October 6, 2009
The saga of Independent News &Media (INM) and the clash of the two Titans involved is the stuff of a Hollywood blockbuster. If you ever had the pleasure of reading a book like Barbarians at the Gate, you will notice the similarities in the characters, the battles and the likely outcome.
Maybe someday, someone will take this material and turn it into drama, but right now, consider the solution on the table and ask whether something like this could be used to good effect for our economy.
As the current spin is that ‘‘there is no alternative to Nama’’, maybe the structure of the INM deal gives us another option rooted in traditional corporate finance, rather than the financial experimentation that Nama represents.
So let’s examine the INM deal in broadest-brush terms. The company has run up huge debts which, if they were to be paid, might tip it into bankruptcy. It also has two major shareholders at each other’s throats for control. The sums of money involved in this battle are staggering, as are the potential losses. But the clash of the Titans – although dramatic – is not the key driver of the story.
The rudiments of the story are as old as the economic cycle. A big company rides the boom and expands using borrowings, which looked affordable when revenues were booming and the share price soaring. Some assets were bought which may not look so rosy in more straitened times. Then recession hits, revenues collapse and the debts look like crippling the company.
The company goes back to the debt holders and says: ‘‘Listen lads, we have a problem and, frankly, our problem is your problem. We can’t pay all the debts today, but we believe that the company will be able to turn itself around in the next few years, so why don’t we do something creative instead of folding the company and you having to take a loss today?”
The fact that Tony and Gavin O’Reilly and Denis O’Brien are wrestling for control of the company is fascinating, but it’s not really the nuts and bolts of the story. The major narrative is whether they will have anything to fight over when the recession lifts. Park the individuals for now and look at the solution.
The bondholders have decided that it is in their interests to swap their debt for equity in the company. They have made a call, which can be summed up as follows:
‘‘We believe the company will make money in the future and therefore we have ‘hope value’. Otherwise, if we were to enforce the contracts for all the debt repayments now, we would strangle the company, and everyone, including ourselves, would lose.”
They have decided to take shares in the company, instead of debt. This means that the major shareholders lose significantly but, importantly, live to fight another day.
The bondholders now have a huge interest in the company turning itself around, because they will be paid through the share price. The fact that they bought the shares at close to rock bottom implies that they lose cashflow today in the hope of capital gain tomorrow.
This, in essence, is what has been achieved. The debt equity swap is one of the oldest tricks in corporate finance and is standard practice for companies and countries that find themselves in a debt induced quagmire after a boom fuelled by too much borrowing.
Now, armed with this template, let’s look at Ireland and our banks and housing mess. Let’s start with the people, not the institutions, because economics is about people, not bricks and mortar or corporate logos. Nobody in Ireland cares where we bank our money, as long as the bank is robust. This is the crux of the problem with Nama. Brian Lenihan, the Minister for Finance, seems to believe that the banks and their survival matters, but they don’t. Only the people matter.
The minister seems to believe that you can’t screw the bondholders, but the INM deal reveals that bondholders are eminently sensible and will do deals which make sense. It also reveals that the creditors are wise enough to realise that they too share some of the blame for lending too much to the company in the first place.
If they were happy to share the gain in the good times, they should be ready to share the losses in the bad times.
Despite all the international evidence, our government seems to believe that, if you do a deal with creditors of banks, you are screwing them. Furthermore, the Department of Finance contends that, if you screw bondholders now, the next time you go back to the market, they won’t be there for you.
In contrast, it knows that it can screw the people now, because the next time you go back to the Irish people, we will still be here. Unlike the bondholders, we can’t go anywhere; so we get screwed by the very people who are supposed to be acting in our best interest.
But it doesn’t have to be like this. What if the state looked at all the negative equity in the mortgage market – some 300,000 people at this stage are in this position – and dealt with the long-term solution to this huge and terrifying problem which is shattering families all around the country, by taking the equity in the house.
Why not create a new bank, let the rotten ones go and do a deal with old creditors based on their sharing the responsibility and the potential upside?
We could easily say to the people in negative equity that we are going to write off half the mortgage in their house, so that they can stay in it and try and sort out their lives without all the trauma of defaulting.
In return, the banks’ creditors would own a certain proportion of the house and the homeowner would pay them a small dividend every year. When it came to selling the house – let’s say in ten years – the banks’ creditors and the homeowner would both share any upside.
So we create a debt/equity swap for the nation. No need for Nama, no need for higher national debts and no need for a monster property company, which will jam up the system for years. We also wind down our banks, create new ones and keep the bondholders on side with the new deal.
This is what happens in the real world. This is what happened at INM and it is what adults do when faced with a problem: we find a deal. It’s not unusual, it’s capitalism.