December 27, 2009
This time last year, this column predicted that Anglo Irish Bank would be nationalised within weeks. That came to pass in late January. At the time, the mainstream view was that Anglo could limp on, but this was codswallop.
The reason for the nationalisation was simple: no one was paying big depositors to stay with Anglo. They simply were not being paid for the reputational risk of being associated with such an outfit.
My argument on the eve of 2009went as follows: ‘‘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. To save you listening to the usual 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.”
Anglo was nationalised on January 16.
Now the question for the next few months is whether our big two banks will face a similar crisis of confidence. How will the big hole in their capital bases be addressed, a hole which will widen due to a new wave of mortgage default in 2010?
Will big corporate depositors start to ask why they should keep their money in Bank of Ireland and AIB?
The risk that the banks will have to be nationalised – or something close to it – is now very real. The government draws a distinction between 100 per cent nationalisation and holding a majority stake, but either way we, the taxpayers, are taking control. Let’s put a date on it.
February is my guess. What’s yours? The underlying logic for this is primarily because no one will touch the Irish banks with a bargepole.
Regular readers will know that this column has argued time and again that the scam that is the National Asset Management Agency (Nama) deals only with â‚¬90 billion of the â‚¬400 billion total loan book the Irish banks have. This rest of their loan books will atrophy in the months and year ahead.
Last Wednesday, the head of AIB declared to shareholders that he had no idea how much capital the bank would need. This would hardly inspire confidence. But it is clear when you examine how this bank blew its balance sheet that the non-developer proportion of its loan book will be negatively affected by increased levels of unemployment, lower incomes, a falling population and ongoing negative equity.
It is clear now that the state is likely to have to introduce a ‘Nama 2’ to deal with mortgage defaults. Anyone with a passing knowledge of economics knows that the bad debt cycle lags behind the economic cycle and becomes apparent only when the banks stop rolling up interest and when people realise they can’t pay now and have no real prospect of paying in the future.
Against this background, the state has to decide whether it can – or would want to – back all these debts by injecting capital and raising the national debt. A more sensible course of action is to realise how bad the situation is and get an accurate figure from the banks about how serious the bad debts will be.
If our debts are 10 per cent of the loan book, the banks need to find â‚¬40 billion. If debts are worse – say,15 per cent of the book – the figure goes to â‚¬60 billion. The state simply can’t afford this, nor should it have any business worrying about it.
A smarter approach would be to do a deal with the major creditors of the bank – the big bondholders who have billions of euro invested in the banks. Tell them how much we can afford to pay and suggest they should get their acts together now because the guarantee runs out in ten months. In ten months, they will get nothing because the banks will be bust, so do they want to do a deal?
Nothing focuses the mind of a creditor more than the sight of a debtor refusing to pay. The depositors would, of course, be protected, but the bondholders – who got a better return on the basis of taking a risk – should not be.
Even if we did a deal with the creditors, would we be out of the woods? No, because there remains the huge problem of deleveraging, which itself drives the bad debt cycle. Over the past year, with the aid of huge extensions of credit from the European Central Bank (ECB), the banks have managed to avoid the massive deleveraging which has to happen here.
The contraction of credit in the bust is the counterpoint of the expansion of credit in the boom. Put simply, in the boom, our banks borrowed from whoever they could to force credit into the economy. So, in banking parlance, they borrowed ‘short’ (in the short term, from three months out to five years) to lend ‘long’ (lending this money out for 30-year mortgages).
When the market shut down last year, they had to go to the ECB to make up the shortfall – and the shortfall was enormous. The banks’ loans-to-deposit ratios hit 160 per cent in 2008.
Therefore, we will see a huge fall in the amount of credit in the Irish system over the coming years. This could be as big as â‚¬100 billion, unless someone else comes in and plugs the gap. Think about the scale of defaults when this comes to pass.
The market knows all this, which is why no one will lend money to the Irish banks on a normal basis until they know everything. The problem is that, once things become apparent, large depositors might just start to take their cash out as they did with Anglo a year ago.
In this scenario, the government would have to nationalise. But it doesn’t have to get that bad for the government to be compelled to nationalise. Further downward movements in the bad debt outlook will require new capital and, if it won’t come from the market, it will have to come from the government .This is likely before St Patrick’s Day.
But does it have to be like this? No, obviously not. The best course of action now would be to give away both main banks free to a European bank, which would deal with the big creditors. This, in a sense, would allow the banks to ‘go bust’ by admitting they were worthless, and by giving the new owners the deposit bases and the branch network free. In return, the new owner would issue its own paper to pay the old creditors at some deep discount, maybe 90 per cent. Problem solved, and we start again. This is what would happen in normal business.
It is called capitalism, and it is our only way out. Otherwise, we will tie ourselves in knots trying to borrow from tomorrow to pay for yesterday.
Better to come clean now, face the music and start again. This is what we would do if a sweet shop went bust; banks are no different.