Beefing up Europe funds could solve our problems

BUSINESS OPINION:The right scenario might create the sort of cheap financing that would ease our lot

CONSENSUS IS easily achieved in Ireland, as we have learnt to our cost; just think property market soft landing.

It is no harm to bear this in mind when looking at the consensus that now seems to be taking shape on how to deal with the remaining bad assets on the Irish bank balance sheets.

The last couple of weeks have seen various research notes, proposals and documents floated by several parties including Davy, Glas Securities and the self-styled Ireland First grouping. What they all seem to agree on is that the banks’ balance sheets – and by extension the taxpayer – just cannot take any more pain now.

The plenary view – for want of a better word – seems to be that at this stage any further bad assets or asset classes – running into the tens of billions – will have to be transferred out of the banks at face value into some sort of special purpose vehicle (SPV).

Transferring the assets out at face value would mean the bank balance sheets are spared what at this stage would be a fatal blow. Likewise the Government finances. The losses are not avoided but are spread over sufficient time to make them manageable.

Various mechanisms have been put forward as ways to do this but the “problem” with all of them is encapsulated in the acronym SPV. Anyone who has paid even passing attention to the financial meltdown of the last three years would know it is a byword for the type of complex financial engineering that went so catastrophically wrong, plunging the world into the worst crisis since the 1930s.

The notion that someone might suggest the solution to a problem caused by bad financial engineering is in fact more financial engineering is something that is beyond comprehension for many, particularly in Europe.

The governor of the Central Bank said as much last week at the International Centre for Monetary and Banking Studies in Geneva. Patrick Honohan ran through the gamut of potential financial engineering solutions before concluding: “... such solutions are not as easily taken off the shelf as plain vanilla lending. In particular any insurance contract is beset by moral hazard problems. While these could be addressed, unfortunately no pre-existing template exists for intergovernmental arrangements of this type, and most observers are sceptical that one could be put in place soon.”

Honohan appears to accept that faced with this reality we have little choice but to proceed along the lines agreed with the European Union and the International Monetary Fund.

Under this scenario the banks will be subjected to extremely stringent stress tests in the next few weeks to find out how much capital they need to meet future losses. The potential bill will be pretty much placed directly on the taxpayers’ shoulders with immediate effect.

This will raise a fundamental question about Irish debt sustainability. Can the Irish economy – based on expected growth rates – afford the bill? Because there is a real prospect that it cannot, we will soon come full circle and arrive back at the need to transfer the remaining bad assets out of the banks at face value and spread the cost.

But if you are not prepared to go down the SPV/financial engineering route to achieve this, then you are looking at a pretty straightforward good bank, bad bank split funded by the ECB.

One suspects this idea leaves Frankfurt pretty underwhelmed given that the ECB is on the hook to the Irish banks for €150 billion odd as things stand with no sign of any of it being repaid in the short term.

However, another possible solution may have presented itself last week, but seems to have been lost in the furore about corporation tax. Europe’s leaders have agreed to beef up the European Financial Stability Fund and its successor, the European Stability Mechanism.

Crucially the funds will now be allowed lend directly to member states, or, more accurately, buy their bonds in the primary market. What has to be determined – possibly at this Friday’s European leaders’ summit – is at what rate and over what time countries such as Ireland will be allowed borrow and for what purpose.

If the fund was empowered to buy low-yielding 20- or 30-year bonds issued by Ireland to restructure its banking system, that might create the sort of long-term, relatively cheap financing that would either fund bad banks and or make another round of bank recapitalisations affordable. Hope springs eternal.