Better to incinerate €1.5bn than squander it on Anglo Irish Bank

Tue, Dec 23, 2008, 00:00

For this Government, the bailout follows a compelling political logic: Anglo Irish funds developers, and developers fund Fianna Fáil, writes Morgan Kelly

FOR THE current Government, a month without a catastrophic policy error has come to seem like a month wasted. After the bank liability guarantee in September and the medical card fiasco in October, the Government had a quiet November but has now come roaring back to form with the bailout of Anglo Irish Bank. Attempting to recapitalise Anglo Irish is not only expensive and economically pointless, but futile.

Some simple arithmetic shows the hopelessness of what the Government is trying to do. In the typical property bust over the last 30 years, US banks have lost on average about 20 per cent of what they lent to developers.

Let us suppose that Anglo Irish is no more incompetent or dishonest than the average bank and will also lose up to 20 per cent of what is has lent.

Then, given lending of about €80 billion to developers, it follows that Anglo Irish is facing losses on the order of €15 billion. The true figure could easily turn out to be twice as large.

With likely losses of this magnitude, the Government's proposed investment of €1.5 billion will vaporise in months, forcing it either to continue pouring good money after bad, or to repudiate Anglo Irish's liabilities. For all it will achieve, the money might as well be piled up in St Stephen's Green and incinerated.

Anglo Irish epitomised the Irish bubble economy. Its rise began a decade ago as the boom created a demand for houses and commercial property. As prices started to rise, banks made a miraculous discovery: the more they lent, the more prices rose; and the more prices rose, the more people wanted loans to get into the booming market. And the more loans that bankers made, the bigger the bonuses they could award themselves.

It was brilliant while it lasted. One of Bank of Ireland's stable of developers would buy an office block for €100 million, and sell it on a year later to one of Anglo's for €120 million, and so on: a process known to bankers as adding value.

Everyone was a genius and nobody could lose.

As a senior executive of Anglo Irish once assured me, there was no risk involved. All of the loans were guaranteed by the enormous property portfolios of the borrowers.

What concerned me at the time was not that he was spouting transparent nonsense - that, after all, was what he was paid to do - but that he clearly believed it himself.

Sadly, like any pyramid scheme, it contained the seeds of its own destruction.

Once banks stopped lending, as they were forced to do earlier this year, the market collapsed. Developers were left holding properties whose rental incomes were a ruinously small fraction of their interest payments, and banks discovered that their collateral was worthless.

All Irish banks have been injured by the collapsing property pyramid, some fatally so. Unfortunately, as international experience shows, banks that have been overwhelmed by bad property loans do not simply fade away. Their final act typically has three scenes.