April 1, 2009
Why should we pay now for the sins of our bankers? Why should we cough up any more to support these institutions that have, through their own greed and outrageous misconduct, brought the economy to the brink?
In recent days these are the sorts of questions people are asking, not just here but all over the world. Before we sort out the mess, we need to go back to basics and define what exactly it is that a bank does. This might appear obvious but, given how the present management of Irish banks turned them into casinos, it is not always clear.
One way of looking at the banking mess is to divide the banks’ role into two functions. The first and most crucial is to provide credit to us, in the same way as an electricity company provides electricity. This is the basic business of banking, it allows us to pay bills, to set up accounts to do our day to day financial stuff without too much hassle, and for this we are prepared to pay a fee.Let’s call this the “utility” side of banking.
The second part is the one which has got us all into this mess. We can call this the “speculative” side of banking. This is the weak link. The banks used our money to double up and bet on the property market and all sorts of other assets. Now that the bet has gone sour, their balance sheets are in tatters.
So what are we to do? How do we quarantine the bad loans so that the core business of banking can resume? And how can we minimise the cost to the taxpayer, making the banks — not us — responsible for their bad decisions? The stakes couldn’t be higher. If we get this right, we might lay the foundations for some recovery. If we get this wrong, we are doomed.
One approach is to decide whether we can avoid taking the hit now. If you believe that we have not yet seen the bottom of the property market and that when that point is reached, the property market will very gradually recover, not to the ridiculous levels of 2006 but to somewhere above today, then it makes sense to borrow today to tide you over. The reason this approach has value is that it avoids the taxpayer getting caught buying assets today from the banks that might be even cheaper tomorrow.
At the moment, there seems to be a consensus emerging in the Department of Finance to buy everything from the banks today, put all the stuff into a “financial skip” and then, over the course of the next 10 years, manage these properties as an asset management company. The aim is to buy the distressed property today at “market” prices and to pay for this by issuing a government bond. Given that the calculations of just how bad the toxic loans on the bank’s balance sheet varies from â‚¬40bn or â‚¬50bn to â‚¬100bn, this is going to be very expensive for the taxpayer at a time when we do not have the cash. And nor do we know where the floor in property might be.
This is known as the Swedish or “bad bank” model. However, as this column has pointed out in the past, there is one seismic difference between the Ireland of today and the Sweden of 1992. The Swedes underpinned their banking bailout with a huge 40pc devaluation of their currency, allowing inflation to rise and so the resulting uplift in property values was swift because it was facilitated by a new softer currency. Their “bad banks” offloaded properties in the recovery and paid back the taxpayer, at a profit, reasonably quickly.
Without the devaluation of the currency and the printing of money in Sweden, the bad bank idea might not have worked so well. In fact, the risk is that it does not work at all and we, the taxpayer, end up not only bailing out the banks but bailing out the bankers and developers; they’d be off the hook and we’d be left carrying the can. So without a devaluation to ease the pain, what can we do now to ensure that we don’t end up with a bunch of toxic assets that an asset management company can’t sell?
Maybe we should think about getting the banks to actively work for us, locking them in to clean up their own mess.
Let’s say the worse case scenario comes to pass and there is close to â‚¬100bn of bad debts in the Irish system. Instead of buying the assets now and risking buying too early and too expensively, we could set up the asset management company with a contract to dispose of the banks’ assets over time.
The State could borrow the â‚¬100bn from the ECB at 4pc but charge the banks 10pc for this money and a 0.5pc fee, payable to the asset management company to enable it to function. The 6pc difference between the rate at which the State borrows from the ECB and the rate the banks pay the State to take the assets, goes straight into the coffers to build roads, hospitals and the like. This is â‚¬6bn that the banks pay the State from their profits over the lifetime of the asset management company.
Now we are moving towards a situation where the State doesn’t need to nationalise the banks and thereby take on more liabilities. It actually gets paid for looking after the bad debts of the banks. It can also take warrants, if it wants to, in bank shares, so that we the people get paid twice.
Therefore instead of costing us money, we could actually make money by getting the bankers to work for us.
In essence all we are doing is using the ECB, as the guardians of the European banking system and ultimately the controller of the monetary union, to show financial solidarity. We joined a monetary union in good faith and now we should call on the monetary union in the spirit of the European family of nations for a bit of help. This won’t cost them or us a cent.