In due course Ireland needs to have a functioning banking system which is adequately capitalised, does not impose excess costs on the productive economy, and does not enjoy any free insurance on its liabilities. The exit strategy from the guarantee is critical.
The banking problem for countries like Ireland is not addressed by the separation of commercial from investment banking – the Irish banks did’nt collapse through casino losses, but through explosive balance sheet growth and huge loan write-offs, a very old-fashioned commercial banking failure. Countries that have stood behind investment banks need to think about too-big-to-fail issues, reviving Glass-Steagal, much higher capital ratios and so forth, but this is not the Irish problem.
Nor is it clear that, cet par, having ten commercial banks rather than three helps either. If all ten were to behave in the same way, you are in the soup anyway. The fisc ends up as lender of last resort in the Eurosystem as currently operated. But the fisc is’nt big enough to credibly underwrite the next failure in several countries, and the fisc in Iceland clearly not big enough to underwrite the last one.
Unless full-blown EMU emerges soon, with all commercial banks covered by a European FDIC with centralised European regulation and supervision, the implication is that the size of the domestic banking system which the state can stand behind must be constrained by the fiscal capacity of that state. In Ireland we got it wrong by permitting domestic bank balance sheets to expand beyond what could comfortably be supported by the fisc, and then failed to supervise them. Iceland made the same mistake muliplied by three or four. Scotland emerges as the smartest small European country, through not voting for the Nats.
The implication is that the contraction of Irish bank balance sheets is not just an important component of de-leveraging, it is necessary in order to match the state’s capacity to its responsibilities. Shifting existing assets off bank balance sheets through market transactions would complement NAMA, and help to avoid adjustment through an excessive restraint on, for example, working capital lending to private business.
It is difficult to see how an explicit deposit insurance system can be avoided, on a much bigger scale than the pre-crisis scheme. When push came to shove, it transpired that we had a much bigger scheme than we thought, and one which the banks cannot pay for. The next one should avoid any element of taxpayer subsidy.
Given the scale of the risk-to-the-fisc, commercial banking is an industry in which small European countries should plan to punch below their weight. Shame the Irish banks were’nt bought out in a European consolidation!
The target size for the aggregate balance sheet of the domestic banks needs to be addressed in designing the exit strategy, and it would help if the Central Bank could arrange to publish a new table in the monthly bank return for guaranteed banks.
56 replies on “Punching Below Your Weight and the Exit Strategy”
1. We could eradicate any implicit guarantee, and
2. We could limit the personal indebtedness of consumers,
would we need to be so concerned about the bank balance sheets?, i.e., if we can generate assets, products, and income with values which properly secure the loans then isn’t it ok to have a balance sheet which exceeds the the amount of debt which the exchequer can fund.
Didn’t, isn’t, weren’t, etc. The apostrophe indicates a contraction.
but how do you eradicate the implicit guarantee? If there is one clear lesson from the debacle, it is that letting sizeable commercial banks go wallop is not an option democratic governments will contemplate. They will always compensate depositors, so maybe best to make the implicit guarantee explicit, and charge for it.
If the government has to pay the creditors of private institutions when they go bankrupt, they must always be included when telling the public what the national debt is. It it is to be the case, then it must from now on always be stated that the government debt is X and the total national debt (government plus banks) is XXX.
The public was never told it was liable for any of the debts of these private companies. As far as the public knew, their country’s debt was going down and down. Now they are told that in reality it had been spiralling upwards out of control for several years.
The people who lent the debt to the banks, senior or subordinate, DID know that the debt of the private companies they were lending to was spiralling out of control. As with the creditors of any other private company, I believe that they are the ones who should be taking losses in the first instance.
The post considers the split between commercial & investment banks as not addressing Ireland’s particular issues; but a split between less risky (and government guaranteed) and more risky might do / have done the job.
Government guaranteed banks could have constraints on loans to businesses of a size, duration and (expected) risk (as reflected in the interest margin over the interbank rates) and mortgages to individuals could be limited to a certain multiple of salary.
There is no particular need for the split to be made on traditional (or Glass-Steagal) lines; the split could be defined to suit the economy best rather than being the solution that looks the neatest.
I think the goverment needs to move from an implicit model to one that is 100% explicit.
Every single deposit, bond and interbank deposit that a bank sells should either be explictly guaranteed or not guaranteed at all.
Anything that is guaranteed by the state should be charged at market rates to the banks. Obviously the guaranteed stuff should have a lower yield to compensate the banks for the higher cost.
The state can then either choose to hedge this risk or accept it.
In an ideal world banks would have to offer every single deposit, bond etc in both versions so that investors/depositors know exactly what they are getting and the risks they are taking.
Another aspect that needs to be addressed is securing the payments system in the event that a bank becomes insolvent.
I think the best approach would be for the goverment to clearly state in advance that in the event of default it will has the option to purchase the payment system from the banks for a predetermined price for the system, reviewable periodically and exercisable the instant of a credit event.
If we managed to restrict risk in Ireland, the banks would go adventuring… look at the mess the Swedish banks have gotten themselves into in the Baltics.
However, I still think limiting personal indebtedness of consumers on a recourse basis to a multiple of declared income would be a good idea. It would concentrate the mind of the banks and would also mean that only people who are tax compliant (and so pay for bailouts) get credit…
“a split between less risky (and government guaranteed) and more risky might do / have done the job.”
What we need, then, is a bank that does the risky stuff – C&D, landbanks, Commercial, ‘Other’ loans for boats, horses and stuff… ah, didn’t we already try that?
The problem in Irish banking is that, through what can be described as a lack of competence, or perhaps an excess of it, it has gone bust in an entirely conventional way. There is no category or type of loan that is in and of itself risky. Instead, we have incompetence at one bank (which didn’t understand the risks it was taking with the entire banking system) being aped by incompetence at other banks who, although they didn’t know how the first bank was making money, wanted the bonuses that came with making the same amount of money, so they began to lend to all the same people all over again…
IQ tests for bankers. Common sense test. Home economics classes. I don’t know the answer, but senior bankers in all the main banks in this country have proved themselves incompetent. How else do you account for them taking businesses that are cash cows, even in the worst of times, and running them into the ground?
On the Payment system:
Better still, let the state get the payment system from the banks as part of their recapitalisation. Let it set up a separate company for it, or perhaps two or three of them and then float them as independent entities… aside from anything else, it might open banking up… ah, never mind, the consumer is not part of the game…
@ Colm McCarthy,
“In due course Ireland needs to have a functioning banking system which is adequately capitalised, does not impose excess costs on the productive economy, and does not enjoy any free insurance on its liabilities. The exit strategy from the guarantee is critical.”
Sounds very like a medical procedure, doesn’t it?
I highly recommend the various DVD box sets of ‘House M.D.’, about a doctor house played by Hugh Laurie. I became addicted to the TV series not so long ago – something which never happens to me. For some fortunate reason, I didn’t acquire the gene which addicts people to watching endless episodes of Coronation Street, C.S.I., or any of the hit TV series. But I am surprised to say, that ‘House M.D.’, did puncture straight through whatever defenses to TV I enjoyed, and I couldn’t stop until I had seen every single episode. Given there has been 5 no. seasons and on average 24 no. episodes per season, that is a lot of TV viewing.
A couple of years ago, the ex. Havard Business Review editor, book writer, technology commentator and blogger (Roughtype dot com), Nicholas G. Carr wrote a blog entry. I could still find it, if I looked back over his archive of blog entries. The reason Mr. Carr’s blog entry was interesting, is because it looked at language and what influences our vocabulary and our metaphors.
Namely, that in recent times due to the prevalance of computer technology in our lifes, and on foot of popular technology high priests such as Kevin Kelly, Marshall McLuhan, John Perry Barlow, Tim Berners Lee etc – we employ a lot of metaphors which evoke swarm logic, self-organisation, emergent intelligence, distributed behaviour and on and on.
Nicholas G. Carr’s point (as far as my recollection of reading a single blog entry goes) was that depending on the technology prevalent at a certain point in human history, we lean heavily on metaphors which depict everything through the lense of that particular technology.
One can look at writings about the economy and so forth, from the nineteenth century and one imagines this collosal machine, with moving parts and gear ratios etc.
At another stage in human history, where medicine was a new science in the process of becoming respectable and even popular, the metaphors lean heavily on those to do with biology. Of course, then there are cross hybrids. Some people like to think about a computer as being like a brain. If one reads Kevin Kelly’s he talks about a computer as if it was like ants. Paul Ormerod of course, being another one of economists who likes to use that metaphor.
David McWilliams wrote a very useful article for the Sunday Business Post last weekend. A very powerful use of metaphor, comparing Ireland’s participation in the Euro money system to a couple in a marriage, un-able to divorce.
I guess, the point I am trying to make, is no matter how clever the metaphors we use are – all are bound by certain limitations – there is only so much of the subject of economics that one can describe accurately by means of medical, ants, mechanical or other metaphors.
Anyhow, the ‘House M.D.’, DVD box set is a very nice present to receive, especially if your obsession lies in things to do with economics, problem solving and general team work. A good few laughs too.
David McWilliams article:
Nicholas G. Carr’s essay Is Google Making Us Stupid? can be found linked from his blog entry here:
A quote from the essay:
“More than a hundred years after the invention of the steam engine, the Industrial Revolution had at last found its philosophy and its philosopher. Taylor’s tight industrial choreography—his “system,” as he liked to call it—was embraced by manufacturers throughout the country and, in time, around the world. Seeking maximum speed, maximum efficiency, and maximum output, factory owners used time-and-motion studies to organize their work and configure the jobs of their workers.”
Your approach has much to recommend it. In the future we should make sure that Irish banks are treated as the Hannibal Lecters of the global banking world. All their lending here or abroad should be legally restrained in the most explicit way.
Bank bonds should not be guaranteed under any circs – an explicit provision in the next Central Bank bill should preclude it. This is an exit strategy after all.
As for interbank deposits, it seems unlikely that a big market in unsecured lending between banks is going to re-emerge, and the short-term funding of banks will become secured, a repo market. If the Irish banks were required to hold secondary liquidity, there would be no need for official support here either. Secondary liquidity ratios, if my memory serves, were over 20% at one time – happy days.
“Nor is it clear that, cet par, having ten commercial banks rather than three helps either. If all ten were to behave in the same way, you are in the soup anyway.”
You are right, of course. The number of banks is almost irrelevant – a larger number of small banks would just leave a us with a system that is ‘too big to fail’ rather than individual banks that are TBTF. In fact, it is the systematic, rather than the TBTF, excuse that has left us holding the Anglo bag.
“The implication is that the contraction of Irish bank balance sheets is not just an important component of de-leveraging, it is necessary in order to match the state’s capacity to its responsibilities.”
Doesn’t the State have to define its responsibilities before we can calculate the size of them? The banking guarantee seems to point towards a definition of these responsibilities, but as we all know, this is a guarantee in name only, being beyond the states capacity to pay. Like Iceland’s finance minister famous offer to pay in fish, our guarantee as it stands could lead to Mr. Lenihan offering to pay in turf.
If the guarantee only extends to domestic depositors, then our responsibilities currently would be about equal to our GDP. Is this too much, or is it ok?
Basically, like the banks moving assets off balance sheet to reduce their size, could the state move responsibilities off the table to reduce their exposure?
‘Scotland emerges as the smartest small European country, through not voting for the Nats’
We didn’t have to put on the Green Jersey, but a myth was created and enough of us believed in it. In this state of delusion, we allowed ‘our’ banks to gamble away our hard won sovereignty. No point in complaining now.
Serious money was made, and them’s the rules of the casino. That’s ‘state capture’, (as set out by Simon Johnston in his AEA presentation), and our state wasn’t that hard to capture.
Looks like we have to do it all over again now in economic development terms. An extended grinding down of aspirations and living standards. Let’s see who puts the Green jersey now.
The advantage I see in having guaranteed and non-guaranteed bonds/deposits/inter bank funding is that it removes all ambiguity in the future.
So long as the state is paid a true market price for this guarantee, maybe even add a margin to be sure, I would have no problem with it.
The state could and probably should hedge this exposure in the CDS market.
In reality IMO there would be very little interest in the guaranteed stuff from investors. As they could just buy government bonds to give them the same return. They might even get a little bit more if the margin was sufficient.
I just think it is very hard to remove the implicit banking guarantee in practice. The banks will always claim that letting the bondholders go would have disastrous consequences for the economy and the only way to counter this is to clearly define what is and what isn’t guaranteed.
If you buy the guaranteed stuff you are guaranteed and if you don’t then you got you extra return and took your chances with the credit risk.
Just a quick last comment.
By way of the medical analogy/metaphor I was toying with above – what I was trying to get at, in a subtle and round about way – what Colm McCarthy, to me, seems to be suggesting, is that we wean the ‘patient’ off the addiction in such a way as the detox-ification is lasting and does not out-right kill the patient in the process. A patient which has developed a behaviour which has now become routine and pattern-ed.
I suppose, the procedure involved in the Ireland government budget process was also a delicate one. How to release stimulus from the economy, without doing permanent damage to any major organs. That is without causing the patient the trauma which would send it into a sudden shock spiral out of control and balance.
Alan Greenspan’s writing is always full of these analogies too I notice. Obviously the use of the medical metaphor is of considerable use. What I noticed with Greenspan though, was he spent a large amount of his time monitor-ing the patient. At times of crisis he would demand very regular updates on the patients progress, to observe symptoms. I only hope that before Ireland embarks on this kind of procedure, we get very proficient with our bedside manner and observation skills etc. I.e. Good efficient reporting.
Which we obviously didn’t have in September 2008 – hence a reason for a banking inquiry – to understand how well, or how poorly Ireland can cope when the patient’s vital signs start to do strange things.
Lorcan RK, Dreaded Estate:
If bonds and interbank deposits are not going to get guaranteed, then these sources of funds will become more expensive, as they should. A source of the recent catastrophe was inadequate bank margins (ex post, anyway) in addition to official rates that were also too low. So only retail deposits get guaranteed, explicitly, and with the cost fully charged.
I don’t know whether GDP times 1 is the right level, but clearly GDP times 3, with no charge, was not a good idea. If the Govt laid off the risk in the CDS or some other market, the price would tell plenty about the right level.
Indeed, in due course Ireland needs a functioning banking sector. However, the banks need a new business model in my view.
Out must go fractional reserve banking. Out must go interest paid on deposits. In must come bank fees for storage of deposits. Banks should not lend but simply ply their trade as a repository for money.
Saving the banks as they are presently constituted is pointless. The business model is fatally flawed and leaves the citizen exposed to financial annihilation in the final analysis.
We need investment in worthwhile enterprises but banks have not proved to be the best judges of what is a good bet. They use unsecured deposits to make loans. Loans that go bad are eventually made good by the citizen who played no part in the transaction. This practice is immoral and amounts to theft.
Investment will still take place. Venture capital is one of the better ways to secure investment in small businesses and bond issuance the means to finance larger enterprises. Mergers and Acquisitions help entrepreneurs become Capitalists. Capitalists in turn must always find ways to sustain their capital.
People who are free from debilitating regulations and able to make their own subjective decisions given what they know about risks and rewards, are at bottom the basis of a free Society and the Free Market Economy. To curtail this freedom and to thwart the citizen in his quest to improve his situation is counter-productive in the end. Planners and Socialist thinkers who allowed to indulge their Utopian delusions are the enemies of freedom and the Free Market.
The banks are insolvent. No effort must be expended to save them on the part of the citizen through his Government. If the bondholders of these banks deem them salvageable and likely to turn a profit in the near or medium term, then they must foot the cost of saving them. If not them, then why us? Why, if they do not see a future for these banks should anyone else be forced to pay for them?
As to how much of its fiscal resources the State need allocate in order to cover the banks liabilities, my answer is nil. Your speculation on whether, perhaps it would have been better if the banks had been sold off to foreigner banks is moot.
The relationship with Europe is the real preoccupation of the Planners and Socialists at the moment. How do we keep them on-side? How to we ensure they keep lending us the money to pay for our Socialist malinvestments? How do we retain access to the largest market? Will they deny us access or thwart us in any number of ways? – We cannot concern ourselves overly with such matters now. We surely should be looking to get our own house in order. If we solve our problems we help Europe.
Your an Bord Snip recommendations would be a start in the monumental effort required to reduce the size of Government in this State. Together with de-regulation and sound money policies it would be possible to restore freedom, dynamism, growth and some sense of wellbeing to this sorely mismanaged country.
The size of the risk always matters. It would strongly suggest that there was reckless lending if it was significantly out of line with fiscal ability to mend fences. The whole point of having regulators and Central Bank and DSoF was to ensure this never, NEVER, happened. These chumps were clearly out of their depth: incompetent and possibly noticeably incontinent to boot!
Explicit guarantees merely raise the question of implicit guarantees. There is SIMPLY no substitute to having COMPETENT regulation. The best way to rule out implicit guarantee is to watch them go to the wall! We have a welfare state to catch those who end up on their uppers! THIS IS NOT ROCKET SCIENCE!
You do not address the IFSC. Interesting lacuna given your insider status! This is where the laundry must never see the light of day and I shudder to think what is waiting to pop out as the crises unfold. VERY i9nteresting stuff. See BCCI!
The FDIC in the USA is broke, just when it is needed! NO SYSTEM survives CORRUPTION. They now have imposed a temporary measure of getting in the next three years levies…… temporary because in a few months they may need to do it again for the next ten years levies!!!
“I think the best approach would be for the goverment to clearly state in advance that in the event of default it will has the option to purchase the payment system from the banks for a predetermined price for the system, reviewable periodically and exercisable the instant of a credit event.”
Yes it should be under government control as it is of crucial importance even if cheques are being abolished!?
Clearly a good suggestion. Were it to be enacted, the drivelling, dribbling, idiots in power would then issue a guarantee if they were paid enough under the counter! There is no system that can survive corruption, whereby mere gombeen men who can threaten others with physical violence, CJH, can do what they like. NO SYSTEM survives CORRUPTION.
Ugh? Not even I am against the easily corrupted fractional reserve banking. It is far too clever a device not to be used. It should be recognized for what it is: a snarling 800lb gorilla with a nasty fetish for knives. Cage it with regulation and regulators. It serves well as servant and badly as master.
The reason why all this post is nonsense, so welcome Mokabaybob, is that there is too much dirty money around. The US SE and bond sales have been massaged by the arms/drugs monety mainly of US prigin. No system can survive corrosive acids like that. The co may say it is all under control but they have decided to pull the plug, by deliberately triggering the Kondratieff winter. They knew it was coming. So they managed it. Fine! Does it matter what colours we have the deckchairs? The name is RMS Titanic!
I would have thought whatever exit strategy we define should reference the ECB’s exit strategy which they published a while back, actually before NAMA was passed, though you wouldnt have thought so by the way our boys are planning to endlessly roll over short term debt.
The ECB have been very up front as to what they are going to do at the earliest possible opportunity.
So it’ll be interesting to see what if anything the ECB do to the Greeks
will they just tut tut and we can ignore them or will they put the boot in.
The most important implication of Colm McCarthy’s post is an additional and pressing motive for Irish banks to reduce their balance sheets. The probable implication of that is, for the foreseeable future, reducing credit levels in the Irish economy.
An additional implication, which we are already seeing, will be the nationalisation of credit. Why should we as Irish taxpayers, support an Irish bank in its British lending activities? Why should British taxpayers support a British bank in its Irish lending activities? The gradual run-down of the loan books of foreign banks would, if it were to happen, be another significant factor reducing credit levels in the Irish economy.
Low interest margins charged by Irish banks was another point which Colm adverted to. The implication of this is that Irish banks will have to charge higher loan margins in the future. Needing to raise fresh private capital this year, they are already signalling this.
All of the above – contraction of loan books of Irish banks, contraction by foreign banks of their Irish loan books, increased loan margins – will have a very significant effect on the residential property market. The eventual drop in Irish house prices that one would have expected may have to be increased again. That in turn may lead to further problems for the wider economy and for the bad debt provisions at Irish banks.
@Colm McC: the irish problem arose due to the explosion of bank balance sheets – who could have or should have controlled that? It isn’t the banks themselves unless you are happy to put the future of the public good in private hands – in particular private hands that have a first duty of care to shareholders. The failure in Ireland was first and foremost a regulatory one.
As for the commercial/investment bank split, we didn’t have that issue implicitly but the movement of prime clients from traditional banks to the capital markets meant our banks took greater risks in expanding their balance sheet (and competition was fierce, driving down margins and therefore operational profit that could cover future losses).
The whole issue is perhaps that of capital adequacy and regulation, while we don’t have a mirrored problem compared to the US we do have one that occurs within the market when banking clients move their funds to investment banks in the search for yield – that void has to be filled and off balance sheet activities wouldn’t cut it.
How do you change the government guarantee? You change the government.
A new government with a well communicated strategy for letting the bank guarantee lapse would have the international legitimacy required to avoid the “collapse” in the market for Irish government debt that is feared by some commentators.
But of course for the current govt that would be like turkeys voting for Christmas.
Colm McCarthy said:
“The banking problem for countries like Ireland is not addressed by the separation of commercial from investment banking – the Irish banks did’nt collapse through casino losses, but through explosive balance sheet growth and huge loan write-offs, a very old-fashioned commercial banking failure.”
One could suggest that banks who put together projects, managed finance, developed property investment products and took an active roll in development projects were acting as “investment banks” rather than commercial banks. CMcC’s point is no less valid for this aside. However, we might want to limit the degree of hands on investment involvement which banks can have. Getting into the buzz of property may have led to the suspension of disbelief.
We might also decide to require banks to diversify risk between sectors which are not systemically interlinked. This could incentivise lending in export oriented areas while incentivising deleveraging in sectors to which banks are over-exposed.
Another matter which needs to be looked at is systemic borrowers. We cannot again have a situation where an Irish Bank cannot take control of a borrower’s assets because it would cause huge losses for other banks. We need to limit borrowers and groups of companies to one lender or another.
I think we should also consider limiting recourse on security instruments such as personal guarantees where banks can end up providing loans secured on non-existent assets or assets which have already been encumbered a number of times. Banks should have to satisfy themseles properly as to the assets they have recourse to.
I further suggest that any bank rescue and any bank resolution legislation should specify that officers of a failed financial institution will not be indemnified by the rescued or restructured institution in respect of acts or ommissions occurring before rescue/resolution. This would put bankers’ personal wealth on the line in a small way that would incentivise prudence and responsible behaviour. It is also morally, commercially and legally justifiable.
Colm McCarthy said: “Unless full-blown EMU emerges soon, with all commercial banks covered by a European FDIC with centralised European regulation and supervision, the implication is that the size of the domestic banking system which the state can stand behind must be constrained by the fiscal capacity of that state. ”
I suppose this answers my question and your question. It is difficult to see how the implicit guarantee can be removed outside of full EMU. However, implementing a Bank Resolution legislation would help to remove the implicit guarantee for bondholders at least.
“Bank bonds should not be guaranteed under any circs – an explicit provision in the next Central Bank bill should preclude it.”
Could you comment on whether any complementary legal or institutional provisions would be necessary to prevent bond defaults from collapsing domestic banking services, or from triggering hard-to-finance calls on the Government deposit guarantee?
Your forward-looking post is very welcome. Hopefully it will encourage some focus on the looming challenges. (Btw, does this indicate that you have eased off on your demand for a banking inquiry? I think for most people the diagnosis in your post is more than enough. In any event, the Government seems determined to kick an inquiry into the long grass – and even if it is compelled to establish one its TOR will ensure there will be no examination of its (or its predecessors’) culpability.)
For me, and I suspect for other, the outlook is depressing. “Shifting existing assets off bank balance sheets through market transactions would complement NAMA, and help to avoid adjustment through an excessive restraint on, for example, working capital lending to private business” as you suggest is likely to increase the recap required – i.e., on top of the recap generated by the transfer to NAMA. Given the current fiscal capacity, this is probably more pressing than excessive tax-funded guarantees to bond-holders and depositors.
Big margins will be needed to attract private equity and this will do even more damage to the productive economy.
In terms of the bank deposit guarantee is it only a choice between having it at 100% or 0%?
How about 80%? – high enough not to lead to widespread distress in the case of a bank collapsing but low enough to make people carefully consider where they are putting their money.
I know of people in Iceland who have lost in the region of 75% of their retirement savings in bank deposits which is devastating and this needs to be avoided at all costs. Having 0% guaranteed deposits available with higher yields will not help the many thousands of customers who do not understand the financial risks involved and if and when a bank goes under there would be a lot of very angry people (largely pensioners) outside the dail demanding action.
“In terms of the bank deposit guarantee is it only a choice between having it at 100% or 0%?”
Yes. Or rather, it’s a choice between having a run on deposits and maybe not a run.
The people who queued for their savings from Northern Rock largely stood to lost at most 10%, many even nothing. But at the level of deposit rates, why would you risk losing anything at all? At the first sign of trouble, you would move your money to safety.
This would have multiple bad effects:
– runs on banks
– a shorting of deposit terms
– more expensive deposits?
I take your points and am far from being an expert.
I don’t think a 0% guarantee is politically acceptable in practice though and for any figure other than 100% is there some way to mitigate the effects you suggested will happen e.g. restrictions on timing of withdrawals and amounts allowed, more attractive higher yield than fully guaranteed deposits etc.?
No expert either!
But observation is instructive in terms of behaviour (i.e. what do people do, rather than say).
I suspect there is no way to offer less than 100% below a certain limit. The reason being that whatever you set it at, when push comes to shove, people will neglect the benefits they get from higher yield, want to skip out from the restrictions and get 100% back. The politically acceptable old ladies and cripples will be pushed to the front to make the case “sure nobody believed that this could happen, we’re not financial experts”. And, largely speaking, they would be right. Deposits already pay DIRT on the small gains they make. Is DIRT ringfenced as deposit protection money? (The point being that the government is happy to tax and regulate, but not be responsible?).
So we are back to limits and costs. What should the limit be pegged at? What should be the cost of the deposit guarantee? Who should pay? Who should be covered? Should there be a large deposit guarantee too? (Since the slosh of large corporate deposits was deeply destabilising, a very private run…).
@ Cormac Lucey
Your prognosis for credit is bleak but realistic. The patient is steadily deteriorating. I submit that we simply failed to take care of our own business, and we accepted a synthetic substitute for economic development.
We unwisely allowed our state and leading professions to be dominated by monopolies and private vested interests. The individuals concerned cashed out, via the financial service sector, because we looked up to them and trusted them not to. They did it anyway. That’s human nature. There are no Higher Persons.
Now we are stuck with a moribund economy. Of course, we are not the only ones to have fallen for the various Ponzi schemes.
‘Given the scale of the risk-to-the-fisc, commercial banking is an industry in which small European countries should plan to punch below their weight. Shame the Irish banks were’nt bought out in a European consolidation!’
Banking takeovers were always inevitable here, but the local players held onto the steering wheel as long as the going was good. The eventual takeover terms, if there are any, are now going to be disastrous for the fisc and the real economy.
This was not simply a problem of regulatory failure in a single sector, or old-fashioned links between builders and politicians. Our problem of political governance extends into the heart of the state and its institutions. A banking enquiry could not fail to reveal its systemic nature.
We are no longer afraid to investigate the Church, but our economic collapse is still as mysterious to the citizens as Swine Flu. It seems things have to get much worse before we will ask the hard questions.
Meanwhile, our younger folk have been reared on a diet of slick Anglo-American culture and ‘free market’ individualism. There is an upside to that, but the downside has arrived. And then some.
Absent any meaningful process of institutional accountability and social solidarity, is it likely that the brightest and the best will stick around to pay the bill for our Green Jerseys ?
@ Pat Donnelly
We have had the Great Moderation, and the End of History. Or so they said.
Like the pitchfork, the C word has been out of fashion for a while, but I’d say your instincts are sound.
very useful and insightful points raised above. Well done all, as per usual. I will insert one quick comment if I may. Obviously what Colm McCarthy describes is a procedure to improve the long term health and chances of the Irish economy. The discussion here has all been very well informed by the economist’s point of view.
However, pretend for a moment that you are not economists, but are all standing around the patients bed performing a differential diagnosis. If Gregory House M.D. was standing here now, he would be reluctant to proceed without an informed and substantial patient history. Any course of treatment would be depend on this basic component. Gregory House M.D. would be sending his team in through back windows of organisations, and going through underwear drawers to find out what the patient (and extended family) finds it easier to lie about. In the timeless words of Gregory House, everybody lies.
I am reminded of a quote from Shane Ross’s brilliant book The Bankers. Where he compared the approaches of BOI and AIB bank. BOI would knock politely at the front door of their prospective client. AIB would be breaking in the bank window with a crow bar.
“Another matter which needs to be looked at is systemic borrowers. We cannot again have a situation where an Irish Bank cannot take control of a borrower’s assets because it would cause huge losses for other banks. We need to limit borrowers and groups of companies to one lender or another.”
I am delighted you have brought up that point Zhou. I could not agree more with you. Taking Liam Carroll as an instance – his borrowings were diversified between various types of assets, stock market takeovers, land assets interests etc. But of course, the problem as you correctly interpreted, is the fact that so many other lenders were affected immediately if only 1 no. lender moved in. This game of chicken went on between borrower and lender(s) for far too long. Who the heck knows how much good money was thrown after bad. If not for the ‘crisis’ of September 2008, how much worse could it have become? I have already mentioned before at IE blog, that ACC bank were competing aggressively in 2007 to begin opening credit lines to Liam Carroll’s companies.
In one of the early chapters of Charles D. Ellis’s book The Partnership, the making of Goldman Sachs is a historical account of Waddill Catchings and his Goldman Sachs Trading Corporation – the one behind Shenandoah and Blue Ridge investment trusts, which collapsed after the 1929 Wall Street Crash. As I read through Ellis’s excellent historical accounts, I kept getting ‘flash-backs’ of the 2009 Liam Carroll court cases. Indeed, I wondered if the high court and supreme court judges had borrowed some of their vocabulary from that very book.
“They will always compensate depositors, so maybe best to make the implicit guarantee explicit, and charge for it.”
“Big margins will be needed to attract private equity and this will do even more damage to the productive economy.”
Underpricing risk, encourages risk which leads to growth.
Will it not be the case that risk insurance and larger margin requirements lead to a long term growth ristrictions for the economy?
The banks are going to be restricting growth in the medium term anyway
to get their balance sheets in order. If you guys are suggesting different ways of ensuring fair pricing for risk I for one would welcome it but surely these ideas always come up at this point in the cycle but are shelved once the economy starts growing again.
Am I being too Cynical?
@ Eamonn Moran,
An article I can recommend, is Cliff Taylor’s SBP article from last Sunday, Getting the Big Picture. He looks carefully at the situation now, in the cycle relative to where Ireland was 12 months ago. It is an interesting and useful approach to take with an article, and I enjoyed reading it this morning.
Karl deeter: I am not sure it is correct to confine criticism to the regulatory failure alone. The bank boards and management failed too, and have not even commenced to explain what happened. The charge sheet is: excessive balance sheet expansion, loan concentration, bad lending decisions on poor security, and risky liability management. The regulators failed too, but AIB and BoI should not need regulation to stay solvent.
Tim Morrissey: Given what has happened, I guess we are stuck with 100% deposit guarantees for retail banks for the foreseeable future. What alternative exit strategy is practical? But best make it explicit and charge for it. Implies tight regulation (no prop trading, for example) and the moral hazard implications are scary.
Eamonn Moran: If banks are to distribute credit efficiently, they must charge adequate risk-adjusted margins. Margins may have gone too low.
@ Colm McCarthy,
“The regulators failed too, but AIB and BoI should not need regulation to stay solvent.”
Good diagnosis, no more than the heart muscle should require assistance to keep itself pumping.
David McWilliams is right. A lot of it is not complicated, more like first year economics should-know stuff – that is, had I even attended first year economics.
This article at the weekend was shocking:
“The organisers of the 50th Eucharistic Congress in Dublin in 2012 are seeking commercial sponsors after just €500,000 was raised from a national church collection.
Revelations in last year’s Ryan and Murphy reports about the church’s record on child abuse have rebounded on preparations for the biggest international pilgrimage in the Catholic calendar….
….Fr Kevin Doran, who has been appointed by Diarmuid Martin, the archbishop of Dublin, as general secretary of the event….
Asked if he expects the state to cover some of the costs involved this time, Doran said: “I would certainly say things are not going to be all one way. “If it is successful, clearly it will bring large numbers of people into the city in terms of nights in hotels, dinners in restaurants and cappuccinos in cafes. Hopefully, there will be a spin-off for the economy.”
A government spokesman said: “It’s too early yet for any commitments to have been made but it’s very likely the state will play its part.”
What was that all about? Just a replacement of capital taken by the DIRT “Discovery”? It certainly added fuel to the fire?
@ Colm McCarthy
“I am not sure it is correct to confine criticism to the regulatory failure alone. The bank boards and management failed too, and have not even commenced to explain what happened.”
I think it is clear that the boards simply did not comprehend what was happening. How else can one explain, then AIB chairman, Dermot Gleeson’s decision to invest €3m of his own money in AIB shares, right at the top of the market, in the summer of 2007?
The question is why did so few people in positions of authority comprehend what was happening in 2007 and earlier? In my opinion the key reason was psychological. As the Romans put it centuries ago, mundus vult decipi ergo decipiatur: the world wants to be deceived, therefore let it be deceived.
Should we also question the bondholders and lenders to banks who should have noticed that Irish bank debts were growing to a multiple of GDP?
CMcC said that commercial lending and balance sheet expansion lies at the heart of Ireland’s problem. Lloyd Blankfein of Goldman Sachs goes further. He blames real estate lending decisions (and presumably absolves investment banks in large part) for the global crisis.
“As the Commission appears to indicate through its lending-related questions, almost all of the losses that financial institutions sustained over the course of the financial crisis thus far have revolved around bad lending practices, particularly in real estate. According to Goldman Sachs Research, the vast majority of the losses can be traced to bad credit decisions in general, and most of those can be traced back to bad real estate loans. While positions in securities like CDOs and in derivatives, such as CDS, led to losses, these instruments embedded and leveraged what were essentially credit risks emanating from lending decisions, not trading decisions.”
One wonders how many clients advise by Goldman sachs loaned money into the banks making these bad lending institutions…
As you say the guarantee has to be explicit. I understand the implications of the “we are where we are” scenario but maybe this 80% or so deposit guarantee should be a long-term goal and not just confined to an Irish context (EU-wide etc.). As you stated the moral hazard involved in 100% guarantees is dangerous and i think such guarantees encourage lazy decision-making and mask all manner of problems that just grow underneath.
Seeing as we’re talking long-term how about introducing a system whereby sound management by institutions could increase this guarantee to 100% and vice versa to 60% or 50% for the opposite with a 5% incremental change in this occurring annually based on performance within preset criteria? This might begin to separate the Anglos from the BOIs. Decisions on limits to amounts and timing of withdrawals and yield rates could be made by the relevant experts and some type of Tobin-tax equivalent could be applied for particular types of withdrawals as a small penalty for large corporate deposits that are sloshing around the system and may encourage increased inertia (@yoganmahew).
Could a similar approach apply to the future guarantees of bondholders?
When it goes wrong, as in Iceland, accounts are frozen overnight and are thawed out over two years with a nasty c. -75% shock at the end.
“I think it is clear that the boards simply did not comprehend what was happening.”
I think you are right. The question then becomes one of whether they are competent enough to look beyond their immediate self-gratification at their own brilliance (and the concomitant bonuses)…? I say not.
“Eamonn Moran: If banks are to distribute credit efficiently, they must charge adequate risk-adjusted margins. Margins may have gone too low.”
I agree completely underpricing risk has been rife in the US and western europe all I am asking is will it not have a longterm effect on growth potential if we play by the rules from now on?
Can’t a large part of our growth over the last 10 years be contributed to cheap accessable credit?
Eamonn Moran: trouble is, excessively cheap credit fuels ‘growth’ in the form of, for example, buildings nobody wants. What was the true rate of growth over, say, 2001 to 2007 with the buildings that were constructed valued at today’s prices? Some ‘growth’ came in the form of retail employment that cannot be afforded now, and over-payment for public service activities which go into the macro numbers at cost, not value.
IN A MATURE, HEALTHY, DEMOCRACY, THE GOVERNMENT IS RESPONSIBLE FOR THE STATE OF OF THE COUNTRY.
THIS COUNTRY HAS HAD A MAN MADE DISASTER.
THEREFORE, THE GOVERNMENT IS RESPONSIBLE FOR THIS DISASTER.
THIS IS NOT A POLITICAL POINT. IT IS A STATEMENT OF FACT.
We need to start recognising this. Starting with yourself I fear.
‘What was the true rate of growth over, say, 2001 to 2007 with the buildings that were constructed valued at today’s prices?’
Truth was a casualty in this war too. Employment, taxes and growth rates matters to politicians, SMEs and the public, but that is really not how big money is made. Our movers and shakers were fully focussed on getting the global tap opened up to the limit.
There was lots of employment and investment as a result, but it looks like the financial process became detached from the real economy. As the ‘big deal’ came to dominate everything, opportunities were explored for spinning off bigger and bigger chunks of it in cash. Creative thinking.
In the ‘Irish CDS’, risk was concealed by packaging it in green jersey, covering it politically, and ‘dispersing’ it over various banks with overlapping and ill-documented personal guarantees. Over the long term, wealth was transferred from those without capital to those with it. The former got immobile and illiquid property equity and the latter got highly mobile liquidity. The banking intermediaries, or more properly risk entrepreneurs, and their associates, got plenty of that too.
No one really anticipated how far this process would go, but it turns out that we have as much animal spirits as anyone. The current spirit here is resentful and rightly so. Maybe we are not talking hot money here, but it sure feels warm enough for an enquiry.
The bondholders must have known all along that bank insolvencies would ensue. It’s likely they were given some form of nod and wink state guarantee much earlier than 2008, but we can’t find that out for thirty years.
@ Colm also
‘The charge sheet is: excessive balance sheet expansion, loan concentration, bad lending decisions on poor security, and risky liability management. The regulators failed too, but AIB and BoI should not need regulation to stay solvent’
Globally, many CEOs have made personal fortunes from bankrupting their instituitions. The Green Jersey was a cover for a huge lowering of banking standards, in which long-established reputations were treated as tradeable or expendable. Anglo is simply the most egregious on view.
Its time we faced up to about our traditional waeknesses of croneysim and double standards. They are IMO the main obstacles to genuine economic development here. If this crisis teaches us to go back and learn the alphabet of corporate and social governance, (e.g. C for Conflict of interest, I for Insider, T for transparency, not to mention D for Common Decency), it will not have been a wasted experience.
You are quite right in pointing out the failure of the professions to exercise independence. The move towards corporate working is giving rise to new and very significant governance issues for them. Slices of ‘equity’ are very tempting for professionals involved in dealmaking, but their tacit compliance can sanitise corporate piracy.
Such issues were certainly not confined to the property professionals, as lots of others were involved in processing the big deals. Some solicitors, for example failed to carry out title searches dilgently during the boom, if at all, and are now bring sued as a consequence. You will not that the relevant professional bodies are rather silent.
@ Colm McCarthy,
“Eamonn Moran: trouble is, excessively cheap credit fuels ‘growth’ in the form of, for example, buildings nobody wants. What was the true rate of growth over, say, 2001 to 2007 with the buildings that were constructed valued at today’s prices? Some ‘growth’ came in the form of retail employment that cannot be afforded now, and over-payment for public service activities which go into the macro numbers at cost, not value.”
Good points made there about growth, cost and value. It is no harm at all to puncture that myth about Ireland’s growth in the said period.
In the United States, the concern seems to be, folks in ‘main street’ are often told, feel happy, the Dow Jones is doing well. When in fact, Dow Jones has little to do with ordinary folk, except when it collapses.
I suppose, Ireland, in the best American tradition developed its own personal version of the same narrative – perk up people, feel good about yourselves, everything is doing well.
Bill Moyers PBS interview (available at the website) with ‘Mother Jones’ journalists David Corn and Kevin Drum on money, politics and banks, most recently was informative to listen to.
What comes up in the interview, is how thoroughly that folk in the US have become accustomed to accepting the narrative, as it is given to them. Perhaps, in Ireland, a similar criticism could be made. Barring David McWilliams, the ‘grim reap-er’ and a few more, how many people were allowed question the myth?
Anyone who did was encouraged to hang themselves by the Taoiseach.
@ Cormac Lucey,
“The question is why did so few people in positions of authority comprehend what was happening in 2007 and earlier? In my opinion the key reason was psychological. As the Romans put it centuries ago, mundus vult decipi ergo decipiatur: the world wants to be deceived, therefore let it be deceived.”
Cormac, I think you would enjoy that PBS, Bill Moyers interview I referred to above.
“CMcC said that commercial lending and balance sheet expansion lies at the heart of Ireland’s problem. Lloyd Blankfein of Goldman Sachs goes further. He blames real estate lending decisions (and presumably absolves investment banks in large part) for the global crisis.”
There has always been this fight going on within Goldman Sachs culture between those who are traders and those who are leaning more towards investment banking. Ellis’s book which I talked about above, has a very interesting couple of chapters about Sydney Weinberg.
Malcolm Gladwell wrote a piece for The New Yorker a while back.
There is 5 no. pages in the article, click ‘next’ at the bottom.
@Brian O’Hanlan – “What comes up in the interview, is how thoroughly that folk in the US have become accustomed to accepting the narrative, as it is given to them.”.
H’mmmmm. Narrative or rhetoric?
Interesting interview. Thanks for the link.
BTW – Bertie, being a good politician, left people to choose a range of options about how they could end their own lives. He probably thought that hanging was too good for them. Sigh, if only he would come back and save us (yes, I am being sarcastic).
sorry for the typo in your name
“trouble is, excessively cheap credit fuels ‘growth’ in the form of, for example, buildings nobody wants. What was the true rate of growth over, say, 2001 to 2007 with the buildings that were constructed valued at today’s prices? Some ‘growth’ came in the form of retail employment that cannot be afforded now, and over-payment for public service activities which go into the macro numbers at cost, not value.”
Reminds me of some thing I read from a wise old sage.
“Markets have inherent and well-known inefficiencies. One factor is failure to calculate the costs to those who do not participate in transactions. These ‘externalities’ can be huge. That is particularly true for financial institutions.
Their task is to take risks, calculating potential costs for themselves. But they do not take into account the consequences of their losses for the economy as a whole.
Hence the financial market ‘under prices risk’ and is ’systematically inefficient,’ as John Eatwell and Lance Taylor wrote a decade ago, warning of the extreme dangers of financial liberalization and reviewing the substantial costs already incurred – and also proposing solutions, which have been ignored.” – Noam Chomsky