Monday, 21 March 2011

Debt-equity swap for banks won't work

Michael Burke: The sheer size of the bank debts being assumed by the State has led to a flurry of alternative proposals which might diminish the burden to taxpayers. The latest proposal is from Karl Whelan, who has proposed a debt-for-equity swap to recapitalise the banks. This has received some mixed support.

But it fails on the first count: it doesn’t reduce taxpayers’ burden at all, it increases it. Scandalously, it does so in order to reimburse bondholders for every last cent of their failed investments.

For Irish taxpayers, the form of the bank bailout, debt or equity, is less important than the amounts involved. It was the last government’s determination to bail out the banks which led to the arrival of the EU/IMF. More precisely, it was the government’s position combined with the refusal of the ECB to countenance further liquidity support for the banks without a bailout for EU banks which brought the EU/IMF impositions.

Under the latest proposal €150bn would be required to recapitalise the banks, which would be achieved by the Irish central bank converting its €70bn in short-term loans to the 6 Irish banks guaranteed by the State into equity. There is a hope that the European Financial Stability Fund (EFSF) would also do the same for the €80bn in loans from the ECB.

If, as Karl Whelan suggests, the true picture is that the 6 banks’ underlying value is approximately -€30bn, yes, that’s a minus number, then the immediate loss incurred by both would be 20% with the CBoI losing €14bn and the EFSF’s loss would be €16bn. Quite why the European authorities would agree to this is not explained, even if others have suggested that Irish referendum voters won’t play ball when there are the (inevitable) further Treaty changes. In context, the European authorities have dug their heels over a 1% cut in the punitive interest rate levied on Irish taxpayers, which would only yield a saving of €450mn per annum.

By contrast a unilateral repudiation of the bank portion of the debt requires no agreement, just a determination to carry out what’s fair and reasonable. That determination alone might even be enough to force a more reasonable stance from the EU itself.

The unwillingness of the EU authorities seems a fundamental practical objection to the plan. But there is an obvious objection in principle. Why would taxpayers in either Ireland or the rest of the EU provide massive amounts of new capital for worthless institutions and their bondholders, or shareholders? It is unfortunate that Whelan, an effective scourge of the previous government’s support for the banks, now seems to accept that the bondholders are to be made whole, while taxpayers, and State finances take the enormous strain.

Whatever the unacceptability and immorality of the plan- it simply won’t work. The ECB has no intention of ‘printing money’ to bailout one of lesser members- the EFSF is borrowed capital ultimately financed by taxpayers. Neither is the ECB is unlikely to allow the CboI to do the same. All of the capital to be handed over for failed investments in Irish banks must come from taxpayers.

In the dizzying collapse of the Irish financial sector - and the authorities’ determination both in European and in Ireland that the private sector be protected from the consequences of their own investment decisions - it is easy to forget that November ‘s €35bn bank bailout provided the tipping point- into the tender embrace of the EU & IMF . Suggesting that the crisis can be resolved by a €70bn bailout has no logic. Irish taxpayers potentially picking up the bill of €150bn (and at an annual interest bill of over €4bn) for the most over-capitalised banks in the world would be simply bizarre.

Although the bank bailout sums are getting greater, and may become greater still if the stress tests are at all serious, the same principles hold. Irish taxpayers can’t pay for a bank bailout. Nor should they.


Robert Sweeney said...

‘Irish central bank converting its €70bn in short-term loans to the 6 Irish banks guaranteed by the State into equity…… the 6 banks’ underlying value is approximately -€30bn, yes, that’s a minus number, then the immediate loss incurred by both would be 20% with the CBoI losing €14bn and the EFSF’s loss would be €16bn.’

If the Irish central bank converted €70bn of loans into equity worth -€30bn, is that not a loss of €100bn? Also, what form of assets is the €70bn? Presumably it is bonds, not cash. As such, it is not necessarily a loss to the state yet. What do you think would happen to the banks if Ireland repudiated the bailout? Surely the run on the Irish banks would accelerate, and, not being able to borrow on the markets, people’s saving would be lost. Terrence McDonaugh alluded to the possibility of leaving the Euro in a recent post. Mark Weisbrot has also been suggesting that the costs of remaining in the Euro might outweigh the benefits. He argues that making preparations to leave the common currency, even if not carried through, would strengthen the peripheral countries’ hands. What are your thoughts?

Michael Burke said...


no, the loss is the recapitalisation minus the net assets (KW's guess is -€30bn for these), although under your surmise all capital given to the banks will be worthless. That too may come to pass.

The liquidity from the ECB and CBoI will be in the form of money market instruments of different types, short-dated instruments that are close to cash but yield an interest rate.

What is of value, immense value, in the Irish banking system is the deposits. These need to be protected at all costs, both for natural justice and economic recovery. These need to be ring-fenced against all other parts of the banks' balance sheets.

Everyone else, including the ECB, has been determined to make whole the bondholders. Irish taxpayers have no reason to stop them, just as long as they don't do it with Irish taxpayers' money.

Robert Sweeney said...

Still a little confused. Am I correct in saying that the figure is arrived at as follows. The banks owe the ECB and CBoI E150bn. The value of their assests (loan book etc.) is estimated to be E120bn. Therefore, if the debt was converted into equity, the combined loss to Europe and Ireland would be E30bn, E14bn of which we take the hit for as we lent slightly less than the ECB. The total losses would therefore be this E14bn and whatever capital we have already injected into the banks over the last couple of years. Is that correct?

Michael Burke said...