Sunday, 13 September 2009

Beyond NAMA – seeing a bigger picture

Sli Eile: Two television documentaries shown, recently: one called ‘Freefall’ a dramatic story of the current economic climate as it unfolded for individuals in the City and a family; the other a story of the demise of Lehman Brothers last year, leave room to wonder how close the parallel to Anglo-Irish and the late-night agonies in board rooms and Merrion Street this time 12 months ago.

Globally, as well as in Ireland, the world of finance is reminiscent of Hamlet's "an unweeded garden" of "things rank and gross in nature".

The explanations are familiar: greed, lack of adherence to moral codes, lack of regulation, blind faith in markets, senior policy makers and public servants asleep at the wheel. It was and continues to be a systemic failure of huge proportions with devastating results for ordinary people.

One of the features of the current financial turmoil in Ireland is the way in which many sharp differences have opened up across the political, media and socio-economic interests fronts. There is no consensus on how to sort out banking (but there is on most other things - hence the Dublin Consensus).

Each political party in the Oireachtas has its own version of how best to proceed from here (NAMA as is, NAMA modified, ‘Good, bad bank’, Nationalisation of the big two banks and other variations of these). It is probable that a mix of sectional economic interest and remnants of past ideology influence the position adopted. I think that it is also true to say that most people haven’t a clue what the mumbo jumbo means and leave it to the ‘experts’ to work it out (but which experts?). It is also true to say that there are massive uncertainties built into any policy response at this time. We simply do not know what the future holds in terms of growth in GDP, lending, equity valuesor property values, as well as Euro currency movements. In this climate it is little wonder that different groups wish to minimise the risk to themselves:

Political parties are aware of the huge electoral implications of ‘getting it wrong’, not to mention the long-term pay-back in fiscal liabilities that might cripple the exchequer for years;

Bankers (as in those who manage banks) need to defend their capital reserves and avoid a run on their deposits and other liabilities post summer-2010 – and (another small point) they need to safeguard their own remuneration out of maximised short-term profits;

Many people working in the finance sector and their families are worried sick about losing their jobs in any rationalisation of banks (whether through nationalisation, or majority state holding, or some other change);

Depositors – large and small – want to be sure of their savings 3-5 years out from now;

Share-holders have taken a hammering but want to regain something – these include pension savers;

Bondholders – large and small, senior and subordinated – need some acceptable non-dire level of predictability of likely return and security of asset;

And …significant borrowers in the toxic wastelands want to cover their losses, move on and start all over again if they can (they will go to any lengths, as we saw in the Courts recently…).

The ‘Regulators’ and other public officials need to be seen to perform and deliver, especially as they failed so abysmally heretofore.

The truth is you can’t please everyone – at least not all of the time. And you certainly can’t fool everyone – at least not all of them all the time.

Essentially, banking in Ireland today is a lame duck. And when the duck is lame the State moves in, at least temporarily, to either subsidise or take-over. Everyone agrees about that. Even Adam Smith would have signed up to that (but I doubt he would have approved of NAMA). At the moment, it is a question of subsidise as the State takes the risk, while citizens pay the premium through higher debt servicing and taking on the value of future losses on over-paid assets through NAMA. Some ducks in the past didn’t matter so much . Hence, steel, shipbuilding, car assembly, mining and the like eventually went to the wall in many European countries. The problem with banking is that it is too central to everything else, so that it cannot be allowed to wreck the rest of the economy - especially those businesses without credit.

I am sceptical about the claims of unique knowledge, expertise and certainty made by those who said only a year ago that banking is fine and does not need to be recapitalised ... or, it does but only a bit. Twelve months later, why should anyone put too much trust in the judgment of those at the helms of banking, regulation, economics and media punditry? Even today, we simply don’t know the scale of bad loans.

Good old fashioned banking needs to be brought back, except this time as mixed economy.

Let me explain. I think we need a single public retail bank constituted from AIB and BOI in competition with other retail banks, an ICC and ACC as they were for business credit and re-structuring, and the Credit Unions when it comes local economy and households. With a tough regulatory regime, corporate democracy and ethics, and public ownership of at least one key financial institution in each of the three key areas: high-street retail, business/wholesale and local community banking. Let the privately owned institutions compete with that on this home ground, and lets have some mixed economy.

In the meantime, what are going to do with the toxic stuff? Without getting lost in technical and legal detail,we need to see the big picture. To the extent that individuals and corporates lost in their gambling, then let them take the hit with one proviso – that individuals and households suffering large drops in incomes are protected by a basic income floor through the social welfare system, plus some attenuated means-tested compensation payment to shareholders reflecting a fair price for shares. That’s only fair, especially if those on social welfare face cuts this winter.

Playing the stock market has to be understood as a game where losses mean losses and moral hazard is opposed.

Let anything guaranteed to September 2010 stand, but that’s it. Let some version of a State asset agency buy up bank debts at some estimate of current market prices (as the Swedes did in the 90s), rather than some fanciful long-term economic value (implying a huge loss on many assets held by the banks), while the State moves in and nationalises AIB and BOI without further delay and starts putting in place a plan for a National Recovery Bank as proposed by Fine Gael some months ago. Any future windfalls from a recovery in the value of some assets could be re-cycled into credit towards new green businesses, as well as re-structuring of those which have a chance of survival. In other words, instead of over-paying for rotten debts through NAMA, lets use the surplus over current market price to capitalise a National Recovery Bank.

As I understand it, the key point in the Labour Party line on nationalisation (which is exactly what Karl Whelan and Brian Lucy have being saying since the beginning of the year) is that

A crucial feature of the nationalisation approach is that it dramatically reduces the risk involved in having to value the bad loans.

I agree that an asset agency would be useful – once nationalisation has gone through.

I am not proposing a nationalised, but unreformed, banking arrangement and corporate ethos. Old-boy networks are everywhere from company boardrooms to a future asset agency to property developers to estate agencies to the golf course.

….in the year 2020 - sure he is a decent chap and you know how much trouble he has had and we can put it all behind us….an equity stake in return for their helpfulness is in order….a levy on windfall profits needs to take account of international market sentiment… blah blah

Question: If nationalisation of the big two banks, AIB and BOI, is the answer, as more and more people agree(including some very respectable and conservative economists) then why should it be only temporary? What advantages arise from a private sector-owned, only, banking system? Discuss.


Paul Hunt said...

I was increasingly in agreement as I read through your long, but lucid and rational post - until I came to the end. If you are determined to ask these questions, you are equally determined not to accept any answers. It is the job of governments (increasingly collectively by pooling their sovereignty) via policy and regulatory controls to to keep the financial and stock market cycles within acceptable bounds (in the same way as efforts are made to combine monetary and fiscal policy to prevent output gaps emerging) - not to own banks.

Michael Taft said...

Sli Eile - I am broadly supportive of many of the points you have made. However, if I'm reading you right, you propose the merger of Bank of Ireland and AIB into a single state bank. Given that there are approximately 40,000 employees between these two banks, would't consolidation result in thousands of job losses in this sector - the scale of which could do considerable harm to the economy and the Exchequer. This would be on top of potential job losses in the proposed 'third force' merger of the smaller banks. Wouldn't a better course - to ensure competition and maintain the maximum number of jobs possible - be to bring both banks into public ownership, clean them up and privatise one of the banks while retaining the other as a public enterprise retail bank? In this way, we can maintain two strong domestic banks - one private, one public, recoup some of the capitalisation investment, while guarding against unnecessary job losses that would occur in the eventuality of consolidation.

Paul, I'd just point out that if we hadn't privatised our two state banks - the ICC and the ACC - we'd have two ready-made vehicles to immediately extend credit to SME's. Now we don't.

Slí Eile said...

@Paul When you say it is not the job of the State to 'own banks' you are pointing to an assumption that I am questionning. State ownership is warranted where markets fail for one reason or another. The classic textbook arguments apply. It may be possible for the State through regulatory agencies and a combination of fiscal and legal measures to ensure that banks behave according to some acceptable set of norms and public policy goals. However, the evidence of recent years and especially the shock effects of 2008 seriously undermine the assumption that the State has no business in running financial institutions diretly through outright nationalisation. You need to convince me. My trust in a finance system entirely run by privately-owned banks is in crisis!

@Michael I agree that retention of jobs (in the banking sector) is a key issue among others. You will agree that the present situation in regard to credit and the plague of toxic assets on the bank balance sheets is a serious impediment to job creation and recovery. A strategy to unblock banking is urgently needed. The Government NAMA project no matter was 'green' concessions and adjustments are made involves a major risk of over-paying for bad assets by 10, 20 or 30% at least. That will most likely cripple future tax-paying citizens. Nationalisation, I believe is the only serious option left albeit with risks attached to nationalising bad assets. However, the best strategy is to wind down these loans by degrees over 5-10 years and to ensure that market price valuation is used and using any proceeds from recovered asset or share values to rebuild the banking system more on the basis of social need and benefit than private or speculative gain. Some of the collateral locked up in half-finished buildings and estates could be turned, after all, to more useful social purposes.
I take your point about possible job losses. However, as matters stand a shadow looms over jobs in the private banks - not least nationalised Anglo-Irish and Ulster Bank and probably the others well. Many scenarios are possible inlcuding foreign bank take-over. What I am suggesting is outright nationalisation of the big two banks and re-grouping of operations. Your suggestion about bringing both banks into public ownership, cleaning them up and possibly privatise one of them seems like a sensible option to consider not only because of the benefits of competition in the retail banking side but because a new banking ethos can be established in the private sector. If job retention and growth is one of the results of this all the better. I can understand the worries and fears of people working in the sector. However, as matters stand the risk is huge and we have to adopt a strategic approach to resolving the impasse which is disprupting the entire economic arteries.

hughgreen said...

'Even Adam Smith would have signed up to that (but I doubt he would have approved of NAMA).'

Perhaps not, but he'd have applied for a job with them nonetheless. (Smith sought a job with the East India Company - famously the butt of his critique of monopoly capitalism)