggest creditors?
Irish banks are now major buyers of the sovereign bonds which the Irish state is obliged to keep selling to finance…well, to finance these same banks!
If this crazy situation sounds eeirily like another pyramid scheme waiting to collapse, that is because it is!
Of course, ultimately, the soveriegn bonds are backed by the sweat, tears and productivity of Irish taxpayers, so anything that saves these good folks any money will strengthen the fiscal security of the Irish state. Ergo, anything that COSTS these gold folks money will weaken the fiscal security of the Irish state…
As for the issue of Leo and his long-suffering bank shareholders: Neither he nor anyone else has put forward a convincing argument for how the core issue is anything other than a zero-sum game. If the banks are broke and we have to spend to fix them, either that money comes from the taxpayers or from the shareholders. Simply put, there is no economic justice in making the taxpayers pay for shareholders losses. Plain and simple.
@graham stull the taxpayer / shareholder is a zero sum game too, shareholders are taxpayers and vice versa, if a shareholder gets wiped why should they pay their taxes to fund something that took from them already?
if a single pension fund goes bang due to this who will bail them out? The taxpayer….
all the talk of ‘taxpayer getting value’ actually surprises me, is everybody under the impression that up until now we were getting good value? was everybody duped? or do we just want good value on this particular issue? If we were getting value in the past then we would have the money to do this right the same as other countries do that had some semblance of counter cyclical planning in their budgeting.
it would be my opinion that the tax payer is perpetually ripped off, but that from time to time we actually bother to question the tax system on certain issues. pity the front loaded bonanza funded from property transactions didn’t get the same degree of enquiry.
So people want prudence in general but not in particular, the ‘state’ have to find an answer, but the individual doesn’t want to pay more at the same time to get there, or be forced to save or many other things. the taxpayer angle is – from what i can see – an emotive by product, I don’t believe for a minute that they are at the true core of this, its about power plays and while bearing the brunt of the heavy lifting taxpayers are (from what i can see) pawns in this game.
forgive my cynical nature in advance.
@ Karl,
You are right to be cynical. And you are right to question the priorities in terms of the taxpayer getting value for money. Personally, I think one of the things that should become part of the ethos of public sector workers (including high and mighty academic economists locked in their ivory towers!) is a sense of obligation towards the oft-maligned taxpayer. (I write this as a former state worker, myself!)
But none of this takes away from the core issue of nationalisation. If the coffers are bare at the banks and they need to be bailed out, then there ought to be nothing for the shareholders. They should lose everything before a dime of taxpayers money gets spents. Anything else I see as economically unjust.
Of course, in many cases taxpayers are shareholders, but for the purposes of assessing the economic justice of the relative banking proposals, it is important to conceptually distinguish the two groups. If every taxpayer owned bank shares in the same proportion as s/he contributed to funding the Exchequer, then of course the issue would be moot.
But this is not the case. Some people chose to invest in bank shares, while others did not. Those that chose to buy shares would have been happy to see their share value quadruple, so they must now face the risk of losing everything.
I am a newbie to this so just looking for a quick bit of info.
If The government has nationalised anglo and anglo can borrow from the ECB for 1% why does the government have to issue bonds and have to pay well over this. Is it just the case that the ECB refuses to give the cheaper rate to governments even though they are less of a default risk than a bank? Speaking of default risk Dan Obrien recons we have a 15% chance of going bang in the next year! I dont know how you would even start to try to come up with that figure?
Not to be confused with Dr Jim O’Leary!!
From a taxpayer perspective the FG proposals seem to be the most equitable – if there are losses the shareholder suffers first then the bondholders and then if necessary the taxpayer. NAMA and Nationalisation appear to insulate bondholders at the expense of Irish taxpayers.
It also avoids the mistake of forcing the crystallisation of losses at the bottom of the market. If you don’t believe that losses will be as great as currently being predicted then the sixteen-month wait until the determination of solvency is a positive. This period also gives the banks the opportunity to work through many of the problems they have created.
The NRB using the banks as agents will be in place to provide funding if there is an increase in credit demand. Under those circumstances shareholders can deal with being zombie like for a few months and there is no impact on the economy.
@Jim,
I don’t see any reason to suggest prices will rebound. The linked document “Asset Price Bubble in Japan in the 1980s: Lessons for Financial and Macroeconomic Stability ,Shigenori Shiratsuka 2003.” is worth a read. The bit I’d draw your attention to is Figure 2 on page 20. Perhaps there are reasons why Ireland is different, but I like graphs!
From the Irish taxpayer’s perspective, NAMA is in some ways what is says on the can, a property deal. Instead of buying one Dublin house at 750,000 we buy the equivalent of 10,000 of them.
I wonder how many economists would be willing to stake their personal financial security on making such a purchase in the current market?
Unfortunately the NAMA assets are of much lower quality than even such (unsafe) houses
Oops, I forgot to add the link in my earlier post.
http://www.imes.boj.or.jp/english/publication/edps/2003/03-E-15.pdf
@ Eamon
the ECB isn’t lending unsecured cash to the banks at 1%, its taking bonds off them as collateral in exchange for that. Most major banks would have large bond portfolio’s that they invest their cash reserves in, and these are eligble to be ‘repo’d’ with the ECB for cash. For instance, the €7 billion in capital injections that the govt pumped into AIB and BOI has possibly been used to buy Irish govt bonds which yield 4% or so, and these are then repo’d to borrow back from the ECB at 1%. This easy money making scheme has been noted and commented on on this site recently.
The Irish government doesn’t have a portfolio of bonds like this to use as collateral, other than probably a few billion in the NPRF.
Good to finally see that opinion is moving towards FG.
For a while I thought I was the only person who agreed with Richard Bruton about burning the subordinated bondholders.
Of course it means that the shareholders will also be burnt – and FG are undoubtedly a bit coy about saying it.
Notice that it is Leo who is talking and not RB.
But that is what they (we in my case) deserve.
To me this is the most important aspect of the whole thing.
Some of the above posters are wrong when they say all these losses are a zero-sum game for the taxpayer.
If the bondholders lose 11 billion, it is a gain to us as taxpayers.
If we can avoid the inevitable barrister fattening exercise that will follow NAMA, we will also save the price of a few tribunals.
High stakes commercial litigation is very very expensive.
Just look at the costs for DCC vs. Fyffes.
Question to those who know.
How does the BoI buyback of debt at roughly 50% discount affect my argument?
I know people have been saying privately for a while that this is what they should be doing.
I think it is
Good to finally see that opinion is moving towards FG.
For a while I thought I was the only person who agreed with Richard Bruton about burning the subordinated bondholders.
Of course it means that the shareholders will also be burnt – and FG are undoubtedly a bit coy about saying it.
Notice that it is Leo who is talking and not RB.
But that is what they (we in my case) deserve.
To me this is the most important aspect of the whole thing.
Some of the above posters are wrong when they say all these losses are a zero-sum game for the taxpayer.
If the bondholders lose 11 billion, it is a gain to us as taxpayers.
If we can avoid the inevitable barrister fattening exercise that will follow NAMA, we will also save the price of a few tribunals.
High stakes commercial litigation is very very expensive.
Just look at the costs for DCC vs. Fyffes.
Question to those who know.
How does the BoI buyback of debt at roughly 50% discount affect my argument?
I know people have been saying privately for a while that this is what they should be doing.
Any comments?
@Not that Jim O’Leary
“It also avoids the mistake of forcing the crystallisation of losses at the bottom of the market. If you don’t believe that losses will be as great as currently being predicted then the sixteen-month wait until the determination of solvency is a positive. This period also gives the banks the opportunity to work through many of the problems they have created.”
Of course, two wee problems with this. A) If you think that we have reached the bottom of the market crash, thats fine. Do you think that? What if in 16m time the situation is worse by, say, 20% from now? Wait more? B) Have they not had loads of time to sort it out? Whats the chance that they will get it right if they have one more shot?
@ahura mazda
thanks for the link – i like graphs too.
@ brian lucey
the corollary of course is that if turns out to be worse why would a taxpayer support a proposition like NAMA or Nationalisation that increases their exposure and their future taxes.
As a taxpayer and shareholder I prefer a framework which secures lending, leaves the risk with the shareholder and subordinated bond holders, minimises the taxpayer liability and leaves the shareholder with upside.
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