OPINION:INTERNATIONAL EXPERIENCE tells us that severe banking crises require systemic solutions. Given the scale and complexity of the problems facing banking systems around the world, it is clear that there is no magic bullet to instantly resolve the crisis, writes ALAN AHEARNE
The editorial in The Irish Timeson May 18th ("Nama's role must be defined") provides a balanced assessment of the Government's approach to dealing with impaired loans that are clogging up the banking system. Importantly, it recognises the complexities involved in addressing the issue of asset quality in the banks. In this regard, the editorial stands in sharp contrast to some of the more bombastic and simplistic commentaries that have appeared in this paper and elsewhere over recent weeks.
There is little debate about the overriding objective: a functioning banking system that will ensure a flow of credit to the real economy. To realise this objective, the banks must have a clean bill of health, their balance sheets must be strengthened and uncertainty over bad debts must be reduced.
The Government’s approach is to establish an asset management company, the National Asset Management Agency (Nama), to buy property and development loans from the banks at a significant discount through the issue of Government bonds to the banks.
These bonds will add to the gross stock of public debt, but so long as the valuation of loans is roughly correct, there will be no change in net public debt. Nama’s assets and liabilities will roughly match.
This approach to fixing banks’ balance sheets has a proven track record. The asset management model has been supported and recommended by banking experts across the globe and used successfully in many countries in the past as part of the work-out process of problem loans. Done properly, investments in the banking system using this approach have eventually been recovered in full.
There are three main benefits of such an approach.
First, transferring development loans to a State-owned asset management company protects taxpayers. The evidence from property busts in other countries shows that the longer bankers and developers are allowed to deny the reality of the losses they face, the greater the ultimate cost to the taxpayer and the economy more generally.
Decisions about which development projects are viable and which are not should be made in the taxpayers’ interest, not in the interests of developers and bankers. After all, additional funds will be required to bring viable development projects to completion. Troubled developers should not be allowed to use taxpayers’ funds to gamble for resurrection.
Second, managing distressed assets requires expertise that rarely exists inside banks but can be brought into a single asset management company. The NTMA is already moving to procure specialist expertise, including valuation expertise, to support the development of Nama and to ensure that it is efficient and effective in its operation so as to safeguard taxpayers’ interests.
A request for proposals has already been issued by the NTMA seeking to identify appropriate professional advisers in all the fields where specialist expertise will be required. Experts will soon be in a position to provide advice on property finance, planning, the management of transferred loans and the law.
Third, cleaning banks’ balance sheets of their riskiest class of assets allows management to refocus the banks’ operations towards lending to small and medium-sized firms and away from property speculation.
We know from other countries’ experiences that management of troubled banks tend to devote substantial time and effort to trying to work out distressed assets, often at the expense of other borrowers such as small businesses and other banking activities.
It should be noted that the German approach to the “bad bank” option announced last week, while probably appropriate for that country’s situation, would not work well in Ireland. German banks’ difficulties stem from exposure to toxic financial products, such as mortgage-backed securities, not property loans.
Under the German model, each bank is to have its own off-balance sheet entity to store these toxic securities for a period of up to 20 years. In essence, the securities will be frozen until they mature.
Clearly, it would make no sense to try to freeze activity in the Irish property market for the next two decades. The reality of the bad property loans on our banks’ balance sheet must be faced up to promptly to restore normal activity in the banking system and the property market.
Japan is an interesting case of where problems in the banking system following the bursting of a property bubble were allowed to fester and ultimately proved more costly to resolve. The Japanese government eventually established asset management companies after struggling for many years to find a solution to that country’s banking crisis in the 1990s.
But studies have shown that the Japanese asset companies were not particularly successful for two reasons: they were established too late in the crisis and they were too small. That experience highlights the importance of a speedy and comprehensive approach to cleaning up the banks.
That is not to say that there are not practical difficulties associated with a project as large as Nama. The Government is aware of these difficulties and they are being met.
The legislation to establish Nama is being drafted and should be published by the summer.
The Attorney General is working closely with the Department of Finance to ensure that this legislation is sufficiently clear and robust to withstand all legal and constitutional scrutiny. Potential legal challenges to Nama from vested interests cannot be allowed to derail the process.
The Government has appointed an interim managing director of Nama, Brendan McDonagh, to ensure that the implementation process will be driven forward in the interim period pending legislation. The Minister for Finance will soon appoint an advisory committee to advise him and the interim managing director on relevant issues.
Cleaning banks’ balance sheets is crucial not only to restore the flow of credit to households and businesses, but also to allow the banks to stand on their own two feet without the necessity of a State guarantee.
For all the huffing and puffing by commentators, the reality is that by establishing Nama, the Government is taking credible actions to restore confidence in the banking system based on an approach with a proven track record.
- Alan Ahearne is an economic adviser to Minister for Finance Brian Lenihan. He was previously a senior economist at the Federal Reserve Board in Washington DC