Resolutions and Bondholders, Again

The S&P downgrades make for depressing reading. I really don’t want to beat the drum again about the government over-promising in relation to what the establishment of a NAMA could deliver. Still, it’s interesting to note that the basic problems afflicting the Irish banks—loan losses, weak operating income and concerns that the banks will be undercapitalised—are pretty much the same as they were this time last year.

This isn’t to say that a NAMA vehicle shouldn’t have been part of the solution: I advocated prior to Peter Bacon’s report that an asset management agency should be part of a comprehensive solution. At this point, it will be interesting to see in the end how different an outcome we get from the one I proposed last Spring and if it’s not so different, whether the government’s policy in the interim period will be seen as the dithering of officials in denial or an inspired period of delay to allow some breathing space to deal with the problem.

One shift in my thinking since last Spring is that the size of loan losses is now clearly large enough to warrant putting the banks through a resolution process and negotiating with bondholders prior to using state funds to recapitalise. In particular, it is worth noting that the covered banks have about €10 billion in outstanding subordinated bonds (€8 billion of which is accounted for by AIB and BoI).

Without doubt, our usual Bond friendly commenters will tell us that any subordinated bondholders losing money would lead to financial ruination for every Irish man, woman and child. However, given that the European Commission has been taking a hardline stance on the idea of state funds being used to compensate subordinated bondholders (see here and here) it is hard to see how this position can really be justified on practical or moral grounds.

67 replies on “Resolutions and Bondholders, Again”

@Karl:
“Without doubt, our usual Bond friendly commenters will tell us that any subordinated bondholders losing money this would lead to financial ruination for every Irish man, woman and child.”

My poor understanding, after about a year and a half, is that we are facing financial ruination anyway, but that the government has chosen a particularly expensive way of bringing that about.

bjg

What resolution scheme would be used for banks? Could we pass something like UK SRR or would that make intentions too obvious? We can’t just send these banks to Commercial Court.

Share the pain and remind them that the guys who did the Baltic Exchange did not go away …. We are not Iceland!

Tell em that the faster we get back on our feet the faster their remaining equity stakes rise….

Tell em whatever it takes, but any attempt to pay them 100% is fiscal suicide and that it ain’t gonna happen.

@Karl,
I think you are being a bit unfair to SOME “bond friendly” commentators. Most of this group would countenance burning sub debt holders because they are part of the capital structure. Indeed, investors have already lost principal through the buy backs of these bonds.
The doubts have always been about the wisdom of touching senior bond holders bond holders in the bank.

@joe lawlor
While it seems that during this crisis “senior bondholders” will get away untouched, I see absolutely no reason why that should be the case long term.

Why should banks receive a free implicit/semi-explicit guarantee from the state?
Shouldn’t the state just secure the payments system and let the bank bondholders like any other bondholders accept the risk they are taking investing in bonds.

I think it’s very important that these issues be resolved *before* the banks end up being nationalised by acccident, as it were.

@ Karl

the capitalisation of the word “Bond” makes me think you’re referring to me!! But i have to say that its an unfair accusation if so.

I have never had very much issue with subordinated debt holders losing a lot of money, indeed i have repeatedly extolled using market-friendly mechanisms such as buy-backs or coupon-deferrals to enforce real losses on these bondholders (this generates the argument above over-paying and why they should get anything, but is anyone going to sell for zero or near-zero? Of course not). I have also never been against any type of negotiated debt-for-equity swap taking place. The only thing i have criticised in this line of thinking is the assumption that the Irish State could ‘enforce’ losses on subordinated debt-holders without the debtholders agreement or acceptance. To simply renege on the debt would lead to bankruptcy proceedings being brought against the defaulting bank, and we would have to risk the complete liquidation of a major Irish bank in order to enforce losses on these debtholders via this route. I’m fairly sure there aren’t too many people suggesting liquidation (including Monsieur Trichet) given the obvious mega-downsides to the economy from this, and the bondholders also know this, so it becomes a Mexican standoff where we have to pay them 30 cents on the Euro or so to get rid of them. Expecting them to accept 5 cents is unrealistic and naive, but was seriously suggested on here. Likewise expecting a debt for equity swap where the existing shareholders get wiped out is also naive in the sense that the shareholders would never vote for it.

My focus beyond this has been much more on how the senior bondholders were going to be treated. This is where i would disagree with what DE has commented above, that senior bondholders should suffer the risks associated with buying bank senior debt. I have continually disagreed that senior debt should be classified as “risk capital”, an argument backed up by Alan Ahearnes recent presentation and by bank financial statements. It should be remembered that senior bank debt is generally classified as “long term funding” on bank balance sheets, and Irish senior debt used to pay around 10-20bps more than Irish government debt back in the day, which could hardly be called a meaningful ‘risk premium’ and is as much to with liquidity as anything else.

However, that said, i do think the situation has stabilised enough now (whether dithering or inspired delay, its had the same positive effect) that more aggressiveness could be taken with regard to the banks and their debtholders, particularly with regard to Anglo or IRNW where we could be willing to let them fold if the situation was bad enough (and the Anglo good vs bad bank would appear to be going down this route). I also think the new govt guarantee scheme is far too broad in its scope and there’s no reason for to cover a lot of what it is intended to cover (which is part of the problem with negotiating with bondholders right now).

@DE

Your point about the status of senior bond holders is well made. However, we are where we are. We have already explicitly guaranteed their principal. In addition, under current laws, the rank parri passu with depositors.

That does not preclude using Eoin’s market mechanisms. IF they trade below par because the holders are in doubt about getting their money back, then the could be bought in at the market price.

@ Karl

by the by, i mentioned this somewhere else but its even more relevant on here. Bk of Ireland last week mentioned ongoing review of “liability management”. The initial thinking was that this referred to more debt buy-backs, but this has since evolved into some people thinking that BoI will shortly propose a debt-for-equity swap with their subordinated debt holders, now that they have stopped paying them any of the coupons.

@ Eoin and Joe

Good to see so much agreement on this issue. Let’s hope this agreement is shared where it actually matters.

On debt-for-equity swaps, is it your understanding that if a debt for equity swap is conducted with the relevant bondholders that the “dividend stopper” clauses are then waived and the conversion of the government’s pref share dividends to ordinary shares can be prevented? If so, wouldn’t this deal have to be completed pretty soon to achieve that?

By Post Author

Karl,

You should be a little wary of Eoin Bond’s stance. The government’s 7bn of AIB/BOI preference shares is probably in his sights. 😉

It seems most are in agreement about the subordinated debt holders. Which could lead to an interesting discussion about the senior bank bonds & maybe a separate topic could be raised about how they should be treated in the future?

The extra liquidity provided by these bonds could also possibly be called a source for extra leverage. If one of the causes of the current crisis is too high leverage, wouldn’t it make sense to remove that source in the future?

Also, if the bonds are expected to have an state guarantee, shouldn’t the state have the right of veto against their issuance? (again in the future)

The premium over government bonds might be small, but why should there be any? Money for nothing…..

If the senior debt is assumed to be backed by the state, then it will also compete with the government in attracting buyers. In theory the governments could have gotten better deals on the government debt if it didn’t have to compete with this senior debt.

In short, senior bonds are definitely good for banks but are they good for the economy?

Isn’t the ability to threaten to wipe out bondholders a prerequisite to negotiations of any kind (debt for equity, etc.) I mean, if the bondholders know that the govt will never, ever, under any circumstances allow these debt obligations to fall, aren’t we negotiating from a position of weakness?

Govt: Accept 30 cent on the euro or else
Bondholder: Or else what?
Govt: Or else … nothing. But just, please, accept 30 cent.
Bondholder: Tell you what, I’ll take 100 cent. How about that?

@ Graham

the bondholder could also ask this question to himself: is the Irish state really willing to liquidate AIB or BoI? At some point common sense and pragmatism comes in, hence the 30 cents i referred to above.

Also, “the govt will never, ever, under any circumstances allow these debt obligations to fall”?

Well they have allowed them to ‘fall’ already, via buy backs and coupon deferral and now likely via leaving subordinated debt in the Anglo Bad Bank (and probably IRNW Bad Bank) going forward. This notion that the Irish govt is unwilling to see any bondholder losses is wholely incorrect.

“One shift in my thinking since last Spring is that the size of loan losses is now clearly large enough to warrant putting the banks through a resolution process and negotiating with bondholders prior to using state funds to recapitalise.”

Are we benefitting in this regard from the delay, by accident or design, in implementing a solution? The worse the situation gets the more the bondholders are going to come to the table. A common stance in any negotiation is for one party to say that whatever the merits of the deal it does not have the money to pay the price.

As Colm McCarthy has said numerous times, a bank resolution scheme and an exit strategy from the Guarantee are critical.

We aren’t protecting senior bondholders for reasons of principle so let’s not waste our breath on “long term funding”, “parri passu” and the likes. At the end of the day the decision is economic. The senior bondholders know that too. Don’t forget we devalued our currency effecting a de facto default before. The prerequisite was that we did everything in our power to avoid devaluation. We must be getting close to the same stage with Bank resolution. A few low NAMA valuations (according to rules dictated by the EU Commission) could be the tipping point.

@eoin

You might edit your last sentence to include the following “the Irish govt is belatedly willing to see any bondholder losses.
At the time of the guarantee and indeed the Anglo nationalisation the current administration wanted to ensure that all obligations were paid on time. Go back to the Dail record and you will see reference to a letter from an T to Enda Kenny and Eamonn Gilmore promising not to go down this route.
One suspects that that this willingness to hurt sub debt holders is coming as much from Brussels as from Merrion Street. There might just be a sensible man “behind the curtain”.

@ Joe

i’ll meet you halfway on that. While there the guarantee itself covered the vast majority of bank liabilities, senior and subordinated, all public utterances from the govt over the last year or so has made a strong and clear distinction between senior debt and the rest. Brian Lenihan has been fairly vocal on this on repeated occasions. As such, i would say that while they were on the one hand looking out for ALL the debt in ALL its forms, they were on the other hand letting the market punish the subordinated debt on its own, in a stable and rational manner (as opposed to a messy crash).

As early as the late spring Bank of Ireland began buying back its sub-debt at 35-40 cents, and AIB followed suit in June. Coupon deferrals then started occurring in the Autumn, and now we’re looking at Anglo Bad Bank ringfencing and potential BoI d-for-e swapping in the coming months. While at times this whole saga has seemed to be messy and ill-considered, i also think that there are, as you suggest, sensible people guiding this is in some form from both Merrion St and Brussel (or more likely Frankfurt), and that the sequence of events has not been completely accidental or by chance.

@Eoin
“This is where i would disagree with what DE has commented above, that senior bondholders should suffer the risks associated with buying bank senior debt. I have continually disagreed that senior debt should be classified as “risk capital”, an argument backed up by Alan Ahearnes recent presentation and by bank financial statements. It should be remembered that senior bank debt is generally classified as “long term funding” on bank balance sheets, and Irish senior debt used to pay around 10-20bps more than Irish government debt back in the day, which could hardly be called a meaningful ‘risk premium’ and is as much to with liquidity as anything else.”

I still disagree I still see no reason why senior bank debt should be considered risk free. Whether it is classified as long-term funding or risk capital is irrelevant in my mind.

@ DE

“I still disagree I still see no reason why senior bank debt should be considered risk free. Whether it is classified as long-term funding or risk capital is irrelevant in my mind.”

I never said is should be considered risk free, but legally its as risky as a deposit, and systematically its as important as both a deposit or government debt. Neither of those are explicitally “risk free” either, but i think we’ll all agree that we treat them differently to lots of other types of market securities in terms of their “risk”. People invest in them (in theory) believing they’ll get a modest return on an ultra safe asset. For some transactions we are allowed to consider government bonds as “risk free”, even though we also know there is a very large and active CDS market operating on the same bonds at the same time.

While you could argue that senior bank debt simply isn’t on the same level as deposits or government bonds, over the last decade they have sat very very close to them. As such, for a government or an investor to make a very large distinction between senior and subordinated debt, and a very large comparison between senior debt and deposits/govt debt, is completely understandable and rational. In a financial system (Ireland) that is chronically in need of external funding, to place senior debt in the same sphere as subordinated debt would radically alter the entire functioning, pricing and availability of credit therein.

The discussion about how/whether we should charge back the implicit or explicit support for this debt is an important one, but irrelevant to how we should consider senior debt in this context.

@ Eoin
“While you could argue that senior bank debt simply isn’t on the same level as deposits or government bonds, over the last decade they have sat very very close to them.”

This doesn’t matter a jot. All it shows is that investors failed to price this risk correctly. Also, deposits are mobile. It would be quite possible to engineer safe passage of deposits while leaving snr bondholders on the hook. Given the scale of Ireland’s problems, it may be necessary to share the pain.

It was crazy to include existing bonds in the guarantee. Only new bond issues should have been covered.

@Eoin: Senior debt is not necessarily pari passu with deposits. Take the WaMu bankruptcy as a clear example of that. I assume there is provision in Irish law for something similar and if you disagree you’d have to show me the money!

You also state “While you could argue that senior bank debt simply isn’t on the same level as deposits or government bonds, over the last decade they have sat very very close to them.
…….
In a financial system (Ireland) that is chronically in need of external funding, to place senior debt in the same sphere as subordinated debt would radically alter the entire functioning, pricing and availability of credit therein.”

That is fallacious reasoning. just because things have been one way – and possibly contributed to a massive crisis – is no reason they should remain this way. Perhaps, if international funding for Irish banks was more constrained in the knowledge that there was a real risk of senior debt being wiped out, we would not have had such a massive credit fuelled bubble here. So a higher price and lwoer availability of credit would not necessarily be a bad thing for Ireland in the long run. Ireland did pretty well in the 90s with substantially lower availability of credit.

PS: And what Ahura Mazda said: Just because investors mis-priced senior debt doesn’t mean we have to bail them out for their own irresponsibility and lack of financial acumen.

@ Ahura

“Also, deposits are mobile. It would be quite possible to engineer safe passage of deposits while leaving snr bondholders on the hook”

you’re making the same mistake as DE: i have never said what you are accusing me of saying.

I’m not saying we “cant” leave (legally or technically) snr bondholders with the smouldering embers of our banking system. I’m asking whether we “should”, given what this reqires practically (liquidation), given the dubious ‘moral’ considerations being put forward (“bank bonds are risk capital”), and given the aftermath that this might create for Ireland going forward (€100bn+ in external funding required over the next 4-5 years).

Legally of course bank debt shouldn’t be guaranteed (or supported) without an explicit and costed guarantee scheme in place. Practically it probably should be, and it usually is in most sophisticated economies. What was it that Trichet said, “Save your banks”? Words of a madman, clearly.

As an addendum, i have never been against negotiations with bondholders, i’ve simply questioned what we can really expect to materially gain from this given our weak bargaining position (ie national bankruptcy doesn’t seem like a particularly good suggestion). It would also have lead to serious funding issues at a time (ie last spring) when an acute (or total) funding crisis was about to occur. We have more room to manouevre now, but it wouldn’t take much to upset the situation either.

@ Garo

“Take the WaMu bankruptcy as a clear example of that”

WaMu had two seperate companies – a holding company and an operating company. One had the cash. The other issued the bonds. If they had been in the same legal entity they would have been pari passu.

@Eoin,

In WAMU case, what happened to the senior debt at the opcos. My memory is that they were paid in full. Am I correct? The hold co debt was written down to zero?

@ All
Would it make a difference who the bondholders,etc were?
What would happen if it turned out that a large no of Irish credit unions, pension funds, bingo cartels etc were bondholders,etc?
If they represented a further domino within the country would the current situation make sense?

Al

@ Joe

it was a complicated issue from memory. At the top of the corporate streucture there was Washington Mutual Inc (the listed holding company). Below that there was Washington Mutual Federal Savings Bank. Basically the FDIC seized the BANK and JP Morgan took it over and covered all its liabilities (deposits, covered bonds, some other secured debt), while all the unsecured debt had been issued by the INC, who got nothing back (technically i think they are still sueing the FDIC).

The essential point was that the senior unsecured debt of the holding company became subordinate to BOTH the senior debt AND the subordinated debt of its subsidiary. However i dont think this structure really exists in Europe.

@ Garo

from an Irish bank perspective, the issue is that both depositors and senior debt are classed as “unsecured creditors”, and there is no way to differentiate one from the other in terms of who gets paid out first.

@ Joe

and if i remember correctly, when news of WaMu being taken over by JP Morgan first broke, bonds in WaMu Inc actually rallied massively because they thought they’d been bailed out. Think about 30 mins later everyone realised that the FDIC were yanking the Bank out of it and leaving the holding company behind, meaning the bonds were actually worthless, and leaving a load of banks (including the best of the best) nursing large losses.

Karl

You write that “One shift in my thinking since last Spring is that the size of loan losses is now clearly large enough to warrant putting the banks through a resolution process and negotiating with bondholders prior to using state funds to recapitalise.”

Is that not what FG were advocating at the time – a “good bank: bad bank” break-up to ensure that any recapitalisation by taxpayers was used to support new lending, rather than to pay off sub-ordinated bond-holders in insolvent banks?

Andrew

Hi Andrew

I was actually quite sympathetic to the FG plan. I had two reservations about it:

1. It seemed to be a recipe for postponing the inevitable restructuring of the banks until September 2010. There seemed to be a risk of a long period of having a zombie banks and I wasn’t convinced that the National Recovery Bank idea would make much difference.

2. I was worried about the idea of going beyond subordinated bonds in terms of loss sharing.

In relation to these two reservations what do I think now?

1. On zombie banks until September 2010, the government’s own approach has done nicely in ensuring that outcome so far thanks to the legal complications and pricing difficulties associated with NAMA. From the point of view of late January 2010, the idea of using the withdrawal of the guarantee as a chip to bargain with bondholders — a backward induction version of the FG plan — makes a lot of sense. But that doesn’t mean I disagree with my May 2009 position that we should have gotten this thing sorted out last summer.

2. On bonds and loss-sharing, I’ll freely admit that I tend to waiver on this issue a bit depending on who has my ear. But I tend to settle on a position that, at least for now, the world has experienced a shift towards bondholder-friendly policies and that it could be a mistake for us to buck that trend in relation to senior bonds. I would like to see there be a move away from the bondholder-friendly trend—for instance, I’d like to see the EU outlaw blanket guarantees of the type that we imposed. But that’s another day’s issue.

@ Eoin,

<<>>

Given the state of our finances, it is necessary to keep all options open. We need to distinguish sovereign risk from corporate risk. Pre-guarantee bondholders invested in corporate bonds and got a premium (albeit small). I have no problem with new bank bonds being guaranteed, if that is what’s required.

<<>>

Are you suggesting there was only one course of action? Or the course of action Trichet recommended? At the time the banks faced a funding crisis (deposits/interbank). Guaranteeing existing bondholders made no difference to this.

<<>>

Again, this is why it’s important to differentiate sovereign from corporate risk. Ireland needs to keep its powder dry as much as possible. By Ireland soaking up bank losses, we weaken our credit strength. Getting external funding depends on this.

@ Karl,

re 2, the world (=consensus) may be moving around but its now back to the legal position, sub debt is part of the capital structure (loss bearing to some degree) and senior bonds in a bank are part of the funding (not loss bearing). That is the assumption that bank investors always operated with. To some extent that. I remember being told to buy bank sub debt because you got extra yield but banks did not fail because they were regulated entities. However, I also believed in Santa, the Tooth Fairy and the integrity of Bertie Ahern.

The mob may be wondering around with torches shouting “Burn the Senior Bond Holders” but what do you do a) if you have guaranteed them and b) if you will still need them on the other side of the crisis.

(oops – last post didn’t work as I’d hoped. please ignore)

@ Eoin,

“…I’m not saying we “cant” leave (legally or technically) snr bondholders with the smouldering embers of our banking system. I’m asking whether we “should”…”

Given the state of our finances, it is necessary to keep all options open. We need to distinguish sovereign risk from corporate risk. Pre-guarantee bondholders invested in corporate bonds and got a premium (albeit small). I have no problem with new bank bonds being guaranteed, if that is what’s required.

“…What was it that Trichet said, “Save your banks”…”

Are you suggesting there was only one course of action? Or the course of action Trichet recommended? At the time the banks faced a funding crisis (deposits/interbank). Guaranteeing existing bondholders made no difference to this.
“…given the aftermath that this might create for Ireland going forward (€100bn+ in external funding required over the next 4-5 years)….”
Again, this is why it’s important to differentiate sovereign from corporate risk. Ireland needs to keep its powder dry as much as possible. By Ireland soaking up bank losses, we weaken our credit strength. Getting external funding depends on this.

@Eoin
I don’t think we are going to agree on the senior bondholder in terms of loss sharing now.
I think they invested in bank bonds for the extra return and if they wanted a “risk free” investment they should have just purchased goverment bonds.

But do you think senior bondholder should be implictly or explicitly guaranteed in the future?

@ DE

How about stating explicitly where you are in the liability stack. Deposits at the top, Equity at the bottom, every thing else on a neat ladder in between. Then the investor knows where he stands and can make his own judgement on pricing and risk.

The problem at the moment is that most senior bond investors thought they were in line with depositors and they have a point.

@Karl

You can claim to have been quite sympathathic to the FG proposals at the time but my memory is that those of us of a true blue persuasion ploughed a lonely furrow.

It was intensely frustrating at the time to see quite straightforward solutions, already tried and tested in other jurisdictions, being rubbished not just in the puerile/febrile politics.ie but also in this much more influential blog.

The pointless debate on the merits of nationalisation proved a perfect distraction which allowed a supine government to do what they were told by big money.

Slow learning is not the exclusive preserve of the DUP/SF special needs polticians.

@ DE

im with Joe. I’d love a world where everything was very clear and explicit, nothing was implicit, and there was never any moral hazard situation like this. However that perfect world only exists in textbooks.

Maybe the current situation is serious enough that we will finally try to create that textbook world for the future, with explicit situations and rules, but we’re nowhere near it right now. And no matter how clear and explicit the rules are going forward, sometime, somewhere there will be a situation where something implicit or serious enough will create a reasoned argument for breaking those rules. Such is politics, economics and life.

Re senior debt guarantees going forward, i think some form of guarantee may be required if we want credit to start flowing again in the short to medium term. Longer term i think the entire structure of financing needs to change so that debt guarantees simply aren’t required. But this will also involve all sorts of implications on balance sheet size, TBTF, leverage ratios, capital requirements and the policy of wanting cheap credit as a means of nominal economic growth. Its not as simple as yes or no.

@ Ahura

we’ve been down this road before when discussing “what would happen if we burnt snr debtholders”.

The Irish state needs to borrow a huge amount of money for the deficit. The Irish banking system also requires a huge amount of money for ongoing funding requirements. Although one is corporate risk and the other is sovereign risk, they generally get bought by the same people – other banks, pension funds, asset managers etc. As such, if we accept that the Irish banking sector was/is in a systematic crisis (as opposed to individual), and the Irish State was also suffering from a deficit crisis last year, if we decided to burn one of these risk categories (corporate) do you not see a decent chance of major contagion into the other risk category (sovereign)? Is a sudden funding stop not possible? Does this not become even more of an issue when many people across Europe see our banking problems as a quasi-sovereign issue? Again, legal and technical considerations be damned, this is a purely practical issue to consider.

@Eoin
Well I think we need to create a “textbook” situation for the future. Because we cannot afford to be providing a free guarantee to the banks.
This time around it will probably cost us €30bn-€50bn and that isn’t a cost we can afford even once every few generations.

I have suggested this before but I think we should force the banks to offer every liability/deposit/bond in a guaranteed and a non guaranteed form.
For everything that is guaranteed the banks would pay fully commercial rates plus a margin to the state for the privilege.
The guaranteed stuff would have a much a lower yield to take account of the extra costs for the banks.

That could be no complaints in the future under any circumstances IMO. If you buy the guaranteed stuff you are guaranteed if you didn’t then you went for the extra yield knowing full well the additional risks you were taking on in return.

@ Maurice

I completely understand your position. But remember that I could just as easily argue that there was some momentum building last Spring for nationalise/recapitalise/privatise as an alternative to the government’s approach that “the pointless debate on the merits of the FG National Recovery Bank proved a perfect distraction.”

My suspicion was that FG figured they appeared clever and moderate by putting forward a plan that didn’t use the phrase “nationalisation”. In fact, the plan was quite a bit more radical than anything I had proposed, for instance.

If the nationalise/recapitalise/privatise approach had common opposition support, then there was room to go further and discuss the more extreme elements in the FG plan involving bondholders. As it was, the spin merchants were able to paint the opposition as being totally at odds — with the incorrect impression always given that Labour’s plan was the more radical. The FG plan gave FF-friendly columnists all the opportunity they needed to write rubbish about only games in town and only credible plans.

But, look, there’s no point in engaging in sour grapes. Reasoned opposition was never going to get in the way of the NAMA train.

@Karl

FG avoided using the word nationalisation because they didn’t want the Anglo fiasco repeated. The FG policy has been the only consistent one insisting that risk capital gets burnt. At least now Brussels is (as usual) partially rescuing us from some of our idiotic policy decisions which were driven by big money and not the national interest.

To think that Richard Bruton would dream up a populist policy that simply appeared to be clever and moderate rather than being actually radical in a time of total national catastrophe is to totally underestimate RB and FG. Never has there been a more important time to put the interests of the Irish people/taxpayers ahead of big money.

Our alternative National Recovery Bank, far from being a distraction, addressed the core issue which nationalisation/NAMA has so far failed to address.

Lenihan is his father’s son and he was always going to succeed in getting his own way over NAMA when so many people ran down the blind alley of nationalisation. The vacuous Pavlovian response of the Labour Party approach, supported by all the usual suspects as well as by people who should have known better, gave FF-friendly columnists every opportunity to portray the opposition as divided.

It is disappointing that the LP came up with so little meaningful reasoned opposition to the debate. The LP was simply not interested in presenting a joint approach with FG. They were far more concerned about presenting Gilmore as Taoiseach in waiting and Burton behaved like a 15 year old who has just been kissed for the first time in all her encounters with Lenihan.

So yes, you are right, NAMA was probably inevitable.
But no one can say that it was FG who handed it to them on a plate.

@Eoin
“The initial thinking was that this referred to more debt buy-backs, but this has since evolved into some people thinking that BoI will shortly propose a debt-for-equity swap with their subordinated debt holders, now that they have stopped paying them any of the coupons.”
Tell me it isn’t the case?

More accounting trickery to appease bondholders that they can just ignore? Indeed, that they have been told to ignore? It is bad enough that they bought back subordinate bonds they didn’t need to…

meant to add…

The only debt to equity swap that makes sense is one for senior unsecured debt.

Secured debt could also be told to take its security, thanks very much for your time, goodbye, but I think this would be genuinely risky…

@Maurice O’L
I agree with you that nationalisation per se is a dud.

Where, though, do you stand on the guarantee?

@ Maurice

my recollection, as a non partisan and reasonably close watching independent, was that FG came out with their NRB idea, talked about it for a few weeks, and then never mentioned it again. If you guys don’t believe in it, why should i?

Also, swsn’t one of the problems with the FG plan due the fact that they said “we wont extend the guarantee, and we’ll wind down insolvent banks at that point”, at which point someone put their hand up and said “eh, won’t all the depositors run for the hills on (or before) Sept 29th, causing a collapse of the banking system”?

@ YM

re BoI d-for-e: whats your pitch to the senior debtholders – swap your debt or we’ll liquidate? Not exactly a strong bargaining position. At least with the subs they have an incentive to crystalise their losses given the lack of a coupon anymore.

@ DE

your idea is certainly a decent one for the future of banking. Unfortunately we’re still trying to sort out the current mess and the previous bad decisions from all parties involved.

When Garret FitzGerald publicly came out in support of nama and later Alan Dukes too, it had the effect, on ordinary mortals of making them sit up and pay attention.

The reaction was that if Garret Fitzgerald and Alan Dukes were backing Brian Lenihan over their own party FG, then Lenihans plan must indeed be the best.

They forgot that both were entirely compromised.

@Eoin
re BoI d-for-e: whats your pitch to the senior debtholders – swap your debt or we’ll liquidate? Not exactly a strong bargaining position. At least with the subs they have an incentive to crystalise their losses given the lack of a coupon anymore.
Nah.

Swap your debt or we’ll do a good bank/bad bank split and you’ll be left in the bad bank…. and then we’ll liquidate it.

@ Ym

you can’t leave the deposits in Good and senior debt in Bad, they both have to remain in the same place and be treated the same…

We seem to have forgotten that the economists argument on nationalization was that the losses would be so large and the likelihood of external capital so low that the state would have to inject such funds as to in effect nationalize the banks.
Lets revisit 17 April 2009 and the “20 economists” letter

“We see nationalisation as being the inevitable consequence of a required recapitalisation of the banks done on terms that are fair for the taxpayer.”

“Furthermore, we explicitly recommend nationalisation only as a temporary measure. Once cleaned up, recapitalised, reorganised with new managerial structures, and potentially rebranded, we recommend that the banks be returned to private ownership.”

“We can summarise our arguments in favour of nationalisation, and against the Government’s current approach of limited recapitalisation and the introduction of an asset management agency, under four headings. We consider that nationalisation will better protect taxpayers’ interests, produce a more efficient and longer lasting solution to our banking problems, be more transparent in relation to pricing of distressed assets, and be far more likely to produce a banking system free from the toxic reputation that our current financial institutions have deservedly earned.”

And where are we now, a year on?

The FG plan was fine in theory but as KW notes it did give lots of hostages to fortune via the timeline.

Lets revisit 19 May 2009 wherein I noted

“However, as Karl Whelan points out on irisheconomy.ie: “The FDIC arrive secretly on a Friday afternoon – they don’t signal 16 months beforehand that they’ll be shutting a bank down.”

The reason for this is that a time period between announcement and effect allows for significant problems to emerge.

The Fine Gael plan would create a system which, at least for a while, is populated by undercapitalised or zombie banks, banks which are not be able to carry out their normal role in the economy. As well as undercapitalisation, the banks would be illiquid. As a consequence of the announced end of the guarantee, banks would not be able to source any funds that extended beyond September 2010 (when the guarantee ends) and so would be forced to rely only on the sluggish interbank markets, with the certainty that as the end of the guarantee looms, they would only be able to source short-term expensive funding.”

Question maurice and andrew : would FG not have been better off in terms of serving the country if they agreed with the inevitable consequences, and suggested that they agreed with the implications that this would require the state to take the banks into care ; they could then state clearly that they disagreed with the second round decision, they favouring a bad/good split asap, Lab favouring whatever they favoured? As it was FG and LAB came across as having good, incoherent and wildly divergent plans while FF came across as having a bad, coherent and agreed plan.

@all

I dont have total recall but the following is my recollection.

FG supported the guarantee but I dont recall the issue of subordinated debt being raised at the time – my memory is that Lenihan was given powers to introduce regulations and that he then included subordinated bonds into the guarantee.

To me the most important date in the chronology is December 2008 when Lenihan offered preference shares to AIB, BoI and Anglo. FG opposed any “investment” in Anglo and called for it to be wound up over a 5-7 year time frame, a timeframe in which dated subordinated bond holders would lose the advantage of the guarantee.

As regards the divergence between the Labour and FG plans in the spring of 2009, the LP is an independent party and is entitled to pursue its own agenda which no doubt they sincerely believe to be in the long term interests of the Irish people. They showed absolutely no interest in cooperating with FG to prevent the introduction of NAMA. To my mind this was a repeat of the Spring/Finlay decision to rubbish FG in 1992 – the only difference is that their decision in this case has cost us all probably 10s of billions.

FG equally were not prepared to support Nationalisation of AIB/BoI as this had already proven to be disasterous in the case of Anglo.

The experience of the last year and a half has shown that a determined government can exercise power in this state in the manner of an elected dictatorship on a scale we would never have imagined 18 months ago.

@Brian Lucey

Temporary Nationalisation – a tempting concept – but no one explained what tidying up you were going to do during those few years.

Did you support nationalisation so that the state could then hand the banks over to the bondholders?

If yes, then why not just provide the legislative format under special resolution regime for this to happen directly without the state takeover.

If no, why did you want to let the bond holders off the hook?

@Eoin
“you can’t leave the deposits in Good and senior debt in Bad, they both have to remain in the same place and be treated the same…”
Sez who?

Parri passu?

So legislate special resolution schemes around it… it works for the FDIC…

@ YM

which FDIC example are you referring to? Almost all depo/bondholder splits have come from overnight/weekend collapses. The idea is you are taking emergency action to save the depositors from a run. Seems more or less legally impossible from the point of view of a stable (but potentially insolvent) nationalised bank like Anglo.

@Eoin
The friday failures that the FDIC imposes are not overnight/weekend collapses. The FDIC keeps the banks going until they have the resolution ready. The bond and equity holders then go into wait for workout of assets to see if they are going to get anything back.

The Irish banks are actually in a better position for this resolution process given their low deposit:loan ratio, many of the US banks were operated under far lower leverage and with far higher deposit:loan ratios.

@Maurice
“Temporary Nationalisation – a tempting concept – but no one explained what tidying up you were going to do during those few years.

Did you support nationalisation so that the state could then hand the banks over to the bondholders?

If yes, then why not just provide the legislative format under special resolution regime for this to happen directly without the state takeover.

If no, why did you want to let the bond holders off the hook?”

Maurice
Not sure where you were the last year, but thats a pretty rank misrepresentation of my position. I argued, forcefully and often, in print, electronic, radio and TV that ALL (yes, that includes bondholders of the non-senior variety) risk capital should be forced to absorb losses BEFORE the state recapitalizes. So the bondholders would far from being of the hook be right on it wriggling.
Maybe you were so enraptured by FG’s plan for mass zombification that you missed that bit? 🙂

@BL
Thanks for the reply.
I apologise for my failing memory – a sad result of my zombie status.

At the risk of further trying your patience, how could all risk capital providers be forced to absorb losses before the state recapitalised without the time pressure of the guarantee running out?

Would they have lost everything in your plan?

As we approach 300 days since Lenihan proposed NAMA, what signs of life suggest that AIB and BoI are not in a zombie state?

And like the original Haiti zombies, their property pertfolios lie in rubble about them.

Eoin,

I disagree with your analysis. If the state can share losses, it’s future credit strength is greater. The idea that covering Irish bank losses will ensure future participation is bizarre. As an investor, if I have a lucky escape, I’m not going to wade back in and expect another lucky escape. Especially if the ones who saved me are looking weak.

To clarify my point on Snrs – I’m not saying they should be hit, but looked at. If the country’s finances are a lot worse than acknowledged, it might be a least worst option.

@ Ahura

“As an investor, if I have a lucky escape, I’m not going to wade back in and expect another lucky escape.”

As an investor, i think i’d be more willing to invest again if i got all my money back this time, as opposed to if i suffer a loss. And that appears to be how the bond markets are reacting right now.

@ Brian

You might explain, step by step, how you proposed last year to force guaranteed bondholders in nationalised banks to absorb losses before recapitalisation of the institutions? As Anglo demonstrated, beyond voluntary debt buy-backs, there was simply no legal mechanism available to force losses on bond-holders before the State recapitalises.

This was always the dilemma posed by early nationalisation of AIB and BofI, as Karl Whelan acknowledges at the very beginning of this thread when he writes:

“One shift in my thinking since last Spring is that the size of loan losses is now clearly large enough to warrant putting the banks through a resolution process and negotiating with bondholders prior to using state funds to recapitalise.”

It is not possible to put banks through effective resolution and negotiate with bondholders until the Guarantee expired,or at least is close to expiring. This is what Fine Gael and Richard Bruton recognised from the beginning of 2009, when the scale of the solvency problems faced by the banks was becoming clearer.

It is true that our threat of putting banks through resolution at the end of the Guarantee period if they remained critically under-capitalised would have given them every incentive to shrink their loan books – perhaps by even more than they are doing now.

That is why we proposed the establishment of a temporary, wholesale National Recovery Bank to allow the banks to move new lending to businesses and households off their own balance sheets and onto the balance sheet of a state-backed entity, which could in turn draw funding from both the ECB and wholesale funding markets. This is similar to what the French did with their “French Economy Financing Corporation (SFEC)” which they established in November 2008 in a matter of weeks.

I agree that the lack of an agreed alternative between opposition parties and independent commentators gave NAMA and Government a fair wind. I would point out, however, that Fine Gael set out its stall on banking as early as February 2009 (see Oped in Irish Times by Richard Bruton on Feb. 11, 2009), long before either the Government announced NAMA or independent economists and Labour were calling for nationalisation.

Everything that has happened since has confirmed by belief in the merits of the approach we advocated.

Andrew

[…] Karl Whelan is still fighting the good fight re Nama, the single biggest potential cost on taxpayers for many years to come.  Smart Taxes has supported rapid nationalisation (and re privatisation) of the main banks as soon as the depth of their property loans exposure became public.  The government persisted in assuming the best of all possible recoverable loans outcomes and the most helpful of ECB lending policies.  Neither has come to pass.  Karl Whelan wearily raises the question again, should the bondholders not contribute to resolving the crisis they helped create rather than placing the entire burden on the taxpayer and citizen.? …This isn’t to say that a NAMA vehicle shouldn’t have been part of the solution: I advocated prior to Peter Bacon’s report that an asset management agency should be part of a comprehensive solution. At this point, it will be interesting to see in the end how different an outcome we get from the one I proposed last Spring and if it’s not so different, whether the government’s policy in the interim period will be seen as the dithering of officials in denial or an inspired period of delay to allow some breathing space to deal with the problem. One shift in my thinking since last Spring is that the size of loan losses is now clearly large enough to warrant putting the banks through a resolution process and negotiating with bondholders prior to using state funds to recapitalise. In particular, it is worth noting that the covered banks have about €10 billion in outstanding subordinated bonds (€8 billion of which is accounted for by AIB and BoI). Without doubt, our usual Bond friendly commenters will tell us that any subordinated bondholders losing money would lead to financial ruination for every Irish man, woman and child. However, given that the European Commission has been taking a hardline stance on the idea of state funds being used to compensate subordinated bondholders (see here and here) it is hard to see how this position can really be justified on practical or moral grounds. (link to article) […]

1) The senior bondholders are equal (pari passu) to deposit holders.
2) The senior bondholders are held by any in the world.
3) The depositors are held by Irish (voters).
4) Any loss for senior bondholders without a loss for depositors is injustice and prejudice by the Irish government by illegally changing the rules in favour for their citizens.
5) Sen. bondholders should be paid in full at any cost with the exception of a full bankruptcy respecting the rules of a bankruptcy as they are.
6) Note that senior bondholders are held by pensionfunds, other banks who also hold deposits.
7) Note that even the hint of a solution outside the contract as now is the case will directly lead to more expensive lending add to the crisis we are already in.
8) We all gonna pay for this crisis, the only thing is how much and by who?
Some solutions look like they dont hurt, but they will back fire. If you dont want tax money in it, ok how about out of a job, or more inflation, or less pension, or paying more for morgages? Avoidance of pain increased only the total pain.

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