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Is Nama Madoff or Obama? [Updated]

by Frank Schnittger Mon Jul 6th, 2009 at 08:25:20 PM EST

[Update] My LTE on this topic has just been published:

Handling the banking crisis - The Irish Times - Tue, Jul 07, 2009

Madam, – Morgan Kelly raises some extremely worrying questions regarding the Government’s handling of the banking crisis.

Firstly, the taxpayer is being asked to pay up to €90 billion for toxic assets which may be almost worthless. Had those “investments” been a success, the taxpayer wouldn’t have owned one cent of them.

Secondly, the Government has guaranteed not just depositors, but corporate bondholders in those banks as well. Investors gain a better rate of interest on corporate bonds because they take on the risk of default. So why are taxpayers now being burdened with the investors risk when they were never recipients of the interest or party to the contract?

Thirdly, Anglo Irish Bank was run by and for property speculators and developers. It had no strategic value to the Irish economy other than that it bid up the price of land for everyone else and thus created an unsustainable property bubble. Why are we bailing out the very people who caused the economic collapse and who have no strategic role to play in our long term recovery?

Fourthly, the cost of the bail-outs is so huge – potentially two thirds of national income – that it will bankrupt the nation and make recovery impossible for decades to come.

Fifthly, why are we implementing the bad bank idea when even the US administration rejected it as unworkable?

Let those investors who gained the returns now also take the hit, and let us rebuild our economy based on an ethical banking industry. – Yours, etc,

[End Update]

Barack Obama, Brian Cowen (and I) may share County Offaly roots but Brian Cowen is proving to be a good deal less sure footed in his management of the economic crisis in Ireland.  His latest hare brained scheme, the National Assets Management Agency (NAMA) is something of a misnomer.  It is actually a proposal for a bad bank to take over all the toxic assets which had been accumulated by a coterie of banks, developers and property speculators.  

Had those investments turned good,  tax payers wouldn't have seen a cent.  Now that they have turned very bad indeed, taxpayers are expected to pick up the tab - to the tune of up to €90 Billion, or two thirds of Irish GDP. Private Liabilities Nationalisation Scam might be a more appropriate handle, although it doesn't have quite the same ring to it.

Morgan Kelly is professor of economics at University College Dublin, and has just written an excoriating piece on the Government incompetence that is likely to bankrupt Ireland. If you can take any more of this, please follow me below the fold...


Brought to our knees by bankers and developers - The Irish Times - Fri, Jul 03, 2009

Nama is in effect Fianna Fáil's shrine to the property bubble for which the party still yearns. Prepare to pay 10 per cent more in income tax for the next 10 years to pay for it all . . . we are headed for national bankruptcy, argues MORGAN KELLY

WRITING HERE two years ago, I pointed out that the exuberant lending of Irish banks to builders and property developers would sink them if the property bubble burst. Since then, the bubble has burst, the banks have sunk, and we are all left wondering how to salvage them.

Two ideas for fixing the banks have been suggested: a bad bank or National Asset Management Agency (Nama) and nationalisation. While these proposals differ in detail, their impact will be identical. Irish taxpayers will be stuck with a large bill, and in return will get an undercapitalised and politically controlled banking system.

A far more efficient and cheaper alternative to Nama is to copy what Barack Obama did with General Motors, and transfer ownership of Irish banks to their bond holders. In this way we can achieve well capitalised banks, run without political interference, at minimal cost to taxpayers.

By converting a portion of Allies Irish Banks' approximately €40 billion of bonds, and Bank of Ireland's €50 billion, into shares, each institution can be recapitalised. Transferring ownership to bond holders will not cost the taxpayer a cent and will avoid interminable legal battles over the transfer of assets to Nama.

While the shaky state of Irish banks had been worrying investors since early 2007, when the crisis finally broke in late September the Government was taken completely by surprise and reacted with blind panic. Faced with a run on Anglo Irish Bank by institutional depositors on September 29th, the Government was stampeded into guaranteeing virtually all liabilities, except shares, of the six Irish banks.

This guarantee contained two obvious but fundamental flaws. Everything that has happened since - the proposed recapitalisation of Anglo, the nationalisation of Anglo, the establishment of Nama - can be understood as the Government scrambling to catch up with the consequences of these two errors.

The first mistake was to guarantee not only deposits - which had to be guaranteed - but also most of the existing bonds issued by banks to other financial institutions. Bond holders receive higher returns in the knowledge that they are accepting the risk of losses on their investment. In addition, unlike depositors who can scarper, existing bond holders are effectively stuck.

It made no sense for the Government to insist that taxpayers would take the hit on any bank losses instead of the financial institutions that had already entered legal contracts to do so.

The second mistake was to extend the guarantee to Anglo Irish and Irish Nationwide. As specialised property development lenders with incompetent management, they were at risk of heavy losses as their market collapsed, and fulfilled no role in the wider economy.

In making the guarantee on September 29th, I do not doubt that the Government believed that the difficulties of Irish banks ran no deeper than temporary liquidity problems stemming from the international crisis. However, as it has become apparent that Anglo was a mismanaged wreck, with AIB and Bank of Ireland scarcely better, the Government has stuck with the mantra that all banks are equally important and equally worth saving at any cost to the taxpayer.

Brian Lenihan and Brian Cowen are happier to dice with national bankruptcy than lose face by admitting that they were misled about the state of Irish banks last September.

Nama, then, is the latest twist in the Government's increasingly bizarre efforts to save the Irish banking system while claiming that it does not really need to be saved.

Underlying Nama is the delusion that the collapse of our property bubble is a temporary downturn. In a few years time when the global economy recovers we will be back building houses like it was 2006. All the ghost estates, empty office blocks, guest-less hotels and weed choked fields that Nama has bought on our behalf will once again be worth a fortune.

The reality is that, because of our surfeit of empty housing, there will be almost no construction activity for the next decade. Empty apartment blocks in Dublin will eventually be rented, albeit at rates so low that many will decay into slums. However, most of the unfinished estates that litter rural Ireland - where the only economic activity was building houses - will never be occupied.

Nama is a variant on the "Cash for Trash" scheme briefly floated in the United States last year where the government would recapitalise banks by overpaying for their bad loans. Our Government is proposing to buy €90 billion of loans and will reportedly pay €75 billion for them.

The International Monetary Fund (IMF) guesses that Nama will cost us €35 billion, and this is probably optimistic. The narrowness of the Irish property market meant that banks effectively operated a pyramid scheme, bidding up prices against each other. Now that banks cannot lend, development assets are effectively worthless.

The taxpayer is likely to lose well over €25 billion on Anglo alone. Among its "assets" are €4 billion lent for Irish hotels, and almost €20 billion for empty fields and building sites. In fact, I suspect that the €20 billion already repaid to the casino that was Anglo represents winners cashing in their chips, while the outstanding €70 billion of loans will turn out to be worthless. And it is well to remember, as the architects of Nama have not, that although the problems of Irish banks begin with developers, they do not end there.

The same recklessness that impelled banks to lend hundreds of millions to builders to whom most of us would hesitate to lend a bucket; also led them to fling tens of billions in mortgages, car loans, and credit cards at people with little ability to repay. Even without the bad debts of developers, the losses on these household loans over the next few years will probably be sufficient to drain most of the capital out of AIB and Bank of Ireland.

Brian Lenihan's largesse to bond holders could cost you and me €50 to €70 billion.

---------

Even without bankrupty, Nama will ensure a crushing tax burden for everyone in Ireland for decades.

The tragedy is that, were it not for the Government's botched efforts to save financiers from the predictable consequences of their own greed, the Irish economy would have recovered far more quickly than most people, including the IMF, expect.

Recovery for the Irish economy will not be easy - there is no painless way for an economy to move from getting about 20 per cent of its national income from construction to getting about zero - but the flexibility of the Irish labour market would have ensured that our incomes and share of global trade would have rapidly recovered. Now, however, any fruits of recovery will be squandered on Nama.

Aside from the fact that Nama will spend huge sums to achieve little, its governance is problematic. Here, the fog of secrecy that has quietly settled over Anglo Irish since nationalisation sets an unsettling precedent.

After revelations of financial irregularities forced the resignation of three executive directors, Anglo moved decisively to replace them with . . . Anglo insiders. Most astonishing, in the light of the scandal over Irish Nationwide deposits, was the decision to replace Anglo's disgraced financial director with his immediate subordinate, Anglo's chief financial officer.

It is hard not to conclude that a deliberate decision has been made at the highest level of Government that what happened in Anglo, stays in Anglo. And we can expect Nama to be run in the same tight manner.

While there has been considerable speculation about dark motives for bailing out developers and banks, I do not believe that the Government's behaviour has been corrupt: it has been far worse. At least corruption implies a sense that you are doing wrong, and need to be paid in return. Our Government actually thought it was doing the right thing in risking everything to safeguard the interests of developers who had given us an economy that was the envy of Europe.

Instead of recognising bankers and developers as parasites on our national prosperity, the Government came to see them as its source. While everyone else in Ireland has come to see the past decade as an embarrassing episode of collective insanity to be put behind us as soon as possible, the Government still sees it as the high point of our nation's history. Nama is effectively Fianna Fáil's shrine to the bubble, and likely to be an expensive and enduring one.

What should be done instead of Nama? First, we need to understand how the idea of Nama follows from a mistaken analogy with the Swedish banking crisis and bad bank of the early 1990s. The Swedish banks differed in one fundamental way from ours: they only had deposits as liabilities. If their government had not taken over their bad debts, ordinary depositors would have suffered. By contrast, Irish banks had borrowed heavily from other financial institutions through bonds, and these bondholders originally agreed to take losses if Irish banks got into difficulties.

By placing the costs of the banking collapse primarily on existing holders of bank bonds, the State can improve its credit rating and pull back from the edge of bankruptcy. Knowing that taxpayers are not liable for the losses of AIB and Bank of Ireland will make capital markets more willing to lend to the Irish State.

Instead, like a corpulent Tooth Fairy gently slipping billions under the pillows of sleeping bond holders, Brian Lenihan has chosen to extend the liability guarantee and further weaken the bargaining position of the State.

The drift into national bankruptcy looks increasingly unstoppable.

So what possessed the Government to guarantee not only depositors but bond-holders as well - who as Morgan Kelly states -  have contractually agreed to carry the risk of bank default in return for higher rates?  Personally, I believe the banks convinced the Government that they would go bust without such a guarantee, and the Government felt it had no option but to do whatever it took secure their survival.

But whatever about AIB and the Bank of Ireland being essential to the functioning of the Irish economy, Anglo-Irish Bank and Irish Nationwide were essentially developers banks run by and for developers.  Morgan Kelly appears to believe it was Fianna's Fail's ideological and personal affinity to the the relatively small clique of developers, builders, land speculators and bankers which left it powerless to see that it was being taken for a gigantic ride.  That is about the most charitable interpretation that can be put on the débâcle.  A less charitable interpretation would be that Cowen has engaged in a fraud that would make Madoff blush.

This is not the first time the Irish banks have run rings around the Government.  AIB, the largest bank in Ireland convinced the Government to bail it out in 1985 after a spectacularly ill-judged investment in the Insurance Corporation of Ireland - and then promptly turned around and paid its shareholders a larger dividend.

So was it really a case of the Banks stealing toys off children - an inept Taoiseach and inexperienced Finance Minister? Or is it not too late to undo this spectacular blunder and withdraw the guarantee given to Bond-holders - if not the money already given to Anglo-Irish?  Any bankers around here know the answer to that?

Display:
Morgan Kelly (Opinion, 3rd. July) raises some extremely worryin questions regarding the Governments handling of the Banking Crisis.  

Firstly the tax payer is being asked to pay up to €90 Billion for toxic assets which may be almost worthless.  Had those "investments been a success, the taxpayer wouldn't have owned one cent of them.  

Secondly, the Government has guaranteed not just depositors, but corporate bond-holders in those banks as well.  Investors gain a better rate of interest on corporate bonds because they take on the risk of default.  So why is the taxpayer now being burdened with the investors risk when he was never party to the contract?

Thirdly, Anglo Irish bank was run by and for property speculators and developers.  It had no strategic value to the Irish economy other than that it bid up the price of land for everyone else and thus created an unsustainable property bubble.  Why are we bailing out the very people who caused the economic collapse and who have no strategic role to play in our long term recovery?

Fourthly, the cost of the bail-outs is so huge - potentially two thirds of Ireland total GDP or national income - that it will beggar the nation and make recovery impossible for decades to come.

Why are we implementing the bad bank idea when even the US Administration rejected it as unworkable for the USA?  NAMA is closer to Madoff than Obama and should be abandoned forthwith, as should the guarantees to corporate bond-holders.  

The banks have scammed us once too often. Does nobody remember AIB paying increased dividends to it's shareholders soon after taxpayers had to bail it out for its lamentable takeover of the Insurance Corporation of Ireland in 1985?

We are better off without a banking industry led by greed, speculators, and pyramid fraudsters.  Let those investors who gained the returns now also take the hit. and let us rebuild our economy based on an ethical banking industry.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Jul 5th, 2009 at 11:09:47 AM EST
Well, I reckon that it's possible to set up NAMA as a framework for a debt/equity swap on a countrywide scale.

ie it is possible to "pool" land and property rental values in respect of distressed properties and then the existing secured debt could be exchanged for "units" in the NAMA (quasi partnership) Corporation.

So my LTE would be a constructive one explaining just that.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sun Jul 5th, 2009 at 12:05:00 PM EST
[ Parent ]
Please send in an LTE on those lines, as this isn't getting the debate it deserves.

However my reading of the situation is that any rent likely from the €90 Billion in debt related property is likely to be so low as to render the investors bankrupt.  Nama will only succeed in "rescuing" the banks if it pays way over the odds for the assets.

And all of this is before the lawyers make a few billion defending developers property rights under the constitution.  I kid you not.  This is going to create a veritable industry for developers using lawyers to claim full compensation for assets appropriated - at below their book value - even though the taxpayer will be taking the bulk of the losses.

The lawyers have already made hundreds of millions from the various tribunals which have led to not one conviction for anything.  It is the only growth industry in the country.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Jul 5th, 2009 at 01:04:16 PM EST
[ Parent ]
The "bad bank" concept (simulated bankruptcy protection) is NOT dead. In fact the Fed is the "bad bank" of first and last resort. Every single repo contract, every SPE created and "temporary" credit window opened is a vehicle to launder non-performing balance sheets of US banks and corporations.

The Fed balance sheet is swollen with "bad" securitized collateral. It is FUBAR. That is "bad" for beta. For this reason in fact the administration has endorsed "emergency" Fed capital market manipulations and continues to encourage Congressional enquiry to institutionalize the governors' authority to regulate price discovery. That is in effect fix prices of "systemic risks" rather than establish and enforce with prejudice or penalty the underwriting standards and marketing practices of its clients. That is "primary dealers"of US treasuries.

bad bank idea when even the US Administration rejected it as unworkable for the USA

Administration officials have simply stopped talking their book in the press.

Diversity is the key to economic and political evolution.

by Cat on Sun Jul 5th, 2009 at 01:14:49 PM EST
[ Parent ]
Maybe we should offload all our bank toxic debt onto the ECB so!  We appear to have allowed the creation of a global system that is unregulatable, and which rewards the most extremely leveraged behaviour.  Maybe Islam isn't such a bad idea after all!

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Jul 5th, 2009 at 01:50:20 PM EST
[ Parent ]
I'm afraid Mr Kelly does not have a servicable grasp of events he attempts to critique. From this statement --in one hand grossly misreprentative and in the other factually incorrect-- cascades ill-conceived aspersions on "corruption"in policy prescriptions and offices of trust.

A far more efficient and cheaper alternative to Nama is to copy what Barack Obama did with General Motors, and transfer ownership of Irish banks to their bond holders. In this way we can achieve well capitalised banks, run without political interference, at minimal cost to taxpayers.

What "Barack Obama did" (and George Bush did) through executive agencies and special legislation was lend GM $18B, secured with convertible bonds (warranted "ownership interest") held by the US Treasury. What the US Treasury did then was appoint a "Car Czar" to re-negotiate GM payment obligations to existing bondholders (top-5 bank holding companies, eg. Citi) by charge-off the debt value for the purpose of determining par value of  common shares ("equity") of a NEW! GM issued in lieu of interest payable.

OLD GM is not "capitalised"; Car Czar is liquidating  assets which do not convey to NEW!GM. NEW!GM is not "capitalised" until such time management raises capital by sale of assets or IPO. In fact both entities are as I write incurring fresh debts by "bridge loan" and DIP financing.

Worse:  What "Barack Obama did" in haste to shed federal auto industry ownership was approve the appointment of Ed "I Don't Know Anything About Cars" Whitacre --formerly AT&T, Ma Debt Load-- chairman of the NEW!GM.

"Lots of conversations" followed with Steven Rattner, the Wall Street dealmaker running President Barack Obama's car task force, said Whitacre, adding that Treasury's message was: "We need your help. It's a great company. You could be a lot of assistance to GM."

I cannot think of a worse exemplar of low-risk taxpayer-funded "nationalization" than GM except the TARP authority itself --which is the strategy it appears the Taoiseach immediately adopted for fear of FDI flight. What is Mr Kelly thinking by comparing Ireland's charter banks to GM? Surely he'd do better by his readers to develope a prospectus for "the flexibility of the Irish labour market" than to beat the dead horse of bankers' leverage.

Diversity is the key to economic and political evolution.

by Cat on Sun Jul 5th, 2009 at 12:16:24 PM EST
Yup. He's got a nice line in invective, but his proposed solution doesn't stack up.

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Sun Jul 5th, 2009 at 12:29:36 PM EST
[ Parent ]
I think it's fair to say the Obama reference serves its polemical purpose by distancing the NAMA proposals from what was done in the US - where bad bank proposals appear (?) to have been abandoned.  The Government's constant refrain is that the banking crisis is a global one, and we did nothing worse than anybody else... so Morgan Kelly's first task is to show that the Irish situation and the Government's response IS different.

I don't claim to understand the the GM deal in any detail, but my understanding was that the corporate bond-holders did take at least some hit, and were forced to accept a "negotiated" deal where their benefits were much reduced.  This hasn't happened in Ireland despite the fact that the banks are insolvent.  The Irish taxpayer is taking the full hit.

Morgan's other point is that the huge liabilities being taken on by the state are almost unfundable, and the states debt and credibility would be much enhanced if it didn't take on the bond-holder guarantee liability.

I don't know which would be worse for Ireland's economy long term - some FDI flight due to bond-holders getting burnt, or a huge increase in Ireland' Debt/GDP ratio.  There ain't much FDI doing the rounds at the moment in any case, and the Government isn't adopting an anti-business stance by letting bond-holders get what they signed up for - and what they are getting elsewhere in the world.

The Government - like Obama - have a terror of actually having to run the banks/motor industry - and want them to survive as independent entities.  But there are other players in the credit field and we cannot keep bailing out the primary culprits on the basis that they have us by the short and curlys.

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Jul 5th, 2009 at 12:56:30 PM EST
[ Parent ]
Morgan Kelly's first task is to show that the Irish situation and the Government's response IS different.

Well, yeah. And he doesn't, because he can't, unless he lies boldly, of course, and to do that he'd need to re-write the OpEd.

my understanding was that the corporate bond-holders did take at least some hit

You'd do well to search ET comments, phrase "GM." Myself and ManfromMiddletown have captured pivotal documents and events since, oh, at least last August. The key point is that by discounting GM debt by ~75% and dictating terms of debt-to-equity swap to surrogate courts, the Car Czar foregave ("wiped out") fixed income owed pensions, unions, and banks (who are the majority shareholders apart from US fed) --AND-- diluted the marketable value of shares outstanding.

Morgan's other point is that the huge liabilities being taken on by the state are almost unfundable

That hasn't stopped either the FRB or US Treasury from executing TARP guarantees. Then again, US TARP is self-funded. To obtain a similarly bogus level of capital reserve for servicing its charter banks' debt  Ireland would either issue own treasury bonds (future tax revenue that will not be collected).

That would be easier than applying to the ECB open market facilities for liquidity <-- gerbil wheel --> before the govs get too picky, eh.

And that would be easier than dictating bankers' default terms (e.g. debt-equity swap) in favor of explicit national investment projects to lever the "flexibility" of Irish labor and ingenuity (e.g. not Build America bonds, m'K?). Government bodies have to be willing, at least, to experiment with making markets for there sources in hand rather mourning those wished it had. The leadership has to be craftier than "Obama" who is after all one of the dullest tools in the garden shed. Really. Keep watching.

Diversity is the key to economic and political evolution.

by Cat on Sun Jul 5th, 2009 at 03:01:00 PM EST
[ Parent ]
Is there a specific proposal as to how Nama will work?
by Colman (colman at eurotrib.com) on Sun Jul 5th, 2009 at 03:13:48 PM EST
I'm actually beginning to think that the whole Nama thing is an attempt to push the problem away in the hope it'll disappear. They're not even planning the specific legislation until September - "probably".
by Colman (colman at eurotrib.com) on Sun Jul 5th, 2009 at 03:19:39 PM EST
[ Parent ]
This is possible, although apparently the Heads of the Bill have been approved in cabinet and the final bill is supposed to be approved by Cabinet before the long summer hols.

It should be interesting watching the government simultaneously giving the banks Billions and taking food out of children's mouths via on Bord Snip Nua's cuts in social welfare, health, pensions and just about everything else.

Politically an undoable combination, in my view, but lets see what the next few months bring...

It's also worth noting, that proportionate to the size of the Irish economy, €90 Billion is about 10 times the size of the US stimulus plan.  

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Sun Jul 5th, 2009 at 03:44:17 PM EST
[ Parent ]
Frank Schnittger:
It should be interesting watching the government simultaneously giving the banks Billions and taking food out of children's mouths

You say that like it's a bad thing.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Jul 5th, 2009 at 06:12:08 PM EST
[ Parent ]


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