In the days leading up to the release of the latest instalment of the bank bailout programme, all sorts of numbers circulated about the size of the latest bank recapitalisation. Now, it is widely presented in mainstream media and elsewhere as a relief that ‘only a further €24bn’ is needed.
The insouciant recommendations of further debts that amount to €5,000 for every woman man and child in the state, while at the same time slashing public spending are remarkable. Another €24bn for the banks is entirely manageable, it seems, while benefits to lone parents, jobs seekers or the disabled amounting to tens of millions of Euros must be slashed, for fear of destroying the public finances
There are two practical reasons why further bailout for the banks should be rejected. First, the current level of projected debt is insupportable. Secondly, the current level of projected debt is wildly understated.
Unsupportable debt
The €24bn, even if it were the last recapitalisation, would take the bank debt to unsustainable levels. The Department of Finance table below shows the bank recapitalisations to date.
It is variously argued that the €24bn is the last of the bailouts, that this recapitalisation contains a ‘buffer’ against adverse developments and that there is a residual value in the banks. It might be objected that:
• we have heard the ‘one last heave’ argument before
• that the buffer is nothing of the kind as even the ‘stress test’ scenario includes assumptions that are more optimistic than the current situation
• and that the combined market capitalisation of AIB and BoI, the new ‘pillars’ is now only around €800mn, reflecting market expectations that the authorities are determined not to wipe out shareholders in full, if necessary by further capital injections.
These objections need to be fleshed out. But for now, they are largely beside the point. The cost of the bailout funds is close to 6%. Before these policies led to the state being excluded from financial markets interest rates had reached much higher levels. 10yr government yields are still close to 10%. On €70bn an annual average interest rate of 6% produces an interest bill of €4.2bn.
Under the terms of the impositions from the EU & IMF there is a total of €6bn in spending cuts and tax increases planned for this year, and an average of €3bn in same planned over the following 3 years. That is, very rapidly, the interest paid on the bank debt of €4.2bn exceeds the supposedly vital measures to secure public finances and reduce the deficit. It is argued that these cuts/taxes are permanent, whereas the bailout measures are temporary, and will be concluded within the life of this Dáil.
Putting it politely, this claim is pure fiction. If, as advocates for bailing out EU banks with Irish taxpayers’ money assert, interest will only have to be paid for a short number of years, where on earth are the funds to repay the principal going to be found - all €70bn of it?
If the principal cannot be repaid in that timeframe then interest will continue to be paid on it until it is repaid. It does not appear as if the IMF, still less the EU Commission and the ECB are about to become charitable institutions.
Therefore Irish taxpayers will either have to fund €70bn is a few years’time- or, more accurately will for many yeasrs to come, be paying greater interest on bank-related debt than the ‘savings’ made from a fiscal consolidationthat is billed as necessary to save the finances of the State.
Unstated debt
These numbers are an understatement of the true position, both currently and prospectively. NAMA has issued €28.6bn in bonds. Although the DoF seems desperate not to have them classified as government debt, the classificialtion is immaterial as to the source of the interest on them- Irish taxpayers. In a re-run of the net asset argument and the eventutality that the NAMA assets will at some point be worth something,that is entirely possible but again besides the point. They are ‘non-performing assets’ currently, ie bearing no interest, and taxpayers are paying interest to acquire them. Jam tomorrow is never a convincing argument. It is irrelevant when dealing with an immediate crisis.
The terms of the bailout are set out in the 'Financial Measures Programme Report' from the CBoI. This has had a wide airing in the media, but not a very criticial one. For example, in 88 pages of the report there are references to but no examiation of the impact of pojeced ECB interest rate increases over the next period.It is certainly daunting to contemplate the likely impact on the Irish economy.
It may be that the scenarios included in Appendix C include adverse changes to interests (and the possibility they are greater than currently projected by the money market yield curve), but, if so, these are not stated. There are also a number of key assumptions inboth the ‘base’ and ‘stress test’ scenarios which are highly questonable:
• The projected fall in property prices reflects the experienceof Finland, Britain and Sweden in the 1990s, none of whom were in a monetary union and responded with lower interest rates, not higher ones as the ECB threatens
• Even so, both base and adverse sceanarios project rising propoerty prices from next year (Exhibit 7), despite the earlier admission that even in those countries in the 1990s, ‘house prices tend to follow a pronounced decline for a protracted period’ (p.51)
• The base case interest yields on Irish debt are below (8.63% at 10yr) the current level (9.8%)
• Both the base and adverse cases for the fall in 2010 GDP (-0.2%) are below the latest offical estimate of the decline (-1.0%)
• The uenmployment rate for this year is variously estimated at 13.4% (base) and 14.9% (averse) when the starting-point is 14.7% and rising
Whatever the outcome, the consistent pattern is the current indicators are closer to the adverse of ‘stress test’ senario than the base scaenario.
There has been much discussion on the gap between the Blackrock projected €40bn in lifetime loan losses and the CboI’s recommendation of €24bn in recapitalsation and the assertion that this includes a large ‘buffer’. (The buffer is just €2.3bn in total, plus €3bn in continegent capital (Table 18)). But the CBoI’s own assessment is only for 3-year losses, and under the (undemanding) stress test this amounts to €27bn (Table 10, p.29).This is greater than €24bn, buffer included.
And, as with the €70bn repayment argument, is it seriously suggested that AIB and BoI will be genrating profits in 3 yeas’ time? Without the capital injections, all he insitutions would have negative capital (that is,worth less than zero) in 2013 (Table 14).
Crucially, the entire exercise is premised on large scale ‘deleveraging’ of the banks’ balance sheets, that is a further disposal of loans. There are two avenues for this, commercial disposals and public ones- NAMA. To date, total disposals have amounted to €120bn, but only €49bn of this has been commercial disposals (including write-offs). €71bn has come from dsposals to NAMA.
Over the next period a further €84.1bn delveraging is projected to take place mainly through the run-off and disposal of non-Irish loans, described as ‘non-core’. Therefore, to some extent, the whole plan relies on finding a buyer for these assets at book value- even though it is widely known the Irish banks are forced sellers. Realising further losses, beyond any write-down in loan values to date, may be inevitable under this plan. Surveying the world economy, it is certain that an optimal loan book would not be 100% concentrated in Irish and British lending, which is now the aim of policy.
Conclusion
Finally, in effective the same authorities who produced an economic and fiscal crisis leading to the impositions of the EU and IMF are now arguing that the related banking crisis can be resolved by parallel measures; assets sales and the protection of capital at the expense of labour. But Adam Smith noted long ago that all value is created by labour. Diminishing productive labour, failng to optimise its skill levels, increasing its naked exploitation and expelling a portion of it from the country for a prolonged period will damage the entire economy. Clearly, policymakers who have embarked on this course do not understand that economic principle or care less.
But, if they cut the wages of public sector workers and their numbers, and thereby hope to promote a ‘demonstration effect’ of lower wages in the private sector, and mortgage defaults rise as result, guess what the arguments will be? We need more capital for the banks and more cuts in public spending.
It has already begun here and here.
9 comments:
Michael,
This is a generally useful analysis. I would have issue, though with two elements
1) The headline €70 billion figure you use, and
2) The perception of the expected "profits" of the banks.
Thus far €46 billion has been poured into the banks. Last week we were told they will be need to be recapitalised to the tune of a further €24 billion. This sums to €70 billion, but there is no necessity that the State has to put in all of this money.
We know that about €2 billion will come from the assets of Irish Life and the Minister for Finance has promised us further haircuts of €5 billion to junior bondholders. Over the next few months BOI will be stringently attempting to raise much of the capital it needs through internal means as it tries to stave off majority state ownership. It is hard to know how successful this will be.
This brings down the total contribution by the State. I estimate the cost of this madness to be around €63 billion. Because of the pillaging of the savings built up in the NPRF the new borrowings will be around €42 billion. We probably should also include some of the recent contributions to the NPRF, particularly the €6.3 billion since 2007 as the Exchequer has been in deficit throughout.
This means the debt is probably more than €20 billion lower than the €70 billion figure used. The cost is a staggering €63 billion and nothing can ever hide that.
Of course, your argument that this debt is "unsupportable" may still hold. At any rate there is no way it can be supported from any social perspective. The issue of the unstated debt is very valid, as are many of the concerns about the stress tests.
On the whole issue of profits in the banks, the €3.9 billion of profit that BlackRock estimate over the periof 2011-2013 is operating profit, i.e. before impairment provisions. It will be years before these delinquent banks again generate a net profit.
The point is that this profit from the day-to-day operations of the banks (current accounts, credit cards, business accounts etc.) can be used to offset some of the huge losses that are on their balance sheets. This profit will be swamped by these losses but it does exist. And will continue to exist in the years after 2013 which is why the lifetime losses that BlackRock estimated have not all been included. Net profits for these banks remain just a pipe dream.
Seamus,
thanks for the comments. On the 2 points:
1) The headline figure is just that, reporting only what is officially sanctioned. In terms of judgement, my view is that the total sum is likely be larger not smaller. You correctly term it the 'pillaging' of the NPRF, but this too entails a cost of both principal and prospective interest - which would have otherwise accrued to Irish taxpayers. It is a net cost to them.
Time will tell whether BoI is able to raise money in the markets, rather than shuffling assets from another state-owned entity. But if the judgement is correct that the stress tests are insuffuciently stressful there will still be a capital shortfall - and Irish taxpayers will be on the hook for BoI's new capital too.
ILP is expected to make net losses after writedowns of €2.27bn in the next 3 years (Table 11) and itself has a €2.569bn in capital shortfall under the (undemanding) stress test (Table 12).Its own total capital requirement is €4bn (Table 18).
Time will also tell whether the Minister carries out his promise for haircuts on junior bondholders and how much that might save, maybe €2bn?
Even in aggregate, these sums do not approach the €28.6bn in issued NAMA bonds, which is on top of the €70bn. And the economic outlook means that risks are skewed towards increased bank losses.
2. There is no disagreement on net losses. These will continue to stretch out beyond 2013, net of any operating profit. But that only reinforces the view that this is not the last of the bank recapitalisations - if they are not stopped.
@Seamus,
Once again you have increased public understanding. Thank you. However, in addition to the points you raise, I think a major source of uncertainty is how the huge ECB/ICB liquidity support will be unwound. In response to last Thurs.' recap the ECB committed itself to keep this support in place and, indeed, to accept any bit of paper with a harp on it as collateral.
Despite the vilification of the ECB that goes on it is actually the only EU institution that has performed. It has been pushed into a position that is probably beyond its mandate (and with which it is clearly uncomfortable) because of a serious governance deficit in the other institutions of the EU.
Ireland not only exploited this governance deficit in the EU, it also failed to develop adequate compensating governance itself.
All EZ members are suffering to some extent from these twin failures of governance, but the main core members are trying to address it at the EU level and, very quietly, at the national level. An attempt is being made to build a contagion fire break between the small peripherals (Ireland, Greece and Portugal) and the 'vulnerables' - Italy, Spain and Belgium.
Ireland is where it is because the impact of its failure of governance was so spectacular, unhideable and far-reaching.
@ Michael,
The net loss figure for IL&P is correct but this is after impairment provisions. Table 11 also show that IL&P will make €413 million of operating profit over the 2011-2013 period.
In the context of the losses on the balance sheets of the banks this is a relatively small figure but we cannot ignore that it exists. The Central Bank have taken this into account and the €4 billion capital requirement is net of that. It is the period after 2013 that the operative profit has allowed the Central Bank to reduce the €40.1 billion of lifetime (30 years?) losses to the €27.7 billion of losses that will crystalise over the next three years. We do not need to put money into the banks now the cover losses that might occur in 2020 or beyond.
I agree that there is an interest loss from the destruction of the NPRF. However, the sustainability of the debt will be based on the balance of the interest accrued on additional borrowings against government revenue. Using the analogy of a family buying a house, the NPRF is the deposit we have put down. We must now determine whether we can afford the mortgage. A bigger deposit makes this more likely, even though there is a larger opportunity cost of the lost interest.
Of course, a family gets a valuable resource that will provide shelter and comfort for many years and sees it as a worthwhile investment. We have bought a set of rubbish banks.
@Paul
I would not be so effusive about the ECB. Yes, it does appear that we can rely on them to continue to provide the funding for the banks. But you have to remember what a lot of this money was used for - to pay the bondholders.
We now find ourselves in a policy straightjacket because of this. There has been a reduction of €54 billion in non-resident holdings of bonds in the covered banks since August 2008. They had the money to pay for the losses in banks they invested in. That option is now largely gone. The least the ECB can do is provide the cheap funding the banks need.
@Seamus,
Don't worry. I'm not starry-eyed about the ECB. I've been banging on for years about the serious democratic governance deficit at the heart of the EU. It's simply that, on the basis of your excellent forensic analysis, it's worth while to stand back and look at the bigger picture.
The FT has a detailed assessment of Germans banks:
http://www.ft.com/cms/s/0/a3b632e8-5fb7-11e0-a718-00144feab49a.html#axzz1IUPhXad6
I'm sure that could be replicated in all the core EZ economies. The ECB was forced into a position to make a call. Either authorise the burning of bank bonds in Ireland (and sovs in Greece and Portugal) with the risk of blowing every dodgy EZ bank - and possibly the entire financial system and Euro as well; or provide huge cheap liquidity to allow redemption of the Irish bank bonds as they fell due and prevent contagion. It opted for the latter. And it ran with the grain politcially in the core EZ countries who consider themselves far better governed than the peripherals.
Even though, legally, it wasn't its job, no other institution or entity had the resources or capability.
My expectation is, that over time as this liquidity support is unwound the ECB will take a hit on the pieces of paper with a harp on them. The other EZ players will, very quietly, provide some recap of the ECB to compensate for these losses. The irony is, that the more noise we make about the need for burden-sharing (in this or some other way), the more difficult it will be for the other EZ players to bee seen to be indulging in burden-sharing with the feckless peripherals - as they are perceived by thier voters.
Michael,
Very useful post - I would add two concerns.
The first is that capitalisation is intended to absorb bank normal operational losses and normal risk. Stress tests typically assume a normal distribution of risk, but risk management in Irish banks suggest that this is not the case. In this scenario capitalisation demands would need to err on the high side.
Secondly capitalisation does not resolve the underlying funding gap – the initial and still unresolved problem. Mainstream projections and the previous government’s four year plan appear to assume a return to normal banking activities with an intention to deleverage to about a loan to deposit ratio of 120% - this is still much higher than at the end of the 1990s. This ratio is still on the high side and might be achievable after extensive deleveraging and provided further deposits do not flow out of the system. One would assume that based on current growth forecasts deposit raising prospects would be somewhat bleak over the next few years. This might imply a prolonged period of liquidity support and further demands of the fiscal system if banks are not in a position to lend.
Seamus, Damian
apologies for delay in replying,
Seamus,
On ILP, its operating profits are not unique, in fact all 4 institutions make operating profits except AIB (Table 11). But they all also make net losses after writedowns over the next 3 years.
The €24bn recapitalisation includes both those operating profits and writedowns, and ILP's share of of that is €4bn.
A 3-year cut-off invites us to assume that after 3 years the operating profit will be greater than the continued writedowns even though house prices are likely to decline 'for a protracted period'. This seems unfeasible and therefore the cut-off is misleading.
The assumption that average loan duration is 30 years is also likely to be incorrect. ESRI states that the average residential mortgage duration is 10 years, and the average life of commercial property, small business, car and credit card loans is much shorter. The 'lifetime' losses are likely to take place in 5-7 years, on average. Given the economic crisis, the losses are likely to arise front-loaded.
€24bn takes no account of these likely further losses, and is also based on a very undemanding base case (where even the GDP starting-point is too high). Combined with NAMA, this brings the total to over €98bn, and rising.
Damian
You raise a very good point. There will still be a projected 'customer funding gap' of €31.5bn in 2013 (Table 19), requiring liquidity support. It is very unlikely that there will be any new lending in this economy from these banks.
The entire exrcise will have been to transfer incomes from who will spend it (taxpayers) to those unable to (zombie banks). They will be no more fit for purpose at the end of the bailout than before.
ps
In the redacted briefings just released it is noted that the EU believes a full €25bn will be required for further recapitalisations,while the IMF puts it at €35bn.
Meanwhile, NAMA is scheduled to pick up a further €16bn in bank loans below the value of €20mn, for which it will also have to issue bonds, say, another €6.5bn liability for taxpayers?
@Michael - the heavy black bits all over the redacted document is teasing in the extreme. Its like a heavily edited version of the chain saw massacre or some soft core movie. One if left wondering. How much is commercial secrecy or just plain 'the public shouldn't know' line?either way it is distasteful in the extreme. You would think that they would leave the black bits out altogether instead of teasing people with blacked out tables, blacked bits in between brackets and blacked out bits except for the first sentence.
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