June 30, 2008
The longer the banks go on protecting their developer clients, the bigger their problems are eventually going to be.
The Irish banking system is facing meltdown. The choice for the banks is now simple: they allow one of the big developers to go under or they risk going under themselves.
At the moment, the banks are frantically engaged in a game of bluff with the property market. Many of their builder-developer clients -the former crown princes of the boom – have no cash and cannot service the loans they took out in the past five years. Sites they paid fortunes for – confident that they could flip them on to a ‘‘greater fool’’ after they got planning permission – are now worth a fraction of what they paid.
Many sites are lying idle as no one wants to build, now that residential demand has fallen away. Huge debts are mounting and former high-flyers – the ‘Algarve and blacked-out Jeep brigade’ – haven’t a farthing.
The simplest way of getting the cash back (or at least some of it) would be for the banks to force the developers to sell sites and property. However, the banks know that the psychological damage of such an event would be so traumatic and the panic in the market so destabilising, that they are postponing this day for as long as they can.
Another possible reason for the unwillingness of the banks’ management to put up the land for sale is that they do not want to face the consequences of their own recklessness. They are in denial about the true valuations of their portfolio.
The developers know this and have recently begun referring to the banks as their ‘partners’ in mega-deals. The larger developers are assuming that the ‘too-big-to-fail’ moniker will save them. They are mistaken.
As a result, the Irish financial system is living in daily fear of the domino effect, where one large developer failing might bring them all down.
How long can – or should – the banks carry these bad loans? Are we talking weeks, months or years? Clearly, bank shareholders, who have been dumping bank shares for months now, believe that enough is enough.
Ultimately, the banks are caught in a brace. If they protect their developer mates, in a futile effort to protect themselves, their share prices will continue to fall. So will their bond prices.
More importantly, they could run out of cash because no one will lend to them as long as their balance sheets are hiding such colossal non-performing loans. Two events last week shed light on the banks’ position.
Banks are offering 6 per cent for ‘touch’ deposits. These are deposits you can withdraw at any time. For the banks, this is the worst, least secure deposit it can have. Yet they are prepared to pay close to 2 per cent above the market rate of 4.09 per cent.
The other story is just one of hundreds doing the rounds these days. A busy liquidator friend told me of a call he made last week to a builder who owed a client â‚¬600,000.He called the builder and the conversation went like this:
Builder: ‘‘Do you know where I am?”
Builder: ‘‘Dublin Airport on my way to Dubai to build.”
Liquidator: ‘‘What about the â‚¬600,000?”
Builder: ‘‘You and your â‚¬600,000 can go fuck off . . . now fuck off.”
This type of thing is happening every day; the lads simply don’t have the cash.
The money is gone and they are not hanging around for the bailiffs. Is it any wonder that one of our reputable banks is offering us 6 per cent for our measly deposits? Cash is king and everyone wants it, no matter what price.
If you look a bit deeper, you see that now we have a chicken-and-egg scenario, where the bad debts on the banks’ balance sheets are causing the banks to go into retrenchment mode. So they are lending less. But the less they lend, the more their builder-developer mates get into trouble because, the tighter the banks’ lending regime, the lower the residential/ commercial demand.
If you look at the financial system as one large game, where the banks borrow from one source and lend to another, the dilemma becomes clear. If the banks can’t borrow, they can’t lend.
One way of looking at the 70 per cent fall in the share prices of Bank of Ireland and Anglo Irish or the 60 per cent fall in AIB is to regard these price falls as the markets’ unwillingness to lend to the banks. They are simply too risky at these prices.
The system needs a net injection of cash, but there is no likely source for this, particularly as the banks’ balance sheets are still jammed with useless rubbish, the bad loans of the boom. Unless the banks face the music and accept that they are not going to get paid back on many of these non-performing loans, no one will be prepared to lend to them. If no one lends to them, they make no loans and therefore, no profits. In the worst case scenario, they run out of cash.
This is a critical juncture for the Irish banking system. The top brass have to wake up to the reality that protecting developers is damaging the banks’ credibility. Ultimately, the banks will have to cut the umbilical cord.
Every property boom/bust and recession is characterised by Icarus moments where the great and the good fly too close to the sun, their wings melt and they fall to earth. Just think of Alan Bond in Australia, Donald Trump in the US, Paul Reichman in London or Patrick Gallagher here in the 1980s. Inmost cases, the individuals recovered their fortunes in the next upswing.
This Greek drama is not unusual. What is odd is the number of Irish financial professionals who seem to be in denial about this or, worse still, the number who don’t seem to understand what is happening or why. Many seem genuinely shocked and, if they are shocked, they are in no position to manage the situation. It is now dawning on the young stars of Dublin’s banking community that there is more to finance than Ron Black’s, a Prada suit, extra firm hair gel and an Audi TT.
However, the banks’ choice is simple: it’s either you or them. They have to realise that it’s not going to get any better. The longer they protect their developers, the lower their share prices and the property market will go.
Why would anyone buy now in serious quantities when they realise that there is huge supply overhanging the market that has to be liquidated to pay bad debts? The longer the banks prevaricate, the further off any recovery.
If one bank were to bite the bullet now and put the assets of one of its bankrupt property oligarchs on the market, the cleansing period would begin. Yes, there would be huge falls in the price of sites, but that’s the only way the market will clear – a child could understand this.
Some of our senior bankers fail to grasp this idea, but maybe that’s one of the problems with ten years of cowboy capitalism: with all these nudges and winks, you forget how a real market works.