I am glad to see that, albeit in his characteristically oblique way, J.-C. Trichet is pushing again for an ECB role in bank supervision.
I have long been an advocate of a euro-wide bank regulator. Isn’t it now obvious that we in Ireland should be cheerleaders for an early move in this direction. We urgently need all the help we can get in financial regulation — even for nationalized banks.
At the time of writing, the Irish bank shares have fallen by about 50 per cent since last Friday’s closing price. The last time there was a one-day fall of comparable percentage size was at end-September, 2008 and it was immediately followed by the announcement of a blanket guarantee.
Let’s not have any knee-jerk reaction this time. The bank shares were already worth almost nothing, so there is scarcely any real impact of this price movement on the economy and on incentives.
Instead we need to have a process of confidence-building in the coherence and feasibility of the overall economic policy strategy for recovery. This must include a broad acceptance of the parameters of tax and spending policy, including on public sector pay. (Banking issues are only part of the equation and they will not be improved by sudden or half-baked initiatives.)
Previous posts have talked about public sector pay and restructuring the tax system. Getting a broad social consensus around an acceptable policy approach must surely be the priority. Here too, precipitate action will not be helpful. We need to know not only the government’s intentions; but that they will be seen as sufficiently effective and fair to elicit broad support rather than a general rejection and protest.
Two contradictory ideas about the consequences of possible failure at Anglo Irish Bank were going the rounds in the last few weeks.
The first idea — a strange one — was that any attempt to foreclose or restructure non-performing corporate creditors of Anglo Irish Bank would have an unfavorable “ripple effect” on the other banks, who also have lent to the same firms. (What kind of ripple? If it causes the other banks to wake-up and help restructure weak firms, that can only be good for everyone — except perhaps the controlling shareholders of the borrowing firms, who are currently living on borrowed times).
The second idea — not quite so strange — was that a bank being wound down would obviously do worse in recovering on the bad loans it had made. (That sort of thing has happened to China’s AMCs, but mainly where the AMC has decided to sit back and not pursue the recovery courses open to it).
Despite their doubtful validity, both arguments are now likely to be used to try to prevent the soon-to-be state-owned Anglo from pursuing delinquent debtors with vigour.
That would be a bad mistake both for the bank’s own recoveries, and for the economy as a whole.
State-owned banks around the world have tended to fall into the pattern of ending-up as lenders of last resort to large but barely viable companies with good political connections.
May I be permitted to repeat a paragraph from my conference paper of last week:
“Distressed firms need to be decisively restructured, and not kept alive on a drip-feed. The dangers here apply especially to property-based companies, but also to others. In other words, parallel to the financial restructuring of banks, there needs to be work ensuring that surviving non-financial firms are financially solid. This can be done largely by the market; the barriers to prompt action here are likely to come from banks that are in denial about the true financial condition of their biggest borrowers, and from political pressure.”
If nationalization means that previously cossetted Anglo borrowers are now going to be pursued energetically, it may prove to have been a good thing.
Well this might not seem like a mystery at all, given the ballooning budget deficit and the overhang of banking problems. But I do want to ask what others think about the potential role of the overfunding/prefunding of the government deficit.
The NTMA’s recent Preliminary Results highlights the fact that there was additional borrowing of 8 per cent of GDP in 2008 over and above what was needed to cover the Government’s borrowing requirement for 2008. This extra amount has been banked (safely I am sure).
Of course this should all be transparent to an efficient market, but could it be that such a large volume of gross borrowing might have contributed to market sentiment against Irish paper and increased the spread over bunds?
After all, this additional borrowing affects the General Government Debt to GDP ratio driving this to 41 per cent. (Though it does not affect the traditional National Debt ratio which is around 31 per cent of GDP).
Publication of the Exchequer Returns today provides more hard evidence on an aspect (previously mentioned by myself and others) which helps unravel this mystery.
Much of the answer lies in the systematic shift towards cyclically sensitive taxes over the past two decades. There has been more and more dependence on corporation tax, stamp duties and capital gains tax (in that order). These three saw their share in total tax revenues rise steadily from about 8 per cent in 1987 to 30 per cent in 2006 before falling to 27 per cent in 2007 and just 20 per cent as soon as the economy turned down in 2008.
This has been an almost automatic albeit unintended consequence of the combination of Partnership with an almost unbroken period of rapid growth. At each pay round, Government negotiators offered concessions in those taxes that are felt by the working person — Income tax and expenditure taxes. These concessions could be afforded because of the steadily soaring revenues in the cyclically sensitive taxes. But each notch in this ratchet made the tax system more vulnerable to an economic downturn.
In 2008, tax revenue fell by almost 14 per cent — but the percentage fall in the cyclically sensitive taxes was much larger, at 36 per cent.
Had Ireland’s tax structure been less cyclically sensitive, the fall in revenue would have been much lower. Indeed, if cyclically sensitive taxes had been back at their 1987 share of total revenue, the fall in revenue last year would have been much lower: 8 per cent instead of 14 per cent.
The medium-term policy implications are clear. The tax structure must be rebalanced in favour of non-cyclical taxes such as income tax, VAT and excises. Politically painfully of course but ultimately inevitable, I would say.
This post draws attention to two recent examples of best current practice for dealing with a problem bank that is not indispensable to the economy.
Key lessons: no need for capital injections if the bank is not going to survive; no protection for unguaranteed subordinated debt holders. In a nutshell, the problem bank is wound up; the guaranteed depositors transferred to a strong bank.
While it is now clear that Lehman Brothers was too large and complex a bank to be wound up, this is not true of many other banks. Indeed, even since Lehmans a number of quite large banks have been intervened. The cases of Washington Mutual and Bradford and Bingley are instructive for any authorities faced with a problem bank whose continued operation is not vital to the economy.
These banks were seen by the authorities as having no viable future, and as not being indispensible to the economy. Their continuing business was transferred to other banks. Government only injected sufficient funds to cover insured depositors: no new capital was needed as the rump banks were gradually being wound up. Holders of uninsured and unguaranteed subordinated debt and preference shares faced heavy losses (they had been earning higher interest in recognition of default risk).
On September 25th, 2008, Washington Mutual, one of the largest banks in the US, was intervened by Federal Authorities. Its insured deposits and mortgage book was sold to the bigger bank JP Morgan Chase. Retail customers were able to continue access their accounts the following morning and in the same old branches, but now owned by JPM. Little or nothing was left to pay WaMu’s $22.6bn in unsecured debt, let alone the shareholders. See: www.fdic.gov/bank/individual/failed/wamu.html
On September 29th, 2008, Bradford and Bingley, a large UK mortgage lender, was intervened by the British Authorities. All of the deposits were transferred to Abbey National and depositors had continued access to their funds through the B&B branches, now operated by Abbey. Mortgage holders continued to make debt service payments to B&B, now owned by the Government. Subordinated debt holders will lose much of their investment. See: www.hm-treasury.gov.uk/press_97_08.htm
CES Ifo’s latest quarterly Forum has just appeared with a special issue on the financial crisis with articles by Hans Werner Sinn, Barry Eichengreen, Martin Hellwig, and yours truly, among others.
Download it free at http://www.ifo.de/portal/page/portal/ifoHome/b-publ/b2journal/30publforum.
My piece develops the argument that containment and resolution policy started too slowly and emphasized liquidity rather than solvency issues. True of Ireland as elsewhere. Only now are some of us coming to terms with this.
Sheltering under the Irish Government’s guarantee, the Irish banks have survived massive falls in their share prices.
In each case the current market price is less than 10 per cent of its peak — 2 per cent in the case of Anglo Irish Bank. Value to book ratio (using the last annual accounts) varies between one fifth and one sixteenth.
Time to recapitalize, then, I would guess. When the regulator finally decides to require them to increase their capital (not least to reflect the large foreseen losses of the “incurred but not reported” type), the Government will have to be ready to participate. But how?
For some ideas and a cautionary comment by an academic scribbler, see today’s Irish Times: http://www.irishtimes.com/newspaper/opinion/2008/1211/1228864660643.html
In case you can’t wait for blogger PH’s rivetting radio lecture: “The Financial Crisis: Ireland and The World” (recorded yesterday before a live audience but not being transmitted until St Stephens Day), you can get the text here.
It’s mostly an interpretation of the causes of — and policy reaction to — the global crisis, and corrects several common fallacies or half-truths.
The Ireland-relevant take-away: Our banking problems were caused by globalization…but not in the way you may think.
It was the fall in interest rates on euro adoption that triggered much of the bubble; easy access to international funding that fuelled it.
(Irish banks’ net foreign borrowing 2003-7 amounted to 50 per cent of GDP; Icelandic banks didn’t do any net foreign borrowing!).