Government Banking Policy Based on Best International Advice?

The Taoiseach has emerged to defend the government’s banking proposals. He has been reported as saying:

The proposal we have brought forward is on the basis of the best international advice, including the European Commission and the International Monetary Fund, and we are doing this in consultation with the European Central Bank.

Invoking international support for their approach has been a key element in the government’s PR strategy in recent months. However, these comments seem to me to confuse the actual roles being played by the various international organisations referred to.

Take the European Commission for starters. By late 2008, it was clear that many countries were looking into providing various schemes to prop up their banking sectors. Because government intervention to buy loans above their fair value, or insure banks against loan losses, are aid from the government to private businesses, the Commission decided to establish a set of guidelines as to how these schemes should operate. Note that these were not necessarily recommendations that these schemes be adopted but rather guidelines as to what was allowable if governments decided to adopt them.

As we all now by know, these guidelines allow governments to pay “long-term economic value” for assets transferred to NAMA-type vehicles and so this could be considered an endorsement of the government’s policy. But, as is often the case with documents like this, the guidelines are an all-things-to-all-people affair. For instance, the guidelines have a section on burden sharing with stuff like the following:

(21) As a general principle, banks ought to bear the losses associated with impaired assets to the maximum extent …

(22) Once assets have been properly evaluated and losses are correctly identified, and if this would lead to a situation of technical insolvency without State intervention, the bank should be put either into administration or be orderly wound up, according to Community and national law. In such a situation, with a view to preserving financial stability and confidence, protection or guarantees to bondholders may be appropriate.

(23) Where putting a bank into administration or its orderly winding up appears unadvisable for reasons of financial stability, aid in the form of guarantee or asset purchase, limited to the strict minimum, could be awarded to banks so that they may continue to operate for the period necessary to allow to devise a plan for either restructuring or orderly winding-up. In such cases, shareholders should also be expected to bear losses at least until the regulatory limits of capital adequacy are reached. Nationalisation options may also be considered.

So one could just as easily argue that the guidelines also provide support for nationalisation.  In any case, the fact that the Commission is permitting the government’s approach does not mean that they are endorsing all aspects of it.  I’d also note that Section 46 of the guidelines on page 11 states that

it is necessary to ensure clear functional and organisational separation between the beneficiary bank and its impaired assets, notably as to their management, staff and clientele.

which seems to me to run counter to the government’s plans to have the bad loans managed by the original banks that made them in the first place.

What then of the IMF? The idea that the IMF supports the government’s approach is one that the Taoiseach has raised before. However, while the IMF supports the idea of establishing an asset management company to take on the bad loans of the banks, their Article IV report also stated:

Where the size of its impaired assets renders a bank critically undercapitalized or insolvent, the only real option may be temporary nationalization

And their statement that the losses faced by the Irish banks through the end of 2010 could be about €35 billion makes it clear that they believe the size of impairments does indeed render our main banks insolvent. So, as I have noted on a number of occasions, the IMF’s advice is best understood as being that the government should simultaneously nationalise and set up an asset management agency.

Finally, there’s the ECB. Unlike the European Commission, the ECB has no formal oversight role in relation to governments setting up asset management companies. However, they have issued some bland “guiding principles” as an input into the Commissions State Aid guidelines.

It is possible that the consultations the Taoiseach is referring to relate to details as to how assets should be priced and how NAMA should operate. However, it is more likely that the focus of these consultations is on the bonds that the government will issue to the banks in return for the loans, with the government making sure that the bonds it issues will count as eligible collateral for ECB refinancing operations. In other words, the government may simply be making sure that the banks can take the NAMA bonds and trade them in for cash. In any case, there is little reason to believe that consultations between the government and the ECB implies a full endorsement from the ECB for their approach.

More generally, it is one thing for the government to be consulting with international agencies to ensure their approach is legal or getting technical advice on its implementation; it is quite another thing to claim that the government’s current plan has widespread international support.

31 replies on “Government Banking Policy Based on Best International Advice?”

I wonder if they have a nod and wink arrangement with the ECB that they can keep implying that ECB supports NAMA, because otherwise it seems like a politically risky issue for the ECB. Way beyond their mandate. It’s also a difficult dance for Lisbon II: NAMA is good because the EU institutions want it.

@karl

is it your understanding that the banks will be permitted to trade NAMA bonds on the open market? or are they purely designed as a device for ecb refi operations?

@Karl

As you say, all things to all people.
(22) clearly supports FG policy of special resolution regimes for insolvent banks. as espoused here by Andrew McDowell.

Are we approaching a situation where our continued membership of the EU will be invoked as EU endorsement of everything we do.

If only it were stated in such clear and debunkable terms.

The financial and housing bubbles in Ireland, their inevitable bust and now a government who devise a bailout (NAMA) for those speculators is symptomatic of the decline of ethics in an era of unaccountability.
The dogs in the streets (in the North West at least) knew that the debt and tax break driven housing boom was unsustainable. House prices could not keep rising forever and there was an oversupply of numbers of houses and commercial developments being built in the last 3 years of the bubble. Some people made a fortune. Most people felt richer because of asset value inflation. I was amazed that the boom went on for so long. But the bubble finally burst and now many in the country (particularly young married couples) are in for a long period of paying off excessive debt.
In the three years from 2005 to 2007 first time buyers borrowed over €23bn (out of an overall total of €108bn) in mortgages. The average mortgage taken out by first time buyers was approximately €230,000. Many of these people are now in a negative equity situation at this stage and many more will join them in the future as house prices continue to decline. The growing unemployment situation creates an appalling prospect for the individuals concerned and for the economy generally.
It is this situation that I find it scandalous that the government should try to heap more debt on these very people who were duped into buying houses at excessive prices. It is these very people who should be getting a helping hand at this stage.
The government is not for turning. It is not for listening to anyone in Ireland. It has got the “best international advice”. The only hope is that Irish citizens demand that they are consulted in a general election before any resolution of the banking crisis is put to a Dail vote.

“Are we approaching a situation where our continued membership of the EU will be invoked as EU endorsement of everything we do.”

With Lisbon pending, this is the best time to get EU acquiesence in any dodgy State venture – mustn’t rock that boat!

As you said Karl, the “consultation” with the ECB was most likely a “clarification.”

Trichet would be extremely cautious in avoiding having the ECB being seen, to endorse particular bailouts.

What Cowen doesn’t need is a slap-down at Trichet’s post-Governing Council meeting press conference on Sept. 3rd, or earlier.

Karl

As we only have the wording in the IMF report to go on, it’s not clear from the relevant section whether they’re advocating nationalisation of the banks in advance of NAMA or whether it should be only as a result of NAMA write-downs on the transferred loans that leave the banks either insolvent or critically under-capitalised.

But as I’ve pointed out before in previous threads, if losses for shareholders are to be crystallised now (whether through early nationalisation or NAMA write-downs), it necessarily requires a value to put on property-related loans, with all the uncertainty that that involves.

There is no legal or constitutional basis for arbitrarily telling shareholders that their shares are worth 10c, 5c (or nothing) in a nationalisation without a fair process for putting a value on their loan book, including their distressed property-related loans. This will bring us right back to issues like current market value vs. longer term economic value.

The only alternatives are Honohan’s plan to pay shareholders in part with equity in NAMA, or Fine Gael’s plan to leave, in the event that the banks cannot recapitalise themselves during the Guarantee period, the assets with the most uncertain values (the developer loans) in a legacy bank (a private AMC) owned by the shareholders and certain classes of bondholders, while taking over the assets and liabilities that are much easier to value (the rest of the bank including the branch network).

The taxpayer may have to have some participation in the AMC, but losses will only be incurred after the private owners are wiped out. FG has never suggested, as Dan Boyle intimated in today’s papers, that the taxpayer would have no exposure to losses beyond the €2 billion put into the National Recovery Bank, but clearly the losses will be shared much more fairly.

As had been pointed out by other contributors, this may require UK- or US-style Special Bank Resolution Powers. But essentially what FG is proposing is to turn the whole process on its head by adopting NAMA-type powers of compulsory purchase to buy the performing easy to value parts of the banks but leaving the most toxic and most difficult-to-value assets in an AMC owned by almost entirely by the private investors.

The downside risks associated with continued property price deflation remain with those who funded the reckless lending. They employ the best skills and judgement to recover as much of the money as possible, and there is no public disquiet about a soft-touch approach for the well-connected developers.

The taxpayer would end up owning the good parts of the banks without having to go through the contentious process of putting a value on the toxic assets, as is required by nationalisation of the entire bank.

Hopefully, this break up will never prove necessary, as banks and their investors would have every incentive to avoid it. Buybacks of both sub-ordinated and longer-dated senior debt could be achieved at much greater discounts than has been possible to date.

Financial stability could be maintained by continuing and extending the Guarantee on all new funding coming into the banks until the sufficient recapitalisation has been achieved and confidence restored.

i hope I’m not boring people with this stuff, but it’s frustrating that the media continue to fail to appreciate that there are alternatives to the current NAMA model that must be fully debated before we make a huge mistake.

Andrew

@ Andrew
I can understand your frustration “that the media continue to fail to appreciate that there are alternatives to the current NAMA model that must be fully debated before we make a huge mistake.”

You do not have to apologise for “boring people with this stuff”. It is complex but I firmly believe your approach is the one that is likely to be the least risky for Irish citizens, most fair and transparent and least likely to be hijacked by well-connected developers,bankers and investors.

Why should the state , through a nationalised asset management agency, clean up the mess caused by the few (local and international speculators, senior bankers, the present and recent FF/PD governments? Why should the state take over €90bn of toxic loans, some/many of which involve fraudulent activities by bankers, developers,solicitors, estate agents, etc?

The FG is best alternative to NAMA at this stage IMHO. Continue to explain it, defend it and sell it . Of course you and FG should be prepared to modify it and incorporate good ideas to strengten the plan.

@Andrew McD
It seems to my reading that its a post writedown scenario that the IMF envisage.
Im not sure why we should pay shareholders in part with anything? While accepting that its hard to see a fair value, there is one way and thats to force the banks to write down the losses, and to see the residual value of the assets (less than zero). If we assume any value in the equity then we are saying that the aggregate losses on the 90b will be no more than 20-25b. Is anybody saying that? No. So we all accept that under even the most optimistic scenario the true value of the equity is zero. So pay that (note : that includes my few quid in AIB being wiped out…ah well).
We need to stop pussyfooting about here : the banks are bust, we need to recapitalise them somehow. What we dont need to do is to bail out shareholders (NAMA + overpayment ) or to toss them sops (PH).

@Andrew McD
It seems to my reading that its a post writedown scenario that the IMF envisage.
Im not sure why we should pay shareholders in part with anything? While accepting that its hard to see a fair value, there is one way and thats to force the banks to write down the losses, and to see the residual value of the assets (less than zero). If we assume any value in the equity then we are saying that the aggregate losses on the 90b will be no more than 20-25b. Is anybody saying that? No. So we all accept that under even the most optimistic scenario the true value of the equity is zero. So pay that (note : that includes my few quid in AIB being wiped out…ah well).
We need to stop pussyfooting about here : the banks are bust, we need to recapitalise them somehow. What we dont need to do is to bail out shareholders (NAMA + overpayment ) or to toss them sops (PH).
OH! You’re my new favorite blogger fyi

@Brian

I’m not sure I understand your disapproval for Patrick’s proposal. Yes, the offer of a share in NAMA’s profits is a sop but it won’t cost us anything to print up these shares and they would be a useful sop. This approach would allow the taxpayer to buy the loans at a lower price. And if it turns out that those who argue for long-term economic value are right, and the loans end up being worth much more than we pay for them, then the bank shareholders will have nothing to worry about.

Patrick has proposed to pay a price that we could be “confident” we can recover. As always, confidence — like long-term economic value — is in the eye of the beholder. But most reasonable people that I’ve talked to are confident that the losses on loans will wipe out the equity of the two major banks. So this plan could be implemented as nationalisation plus a piece of paper for the shareholders, which would be fine for me.

I have always noted that some process for compensation for shareholders (perhaps ending with them getting nothing) would be necessary—and as I have argued to Andrew before, I don’t think this process should hold us back from doing the right thing now. I’d also note that, contrary to Andrew’s suggestion above, I don’t think any legal process of this type has to invoke the concept of “long-term economic value” as described in the legislation.

On a separate note, I’m not sure that the NAMA bonds correspond to the two asset categories described in 6.2.2.

@Brian Lucey
Of course the banks should be forced to recognise the real losses they have incurred. We have laws, regulations and standards that are all ignored. We should recapitalise them without delay. What is wrong with using further NPRF money to achieve this and the taxpayer gets the upside.

@Andrew McDowell
“But essentially what FG is proposing is to turn the whole process on its head by adopting NAMA-type powers of compulsory purchase to buy the performing easy to value parts of the banks but leaving the most toxic and most difficult-to-value assets in an AMC owned by almost entirely by the private investors”.
It is difficult to see this proposal passing the constitutional property protection provisions. Taking their good assets and “zombifying” the banks
does not seem a runner. The FG plan needs clarification and costing.

@KW = yeah, perhaps re NAMA 2.0 a la PH. But it seems to me to be a distraction from the main issue. Maybe its a political (small p) requirement.

Im not sure either what NAMA bonds are. Its not clear from what we see. But if they are to be swapped they have to be somewhere in 6.2
On the radio this afternoon BL seemed to suggest that they would be tradable. But at 1.5% coupon, they shouldn’t be swapped at face value. If they are then the ECB is bailing out. NAMA bonds we know are to rank as state bonds (in the legislation) so they should bear a coupon that is similar to existing state bonds IF they are to be at face value

@Karl
Brian Lenihan appeared to clarify the “long term economic value” issue today(RTE 1) saying that this would be calculated taking historic trends into account but, importantly, not taking the recent “bubble” into account. |At least this should lower expectations.
Interestingly, he also said that the bonds would be at a rate of 1.5% and therefore self funding.
Is this the same strategy that got our banks into the fertiliser – borrowing short and lending long.

@Brian

Did Lenihan really indicate that 60Bn of NAMA bonds would be tradeable without restriction? Private banks become issuers of Irish sovereign debt in competition with NTMA? Guaranteed to create a disorderly irish sovereign bond market.

If the NAMA bonds pay euribor+ spread then the swap market indicates what the average coupon will be. 10y swap rates are close to 4%, so a 10y NAMA bonds will pay 4% + spread. So that probably above 5%.

Lenihan’s 1.5% is the starting “teaser rate”.

@podubhlain
In the last few days, we have seen numerous well informed leaks that the ECB line to IReland waould be of the order of 60bn euros-this implies buying 90bn of loans at 60bn. Does this mean that the EU/ECB have basically given Lenihan the haircut. All other valuations are now irrelevant? At 60/90 assuming a c.70% LTV that would imply a 33% loan haircut and a 50% plus asset haircut. Given that 30% of th loan book is in property markets that a recovering…UK, US…the ECB may be saving us from the government’s folly. The next step would be to figure out the resultant govt ownership and if you run the numbers… AIb is probably be 75% state owned, BOI 55% state owned. So we have de-facto nationalisation. We now move on to the consequences of that in terms of private funding for the backs.

As, regards the NAMA bonds, I believe the interest rate risk on the portfolio is largely floating. Rates for the most part are set by reference to the 3-6month Libor rate. Then it is apropriate to issue floating rate paper to fund that. These bonds will trade close to par if this is true. The down side of that will be coupons will increase as ECB rate normalise but the loan yields will also increase. That is the theory. I do not think that NAMA will issue fixed rate coupons at 1.5%. These would trade at a big discount to par.

The issue of the bonds is crucial. I had heard that it would be 150bp over EURIBOR, set for 18m. Today BL implied it was 150bp to allow the project to be self funding. In either case, these should trade at a smaller or larger discount to face, but if the ECB is paying full face then they are bailing us out.

@Jl,|Brian Lucey
BL seemed clear that the rate would be 150bp. That seems to imply short term bonds. Presumably, rolling them regularly. As the ECB appears to be taking all of these then the issue of trading them becomes irrelevant. We have 67b of bonds out there presently, what happens when we issue another 60b. Will the normal market rules of supply and demand apply or is it that the ECB mechanism will save us on this score? If medium to long term bonds were issued then the ECB could not value them at face with a coupon of 1.5% when our long terms are trading at 5%.

its amazing that we STILL dont know the answers to these questions about NAMA bonds. How many months ago was this thing announced?

funding short term via the international markets, at the low end of the interest rate cycle, to purchase long term illiquid assets….what a great idea. Sure what could possibly go wrong with that.

@ Brian

fair point on that, but if the income yielding part of NAMA also pays floating rate, then it matters less to do it that way as the rates on both assets and liabilities will rise. That is if that is the case…lets see the numbers. You are dead right though if there is no income on the NAMA assets…then we are compounding the sin of overpayment with funing short.

@Brian @KW.

I think Honohan proposal is worth of consideration. forcing the banks to take an equity stake in NAMA incentivises them to do a proper clean up.

@ podubhlain

Why would taking the banks’ good assets (paid for in large part by also taking on their depositor liabilities) be more vulnerable to constitutional challenge that buying their bad assets? If anything, the process is less vulneraable to litigation because the valuations are simpler – banks sell performing loans all the time (or at least used to when the securitisation markets were open). As regards costing, it is difficult to offer an accurate cost for any of the proposals, as they require assumptions on a wide range of issues such as bad loans and the extent to which banks can buy back their own debt at a discount. But surely it is clear that lining up all shareholders and various classes of bond-holders to absorb losses before the taxpayer is cheaper for the taxpayer than overpayments by NAMA?

With the separation into their “good” and “bad” parts of banks that have failed to adequately recapitalise, they will no longer be zombies. The “good” elements will be, at least initially owned by the taxpayer, have a strong balance sheet and a willingness to lend.

@ karl and Brian

If you were a shareholder, would not you argue that the compensation you should receive following a nationalisation, as with NAMA, should be determined by the value of the loan-book under a “held to maturity” or “long-term economic value”? It is unlikely that a compensation process can avoid such considerations if we are forcing shareholders to crystallise their losses now, rather than leaving them “discover” the true value of their loans over time (as under the FG model).

Andrew

@Andrew.
Taking out the good loans (paid for by assuming depositor liabilities) seems to me to be nationalisation of the “good” part of the banks). Is it not likely that the resultant “bad” bank and its shareholders and various bondholders would challenge this as being manifestly unfair? Full scale nationalisation in the public interest is one thing but cherry picking the good assets is another matter.

@Andrew McDowell
Why should the shareholders be given the benefit of a “held to maturity” value?

Without state support the banks would now have defaulted. Shareholders would only be paid after the bondholders are paid off in a liquidation.

Even they won’t even get all their money back.

@ Polo
Certainty is the enemy of speculation. People can use derivatives and lending to make massive amounts on successful speculation. Who would give you such a reassurance on what they ECB might do and why would they forego the chance to make a profit?

podubhlain
The bad bank would be wound down, as with Anglo. The shareholders seem to have acquiesced quietly, not wanting to throw good after bad.

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