The Church of Morganomics: Brought to our knees by bankers and developers

Économiste Monétaire

OPINION: Nama is in effect Fianna Fáil’s shrine to the property bubble for which the party still yearns. Prepare to pay 10 per cent more in income tax for the next 10 years to pay for it all . . . we are headed for national bankruptcy

WRITING HERE two years ago, I pointed out that the exuberant lending of Irish banks to builders and property developers would sink them if the property bubble burst. Since then, the bubble has burst, the banks have sunk, and we are all left wondering how to salvage them.

Two ideas for fixing the banks have been suggested: a bad bank or National Asset Management Agency (Nama) and nationalisation. While these proposals differ in detail, their impact will be identical. Irish taxpayers will be stuck with a large bill, and in return will get an undercapitalised and politically controlled banking system.

A far more efficient and cheaper alternative to Nama is to copy what Barack Obama did with General Motors, and transfer ownership of Irish banks to their bond holders. In this way we can achieve well capitalised banks, run without political interference, at minimal cost to taxpayers.

By converting a portion of Allies Irish Banks’ approximately €40 billion of bonds, and Bank of Ireland’s €50 billion, into shares, each institution can be recapitalised. Transferring ownership to bond holders will not cost the taxpayer a cent and will avoid interminable legal battles over the transfer of assets to Nama.

While the shaky state of Irish banks had been worrying investors since early 2007, when the crisis finally broke in late September the Government was taken completely by surprise and reacted with blind panic. Faced with a run on Anglo Irish Bank by institutional depositors on September 29th, the Government was stampeded into guaranteeing virtually all liabilities, except shares, of the six Irish banks.

This guarantee contained two obvious but fundamental flaws. Everything that has happened since – the proposed recapitalisation of Anglo, the nationalisation of Anglo, the establishment of Nama – can be understood as the Government scrambling to catch up with the consequences of these two errors.

The first mistake was to guarantee not only deposits – which had to be guaranteed – but also most of the existing bonds issued by banks to other financial institutions. Bond holders receive higher returns in the knowledge that they are accepting the risk of losses on their investment. In addition, unlike depositors who can scarper, existing bond holders are effectively stuck.

It made no sense for the Government to insist that taxpayers would take the hit on any bank losses instead of the financial institutions that had already entered legal contracts to do so.

The second mistake was to extend the guarantee to Anglo Irish and Irish Nationwide. As specialised property development lenders with incompetent management, they were at risk of heavy losses as their market collapsed, and fulfilled no role in the wider economy.

In making the guarantee on September 29th, I do not doubt that the Government believed that the difficulties of Irish banks ran no deeper than temporary liquidity problems stemming from the international crisis. However, as it has become apparent that Anglo was a mismanaged wreck, with AIB and Bank of Ireland scarcely better, the Government has stuck with the mantra that all banks are equally important and equally worth saving at any cost to the taxpayer.

Brian Lenihan and Brian Cowen are happier to dice with national bankruptcy than lose face by admitting that they were misled about the state of Irish banks last September.

Nama, then, is the latest twist in the Government’s increasingly bizarre efforts to save the Irish banking system while claiming that it does not really need to be saved.

Underlying Nama is the delusion that the collapse of our property bubble is a temporary downturn. In a few years time when the global economy recovers we will be back building houses like it was 2006. All the ghost estates, empty office blocks, guest-less hotels and weed choked fields that Nama has bought on our behalf will once again be worth a fortune.
The reality is that, because of our surfeit of empty housing, there will be almost no construction activity for the next decade. Empty apartment blocks in Dublin will eventually be rented, albeit at rates so low that many will decay into slums. However, most of the unfinished estates that litter rural Ireland – where the only economic activity was building houses – will never be occupied.

Nama is a variant on the “Cash for Trash” scheme briefly floated in the United States last year where the government would recapitalise banks by overpaying for their bad loans. Our Government is proposing to buy €90 billion of loans and will reportedly pay €75 billion for them.

The International Monetary Fund (IMF) guesses that Nama will cost us €35 billion, and this is probably optimistic. The narrowness of the Irish property market meant that banks effectively operated a pyramid scheme, bidding up prices against each other. Now that banks cannot lend, development assets are effectively worthless.

The taxpayer is likely to lose well over €25 billion on Anglo alone. Among its “assets” are €4 billion lent for Irish hotels, and almost €20 billion for empty fields and building sites. In fact, I suspect that the €20 billion already repaid to the casino that was Anglo represents winners cashing in their chips, while the outstanding €70 billion of loans will turn out to be worthless. And it is well to remember, as the architects of Nama have not, that although the problems of Irish banks begin with developers, they do not end there.

The same recklessness that impelled banks to lend hundreds of millions to builders to whom most of us would hesitate to lend a bucket; also led them to fling tens of billions in mortgages, car loans, and credit cards at people with little ability to repay. Even without the bad debts of developers, the losses on these household loans over the next few years will probably be sufficient to drain most of the capital out of AIB and Bank of Ireland.

Brian Lenihan’s largesse to bond holders could cost you and me €50 to €70 billion. What do numbers like these mean?

The easiest way to put numbers of this magnitude into perspective is to remember that in 2008 the Government generated €13 billion in income tax. Every time you hear €10 billion, then, think of paying 10 per cent more income tax annually for the next decade.

In other words, the fiscal capacity of a state with only two million taxpayers, and falling fast, is frighteningly thin. Ten billion here, and ten billion there and, before you know it, you are talking national bankrutcy. Even without bankrupty, Nama will ensure a crushing tax burden for everyone in Ireland for decades.

The tragedy is that, were it not for the Government’s botched efforts to save financiers from the predictable consequences of their own greed, the Irish economy would have recovered far more quickly than most people, including the IMF, expect.

Recovery for the Irish economy will not be easy – there is no painless way for an economy to move from getting about 20 per cent of its national income from construction to getting about zero – but the flexibility of the Irish labour market would have ensured that our incomes and share of global trade would have rapidly recovered. Now, however, any fruits of recovery will be squandered on Nama.

Aside from the fact that Nama will spend huge sums to achieve little, its governance is problematic. Here, the fog of secrecy that has quietly settled over Anglo Irish since nationalisation sets an unsettling precedent.
After revelations of financial irregularities forced the resignation of three executive directors, Anglo moved decisively to replace them with . . . Anglo insiders. Most astonishing, in the light of the scandal over Irish Nationwide deposits, was the decision to replace Anglo’s disgraced financial director with his immediate subordinate, Anglo’s chief financial officer.
It is hard not to conclude that a deliberate decision has been made at the highest level of Government that what happened in Anglo, stays in Anglo. And we can expect Nama to be run in the same tight manner.

While there has been considerable speculation about dark motives for bailing out developers and banks, I do not believe that the Government’s behaviour has been corrupt: it has been far worse. At least corruption implies a sense that you are doing wrong, and need to be paid in return. Our Government actually thought it was doing the right thing in risking everything to safeguard the interests of developers who had given us an economy that was the envy of Europe.

Instead of recognising bankers and developers as parasites on our national prosperity, the Government came to see them as its source. While everyone else in Ireland has come to see the past decade as an embarrassing episode of collective insanity to be put behind us as soon as possible, the Government still sees it as the high point of our nation’s history. Nama is effectively Fianna Fáil’s shrine to the bubble, and likely to be an expensive and enduring one.

What should be done instead of Nama? First, we need to understand how the idea of Nama follows from a mistaken analogy with the Swedish banking crisis and bad bank of the early 1990s. The Swedish banks differed in one fundamental way from ours: they only had deposits as liabilities. If their government had not taken over their bad debts, ordinary depositors would have suffered. By contrast, Irish banks had borrowed heavily from other financial institutions through bonds, and these bondholders originally agreed to take losses if Irish banks got into difficulties.

By placing the costs of the banking collapse primarily on existing holders of bank bonds, the State can improve its credit rating and pull back from the edge of bankruptcy. Knowing that taxpayers are not liable for the losses of AIB and Bank of Ireland will make capital markets more willing to lend to the Irish State.

Instead, like a corpulent Tooth Fairy gently slipping billions under the pillows of sleeping bond holders, Brian Lenihan has chosen to extend the liability guarantee and further weaken the bargaining position of the State.
The drift into national bankruptcy looks increasingly unstoppable.

Morgan Kelly is professor of economics at University College Dublin

Interesting. Link.

MrMatisse

Its a pretty scary analysis. I cant really see how were going to recover from this unless irish people start setting up export orientated companys at a firghtening rate, not easy in the present situation.

Its looking more and more likely that we are gonna need to get bailed out by the IMF or maybe the ECB at some stage.

stevedublin

Really-Stressed wrote: »

Its looking more and more likely that we are gonna need to get bailed out by the IMF or maybe the ECB at some stage.

I could be wrong but I think getting bailed out by the ECB would be preferable, assuming we get to choose.

MrMatisse

DEFINITLY!

The south koreans still hate the IMF over ten years after they were bailed out for the policies they were forced to implement. Really tough measures. If the ECB save us im sure they wouldnt be so tough although wed wanna make sure were the first to go under, they might not be so helpful f they have already had to save Greece or Spain.

Économiste Monétaire

Eh, why are there people saying that the ECB can directly 'bailout' a country? Maastricht...

Article 101: 1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

Time Magazine

Really-Stressed wrote: »

The south koreans still hate the IMF over ten years after they were bailed out for the policies they were forced to implement. Really tough measures.

And seeing it was so long ago, it's no surprise the IMF have changed their "tone".

If the ECB save us im sure they wouldnt be so tough although wed wanna make sure were the first to go under, they might not be so helpful f they have already had to save Greece or Spain.

Heh, I can see the headline: "Ireland congratulates itself on winning race to default." For some reason it reminds me of The Onion's description of Germany, i.e. two-time world-war runner-up.

Besides, ECB can't save us.

MrMatisse

The ECB is already bailing us out:

Irish bank(Insolvent) buys Irish governement bond

Irish bank swaps Irish governement bonds for cash with the ECB

ECB ends up with loads of Irish government bonds that it doesnt really want but joins in on this merry go round to save our skin.

silverharp

MK- "By placing the costs of the banking collapse primarily on existing holders of bank bonds, the State can improve its credit rating and pull back from the edge of bankruptcy. Knowing that taxpayers are not liable for the losses of AIB and Bank of Ireland will make capital markets more willing to lend to the Irish State."


spot on here , the bond holders should Q up at the court with the other creditors. The bond holders are big boys and would absorb the losses, this way the money taps will be turned off or we'll be borrowing at double digit rates and a standard rate of tax at 50%.

eamonnm79

Spot on Silverharp In a free market economy we were supposed to have had the Bond holders and share holders should have taken the hit.
It is only in crisees that we can see the true colours of the powers that be.
Socialisation of private debt and Privitisation of future public tax receipts benifits who most?

I hope this shows people of free market persuasion as well as left wingers that Freemarket capitalism is just an idea.
That western economies do not persue those policies, never have done.
The only freemarket capitalism that exists is within very small business.
What America and Most of europe have is State Capitalism.

People who give out about the public sector are usually blind to another very well protected, subsidised part of the economy, Large corporations.
What we have is a corporate takeover, where the intrests of Large companies are far more important than views of the citizens.

Économiste Monétaire

Really-Stressed wrote: »

The ECB is already bailing us out:

Irish bank(Insolvent) buys Irish governement bond

Irish bank swaps Irish governement bonds for cash with the ECB

ECB ends up with loads of Irish government bonds that it doesnt really want but joins in on this merry go round to save our skin.

You've just described refinancing operations. These existed well before the current crisis. If they don't want Aa rated debt, why are they accepting BBB- on LTROs?

MrMatisse

Its the state borrowing heavily from the ECB by getting the Irish banks to buy their bonds which is why they wont nationalise them. They have to do it through the back door like this as its not allowed by Maastricht.

Aa rated debt? Firstly i dont think the rating agencies have exactly covered themselves in glory and would we still be Aa rated if the above operation wasnt going on?. The biggest buyers of Irish debt are the Irish banks, what would the yield be if they were not buying it.

Im gonna be slaughtered for the next point, but would we still have a banking system ( Its wrecked i know but at least theres a eh, plan to fix it) if it had been left to International bond holders? . I dont thing so. They'd have simply let the banks hit the walll and have no long term interest in making decisions in the best interest of the country.

Accepting BBb- in LTROS, this just shows they are willing to accept all kinds of crap in order to get liquidity flowing.

MrMatisse

Économiste Monétaire wrote: »

You've just described refinancing operations. These existed well before the current crisis. If they don't want Aa rated debt, why are they accepting BBB- on LTROs?

Could be viewed by some to be a very patronising comment.

Économiste Monétaire

Really-Stressed wrote: »

Its the state borrowing heavily from the ECB by getting the Irish banks to buy their bonds which is why they wont nationalise them. They have to do it through the back door like this as its not allowed by Maastricht.

Aa rated debt? Firstly i dont think the rating agencies have exactly covered themselves in glory and would we still be Aa rated if the above operation wasnt going on?. The biggest buyers of Irish debt are the Irish banks, what would the yield be if they were not buying it.

Im gonna be slaughtered for the next point, but would we still have a banking system ( Its wrecked i know but at least theres a eh, plan to fix it) if it had been left to International bond holders? . I dont thing so. They'd have simply let the banks hit the walll and have no long term interest in making decisions in the best interest of the country.

Accepting BBb- in LTROS, this just shows they are willing to accept all kinds of crap in order to get liquidity flowing.

What proportion of total Irish sovereign debt is held by Irish MFIs and the CBFSAI?

If the senior and dated subordinated debt of the banks wasn't guaranteed by the state, would anyone allow the banks to roll-over on the debt? I very much doubt that.

My comment wasn't on the validity of sovereign credit ratings. There's a list of eligible collateral for refinancing operations, beyond a simple 'investment grade/non-investment grade', so the ECB can exclude specific marketable securities as it sees fit. If they didn't 'want it' it would be removed from the list.

MrMatisse

The proportion of the total ? The main buyers recently have been irish banks. They have kept the yield on recent issues low thus not scaring any other bondholders into dumping it.

jimmycrackcorm

If bond holders had shares instead, what would stop them calling in ordinary loans and performing mortgages to recover their cash?

Économiste Monétaire

Really-Stressed wrote: »

The proportion of the total ? The main buyers recently have been irish banks. They have kept the yield on recent issues low thus not scaring any other bondholders into dumping it.

Retail clearing banks account for about €3.3 billion in holdings of Irish government debt securities at the end of May 2009. That was at €1bn at the end of December '08. Considering we issued about €13bn in treasury bonds alone during the first 5 months of the year...

MrMatisse

That doesnt include the investment/pension funds they control.

Économiste Monétaire

Can you show me the collateral used in CBFSAI repos for the last 5 months? Can you show me figures for Irish banks purchases of Irish sovereign debt since the start of the year? I'm talking about entities that engage in refinancing operations.

MrMatisse

Those figures are not publicly available. I just post on what im hearing. There is no breakdown of each buyer of each issue available. Your basing your view on numbers publicly available, im basing my view on what i hear as to who's doing what from my work in this industry.

MrMatisse

Économiste Monétaire wrote: »

Retail clearing banks account for about €3.3 billion in holdings of Irish government debt securities at the end of May 2009. That was at €1bn at the end of December '08. Considering we issued about €13bn in treasury bonds alone during the first 5 months of the year...

The banks are swapping them with the ECB for cash thus they are no longer on their balance sheet. Your figures assume that they have only purchased 2.3 billion. What about the amounts purchased in the first 5 months that would have left the banks balance sheets as it would have been swapped with the ECB for cash.

There was an editorial in the Irish Times about this merry go round. Ill see if i can dig it out. It outlines the level of purchases.

Économiste Monétaire

I have no doubt they're buying the debt. I'm bemused when people say that €6bn + is being used as collateral for €118bn in repos, like you originally outlined. I've heard the stories, it's become ubiquitous at this stage. I'm sure we can agree that dog shit was exchanged for the year long repo.

Économiste Monétaire

Really-Stressed wrote: »

The banks are swapping them with the ECB for cash thus they are no longer on their balance sheet. Your figures assume that they have only purchased 2.3 billion. What about the amounts that would have left the banks balance sheets as it would have been swapped with the ECB for cash.

I missed this when writing above. The ECB itself doesn't operate MROs or LTROs. That's why resident holdings of government debt is lumped in between MFIs and the central bank.

MrMatisse

100% agrement that they are taking dog **** for the year long repo.

Dug this out on the level of Irish banks involvment with Irish bonds so my posts sound a little less waffley

http://archives.tcm.ie/businesspost/2009/05/17/story41750.asp

Wouldnt surprise me if it was higher then a third. That figure is based on initial subscriptions id be surprised of they were not picking up more debt below par in the secondary market after its issued and then swapping that with the ECB too.

eamonnm79

Économiste Monétaire wrote: »

Eh, why are there people saying that the ECB can directly 'bailout' a country? Maastricht...

Article 101: 1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

The most important word in that article is 'directly'. Its a get out of jail card. It never happens directly. EM you know that the Irish banks have bought 6 billion of the debt between october and march alone (this doesnt include the . I will check to see if the CSO has updated the figures i already provided you when you asked about this before. Really stressed is completely right on this one and you know it.
The ECB last week again released 100s of billions into the european banks in an effort to get credit moving again according to bloomberg. Trichet denied that it would cause inflation. Barely a whimper of this story elsewhere?

Économiste Monétaire

eamonnm79 wrote: »

The most important word in that article is 'directly'. Its a get out of jail card. It never happens directly. EM you know that the Irish banks have bought 6 billion of the debt between october and march alone (this doesnt include the . I will check to see if the CSO has updated the figures i already provided you when you asked about this before. Really stressed is completely right on this one and you know it.
The ECB last week again released 100s of billions into the european banks in an effort to get credit moving again according to bloomberg. Trichet denied that it would cause inflation. Barely a whimper of this story elsewhere?

Yes, it's called a direct outright purchase. They purchase the debt from the government because we can no longer issue the debt to willing private buyers. That's a bailout, not banks using government debt in refinancing operations. I agree that Irish banks are purchasing the debt, I don't believe they're purchasing it on the scale that everyone else is claiming, i.e. they're pretty much the only purchaser of Irish debt and they're offloading it to the CBFSAI. It leads to a position where interested parties can claim that we don't need fiscal consolidation; 'sure, the Irish banks (ECB/CBFSAI) will keep lending to us'.

Repos still show up in the C3/4/5 tables. From the CBFSAI:

Under a Sale and Repurchase Agreement the Bank [CBFSAI] sells securities from its portfolio for cash and simultaneously agrees to repurchase them at an agreed price on a set date. These agreements to repurchase are reflected on the liability side of the Bank’s balance sheet and also lead to an interest expense in the Profit and Loss account (Note 2). At all times the Bank remains the beneficial owner of the securities which remain on its balance sheet.

Under a Reverse Repurchase Agreement the Bank buys securities for cash and simultaneously agrees to sell them back to the counterparty at an agreed price on a set date. These agreements to sell are recorded on the asset side of the balance sheet, but are not included in the Bank’s holdings of securities. At no time during the term of the agreement does the Bank acquire beneficial ownership of the underlying securities. These agreements give rise to interest income in the Profit and Loss account. Repurchase agreements may be transacted in both euro and other currencies.

Also, how do I know if he's "completely correct," did you miss the part where this is based anecdotal stories and an SBP piece? How I can discern from that whether he's correct on information that's not publicly released I'm not sure, I don't see how you can either.

It doesn't take a genius to figure out that €118bn in repos can't match the Irish resident held proportion of Irish GGD. You should be more worried about the increase in securitisation of mortgages over the last year; this is eligible collateral. ABS accounted for over half of the collateral listed in 2007, before MBS/MBPN were taken. That's the garbage being exchanged, as well as the bonds of other financial institutions. About 90% of the collateral used originated outside of Ireland (from the annual report in 2007). The taxpayer will be the one footing the bill for any losses to any NCB of the ESCB.

When you say the holdings of credit institutions went from €500m to €5.5bn between October and March, you're including all of these:

Credit Institutions: Retail Clearing
AIB Mortgage Bank
Allied Irish Banks plc
Bank of Ireland Mortgage Bank
The Governor and Company of the Bank of Ireland
Danske Bank A/S
Ulster Bank Ireland Limited

Credit Institutions: Non-Clearing with Predominantly Domestic Business
ABN AMRO Bank N.V.
ACC Bank plc
Anglo Irish Bank Corporation plc
Bank of America National Association
Bank of Scotland (Ireland) Limited
BNP Paribas SA
Citibank International plc
CitiFinancial Europe plc
DePfa Bank plc
EBS Building Society
EBS Mortgage Finance
FCE Bank plc
First Active plc
HFC Bank Limited
ICS Building Society
Investec Bank plc
Irish Life & Permanent plc
Irish Nationwide Building Society
KBC Bank Ireland plc
KBC Mortgage Bank
Marks & Spencer Financial Services plc
MBNA Europe Bank Limited
Northern Rock plc
Postbank Ireland Limited

Credit Institutions: Non-Clearing with Predominantly Foreign Business
Aareal Bank AG
Bankinter S.A.
Bank of Montreal Ireland plc
Barclays Bank Ireland plc
Barclays Bank plc
Bear Stearns Bank plc
BNP Paribas Securities Services SA
CACEIS Bank Luxembourg
Caja de Ahorros Y Monte de Piedad de Madrid
Capmark Bank Europe plc
Citco Bank Nederland N.V.
Citibank Europe plc
Commerzbank Europe (Ireland)
DePfa ACS Bank
DePfa-Bank Europe plc
Dexia Banque Belgique
Dexia Crédit Local
DZ-Bank Ireland plc
Dexia Municipal Agency
Elavon Financial Service Limited
Fortis Prime Fund Solutions Bank (Ireland) Limited
Goldman Sachs Bank (Europe) plc
Goldman Sachs Private Bank Limited
Helaba Dublin Landesbank Hessen-Thuringen International
Hewlett-Packard International Bank plc
HSBC Bank plc
HSBC Private Bank (UK) Limited
Hypo Public Finance Bank
ING Bank N.V.
ING Belgium SA
J.P. Morgan Bank (Ireland) plc
KBC Bank N.V. Dublin Branch
Landesbank Hessen-Thuringen Girozentrale
Leeds Building Society
LBBW Bank Ireland plc
LGT Bank (Ireland) Limited
Merrill Lynch International Bank Limited
Naspa Dublin
Pfizer International Bank Europe
PNC International Bank Limited
Rabobank Ireland plc
Rabobank Nederland
RBC Dexia Investor Services Bank SA
Sachsen LB Europe plc
Intesa Sanpaolo Bank Ireland plc
Scotiabank (Ireland) Limited
Société Generale SA
UBS (Luxembourg) SA
UniCredit Bank Ireland plc
Volkswagen Bank GmbH
Wachovia Bank International
WestLB Covered Bond Bank plc
WestLB Ireland plc
WGZ-Bank Ireland plc
Zurich Bank

Not all of these can operate in repos. You never gave me CSO figures, you gave me table C3 in CBFSAI monthly stats. So, how do I know that Irish banks bought €6bn worth of Irish government debt based on that list above?

On the point of the €442bn 1 year repo, it was widely covered in the financial news.