Last week was a defining moment for Brian Cowen and Brian Lenihan, but are the
taoiseach and his finance minister making a virtue out of what was a
necessity? Did they have any real alternative to guaranteeing all cash
inflows for AIB, Bank of Ireland, Irish Life & Permanent, EBS, Anglo
Irish and Irish Nationwide? Were the alternatives too difficult, even
impossible, to contemplate?
In the end, the option of providing guarantees for bank deposits and wholesale
loans was a “no-brainer”. It does not require any upfront cash and
represents an unambiguous policy in the marketplace, one that permits an
infusion of liquidity into the cash-starved bank system. It has avoided the
immediate wipe-out of the bulk of shareholder value at the six Irish banks
covered by the scheme, a fate suffered at Bear Stearns, Lehman Brothers,
Northern Rock and Bradford & Bingley.
The alternative was to nationalise the six banks in sequence as they came
under pressure. This was a hugely expensive option riddled with potential
pitfalls.
Both men were well aware that Ireland had become a nation of credit junkies
from 2004 to 2006, a period when we lifted the annual rate of increase in
bank lending to private borrowers to more than 30%. The Irish private sector
owes €400 billion to the banks, of which €110 billion is accounted for by
builders and developers and another €150 billion by mortgage holders.
As the global credit markets on which banks lend to each other froze in recent
weeks, analysts studied the balance sheets of the big Irish banks to see
which were most reliant on the now much-more-expensive “wholesale money” as
opposed to conventional deposits from savers. All were exposed to some
extent. Last week money was not available except at prohibitive cost. On
Monday, overnight money in London was costing almost 7%.
What forced the hand of Lenihan and Cowen was the realisation that corporate
depositors had got the wind up and were shifting their capital from banks
and building societies perceived to be at risk.
The banks were now bleeding on two fronts. In the wholesale money markets they
were finding it difficult and expensive to refinance interbank credits as
they fell due. Then the big multi-million deposit accounts were in danger of
being closed or run down substantially.
Other government-backed measures such as the €100,000 guarantees on savers’
funds in each bank, the ban on short selling of certain shares, and
emergency loans from the European Central Bank had not solved the problem.
Something else was required.
For Cowen and Lenihan the consequences of the guarantee option were infinitely
preferable to pushing the nuclear button and taking Irish banks into public
ownership. Not just was the initial cash cost zero, but there was the
possibility of substantial revenues from “bank guarantee fees”. A quarter
percentage point annual charge on assets could bring in €1 billion.
Crucially, forcing the banks to pay a fee for their own rescue allows the
state to argue cogently in Brussels that the rescue plan is not state aid.
There has been much media comment about the huge exposure involved in the
bailout but Cowen and Lenihan figured that anyone with an ounce of
intelligence could see that the €400 billion would never equal the net cost
of the rescue, unless the asset base of the six banks — currently in excess
of €500 billion — proves to be entirely worthless.
Either way the new legislation gives Lenihan the option of imposing massive
structural reforms on Irish banks, including allowing the state to take
shares or forcing weaker banks into mergers.
The initial reaction suggests that capital has begun to flow into Irish banks
again — presumably the surplus cash of big corporations — while small savers
have calmed down and are leaving their deposits in place. But the underlying
problem remains: the banks are disproportionately exposed to property loans.
Not just to residential mortgages — where the historic level of default is
low — but to the much riskier area of commercial property and land
acquisition.
Unless the property market can also be kick-started, the Irish banks are going
to be forced to make much more substantial provision for bad and doubtful
debts from the sector.
Bank of Ireland has warned that its bad-debt provisions might have to rise to
0.9% of its total loan book. Davy Stockbrokers suggested in a recent note
that, by 2010, AIB Group could face an aggregate bad-debt provision of 1.2%
a year on its loan book.
Even the €150 billion advanced in mortgage loans to ordinary borrowers may not
be as safe as once was thought from the vantage point of bank boardrooms.
Many within Ireland’s 2.1m strong workforce have never lived through a
recession, let alone a slump being billed as the biggest since the 1930s.
How will they react to negative equity? Will they default in bigger numbers
than their parents, or will they soldier on and meet their monthly
repayments?
Unemployment has already hit 250,000 — close to one eighth of the workforce.
The unemployment rate may officially be 6.1% but most labour-market analysts
expect 300,000 people to be on benefit by early 2009. That’s equal to 14% of
the numbers at work. Their prospects of re-employment will not be great in a
market slowed by tax increases and substantial cuts in public spending.
The six Irish banks covered by Lenihan’s new law are now armed with a state
guarantee that shores up their capital base. Ulster Bank, HBOS and NIB may
get similar cover in respect of their Irish operations.
Until now, banks appeared to take the view that big-league borrowers should be
allowed to “work through” the crisis. To be sure they would be forced to
hawk off surplus assets accumulated over 15 years of boom to meet their
interest bills, but the receivers and liquidators would not be sent in to
close their companies.
Armed with the blank cheque of government guarantees for the next two years,
the banks may decide that a more forceful approach to invoking the security
they hold on loans is sensible. Recognising bad debts on a more substantial
scale may become a viable option once the liquidity side of the balance
sheets has been shored up. As asset disposals and even fire sales of
property and land become more common, this could throw up opportunities as
well as risk. The “saner” elements within the property-development sector
could be allowed to pick up written-down assets at attractive prices while
others might be thrown to the wolves.
One thing is sure, players in the property sector cannot expect the banks to
exhibit the same generosity as the government showed the banks in the early
hours of last Tuesday.
System needs revamping
BANKS are crucial for economic activity, writes Alan Ahearne. They are
instrumental in allocating capital and risks and facilitating payments.
Bank collapses tend to be extremely costly for an economy. As a result,
governments put in place stability arrangements, with regimes for regulation
and supervision. The safety nets provided to banks involve public funds, so
taxpayers face risks in protecting the system. The Irish government’s
unlimited guarantees scheme makes these risks explicit.
The usual rule in times of financial stress is that systemically important
banks are not allowed to collapse. Governments sensibly use public funds to
protect banks that could bring down the entire financial system if they were
to fail. Policymakers may also choose to save smaller solvent banks if they
encounter short-term liquidity problems.
One might argue that the reason Irish banks were facing imminent liquidity
shortages was that wholesale-market participants were frightened by the size
and quality of Irish banks’ property loans. In normal times, these market
signals might be allowed to determine the outcome. But these are not normal
times. Banks across the world have had access to funds on wholesale markets
reduced.
The unlimited guarantee does nothing to inject much needed capital into Irish
banks. But nor does it prevent recapitalisation. The worry is that
under-capitalised banks will use the unlimited guarantees to gamble for
resurrection. In the absence of market discipline, responsibility now rests
with the Financial Regulator to police banks.
The new scheme was a response to an emergency. The heavy lifting of
restructuring the banking system has yet to be done.
Alan Ahearne lectures in economics at NUI Galway
If this gurantee is ever called in it will be very painful for tax payers. You think the American bail-out is a lot? That works out as $2,287 for every man woman and child.
For Ireland this bailout of EUR 400 billion works as 114k for every man woman and child in the country! or 37 years of taxes!
Paul, Dublin, Ireland