There Should Be No Sacred Cows
Oct 14th, 2008 by Donagh
The entire Eurozone seems to be following Gordon Brown’s lead and working to recapitalize the banks by having the government take an equity stake in firms that need assistance. This is how Sweden successfully resolved its banking crisis in the 1990s and it appears to be the right thing to do.
So said Matthew Yglesias yesterday.
The result:
Stock markets in Asia and Europe surged on Tuesday after a historic rally on Wall Street saw US markets record their biggest rebound since the 1929 Great Crash after investors welcomed a pledge by European governments to invest €1,873bn ($2,546bn) to shore up their financial sector.
But Yglesias is wrong. One member, Ireland, hasn’t followed Gordon Brown’s lead. If anything Brian Lenihan has insisted that he doesn’t want tax payer’s money being used to shore up the banks.
The result:
The Iseq index climbed just 2.5 per cent, as shares in the State’s two biggest banks fell sharply amid fears that the Government would have to intervene by buying equity stakes in the banks to further bolster the Irish financial system.
AIB fell 18.8 per cent, while Bank of Ireland shed 14 per cent.
But Ireland is different, we’re unique. We’re always different and unique. Of course, we still don’t know if it is a problem of liquidity or capitalization – mainly because the government is hiding the answer to that question until after the budget. Michael Casey, writing in the Irish Times today, thinks its liquidity, although he’s still confused.
In that eventuality it will probably be accepted that the main problem affecting Irish banks was the lack of liquidity and the seizing-up of the global inter-bank market - problems which the present State guarantee are designed to address. In this context though, it is not entirely clear why the Irish banks cannot access enough liquidity from the European Central Bank by pledging their mortgages as security.
Mortgages as security??? Does he not read the newspapers?
Ireland’s banks have extended loans of at least €106bn to builders and developers, accounting for over half of all loans to businesses. At present, associated bad debts are thought to be in the order of €500m.
Listening to Morning Ireland this morning it seems that the value of all Irish banking shares is no more than €8bn at the moment. That sounds like a capitalization problem to me.
But Michael Casey says that people who claim that the bad debt and lack of capitalization don’t know the facts:
Commentators who say that loan write-offs and capital shortage are in fact the main problems facing some Irish banks are essentially saying that they do not believe the financial authorities. These commentators do not of course have the detailed information of the authorities and simply point to anecdotal evidence about distressed property speculators and half-finished building sites. They also seem to assume that the speculators who are selling Irish shares are behaving rationally; this is not necessarily the case at all.
No one does, apart from the regulator. This is the regulator who, according to Morgan Kelly’s anecdote “announced that the view of the Bank was that, as long as international markets were happy to buy debt issued by Irish banks, there could be no problem with their lending policies.” Further on down in his piece, Casey talks about the current regulator regime and that this - and only this - is where the changes need to come:
Close relationships between regulators and banks - difficult to avoid in a small country - will have to be ended. It is not being suggested here that the Irish system suffers from “regulatory capture”, but the long-standing practice of former governors and senior regulators joining the boards of banks on their retirement should be stopped.
At the very least Michael. Of course, it could also be suggested that the selling of shares in Irish banks is occuring for the same reason Irish banks can’t get money off the ECB: because they’re assets are known to be worth substantially less than they claim. There is also the problem of the rapidly changing international situation. With the injection of capital that the major countries in the EU are providing for their banks, it’s pretty clear that until the Cowen follows the Swedish Model that they are going to fall further. In fact, at this point they’ll inevitably require recapitalization – probably before the end of the week.
But the big question is, why did the government go for a large guarantee rather than the route chosen by Brown? Certainly it was political, as Cowen didn’t want to be seen handing over billions of tax payer’s money to the banks at the same time as implementing cuts in public service and increasing taxes.
Perhaps though it was also to avoid their own culpability in this crisis, as an admission of bad debts would illustrate their part in inflating the property market, providing benefits to developers, and in an era of cheap credit (Casey notes ‘for almost 15 years the growth in bank credit outstripped the nominal growth in GNP by a factor of about two or three.’) a windfall for the banks.
Brendan Keenan quotes Brian Cowen’s budgets speech in December 2005:
‘WE should not do anything that disrupts unnecessarily an industry (construction) that is such an important driver of jobs. For this reason, for projects that are already in the pipeline, I am extending the date for which 100 per cent relief for expenditure will apply by five months from end July 2006 to December 31, 2006.
“Thereafter, where 15 per cent of the relevant expenditure on the project has been incurred by that date, the relief will apply to only 75 per cent of the expenditure incurred in 2007 and to 50 per cent for expenditure incurred up to end-July 2008.”
And Charlie McCreevy in his budgets speech in the 2004:
“I am aware that there is a range of construction projects either in the pipeline or under way which will be seriously affected by this termination date of end-2004.
“As the deadline approaches, pressure on construction resources will mount to deliver these projects. Accordingly, I propose to extend the termination date for all of these area-based schemes until July 31, 2006.”
As Keenan points out:
In that period, 320,000 housing units were built. In the first two years of the tax relief extensions, house prices went up by more than 20 per cent.
The question remains, how will the Government proceed with the crisis in Irish banking? With the guarantee there is less room for negotiating with the banks – they have their deal, it’s now the law.
What they should do of course (and should have done all along) is what Sweden had to do in the 90s:
Sweden told its banks to write down their losses promptly before coming to the state for recapitalization. Facing its own problem later in the decade, Japan made the mistake of dragging this process out, delaying a solution for years.
Then came the imperative to bleed shareholders first. Mr. Lundgren recalls a conversation with Peter Wallenberg, at the time chairman of SEB, Sweden’s largest bank. Mr. Wallenberg, the scion of the country’s most famous family and steward of large chunks of its economy, heard that there would be no sacred cows.
The Wallenbergs turned around and arranged a recapitalization on their own, obviating the need for a bailout. SEB turned a profit the following year, 1993.
“For every krona we put into the bank, we wanted the same influence,” Mr. Lundgren said. “That ensured that we did not have to go into certain banks at all.”
By the end of the crisis, the Swedish government had seized a vast portion of the banking sector, and the agency had mostly fulfilled its hard-nosed mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again.
More money may yet come into official coffers. The government still owns 19.9 percent of Nordea, a Stockholm bank that was fully nationalized and is now a highly regarded giant in Scandinavia and the Baltic Sea region.
The government should take a large share in Irish banks and control the way debts are repaid, as well as ensuring that homeowners who were aggressively sold houses that were over-priced by inflationary pressure that the government is in part responsible for, don’t lose their homes, especially after the fiscal stress that a downturn will inevitably provide.
Incidentally, I contacted a well known Irish economist and commentator to get his views for the Irish Left Review. He politely declined to comment, unfortunately, saying that he found the banking crisis ‘really depressing’ and preferred to concentrate on academic work.
Says it all really.
I have to say that I am bemused that you continue to write with such certitude on a subject with which, as far as I can tell, you are acquainted only through reading the newspapers. “Does he not read the newspapers ?” you ask of Michael Casey, who is so “confused” (your word) that he wishes to consider carefully the import of information coming to us through the mass media. I would suggest that Dr Casey (ex-Central Bank and IMF) is in a position to have clearer and more accurate view of the reality of affairs. Nobody should believe what they read in the newspapers, or hear/see in the broadcast media just because most sources are in agreement. Of course, as Casey himself agrees, if the worst rumours/fears are correct - and they might yet prove to be - the authorities will have betrayed our trust very badly, but let’s not get ahead of ourselves.
Donagh, I read Casey’s article this morning too, but my take on it was a bit different!
Simply put, Casey puts forward two hypotheses – one that says that the current financial crisis is caused by factors extraneous to the Irish banking system (i.e. a severe lack of liquidity in the international money markets) and the other that says that the crisis was caused by factors relevant only to the Irish banking system (i.e. a deterioration in loan quality, partially attributable to weak regulation, that was so severe that the banks now need to be re-capitalised). He then fleshes these ideas out (mostly in the form of questions or logical deductions), but notably and disappointingly stops short of ever giving his own opinion. Consequently, I am not clear how you can attribute any of the points above to him, when he studiously makes sure to avoid saying what he thinks!!
Anyway, clearly both factors are relevant to what has happened. Ireland no longer has its own currency nor sets its own interest rates. These two conditions alone automatically make any Eurozone problem an Irish problem. In any event, the open and small nature of the Irish economy leaves it highly vulnerable to volatility on international markets. Consequently, the Irish banks would have shipped some heavy hits even if they were in tip-top shape (which, like you, I would truly doubt they are in).
Equally, though, there can be no doubt that the markets knew precisely where to look in terms of identifying the banks that were most vulnerable – Northern Rock, Bradford & Bingley, Hypo Real Estate, Fortis, and Dexia were all systematically targeted as European banks with weak balance sheets. Each was picked off as surely as lions would do to the slowest and oldest of a herd of buffalo. Anglo Irish Bank looked like it was just about to be caught too, when the government intervened on that fateful Tuesday morning.
The fact that Anglo was in such dubious company would seem to demonstrate pretty clearly that sophisticated investors were clearly not buying its story in a stressed market environment. Add to that, Casey’s remark about the ECB not accepting Irish mortgages as security for loans and the implications are quite concerning.
At the same time, last week did turn into something of a panicked stampede, with even US Treasuries (typically cited as a risk-free investment) being dumped as a good number of investors sought to completely liquidise their positions. As a result, all and sundry were being pulled into the mire. So Casey is right to add this note of caution when interpreting the stock market’s recent behaviour.
+++++++++++++++++++++++++
I have seen this story regarding the Swedish bailout several times over recently. However, all of them leave out the most important fact of them all. This was that thanks to the astute investment in R&D by private companies such as Ericsson in the 80s & 90s, the Swedish economy successfully rode the wave of the IT and mobile communications industry boom that followed. It was this boom that dragged Sweden out of the economic hell-hole that it was in and not State-ownership of the banks. Indeed, it is probably more accurate to think of the latter as ships that benefited from a rising economic tide.
Moreover, if you trace a more detailed history of this so-called Swedish model, you will quickly discover that it was far from some quick-footed and far-seeing move on the part of the politicians, but really one of backs-to-the-wall desperation when all else had failed. Certain banks had already collapsed, interest rates were sky-rocketing, the currency was on the floor, property prices had plummeted, unemployment was surging, and the economy had contracted for THREE STRAIGHT YEARS before they acted. If it had not been for the global IT boom, Sweden would probably still be a total economic backwater dependent on highly cyclical heavy industries such as paper & pulp and an increasingly commodity-like automotive industry.
In all, the State intervention was clearly important, even if it was the playing of a forced hand. However, the real rescue came from there being a powerful way to grow the economy again. Otherwise, Sweden in the early 90s might well have been something of an economic forerunner for what later took place in Japan.
+++++++++++++++++++++++++
As a final thought, with what public money does the Irish government recapitalise the Irish banking system? We are seriously strapped as it is!!
Accordingly, if and when new equity does go into the banks, do not be surprised if King Juan Carlos or the message “Liberté, Egalité, Fraternité” is on one side of the euros that get invested, as the least affected European banks go bargain-hunting.
What a stunningly naive view of the situation you hold there, Fergus. Really. I mean, all the statistical data points to a property bubble that hasn’t even really begun to burst yet, and to employment figures over the past five years bloated with construction workers and shop assistants. house prices are still eight to ten times the average industrial wage, the international credit well has completely dried up - the main factor in seeing mortgages spiral out of control, i.e. mortgage levels not based in income, but on the availability of cheap credit on the international market - and you’re trying to argue that it’s a liquidity problem here in Ireland? That somehow the prices in Ireland, the mortgages in Ireland, bore a relation to the economic facts? That the size of the debts property developers got themselves into were in any way linked to the holdings of Irish banks? Stunningly naive.
“Of course, as Casey himself agrees, if the worst rumours/fears are correct - and they might yet prove to be - the authorities will have betrayed our trust very badly, but let’s not get ahead of ourselves.”
So, Fergus, you’re going to completely ignore the statistical and economic evidence and sit this one out and then, when it’s over, say, “ahh, now who would have thought it?” Completely moon. Ralph Wiggum would be proud.
Oh, and when are people going to realize that open economies are the fucking norm these days? There is nothing special or unique about Ireland having an open economy. Listening to some commentators, you’d almost believe that there’s open economy Ireland, and then there’s North Korea, out there in the world. Open economies are the norm.
The idea of the Swedish model is that you flush out bad debts, and recapitalize. And you adapt that to your own situation. The idea that by calling for bad debts to be flushed out, and banks recapitalized, that you are calling for Ireland to jump into a time machine, go back to 1992, and follow to the letter exactly everything Sweden did is moronic. You adapt the policy.
I presume that your last comment is meant for me, Connor. I agree and have been saying much the same thing on my own site. That still does not diminish the points that (i) we need to establish where the potential billions needed to recapitalise Irish banks will come from (abolish free medical cards for a starter, perhaps, before moving on to scrapping the winter fuel allowance?) and (ii) the impressive Swedish recovery was not a simple direct function of a crippled system being nationalised and magically restored to full health through the fabled powers of socialisation. The nasty private sector and bloody good timing in terms of where mobile telephony was on the development curve were crucial drivers of the recovery.
By the way, Ireland exported the equivalent of 60% of its GDP (on a PPP basis) in 2007. In comparison, France exported 26% and the UK 20%. As Orwell might have put it, all economies are open, but some are more open than others.
Where have I said socialisation of the banking system? where have I given the impression that magic is involved? The fundamentals of the Swedish model - or the British model or the America Model if you wish as both Britain and America have taken on board the lessons of Sweden - are based on the principle that when your banking system is ready to collapse you flush out the bad debts and recapitalize. There is no way of avoiding that. This is not a simple liquidity issue. It is BOTH a liquidity and solvency issue. Now, Ireland hasn’t accepted that the problems facing its banking system are due to anything but the international credit crisis when all the statistical evidence screams otherwise. and whether it would be possible now to turn face given the botch job it did on guaranteeing absolutely everything is up for grabs. As far as getting the capital to do such a thing, the EU has made it clear that capital would be available to member countries, so there is at last some flexibility there. Now, it’s going to take some pain, but the fact remains that the Irish banking system is fundamentally undermined at the moment, and until solvency is addressed, it’s doesn’t matter what is thrown at it with state guarantees, the core issue is not being addressed.
And 90% of Ireland’s exports derive from foreign-owned companies. So is Ireland an open economy or a dependent subsidiary of an open economy? There’s a laziness out there that simply saying “open economy” somehow explains the Irish economy, when there’s a hell of a lot more going on. In that respect, saying “open economy” and leaving it at that is about as much use as a tit on a bull.
You do realise that we are making the same fundamental points?
Me: […] clearly both factors [solvency & liquidity] are relevant to what has happened.
You: This is not a simple liquidity issue. It is BOTH a liquidity and solvency issue.
*********
You: The idea of the Swedish model is that you flush out bad debts, and recapitalize. And you adapt that to your own situation.
Me: I agree and have been saying much the same thing on my own site.
My concerns with (part-)nationalising the Irish banks are raised above - (1) it cannot be seen as a panacea just because Sweden came out if it well and (2) HOW CAN WE POSSIBLY RECAPITALISE THE BANKS when, for example, we are being told that it is necessary to abolish the automatic right to a medical card for our oldest citizens (who never once heard the Celtic Tiger roar) just to plug an existing damn hole in the public finances? I just want people to please start focusing on the potentially HUGE UPFRONT CASH COST of taking shares in Irish banks!
You ask a good and provocative question at the end, by the way. I am only surprised that you said “subsidiary” rather than “vassel”.
Sorry Longman. I’m a bit snappy today - a bit more than usual, even for me. Apologies.
So long as you are not responsible for the automatic right to a medical card being abolished, then I see no need for any apology whatsoever! Thanks though!
Donagh, I don’t think it’s necessarily a case of choosing not to follow the Brown model, rather of not being able to. The guarantee looks like a bit of a hail mary play, fingers crossed and hoping to god it works. But with Irish bank share prices continuing to fall against the general rally in other financial stocks, clearly investors BELIEVE that it’s a bad debt / capitalisation issue - whether or not that is actually the case.
I think the government is hoping that (a) they won’t have to step in and recapitalise themselves - because the cash isn’t there and (b) are banking on a fall back that if prices continue to tumble, some nice private sector sugar daddy will step in and buy up BOI and AIB for next to nothing, saving them the hassle of having to do it themselves. Risky business.
Comments to a blog are a very unsatisfactory way to have a debate, and I am not going to attempt it. (Usenet is the best Internet medium for debate, but people seem determined to let it wither).
Suffice it for now to say that just because I resist the apocalyptic conclusions drawn by Donagh does not make me into an apologist for bad lending, bad government or bad regulation.
Damian, I think you’re right. But there is a problem with that. What is the value of an insurance policy if the Finance minister announces that he has such faith in the adequate capitalization of the banks that he is willing to make a false promise, because it is well known that if one or more banks go down there is no way that Ireland PLC could meet their needs. I would argue that, as we can see from the Irish banking shares (although the flucuations in the stock market are so volitile that it doesn’t indicate very much at the moment) that insurance policy is kinda worthless.
I would change my opinion on one thing that I mentioned above. I don’t think that the motivation behind the guarantee was a political attempt to hide their own part in this mess. That was a bit naive. In a sense, the situation is far worse, and as you say with no money to shore up the banking sector this, they felt, is the best they could do. But it wasn’t the best thing to do, necessarily, and by choosing to provide this guarantee they are postponing the problems for later on, just around the time that the banking sectors in other countries will be beginning their recovery.
Fergus, all of this is speculative. It’s not as if we have had a recession at the same time as a collapse in an over-valued property market, at the same time as international crisis in the global financial system that has effectively brought all private lending to a halt and the part nationalisation of almost the entire global banking sector recently to take pointers from.
Perhaps blogs are not the best forum for gentlemanly (or ladily) discourse, and I have always considered blog posts to be provisional notes on contemporary events, based on the information you have. Comments add to this, making the whole thing into a conversation, challenging points of view or providing more information. If I sound ‘apocalyptic’ it is only because I think that the dangers are being ignored and that the government needs to face up to them if the outcome is going to be better rather than worse.
As the budget has shown, this government is still determined to maintain the price of housing at its current level, while at the same time penalizing those further down the pecking order.
“(Usenet is the best Internet medium for debate, but people seem determined to let it wither).”
Have you tried pigeons?
Pigeons are great.
What about winged monkey’s? People always forget the power of winged monkey’s in a debate.
Winged monkeys powered by pigeons. There’s a neoliberal think tank where such a thing has been proven possible. They don’t provide any evidence, of course, but they ARE experts in these things, so, you know, we should believe them. It would be an awful abuse of trust were it shown that they were lying to us.