Serious Questions about Post-Guarantee Anglo Policy

The documents released yesterday show that the government were aware in September 2008 that, at least under stress scenarios, Anglo Irish Bank was going to be insolvent.

  1. The Merrill Lynch report presented to the government the day they passed the guarantee states that “If one was to apply the INBS stress case scenario the writeoffs would deplete ordinary shareholders and other lower category subordinated debt by €7.5 billion.” Page 10 of the report shows that Anglo’s Tier One capital was €7.1 billion. In other words, they were considering scenarios in which Anglo was insolvent.
  2. On September 25, David Doyle, then Secretary-General of the Department of Finance “noted that government would need a good idea of loss exposures within Anglo and INBS – on some assumptions INBS could be 2 billion after capital and Anglo could be 8½.” I’m not sure what “after capital” means. If it means that Anglo were going to lose all their Tier One capital and then an extra €8½ billion then it means losses of over €15 billion. Even if it just means losses of €8½ billion, it still means that Finance were considering scenarios in which Anglo was insolvent.
  3. The government was also warned by Merrill Lynch that the situation may be worse than presented to them by the bankers. In a September 26 meeting, Merrill Lynch told the Minister for Finance and his officials to take into account that “Management teams tend to play out to the end, because Government intervention tends to change the team, the advisers etc. – their incentive therefore is to be over-optimistic.”

A number of points are worth making about this material.

First, as commenter Tull has been asking, why was Anglo’s management left in place for another three months to engage in God-knows-what in order to try to desperately save the bank? This situation, where seriously troubled banks are given government backing and so have time to gamble for redemption with house money is well known to be a recipe for disaster. Government officials knew that solvency was a serious concern and yet nothing was done to intervene at the executive level.

Second, if Merrill Lynch and David Doyle knew in September that Anglo was insolvent under stress scenarios, then what kind of analysis was performed by Price Waterhouse Coopers when the government asked them to investigate the loan books of the banks? PWC finished their fieldwork in December and concluded in relation to Anglo:

Under the PwC highest stress scenario, Anglo’s core equity and tier 1 ratios are projected to exceed regulatory minima (Tier 1 – 4%) at 30 September 2010 after taking account of operating profits and stressed impairments … We used an independent firm of property valuers (Jones Lang LaSalle) to value a sample of 160 properties held as security in relation to the top 20 land & development exposures on Anglo’s books as identified in our Phase II review and report. The results of this work indicated that impairment charges over the period FY09 to FY11 would fall in a range between the two PwC impairment scenarios but closer PwC’s lower impairment scenario.

Is it in any way credible that a bank that was clearly heading for insolvency under stress conditions in September could somehow look tickety-boo after a detailed examination of its loan book three months later?

PWC’s various analyses of the bank loan books were cited time and again during late 2008 and 2009 to support the idea that the government’s banking policies would not cost the taxpayer money. I would hope that since the Banking Commission’s terms of reference have been extended to go up to January 2009, that the Commission will investigate why PWC (and their partners Jones Lang LaSalle) provided the government with such an extraordinarily flawed assessment of the position of the bank. It would also be worth finding out whether the Department of Finance considered this analysis to be credible. A related question is whether PWC’s report was the basis for Brian Lenihan’s assertions on January 15th 2009, when Anglo was nationalised, that the bank was solvent.

Needless to say, PWC’s reward for this misleading piece of analysis was to continue receiving lucrative contracts from the government, see here and here.

Finally, this material runs counter to the line being reported in today’s newspapers that the documents show that everyone thought it was a liquidity problem. Likewise, another misleading line doing the rounds is that we can’t say Merrill Lynch warned against introducing a blanket guarantee because they said “there was no right or wrong answer”. That sentence was particularly weaselly. However, the documents make it clear that, within the range of options being considered by government, Merrill were less enthusiastic about the blanket guarantee than other options. By and large, the journalistic coverage of this story seems to be making the standard mistake of misleading people in order to conform to the journalistic goal of “being balanced.”

26 thoughts on “Serious Questions about Post-Guarantee Anglo Policy”

  1. I think document 5 makes it very clear that ML were not in favor of the blanket guarantee.

    Two statements in particular

    “Dangers with blanket guarantee – credibility and prolonging weak institutions”

    “On a blanket guarantee for all banks – ML felt could be a mistake and hit national rating and allow poorer banks to continue”

    The options document basically sets out the pros and cons for each option, to be fair the section on the guarantee is very small and very little positive is said about it. However document 5 shows when the options were being discussed ML did not favor the blanket guarantee.

  2. Absollutely right to slate PWC and Jones Lang – how do they still pose as experts in their field? And yes it looks like it would have been better to nationalise Anglo in September ’08 and better still to have done so in September ’06!!

    But there is nothing yet to suggest that even if we knew then what we know now that the blanket guarantee was the wrong call. I have been asking this question on several similar threads – would we have dumped Anglo in Jan 09 except that our hands were tied by the guarantee? I think that analysis is wrong. Even if we had adopted ML’s rather optimistic and naive approach to the liquidity crisis we would still have bailed out the solvency crisis – and this latter is far, far more serious than a blanket guarantee which runs out in December and has cost nuffin’

  3. I think that the onus is on this blog (TPTB of) to put out a message that is very simple to understand for the general public (not trying to patronise here) – a letter from the leading lights is needed again I think. This time, one that Dr Fitz can’t even argue with. Karl/Brian – please put this one to bed once and for all. It has now gone far enough.

  4. @ D-E

    Technically, BW II has a point. Even if Anglo was put into cold storage around the guarantee, the losses would have ended up on the taxpayer’s tab unless the govt had been willing to “persuade” the providers of funding to take a hit. There is no evidence that this was ever countenanced in any option.

    However, one could speculate that if one took the correct decision and took Anglo into state control, the logical next step would have been to look at damage limitation. At the very least all available capital would have been burned.

  5. NATURE OF GUARANTEES ONLY A SECOND-ORDER QUESTION
    You are correct to raise the issue of the form (and thus cost) of the guarantee given. But it is a second-order issue compared to the first-order issues of:

    a. the broad failure of the economic community from 1997 – 2007 to warn clearly of what was going on and of what was likely to happen as the bubble built up. There were some exceptions but they were largely outside the mainstream.

    b. the broad failure of the economic community today to warn clearly that the options we face today are (i) prolonged debt-deflation within the Euro system or (ii) a massively disruptive and massively costly exit from EMU and devaluation outside it. Each carries huge risks and huge costs.

    DEBT-DEFLATION THE KEY PROBLEM
    Why has no mainstream Irish economist used the term “debt-deflation” to characterise our current state when every single one of the debt-deflation elements identified by Fisher is operative in Ireland today?

    “Assuming, accordingly, that, at some point of time, a state of over-indebtedness exists, this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Then we may deduce the following chain of consequences in nine links:

    1. Debt liquidation leads to distress selling and to
    2. Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes
    3. A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
    4. A still greater fall in the net worths of business, precipitating bankruptcies and
    5. A like fall in profits, which in a “capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make
    6. A reduction in output, in trade and in employment of labor. These losses, bankruptcies and unemployment, lead to
    7. pessimism and loss of confidence, which in turn lead to
    8. Hoarding and slowing down still more the velocity of circulation.

    The above eight changes cause

    9. Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.”

    Is monetary analysis, the Great Depression and the study of Irving Fisher wholly passé in Irish universities?

    MAJOR ISSUES BEING SIDELINED
    Any error made in being overly generous with guarantees given to Anglo creditors pales into insignificance beside these important current errors:

    A. the Croke Park deal which means that – at a time of savage cutbacks – already overpaid public servants will be spared additional pain, meaning that welfare recipients and frontline services will have to be cut back all the more.

    B. the continuing requirement of EU treaty law that new entrants to the EU must sign up for eventual EMU membership even though EMU has wholly destabilised the economies of Ireland, Greece and Spain.

    C. the fact that the current budget deficit will not peak until 2011, according to last December”s budget figures. We should be cutting back spending much more aggressively.

    D. the fact that, based on the margin between Irish and German bond yields, markets question the solvency of the Irish state and this after the ECB has bought up around 10% of Irish government debt outstanding (according to last week’s Tribune).

    E. the fact that, according to a Bank of International Settlements paper which takes a 30-year horizon (“The Future of Public Debt: Prospects and Implications”), “the path pursued by fiscal authorities in a number of industrial countries is unsustainable”.

    CONCLUSION
    The Irish state still faces existential economic risks. They have abated but not disappeared. Maybe it’s psychologically easier to fixate on a small and easily-defined part of the problem. But we should be devoting the bulk of our attention to the much greater problems we still face.

    The risk of the car going over the cliff has not been averted but some prefer to nag the driver for not cleaning out the ashtray.

  6. @ Tull

    Great to find someone in this space I can agree with. Subbies should be torched. Karl points out elsewhere that they “mature” around 2014. Maybe by then Anglo has been wound down enough to dump it. I absolutely agree with a point you make in another thread that purchasing subbies for 700M was a disgrace, no matter what the discount.

  7. @tull mcadoo
    “Technically, BW II has a point.”

    Technically he does, but practically he doesn’t IMO.

    If we choose the SLS to get us through whatever liquidity issues were there we could have taken that time to properly examine the Anglo books.

    On discovering the size of the hole I find it hard to believe that we wouldn’t have rapidly introduced banking resolution legislation, as advocated by the IMF.

    A wind down of Anglo without repaying all the Anglo debt could then have been started in an orderly manner.

  8. On the general topic, the Minister is pulling out specific bullet points from the ML presentation to bolster his case. The one that says the guarantee is “best/most decisive/most impactful from market perspective”. Does it have to be explained to him that most impactful on market and protecting the taxpayer are not the same things?

    Note that Merrill also said that if the guarantee was going to be used, “all cards played immediately” and state control of Anglo/INBS was one such card.

    Also on 26 September, ML was looking at the coverage of the guarantee — “at least depositors in serious debt, possibly dated subordinated debt”. A clue maybe to what the subordinated got covered.

  9. @ D_E

    My understanding of the law is that it can’t be changed retrospectively. A banking resolution regime is fine going forward but is really bolting stable doors.

    But I may be wrong, we could possibly have changed the law retrospectively, torched the Anglo debtholders (except other Irish banks, the ICB, the ECB and the depositors) and otherwise kept the thing afloat.

  10. Needless to say, PWC’s reward for this misleading piece of analysis was to continue receiving lucrative contracts from the government, see here and here.

    PwC has long given the appearance of being FF’s favoured firm for getting desired results. A (perhaps not well-known) case in point was the throwing out of the original report on the Defence Forces from the mid-Nineties (which had concluded that the air Corps and Naval Service are inadequately funded for their roles), and the hiring in of PwC to write up a (more pleasing to the Government) replacement which concentrated on cutbacks.

  11. @Brian Woods II
    A banking resolution regime isn’t changing the legal or property rights of the bondholder. It changes how a bank is managed by the state during a wind down period and this isn’t something bondholders have a legal right to control IMO. It won’t in any way change their contract rights.

    Also what do you think it is being changed retrospectively to?
    The crisis itself isn’t a legal event so I am not sure the bondholders can claim something is being done retrospectively to it.
    On the other hand if they think we are changing the law retrospectively to when they entered into the contract then it would be possible ever to introduce the legislation due to the length of some bonds.

  12. Surely the question of whether ML had any clients that held Irish bank bonds also needs to be asked too??????????????????

  13. This wan gets the impression that the total guarantee was not a preferred option of ML and was included in the range of options they examined under pressure – the other options they present form a coherent whole. The guarantee is a significant outlier to that.

  14. @ cormac

    I agree with point s A to E. However, there is no evidence that the current govt agree with your point of view. This was the govt that a) negotiated the Croke Park deal after all b) abandoned all efforts at regulating the Irish financial system post EMU c) probably lied to its own citizens over Anglo and transferred the clean up bill to the taxpayer without consideration of any alternative.

    That said the alternative govt consisting of Labour and one of the weakend centre right parties hardly fills one ith much confidence either. Points A to E would not be addressed by the touch feely Ex Stalinist.

  15. @Cormac Lucey
    I agree absolutely with you about debt deflation. If indeed we are in a position where the weight of debt is going to drag us down whatever we do, we should surely prepare for it. But that presupposes we know that we are in that position, rather than angrily suspecting it from the sidelines.

  16. @Al
    And indeed, how they knew that there was cross-over between subordinate and senior debt ownership since “nobody knows who owns the bonds” as we have been assured many times…

  17. @Joseph
    Sadly, it’s much too late for letters to be of much use, and those worthies know it well. The dunce politicians who idolised bricklayers, the keystone cops in the civil service with their permanent-job-makes-borrowing-easy “investment” properties, they’ve dropped us in it good and proper. Its interesting to see the scrabbling on the part of the government to incentivise enterprise at this late stage when they should have been thinking about it ten years ago. Now it will take us twice as long just to reach the level we were at back then.

    These serious questions about the guarantee were answered long before it was made, there are no surprises here. If we couldn’t stop it then, what makes anyone think they can derail any further disastrous decisions?

  18. @ Karl

    ‘By and large, the journalistic coverage of this story seems to be making the standard mistake of misleading people in order to conform to the journalistic goal of “being balanced.”

    Like any other part of the economy, the MSM reflects the various stakeholder interests which sustain it. In very crude terms, our MSM are controlled by a combination of international capital and local capital, and our journalism has to adapt itself to that businesslike sorry balanced reality. Fair play to those journalists who stand up and are counted.

    It is interesting that we nowadays expect senior members of the Church hierarchy should be held accountable for the various supervisory failures in their organisation. Yet we are reluctant to apply taht basic standard to our secular organisations.

    Economic mismangement results in suffering which is every bit as bad as any other. Dissembling is, sadly, a way of life among our PTB, and it’s one of the main reasons for our economic impasse.

  19. Karl newspapers have no obligation to be balanced. I’d assume it was a manpower-output issue. People will tease everything out over next week

  20. @ D_E

    Maybe I don’t get this resolution thing. But if it doesn’t allow a bank to torch bondholders ahead of depositors and still stay in business then I don’t see why people hold it out to be silver bullet.

  21. @karl

    First, as commenter Tull has been asking, why was Anglo’s management left in place for another three months to engage in God-knows-what in order to try to desperately save the bank?

    One of the words that disappeared form usage during the Celtic Tiger years was ‘clique’. When I was in my salad days the existence of cliques with influence was commonly acknowledged. During the Celtic Tiger, we all pretended it was merit and risk-taking that got the engine running – and to be fair in cases that was true. But what the whole sorry tale of the past week tells me is that the clique mentality was very much alive and kicking (mainly the taxpayer).

    @Cormac Lucey

    Excellent post. Thank you.
    A friend of mine runs a quality deli in a midlands town. I bought some coffee from him on Friday. I was his fifth paying customer of the week. Pause for thought…

  22. @ Ronan Burke

    Well said.

    It’s hard to avoid the searing sense of lost opportunity.

    On May 11, 2007 Bank of Ireland’s Dan McLaughlin said: “there are a number of economic viewpoints about the Irish economy which are often voiced but have little in the way of support from the facts. One often hears that growth is unbalanced but a glance at the data from 2001 to 2006 shows average GDP growth of 5.3%, with all components growing in a 4.5% – 5.5% range.

    The myopic economist was dealing with facts but a little disinterested wisdom would have pointed in an another direction.

    We commented on that day: …in the first quarter, €4.2 million in venture capital was invested in young innovative firms in Ireland, significantly down from €26.3 million in 4Q’06 and the €28.6 million invested in 1Q’06 – – not a basis for believing that we can create a “world class knowledge economy” in six years. Only one deal was completed in 1Q’07, down from 4 deals in 4Q’06 and 7 in 1Q’06.

    In the period 2001-2006, Irish investors put €41 billion in commercial property, mainly overseas. Less than €1 billion has been invested in venture capital for Irish business producing exportable goods and services in the same period.

    In tota,l 86,000 jobs were created in 2006, according to the CSO. The strong growth in the Construction (+28,400) and the Health (+18,700) sectors accounted for just over 55% of the annual increase in the numbers employed. Only 6,000 jobs were created in the tradable goods/services sector of the economy, according to policy advisory agency Forfás.

  23. Brian Lenihan last Friday “I am confident that the cost of saving Anglo Irish and Irish Nationwide will be €23bn to €25bn and the taxpayer will not lose anything with AIB and Bank of Ireland.”

    http://www.independent.ie/business/irish/budget-to-focus-on-cuts-over-new-taxes-2262712.html

    Moody’s this morning “Overall, the recapitalization measures announced to date could reach almost EUR25 billion (equivalent to15.3% of Ireland’s 2009 GDP) — and Moody’s expects that Anglo Irish Bank may need further support.”

    http://www.lse.co.uk/sharecast-news-article.asp?ArticleCode=3580316&ArticleHeadline=PRESS_RELEASE_Moodys_Downgrades_Ireland_To_Aa2_Stable_Outlook

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