Lenihan Admits Banks Couldn’t Be Saved by the State

On This Week on RTE Radio One, just now, Brian Lenihan has admitted that his banking policies failed in the sense that the banking problem proved too big for the state to solve on its own.

The audio is now available here. Here’s the exchange about the failure of banking policies:

Richard Crowley: Our strategy failed. Could you not admit that now?

Brian Lenihan:  Yes it did in the sense that the banks were too big a problem for the country. I accept that.

Richard Crowley:  And the steps you took were not enough to prevent it.

Brian Lenihan:  The steps could not, given the limited resources a small state has. Yes, I accept all that. But nobody has suggested they were the wrong steps.

The incredibly depressing thing about the banking meltdown is how predictable it all was. Click here for a post from a year ago that links to a presentation I gave to the Labour Party titled “The Banks After NAMA.” A few highlighted phrases:

“government argues that the NAMA loan transfers will fix our banks and get credit flowing. There are good reasons to believe that this is not the case”

“The banks have not developed a sustainable new funding model.”

“more losses to come: The severity of this recession will trigger big losses on mortgages, business loans, credit cards”

“major banks are seriously undercapitalised relative to the size of their balance sheets.”

“the ECB’s unlimited lending policy is likely to come to an end over the next year or so. What then?”

I guess we have an answer now to the last question.

Ranking business schools

There is a new ranking of business schools by EdUniversal.

Seven Irish institutes make it into the top 1000 (2 in the top 100, 4 in the top 700). The methodology is particularly vague, so I do not know what it means. The ranking is based on a composite of other rankings plus a survey among deans. It seems to be mostly about teaching quality.

Anyway, two Irish universities come out well, so that is good.

Bank Resolution

It is being reported (by eg Simon Carswell on the Irish Times website) that, in addition to the four-year fiscal framework, there will be an early resolution of the banking issues as part of the IMF/European deal.

De-leveraging the banks further through private sector deals for bank assets, including non-NAMA impaired assets, has long been an option, as argued here before. The tracker mortgages constitute an impaired (though performing) asset which can no longer be marked at par (as appears to have been the case) in computing the balance sheet hole if market disposal is contemplated. Carswell uses the phrase ‘heavy discounts’ and on the face of it the cost of funds, minus the c. 2% return on these mortgages, put them well under water. There are moving parts – the ECB funds are cheap, for example, and the replacement liabilities, and their cost, is unknown.

The banks wrote a very large piece of derivative business when they extended these mortgages and did not (or could not) hedge, so far as I can see. The risk is in the form of an uncovered exposure to an interest rate spread beyond their control. It looks as if this is about to be marked to market.

Stabilising Ireland’s Debt Ratio

To explore Ireland’s chances of avoiding default, the tool of choice has been simulations of debt dynamics under various assumptions about growth rates, interest rates, primary balances and the direct costs of the banking bailout.   Various domestic and international commentators have usefully produced such analyses, but they can be hard to compare given the combinations of assumptions involved.  Unfortunately, there is still a lot of confusion about our chances of stabilising the debt ratio.  An additional complication is that in their recent “Information Note on the Economic and Budgetary Outlook” the Department of Finance did not report their assumptions for interest rates and the primary balance.   This makes it hard to do a clean sensitivity analysis of the DoF’s projections. 

In a brief note (available here; associated spreadsheet here), I use a simpler decomposition of the change in the debt to GDP ratio than normal, but link the analysis closely to the DoF’s baseline case.   Under their baseline, they project the debt ratio will peak in 2012 at 106 percent of GDP before falling to 101 percent of GDP in 2014.  However, there is concern that the growth projections are too optimistic: 1.75%, 3.25%, 3.00%, and 2.75% for real GDP growth from 2011 to 2014.   For some reason they do not report nominal growth rates for 2012 to 2014.   However, the decomposition allows us to infer the nominal growth rate assumptions.  

To test the robustness of the DoF’s projections, I examine a quite pessimistic growth scenario with just 1 percent real growth and 1 percent inflation (GDP deflator) in each year out to 2014 holding the projected deficits as a share of GDP at the DoF target levels.  Under these assumptions the debt ratio is not stabilised — though we still come surprisingly close.   Encouragingly, however, a sustained additional adjustment in the deficit equal to 1 percent of GDP in 2011 would stabilise the ratio at 112 percent of GDP in 2013.   Moreover, combining the low growth scenario with a 10 percent of GDP increase in the starting debt ratio due to a higher bank bailout cost, we still have the debt ratio peaking in 2013, but at the higher level of 121 percent of GDP. 

While the challenge of bringing the deficit down and avoiding explosive debt dynamics (and ultimately default) is daunting, I see these simulations as reasonably hopeful.   Even under a quite pessimistic scenario on growth and banking costs — there may be views on whether it is pessimistic enough — the gross debt ratio is stabilised at what should be a manageable level for a high-income country.   This also does not take into account our cash reserves and assets in the Naional Pension Reserve Fund, amounting together to 28 percent of GDP.   Provided we have the political capacity to make the needed adjustments, the path through the crisis without default and back to creditworthiness is clear enough. 

Floods, repeated

There has been a trickle of news on flood management (or lack thereof).

The Examiner has an op-ed by Minister Gormley, in which he claims that his only role is to provide money. The Oireachtas report (discussed here) notes institutional failures and a lack of leadership. Hickey reached the same conclusion (see here). Others have noted a lack of progress (here, here, here, here), although there are some positive, private developments (e.g., a flood alert system).

Flood management is one of those areas in which the authorities should take the lead — but different priorities were set.