Friday, April 9, 2010

Ireland's Bad Bank

Ireland has received praise for its draconian austerity program and  the creation of the National Asset Management Agency, a "bad bank" formed to purchase toxic assets from Irish banks.  The EU, the IMF, and Moody's have all praised the formation of this bad bank, but is it a good "bad bank" or a bad " bad bank"?

The Baseline Scenario did a good analysis of the Irish financial crisis:  "Ireland’s difficulties arose because of a massive property boom financed by cheap credit from Irish banks.  Irelands’ three main banks built up 2.5 times the GDP in loans and investments by 2008; these are big banks (relative to the economy) that pushed the frontier in terms of reckless lending.  The banks got the upside and then came the global crash in fall 2008: property prices fell over 50%, construction and development stopped, and people started defaulting on loans.  Today roughly 1/3 of the loans on the balance sheets of banks are non-performing or “under surveillance”; that’s an astonishing 80 percent of GDP, in terms of potentially bad debts."

Much to the original consternation of the EU, Ireland responded by guaranteeing all liabilities of Irish banks, rather than a capped amount like other EU members, and injected capital into the banks purchasing 25% of the Allied Irish Bank and 16% of the Bank of Ireland while nationalizing the Anglo Irish Bank, whose CEO had hidden 122 billion euro in loans and has just been recently arrested for fraud.  In the last two years, approximately 40 billion euro in loans in the eleven Irish banks and building societies have been written down.
Now they are planning to buy toxic assets from the banks and give them government bonds; in essence, the government will be issuing 1/3 of GDP in government debt for these distressed assets.

Rather than forcing the creditors of these banks to share the burden, a strong lobby of real estate developers, bond investors, and politicians linked to the developers and bankers prevailed in pushing a "corporate socialist" solution in which the profits were privatized and the losses shoved on the public by making the taxpayers responsible rather than have the creditors pay for their risk taking.  A bad bank formed for the public good would have restructured those debts and the creditors would have taken the hit.

On March 30th, the National Asset Management Agency said it would be taking on $22 billion in loans at an average 47% discount amounting to a 32 billion euro writedown for the banks: 3.29 billion euro from Allied Irish Bank at a 43% haircut, 1.93 billion euro from the bank of Ireland at a 35% haircut, 10 billion euro from the already nationalized Anglo Irish Bank, and smaller amounts from the Irish Nationwide Building Society and the EBS Building Society.  Eventually, NAMA will buy 81 million euro of loans in four tranches of which this first tranche contains 5.5 billion euro of investment property loans, 1.3 billion euro in land, and 800 million euro in hotels.  It will also require the banks to have 8% in private core equity capital, which has caused considerable confusion as to how much each bank will have to raise.  It also means the government will own 70% of Allied Irish Bank and 40% of the Bank of Ireland, but actual ownership statistics are hard to reconcile with respect to ownership statistics before and after discounts and capital levels.

The future tranches may show significantly higher discounts as more land rather than investment gets moved.

The debt burden of this bailout of creditors will force the debt/GDP burden of Ireland to over 100% by the end of 2011.  All of the harsh austerity deficit cuts are still going to leave a 2010 deficit of 12.5%.  While these discounts constitute a restructuring, the use of government debt to finance the purchases rather than shares in NAMA places the burden on the public which faces continue long-term unemployment.  On the other hand, NAMA and the Irish government recognized the necessity to strip the toxic purchases out in parallel from all of the banks and building societies at the same time rather than in a cascading chaos of individual institutions as is so prominently discussed in the United States.

In April, the Allied Irish Bank sold assets for 4.6 billion euro to raise capital and the Anglo Irish Bank raised 2.25 billion euro in two bonds covered by the government guarantee.

A good "bad bank" places the burden on the creditors where is belongs in a capitalist society.  A bad "bad bank" places the burden of future losses on the shoulders of common taxpayers.

Ireland is an excellent case study, but it is not a good example.  Its parallel action in toxic asset purchases is highly commendable and it appears they have actually got, with EU insistence, some value with the discounts in the first tranche.  The use of full government guarantee of all liabilities and government bonds to purchase the toxic assets shoves the losses off to the public and away from the risk takers who caused the problems.



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