Isn't the 400 billion an illegal subsidy?

[sfag]

I've listened to radio commentary on the proposed Irish Government 400 billion banking guarantee but there’s not much mention of possible downsides.

I have to admit I'm puzzled?

Q1. As it is tantamount to subsidized insurance for Irish banks only doesn’t that amount to an illegal subsidy. Wont the EU rule accordingly. - What will be the consequence of this?
Q2. How can overseas owned banks now compete? Surely there will be a transfer of business to the Irish banks from the non Irish owned banks?
Q3 As some of the banks sell insurance wont this give them an unfair competitive edge over ordinary insurance companies. Eg – whats to stop banks transferring bad debts or even costs to those categories guaranteed by the Government. What’s to stop it?
Q4. Will the banks now write down their builders loans (25 billion). Will the government compensate for any losses incurred?. Will these losses include all the extravagant charges they would have enjoyed before hand. Will they start reprocessing housing estates and selling on non secure in the knowledge that any price – no matter how low – will be topped up by the government. How does the government decide the true cost of these assets.
Q5. Cant the banks go back to relaxed lending again since the risk is now removed and the only barrier is an ineffective banking watchdog. Wont that stop the house price drop from now on.
Q6. The government is hoping they will not have to payout but surely the losses are already there. The instant bill could be 12.5 billion if the unsold houses realise half of their original inflated value. How much of a hit can the government take on this?
Q7. Isnt it glib to offer this insurance in the vain hope that they will not have to pay out. Isnt that what AIG were doing?
Q8. Is the Irish banking system now effectively part nationalised.?
Q9. If it was so easy then why didn't other countries do it?
Q10. Isn't any hit by the government mena the economy will incur more taxes to pay the bill thus prolonging any economic recovery. How is this going to save us?

 

[Duke of Marmalade]

A bit of a George Lee rant there sfag. A couple of clarifications are needed:

1. A 12.5M asset write down/loss would not invoke the Government guarantee, as the capital base of the banking industry is much higher than that.

2. The main incentive driving bankers and the rest of us is the desire to make money. A fire sale of housing assets would hit the banks' shareholders/executives hard but would not invoke the guarantee (see 1 above).

3. The profit motive is the main control on reckless lending, I can't see how this guarantee in anyway encourages reckless lending.

4. Most of your questions have a superficial basis but your Q3 on the advantage conferred on bancassurance subsidiaries seems to have no basis whatever, perhaps you can elaborate.

5. Q9 is the most meritorious of your queries. Why indeed have other countries not done this. Maybe some will, but Ireland is uniquely placed just to get away with it. We are just about getting away with it on the EU competition front in a way the larger countries would not. The UK would probably see sterling plummet. Germany, France etc. could precipitate a similar fall in the euro. But Ireland has the shelter of the euro without being large enough to damage it. This move would have been disastrous for an independent punt.

In short, brilliant move Brian and Brian.

 

[z109]

I am puzzled too. I don't know the answers to your questions, but they are all good. The Irish government has indemnified anyone who wants to put their deposits into an Irish bank against loss. That is, anyone in the world - individual or company. I know of no other scheme that guarantees company deposits - they are far too big.

On the competition issue, the BBA in the UK have already launched a complaint to Europe. Gordon Brown was clearly furious on the news last night. Neelie Kroes didn't sound best please either.

On the AIG issue - yes, the Irish government has just written a massive credit derivative swap for the Irish banks. It is an unlimited (by cost) contract only limited by time. They have become the biggest monoline insurer remaining in the world (all the others have gone bust or effectively bust).

The cost of insuring Irish sovereign debt has doubled (from 0.3% to 0.6%). This is more than McWilliams was suggesting they charge for the insurance (he was suggesting 0.25% - so as a nation we would already be losing from the transaction).

And much, much more.

Quite frankly, I am a little bit afraid.

 

[room305]

Quite frankly, I am a little bit afraid.

That makes two of us. When I first heard of the plan I thought the government had collectively lost their mind.

Opinion seems to be firmly divided between this being a stroke of absolute genius by Lenihan or the kind of drunken 3am all-in bluff on low single digit off-suit cards that sees you waking up wondering how the hell you ended up losing the car.

Time will tell I guess but nothing I've heard from senior government officials has led me to believe this wasn't conjured up as a panicked 5am solution to the crisis.

 

[Afuera]

On the competition issue, the BBA in the UK have already launched a complaint to Europe. Gordon Brown was clearly furious on the news last night. Neelie Kroes didn't sound best please either.

It's easy to see why the British would be furious with the Irish guarantee but from what I can tell it looks like it falls well within the rules of what is permitted by the EU regulations on competition. Under those rules the state is allowed to intervene and support an entity or entities for two reasons. One is in the case of an emergency and allows intervention for a period of no more than six months. The other is in the case of a restructuring and has a two year time limit. The British government used both these clauses themselves to rescue Northern Rock, first as an emergency case and currently as part of a restructuring plan. The only problem the Irish government may face might be due to a technicality of not following the correct procedures for implementing their plan or notifying all relevant parties. They will also need to show some sort of restructuring plan such as increasing the deposit/lending ratio of the banks to give it more credibility but all things considered it looks pretty sound.
Having said that whether the plan will actually work or not is still quite a large gamble. If a lot of British consumers move their deposits to Irish institutions and the government is able to lay down strict regulations that reign in risk taking by the banks it would certainly strengthen the Irish banks at the expense of the British ones. If this doesn't happen though and an Irish bank ends up going to the wall it's going to really hurt the Irish tax payer. Personally I think the gamble may be worth it but I certainly have some reservations about how well it will actually be executed.

 

[sfag]

So it looks like Investors aren’t impressed with our state guarantee.
What do they know that we don’t.
Surely this must mean the asset write down/property repossession is going to begin.
But why the continuing sell off – aren’t the banks covered against any loss. Or is the government guarantee not all it seems? Perhaps Europe will stop it?
Any rumours anybody?

 

[sfag]

Actually - I'll part answer one of the questions my self. Have just heard on the radio that the terms of the guarentee are not yet established and that the EU are sounding more favourable on it - which can mean only one thing - its not the guarentee they originally promised.

 

[Duke of Marmalade]

But why the continuing sell off – aren’t the banks covered against any loss?

I think you are misunderstanding this guarantee, sfag. The banks are totally exposed to their losses until the shareholder equity runs out, as is always the case with a limited liability company. It is the depositors who are guaranteed against losses after the shareholders have been wiped out. This is not a silver bullet to bank profitability, but it did stave off immediate collapse by restoring some sort of confidence.

However, it is worrying that bank shares seem subject to some strong law of gravity here. First the "shorties" were sent to the sin bin, and we got a 30% boost, only to be wiped out in a short space of time. Then we got the government guarantee. Another 30% boost, but now after an even shorter honeymoon period they have fallen back to their lowest levels. What further rocket fuel is left? And what about when them shorties get outa the sin bin?

 

[z109]

Actually - I'll part answer one of the questions my self. Have just heard on the radio that the terms of the guarentee are not yet established and that the EU are sounding more favourable on it - which can mean only one thing - its not the guarentee they originally promised.

The Danes seem to be charging a much higher rate for their guarantee than our government (I can't remember the figure I read and don't want to put the wrong one down). Is it likely that the EU will set a tariff for these schemes?

 

[sfag]

thanks for that clarification duke.
However the media reported this initially as being a guarentee against all deposits and loans - and not "just depositors who are guaranteed against losses after the shareholders have been wiped out."

Are you saying the bank has to go bust before the guarentee kick ins?.
In which case how can that protect the Irish Banking system?.
Isnt the problem that real value of the bank assets combined will eventually be worth less than their debts.
Wouldn't we be left with no banks?

 

[Duke of Marmalade]

sfag the move was to improve the liquidity of the banking system by assuring depositors/wholesale funders that, come what may, the Irish government will see them okay.

It was not a guarantee to banks that, come what may, they will be protected from too many bad debts or insolvency.

 

[MichaelDes]

sfag the move was to improve the liquidity of the banking system by assuring depositors/wholesale funders that, come what may, the Irish government will see them okay. It was not a guarantee to banks that, come what may, they will be protected from too many bad debts or insolvency.

Students in the future will study these events with incredulous disbelief.

Currencies need to be pegged again and have value. FIAT could never work again in my opinion given the sheer complexity and scale of the money markets. But neither will the same system of selling IOU petrodollars and IOU bonds to the Chinese.

 

[MichaelDes]

First the "shorties" were sent to the sin bin, and we got a 30% boost, only to be wiped out in a short space of time. Then we got the government guarantee. Another 30% boost, but now after an even shorter honeymoon period they have fallen back to their lowest levels. What further rocket fuel is left? And what about when them shorties get outa the sin bin?

It seems now the dead cat bounce lasts only 30 hours rather than 30 days.

Banning shorties was a mistake - Dominic Frisby had a good piece on this recently in Moneyweek. How the short-selling ban could backfire on the banks By [broken link removed]

Cgnao from GEI and HPC.co.uk hits the nail on the head

A poster on the Global Edge Investors discussion board who goes by the name of Cgnao spelled out a possible road map brilliantly and I reprint this with his permission:

1) Short sellers are mostly hedge funds and other highly leveraged speculators, betting using borrowed money.
2) They went short because they anticipated bank failures and they were making huge profits because they were right.
3) Central banks and governments step in and change the rules.
4) Regardless of fundamentals the shorts have to cover, sending shares of insolvent banks higher.
5) The general public believes the market has turned and buys those banks, sending shares even higher and hedgies' losses spiralling.
6) The huge losses the hedgies are taking make them default on their leveraged loans.
7) But think about it, who lent them the money? The same banks they were shorting!
8) More bank collapses follow. Investors get scared and dump their positions. No shorts left means no more short covering rallies and the ensuing crash is all the greater.

[broken link removed]

 

[Duke of Marmalade]

Another dose of rocket fuel, 1/2% cut in interest rates across the globe. This time there was no bounce left in that poor inanimate feline.

 

[z109]

Another dose of rocket fuel, 1/2% cut in interest rates across the globe. This time there was no bounce left in that poor inanimate feline.

Ah now, it lasted somewhere between 30 seconds and 30 minutes. BoI for example, sold at 4 euro (from it's price of 3.20 before the announcement) to close at 3. Now call me a cynic, but I think that someone was trying to rig the price by making a small purchase at an inflated level in the hope that it would set the new level. Or maybe I'm a cynic and there's a some investor who is going to be a little surprised that his small purchase of shares just happened to be at the high point for the day when his stockbroker calls...

(No interest in BoI and just using the share as an example).