Month: September 2009

Dermot Desmond has put forward an interesting alternative proposal to NAMA. You can read it here. Essentially, the proposal is for the Irish government to guarantee €60 billion in bonds issued by the banks themselves subject to various conditions such as the payment of a fee to the government, disallowing dividends to paid while the guarantee is outstanding and, importantly, allowing the government the right to purchase the banks for €1 in ten years time if the guaranteed obligations cannot be paid back. The banks are then given time to sort out their bad loan problems via setting up their own internal “bad banks.”

I think this is an interesting proposal and I wish that we could have had a better public debate involving proposals like this at an earlier stage. That said, let me put forwards a few (hopefully constructive) criticisms.

1. Why does the amount of issued bonds have to be as high as €60 billion? This figure has been arrived at as a guess of the long-term economic value of assets being transferred to NAMA. If these assets are not being transferred, where does this figure come in to it?  To return to an earlier discussion, it seems highly unlikely that the banks would use €60 billion in fresh funding to make new loans. More likely, if they were able to issue bonds of this amount, they would use it to reduce their dependence on the ECB.
2. Who will buy these bonds? I’m sure Mr. Desmond realises that, without NAMA or some other major intervention by the Irish government, the banks could not raise this kind of funding. This is why he is suggesting the government guarantee. But this effectively implies the issuance of €60 billion in debts that are viewed as quasi-sovereign obligations. Is there the market out there to purchase this much Irish government-backed debt? My understanding of the government’s position is that it’s partly driven by an assessment that the answer to this question is no. This is why they are directly issuing government bonds to the banks, which the banks can use in repo operations at the ECB. The NAMA plan does not involve direct issuance of large amounts of quasi-sovereign debt to the market all at one time.
3. The proposal does nothing to recapitalise the banking system, focusing instead on liquidity problems. If, as many suspect, our main banks are either insolvent (or close to it) without NAMA’s intervention, then Desmond’s plan would leave us with undercapitalised banks given a ten year sentence to get themselves sorted out. This seems like a recipe for zombie banks with an incentive to restrict credit and get risk-weighted assets down as a way of returning to solvency. The ten-year Damacles sword will incentivize the banks to use retained earnings to pay off the guaranteed bonds rather than expand assets. Not a pretty picture.

Desmond’s main objection to nationalisation is that nationalising all the banks would lead to an uncompetitive banking sector. However, it may be possible to adopt a hybrid approach in which some banks are nationalised, recapitalised and then privatised, while others are perhaps given the type of liquidity help that Mr. Desmond envisages. One thing should be clear, however: Any coherent plan for our banking system must focus on its recapitalisation.