We will only get one chance to recapitalise our banks. Our banks have insufficient capital to cover their losses on their loan books and they have a drastic funding shortage. Without the government guarantee, most of them would surely be bust, because no one would lend to them. Without a properly functioning banking system, the economy will continue to contract.
This week, three separate businesspeople told me they were going out of business. They do not have sufficient cash flow and are beginning to renege on debts. Last night, a friend indicated that he would simply have to default on his rent payments because the landlord of his premises was insisting on rent covenants signed last year which he couldn’t pay because business has dried up. Apparently, last year’s business plan now reads like Alice in Wonderland.
In a similar vein, a liquidator friend – a man who likened his position to ‘‘an undertaker waiting for the plague’’ – summed up the banks’ position in a simple story.
A desperate man arrived in his office this week with property debts of €48 million for which he had put up a total of €400,000 cash. Each property, all in mid Munster, was cross-collateralised against others. There were six separate banks involved. All the loans had been taken out in the past three years and covered commercial property, residential property and development land, as well as the ubiquitous second apartment.
Obviously, the man was broke and couldn’t meet any of his repayments. The ‘assets’ were now worth a fraction of the borrowings and there was no way the banks would ever get their money back. Nor should they have ever lent this money to this character, but they did and now we are being asked to cough up to cover the obvious bad debts associated with thousands of ‘entrepreneurs’ like this.
Out in the rest of the country, the unemployment figures announced this week are not only a personal tragedy for thousands of families but, for the banks, rising unemployment means rising mortgage default. These defaults will also have to be covered by the recapitalisation.
So you can see a huge amount rests on the recapitalisation of the banks. If it is not successful, the banks will sink under the weight of bad debts. When the government makes its decision this week, it has to fix the problem. If it fails, the money will be wasted, and the banks will burn through the new capital as they try to maintain their capital adequacy ratios in the face of a meltdown of their loan books.
Let’s cut to the chase: the proposed recapitalisation will fail. There’s little point pussy-footing about: €7 billion of your cash is about to be blown this week on our dysfunctional banks. The reason for using the term ‘‘blown’’ is that the money will be wasted and we will be back at square one by summer, with a larger hole in the balance sheets.
Remember that this deal to be announced, probably on Tuesday, is likely to be a worse deal than the nonsense that was proposed a few days before Christmas. The Irish banking system faces two disasters and one problem is driving the other.
The first disaster is a funding disaster, where the average loan-to-deposit ratio of Irish banks is between 150 and 160 per cent. For the likes of Irish Life & Permanent, it is no less than 260 per cent. For the big two, this ratio is about 160 per cent. This ratio means that for every €160 the Irish banks lent out, they only had €100 in deposits. So they borrowed €60 from the wholesale money markets – which are now shut.
As long as the money markets are shut, the banks are being kept on a life support machine by the state’s guarantee. The strategy to borrow for growth was implemented by the managements of our banks who – amazingly – are still drawing hefty salaries. Without the state guarantee, the banks would have to pay so much for funding that most of them would be likely to go under.
Even with the guarantee, the banks will have to get the loan-to-deposit ratios down to somewhere around 80-100 per cent. This is a process called ‘‘deleveraging’’ and can only be achieved by increasing deposits and reducing lending.
This contraction of credit will have a monumental knock-on effect on the second big problem for the banks: bad loans. At the moment, Irish banks are telling half-truths about their bad loans and, given that the management of Ireland’s banks has got nothing right in the past two years, it is difficult to believe them now.
To get a better idea of what is likely here, we can examine the experience of other countries. Switzerland and Sweden both suffered a banking crisis following a property bust in the early 1990s. In both cases, the banks had to write off close to 8 per cent of their loan books. This was traumatic and the banks lost fortunes, but they recovered.
Given that the Irish loan book is more than €400 billion, a similar write down would reveal a black hole in the Irish banks of about €33 billion. As Bank of Ireland and Allied Irish Bank account for the lion’s share of the market, we can guarantee that their bad loans will be considerably greater than the €8 billion recapitalisation expected to be announced for the two big banks this week.
Take Bank of Ireland alone. Its loan book rocketed from €80 billion at the start of 2005 to a whopping €145 billion by the middle of last year. An enormous 26 per cent of the total loan book (or €38 billion) has been lent to the property sector.
If I can figure this out, what of investors who are being asked to buy into the government’s plans? Brian Lenihan should understand that investors will only come back to Ireland if we make it attractive for them. This means the Irish state has to take a bigger risk in the deal than they do. Given the basic mathematics of why €8 billion will not be enough, don’t be surprised if the shares of Irish banks fall and fall again on the news that this botched recapitalisation has been announced and Ireland has used up all its ammunition.
If you want to recapitalise, you need a much bigger state package that cleans up the banks and gives potential new investors the comfort that they are buying a clean bank If they suspect that this will not be enough to pay for the sins of fellows like our friend with 40 properties in Munster, they’ll wait on the sidelines until all Lenihan’s cash is gone and then snap up the good parts of the Irish banks for free.
The maths example that David gives for what the banks will lose is reminiscent of the maths which got us into this trouble. People taking mortgages that were 10 times their income to buy a 2 bed apartment. Look where that got us.
Help me out here but are we saying that the government really is so stupid that they will blow €8m in the full knowledge that it won’t be enough? Are they missing something or are we? Why would they spend (I am reluctant to use the word ‘invest’) that money if they know that it just won’t work? Is it an expensive con-job that they hope the international markets will fall for? Having listened to Brian Lenihan on the news I am struck that his information is more granular and more ‘perfect’ than the extrapolations above. Maybe David you will… Read more »
David’s figures sem to be very optimistic: “ the average loan-to-deposit ratio of Irish banks is between 150 and 160 per cent. This ratio means that for every €160 the Irish banks lent out, they only had €100 in deposits. So they borrowed €60 from the wholesale money markets – which are now shut.” “Given that the Irish loan book is more than €400 billion, a similar write down would reveal a black hole in the Irish banks of about €33 billion.” I wrote earlier that Dresdner Bank puts current Irish bank liabilities at about €920 billions, more than twice… Read more »
Hi David, > Our banks have insufficient capital to cover their losses on their loan books and they have a drastic funding shortage. Without the government guarantee, most of them would surely be bust, because no one would lend to them. Without a properly functioning banking system, the economy will continue to contract. Its true that our banks are in deep trouble and are “living on borrowed time”. However, its important that if we do give the banks our money that we extract a sufficiently low enough price for it – ie: free. The Munster-chap example you give is one… Read more »
Hi David,
Ireland should fall. When it falls we will build this country once again.
Let’s start from infrastructure…
Cheers
too much pride being an islander ( Irish ) can be too expensive and the icelanders have paid that dear price – lets just let go all the banks and allow company law show that in liquidation and limited liability can save the taxpayers and start new banks again with no significant costs then there will be no more irish slavery – our reputation is already lost we don’t want our families lose their souls as well , we need to say STOP
Einstein’s view: “The economic anarchy of capitalist society as it exists today is, in my opinion, the real source of the evil…. Private capital tends to be concentrated in few hands… [resulting in] an oligarchy of private capital, the enormous power of which cannot be effectively checked even by a democratically organized political society. This is true since the members of legislative bodies are selected by political parties, largely financed or otherwise influenced by private capitalists…. The consequence is that the representatives of the people do not in fact sufficiently protect the interest of the underprivileged sections of the population.… Read more »
Hi David, Perhaps this recapitalisation is the first phase, but it a necessary phase and the alternatives are few. It will give an essential stability to the BIG TWO while they and the property market begin to quantify their loan losses. It may transpire that an additional recapitalisation is necessary.Only time will tell. We must deal with today now. The c.€8 billion euro, along with the operational profits from the lower-risk sectors of the two banks, should allow a phased write-down of the loans which have gone wrong. It may have to be revisited in two or three years time,… Read more »
“A desperate man arrived in his office this week with property debts of €48 million for which he had put up a total of €400,000 cash. Each property, all in mid Munster, was cross-collateralised against others. There were six separate banks involved. All the loans had been taken out in the past three years and covered commercial property, residential property and development land, as well as the ubiquitous second apartment.” David, This paragraph you have written is the essence of the total madness that has characterised the irish property bubble. These words should be cast in stone on a marble… Read more »
“We will only get one chance to recapitalise our banks. ” It is very scary with days to go before an announcement on recapitalisation of the two largest retail banks and over 4 months after the bailout guarantee the Minister for Finance has still so many unknowns to agree – ‘tough talking to take place, deal is not finalised’, ‘we will have influence on the board’, ‘have a detailed (initial) assessment from auctioneering valuation’ and ‘will do a due diligence if agreement to recapitalisation’. This is unbelievable stuff considering we are about to commit at least €10 billion to 3… Read more »
“Smart economy” – its another myth perpetrated by politicians! This particular lie was nailed by the announcement of the exodus of Ericsson last week. In relation to the recapitalisation of the banks. David is right and oddly for him, he has probably understated the problem. Of the €100 billion Anglo have out, most of it is property based. Therefore in view of the fall in asset value, it is not unlikely that at least 30% will need to be written off. Bank of Ireland arrived late to the lending party and aggressively lent on property in the years from 2005… Read more »
Attention: David McWilliams. As a recently returned expatriate I am dismayed by the extreme and damaging negativilty I have seen in most of your articles about the Irish Governments’ response, and action taken by them, to the global financial problems today, and the consequences in Ireland. In my opinion you display a Beginners Knowledge about the manner in which a Venture Capitalist approaches any investment opportunity. The Irish Government is, by necessity, acting as a “soft” venture capitalist as regards the Banks. In this sense, I believe they are doing the Right Thing,and the Right Thing must be done to… Read more »
Sadly like so many politicians they should nto be at the helm during crises. And this one with banks , is a point in case re Lenihan . It is true the amounts required are far in excess of 8 Billion and to suggest it is closer to 40 is near the truth. The Government Cowen included has had plenty of time to get seriosu but they have been distracted tryign to find packadges , so to save slective investors that have been propping up thier poltical capital support for years ! this conflict ahs and will have a price… Read more »
Referendum on who should work at the new banking boards ! as so much taxpayers money is involved and so no ties with the past incompetent lot! especialluy connections to government ! yes a Referendum! more important than so many past issues as the amounts are closer to 80 Billion ! of taxpayers committments
Reading this article and the comments to date triggers the following unpleasant ‘hallucination’ which appears to be hurtling from macabre fantasy to present reality with ever greater velocity: There’s an A&E Department called Ireland. There’s similar emergency rooms called America, Britain, China etc. The triage staff in all of these locations are simply overwhelmed by the disaster, the epidemic, the contagion that has befallen them. They can’t even reliably name the catastrophe using the medical terminology they were trained in. In the waiting room, the walking wounded and the soon to expire mingle with the drunks, the fisticuff merchants and… Read more »
If this money is not ringed or the bad debts, the one will swallow the other. And surely each of the banks are what amounts to a nest of limited companies, so it cannot be all that difficult to hive all the crap off into a bin somewhere. As all the parent responsibility is limited to the shares. It cannot be surely that each and every little branch and division was playing the game.
Logic is DEAD ….Bank Corruption is the ENEMY ……do the decent thing ….Liquidate all The Irish BANKS ( Anglo – AIB – B of I ) …Save Your Children …NOW
If 8B is not enough, Stop trying to fix the problem and start lining up those responsible…
[…] persist in trying to sell redundant profits. Why haven’t we learnt from that experience? (See Can politicians really make banking leopards change their spots, 12th October […]
”Without a properly functioning banking system, the economy will continue to contract.” I think that’s why we have a CRISIS! It’s really beginning to catch my breath- I think it’s called ”panic attack.” Jes, it’s true there seems like there will be no intelligent move to create a new system, a commonsense system that works or at least admit the financial model has failed, not because of a few rouge bankers or the American sub-prime, – and the like – but because the investment model itself does not work in the interest of all concerned. ”Last year’s business plan now… Read more »
It is difficult for anyone who is not part of the inner circle to understand what’s happened. It’s even more difficult to feel confident in any particular solution. I’m placing my confidence in a few ‘knowns’. I call them my truths. (1) There is a lot more bad debt out there than anyone admits. The banks probably have an idea how high it really is, but they probably underestimate it because no one employed by the banks wants to say how awful the situation is: they would probably get no reward for being the one who was prepared to say.… Read more »
I agree with most of what you’ve written Johnny Dunne and SamB. SamB> it is costing the banks more to borrow than they can charge their clients Yes, this is whats happening and its the collective equivalent of holding their breath. People are talking about bad debts, yet, many of those debts will only go bad over time and when the bank can no longer ‘hold its breath’. Commercial should clearly be let go before residential and owner-occupied homes should be last, apart from those that were used as a basis to build up commercial properties. Giving the two big… Read more »
I saw Jack Welch, former General Electric chief, on CNBC last week and he said that Walter Wriston of Citibank told him that if Citi had immediately recognised all its losses from the Latin American debt crisis in 1974, it would have gone bust. Three years after Wriston’s retirement, his successor John Reed set aside $3 billion to cover loan losses in Latin America — the total of the bank’s earnings for the last four years of Wriston’s watch. With columnist Wolfgang Manchau in the FT today, saying that Ireland is entering a depression, I guess that it’s best for… Read more »
I think we should have a new bank rescue plan…. Introduce a bit of reality TV and a phone vote, it might even make a few quid…I’m thinking more “The Running Man” than “Big Brother”. Spice it up, have the bank executives on TV begging and fighting for the money, Put a few swindled shareholders in the mix and give them immunity from prosecution. It could be set in some of those ghost estates that nobody will ever live in…. Sure we might as well get some entertainment out of this. and given the high regard bankers are held in… Read more »
Some of the figures mentioned above are really scary. How on earth are we going to find €33bn when saving under €2bn in public services wages was so difficult.
Even the Pension Reserve Fund is only worth around €18bn (I think).
The country is basically bankrupt and it is only a matter of time before the IMF have to come in.
There is an interesting article in today’s NYT suggesting that an attractive way to encourage innovation is to establish a federally sponsored prize fund: http://bits.blogs.nytimes.com/2009/02/09/super-bowl-ads-and-the-rise-of-the-prize-economy/ As an alternative to VC investments, a few millions in this kind of initiative could form a seedbed for new growth in the Irish economy. Tied to a television program it would show the audience that some people were actively trying to get us out of this mess, and encourage others to do the same. It would be much more productive in the long run than the mindless lotto dreamweaver most people live for at… Read more »
From todays (09/02) Irish Times – “Protecting the interests of the banks’ beaten-up shareholders and limiting the exposure of taxpayers is all very well, but it’s rather pointless if the €7 billion being spent by the State at this point in time does not contribute directly to reviving economic activity and, in the words of the Taoiseach, “jobs, jobs, jobs”. Quite. I had a look at politics.ie on David’s latest… in between the usual slagging match there wasn’t much real content. I’m afraid the same is true here. David says that this (re-capping) won’t work, ok, so what might work?… Read more »
David is correct – without institutional reform of the banks, this is dead money. There is an Irish phrase for this “obair in aisce” (work that is wasted). All the effort that is took to accumulate that pension fund is now to be lost. What annoys me is the way the state (government plus department of Finance officials) “negotiates” in these deals. Brian Lenihan telling us that the taxpayer is getting great return for their money is like something from a tragic play or something. We are all sitting here in the audience, overcome with an impending sense of disaster… Read more »
Came across interesting commentary from Marc Faber over the weekend. Faber has a rather unique propostion for dealing with this sort of crisis. He suggests making dividing each troubled bank in two intoa good bank and a bad bank. The government takes over the good bank. The bad bank continues to be held by the ordinary shareholders, preference shareholders, bond holders and creditors. The good bank acts as the credit facility for the non-property sector of the economy. And the bad bank nurses the mortgages. What an intelligent idea ? Effectively the government (taxpayer) keeps the critical part of the… Read more »
Before we will get out of this crisis – we will need a structural change in the Irish economy that makes it more efficient or more effective or both. Deflation of the cost base is our best option.(more below). Inflation of the currency was an option in previous times – but is not an option now. Allowing capitalists to get capitalist consequences for failure – in other words, to go bankrupt – is another option. But it seems as if there is a persistent effort to maintain the current structural inefficiencies of the Irish economy. The market rigging has to… Read more »
Maurice Hayes on today indo says it nicely in his column on the passing away of Rev Roy Magee. “Society faces a new set of terrorists – the international bankers and financial speculators – without as yet, the wise men who can guide them to safety”. There is no morality and we are going to pay for it. An 8bn bung to plug 20bn oriface will just dissappear and do nothing – except loose an 8bn bung. And we are not sure if a 20bn bung will work either. The only responsible thing to do now is let the banks… Read more »
Absolutely but be clever about it….. don’t put any money in but form a cross party committee to talk about it… in fact establish a tribunal to look at directors loans or some other bullshit. Invite the social partners in and sure that’ll keep the talks flowing. Keep talking until the guarantee expires, when the pressure comes to extend or some other manufactured crisis, talk some more…. The share price will drop but who cares, better the shareholders squirm than the taxpayer. What’s the pressure? Sure the debts are guaranteed, do we really care if the banks share price goes… Read more »
I’d like to say how much I support the long post by Deco, especially “We need to think outside the box – and completely disbelieve the ‘official’ version of what we get told. The more people that are liberated from ‘mainstream’ nonsense in this country – the more people will be able to apply pressure to weaken the networks of incompetence, the delusional nonsense, the rampant corruption, all the market rigging, and the chronic underperformance.” Thank you very much for the information about who the head of ESB is and the relevant connections. Perhaps some good will come out of… Read more »
Look, this forum, which used to be a good pointer to the kind of thinking we need, is becoming more like Anthony Coughlan’s Public Enquiry blog, true, but tilting at windmills. We all know this country is managed by a same-sort-of-schooling commune, what else do you expect? we are only a few years out of the dark ages in terms of an economy, there is no flexibility in the appointment/election system (viz the ex Foreign Affairs Sec Gen and the Garda Ombudsman chairmanship). Over here is maybe an indication of why Lenihan is looking over his shoulder at Brussels; a… Read more »
on another topic did anyone hear Joe Duffy today? Apparently the Energy Regulator turned down a request from the ESB to drop their prices…People up in arms about their bills and then someone comes in with this. In a recent article Philip quoted that “technocracy grew to consume all profit margin to least benefit of the shareholder and the customer during times of plenty. ” Here is a perfect example… Before regulation the ESB provided electricity to Ireland reasonably competitively. it was the 3’rd cheapest in the EU… So in an effort to introduce best practise we hired and paid… Read more »
Wise words: “International markets have their own problems and couldn’t give a ‘rat’s arse’ for Ireland. No, Lenihan is struggling to hold on to his seat and try to impress the voters. He does this with voters’ money but, politics was ever thus.” In a democracy it is, of course, right and proper that the minister tries to “impress the voters”. And it won’t help us to think that a white knight will come over the hill from Frankfurt or beyond. Perhaps it is a matter of judgement whether it is best to invest a little at a time or… Read more »
Monday 9th [4.40 pm]
David McW will be on Today FM (Matt Cooper) shortly
The time for whinging and moaning about the past is over – it cannot be changed, we can only learn from it and look to move forward and focus on getting ourselves out of this mess that we are in. Now is the time for all of us to take Responsibility. Remember, responsibility does not mean taking the blame. Instead it means “response-ability” – the ability to respond to the situation we are in and to find a way to get ourselves out of it. I detect a sense of glee amongst some of the bloggers on this site with… Read more »
Reading that Vox article from Garry on Gov Bond spreads – In a way, the ECB has a duty to narrow those spreads. The EU gave us a lot. But an argument could be made that it inflated us beyond our ability to consume funding correctly. Also, I think the oversight on EU funding was never very good and did not yield the intended benefits. We received a lot for infrastructure e.g. roads and also agriculture – which in turn funded fat cat farmers and developers & land owners. That funding should have come with taxation strings attached. One could… Read more »
Firstly, I fully agree the €8bn is a band-aid for a shotgun wound, only papering over the cracks etc., etc. MK1 argues above, as I have done here in the past, that nationalisation is probably the only way forward for the banks here, but the question now seems to be where we are going forward to. Anyone seeking liquidity at the moment should look no further that the financial crisis itself, it is the most liquid thing around at the moment! The crisis is growing each day and with each passing day the unthinkable becomes the possible before turning into… Read more »
After listening to Mr Lenihan at 6 oclock news, it seems clear that he is going to go for the strategy of saying that a “remuneration committee” will look into the whole question of remuneration. He says that he expect such a committee to take full account of the “government’s” advice. Meanwhile, it also looks as if he’ll recapitalise the banks first and deal with remuneration later,and argue that this is urgently needed. I’m convinced this is a method to avoiding change. I think it’s a stratagem to perpetuate the status quo. On a day when one financial institution has… Read more »
The problem with writing down loans on property that nobody is buying is that it inaccurately reflects the potential of the property to reach a higher value within what might be a short space of time. To predict development property’s value in 12 months time is relatively straightforward, does not raise spirits, and , relative to the purchase price, and in the absence of buyers, it may prove prudent to hold back on selling the property for a further 12 months. Many factors are currently adversely affecting values: Northern Ireland’s retail competitiveness is dis-incentivising further development even in towns that… Read more »
This is about TIMING. A concurrent property crash AND worldwide credit crunch. The solution is also about timing. We should NORMALISE domestic activity by COMPLETELY REMOVING STAMP DUTY, immediately. The banks can then return to normal and safe lending as folk will have deposits for houses instead of using deposits to pay stamp duty. A decent property tax regime would discourage “hope value” investors. Once a more normal economic activity resumes the problems of the current account and bank regulation can be tackled. Lastly…a note to the morons who suggest letting the banks go bust. What would happen to savings… Read more »
In response to John Rooney: what a substantial contribution to the discussion… The part of your analysis that most stood out for me is the section… “So what had the government to do to make this work? It must cut the public pay that is going to be cut (that means more than just pension contributions), reduce the social welfare payments that are going to be reduced, it must also reign in the costs associated with daily domestic purchases and essential services. We must receive the ECB interest rate cuts that are coming, when they decide that they have waited… Read more »
John Rooney> The problem with writing down loans on property that nobody is buying is that it inaccurately reflects the potential of the property to reach a higher value within what might be a short space of time. Immature or trigger happy write-downs would be a problem and a mistake IF that was what was actually the root cause and the problem. It isnt. Write-downs are happening well past the actual sellable values, the market realisable values. Some by 2 or 3 years! And many ‘assets’ are still being held at their peak/book values. But write-downs arent the only problem… Read more »
It is too late to let the banks go bust – that would need to have been done before the guarantees were given last September. During the Celtic tiger years, our economy was fueled by consumer spending and by credit. To reinvigorate it, requires the re-establishment of credit and the encouragement of the the consumer to spend. Obama is trying it in the USA with his new stimulus plan. The problem that he or anyone else will have pumping money into the economy is that it will be used for debt repayment – not spending. The only way that you… Read more »
Reduce stamp duty to zero immediately – what’s the point in having an asset transaction tax when assets are not moving.
Then move the country SLOWLY away from it’s property mania, and encourage private investment in infrastructure, medical services and rewarding good old fashioned working capital financing for business and r&d.
I think its a bad idea to air your dirty washing in public while you are in the eye of a storm.Why? Because its a sure way to loose perfectly serviceable washing.We can all laugh at the neighbours shirt on top of a tree,until we realise we all have to import another one for him.Result GDP- ONE SHIRT… Advice to Bank shareholders for 2009,no dividend,sorry pal them’s the breaks,elect more competent people at your next AGM.Meanwhile if you want to move somewhere else in the casino,cash in,otherwise less whinging,your undermining the Banks main function.P.S remember ye little upstart Banks are… Read more »
We have an economy smaller than that of most US States, it is in some respects an advantage, it means we can restructure it and get the results ther of a lot faster than larger economies. If our current situation were to be tackled as an economic experiment , there is an array of options , an array of opportunities. its a tiny economy. We are a smaller economy than most Global cities. Undoubtably with the genuine talents of some Irish citizens we could turn this crisis around and do so rapidly, and this is the point .We have two… Read more »
Haven’t seen this mentioned here. An optimistic research note from the supposedly uniformly Europhobic financial centre of London: ‘Ireland can easily see off the Euro bullies’ http://www.irishtimes.com/blogs/business/files/2009/02/dumas-on-ireland.pdf Unfortunately events are rapidly eroding the basis of the article, the low debt ratio is vanishing daily.As for the comment: ” ‘In a small flexible service economy, with a small public sector, incomes can much more readily be lowered than in large, bureaucratic economies like most European countries.’ Not sure what they base this assertion on. I guess they don’t read this blog. Or the Irish press. Hardly seems likely. But worth reading… Read more »