Although I never thought I would say so, it would be preferable for us to nationalise our banking system than to allow a private equity consortium to own and control our major banks.
Private equity firms are probably the worst possible owners of a strategic asset like the banking system. If Mr Lenihan sanctions, at these distressed prices, a takeover of the Irish banking system by a private equity consortium, he will have used the guarantee of the Irish taxpayer to subsidise the profits of a tiny few speculators for two years.
Before he announced the guarantee he could have argued that the ownership of the banks has nothing to do with the State because they are private firms.
However, by using the sovereign name to prop up the system, he has changed the game completely. This is also acknowledged in the legislation because the minister now has a veto over who will ultimately buy the Irish banks.
He will also signal chaos in the banking system because the strategy of a private equity fund is to sell. The minute these lads buy an asset the first and only thing on their minds is how to get out of this asset, making the most money by selling to the highest bidder.
What is a private equity fund? A private equity fund is a highly leveraged takeover machine.
For the sake of simplicity, let’s say the investors put in $1bn. The private equity fund then borrows 10 times that so the fund with equity of $1bn now has $11bn to play with.
Crucially, private equity funds have a 10-year lifespan. The manager promises the investor at least 20pc back on his money, which becomes feasible when you see that the initial $1bn investment grows to $11bn with borrowing.
The fund manager spends the first four or five years raising money and buying assets and the next five or six years selling the investment. The manager takes a 1pc fee for managing the money but his real prize comes from the profits he makes when he sells everything and closes the fund after 10 years. He can’t take an extra penny out of the fund until everything is closed, the fund’s assets are re-sold and the profits are divvied up among the original investors and the fund manager after the banks are paid back their borrowings.
Therefore, it is clear that these private equity players are only in the game for the short-term and while they control the asset, they squeeze every last drop out of it in cost savings and the selling of what are called “non-crucial” assets. So, when it comes to selling the bank, the private equity fund ensures that at that particular time, the bank will be at its most profitable, irrespective of how many jobs are lost or how many branches are closed in the process.
The private equity manager doesn’t care who buys the asset, so once a private equity firm or consortium gets the controlling stake, the future of the Irish banking system is anyone’s guess.
Although this seems like a great business to be in, things have not being going well for our private equity friends of late. Many investors have been trying to get out of private equity funds in the past year because they realise that when prices are falling, the private equity managers are just as fallible as the rest of us.
Many of these “masters of the universe” have lost fortunes this year and the problem with private equity funds is you can’t take your cash out until the end of the 10- or 12-year cycle.
As a result, investors who want to get out of private equity funds are selling their stakes at 50pc discounts simply to get hold of some cash. Eighteen months ago, when the markets were soaring this would have been unheard of. Yet the Financial Times reports many such funds are in serious trouble.
If you think about it, it is not surprising that an investment vehicle designed for a bull market when credit was ubiquitous might have problems in a bear market undergoing the most violent credit contraction in history.
The fragile state of the private equity industry and the jumpy nature of previously secure investors, is another reason that Mr Lenihan shouldn’t touch these lads with a barge pole. In these conditions, a private equity owner of the Irish banks will make the debacle of Eircom seem like a honeymoon.
Most crucially, the private equity option doesn’t solve Mr Lenihan’s problem, which is the bad debts of the Irish banks stemming from property.
What happens to the private equity investment if they get their sums wrong today and run out of money to cover the debts of the banking system? They will simply walk away, leaving us with no banking reform and a bigger problem when the rest of the world is coming out of recession in a few years’ time.
Make no mistake about it: they will promise you the sun, moon and stars to get the assets cheaply, but once trouble begins they will not come to your aid and the Government will be back to square one.
Unless Mr Lenihan can quickly find proper strategic investors to take over our financial institutions, such as a large European financial player who knows how to run the business, he’d be better off waiting.
If he feels he can’t wait and private equity is his only option, we’d be better off if he nationalised the banks by taking a significant minority share using a preference share, which should generate a minimum 10pc to the State per annum.
He can also write himself an option to take more of the banks’ equity — on behalf of the taxpayer, exercisable in five years’ time — at a deep discount to today’s share price. You can use private equity money if you need a make weight, but don’t give them control. And of course, open up the recapitalisation to the Irish taxpayer as direct investors. The State can then sell its stake in a few years so the profit accrues to us the Irish people, not a bunch of private equity traders, masquerading as national saviours.
In this way we can stabilise our own ship, and solve our own mess in an orderly fashion. This was what the guarantee was about in the first place.
Private equity fund managers are not investors; they are leveraged traders. They think with a trader’s mind that tells them that as soon as they have bought, they need to arrange how to sell. Even if they wanted to invest for the medium term, the private equity time horizon is legally bound to sell during the timeframe of the fund, normally 10 years, or less.
Ireland’s degenerate bankers do not deserve to be saved.
However, we the Irish people, whose deposits, mortgages and business keep the banks open, deserve more than to be pimped out to the least suitable bidder in this, our weakest moment.
I recently finished reading the excellent ‘Ascent of Money’ by Niall Ferguson (picture DmcW as a scottish economic historian).
Anyway, in it he critiques the work of Peruvian economist Hernando de Soto who argues that the way for the poor in less developed countries (LDCs) to escape the poverty trap is through property ownership. Mr. de Soto, through his Institute for Liberty and Democracy, has certainly done plenty of sterling work in pursuit of his ideals. But, as Niall points out, property ownership in itself doesn’t lead to a release of capital resources for entrepreneurial activity.
For that the poor in LDCs need access to credit, or more specifically, the microfinance movement founded in Bangladesh by Nobel prize winner Muhammad Yanus. Microfinance does exactly what it says on the tin. Small loans for small projects, the first step out of the poverty trap.
All very noble, but what does Peruvian economists and Bangladeshi bankers have to do with us? Well, one of the points Niall makes is that owning property does not give you financial security, it only gives your creditors financial security. So those in negative equity cannot secure credit because as far as credit institutions are concerned they are a worse bet than those who have no assets at all.
So negative equity becomes the very worst type of poverty trap. Add to this the lack of credit available for those who can offer financial security to potential creditors, and we start to see what a retrograde step the financial world is currently taking.
So does it matter who is running our credit institutions? I know that if I was looking for a loan it wouldn’t bother me if I got it from Halifax (where i know any profits will be expatriated) or from a pension/PE/Government funded ‘Irish’ bank. We will all be worse off without credit, and the longer we agonise over who profits from credit creation in the economy the longer the economy will remain credit starved.
Philip, I have 100 acres of reasonably productive farmland, two dogs, and a shotgun. Should I start selling farm production futures? I will guarantee to feed your future for a reasonabe fee today…
I’d be happy to underwrite your farm production futures with a “starvation” bond. I’ve enough detail from your 1 sentence description to get it AAA rated. Although, as we’re in less extravagant and more circumspect times I might AA rate it. After I sell it, a pyramid of people less scrupulous than myself will create new bonds to underwrite the risk buying my bond exposed them to. Private Equity firms will buy the banks and avariciously buy my new starvation bonds. I won’t be able to issue them fast enough and down the pyramid new kinds of derivatives will need to be created. These won’t be secured by anything but the promises (lies) of the institutions that issue them.
As these bonds require risk, the banks will do their level best to discourage the use of land for food production. You won’t be able to get any credit to finance your farm so buy all materials you need now. Food prices will skyrocket but the banks will lend people all the money that they require to buy the 1,000 Euro sliced pan. People will be able to get a trans-generational mortgage if they want to eat out. Subsistence farming will be outlawed by the EU on spurious “public health” grounds and you’ll need to use that gun of yours! Some people will realise that this situation could lead to the extinction of the human race. They’ll be ignored. Others will see an opportunity to short my bonds. They might finance this shorting based on non-perishable food they’ve horded during “good times”. If we’re really lucky the market will crash but only after millions have starved to death.
If this all seems too dystopian then I apologise but this is very similar to what’s happened in the “developed world” housing market over the past few years. Something as basic as having a roof over your head became onerous requiring long commutes, two income families, nixers to support childminders and little of the leisure or quality time we thought we’d have. My long-winded point here is that the kind of thinking that produced the current financial crisis produces wars, famine and children dying from curable diseases. At best it’s leading to a disenfranchised generation that will spend a lifetime cleaning up after the reckless and irresponsible baby boomers.
David wrote:
“The fragile state of the private equity industry and the jumpy nature of previously secure investors, is another reason that Mr Lenihan shouldn’t touch these lads with a barge pole. In these conditions, a private equity owner of the Irish banks will make the debacle of Eircom seem like a honeymoon.
Most crucially, the private equity option doesn’t solve Mr Lenihan’s problem, which is the bad debts of the Irish banks stemming from property.”
That-in a nutshell- is the problem.
There is no clear way forward. We have a lawyer as Minister for Finance- headless and totally out of his depth; surrounded by a legion of advisers who are equally clueless (as the best economic brains in the world are), making it up as he goes along; wondering which of the momentous decisions he now makes re keeping a banking system on a life support machine(Private Vulture Equity?),will be less disastrous than another.
One thing is sure and certain though-only one Irish political party of incompetent strokers (Fianna Fail) can compound it-and they will-mark my words-they will.!
The blanket bank guarantee may turn out to be the costliest decision of all for the unfortunate taxpayer.
At least one of the banks he has bailed out (the worst of the offenders) should have been allowed go to the wall.
We all know which one.
Interesting post from Ruari,
“Instead of having a go at Declan Ganley, the ‘ruling elite’ should remove the plank from their own eye. FF have shown, for years now, how politics ‘works’ in this country, from county manager to VEC Boards to FAS to first-time subprime banking schemes. It was often said that the IRA was so lethal because they went up against the best army in the world so they had to learn hard. While having locked horns successfully with FF using some of their BS tactics back at them (my opinion), I do sincerely hope he doesn’t catch any of their immoral diseases. Sean Lemass, I’m sure, would instigate his own Twelve Apostles squad if he could find a way from the grave. De Valera might even suggest just giving old Ireland back to the Brits, rather than have this new breed of clientelist landlords hanging out of us.”
Heat of the moment stuff, Soldier of Destiny. I of course was attempting to metaphorically light a fire under them, not suggest a twelve apostles reunion, unless someone wants to run with that ‘thought for the day’ for the druglords.
As a disaffected member of an old FF family, I am saddened at how out of touch they are but I actually would love to see them surprise us and turn it on in a crisis. I believe Cowen’s heart is in the right place usually, but soft times makes soft people. Equally, hard times may produce the leader in him that we desire. Let’s not fool ourselves that the majority of the country is innocent in regards to our debt-splurge. Its a very difficult situation to call a halt to. If a politician did, we, the gobshites, would disempower them, and quickly. We all want to have our cake and eat it. There is no other more competent party in Dáil Eireann and that should be frightening most of us right now.
As bad as it’s got, I want FF to cop themselves on and focus on the majority and lead us to a recovery. There is always a recovery. And there is always pain. I accept your viewpoint completely on FF, but don’t agree with it fully. FF has many good aspects to it, it would be unwise to throw out the baby with the bathwater. The opposition agreed with the conscensus view on housing, tax, stamp duty, national resources such as oil & gas; they merely tinkered at the edges in order to produce radical policy, as is the wont of any mature political party who wants to ‘replace’ the incumbents. Only rarely does a radical party take power. We’re very far removed from that necessity, thank God, as with change on that scale comes packaged hidden Head-the_Balls also.
We need a national discussion on productivity, what it is and isn’t, who we a re interdependent on etc. We all took part in the shameful Tiger bubble, not just our ‘masters’.
What I don’t understand is why we’re prepared, as a people, to underwrite such banking risks, yet not take them over as majority shareholder if the deal is already appealing enough to PE players? It reminds me of a big media group who blindly marched into the new media sphere and, when confronted by big ideas with small pockets, stated blandly that they weren’t a VC, they just wanted fully funded, ready to go new media partners. A bit like the frog in the kettle. Oh dear. We have an opportunity amid the chaos. As David says, wait a little longer, then take a major share of the banks! Isn’t this the logical step after legislating a guarantee into existence??
Malcolm McClure,
In response to your question regarding Phillip’s view, expressed above.
There’re a few things that unsettle me, quite profoundly, about the current situation.
1. The banks are being very coy about their liabilities. So coy, in fact, that it’s unnerving other banks to the extent of stopping the other banks from lending to them. Taken as a business decision, this is suicidal for a bank. So why are they doing this? (a) They know the worst, (b) they don’ know, but fear the worst (c) the conspiracy theorists are right (d) they’re suicidal. For me, it’s a combination of (a) & (b).
2. The increasing scale of state intervention – bail outs, guarantees, recapitalisation, banning short selling, direct corporate lending by governments, etc.
3. The occasional, but possibly increasing, panic attacks, suffered by governments and central banks. US $700bn bail out decision, UK 1.5% interest rate cut, Republic bank guarantee, Citi bank bail out, UK Bank recapitalisation, UK anti-terror laws used against Iceland, and so on.
These are all huge, and very sudden.
4. The near, de facto, news blackout in the national media, on related subjects.
I reason as follows:
1. Banks. If the banks were really OK, surely they’d be yelling it from the rooftops, and waving the evidence in the faces of anyone who’d listen. The only reason for this misinformation, obfuscation, and breathtaking arrogance, is that all is profoundly not well.
2. Global capital markets. The foundations of the vast increase in these, over the past 10 years, has proven to be hopelessly unsound. As a result, we’re going through a period of capital destruction, and economic restructuring. Even in theory, in a world of perfect information and rational man, it’d be impossible to centrally manage these two processes to everyone’s satisfaction. We, here, have argued vehemently against bailing out FTBers, for example.
Stephen: I have a slightly different take on the situation.
1. We are in a recession, so people are shy of spending, making every penny count, waiting for sales, buying in Aldi or driving to Newry, pretending they are keeping the old car for ecological reasons, turning down the central heating, etc, etc.
2. Shops and small manufacturers are depleting their existing stock piles.
3. Solicitors and estate agents are living off their fat.
4. Housing market is falling but small volume means basically stagnant until the spring.
5. People are trying to keep up with mortgages and pay off credit cards if possible.
Previous points mean that people are not approaching the banks for credit at the moment.
So long as there isn’t a popular run on deposits and the MNCs don’t take fright, there isn’t a problem for the banks if they can extend their lines of credit for another year. With the guarantee, this shouldn’t be a problem.
In 2009, when the British and American Billions start to filter through the system, the Irish sideshow will start to attract customers again. The FF & FG Punch and Judy show will give investors confidence that we are still a thriving democracy. The gorse will bloom in April and grass will start growing in May; people will realize that skilled labour is cheap again and start thinking again about redecoration or the extension they had been putting off.
In short: Life goes On.
David, if anyone needs evidence of the complete ‘shut down’ in credit from banks – they should reads the latest stats.
According to the latest data, the amount of money lent for residential mortgages last month rose by just ‘€26 million’. This compares with an average monthly increase of over €700 million in the previous three months (remember less than 2 years ago we were adding €3 billion to residential mortgage debt per month = €36 billion out of the economy)
http://www.irishtimes.com/newspaper/breaking/2008/1128/breaking31.htm
Overall private sector credit increase by €2.1 billion in October and exceeded €400 billion. Which is down from an increase of €3.6 billion in September (current growth rate is less than 6% – wouldn’t even cover the interest rollover!)
The construction and property lending combined continues to rise due to interest roll up and principle rescheduling. Take out property lending and inter bank ‘stuff’, credit growth to the rest of the economy is shrinking. So it obvious to all lending is contracting to SME’s and taxpayers – should the banks be let swamp all ‘available’ credit into property ?
We need a bank and/or fund with access to circa €50 bn asap with the sole objective to provide productive ‘credit’ …
Malcolm, I do not mean to be pessimistic. Stephen above has just articulated the issue far better than I. I am merely drawing a logical conclusion. I would go further..I no longer hold the view that common sense would say that the banks are a good bet because sooner or later Ireland Inc will recover. I now believe these very institutions as they stand are a barrier to the country’s further progress. Furthermore, I believe the banks abroad are in similar trouble for different reasons. Production output is simply way below the consumption rate. Ruskin’s rule of a dollar’s pay for a dollar’s work has been violated.
Also, I am not at all pessimistic. I think the changes being brought upon are frightening mostly to those who wish the existing status quo to persist. We are about to enter a period which will demand profound change. People are starting to talk more and are becoming more interested in the economics and politics. And they are more educated. The anesthetic effect of the boom is wearing off. The Greens organisation must be feeling profoundly cheesed off – their cred is destroyed. Election will be called very soon. Probably February we’ll see the cracks. The sooner the better and the faster we can start to clean out a lot of rubbish. And some good leadership for a change.
There is nowhere to run. It’s not good anywhere. The money system may be in need of a radical reboot on the lines I mentioned above. A solid FG/ Labour party is needed to pull it off. Who knows, we might just get a few defections from FF. I have every reason to be optimistic…cos right now, things are not good at all.
Phillip: Most Irish are profoundly conservative by nature. Even if the rest of the world experiences huge changes, like the Lower Palaeozoic explosion of species, the rootstock Irish will be like the brachiopod Lingula, content to skulk in the mud, well below those waves of change. (Lingula is the oldest, relatively evolutionarily unchanged animal known. The oldest Lingula fossils are found in Lower Cambrian rocks dating to roughly 550 million years ago.)
This is by no means a criticism of our brethren. Keep the head down and avoid trouble has always been a successful evolutionary strategy. It’s the over-specialized, florid and exotic that tend to have the shortest evolutionary shelf-life.
Yeah. The DODO theory.
“…over-specialized, florid and exotic…”. I was thinking more of those who manage syndicated property investment schemes.
The problem is that something radical needs to be done with the banks. It isn’t enough to put in new money. They need a new way of doing business too.
Shinsei Bank is an example of a bank that has been rejuvenated by external investors. (See for example http://www.forbes.com/markets/2007/11/20/shinsei-bank-flowers-markets-equity-cx_vk_1120markets02.html). It hasn’t all been plain sailing, but the investor has stuck with it, building a stake in an adverse situation.
The idea that private equity is inherently a bad thing is just not true, any more than the idea that state ownership is inherently a bad thing is true.
There are good deals and bad deals, good investors and bad investors, good management and bad management. In this case, a good deal will bring new blood into the market, a bad deal will give us more of the same, propped up with our own money.
If a bank doesn’t give good service and make good loans, its customers will leave, its revenues will collapse and it will eventually eventually die.
The situation is quite different from eircom, which has a hold on infrastructure which cannot be easily replaced or duplicated.
perusing various contributions on this site/room it appears we all seem to know what should be done and believe it wont be done …I agree with that
—the difference between getting things done in previous generations is that people then had nothing and knew that …..today we still have nothing …but we dont know that…….we are still in denial ……demonstrators in bangkokhad moved to …fear ….and desperation ….and..Panic…..if we get there it maybe too late
In an earlier post I said “I think at this stage there is a higher chance of us having to pay out on the guarantee than of the guarantee actually expiring in 2010.”
http://www.tribune.ie/business/article/2008/dec/07/state-to-extend-bank-guarantee/
I didn’t think the banks were going to let that safety net disappear without a fight….
Please tell me we are doubling the fee every year so at least there is some built in mechanism to get rid of it.