Brought to our knees by bankers and developers
OPINION:Nama is in effect Fianna Fáil’s shrine to the property bubble for which the party still yearns. Prepare to pay 10 per cent more in income tax for the next 10 years to pay for it all . . . we are headed for national bankruptcy, argues MORGAN KELLY
WRITING HERE two years ago, I pointed out that the exuberant lending of Irish banks to builders and property developers would sink them if the property bubble burst. Since then, the bubble has burst, the banks have sunk, and we are all left wondering how to salvage them.
Two ideas for fixing the banks have been suggested: a bad bank or National Asset Management Agency (Nama) and nationalisation. While these proposals differ in detail, their impact will be identical. Irish taxpayers will be stuck with a large bill, and in return will get an undercapitalised and politically controlled banking system.
A far more efficient and cheaper alternative to Nama is to copy what Barack Obama did with General Motors, and transfer ownership of Irish banks to their bond holders. In this way we can achieve well capitalised banks, run without political interference, at minimal cost to taxpayers.
By converting a portion of Allies Irish Banks’ approximately €40 billion of bonds, and Bank of Ireland’s €50 billion, into shares, each institution can be recapitalised. Transferring ownership to bond holders will not cost the taxpayer a cent and will avoid interminable legal battles over the transfer of assets to Nama.
While the shaky state of Irish banks had been worrying investors since early 2007, when the crisis finally broke in late September the Government was taken completely by surprise and reacted with blind panic. Faced with a run on Anglo Irish Bank by institutional depositors on September 29th, the Government was stampeded into guaranteeing virtually all liabilities, except shares, of the six Irish banks.
This guarantee contained two obvious but fundamental flaws. Everything that has happened since – the proposed recapitalisation of Anglo, the nationalisation of Anglo, the establishment of Nama – can be understood as the Government scrambling to catch up with the consequences of these two errors.
The first mistake was to guarantee not only deposits – which had to be guaranteed – but also most of the existing bonds issued by banks to other financial institutions. Bond holders receive higher returns in the knowledge that they are accepting the risk of losses on their investment. In addition, unlike depositors who can scarper, existing bond holders are effectively stuck.
It made no sense for the Government to insist that taxpayers would take the hit on any bank losses instead of the financial institutions that had already entered legal contracts to do so.
The second mistake was to extend the guarantee to Anglo Irish and Irish Nationwide. As specialised property development lenders with incompetent management, they were at risk of heavy losses as their market collapsed, and fulfilled no role in the wider economy.
In making the guarantee on September 29th, I do not doubt that the Government believed that the difficulties of Irish banks ran no deeper than temporary liquidity problems stemming from the international crisis. However, as it has become apparent that Anglo was a mismanaged wreck, with AIB and Bank of Ireland scarcely better, the Government has stuck with the mantra that all banks are equally important and equally worth saving at any cost to the taxpayer.
Brian Lenihan and Brian Cowen are happier to dice with national bankruptcy than lose face by admitting that they were misled about the state of Irish banks last September.
Nama, then, is the latest twist in the Government’s increasingly bizarre efforts to save the Irish banking system while claiming that it does not really need to be saved.
Underlying Nama is the delusion that the collapse of our property bubble is a temporary downturn. In a few years time when the global economy recovers we will be back building houses like it was 2006. All the ghost estates, empty office blocks, guest-less hotels and weed choked fields that Nama has bought on our behalf will once again be worth a fortune.
The reality is that, because of our surfeit of empty housing, there will be almost no construction activity for the next decade. Empty apartment blocks in Dublin will eventually be rented, albeit at rates so low that many will decay into slums. However, most of the unfinished estates that litter rural Ireland – where the only economic activity was building houses – will never be occupied.
Nama is a variant on the “Cash for Trash” scheme briefly floated in the United States last year where the government would recapitalise banks by overpaying for their bad loans. Our Government is proposing to buy €90 billion of loans and will reportedly pay €75 billion for them.
The International Monetary Fund (IMF) guesses that Nama will cost us €35 billion, and this is probably optimistic. The narrowness of the Irish property market meant that banks effectively operated a pyramid scheme, bidding up prices against each other. Now that banks cannot lend, development assets are effectively worthless.
The taxpayer is likely to lose well over €25 billion on Anglo alone. Among its “assets” are €4 billion lent for Irish hotels, and almost €20 billion for empty fields and building sites. In fact, I suspect that the €20 billion already repaid to the casino that was Anglo represents winners cashing in their chips, while the outstanding €70 billion of loans will turn out to be worthless. And it is well to remember, as the architects of Nama have not, that although the problems of Irish banks begin with developers, they do not end there.
The same recklessness that impelled banks to lend hundreds of millions to builders to whom most of us would hesitate to lend a bucket; also led them to fling tens of billions in mortgages, car loans, and credit cards at people with little ability to repay. Even without the bad debts of developers, the losses on these household loans over the next few years will probably be sufficient to drain most of the capital out of AIB and Bank of Ireland.
Brian Lenihan’s largesse to bond holders could cost you and me €50 to €70 billion. What do numbers like these mean?
The easiest way to put numbers of this magnitude into perspective is to remember that in 2008 the Government generated €13 billion in income tax. Every time you hear €10 billion, then, think of paying 10 per cent more income tax annually for the next decade.
In other words, the fiscal capacity of a state with only two million taxpayers, and falling fast, is frighteningly thin. Ten billion here, and ten billion there and, before you know it, you are talking national bankrutcy. Even without bankrupty, Nama will ensure a crushing tax burden for everyone in Ireland for decades.
The tragedy is that, were it not for the Government’s botched efforts to save financiers from the predictable consequences of their own greed, the Irish economy would have recovered far more quickly than most people, including the IMF, expect.
Recovery for the Irish economy will not be easy – there is no painless way for an economy to move from getting about 20 per cent of its national income from construction to getting about zero – but the flexibility of the Irish labour market would have ensured that our incomes and share of global trade would have rapidly recovered. Now, however, any fruits of recovery will be squandered on Nama.
Aside from the fact that Nama will spend huge sums to achieve little, its governance is problematic. Here, the fog of secrecy that has quietly settled over Anglo Irish since nationalisation sets an unsettling precedent.
After revelations of financial irregularities forced the resignation of three executive directors, Anglo moved decisively to replace them with . . . Anglo insiders. Most astonishing, in the light of the scandal over Irish Nationwide deposits, was the decision to replace Anglo’s disgraced financial director with his immediate subordinate, Anglo’s chief financial officer.
It is hard not to conclude that a deliberate decision has been made at the highest level of Government that what happened in Anglo, stays in Anglo. And we can expect Nama to be run in the same tight manner.
While there has been considerable speculation about dark motives for bailing out developers and banks, I do not believe that the Government’s behaviour has been corrupt: it has been far worse. At least corruption implies a sense that you are doing wrong, and need to be paid in return. Our Government actually thought it was doing the right thing in risking everything to safeguard the interests of developers who had given us an economy that was the envy of Europe.
Instead of recognising bankers and developers as parasites on our national prosperity, the Government came to see them as its source. While everyone else in Ireland has come to see the past decade as an embarrassing episode of collective insanity to be put behind us as soon as possible, the Government still sees it as the high point of our nation’s history. Nama is effectively Fianna Fáil’s shrine to the bubble, and likely to be an expensive and enduring one.
What should be done instead of Nama? First, we need to understand how the idea of Nama follows from a mistaken analogy with the Swedish banking crisis and bad bank of the early 1990s. The Swedish banks differed in one fundamental way from ours: they only had deposits as liabilities. If their government had not taken over their bad debts, ordinary depositors would have suffered. By contrast, Irish banks had borrowed heavily from other financial institutions through bonds, and these bondholders originally agreed to take losses if Irish banks got into difficulties.
By placing the costs of the banking collapse primarily on existing holders of bank bonds, the State can improve its credit rating and pull back from the edge of bankruptcy. Knowing that taxpayers are not liable for the losses of AIB and Bank of Ireland will make capital markets more willing to lend to the Irish State.
Instead, like a corpulent Tooth Fairy gently slipping billions under the pillows of sleeping bond holders, Brian Lenihan has chosen to extend the liability guarantee and further weaken the bargaining position of the State.
The drift into national bankruptcy looks increasingly unstoppable.
Morgan Kelly is professor of economics at University College Dublin