By inserting a clause which ties the fortunes of our biggest banks to those far more susceptible to financial ruin, the government has erred – with potentially catastrophic results.
There is a clause in the bank guarantee rescue plan that has the potential to complicate the scheme by placing the weaker banks in the state on a par with the stronger ones. In so doing, it threatens the integrity of the system. This column has maintained that the guarantee has to be the first phase of a three-phase programme, which would convert a banking threat into an economic opportunity.
Phase one was the guarantee, aimed at saving the system; phase two was a root-and-branch reform of the banks’ boards and senior management, which got us into this mess in the first place; and phase three was the orderly recapitalisation of the banks, to enable them to lend again and get the economy moving once more.
In arguing for the guarantee, this column understood that it would be part of a process which would lead to a better banking system in the years ahead. Underpinning such confidence was the expectation that the government would act in the national interest, rather than in the banks’ interest.
In addition, the working assumption was that ‘bad’ banks would not be rewarded for their ‘bad’ behaviour. However, now that the details of the guarantee have been published, we see a clause which has the potential to insulate those banks which behaved most recklessly and lumber those banks which are stronger with the sins of the others.
Clause 2.6 of the legislation covers the possibility of what might happen when a bank which has taken the state guarantee goes bust.
It says that, where the guarantee is called on and a payment is made, but the financial support cannot be recouped in full from the covered institution to which it was provided, it would be recouped in full from the covered institutions by the state over time, ‘‘in a manner consistent with their long-term viability and sustainability’’.
At first blush, it looks okay. It seems to protect us, the taxpayers, from the possibility of having to cough up for a bank which, despite the guarantee, might fail under the weight of the bad debts incurred during the boom.
Typically, in these desperate circumstances, such a bank would be unable to find a buyer at any price, the capital of the shareholders would be wiped out and the state would be compelled to nationalise the institution.
According to the legislation, any costs accruing to the state/taxpayer from such a bank failure would be recouped from the other banks. So far so good – we are insulated and at least the banks will pay for the sins of other bankers.
But let’s look at this another way. Let’s look at this from the perspective of cui bono. Who benefits from this clause? The people who stand to gain most are the management of the weakest banks because, by tying all the banks together, the government has linked the shareholders of the stronger banks to the balance sheets of the weakest.
This means that, if one bank goes, they all pay. The clause casts a huge cloud over the whole system because it implies that the ability of the strongest banks to lend over the coming years will be hamstrung by the bad debts of the weakest banks.
This is a living example of what is known in economics as Gresham’s Law. Sir Thomas Gresham was Elizabeth I’s chancellor, and came up with the expression that ‘‘bad money drives out good money’’, when trying to stamp out the use of debased coinage in England at the time.
He forecast that, if two currencies were in circulation and one was fully silver and the other debased silver, people would try to use, and thus get rid of, the debased silver coins, while hoarding the real silver ones. In such a case, the good coins would be hoarded out of circulation, leaving only the debased ones. This, he argued, would undermine the currency, leading to the progressive debasement of the currency and, eventually, to barter.
Fast-forward to today and we see the threat of Gresham’s Law in our banking system.
If the worst banks are tied to the better ones, the better ones will suffer. The ability of the better ones to lend will be compromised by the threat that their balance sheet will be penalised if one of the other banks goes under.
More egregiously, the management of the weaker banks – the most excessive cheerleaders and sponsors of the property mania – have managed to hitch their wagon to the stronger banks. Obviously, this is a brilliant deal for the management of our most reckless banks.
A conspiracy theorist might suggest that the weaker banks have pulled a stroke over the bigger ones – AIB and Bank of Ireland – using the Department of Finance in the process. Surely not? Could this happen in our clear-thinking country? Could our Department of Finance favour one bank over another? Never!
More likely, the scheme was drawn up with political considerations in mind – with the government under pressure from the opposition not to be seen to put taxpayers’ money at risk.
For the economy in general, the worst aspect of penalising all the banks for the sins of one is that it smells and looks like the discredited Japanese model. It means that we have tied the whole banking system up in knots. This can only slow down any recovery of the banks.
It would have been far better to have followed the Swedish or Swiss approach, by sticking to the three-phased programme, weeding out the guilty while recapitalising the system using government preference shares.
Now we potentially have the worst of all worlds. The moral of the story is that, when you try to satisfy the left- and the right-wing, you end up with a dog’s dinner. This is hardly the best platform for recovery.
Well David, it seems the Govt just did what you suggested without really understanding what that exactly was… Anyway, it’s a daft thing altogether. All that should have been “guaranteed” are the depositors savings, to avoid panic and a run on banks, like some Eurpean countries have done; guaranteeing everything (all loans included) was a mistake. Best thing that can happen in my view is for the weak banks (all of them…?) to be let fail; let some strong banks (e.g HSBC, Santander) come in and take over their deposit accounts and the good loans, get rid of the rubbish… Read more »
Seems to me that the government is deliberately setting the banks (and itself) in a dominoes formation, telling everybody in no uncertain terms that if one falls, they all fall in quick succession, with the state at the end of the line. Quite clever really. Therefore they must work together to ensure that everybody survives by extending interbank loans to each other. After all, they collectively got us into this mess, so it behooves them to pull together to get us out of it.
“The moral of the story is that, when you try to satisfy the left- and the right-wing, you end up with a dog’s dinner” All the banks assets are backed by mortgages or security from Irish property owners and all the liabilities by taxpayers. Minister Lenihan has signed a guarantee with no management control over the banks or insights into their ‘solvency’. There was haste required in drafting the legislation but who was giving ‘independent’ advice. It seems the Government are not seeing the ‘wood from the trees’ ? Any business person can see the banks got an amazing deal.… Read more »
“In arguing for the guarantee, this column understood that it would be part of a process which would lead to a better banking system in the years ahead. Underpinning such confidence was the expectation that the government would act in the national interest, rather than in the banks’ interest.” Theres your mistake…. expecting our government to act in the national interest. I started to realize this as soon as it became clear nobody would resign or be fired, it is ‘business as usual’. They have gotten so used to “the politics of plenty”, that they cant envisage whats coming down… Read more »
It seems David’s plan was doomed from the start. When you think of it, the whole auditing process which should have been showing red lights everywhere for the last few years is a symptom of the underlying issue we have in this country. PwC, KPMG, you name it are supposed to be the experts and the honest monitors for the whole process. But they gave the all clear and got the fees and no doubt the partners and the boards of management are all on their regular golfing outings discussing the next stratagem. And guess who’ll be “untouchables” in the… Read more »
Question.
Do the Chinese have medical cards for over 70’s?
You are correct. It is a support for inefficient, badly managed capitalist enterprises. There is a term to describe this. Socialism for the rich, Capitalism for the poor. The electorate is outraged. So we will see a response of state intervention, as those with a stake in the state (all of us) respond to protect interests. The biggest conflict will be Private Sector Taxpayers vs Public Sector Taxpayers. This is going to get very ugly. So far the Public sector have been winning. Private sector unemeployed are getting out of the country. Immigrants – who nearly exclusively in the private… Read more »
Deco: They’ve also given the builders a dig-out under the guise of a social-housing initiative. Why roll out such an initiative now when many commentators are suggesting there’s significant drops yet to happen. Sure, it wouldn’t be like the Irish government to try to reheat the building market in a budget initiative. Can’t remember when that last happened :) I think the fundamental thrust of your interesting post is that the current government lacks the expertise to deal with this problem. In particular they lack economic sophistication and are not prepared to take advice from more knowledgable economic commentators. Malcolm’s… Read more »
David > A conspiracy theorist might suggest that (…) Not that I am one, but having just watched the nine o’clock news on rte, I was struck by the lack of commentry on the economy. Has it become old news already? Or will Fianna Fail’s ‘attack’ on pensioners prove to be a public opinion masterstoke? The PR legerdemain that is the medical cards issue has taken fickle media attention away from the Irish banking crisis, and the longer it can be dragged out the better for the banks and their supporters. I worry that there is a hope among the… Read more »
Our “leaders” have no idea what they are doing and it is our own fault for being a shower of thicks and voting them in yet again. We don’t have anyone bar Richard Bruton and Joan Burton who knows what is going on. Neither are being listened to. I don’t vote for the wack jobs in either Labour or Fine Gael but Fianna Fail with their absolutely stark raving bonkers loan scheme of housing loans is even loonier than I thought they could be. I would vote for that loser the Financial Regulator first. The patriotic flag that Lenihan pulled… Read more »
Once upon a time, poor Paddy went to the races. Before going, he spent many hours studying the form of the prospective runners. He found out everything he could about each of the horses. How they were bred and raised, who had trained them, how they had performed in previous races, any injuries they had suffered, etc. From this preparatory study he was able to deduce what was the ‘reasonable expectation’ of each horse winning the race against the other competing horses, thus providing him with some winnings. He really needed to get this right as his business was having… Read more »
nice story…and nice analogy….but predicting the future race winner is very difficult nigh impossible..except to say..the 2 brians will not tackle the public sector issue after the lambasting they got over the medical cards…so how much longer can a struggling private sector ..support a bloated public sector ? Next year is going to be 10 times worse than this year unless somebody fixes the race and gets us out of this mess!!
When did the Irish get into FIAT Money? Dear David, I am an avid reader of your columns and I would like to complement you on your work. When I first heard on that Tuesday morning, the 30th Sep, that the minister was going to guarantee all Irish Bank deposits, alarm bells immediately started ringing in my mind. The first question that came to mind was, where the hell is the Irish Government going to get all that money to cover deposits in the event of a Banking System collapse?. I rang the Financial Regulator as soon as the news… Read more »
Just going back to the point about the social housing initiative:
http://www.irishtimes.com/newspaper/frontpage/2008/1020/1224454388516.html?via=mr
It makes the blood boil!
http://news.bbc.co.uk/1/hi/england/oxfordshire/7678843.stm What’s the betting this is next “Initiative” to offset the medical card mess? I’m sure the Senior Civil servants have Google alerts set up for this type of buinniocht. dc, In engineering, “assumptions are the mother of all F***ups”. Only if they’re not backed up by sensible risk assessment.Anyway, only Architects make assumptions. We engineers are paragons of sober deliberation. In commerce though, assumptions like our recent budget, based on out of date information from ERSI etc, are fiscally fatal. I know it’s difficult to effect social change. Everyone affected gets twitchy posteriors but we could make a start… Read more »
Agreed Shane, @Malcolm Seems to me that the government is deliberately setting the banks (and itself) in a dominoes formation, telling everybody in no uncertain terms that if one falls, they all fall in quick succession, with the state at the end of the line. Quite clever really. Therefore they must work together to ensure that everybody survives by extending interbank loans to each other. After all, they collectively got us into this mess, so it behooves them to pull together to get us out of it. … @Philip Malcolm is correct. It is a clever mechanism of creating mutual… Read more »
@DC: Welcome to the DMcW blogosphere. Views expressed here don’t always agree with David’s line of argument but mostly accept that he raises topical issues that are most relevant to Ireland’s economic welfare. In so doing he kindles responsible patriotism, unlike Lenihan, who larded his Budget Speech with words about patriotism to the effect that “Kathleen Mavourneen wants you peasants to tighten your belts”. Real patriotism requires taking your commendable actions (phoning the Financial Regulator and Dept. of Finance) a stage further. (Its too easy for them to rig their exchange with an answering machine saying “If your inquiry is… Read more »
dc – your search for answers from the various state institutions concerning this gigantic scheme makes for an interesting case study into experience of accountability in Irish Public institutions. In effect, we get little if any. These people and not the pensioners should be the ones to take the hit for incompetence that was caused by their failure to do their jobs. Andrew GMooney. Your story concerning Paddy at the races is completely correct. Problem is hard work and hard saving are concepts that were supposed to be destroyed by Reaganmics as practised by Bertie Ahern – with a socialist… Read more »
Hi David, I’ll come to your article later (see below). Did you see that TV programme on BBC3 about chaos maths and economic modelling? Basically, the summary of the programme was that chaos in the universe is normal in nature, on earth, elsewhere, etc, yet economic models are based on very basic and non-chaos mathematics. This results in economists being unable to predict whats going to happen, especially important shift-changing events such as the one we are living through now, the so-called credit crisis. Thoughts? Back to your article: > In addition, the working assumption was that ‘bad’ banks would… Read more »
Ok, New tack. Given the assumption or certainty that the friendships and relationships forged 30 years ago in the States elite schools and Universities have carried on through cossetted career development and given that this State-within-a-State Entity has always found it rather common to concern itself with life outside the Pale, it follows that the only solution possible is one that ensures the survival at all costs of that Entity. That the same Entity has been incestuous regarding ethics, ethos and probity can be deduced by simple logic. To ascribe generally accepted norms to this Entity is therefore impossible. Their… Read more »
I agree.
Chaos is the norm. Stability is an illusion.
Unfortunately this scares the horses. So we have a political class based on Officer Barbrady from South Park. Nothing to see here, move along. We can fix all your problems. Keep watching Ryan Tubridy and Fair City and it will be OK.
What astonishes me the most is the lack of protest. Take medical cards from a few aul wans and the place is up in arms but risk the whole country on a few gambling shysters is OK.
Mk > I watched that BBC4 programme last night too about the maths of chaos. It’s economic commentary seemed to be along the lines that it is easy to spot ‘tipping point’ events retrospectively but finding them in the present is hard, and looking for them in the future is pointless. They used the assassination of archduke Franz Ferdinand to illustrate their point. i.e. a random act that caused huge international ripples, the ‘butterfly effect’. It did, as you point out, make some interesting points pertinent to the current crisis. Mathematical ’cause and effect’ models can be very badly skewed… Read more »
Shane, you say “Many feel there’s a storm brewing on the 21st when the Lehman CDS’s come into play” – What could happen next? Will we see first effects in Asian markets tomorrow?
We are seeing a massive fallout to the Lenihan budget. The medical card policy seems to be politically unpalatable. We are seeing Irish society divide right down the middle. Those who have to compete in the harsh world, and those that expect the state to enable an easier life, are heading in an all out political conflict. But every political party is trying to play both sides. In 1987 McSharry and Alan Dukes both knew which side would need to be taken seriously in order to get Ireland out of trouble. Bertie Ahern completely rolled this back and made the… Read more »
Seriously. Cowan and Lenihan are two lawyers. They haven’t a bulls notion. Look after yourself. Minimize your exposure to the banks and to the government. Every euro you give the bank goes towards buying the boss man a Ferrari and the more the State gets the more interpretive centres in the Burren they will want to open. We give them our hard earned cash and if we are lucky and with a mealy mouthed dance they will throw what ever they shat out this morning and call it a “service”. But we will vote for the same losers again. So… Read more »
Irish solutions to Irish problems…aka lets sit on our Dail canteen supplemented asses and throw out soundbites and cover everything with an emerald green view. As before the country will mull along for a year or ten without proper corrective action, let’s face it folks…..things get brushed under the carpet here in Ireland with the end result being of little significance by the time it comes around. It’s been a total ballsup I agree, from the govt. mismanagement to the cozy VIP set who gained most from the present high anxiety of others who ended up getting shafted. Lean times… Read more »
@ B , I don’t think we will vote in these gangsters next time too much has happened too fast here , taking the chaos factor and the butterfly to the next level. Just a few articles back David here was writing and warning about the banking sub prime crisis been in here in two years , which I posted would be here sooner ( and it was ! ) . There has been several events only in the last two months that are bringing our house of cards down , first the ‘slow down’ in construction which people in… Read more »
@Furrylugs With regards to the social elite and “New tack” I agree, however I would not give the Irish social elite the credit to really understand and manipulate the system that yields for them the prime grazing pastures of life to which they are accustomed. Which tips on the point made by B that the two boys haven’t a bulls motion. I see them as just more priviledged sheep, dining on better pastures but none the less even less likely to rock the boat for fear of getting kicked out of the pasture. The saying “Say Nothing and Keep on… Read more »
DC, the waking up of the average citizen in Ireland will never happen as long as we have a situation where medical cards can cause a near revolution and financial collapse, toll roads etc is just seen as fate. You have to look at the Med card crisis, unpack it and see how it alarmed people. Look at the back benchers. They looked frightened. They saw their jobs going at the next election. Med cards hit all constituencies uniformly – big and small. Hence crisis. Now, take education – where not all constituencies are that badly affected and the minor… Read more »
Some very interesting comments, as usual. David, you might be upset at clause 2.6, and you might be right, but what about clause 20? “The amount of the charge payable by a covered institution(ie bank) in respect of each quarter shall be calculated by the covered institution…..” So the banks set the charges to be imposed on them by the taxpayer for the guarantee given by the taxpayer to bail out the banks. Could this happen in any democratic country? Would it happen in a dictatorship? The Government, elected by We the People, hand over the family silver to the… Read more »
Big sentence. Since rating agencies failed to accurately evaluate the banks when they were enticed into sub-prime etc because they could insure the risk and this risk became a tradeable CDS beastie which caused runs on the banks by pirate hedge funds, now that all bets are off and credibility is shot worldwide, why are these same rating agencies still rating anything other than themselves? If regulators used this “expertise” to fulfil the watchdog function that explains Paddy ther Regulator here. Asleep at the wheel. Reverting to the fact that all credibility is shattered, what qualifications, accreditations or abilities do… Read more »
Oi Moderator, where’s my comment??
WE borrowed the money.
WE elected losers like Cowan, Harney, Ahern and Lenihan.
This is OUR fault.
OK, once more with feeling. Interesting analysis David, but what about clause 20? “The amount of the charge payable by a covered institution(bank)….shall be calculated by the covered institution…” So in return for handing over the nation’s silver and gold on trust to the banks that got us into the mess, the criminally reckless and incompetent bankers set the insurance premium that our government is to impose on them? Is there a more clear demonstration of the fact that We, the People do not run this country? Hang on, there is. See below. What about clause 32? “In order to… Read more »
Already, the government are discussing raising the taxes on those earning under 100k by reducing the threshold for the 2% levy. Not a mention or utterance of taxing people higher when they earn over 200k. I heard Jim Power on the radio today echoing the comments of several other economists that the governmental tax revenue figures are insane. We have high levels of indirect taxation in this country as we’ve flirted with the idea of tax on consumption. How is a recession and direct personal tax increases not going to reduce consumption substantially? The decline is well underway. Retail sales… Read more »
Whom were the movers and shakers down the years that changed the mindset of this country for better or worse. What was common? Any ideas? What causes chnage (aside from recession and hardship?). Mick O’Leary of Ryanair and co. Anyone else? Am not looking for nice honourable people. Just those that caused serious positive change?
It is clear from this blog that people want thing done differently…but how? How do you fight a media machine like FF? Is this even a correct approach? Thoughts?
History Lesson or Deja Vous?. “It ought to be remembered that, when the wisest government has exhausted all the proper subjects of taxation, it must, in cases of urgent necessity, have recourse to improper ones. It occasions a general and most pernicious subversion of the fortunes of private people, enriching in most cases the idle and profuse debtor at the expense of the industrious and frugal creditor, and transporting a great part of the national capital from the hands which were likely to increase and improve it to those which are likely to dissipate and destroy it. And when, in… Read more »
Without any meaningful reform of the bloated, inefficient, overmanned, expensive public sector it is impossible to balance the state’s finances. The public sector expenditure is the Elephant in the boat, and the reason why we are all sinking. Our teachers are too expensive. Our gardai are too expensive. Our civil servants are too expensive. We simply cannot have 12% tax on the private competitive sector and continue to provide outlandish upkeep levels for public sector workers. And we need that tax rate to compete with emerging economies. So the 12% tax rate is non-negotiable. We have to make a choice… Read more »
Deco, fully agree with what you say even though our public service as a percentage of population is one of the smallest around. That said, efficacy is another issue. Objective and comparitive measures of same seem lacking and so the PS can go on with their mantra that they are still woefully underresourced. The financial crisis seems to have passed – media coverage has dwindled and the world here has moved on. It’ll be boiled frog syndrome for now. We will all be too busy busy busy in our daily commutes doing nothing new and surviving looking for some consolation… Read more »
A lot of good points being made here. Public Sector I would agree that the public sector is a monster that “we” have expanded to unsustainable levels during the ‘good’ times, and We will all pay for that. I’ve been bleating on about it long enough. The problem for any government is that the public sector actually vote, so I would envisage FF allowing the public sector to slowly deflate by natural wastage. Its a nettle that should be grasped but so far they havent touched it nor do they want to. Even some smart people have gone into the… Read more »
Deco, you have hit the nail squarely on the head. In fact I’d agree with more or less everything written here over the last few weeks (I know that sounds contradictory!). I think the Irish don’t trust either the state (I don’t) or each other (I’m not sure) and in the end act out of fear. Get on the property ladder before your neighbours price you off it. Get a secure job so that when it all crashes down (as everyone knew in his heart it would) at least you won’t be the worst off. I think that’s why the… Read more »
Great posts here. “nice story…and nice analogy….but predicting the future race winner is very difficult nigh impossible..except to say..the 2 brians will not tackle the public sector issue after the lambasting they got over the medical cards…so how much longer can a struggling private sector ..support a bloated public sector ? Next year is going to be 10 times worse than this year unless somebody fixes the race and gets us out of this mess!!” Succinctly put by Sue. Deco is like a biblical prophet. He has enunciated the cold reality of the Irish dilemma all too well. The current… Read more »
A potentially huge story in todays FT, http://www.ft.com/cms/s/0/4489f006-a45d-11dd-8104-000077b07658.html?nclick_check=1 “The Irish government has bowed to pressure from its two biggest banks and dropped an insistence that the industry as a whole help to pay the costs involved in settling the debts of any insolvent bank. To minimise the cost to Irish taxpayers, the original plan envisaged that where the guarantee is called upon, and the creditors repaid, any cost not recovered from the bank in trouble would be recouped from the other covered institutions “over time in a manner consistent with their long-term viability and sustainability”. Can anyone clarify if this… Read more »
Well spotted Garry. I said above 19/10 that the government was putting itself at the end of the dominoes line and thought this quite a clever move. The big banks have taken fright at this and moved their dominoes out of line. What we are left with is a recipe for financial chaos. If the Irish government have indeed bowed to this pressure then we all, (except foreign shareholders in the big banks) will become liable for paying the debts of any bank that fails.
[…] taxpayer by shifting the cost on to the banks. But the hapless Minister must have been reading David McWilliam’s demolition of this provision in the Sunday Business Post. So the Government rowed back- banks participating […]
zeitgeist …. “the spirit of the age and its society”
http://video.google.com/videoplay?docid=7065205277695921912
http://www.thevenusproject.com/
The re-design of a culture
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