Why we can't let the banks go bust

[DerKaiser]

This was an alternative proposal on another thread (off topic) as to how the govt should deal with our banking problems


What about this option:

1. don't renew the bank guarantee scheme in September 2010.
2. allow the banks to go bust if necessary
3. watch the shareholders getting burnt
4. watch the uninsured bondholders getting burnt
5. watch the cds writers getting burnt on covered bonds
6. payout deposit insurance for small depositors
7. allow large depositors to get pence in the pound for their deposits past 100k
8. everyone banks in future with NIB, Ulsterbank, Rabobank, Halifax etc

In this scenario, the state doesn't have to pay for the banks' mistakes beyond the agreed deposit insurance scheme.

Nobody loses who wasn't gambling themselves.

In the NAMA scenario every tax payer compensates the bondholders, shareholders and large depositors of the banks that were themselves limited companies. Now what about the taxpayer who simply wasn't involved. The man who didn't borrow money to bet on property, the man who didn't have 500k on deposit when only 18K was insured, the man who didn't invest in high yield bank shares, the man who didn't buy bonds from these crappy institutions - what about him?

I am sure I am missing something here. What is it?

I think there are many valid arguements here, the ones I have a problem with are as follows:

• Many ordinary people have more than €100k on deposit. Older people, for example, may have saved all their lives and plan to live off this money. It shouldn't be seen as a gamble to keep your life savings in a bank
• It has been shown that AIB and BOI are the only banks maintaining any flow of liquidity in this country. We cannot depend on foreign banks to supply us with credit, it is too big a risk

Other than that I think the point of bondholders and shareholders sustaining maximum losses possible is valid. If anything the international markets believe bondholders in Irish banks should be taking bigger hits.

Can we save the banks, maintain deposits but hit the sharholders and debtholders to the maximum extent?

 

[Sunny]

Shareholders and deeply subordinated debt holders have already been hit pretty hard. Targeting senior debt holders is more difficult because as senior unsecured creditors, they rank pari passu with depositors. Also, you would be shutting the banks out of the capital markets so where would they get future funding? Not to mention the knock on effect on Irish Government borrowing.
I don't understand what 'uninsured debt holders' are or what Credit Default Swaps on covered bonds have to do with anything.

The simple fact is that BOI and AIB are too big to fail. People really need to start accepting that. They might not like it but it is a fact of life. The other banks, we can argue about.

 

[Mpsox]

5 things spring to mind immediatly

1: Thousands of people (bank staff) would lose their jobs which is a significant cost to the state in terms of social welfare payments and lost taxes

2: Pension funds and investment funds would take a big hit over the write down of the value of their shareholding in the banks in question

3: None of the foreign owned banks have either the interest in lending or funds available to do so to the scale required to replace the big 2 banks. NIB are closing branches, BOSI contemplating pulling out, Ulster Bank seems to have stopped mortgage lending and is closing First Active,

4; They'd be a run of funds out of the country if it was thought this was going to happen

5; Ordinary depositers with funds in excess of €100k would be punished for playing it safe and not "gambling" with their money in investements instead of simply putting it in the bank.

 

[michaelm]

My understanding of the whole banking drama is fleeting (maybe naive). I would have thought that the banks of systemic importance were BOI and AIB and that the rest should be left to their fate. We seem to be borrowing money that the taxpayer will have to repay and pumping it into theses banks but we have little control over said banks. Also nationalising the banks exposes the taxpayer to a big downside.

Can someone tell why we couldn't have bought AIB and BOI when the shares were on the floor (for less than we recapitalised them with, I think) and had full control over the banks but had our liability limited to the cost of those shares?

 

[steviel]

My understanding of the whole banking drama is fleeting (maybe naive). I would have thought that the banks of systemic importance were BOI and AIB and that the rest should be left to their fate. We seem to be borrowing money that the taxpayer will have to repay and pumping it into theses banks but we have little control over said banks. Also nationalising the banks exposes the taxpayer to a big downside.

Can someone tell why we couldn't have bought AIB and BOI when the shares were on the floor (for less than we recapitalised them with, I think) and had full control over the banks but had our liability limited to the cost of those shares?

you are right that BOI and AIB are the only banks that we need to support the economy in the future. But if the others (Anglo, Irish Nationwide, IL&P) were let go, it would have been disastrous, as evidenced by the current ACC / Liam Carroll situation. Take Anglo, for example. If it failed, and a liquidator or examiner took over, they would have chased for repayment of tens of billions of euros of impaired loans through the courts, bringing down all the cross collateralised or otherwise linked companies of the big developers banked by AIB and BOI, in the same way as the ACC action is a threat to the orderly workout of the Carroll loans through NAMA. Commercial real estate prices would crash even further through the floor than they would otherwise do, AIB and BOI would fail outright and have to be fully nationalised, with larger losses (which have to be met by the taxpayer) and a bigger fallout to the economy.

Make no mistake, Anglo etc are not going concerns, and are not being run as such. The current situation just allows them to be wound down in an orderly way, minimising the wider impact. The 'short, sharp shock' of letting the banks fail, as advocated by some (including surprisingly naive professors at Trinity and UCD) would have been the biggest gamble imaginable, and there is no doubt in my mind that the IMF would now be running the country had this happened.

 

[TarfHead]

.. including surprisingly naive professors at Trinity and UCD

[Rant]
There is one of those individuals who makes me shout at the radio/TV whenever he pops up. He looks as if he only recently started shaving, yet pontificates about banks like he has a wealth of experience and wisdom. I never heard of him in the media until things started going south last year, and now he's never off it - a rent-a-quote numty.

"Those who can, do, Those who cannot, get a job as a XXXXXXXX of XXXXXX in xCD"
[/Rant]

 

[Brendan Burgess]

Hi TarfHead

I don't think that you are being fair

He has been quoted in the media as far back as February 2006.

[broken link removed]

 

[TarfHead]

Hi TarfHead

I don't think that you are being fair

He has been quoted in the media as far back as February 2006.

[broken link removed]

My bad - he evidently does has a track record of prescience !

Good spot Brendan - and there was me thinking I was being sufficiently vague about the subject of my rant

 

[PaulHoughton]

OK, thanks DerKaiser for opening this thread to discuss the question of why the mistakes of some privately owned limited companies must be redeemed by forcing every tax-paying Irish citizen to pay hugely increased taxes for greatly reduced public services for the foreseeable future. The alternative that I propose is that Irish banks should be allowed to fail because they are limited companies and anyone who lent them money had a chance to take that into account.

Just to remind ourselves of the scale of the exposure we are opening ourselves up to by sustaining these failed companies: the bank guarantee scheme is for 440 billion - 13 times annual tax revenue and clearly more than the state could ever hope to pay. The for Irish bank losses by the end of next year alone is €35 billion.

Let's see what we have...

I think there are many valid arguements here [..against allowing irish banks to fail...], the ones I have a problem with are as follows:

• Many ordinary people have more than €100k on deposit. Older people, for example, may have saved all their lives and plan to live off this money. It shouldn't be seen as a gamble to keep your life savings in a bank

When they placed their money in the bank only the first 20K was guaranteed by the state. They are doing very well to get 100K back (200K for a joint account). Everyone knows that AIB and BoI are limited companies with the chance of failure and the possibility that they will not be able to repay their lenders.

Placing money with a bank does incur a small risk in the same way that crossing the road incurs a small risk.

• It has been shown that AIB and BOI are the only banks maintaining any flow of liquidity in this country. We cannot depend on foreign banks to supply us with credit, it is too big a risk

Do you have a source for this? It has been suggested that most of AIB and BoI's stated new lending is in fact rollup lending and making new loans to cover loans that are due by borrowers likely to be bought out by NAMA.

Lending money is not an act of charity or patriotic duty, it is a business decision taken in self interest. Usury is not performed for the benefit of the borrower. Companies will lend to Irish customers if those customers are judged likely by the market to repay those loans with interest. There is a competitive international market for lending and if AIB and BoI stop lending to the Irish then Irish people will become willing to pay increasing amounts of interest to borrow and someone else will start to lend.

Can we save the banks, maintain deposits but hit the sharholders and debtholders to the maximum extent?

Shareholders are paid only after bondholders but, according to Sunny below, senior bondholders and depositors share losses equally.

Shareholders and deeply subordinated debt holders have already been hit pretty hard. Targeting senior debt holders is more difficult because as senior unsecured creditors, they rank pari passu with depositors. Also, you would be shutting the banks out of the capital markets so where would they get future funding?

The scenario we are discussing is one where insolvent banks are allowed to fail. Insolvent banks don't need future funding as they are dead.

Not to mention the knock on effect on Irish Government borrowing.

Is there a knock-on effect? is there not a difference between sovereign debt and limited company debt? Would you be more willing to lend to an Irish government that has guaranteed 440 billion euro of borrowings or an Irish government with the sense to allow limited companies to fail?

I don't understand what 'uninsured debt holders' are or what Credit Default Swaps on covered bonds have to do with anything.

In my simplistic understanding of bonds, there are some people who buy bonds and choose to insure them by purchasing credit default swaps at the same time. These are insured debt holders. They face no loss if the issuing institution defaults. They are repaid by the organisation that wrote the swaps. Is that right?

When I said covered bonds I meant bonds insured by CDSs. 'Covered bonds' is the wrong term.

The simple fact is that BOI and AIB are too big to fail. People really need to start accepting that. They might not like it but it is a fact of life. The other banks, we can argue about.

'Too big to fail' is a loaded phrase that implies that such a thing exists. In competitive markets, companies fail when they make stupid decisions in their allocation of resources. In this way their more efficient competitors are rewarded. The winner is the consumer. I am sick of hearing about the lack of credit available to Irish SMEs when I have spent the last 15 years competing against companies using endless credit as a substitute for profits.
What if AIB fails, in a short time, their branch network would be sold to someone less accident-prone, the signs would change to Santander or HSBC, the mortgage would be sold on. Same sh*t, different day from the consumer's point of view.

5 things spring to mind immediatly

1: Thousands of people (bank staff) would lose their jobs which is a significant cost to the state in terms of social welfare payments and lost taxes

Is it worth turning the populace to debt slavery and risking the solvency of the entire state for the sake of these employees? Company failure and consequent job losses are part of the natural order of free market capitalism. Attempting to preserve failing companies is unfair to competitors and sustains the inefficient allocation of resources that caused the failure in the first place.

2: Pension funds and investment funds would take a big hit over the write down of the value of their shareholding in the banks in question

Bank shares are already down 90-95% so there's not much further to go. The failure of a couple of stock market companies should not impact on a properly diversified investment fund.

3: None of the foreign owned banks have either the interest in lending or funds available to do so to the scale required to replace the big 2 banks. NIB are closing branches, BOSI contemplating pulling out, Ulster Bank seems to have stopped mortgage lending and is closing First Active,

I understand the foreign owned banks lack of appetite for competing in the Irish market as the Irish government appears willing to do anything to bailout their failing competitors. How would you feel if you were NIB in the face of such a policy?

4; They'd be a run of funds out of the country if it was thought this was going to happen

Is money on deposit in AIB or BoI really in Ireland? And if it is, does society benefit as a result? AIB and BoI are owned by international shareholders and institutions. Having loads of money on deposit in the past led to them making stupid lending decisions. Perhaps we would all have been better off if they'd had less money to lend?

5; Ordinary depositers with funds in excess of €100k would be punished for playing it safe and not "gambling" with their money in investements instead of simply putting it in the bank.

I've answered this previously above. 100K is not a pittance to be left with. The state guarantees an income for the old. Caveat emptor. The alternative punishes the poor and the innocent, the uninvolved, the people with no assets.

 

[DerKaiser]

Is money on deposit in AIB or BoI really in Ireland? And if it is, does society benefit as a result? AIB and BoI are owned by international shareholders and institutions. Having loads of money on deposit in the past led to them making stupid lending decisions. Perhaps we would all have been better off if they'd had less money to lend?.

Yes, it is there to back the supply of credit vital to maintain business in this country. A lot of this cheap credit was directed towards an overheated propery market, in this sense there was too much credit, but we now have the problem of well run businesses being choked of credit, and this is very very bad for employment and enterprise.

I've answered this previously above. 100K is not a pittance to be left with. The state guarantees an income for the old. Caveat emptor.

I still beg to differ here. There are plenty of retired people who'd have larger sums on this on deposit that they've spent their entire working lives building up. If they live another 25 years, €100k provides a fairly limited addition to their old age pensions.

I think it's worth paying a price to protect a system that allows people sleep easily in the knowledge that their life savings are secure and a system that keeps businesses running through a steady supply of credit.

Certainly €440m would be too high a price, but that is a total exposure figure and bears no relationship to what the true cost to the tax payer will actually be after sharholders and subordinated debt holders have taken their losess

The alternative punishes the poor and the innocent, the uninvolved, the people with no assets.

The situation I find disturbing is this.

We've had 10 years of almost full employment. There is a section of society who would otherwise have been on the dole all their lives who have worked and provided for themselves and now find they are out of a job with mortgages to pay off (they'd have been better on the dole with a council house).

Consider also people who have worked hard and saved all their lives who would lose much of their savings if banks went bust.

People are not stupid, they respond to incentives. If we say screw the people with houses and savings we are sending out a strong signal that honest effort and looking to improve your lot through hard work is to be punished in this country. I think sometimes the people who view themselves as champions of the poor forget that rewarding honest effort and seeking maximum possible employment is by far the best way of getting people out of the poverty trap.

 

[Duke of Marmalade]

Placing money with a bank does incur a small risk in the same way that crossing the road incurs a small risk.


'Too big to fail' is a loaded phrase that implies that such a thing exists.

You are misinterpreting this phrase. Of course banks aren't too big to fail, haven't they proved that in spades. But some are too big to be allowed fail. And that is not because it would be unfair on staff, unfair on depositors who trusted their banks with their savings, unfair on bondholders who supported the Irish economy. Not for any of these moralistic reasons but solely because they are "systemic", that's the word, to our whole economic survival.

The only similarly systemic enterprise I can think of is the ESB. If the ESB made one holy mess of their finances, say buying up all the damns in Africa or whatever, and was hopelessly insolvent I am afraid the State would have to bail it out in a similar fashion. Or would you be suggesting that a minimum power facility should be maintained to let ordinary folk boil a daily cup of tea, but let the rest of us fat cats with our dishwashers, and washing machines etc. be damned. After all we bought those appliances taking a risk that there would be a continually available power supply. If we take risks like that what can we expect.

 

[Mpsox]

I've answered this previously above. 100K is not a pittance to be left with. The state guarantees an income for the old. Caveat emptor. The alternative punishes the poor and the innocent, the uninvolved, the people with no assets.

What you are suggesting is punish the people who were prudent, who saved for a rainy day, who managed their affairs wisely so that they would not have to rely solely on the state to support them. These people should be applauded, not potentially punished.

 

[PaulHoughton]

A lot of this cheap credit was directed towards an overheated propery market, in this sense there was too much credit, but we now have the problem of well run businesses being choked of credit, and this is very very bad for employment and enterprise.

I don't understand this idea that credit will dry up. Is this not like saying that Irish people will have no more crisps if Tayto shuts down? We are living in an economic community of 500 million people with thousands of lending institutions of all sizes. The law of supply and demand dictates that they will sell credit to Irish people in the absence of local lenders such as AIB & BoI. Maybe they won't lend 100% LTV and 5x income for 40yrs at ECB + .5% but there is a market value for credit all the same.

I still beg to differ here. There are plenty of retired people who'd have larger sums on this on deposit that they've spent their entire working lives building up. If they live another 25 years, €100k provides a fairly limited addition to their old age pensions.

Yes it would be very sad but is it worse than recovering their losses from the rest of us and our children over the coming decades? In 2009 it is clear that trusting a large sum of money to any one Irish bank is stupid and dangerous. There are plenty of places to invest large sums of money other than dropping it in the local bank. Post office, AAA gilts, AAA foreign banks - spread it between several institutions. The state had a deal with depositors: only the first 20K was guaranteed.

We've had 10 years of almost full employment. There is a section of society who would otherwise have been on the dole all their lives who have worked and provided for themselves and now find they are out of a job with mortgages to pay off (they'd have been better on the dole with a council house).

Yes they are in negative equity and must slave to pay off their debts for many years. This will happen with or without the closure of the failed banks. In hindsight, the Irish state provided too many incentives to buy property: section 23, section 27, section 48, section 50, mortgage relief, allowing large multiples of salary to be lent out, overpaying public sector staff with consequent salary rises for private sector staff, reducing stamp duty, affordable housing schemes, co-ownership, local authority buyout... Living in a council house is not the only alternative to buying property, you can also rent. An alternative govt policy to promoting house ownership for all would be to promote long term residential rental leases and reduce the supply of state housing.

Consider also people who have worked hard and saved all their lives who would lose much of their savings if banks went bust.
People are not stupid, they respond to incentives. If we say screw the people with houses and savings we are sending out a strong signal that honest effort and looking to improve your lot through hard work is to be punished in this country. I think sometimes the people who view themselves as champions of the poor forget that rewarding honest effort and seeking maximum possible employment is by far the best way of getting people out of the poverty trap.

I see your point, but I think the alternative is worse. The signal we are now sending out is that if you lend money to private Irish banks and those banks then lose the money, that the state will compensate you by taxing the honest effort and hard work of a future generation of innocents. Incentives to work and to employ are created by low income taxes and low corporate taxes.

You are misinterpreting this phrase. Of course banks aren't too big to fail, haven't they proved that in spades. But some are too big to be allowed fail. And that is not because it would be unfair on staff, unfair on depositors who trusted their banks with their savings, unfair on bondholders who supported the Irish economy. Not for any of these moralistic reasons but solely because they are "systemic", that's the word, to our whole economic survival.

Is this not the same argument produced whenever a large irish owned employer is insolvent. Irish Steel, Irish Sugar, Waterford Crystal all too big to fail - but too crap to serve their customers profitably. I don't understand systemic risk although it has been often repeated since the blanket guarantee scheme. What is the systemic risk of Irish banks collapsing? The purpose of this thread is to try to answer that question.

The only similarly systemic enterprise I can think of is the ESB. If the ESB made one holy mess of their finances, say buying up all the damns in Africa or whatever, and was hopelessly insolvent I am afraid the State would have to bail it out in a similar fashion.

Utility companies around the world do go bust or are acquired or merged. When insolvent, their infrastructure and other assets are sold to a more solvent competitor who is still in business as a result of making smarter decisions in the past. If the ESB shuts I imagine I would be getting my electricity from Airtricity or Bord Gáis or Veolia or GE or from whomever acquires their assets from the liquidator. In the UK, for example, the cable TV operators regularly go bust and are then acquired by each other. Telewest was taken over by NTL and in turn NTL was taken over by Virgin.

I see this process of companies failing and their assets being acquired by new companies as healthy and an integral part of the capitalist system that has brought us ever improving consumer benefits.

I am not saying that I am sure that allowing Irish banks to fail is definitely the better option than saving them. I am not sure and I want to discuss it. We seem to be betting the entire economy on this policy. I am not sure that the various organisations that have promoted the bailout such as the IMF and OECD have the interests of Irish people at heart. Perhaps their primary concern is protecting the international bondholders.

If AIB and BoI had been bought by overseas banks a few years ago, then this situation would presumably not have arisen. We would never have tried to save a foreign bank, would we? In what sense are AIB and BoI irish? Their shares and bonds are held internationally. They happen to be headquartered here, does that make them Irish? They are listed on multiple stock exchanges. They have Irish staff but then so would any foreign bank that owned them. Should we allow institutions to operate in Ireland that are considered 'too big to fail', if their existence constitutes a threat to the viability of the state?

 

[Duke of Marmalade]

Okay, Paul, bad analogy with the utility company.

If we woke in the morning to hear that the ESB was insolvent, the lights would still be working and would continue to do so until someone took over the infra structure.

If we woke to find a leading retail bank was insolvent then all its services would cease, because its services are in effect its balance sheet. ATMs would have to be closed down - can't have creditoirs rushing to get ahead of others. Cheques would be worthless. Direct Debits would all cease to function. Credit cards would be useless. Not to mention the enormous wealth effect as 40% of the population suddenly find themselves potentially impoverished. Economic activity would be paralysed. And if one can be let go how long before the other goes? Panic, panic, panic. That's why the big banks are too big to be allowed fail. Not sure about the others.

 

[darag]

I would have a lot of sympathy for Paul's argument. But I have a fear that the shock of banks failing would cause huge economic damage. I'm not sure of the basis of this fear; Duke's picture is certainly a worst case scenario where banks would be allowed to suddenly fail. I can't imagine that, having accepted that the government were not going to take on all current and future retail banking losses, that they would at least ensure an orderly wind-down. If you were presented with what looked like a reasonable plan for the orderly wind-down of the insolvent banks, Duke, would you accept the idea of allowing the banks to fail, then?

I did a quick google on the effects of bank failures and what stands out is that most economists who have written on the subject distinguish two types of bank failure. One is caused by a panic and the other is caused by insolvency. I think that initially when this crisis (in Irish retail banking) started, the banks and the government repeatedly claimed that the reason for the stress in Irish retail banking was a type of panic (claiming liquidity problems) and not because they were insolvent - which everyone now agrees is the case. I at the time believed that only Anglo (and maybe IN) was insolvent and that the others were sound. That now is evidently not the case - most of the Irish banks are probably insolvent.

Most seem to agree that governments should help banks threatened by panics. However, many economists, like Paul, disagree that government should protect insolvent banks. Since, in the space of a year, we've established that the nature of the problem with the Irish banks is fundamentally different that what was first assumed, the argument that Paul makes is far more reasonable now than it would have this time last year.

 

[sunrock]

It would be so much simpler if the government nationalised the bankrupt banks, guaranteeing the safety of the deposits and the bond holders.Unfortunately the shareholders shouldn`t get anything as the banks are bankrupt.NAMA can then take the toxic loans of the banks on its books and dispose of the assets of these loans gradually over 5 years or sf course new regulations and personnel are needed at these banks and serious penalties for flouting the rules.

 

[PaulHoughton]

Okay, Paul, bad analogy with the utility company.

No, I think it's a good analogy. A bank, after all is just a private company with a bunch of assets that can be transferred in the event that it can no longer figure out how to continue as a going concern.

If we woke to find a leading retail bank was insolvent then all its services would cease, because its services are in effect its balance sheet. ATMs would have to be closed down - can't have creditoirs rushing to get ahead of others. Cheques would be worthless. Direct Debits would all cease to function. Credit cards would be useless. Not to mention the enormous wealth effect as 40% of the population suddenly find themselves potentially impoverished. Economic activity would be paralysed. And if one can be let go how long before the other goes? Panic, panic, panic. That's why the big banks are too big to be allowed fail. Not sure about the others.

I imagine there would be problems but I think these problems would be temporary. I think they would pale into insignificance compared to the pain we are planning to inflict on ourselves now and for the coming decades.

I don't know how old you are but we had a general bank strike about 40 years ago during which people wrote each other IOUs on bits of paper and society continued to function. ATMs did not exist at this time.

Going through the items you raise:
Cheques are orders made to your bank to settle a debt. If the cheque bounces then the debt remains. So if you receive a cheque from a debtor drawn on an insolvent bank, neither you nor your debtor has lost the money. You simply ask your debtor for another form of payment such as a promissory note or an IOU

Direct debits are simply instructions to a bank to allow a trusted creditor to withdraw money from an account. Direct debits fail all the time, for example when the customer closes the account or withdraws the direct debit instruction or simply repudiates the transaction. In this case, the creditor simply adds the amount due to the customer's balance and contacts the customer to arrange a new form of payment. Some utility companies have direct debit failure rates of up to 10% of monthly accounts so they're well used to it. I don't think they'd be very happy if their failure rate hit 80% one month but they's get over it. Few companies have more than a portion of their customer base on direct debit.

Credit cards: a large credit card customer base is a juicy asset. An insolvent bank would have no problem selling its credit card customer base to someone else. MBNA perhaps? Customers can easily switch credit card providers.

ATMs and debit cards: Nasty but short term problem. If an Irish bank shuts I guess you get your next pay cheque made out to NIB or the post office and use IOUs and barter until then.

'the enormous wealth effect as 40% of the population suddenly find themselves potentially impoverished' I think this is illusory. I've just had a look at AIB's latest balance sheet. The group has asets of 180bn. In the event of insolvency, Sunny says that senior debt and customer deposits share first dibs on assets. customer deposits are 83bn worldwide and senior debt is 12bn. So, I'm not sure that any customers would really be left short. It might take a while though.

More than 60 banks in the US have gone bust this year alone so there must be plenty of experience worldwide of bank liquidation.

It would be so much simpler if the government nationalised the bankrupt banks, guaranteeing the safety of the deposits and the bond holders. Unfortunately the shareholders shouldn`t get anything as the banks are bankrupt. NAMA can then take the toxic loans of the banks on its books and dispose of the assets of these loans gradually over 5 years or sf course new regulations and personnel are needed at these banks and serious penalties for flouting the rules.

Nationalising the banks would mean the taxpayer assuming all their liabilities in perpetuity. Why would we do this when the banks can legitimately fold and make their bondholders and shareholders pay. Buying a corporate bond is one step up from buying a share but it's still a gamble. Nationalised institutions are susceptible to low efficiency operation, political intereference, corruption and so on.

The IMF has a research paper carried out before the Irish banking crisis that summarises the methods uses to deal with 42 crisis episodes over the past 40 years in countries around the world. Bank closure is common. They also list the occasions when countries extended blanket guarantees to their banks and those crises that led to losses for depositors.

In their , they detail how 6 countries exited from their blanket guarantee schemes.

I guess whatever strategy we adopt has to find a balance between protecting depositors and protecting the future earnings of taxpaying citizens.

The last two budgets sought to raise tax revenue by less than 3 billion in 2009. Yet we have already shovelled 7 billion into Anglo. Is there anyone who believes this is anything but the tip of the iceberg of future cash burning exercises?

 

[Duke of Marmalade]

Paul, good reminder about the bank strikes. We could, I suppose, enter a barter phase until alternative money transmission arrangements were put in place. Probably result in a temporary further 10% fall in GDP but of itself not a compelling reason for a bail out.

No, one is reminded of the real reason by darag. This is first and foremost a liquidity crisis. We are told there is €440Bn at stake. After the initial run had been met by available liquid resources I would guess about €350Bn of deposits/bonds would be frozen, pending liquidation, by the time the banks closed their doors. With or without a government guarantee this would be sheer economic disaster. darag has pointed out that we now also potentially have a solvency issue, but even the most grim doomsayer puts this at no more than €20bn in excess of available capital. If the worst comes to the worst and over 10/15 years the taxpayer loses €20Bn that is far better than shutting down the system and leaving €350Bn frozen behind a liquidator's doors.

 

[darag]

Why should this be an all or nothing question?

If we could agree that some of the banks were clearly insolvent, then you could far easily accept Paul's arguments in favour of letting those ones go to the wall.

It seemed pretty clear to me even a year ago that Anglo was insolvent - having just 3 billion in equity on a 100 billion balance sheet where, I can't remember exactly, but about 60% or 70% of their assets comprised of property loans in the context of a collapsing property market and a general increase in the cost of credit.

Admittedly determining whether any enterprise is solvent is a little more complex and subjective as you must also consider whether you can expect profits in the future. An enterprise or bank may have zero or negative shareholder equity but still be solvent if it is generally agreed that they can generate profits to fill the gap.

Besides Anglo, the solvency of the other banks is not completely clear to me. It seems that AIB at least may be solvent with a 180 billion balance sheet but from what I recall they only have 5 billion or so shareholder equity? What is their property loan exposure? However I think that AIB possibly has the ability to generate profits in the future - from boring old retail banking - while Anglo, like Northern Rock, represents a busted business model that has no future even if they had a healthy balance sheet.

A bigger question is why is the government intent on applying an one-for-all and all-for-one approach? The original guarantee exasperated me at the time because of this when it seemed like a single solution was not appropriate for all the Irish banks. I am similarly skeptical about the NAMA plan because it represents a continuation of this crude policy. As Duke pointed out elsewhere in relationship to the valuation model NAMA, this is a very costly and completely unnecessary basis on which to derive policy.

I think Paul would do better arguing that there is no point in maintaining Anglo and that we should be planning to let them go bust. The others should be argued on a case by case basis. Arguing that they all should be let go bust on the basis of appealing to capitalist principles (while appealing to me personally) makes it sound like you are basing your policy on dogma while pragmatics should be the driving force of the argument.

Many people mention the Swedish response but I have to admit ignorance of the details of it. Through google I came across this article which contains excerpts from a speech given by the Swedish minister of finance at the time. It makes for great reading.

 

[PaulHoughton]

...darag has pointed out that we now also potentially have a solvency issue, but even the most grim doomsayer puts this at no more than €20bn in excess of available capital. If the worst comes to the worst and over 10/15 years the taxpayer loses €20Bn that is far better than shutting down the system and leaving €350Bn frozen behind a liquidator's doors.

Is it possible that the cost will far exceed 20bn? As previously noted, the IMF estimates Irish bank losses at 35bn by 2010 alone. I don't understand why the assets of an insolvent bank would spend long 'frozen behind a liquidator's door'. The banks assets are mostly virtual: certificates, deeds, bonds, mortgages. Tradable assets.

Why should this be an all or nothing question?

The truth always seems to lie somewhere in between.

Besides Anglo, the solvency of the other banks is not completely clear to me. It seems that AIB at least may be solvent with a 180 billion balance sheet but from what I recall they only have 5 billion or so shareholder equity?

I don't know how useful shareholder equity is as a measure of the strength of a bank. A large amount of uncollectable loans will give a high number for shareholder equity.

Here are some numbers from various banks for their ratio of equity to assets:
hsbc 6% (h1 09)
rabobank 5.8% (2008)
santander 4.8% (h1 09)
aib 4.4% (h1 09)
boi 3.6% (march09)
anglo 3.6% (sep-08)

I chose hsbc, santander and rabobank as the best I could think of.

However I think that AIB possibly has the ability to generate profits in the future

I think it's clear that they are continuing to produce very strong operational profits before provision for bad debts. It's just a question of whether their asset writedowns are too much to bear.

A bigger question is why is the government intent on applying an one for-all and all-for-one approach?

perhaps any other approach would be judged discriminatory and anti-competitive.

...there is no point in maintaining Anglo and that we should be planning to let them go bust. The others should be argued on a case by case basis.

As Anglo is now 100% state owned, allowing it to go bust is more difficult than when it was in private hands. I don't think that governments normally allow their limited semi-sate companies to shut down, leaving creditors short. As pointed out before, however, we no longer have much reputation to defend. The Economist has referred to Ireland as "Reykjavik on Liffey".

Arguing that they all should be let go bust on the basis of appealing to capitalist principles (while appealing to me personally) makes it sound like you are basing your policy on dogma while pragmatics should be the driving force of the argument.

Market economics is hardly some wacky ideology that may or may not work. 'Dogma' is just a pejorative term for somebody else's belief system. Market economics is indeed a dogma so long as you are an economist in Cuba or North Korea. For the rest of us it's like gravity or magnetism, just another force of nature that is neither good nor evil in itself.

There will always be a constituency pressing the state to save failed companies. It includes the directors, shareholders, bondholders, employees and their unions. Not heard so loudly are the competitors and consumers who are the big losers in any bailout.

The EU precludes state aid because it is the belief of the member nations that state aid is unfair to competing companies and consumers and ultimately punishes success and rewards failure. The individual governments are delighted to have their hands tied when asked to provide state aid because they know it is hard to deny but bad for society overall.

Sadly, EU countries decided to allow unlimited state aid for banks last year. And sadder still, Ireland stood to lose the most as a result.

In this part of the world, limited companies are so named because their directors and shareholders have limited liability for their debts. Essentially all limited companies hold an option to self destruct rather than pay their debts. Anyone who supplies credit to a limited liability company is granting an option not to be paid in the event of insolvency and that option is priced by the market and reflected in the cost of credit supplied to the company.

If we want banks with unlimited depositor protection then we should constitute them in this way and force them to insure these schemes on the open market. Or it could be an option for depositors to have an insured account or a higher interest uninsured account.

Another option would be to force irish banks in future to be constituted as unlimited liability companies. As such the shareholders might take a more conservative approach to risk.

As it stands we are setting ourselves up for this situation to happen all over again - the banks now know that they can take any kind of risk and rely on the taxpayer to provide a safety net. In the good years, an Irish bank will make a couple of billion euro in profit, in a bad year the taxpayer can pick up the tab.

I think this [broken link removed] says it all.