Dealing with a problem bank

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).

More detail:

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

Crisis containment: too little, too late

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.

How to recapitalize the Irish banks

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

St Stephen’s Day entertainment

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!).