David McWilliams: Deposits in Irish Banks Should be Converted into Share Capital

[Duke of Marmalade]

The EU has no business telling us to destroy our country by putting gamblers first, gamblers who understood the rules as surely as I understand the rules when, after passing age and identify verification I enter a casino and put my hard earned cash on the roulette wheel.

Nice rant. Bondholders are not gamblers, they are the antithesis of gamblers, most risk averse folk indeed.

What the bondholders didn't realise is that they were lending to gamblers. That the gamblers were allowed to indulge this chicanery was entirely the fault of the Irish regulatory system. There we were, convincing the World to set up in our IFSC, boasting of our well skilled staff our traditions of good governance etc. Goddamit, the name itself "Anglo Irish Bank" smacks of a probity and solidity backed by the country itself and possibly with a hint that it had the backing of our neighbour as well. Our regulator allowed this very pompous deception to be the front for the greatest and worst run casino the world has ever known.

The depth of this infamy was manifested on our national day in 2008. Real professional gamblers spotted the Anglo amateur and greedy versions for what they were and were dumping everything Anglo Irish. Our Regulator stepped in and lambasted this iniquitous plot by short selling hedge funds for trying to undermine those wholesome honest folk down at Stephen's Green. He also issued a statement to any bondholders that might be getting a bit queazy, reassuring them that everything was solid as a rock in that institution. The bondholders were naive, unlike the hedge funds, and swallowed these official reassurances hook, line and sinker.

And you want to blame the foreigners for being so gullable as to fall for this massive fraud which was aided and abetted by the Irish State.

 

[Jim2007]

The part that I have a hard time getting my head around is the idea that people have that they can just cut the banks free and there will be no consequences to them...

As many people have pointed out the banks are private companies, so we're not talking about the typical default of sovereign debt. So presumable the creditors will go to court and have a liquidator or receiver appointed...

Now the liquidator/receiver's responsibility is to gather as much cash as possible for the creditors and here is how I'd expect he would go about it:
- Freeze all deposits and check which customers have got banking conditions allowing the bank right of offset: then keep the cash!
- Foreclose on all the loans etc... for whatever I can get
- Dispose of very bit of property I can lay my hands on for what ever I can get!

The consequences for such action would result in:
- The depositors will get to test how got the government guarantee is
- Businesses will loose their source of finance and have to close pushing up unemployment
- Just how much equity will be left in property is a very big question?
- Little or no banking system left
- Zero credibility to start again

And all of this would just be the local issues, we have not even got started on the international stuff!!!

I think anyone who expects the creditors to stand by, while we walk away with their cash, is going to be in for a very sharp awakening!

I would love to see the detail plan of how one pulls the plug on the banks (private companies) and walks away without consequences!

Jim.

 

[Smart_Saver]

And you want to blame the foreigners for being so gullable as to fall for this massive fraud which was aided and abetted by the Irish State.

I don't want them to take the blame - but I do want them to share the pain. Why should I take all the pain when I was not to blame one bit either ?

 

[Jim2007]

The EU has no business telling us to destroy our country by putting gamblers first, gamblers who understood the rules as surely as I understand the rules when, after passing age and identify verification I enter a casino and put my hard earned cash on the roulette wheel.

Do you actually know any of the bond holders??? Over the weekend I was listening to a program on German radio and it appears that the German Landesbanken are heavily invested in the PIGs, mainly Ireland. Now these banks are basically local government run banks, they offer various savings products, manage local pension funds and so on.... These banks are some of the institutions who hold Irish bank bonds!

So as you can imagine, the German Chancellor would have a hell of time trying to explain to the German taxpayer why they should put more money in to bailing out Ireland, while at the same time their savings and pensions were going up in smoke!!!

Although French pension funds are trying to keep very quiet about their situation, it is believe that they are also very exposed to the PIGs

So yes the EU has every right to insist that we meet our obligations, we took their pension funds and savings while all the time claiming it was being invested in a low risk manner!

Jim.

 

[Duke of Marmalade]

I don't want them to take the blame - but I do want them to share the pain. Why should I take all the pain when I was not to blame one bit either ?

Fair point.

 

[Chris]

It is complete rubbish. The problem I have with McWilliams is that he is actually a clever guy who knows better. I would almost be suspicious that he might be looking at a political career!

I completely agree, which is why I have come to ignore his commentary.

It is somewhat disingenuous to categorise senior bondholders as gamblers. They advance funds at modest rates on the presumption (admittedly, sometimes mistaken) that their investment is safe. They are on a par with ordinary Joe Soaps who have their savings on deposit.

The gamblers are the subordinated bondholders, who invested for a higher return, but accepted more risk as part of the deal.

I agree that senior bond holders are not gamblers, but the problem is that they have come to exist in a financial world where implicit and explicit government guarantees make them completely ignorant of and oblivious to the risks that are involved even when lending to governments and "Blue Chip" banks. To a bond holder it didn't matter if they invested in Anglo Irish or AIB or Santander or the Dutch government; it was all Euros implicitly backed by governments and the ECB, which is why for most of the 00s there was very little difference in the interest rates.
If this guarantee were not there, senior bond holders would have to look into the institutions they invest in more carefully and demand more adequate interest for higher risks, thereby keeping a check on risk appetite. In the case of Anglo they would have seen large exposure to real estate and construction (I believe the figure is 80%). The question then would have been whether this was risky or not to the potiential bond holder, rather than completely ignoring the underlying use of the provided credit.

Back in 2008 [broken link removed] yet yesterday he joins the bandwagon to say how foolish it was:...

Very well spotted. To add to this, I met McWilliams in Kilkeny in November and asked him straight out, given a likely IMF/EU bailout and possible default, did he still think that his idea of a total guarantee was a good one. He ranted on about Lenihan being an idiot for about a minute when I repeated my question (not that I necessarily disagree with him about Lenihan). He continued very much like a poilitician in avoiding a direct answer and concluded that the problem was that under the guarantee banks were allowed to swap long dated for shorter dated debt. Basically a lot of back tracking and finger pointing.

The part that I have a hard time getting my head around is the idea that people have that they can just cut the banks free and there will be no consequences to them...

As many people have pointed out the banks are private companies, so we're not talking about the typical default of sovereign debt. So presumable the creditors will go to court and have a liquidator or receiver appointed...

Now the liquidator/receiver's responsibility is to gather as much cash as possible for the creditors and here is how I'd expect he would go about it:
- Freeze all deposits and check which customers have got banking conditions allowing the bank right of offset: then keep the cash!
- Foreclose on all the loans etc... for whatever I can get
- Dispose of very bit of property I can lay my hands on for what ever I can get!

But a liquidation doesn't necessarliy mean a sell off into tiny pieces as you describe. The first thing a liquidator would attempt is to try and find a buyer for the whole organisation. In the case of the Irish banks it would probably involve a nominal price of €1. Of course only a company which had enough capital to inject would be able to do such a thing.
The other option would be to split the bank into investment and retail banking and sell these assets off seprately. Only after such steps have failed would a liquidator be forced to sell off in tiny pieces.

The consequences for such action would result in:
- The depositors will get to test how got the government guarantee is

Which is exactly zero in the first place. It can never be honoured which is why so much money is leaving the country.

- Businesses will loose their source of finance and have to close pushing up unemployment

Not if the banks are sold off to foreign banks. Bankrupt organisations generally do not disappear from the face of the earth.

- Just how much equity will be left in property is a very big question?

Not sure how this directly links to liquidation of the banks, but artificially propping up real estate prices is of no benefit, quite the opposite.

- Little or no banking system left

Again, this is not a likely outcome when banks are sold off.

- Zero credibility to start again

I assume you mean in the sense of ability of the government to borrow money. This would be one of the biggest benefits of a default. The reason the country is in such a mess is because too much money was borrowed publicly as well as privately. If the government cannot borrow then that is a good thing for the financial state of the country.
Apart from that, the lost credibility would be very very short lived, as recent experiences in Argentina's default have shown.

 

[Duke of Marmalade]

He continued very much like a poilitician in avoiding a direct answer and concluded that the problem was that under the guarantee banks were allowed to swap long dated for shorter dated debt.

That is a very serious allegation and almost certainly McWilliams making it up on the hoof. So we are meant to imagine that banks having previously raised long bond funding went to these bondholders and said "you can swap your long bonds for short ones so as to enjoy the guarantee". This would be a totally unnecessary move by the banks, damaging to ther balance sheets and worse, if ever found out, that would be deliberate treason.

 

[Jim2007]

But a liquidation doesn't necessarliy mean a sell off into tiny pieces as you describe. The first thing a liquidator would attempt is to try and find a buyer for the whole organisation. In the case of the Irish banks it would probably involve a nominal price of €1. Of course only a company which had enough capital to inject would be able to do such a thing.
The other option would be to split the bank into investment and retail banking and sell these assets off seprately. Only after such steps have failed would a liquidator be forced to sell off in tiny pieces.

Not if the banks are sold off to foreign banks. Bankrupt organisations generally do not disappear from the face of the earth.

Again, this is not a likely outcome when banks are sold off.

I don't believe anyone has an interest in doing so! First of all, all the the major banks have suffered serious losses of capital and are now trying to raise capital to meet Basel III requirements - last estimates I saw was that this would take about 3 years and as a result banks have stopped paying dividends and started to reduce their exposure, so the last thing they need now is to start trying to recapitalize an Irish bank.

Then there is the issue of exposure - there is no way of knowing what kind of exposure you would be taking in buying an Irish bank.

As regards Investment banking, the numbers have been very bad here for some time now and most banking are downsizing their offerings in this area, so why buy another?

And of course there is the question of profitability.....

I expect the CEO of a foreign bank would have a hard time getting his shareholders to go along with such an action.

I assume you mean in the sense of ability of the government to borrow money.

No actually I was talking about how to you start to but a new banking system in place, how to you get the public to place money on deposit etc....

Apart from that, the lost credibility would be very very short lived, as recent experiences in Argentina's default have shown.

I would suggest we are taking about to very different things here, in the first place Argentina was a sovereign default, where as we are talking about private banks defaulting and secondly at that time not all financial institutions were impacted by the default - there were several institutions that were willing to step up for round two. Today we are in a situation where all major banks have been hit with capital losses of one type or another, so it is hard to see where the cash will come from in the short term.

Jim.

 

[spreadsheet]

I've mixed opinions on DmcW. I've been reading him for 10 years and got bored many times as he rolls out the same 20 articles with different first paragraphs year after year.

But now the fact that he has been repeating the same stuff for so long is actually making him more credible.

Of course he has to be sensational. He's not a reporter. He writes the Indo articles to 'sell' the paper. He's supposed to get people talking and therefore has to say something that hasn't been said before.

So whats wrong with his 10 point plan getting us talking? Very few others have a clue what we are going to do.

We cannot pay this debt.

Our current plan is not working.

If we don't start getting moving on a radical plan we agree on, we risk having a radical plan forced on us.

 

[Chris]

That is a very serious allegation and almost certainly McWilliams making it up on the hoof. So we are meant to imagine that banks having previously raised long bond funding went to these bondholders and said "you can swap your long bonds for short ones so as to enjoy the guarantee". This would be a totally unnecessary move by the banks, damaging to ther balance sheets and worse, if ever found out, that would be deliberate treason.

In defence of McWilliams I don't think he was pointing at such a sinister situation, but rather that maturing bonds that were originally long dated were then replaced with either short dated bonds or direct overnight funding from the ECB, and that any additional funding needed was short dated so as to be covered by the guarantee. But it would be intersting to see how much the debt terms have reduced by in recent years.

I don't believe anyone has an interest in doing so! First of all, all the the major banks have suffered serious losses of capital and are now trying to raise capital to meet Basel III requirements - last estimates I saw was that this would take about 3 years and as a result banks have stopped paying dividends and started to reduce their exposure, so the last thing they need now is to start trying to recapitalize an Irish bank.

I see where you are coming from, but I would not be as pessimistic as you. There are plenty of banks around the world that did not suffer losses on a large scale, especially Asian banks. Also, while the scale of the necessary recapitalisation in Ireland is huge for a small country, the amounts are relatively small for some of the large international banks.

Then there is the issue of exposure - there is no way of knowing what kind of exposure you would be taking in buying an Irish bank.

Yes indeed, that is a huge problem, but I don't believe that a liquidation process would not succeed in finally dismantling the mess created.

As regards Investment banking, the numbers have been very bad here for some time now and most banking are downsizing their offerings in this area, so why buy another?

And of course there is the question of profitability.....

I expect the CEO of a foreign bank would have a hard time getting his shareholders to go along with such an action.

That is true, and it may well turn out that the whole investment banking section does end up as a write off. But rather than have the public on the hook for this it would make sense to at least try and sell it off at whatever price possible.

No actually I was talking about how to you start to but a new banking system in place, how to you get the public to place money on deposit etc....

OK, I see what you mean. If it were easier and less costly to set up banks from a regulatory point of view I believe that you would very quickly be able to see completely new small banks created. However, I don't believe that there is any interest in making the financial industry more accessible to new competition. This would mean that credibility would hinge on the foreign banks buying up banking assets.

I would suggest we are taking about to very different things here, in the first place Argentina was a sovereign default, where as we are talking about private banks defaulting and secondly at that time not all financial institutions were impacted by the default - there were several institutions that were willing to step up for round two. Today we are in a situation where all major banks have been hit with capital losses of one type or another, so it is hard to see where the cash will come from in the short term.

Jim.

Yes, it does look like we were talking about two different things. And indeed, the global situation at the moment is very different to what it was when Argentina defaulted, which certainly complicates things. Nevertheless, the Argentine experience sheds some light on how bond holders would actually behave. I believe that Argentina defaulted to the tune of 30c on the Dollar, and at the time the international commentary was that Argentina would never again be able to borrow money. But within months of the default bond yields started going down again. Yes, the old bond holders were very annoyed, and probably didn't invest more money; but new bond holders saw a country that now had managable debt levels and therefore were willing to lend to them.
As for where the money will come from, I would reiterate that the amount of money needed is rather small on a global banking scale, and would be even smaller once some of the debt is defaulted on.
Just want to add that my scenario does not mean it would be easy. Ireland has a massive banking and sovereign debt problem, and there simply is no silver bullet that will result in a pain free solution. But any solution that takes the next two generations off the hook is better than a government intervention solution.

 

[Sunny]

Nevertheless, the Argentine experience sheds some light on how bond holders would actually behave. I believe that Argentina defaulted to the tune of 30c on the Dollar, and at the time the international commentary was that Argentina would never again be able to borrow money. But within months of the default bond yields started going down again. Yes, the old bond holders were very annoyed, and probably didn't invest more money; but new bond holders saw a country that now had managable debt levels and therefore were willing to lend to them.
As for where the money will come from, I would reiterate that the amount of money needed is rather small on a global banking scale, and would be even smaller once some of the debt is defaulted on.
Just want to add that my scenario does not mean it would be easy. Ireland has a massive banking and sovereign debt problem, and there simply is no silver bullet that will result in a pain free solution. But any solution that takes the next two generations off the hook is better than a government intervention solution.

That is a huge simplification of the impact of the Argentinian default. Argentina still does not have normal access to international capital markets 9 years after defaulting. There are no new bondholders. They are still trying to solve the default and still face numerous lawsuits and only in the past couple of months have they reached some sort of agreement with the Paris club nations.

 

[shnaek]

That is a huge simplification of the impact of the Argentinian default. Argentina still does not have normal access to international capital markets 9 years after defaulting. There are no new bondholders. They are still trying to solve the default and still face numerous lawsuits and only in the past couple of months have they reached some sort of agreement with the Paris club nations.

And they are pretty poor over there now. Don't get me wrong, I love it over there, but they are a hell of a lot poorer now than they were 10 years ago.

 

[Sunny]

And they are pretty poor over there now. Don't get me wrong, I love it over there, but they are a hell of a lot poorer now than they were 10 years ago.

Exactly. And they also had a huge currency devaluation, massive inflation and huge increase in unemployment and over 50% of the population went under the poverty line after the default. Agree though that it is an amazing Country. Any Country that can produce those steaks and wine will survive!

 

[Chris]

That is a huge simplification of the impact of the Argentinian default. Argentina still does not have normal access to international capital markets 9 years after defaulting. There are no new bondholders. They are still trying to solve the default and still face numerous lawsuits and only in the past couple of months have they reached some sort of agreement with the Paris club nations.

I don't believe it is a simplification, but as I said before, default is not an easy way out, but it is better than condemning the next two generations to debts built up in a couple of years.

Argentina does have new bond holders, and there have been many over the past years. But you are right in that Argentina hasn't gone to the money market, but they were not able to do that at the time of default either.
Argentina realised at the end of 2001 that default was the only option. But it took until 2005 to finalise the debt restructuring (at least a large portion of it). In 2002 the bond yield hit about 50%, but once details of the default started emerging the rate plummeted down again, with the yield going below pre default levels. At this stage Argentina's bond yield is lower than Ireland's.

In 2005 the default was seen as a success: http://www.economist.com/node/3715779
More dificulties arose that were to an extent separate to the 2001 default, and the global debt crisis also added problems.

Bottom line is that Argentina is in a far far better position because it faced up to the fact that it could no longer service the debts. They probably could have done a better job at managing the default and reducing the time it took, but the benefits would be the same for Ireland.

However, should a drop in bond yields not happen after a default in the short or medium term, then this would be a good thing, as the aim of a default is to bring debt to a manageable level, not to go and borrow more.

 

[Chris]

And they are pretty poor over there now. Don't get me wrong, I love it over there, but they are a hell of a lot poorer now than they were 10 years ago.

But all that debt would only have added to the economic woes and the level of poverty.

Any Country that can produce those steaks and wine will survive!

Ireland produces some great steaks too, maybe the solution to our problems is a lack of wine production ;-)

 

[Duke of Marmalade]

In defence of McWilliams I don't think he was pointing at such a sinister situation, but rather that maturing bonds that were originally long dated were then replaced with either short dated bonds or direct overnight funding from the ECB, and that any additional funding needed was short dated so as to be covered by the guarantee. But it would be intersting to see how much the debt terms have reduced by in recent years.

Then he was making a nothing point. Of course any temporary guarantee on new moneys is going have the effect that all new moneys will seek to avail of the guarantee. The ELG scheme attempted to lengthen the profile somewhat. A big criticism of the original guarantee was that subbies were included. How do these critics explain then why not a single subbie was issued since the guarantee was introduced?

 

[Chris]

Then he was making a nothing point. Of course any temporary guarantee on new moneys is going have the effect that all new moneys will seek to avail of the guarantee. The ELG scheme attempted to lengthen the profile somewhat. A big criticism of the original guarantee was that subbies were included. How do these critcis explain then why not a single subbie was issued since the guarantee introduced?

I absolutely agree, the point he was making was purely a defensive statement. He was not too eager to engage in a conversation about the matter either.

 

[Sunny]

I don't believe it is a simplification, but as I said before, default is not an easy way out, but it is better than condemning the next two generations to debts built up in a couple of years.

Argentina does have new bond holders, and there have been many over the past years. But you are right in that Argentina hasn't gone to the money market, but they were not able to do that at the time of default either.
Argentina realised at the end of 2001 that default was the only option. But it took until 2005 to finalise the debt restructuring (at least a large portion of it). In 2002 the bond yield hit about 50%, but once details of the default started emerging the rate plummeted down again, with the yield going below pre default levels. At this stage Argentina's bond yield is lower than Ireland's.

In 2005 the default was seen as a success: http://www.economist.com/node/3715779
More dificulties arose that were to an extent separate to the 2001 default, and the global debt crisis also added problems.

Bottom line is that Argentina is in a far far better position because it faced up to the fact that it could no longer service the debts. They probably could have done a better job at managing the default and reducing the time it took, but the benefits would be the same for Ireland.

However, should a drop in bond yields not happen after a default in the short or medium term, then this would be a good thing, as the aim of a default is to bring debt to a manageable level, not to go and borrow more.

Argentina has not sold international debt in almost 10 years and they were legally blocked from doing so since 2005. Also they didn't finalise the debt restructuring in 2005. They are still in negotiations and are still being sued. They issued local bonds domestically and got a few billion from Venezuela in private placements. They do not have access to the markets although they hope to get back into them this year because they need them again.
Countries recover from default but it doesn't happen within one or two years and there is huge pain. Especially when it is a Country like Ireland that investors don't give a damn about in the grand scheme of things. Its a lot easier to forgive Countries like Russia and Argentina with huge natural resources than a little Island in the Atlantic on the outskirts of Europe.

By the way, I remember reading articles from the Economist pointing out the damage that was done because of defaulting. They are fond of contradicting themselves!

 

[Duke of Marmalade]

I would almost be suspicious that he might be looking at a political career!

You read it first here folks on AAM. According to the Sunday Tribune McWilliams is going for election in Dun Laoghaire. If successful, watch for the slow deterioration of the drainage system in that neighbourhood.