Resolution Regime

Colm writes: “Corporate insolvency procedures kick in after solvency has been lost. With banks, in order to avoid bank runs and contagion effects on other solvent banks, it is desirable that imminent failure be preempted prior to actual insolvency which, in any event, can be difficult to distinguish from illiquidity.”

Did I read that right? “preempted”? If there’s one thing I’ve learned from our pro-NAMA commenters it’s that doing anything pre-emptively is bad. Very bad. Back to the drawing board for Colm. 😉

@ John McHale,

What have we lost as a result of our economic turmoil? We have lost 3 no. things in particular. We have lost Ireland’s good reputation abroad, and the opportunity to take advantage of that good reputation. (See professor Niamh Brennan’s Sunday Tribune article today) In the Celtic Tiger years we witnessed a willingness on the part of young Irish citizens to invest in Irelands future. We blew that opportunity too, and have empty houses all across the country. We mis-managed and abused that opportunity. If we take the route as suggested by Irish economists, we are also about to abuse a third opportunity also. Given to us, down through the years, by thousands of small shareholders of BOI and AIB, who contributed. They weren’t affording ‘risk capital’ to the large Irish banks, as economists like to think. (Because it fits some mental model of how the world operates) How could the small shareholders be affording risk capital when some of them own shares in bank(s) since my grand father’s time? I don’t think Irish economists have an answer to that.

We have lost badly on all 3 no. counts I describe. But most of all, we have mis-managed and abused the opportunity to put all of those 3 no. opportunities together somehow. If those opportunities had been combined together in better policy making by the Irish government, we would not be in our current predicament. That is the super mis-management flaw of all. I do welcome input from Colm McCarthy about a long term resolution regime. We need to be careful in my view, how we treat the resolution of existing shareholders of BOI and AIB. I don’t buy into BL’s assertion, they simply lose it all. I don’t. If those small shareholders are treated badly, people who have been around since the 1920s and have contributed to the building of the state’s financial infrastructure, we will make a very grave mistake. In my blog entry, The Rise of Dumb Bank-ing, I added a sub note to professor Whelan today. I do not believe Irish economists have grasped the full extent of where we are. That is evident in the way they present their arguments and their proposals.

http://designcomment.blogspot.com/2010/03/rise-of-dumb-bank-ing.html

@John McHale
Yes – we need resolution mechanisms BEFORE the bank guarantee is NOT RENEWED in September 2010. As Ms Justice Denholm is reported to have put it [Irish Examiner, March 6, p. 9] on the Supreme Court Judgment in the Fleming case recently – ‘… The Companies Acts were not designed to immunise company principals or shareholders from the consequences of financial difficulties’. One could add bond-holders here, and the Irish Supreme Court remains one of the few institutions to retain any credibility, and in terms of Corporate Governance, it did not fudge any issues in the DCC case. Perhaps time for Professors Brian Lucey and Karl Whelan to expand discourse with pragmatic legal eagles, and constitutional experts, and investigate how a case could be made to the Irish Supreme Court, on the Irish Citizenry’s behalf, re the present crisis. I retain faith in the Irish Supreme Court, and its members, not to make errors of judgment on behalf of an entire generation of Irish citizens.

Yes. V. important thread.

@Brian Lucey & Karl Whelan

I have no problem with what Colm McCarthy writes, but John McHale is proposing something more. It depends on the letter of the bond contracts, but what is being proposed certainly sounds a lot like an examinership rigged in favour of certain creditors and to the detriment of others. Is this really legal?

It would be better to find some other way of drawing a line under the old banking regimes (as was done at LTCB and Nippon Credit in Japan).

@ Paul,

Thanks Paul. BTW, I am not a shareholder myself. But I merely wish to confront Irish economists (who understand the mechanics a lot better than I do) with different points of view. That will strengthen their argument(s) and strengthen their position(s). At the moment, as I see it, the Irish economist operates like the boxer in a ring fight, who hasn’t learned to use any footwork. They are able to adopt a strong stance, and throw a knock-out blow. But they also need to develop the footwork. BOH.

If it’s a choice between the shareholders getting hammered or all us tax payers furthering our capacity ‘to take pain’ I know what I’d choose. Most citizens don’t have shares, most citizens children and future children don’t have shares.

So Im not an economist but did shareholders give their dividends to the state during the profitable bubble times? Considering the losses are being socialized I can only assume the profits were too?

It doesn’t matter what they thought the risks were!!!! I can’t go to paddy power and say I thought there was only going to be my horse in the grand national! Theses are grown ups you guys are talking about.

@ Karl

i’ve got nothing against pre-emptively doing anything, so long as there’s an actual process that will work once you do. Isn’t that the entire point of Colm’s article, that we need such a process? As such, its a valuable effort to move the debate along to preventing future situations like the one we are in now. Going way way way way back i have continually said that as there is no way to enforce losses on subordinated debtholders, therefore nationalisation would only serve to endanger our funding whilst giving very little benefits. As Colm says:

“The difference is that the wider economic and social consequences arising from widespread or systemic bank failure are potentially very damaging…Thus, the ordinary insolvency legislation which applies to limited liability companies is not suitable for banks…..the options open to government in dealing with the failure of Anglo Irish Bank were constrained by the absence of resolution options.”

As i have previously said, the threat of liquidation of AIB or BOI is a empty one, and therefore we have a far weaker hand than most people admit when negotiating with bondholders.

An alternative view:
n this open letter, 28 leading economists, social scientists and economic analysts tell the Government that it’s policies for dealing with the economic crisis are wrong. And they chart a different course

THE GOVERNMENT’S economic strategy is failing. The Irish recession has been deeper and longer than almost any other in the industrialised world.
http://www.irishtimes.com/newspaper/opinion/2010/0308/1224265794036.html

I’d like to thank Colm for his excellent and important article, which to my mind strikes exactly the right notes. A good bank/key financial institution resolution regime is something that all should be able to agree is an extremely important policy tool to have in the arsenal of the Government and financial regulatory authorities.

It should not be a matter of partisanship over political affiliation or over the proper strategy for our current crisis, hard though that is to set aside in discussing the issue. If it is treated as a matter of partisanship, to my mind that kills whatever chance we have of getting the resolution regime within a reasonable period of time, and it also, as Antoin highlights, risks having the regime seen as being a means of improperly favouring one set of creditors over another in the current crisis.

A resolution regime will not force a particular strategy to be used in any crisis, but it will add valuable new options to the slate of choices from which any Irish Government can choose. I think we should all be able to sign up enthusiastically for that.

@ Karl

with all due respect Karl, im quite clearly talking about “as things stand right now”. My point is that everyone keeps calling for the banks to be nationalised and subbies taken out, without very much debate about the need for a new resolution regime to actually make this process work. For example, for all the threads on here and articles in the papers (ie dozens and dozens) about nationalisation, loss-sharing etc, isn’t this pretty much the first one on here about the need for a brand spanking new resolution regime to actually make all these great ideas work? I think Brian O’Hanlon made the most salient point in noting that its now time to start looking at this from a legal perspective as much as an economic one.

@ KW,

Equity holders lose out. Hmmm, still stuck on that particular rut.

What aught to happen, is the government of Ireland should pump €2.0 billion into both AIB and BOI at the moment. Whatever the market capitalisation of those banks currently is. Then a separate vehicle should be created, where the existing shareholders of BOI and AIB are moved to – some sort of a low risk, non-high return vehicle, a basic framework for a new banking infrastructure. To which we should then plug onto that, the enterprises which are ESB, Irish Nationwide (what is worth saving) and some one of the small components, which Anglo is spinning off. Sunday Tribune journalists Neil Callanan and John Ihle featured the latest story on Anglo’s business plan here:

http://www.tribune.ie/business/article/2010/mar/07/anglo-irish-to-shrink-loans-to-just-24bn/

My point is, you don’t allow the ‘equity holders lose out’. That is the whole flaw in the KW proposal in my view. It represents too much of a political hot potato. We are in the realm of political economics at this stage, rather than classic economics per se. Once the equity holders have been moved out of the way, then you can go to work on subordinated debt. The point is, with that €2.0 billion market capitalisation from existing equity holders of BOI and AIB, that can provide liquidity to the third banking force. (I don’t know how much you can leverage that €2.0 billion in terms of lending, but certainly, it would offer lending that SME’s currently don’t enjoy – say, half a billion of new money in circulation) Those equity holders will be happy with that deal, and as another poster pointed out above, they are only interested in the long term picture. To buy a present for their grand kids perhaps – a whole plethora of McDonalds Eurosaver hamburgers! BOH.

@ Karl/Zhou

100% backing a new resolution regime for all the obvious reasons. Basically i see the steps as follows:

1. Set up/Have effective resolution regime
2. Enact it on failing bank
3. Deal with ordinary share holders
4. Enforce losses/loss sharing on debt holders in order of subordination/rank
5. Re-capitalise, re-structure, assess viability etc
6. Re-float/sell on
7. Get on with running the country

As previously noted by me, unless you have Step No 1 in place, i think its rather foolish to talk to the ends of the earth about how we need to get on with Steps 3 through 6, and the government “ideologies” that are currently preventing this. At the moment it seems like people are almost ignoring the fact that there is no resolution regime in place (until this thread). As Zhou noted, this is where the criticism or analysis should be focused – why don’t we have one, and how can we go about setting one up?

Here’s Philip in June

http://www.irisheconomy.ie/index.php/2009/06/24/the-imf-and-institutional-reform-in-ireland/

@KW

You have left out Colm McCarthy calling for it as well 🙂

Karl, the FDIC can act ‘pre-emptively’ in the sense that it need not definitively distinguish a failed from a failing bank. Any sensible bank resolution regime needs to help the authorities with this type of adverse selection problem. It’s disingenuous to conflate Ireland’s ‘pre-emptive’ extension of a too-broad liability guarantee in October 2008 with pre-emptive powers under a proper resolution regime.

Karl is of course right that this is not the first time a resolution regime has been called for. But I think the waters have been muddied by the sometime equation of such a regime with temporary nationalisaion. I think it would be very helpful to have more views on the legal constraints on imposing losses on existing bondholders short of bankruptcy.

@ Karl

ok, apologies on not noting these three contributions, but you’ll also forgive me for pointing out that this represents 3 threads over the space of 10 months. I’m guessing that loss-sharing/enforcements and nationalisation have had maybe 10-20 times that in terms of discussion space (and 100 times that in terms of comments), despite the fact that neither of them are particularly effective without the resolution regime in place to start with. Most discussions on nationalisation etc generally don’t even have a mention of the concept of a resolution regime. I have on dozens of occasions raised this point by asking “how do we impose losses on the subbies?”, and very very very rarely has the response been “by first bringing in a new resolution regime”. It generally ends up being “tell ’em we’ll pull the g’tee”, and then peters out after that.

At some point you need to leave the sanctury of the Arts block, lumber up to Roebuck and see what the legal eagles there think about how we do this. 😀

I dunno Eoin. From the point where I started to emphasise dealing with bondholders — the post linked to last July — I’ve been pretty clear about the need for a resolution regime. Perhaps some of our readers haven’t always realised that this is the case but I think all the contributors to this site who’ve discussed the issue have been clear.

@Eoin/Karl

The resolution scheme has long been part of the debate. I think that some contributors to the national debate, such as Constantin Gurgdiev, did not perhaps appreciate the size of the administrative obstacle posed by the lack of such a scheme at times. Certainly Prof Honohan, Karl Whelan, Colm McCarthy and [I think] Philip Lane have all alluded to the importance of a bank resolution scheme form time to time.

I can only think of two reasons for the ongoing delay in progressing a bank resolution scheme:
1. A lack of DoF competency and/or capacity.
2. A fear that some elements of the bond markets might see a resolution scheme as a signal that Ireland is getting ready to default on senior bonds after the guarantee expires. That fear may be justified.

BTW, I should have noted – I think the pulling teeth and property valuation problem, is precisely the problem which Dr. Peter Bacon set out to fix. I.e. Dr. Bacon set out to retro-actively fix the problem, that a property market doesn’t have a ticker tape, signalling mechanism. (Peter Bacon correctly identified that deficiency, because his background is in stockbroking, but his recent experience is with property investment) At least now, international investors can see the ticker tape for Irish property loans coming up on their screens, as loans move to NAMA. So it removes one more unknown, and cleans up the general market situation – from an international point of view.

Eugene McErlean, made a similar point when interviewed about the banking inquiry, about the international view of Ireland Inc. This ties in with my point in relation to economics and the George Lee/Kevin O’Rourke resolution strategy I mention above.

We need to see how NAMA stands as a solution, in context with suggestions from Colm McCarthy, Karl Whelan, George Lee, Kevin O’Rourke, the behavioural economists, myself and Jack the Ripper. BOH.

@Eoin

That would only work if you could require all banks in all jurisdictions to include such clauses in bonds. That is why such reform requires huge international co-operation. Otherwise, we would place our banks at a competitive disavantage in the bonds market at a time when that is the last thing we want.

@Eoin
“For example, for all the threads on here and articles in the papers (ie dozens and dozens) about nationalisation, loss-sharing etc, isn’t this pretty much the first one on here about the need for a brand spanking new resolution regime to actually make all these great ideas work?”
I resemble that remark.

I’ve been calling for it for two years. It isn’t an original thought. This site is a day late and a dollar short in getting to the implications of a property bubble which results in a banking crisis. A resolution regime is always required for a successful resolution. Acting pre-emptively is also always required, otherwise you end up with dead losses like the nationalisation of Anglo (the worst examples and the worst losses nationalised).

As Maurice O’Leary points out, we didn’t even have to think it up.

Diverging to NAMA:

It would be good if there could be analysis of the NAMA valuation regs which were published on Wednesday last:
http://www.nama.ie/Publications/2010/NAMALongTermEconomicValueRegulation.pdf

I note the Regs refer to the “relevant period” for determining long term trends as from 1/1/1985 to 31/12/2005. That means a huge chunk of bubble uplift is included in determining what is supposed to be a historical norm. Never mind that 1/1/1985 is not long ago.

I also understand from my attendance at the NAMA legal conference on Saturday that a model for valuing LTEV has been settled upon and has been circulated to the banks. The banks are using this model to determine recapitalisation costs. The word model was not used but it was said that the methodology for detrmining LTEV was highly scientific, had been developed over a long period and that if one fed certain inputs into the methodology then one got a specific answer at the other end. This was in answer to an accusation that the methodology was anything but scientific.

If there is a model then where is it and why have the public and the Oireachtas not been afforded the opportunity to scrutinise same?

@Zhou_EnLai

Chase down that ‘scientific’ model, equation or whatever it is being called. It has some fairly mega_implications for Joe, Joan, and their offspring. If anyone else around here can track it down – and open it up to ‘peer review’, supported by most on this blog, it might be illuminating.

@Eoin
“you could actually sidestep the entire resolution process altogether (or at least to a large extent) by insisting that banks have to issue debt (at any level) with contingent capital clauses in them where they convert or get written down if capital buffers go below a certain level.”

That would confine us dealing with future crisis’
A bank resolution regime may allow us to spread the losses from the current mess.

I am not aware if that is the case Con. However, 1985 is not long enough ago by any stretch to ascertain long term values. Futhermore, we were told the bubble years would not be counted. This is not the case if 2005 marks the end of the periof over which the long term trend is assessed.

@ Jan,

Is there any strategic value in having a bank network run by indigenous companies?

For the immediate future, certain parts of the banking sector are destined to suffer a miserable, profit-less existence. For a whole variety of reasons, not least of which is, we simply don’t know how the Irish banking system is meant to plug into Europe, and ensure compatibility with the larger system. I would say, allow the Irish government to sponsor development of a basic infrastructure, until such time as we everything figure out. The reason I mentione George Lee above, is because since 2002, our banking network in Ireland which is part of a larger Europe wide network. Your part of that overall system has been mal-functioning in all sorts of ways we do not understand. The old banking management were not able to deal with the problems experienced. (They didn’t have to be brilliant trouble shooters previous to 2002, because banking hadn’t altered in fundamental ways) It is now up to the Irish as a people to understand, why our reception (to employ the phone network analogy) has been so awful since 2002. The best way to conduct the de-bugging exercise, is to impose state control over all of the basic levels of banking infrastructure. That erases any unnecessary boundaries that might get in the way of investigators doing their work. Unless we figure out how Ireland can operate at the edge of this new banking super-grid of Europe, it is pointless making very ambitious plans.

George Lee is right, in that we can afford to push for a better deal with Europe. Until such time as we apply the best, legal/economic coordinated technical resources to the problem in Ireland. We needed a €440 billion guarantee scheme to simply hold onto our deposits. Yeah, I would say, a large portion of our banking infrastructure (and thinking) is ready to go into the dustbin. The truth is, as George Lee described it I think. It is up to the Irish to communicate back to Europe, what exactly are the problems we are experiencing here on the periphery. What do we need to implement solutions. Only then can we see how the markets feel about Irish bank(s) as investments. People often say we are lucky to have Europe, or else we would be hosed. That is missing the point a bit. We plugged ourselves into this single currency gadget, like plugging an old out-of-date appliance into a modern power socket. We short-ed out on this end basically. BOH.

@ All,

I haven’t gotten around to reading Vince Cable’s book yet. But I understand from listening to an RTE podcast, that Cable has come up with a vision for financial markets in the future, which involves 2 no. layers. One layer below, which needs to work 100% all of the time, and cannot let people down. Then there is another layer, which sees to operate according to different regulations, but should not be entitled to support. If you lose, you lose, simple as that. If you look at most succesful pieces of engineering you see this strategy in evidence. The TCP/IP protocol which is the foundation of the internet, is a combination of a base layer, where speed and robustness is obtainable, with another set of devices on top, which address the more intricate needs of the network. The Unix operating system, and Linux operating system operate exactly along the same principles. It works basically. Banking is something like a network, like an OS, which should not go down. Brendan Keenan in the podcast also made the observation, we tried to make financial markets – i.e. markets for ‘money’ operate like markets to buy computers and beef – that was a big, big mistake. We cannot expect those markets to be exactly the same. BOH.

Off the Shelf 3 Oct. 09.
Mary Raftery, Alan Dukes and Brendan Keenan discuss “The Storm” by Vince Cable.

http://www.rte.ie/radio1/podcast/podcast_offtheshelf.xml

@ All,

It is very interesting today, to observe the news media coverage of results released by AIB bank. Bear in mind, what the media has honed in upon, is only the payments to directors, and breakind down those numbers. Here is the thing, imagine there wasn’t a NAMA scheme. Imagine, that for the next 10 odd years in Ireland, we had to rely on these awful news media reports of information released from Irish banks, in relation to performance of troubled property loans. Bearing in mind, that a lot of build-er(s) had multiple lender(s). So on a particular day, we would all be trawling back through figures released about performance of loans from other lenders, and trying to extrapolate from that, the situation regarding build-er(s) and loans. Imagine the sheer time and effort required by that pathetic sort of exercise. At least with NAMA it cuts down an awful lot of the information processing load, with regards to results reporting of Irish banks – there is no one bad bank for all sizeable & troubled property related assets. NAMA is a reporting device, to enable better functioning of the financial market, vis-a-vis Irish banks. As Brian Lucey would say, either way the discussion is academic, the hold still exists to be filled. The only difference that NAMA makes I would argue, is we are destined to spend a lot less time actually speculating and listening to whispers and rumours. BOH.

@Eoin

Most interesting to the non-expert on these Rabo (as distinct from Robo) type hybrids. Think we will be returning to this …….. sure you have a few ideas gestating away in the background …….