Terry McDonough: It has been repeatedly asserted over the last few days that NAMA is the only game in town. Below is a list and description of the games currently being played. I would appreciate any corrections from readers of this blog.
“Good Bank” proposal.
The government takes over the deposits of the banks. These are liabilities. In exchange for taking the liabilities the government also assumes the best performing assets of the banks. This creates a clean bank with deposit obligations backed by performing assets. The government then invests in this bank to top up required capital. The bad assets are left with the shareholders and bond holders to work out in the “legacy” bank.
The advantage of this is that it doesn’t cost the government anything, as the bad assets are not bought and the capitalization of the banks confers ownership of a valuable asset, the clean bank. The losses are left to the shareholders and the bond holders.
A complication with this is the government has guaranteed the bond holders until September, 2010. This can be dealt with in several ways. The legacy bank can be required to manage its assets so as to meet all obligations falling due prior to September 2010. The government can withdraw the guarantee. This is not the same as defaulting on sovereign debt but does undermine government credibility. It could be done more easily by a new government. The Fine Gael proposal avoids this by setting up a clean bank from scratch now, and only splitting the private banks into government owned clean banks and bad privately owned legacy banks after the guarantee expires in 2010.
Upsides: Taxpayers leap free. The good bank under government control can decide to extend credit. Shareholders and bond holders take the hit.
Downsides: Bond holders take the hit and the bond markets are mad at Ireland.
Response to downside arguments: Since the Irish government is no longer responsible for the bad debts of the banking system, it is more solvent and better able to borrow on the bond markets. The bond investors are businessmen. They don’t hold grudges. In fact, they respect taking the tough decisions in the national interest.
This solution is often presented as temporary, as the clean bank can be sold eventually perhaps at a profit for the government. The clean bank could also be run into the future, emphasizing public priorities like local business and green investment. Credit is necessary and should be run as a public utility, rather than a gambling den as it is periodically under private control.
Nationalising the banks
This involves purchasing the bank stock by the government. This leaves the government in ownership of both the good and the bad assets of the banks. The government would probably then separate the nationalized banks into clean and “bad bank” divisions and further capitalize the clean division.
Upsides: Taxpayers pay less. If banks are judged valueless on balance, taxpayers pay nothing. Shareholders take the hit. Taxpayers get good as well as bad assets. Government can dictate that banks begin lending again.
Downsides: Bondholders now owed money by state institutions. Paying back bondholders can create substantial losses for the state. It has been argued that lenders in the future will not lend to a state bank. This is historically unsupported.
Like the “good bank” proposal, the nationalized state banks can either be sold off later or retained to provide credit outside the private bank cycle of boom and bust.
NAMA with bad assets purchased at current market prices
NAMA buys bad assets at current market prices. Banks forced to write down their losses. Government recapitalizes banks. Government ends up with majority ownership of banks.
Upsides: Taxpayers do not lose money in creating “bad bank.” Ownership shares could be used to mandate the restart of lending.
Downsides: Bondholders still owed money by clean bank, now majority-owned by government. This could mean substantial losses for the government in the future.
NAMA with Honohan amendment
NAMA pays roughly the market price for the bad assets. In addition, the banks receive shares in NAMA which entitle them to the profits if NAMA makes money after paying back the government. As with the above purchase of bad assets at market prices, the government is required to recapitalize the banks by taking substantial shares.
Upsides and downsides as above, with the added downside that if the bad assets perform better than the market expects the additional money goes to the banks rather than the taxpayer.
NAMA acquires bad assets at some markup above market rates. The government then recapitalizes the banks but buys fewer shares because the banks now have capital received from the overpayment for the bad assets.
Upsides: Banks now cleansed of bad assets, but this advantage is shared by all of the above proposals.
Downsides: Government pays the same as under the above modified NAMA proposals for the bad assets and the bank recapitalization, but owns a smaller share in the banks. There is no guarantee that the banks will begin to lend again. Shares in the banks leave the government exposed to losses through payment of the bondholders.
The “Good Bank” option is clearly superior in that it is the only one which relieves the taxpayer from responsibility for compensating bond holders for losses. It also creates a government controlled bank which can be instructed to begin lending.