Brian Lucey: Taxpayers left hanging out the window without a parachute
The beginning of the end of the banking crisis may be in sight, but there is a significant danger that the light the government sees at the end of the tunnel is that of an oncoming juggernaut.
Three events suggest that the banking policy of the government is unravelling. The policy, let us recall, is that noxious mixture of surreptitiously rebuilding the capital base by overpayments through NAMA plus providing a blanket guarantee for all liabilities of the banks plus a reflexive ideological bullheaded refusal to countenance the State stepping in except in absolute extremis.
First, and without a word, EBS slipped into the hands of the State, at a cost of a mere €800m. This was down to its inability to raise the required funds from the markets.
Second, the State flung another two billion into the bottomless maw of Anglo, purely to bring its capital base up to (temporary) scratch while the EU examined its business plan.
One is reminded of Matthew 23 "Ye make yourselves like unto whitened sepulchres, which indeed appear beautiful outwardly, but within are full of dead men's bones and of all uncleanness".
Third, and potentially most damaging, the EU Commission, which has emerged as one of the few (and faint) voices in authority supporting basic market principles which in the end aid the taxpayer, it gave very lukewarm support to the extension of the bank guarantee scheme.
The guarantee is in effect the State (which has no money save what we give it) saying to the markets that it (the taxpayer) will underwrite the liabilities of the banks come what may.
These liabilities consist of subordinated bonds (the debt equivalent of shares), senior bonds (the debt equivalent of really really safe shares), interbank loans (working capital) and deposits (savings of real people and corporations).
The Credit Institutions (Eligible Liabilities Guarantee) Scheme 2009 which is made on foot of Section 6(4) of the Credit Institutions (Financial Support) Act 2008 states that we would pick up the tab in the event of the bank being unable to, perhaps through having been bankrupted via lending for speculation on boggy fields in Bohola secured on the basis of the word of a solicitor.
The banks are probably not able to pay these debts; therefore there is a massive potential liability, equivalent to a decade or more of tax take, owed by us to the international capital markets.
It is this legislative act that has created a conflation of Ireland with banks that has made the Government so adamant that a default by a private institution (eg Anglo) is the same as a default by the State.
As laws go, it's as sensible as the one banning whale fishing in Nebraska. This law had contained within it a kicker -- that the guarantee was subject to the ongoing approval of the EU, and in any case the guarantee would expire (unless extended) on September 29, 2010.
In a communication this week the EU gave only a one-month extension while they examine its application.
It is hardly coincidence that this happened the same week as Anglo presented its "plan" for a future, which seems to involve splitting itself time and again into a good-bad-ugly bank, fading away like a radioactive Cheshire cat, leaving not a smile but a two-fingered salute to the Irish taxpayer.
There were alternatives to the blank cheque
When the Government gave an unlimited blank check to the banks in September 2008, it did so in the knowledge that there were alternatives.
However, the guarantee may prove to be what is called a "valve" decision -- one way only. It is probable that the banks were able to raise more, and cheaper, funds under the guarantee than would have been the case without it.
However, with the guarantee being time limited, there was always the danger that it would induce or exacerbate "funding cliffs".
This is where an entity, the banking system here, faces a need to refinance a very large part of its liabilities over a very short horizon.
Recent discussion on irisheconomy.ie, uncontested by anyone, indicates that in the next six months the banks, mainly AIB/BOI, will have to raise some €70bn in funding.
That, to put in context, is about what the national debt was when we entered this crisis. The great proportion of this, were it to be raised now, would be raised under the comfort blanket of the guarantee. Absent the guarantee, and it has only been given a one-month reprieve, and the banks are on their own.
Absent the guarantee, Irish bank bonds are at or near junk status, and as such would either have to pay greatly increased interest rates and/or issue less. Issuing less would require that they shrink their assets by recognising that, even after NAMA, many of the loans carried on the books are worth less, and marking these to market, not to myth.
Such deleveraging, reducing the assets and liabilities of the banks, was always required and will be required.
It is a long time since we heard the gibbering screeches that "nama will get credit flowing".
Having started off as a capital crisis, which the bankers sold to the government as a liquidity crisis, the banks now face a real liquidity crisis at the time when, however one might decry it and however partial and halting it may be, there is a plan to repair the capital bases.
Truly, no good deed goes unpunished.
Several alternatives were available; Anglo/INBS could have been excluded, and we are informed that this was the original plan, their inclusion being a last minute decision (by whom, on whose advice?).
The guarantee could have been for just deposits, or deposits plus interbank loans, but instead subordinated debt was included (by whom, on whose advice?). The guarantee could have been for a shorter period, to give breathing space but instead was given for two years (by whom, on whose advice?); or the banks could have been left swing.
What could not have been done and what, amazingly, cannot still be done is for the banks to be wound down or restructured in an orderly fashion.
We did not then and still do not now have a legal mechanism in place for this.
Such banking resolution schemes are standard tools in most advanced economies, but then most advanced economies don't end up with the body of the taxpayer being flung onto the exploding bombs of the banking system to clear the way for insiders to move forward.
Resolution scheme should be in place by now
A banking resolution regime is now urgently required. Such a regime was flagged as being required in April, by Minister Lenihan.
Banking resolution regimes in advanced countries work by providing mechanisms to force loss sharing on various liability providers in the event of banks becoming insolvent or being undercapitalised.
They also typically provide for banks to be forcibly merged or split, and to provide legal protection for them to operate in whole or in part while they are resolved.
Two years into the crisis that we do not have such a regime in place is not simply puzzling, it is deeply irresponsible and represents an abdication of responsibility.
Absent such a regime and there is only a binary choice that the regulators face -- to keep a bank going (by for example the imposition of massive guarantees) or to close it and face the consequences.
This is a false dichotomy, one that is within the power of the Government to remove. However, to do so would be to also remove a crucial plank of their argument to date, that l'etat cest les banques, that closing a bank and thereby perhaps requiring bond holders to take losses represents a sovereign default.
Such a dichotomy is false, and in so far as sharing the pain between all elements of the system -- taxpayer, bondholder, shareholder -- is a moral issue, it represents a deeply immoral choice.