Nama plan just delaying the inevitable

 

OPINION:Fine Gael’s bank plan makes more sense than Nama (whose ultimate head doesn’t know what’s going on anyway). All roads still lead to nationalisation, writes BRIAN LUCEY

NAMA IS dead in the water, moving only due to political inertia. It is drifting towards legal reefs and organisational shoals that were clearly visible on the charts.

Six weeks after its announcement in the Budget, nine months into the domestic banking crisis and the Government is reduced to pleas to trust them that the operational details will be revealed, eventually.

It is startling enough to see the Minister for Finance of a Eurozone country engaging on what is effectively a roadshow to sell bonds, a task more typically entrusted to mid-ranking corporate financers; it is surely unprecedented that on such a roadshow, the aim of which is to raise funds, the person doing the selling would cast such cold water, as he did, on the very concepts underpinning the sales concept.

To make matters worse, back at home, Michael Somers, the ultimate head of Nama (the National Asset Management Agency), more or less suggested to an Oireachtas committee that he had no idea how the organisation would or could work.

In this regard, Fine Gael’s plan for the banking system is to be cautiously welcomed. It represents an attempt by that party to engage with the complexity of the banking crisis, and although in my view potentially flawed, is superior in almost every way to Nama.

The Fine Gael plan seeks to create a National Recovery Bank which would be capitalised by the State. This National Recovery Bank would underwrite or guarantee the SME (small and medium enterprise) lending of the existing banks via short-term Government-guaranteed borrowing from the European Central Bank.

The recovery bank would signal the end of the blanket guarantee on interbank and debt instruments after September 2010 in an effort to force the holders of those instruments to take a share of the losses on toxic lending; and it would create good and bad banks from the existing stock of banks – the bad banks then remaining as workout vehicles to run themselves to liquidation.

The Fine Gael approach is conceptually similar to that of the Federal Deposit Insurance Corporation in the United States when they move to rescue or liquidate failed banks.

However, as Karl Whelan points out on irisheconomy.ie: “The FDIC arrive secretly on a Friday afternoon – they don’t signal 16 months beforehand that they’ll be shutting a bank down.”

The reason for this is that a time period between announcement and effect allows for significant problems to emerge.

The Fine Gael plan would create a system which, at least for a while, is populated by undercapitalised or zombie banks, banks which are not be able to carry out their normal role in the economy. As well as undercapitalisation, the banks would be illiquid. As a consequence of the announced end of the guarantee, banks would not be able to source any funds that extended beyond September 2010 (when the guarantee ends) and so would be forced to rely only on the sluggish interbank markets, with the certainty that as the end of the guarantee looms, they would only be able to source short-term expensive funding.

The banks would not be able to extend new credit, nullifying the desire to pump credit to the SME sector.

Indeed, the effect of the drastic reductions in capital that would be a consequence of the banks having to, on their own, absorb toxic loans would be to reduce the banks to a state where they were unable to continue in business.

While it is proposed to rectify this at the end of the guarantee period by carving good banks out of bad, the plan would result in at best temporary zombification of the entire system and at worst a closure of the banks.

The consequences of this for the economy are well known and would be utterly disastrous. There is an issue common to both Nama and the Fine Gael plan: an assumption that they will, if implemented “get credit moving”. This is fallacious, as no plan thus far suggested can, in fact, increase credit.

A combination of a shrinking economy and shrinking capital bases of banks will inevitably result in shrinking lending. It cannot be otherwise.

The key issue is to manage the shrinkage, to ensure that the percentage of credit overall which extended to non-productive investment or overextending household leverage is drastically reduced.

Sectoral credit exposure management is properly the role of the financial regulator and the central bank.

Another issue with the Fine Gael plan is related to the period between announcement and implementation. Depositors would be told that deposits would be transferred to new, clean banks, when set up. In effect, the Fine Gael plan would be to say “I’m from the government, trust me”.

In an environment where not only trust in the banking system but in the political system is broken, this is not in my view sufficiently strong to stop people moving deposits to other credit institutions. Politicisation of credit decisions is rarely a good idea. There is no guarantee whatsoever that the National Recovery Bank would not be politicised.

Indeed, the plan says that “some” banks would be provided with new guarantees to enable them to operate in the interim between announcement and implementation. This raises the questions of who decides what banks get which funds and on what criteria.

Finally, the Fine Gael plan contains within it, as does Nama, the acceptance that the State will end up the owner of the banks – nationalisation. It states that if the new banks that are carved out are not able to raise funds, the State will provide.

It is certain that were any Irish bank, no matter how clean, to go to the international equity markets in late 2010 and seek funds, they would get a cold reception.

So nationalisation of the active bank system would be required. As all paths identified in the debate so far lead to the same end, nationalised banks, it is surprising that discussion on how to get there persists. It is only delaying the inevitable.


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