Making people’s savings secure is the best way to return confidence to the market.
When ordinary people are flocking to the post office to deposit their savings, we know that we are running out of time. Some Irish banks are in clear and present danger and, as events in the US have shown, when things are moving so quickly, old assumptions no longer hold.
Last Friday’s rally, although welcome, does not change anything. We are still looking at a banking dilemma because the wholesale credit market is frozen. In its simplest terms, the people who lend money do not trust the people who would like to borrow it.
In the Irish case, we have already seen a run on the banks, in terms of investors in any case – foreign investors are trying to get their cash out, and last Friday’s rally will be taken as an opportunity to sell by many investors because the root causes of the malaise are still there.
The question for the state is whether we are looking at a situation of illiquidity or insolvency. Pessimists say the banks are insolvent; optimists argue they are simply illiquid.
If it is insolvency, which is still unlikely, then there are the normal longer-term measures to deal with bad debts. But if it is illiquidity – a short-term crisis of confidence that can be rectified – then the state can manage this with some obvious measures.
Let’s be clear: it would be unforgivable if a situation of illiquidity were to prompt insolvency due to lack of decisive action from the state.
There are two key issues: time and confidence. The banks need more time to work through their loan books to see what is viable and what is toxic. This will allow them to make an accurate assessment. The depositors need confidence to allow them to feel safe in keeping their money on deposit. What happens in banking crises is that time and confidence head towards each other on a collision course.
Ultimately, the banks can’t sort out their bad debts as quickly as depositors can withdraw their money, and thus the banks fail.
Ireland needs to avoid this eventuality at all costs. So what are we to do? We know how we got here – mad over-lending on Irish property. The questions now are how do we get out of this mess and, more importantly, how do we restore confidence.
Three models were tried last week alone in the US. These options are open to us. However, there is a fourth, which might be the most effective for Ireland. Before we explore the different options, there is one argument that we have to settle and this is the argument about morality.
There are many who believe that the banks have been reckless and should not be saved because saving them would reward the bad behaviour of the banks’ bosses. There is obvious political logic to such a view. How can a politician be seen to bail out a fat-cat banker at the cost of delaying building a hospital wing? (One part of me shares this attitude, by the way.)
However, today we have a national crisis and the better part of valour is to sort out the problem immediately and leave recrimination for tomorrow. Heads will roll in time; today is for action, not vindictiveness. After we stem the crisis, we can go back and punish those responsible.
So what are our options? The first approach to dealing with this is the Lehman model. This is where the state allows the bank to fail. This is not an option for Ireland, as only failed states have failed banks.
The collapse of Lehman has done untold damage to the US, but at least the US has the comfort of being the world’s biggest economy and deepest financial market, as well as being able to print its own currency. We are not in that position. If Ireland lets a bank go under – even a small one – panic will follow.
We will get a run on the banks internally, while externally we will scare foreign investors, who are crucial to our economy. It would take years to restore credibility. Countries like Argentina allow their banks to fail with detrimental consequences; Ireland can’t afford to let this happen.
Therefore, the Lehman model is not on, even though some institutions might deserve to go under.
The second option is the AIG option. Last week, the US government nationalised the giant corporation to prevent bankruptcy. This is precisely the opposite of the Lehman approach.
In Ireland, the state could take over a failing financial institution and use a ‘bank bond’ to raise the finance if it were needed. In the past, we have seen this approach in Scandinavia. The state would have to take a gamble on whether it could ring-fence the problem, that is by nationalising a ‘bad’ bank, it would be enough to restore confidence in ‘good’ banks.
The third option is the Merrill Lynch or HBOS model. This is where the authorities broker a deal between a large, more solvent bank and a large, less solvent one. This is the ‘shotgun wedding’ solution.
However, there appears little point in two smaller banks with significant property exposures like Anglo Irish and Irish Nationwide saying they will merge.
What might be interesting is a foreign outfit like Zurich Insurance, which already has an operation here, looking atone of the domestic players, such as Irish Life & Permanent (ILP).This would greatly enhance ILP’s position.
The shotgun wedding scenario will have to involve a foreign bank and one of the big Irish banks. This is because all the Irish banks were at the same game. If we start ‘hiding’ weak banks in not-so-weak banks – as the Japanese did in the 1990s – we will get nowhere, as the weak banks’ balance sheets will contaminate the not-so-weak ones. In the present climate, no bank will do a deal with an Irish bank without some state underwriting of the ailing Irish bank’s balance sheet; the shotgun wedding will cost us cash and, like all marriages, the permanence of any arrangement will depend on the compatibility of the couple.
The fourth option is the most attractive one, but it hasn’t been tried anywhere and would demand a leap of faith from the authorities. Remember what we said before: the two critical elements are time and confidence. The single most persuasive route to take would be for the Irish government to guarantee all deposits in Irish banks. Yesterday’s announcement of a €100,000 deposit guarantee only goes half the way.
In contrast, a full guarantee would have meant full protection for all creditors, all our own deposits and those of the foreign institutions who have lent to the Irish banks. The government could do this for a limited period – let’s say two years.
Straight away all uncertainty would disappear. The deposits, of which there are close to €300 billion, would become sovereign. Peoples’ fears would be assuaged and, if done properly, it would not cost a penny.
The Irish government would be using its well-earned reputation as a sovereign entity, not its hard-earned cash, to solve this crisis. People will not bet against it. This would guarantee the deposit side of the banks’ balance sheets, where there is no problem but uncertainty. Therefore, we would solve the confidence side of the dilemma.
Furthermore, with the return of confidence, the banks would have time to sort out their asset problems. These loans on property will never be paid back in full, and the banks will need to negotiate with debtors.
The banks will have to accept that they will have to take large losses on these debts (with many technically in default already) and, with the property market going nowhere at the moment, these will not recover for some time.
However, financial history is full of such episodes and there are many viable ways of dealing with bad debts. There will always be buyers looking for value, and there can be no doubt that, at deep discounts, Irish property will be a decent bet again.
Of all the options, the deposit guarantee is the most attractive. The guilty parties will be punished in time. This means the heads of the top brass at some of our biggest banks. Over time, consolidation can occur with a well-planned marriage rather than the hasty shotgun affair and, most importantly, the state will be seen as being in charge. The crisis will pass, and Ireland will become a model of financial innovation.
Most crucially, the government must act quickly because, with the property market in tatters, the main engine of growth for Irish banks will splutter for the next few years. This implies that the bailouts we have seen internationally will not offer a lasting liquidity solution.
If we act now, quickly and with confidence, a potential insolvency won’t escalate beyond a temporary problem of illiquidity and will be sorted without panic or long-term consequences.
Hi Where are you getting the 300 billion deposit figure from? From my calculations that equates to about 75,000 euro for every man woman and child in the country!! Not bad for a country that has saddled its twenty/thirty something generation with pvervalued and unaffordable mortgages. I think the figure is more in the region of 250 million on deposit. Most of these deposits are small (by that I mean less than 20,000) and were already protected prior to Minister Lenihans recent announcement. The Minister is in a win-win situation, he gets to look like he is acting decisively, it… Read more »
“The War of the Words”, (with apologies to Orson Welles,) The run on the banks fiasco. The ability to confuse audiences en masse may have first become obvious as a result of one of the most infamous mistakes in history. It happened in September 2008, when millions of irish citizens tuned in to a popular radio program that featured real life drama. The mischief maker/famous broadcasting celebrity, Joe Duffy, took calls from panicky customers of the irish banks who had seen their shares plummet almost below the horizon ,due to the banks rapacious exploitation of the property bubble phenomenon .… Read more »
David: If your figure of €300 billion of deposits in Irish banks is accurate, it implies that the multinationals are using Irish Banks in a kind of ‘Reverse Ansbacher Account’ US tax avoidance ploy. If that is indeed the case, they raise a number of interesting moral issues, including whether the ECB regards us as having double standards, or at least a three monkeys attitude to competition on a level playing field. Leaving that aside, those hypothesised deposits might account for the complacently inert response of the government and Central Bank to the ongoing liquidity crisis. Sums of that magnitude… Read more »
very good John
Based on previous property busts, there will be a large drop in property values, an increase in bankruptcy rates amongst business, an increase in interest rates, rates of inflation that will not be stable, and a lot of bad debt to be digested some where in the financial system. The Irish Banking system only has one conservative bank-the ACC Bank. The ACC Bank did absolutely nothing during the property boom. Completely missed the entire event !! The other banks were laughing at the dullards in the ACC Bank. The highest level of banking activity in Irish history. And what did… Read more »
The point I was trying to make was this. The capitalism of Schumpeter has triumphed over the capitalism of Reagan-Thatcher. It is in the work of Schumpeter and the Austrian Economists that we will rebuild the economic system. Watch the US Administration try to sustain the capitalismof Reagan-Thatcher as it is in on it’s death bed. The lifesupport system is powered by Beijing. Beijing can switch off the power and leave the corpse cold. This is not a situation that we in the West should welcome. It is no healthy for the basis of Western Civilization. But nobody seems to… Read more »
David Unfortunately in reading your fine article you seem to have missed one I think overlooked sector in the irish economy .That is The famous Credit Union area. It operates very quietly in the backround but there are millions stashed away in those accounts. What happens if they go belly-up ? Now as far as I know most Credit unions are affiliated with the Irish League of Credit Unions (ILCU). The ILCU have in effect what is called a Savings Protection Scheme where each Credit Union pays in a certain amount each year into a fund . If a Credit… Read more »
David, are you not thinking here in terms of a solution to a local problem with no reference to the outside world. There are 2 issues…The immediate one of the world financial system collapsing and then the local one of banks property related bad debt. Ignore the outside global issue for a moment, the local banks here are going to find a lot of bad debt needing a solution. That’ll take 2 years to come to its peak and certainly your solution has merit in providing the necessary breathing space required to ensure international credibility. When you start bringing in… Read more »
Deco > It is in the work of Schumpeter and the Austrian Economists that we will rebuild the economic system. This idea, along with education and social and environmental renewal, form the central strategies of the Lisbon Agenda, which was adopted for a ten-year period in 2000 by the European Council. 2000? You may wonder why, if this is the european economic strategy for the past eight years, you’ve heard little or nothing about it. Honestly, I’m not sure, but I suspect the source of the idea may some of the problem. Irish economic thinking has naturally been more influenced… Read more »
Is there any data available for the % of deposits over €100k ? Assume it’s the vast majority by numbers of citizens and SME’s accounts (~99%). There may be very large € amounts from a small number of high net worth’s, large companies and MNC’s. Make sense for the Government to publish this data if it shows ‘voters’ are guaranteed ??
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?? Seems to me that at some time we have to get real and accept that ALL of the property related assets on the banks balance sheets do not reflect any kind of reality. Currently, an average house is what… 300K… but it should really be 2.5 times average salary which comes out at 95K… 2.5 is the only realistic value in light of moral and ethical considerations (ie. current 35 year enslavement of first time buyers), and the amount banks will be able to lend in a climate where micky mouse economics and free money disappears… David has been… Read more »
Also, 95K still leaves a profit of at least 100% over pure building and material costs (using current pre-fab technological practice) to be divvied up among developers, government, auctioneers and all the other property parasites.
Hi David, The financial crises have hit the mainstream (and main st) and now everyone including the cleaning lady is an ‘expert’ on the doom and gloom, the why’s and the wherefore’s, etc. I know some in the banking community here who even have suspended their personal spending as they dont know whats going to happen and fear, even if slight, that their job could in theory go. The scenario’s you outline are interesting, and I would be in favour of the AIG model, whereby the state nationalises the ‘bad banks’, taking on their debts but pays very little for… Read more »
David, Nice article. I just have two quick questions, both of which I’m asking moreso out of ignorance than trying to poke holes or trip you up: 1. What if it fails? Can options 2 or 3 be implemented after we go for option 4? Is it something the state can afford to do (i.e. payout on all deposits held)? I understand that insurance policies like this never intend to pay out on the full amount, but are deemed to be feasible if we can afford to cover one bank failing, but what if the doomsday scenario of AIB, BOI… Read more »
Where does the money come from for this new level of deposit insurance? The principle behind schemes like this is that government licensed market players pay a premium to build up a fund to cover the odd system failure. Like the insurance companies committing to the Motor Insurers Bureau for losses caused by uninsured drivers. How are cash strapped banks going to pay a premium now, when most of them are at risk of system failure? This is a thundering announcement from the government, but are we sure it’s not just pinning the tail on the taxpayer??? The big media… Read more »
David: Your headline “State must act as a safeguard” forgets that the basic function of any State is to BE a safeguard, not merely to wake up one day and resolve to ACT as a safeguard. The crisis in banking is caused by their undertaking lucrative but unwise levels of risk. Those who successfully negotiate these risky investments are rewarded with bonuses running into millions annually. Of course, all this lucre doesn’t leave the bank in a swag-bag but quickly finds its way back home, or to some other bank after being rinsed through a house, car or boat purchase.… Read more »
Mr Lenehan has just played a super ace in a game of “bluff poker”.!
In my opinionThere is no way that customers of a failure by one of our largest banks could-or would-be fully compensated by this government.
Remember-they are as bankrupt as the institutions they are purpoting to shore up.!
It would take emptying the “national pension” fund, to even attempt it.
I took a look at the latest Central Bank report: http://www.centralbank.ie/data/MonthStatFiles/07-%20July%2008.pdf And my reading of it indicates that the level of Household deposits is around 34 billion (table B2.1). That’s household. Non financial businesses have 31 billion. Table C3 indicates deposits of around 340-350 billion in total from Irish entities, and about 918 billion in total including euro area and Rest-of-World depositers. The 100k deposit guarantee only applies to households. There is 146 billion of debt on consumer mortgages and a whopping 396 billion of private sector credit. Lorcan Roche Kelly, you were interested (and many of us are, including… Read more »
“Making people’s savings secure is the best way to return confidence to the market.” – eh…No. Confidence comes from have a secure revenue stream to keep body and soul together along with looking after dependants and a few modest perks. Confidence came because people “felt” they had a reliable source of disposable income – irrespective of it shaky or otherwise its origins. Savings are now starting to show their real value in terms of the productivity of the area on which they are based. That means their purchasing power is reflected in the productivity of that area/ region. If you… Read more »
MK > Their immediate demise is surely exaggerated …. The bank’s demise certainly is, but I think what we are seeing here is the demise of the way they do business. I also read their balance sheet of 31st Mar 2008 and their comprehensive statement of last Thursday. The major difference between the two was the excessive use of the word ‘dislocation’ in Thursday’s statement. This banking euphemism is certainly worrying for their bottom line, but I don’t think it will threaten their medium-trem viability. More depends on whether the bank is willing to turn the clock back to 1985… Read more »
Philip > Confidence was falsely pumped here by the nonsense of property speculation. Same thing happened in the US. It is property centric. Lorcan Roche Kelly > In Ireland we are in the habit of calling it a ‘property bubble’, I think there is a argument for calling it a ‘banking bubble’. The rise in property prices was a function of the availability of easy credit from the banks. It clearly was a credit binge on a grand scale across multiple countries and geographies. Not only was credit afforded to those that were property flipping but businesses too by Private… Read more »
MK > Change the system. I’m watching Ben Bernanke explain himself to Congress at the moment. He is using ‘change for the future’ to avoid explaining the mistakes of the past. I’m sure we’ll be fed (no pun intended) the same line here. > Stand up and be counted ….. We must. Democratic politics is a game of lowest common denominators. I do have sympathy for the politicians currently in power because their jobs depend on their popularity. Any politician that tried to preempt the current property/credit crisis by reducing the availability of mortgage credit last year would have been… Read more »
Shane Ross/ Eddie Hobbs were on the Late Late the other night. I got 3 ideas out of it…start checking out the SemiStates (I see Fas are under the microscope), Freeze Pension Payment into the NTMA for 24 months and best of all – give 20K to every household for energy saving. Now for my bit…All the above cost buttons and the 20K per household should be paid to the government via PAYE back over 5,10, 20 years depending on a means test etc. The savings to the country in energy savings would be huge and it would give a… Read more »
And I would turn our revolution in the eco / green buiz into a tourist attraction and a silicon green valley. 20K per home represents 20% of the outstanding mortgage debt at the moment by my rough calculations. or less than 10% of total residential/personal debt. It would cause a 200bn into the economy based on a 10:1 churn and the Givennment would have it’s money back 2-3 times over and any fceker cauth flipping his investment within 5 years would be subject to murderous capital gain.
Philip > The savings to the country in energy savings would be huge and it would give a massive stimulant to the manufacturing/ R&D industry. There is an easier way to stimulate the market. All that has to be done is the introduction of Net Metering, thereby allowing small scale renewables to become more cost effective, and stop the current situation where any excess power produced has to be given away to the national grid without any compensation. According to 2007 Carbon Fund report (available from the NTMA website) Ireland has committed €290million to purchasing future Carbon credits to meet… Read more »
People are talking about the energy savings. I would take a different perspective – look at the expensive current system. If the government wanted to bring down the oil/petrol/diesel full bill, then I have one very simple suggestion. And it would result in the state saving money. Give all the state employees who work in DublinCity free bus passes on Dublin Bus. And take the free car spaces off them. Because the free car spaces are costing the state 4,000 Euro per state employee. But a free bus pass would cost 800 – 1200. Less Pollution. Would save the country… Read more »
Sorry if this is a bit off-topic but it may be of interest to some participants in this blog that the world’s economic recent economic turmoil seems to be largely controlled by two guys called Paulson. Henry M Paulson, former CEO of Goldman Saks (Creme de la creme of finaglers) who became US Treasury Secretary in 2006, is currently proposing to spend $700 Billion of US taxpayers money to support failing US banks. (Goldman is scrambling to become a depositing bank so that they can benefit from his largesse.) John Paulson is manager of a Hedge Fund who started warning… Read more »
Malcolm > Sorry if this is a bit off-topic but it may be of interest to some participants in this blog that the world’s economic recent economic turmoil seems to be largely controlled by two guys called Paulson. One Paulson made a lot of money investing other people’s money, the other one has to spend a lot of other people’s money to stop the people that made a lot of money loosing their money. Sounds like an ideal time to start a conspiracy theory. Nothing better than a good red-herring to help keep the US tax-payer’s eye off the ball.… Read more »
hmmm,
my name is Furrylugs………it has been three days since my last deal……I am an Illiquid.
SNAFU
Slan
David, I suspect you’re being slightly optimistic in expecting an iterative re-run of past historic bank runs/scams. Surely the problem with the scenario of ‘The State’ rescuing ‘The Banks’ is the assumption that either/both know what to do…….Is this ‘systemic risk event’ necessarily a repeat of previous crises? How can we be sure past remedies will defibrillate the patient, rather than kill them stone dead? Given that inactive/colluding Governments were midwives to this monstrous Frankenstein Banking creation, yet saw no sign of the tragedy before it’s birth: How can anyone assume they are competent to ‘rescue’ us? Maybe they’re just… Read more »
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