Was it a mistake for the Irish government to use a clever ploy to “park” Nama bonds at the ECB? Was it the non-standard use of the ECB’s temporary liquidity facility as a source of long-term bank sector funding that led the ECB this week to demand an Irish debt restructuring? Or should the ECB have accepted that they needed to provide long-term risk capital to the Irish banking sector in this non-standard way, as part of their role as euro-area lender of last resort?
As Brian Lenihan has repeatedly and correctly stated, bank asset purchase schemes, like Nama, are an accepted route to restoring bank sector stability, and can be successful. The US TARP programme was successful, and so it seems was the Bank of England’s programme. The theory behind troubled-bank asset purchase schemes is widely accepted and market-tested.
There are two core problems in the Irish case. One, Nama was a poorly constructed asset-purchase programme, which seemed more like a debt relief plan for politically-connected developers than a genuine, open and honest, bank-sector restructuring plan.
Two, the idea behind these schemes is that the government (or rather, the taxpayer) provides long-term risk capital to banks by purchasing risky, long-term bank assets in exchange for cash. The government (taxpayer) has a long horizon and is not liquidity constrained or risk-constrained like the banks. This transaction crystallizes the losses of the banks and avoids dysfunctional bank behaviour associated with an overhang of excessively risky long-term assets like bad property development loans. But given the contemporary fiscal situation, the Irish government in 2009 did not have a lot of available liquidity, nor did it have the ability to provide a big infusion of long-term risk capital. An asset purchase scheme requires the government to absorb and hold the risk from the banks’ assets. The Irish government did not have the capacity to absorb and hold that risk and so it was not really capable on itw own of implementing an asset purchase programme.
The government came up with a clever alternative to providing the banks with solely Irish taxpayer risk capital. At least, I thought it was a clever alternative, and I was an opponent of Nama. The government issued non-tradeable Nama bonds to the banks in exchange for their troubled assets, and arranged with the ECB that the banks could take these Nama bonds to the ECB repurchase facility and use them as collateral for borrowed cash. So in essence the banks got their cash in place of troubled assets.
The problem is that the ECB is sharing the risk capital allocation with the Irish government. The Nama bonds are Irish-government guaranteed, but that is no longer an AAA-promise. If the banks default on their repurchase, and the government defaults on its bond guarantee, then the ECB is at risk of big losses. Should the ECB be willing to absorb that risk or does that go beyond its remit?