December 31, 2008
The risk now is reputational risk. Credible institutions will simply not want to be associated with an outfit like Anglo Irish Bank
About a year and a half ago in ‘The Generation Game’, I wrote that “one of the big Irish banks is simply a leveraged hedge fund betting its own and its clients’ money on overvalued property” and “normally when the property market collapses, these type of outfits go bust”.
For legal reasons my publisher advised that we couldn’t print the name of the bank — Anglo Irish Bank — in yet another Irish example of stupid law protecting stupid people to the detriment of the majority. But what was right then is still right now, despite capital injections and much hot air about the “culture of Anglo”, the bank will still go bust and will be nationalised. This is likely to happen in the next few weeks.
This event will make Anglo Irish Bank the first bank in financial history to go bust with a government guarantee. This moment will be discussed for years to come.
In fact many professionals working in Ireland who up until recently parroted the idea that the banks were well capitalised or who argued that ‘property collapses don’t necessarily lead to bank failures’ will write brilliant ‘after the event’ analysis of what happened. They will muse as to why depositors did not consider the government guarantee sufficient when they decided to withdraw money en masse from the bank?
To save you listening to this hindsight in February; here’s a bit of foresight and this is what is likely to happen in the next few weeks. Corporate depositors — institutions that had kept large deposits with Anglo — will in the New Year decide that there is no point in keeping money with this bank when they can just as easily, keep their cash with one of the two big banks. The question they’ll ask themselves is ‘why should I keep my cash in Anglo?’. They are not being paid for specific Anglo risk.
But what, you might ask, is the financial risk now, if the Government is standing behind all the deposits whether they be in Anglo, AIB or Bank of Ireland?
The risk now is reputational risk. Credible institutions will simply not want to be associated with an outfit like Anglo. Reputation is about the most difficult attribute for any business to build and about the easiest to blow. Anglo has blown it.
People will shun the bank and take their deposits and business elsewhere. This is a tragic end to a business that many thought at one stage was mould breaking, but that’s the harsh way economic cycles administer justice.
Over the next few weeks this reputational stain will become more evident as horrendous news emerges from the bank in terms of bad debts and the extent to which the loan book was a one-way leveraged punt.
The capital flight from the bank will cause a massive funding problem as its loan to deposit ratio plummets further and its e80bn loan book smothers the bank in the financial excrement that the once “brilliant” bankers of the property boom misdiagnosed as assets.
Eventually, with its share price as zero, Minister Lenihan will have to nationalise the thing fully. This means that the national debt of the country will rise by e80bn (Anglo’s loan book) without a red cent having been spent on health, education or social welfare.
This will push credit spreads for Ireland out further as foreign investors will realise that they are also buying the hazardous waste of Anglo when they think about lending to the Irish sovereign.
The Minister will now face another dilemma, what does he do with Anglo? The thing is now a State liability full of loans to bankrupt developers for half-built developments all around Ireland. It will also be home to a few hundred knackered employees who have seen their dreams and, in many cases, their family’s futures implode. None of this is pretty and for most of these middle-ranking victims, none of this is deserved.
But the same process will happen all over the country as unemployment soars. One of the main reasons unemployment will soar is because of this banking phenomenon called ‘deleveraging’. While deleveraging will cause Anglo to go bust, it will have a vicious impact on credit in our country. The term is one of those horribly grainy expressions that make their way into economics. It means that the Irish banks who have presided over a most ludicrous expansion of their loan books by borrowing abroad, will have to lend considerably less in the years ahead and take in considerably more deposits to bring this ratio down to the European average.
The main Irish banks have a loan to deposit ratio of over 160. They will have to bring this figure down to between 80 and 100 in the next few years. This implies a massive contraction of credit, retail sales, tax revenue and cash in the economy. So what are we to do?
Well ironically, if we put our thinking cap on, this is where the coming nationalisation of Anglo might help the nation.
To see why this might be, let’s switch the discussion to Argentina, Brazil and Mexico. These countries suffered terribly from defaults on sovereign debt in the early 1980s. They couldn’t pay back the cash they’d borrowed.
For an entire decade they were frozen out of the global financial markets because no one would lend to them until they figured out what to do with the old debts. The lending banks realised they’d never see their cash in full again but needed a mechanism whereby they could trade these debts and possibly, see some upside from a disasterous situation. So both borrower and lender needed a way out.
Up stepped Ronnie Reagan’s finance secretary Nicholas Brady. Brady hammered out an agreement whereby the countries would undertake to pay a fraction of what they owed to the banks and the banks were satisfied with that because they were getting nothing with the market frozen. Brady also got a concession out of the countries that another portion of the debts might be paid back as long as things were going well.
In all, the debt write offs amounted to between 50pc and 70pc of the principal. New bonds were issued to replace the old debt and thus began the era of “Brady Bonds” which heralded the beginning of the recovery of much of Latin America.
Think about this idea in the context of the Irish property market. Irish property loans issued in the past five years are about as valuable as Latin American debt in the 1980s. The cash will never be paid back, simple. So let’s accept that and get on with it.
If we took the nationalised Anglo and filled it with the toxic waste of the other banks and then started to trade these property loans as a deep discount, let’s say 20pc or 30pc of their face value, we could trade our way out of these problems. Clearly the banks would bear the brunt of the pain but it was their problem in the first place.
This is the only way out for us. And the bust, but nationalised, Anglo might just hold the key as a vehicle for the new defaulted-debt trading model. But to arrive at this conclusion we first have to get it into our heads that in 2009, Ireland is more South America than Western Europe.