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Let Irish Nationwide fail as a test

WITH the cost of bailing out the banks still rising, is it time to start thinking the unthinkable? With the cost to the taxpayer of keeping the Irish banks in business now hitting €80bn, should Anglo and the Irish Nationwide be allowed to fail?

Ever since the Irish banking crisis first erupted in September 2008 our politicians and bankers have been struggling to get a grip on the situation. At every stage up to now they have been playing catch-up.

First we were assured that the deposit guarantee would do the trick. It didn't. Within weeks Anglo had to be nationalised and AIB and Bank of Ireland were going cap in hand to the Government seeking fresh capital.

Last year's bank bailout ended up costing the taxpayer €11bn.

It wasn't enough. Not even close.

When last September the Government first announced its detailed plans for the Nama "bad bank", the idea was that it would take bad loans with a book value of €77bn, which it would buy at a 30 per cent discount, off the books of the newly recapitalised banks. This, so we were assured, would get the banks lending again and we would all live happily ever after.

It quickly became clear that the 30 per cent discount proposed for Nama was way too generous to the banks. If the State had followed through on its original plan to buy loans with a book value of €77bn for €54bn it would have gifted billions of taxpayers' euro to the banks.

Just how generous became clear this week when Brian Lenihan announced his revised plan for Nama. This will see the new organisation buy bank debt with a book value of €81bn for €43bn, a 47 per cent discount.

While the more severe, ie. realistic, haircut has spared the taxpayer the expense of buying the banks' bad loans at the inflated prices proposed last September, last Tuesday's announcement will force the banks to crystallise far higher loan losses than had previously been expected. This, in turn, will force the banks to cadge even more fresh capital from the State.

While Brian Lenihan's announcement that Bank of Ireland would require an additional €2.6bn and AIB €7.4bn caused only mild surprise, the revelation that Anglo, which received €4bn of fresh capital in last year's recapitalisation, would need at least another €8.3bn and possibly as much as €18.3bn came as a severe shock.

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Lenihan also told us that Anglo's delinquent little brother, the Irish Nationwide Building Society, would need €2.6bn of fresh capital.

In addition, the Government will be buying loans with a book value of €36bn from Anglo at a 50 per cent discount, i.e., for €18bn, and loans with a book value of €8bn from the Nationwide at a 58 per cent discount -- that is, for €3.4bn.

In other words, Anglo is set to receive up to €40.3bn from the taxpayer, and the Nationwide €6bn. When you consider that Anglo had a peak loan book of €72bn and the Nationwide just €12.5bn, the logic of pouring ever-greater sums of money into such failed institutions must be questioned.

Lenihan has justified keeping Anglo, and by implication the Irish Nationwide also, alive on the grounds that the costs of allowing an Irish bank to fail, both financial and reputational, exceed the costs of keeping it alive.

This was always a dubious argument. It is much more dubious following last Tuesday's announcements.

At the end of December 2009, Anglo still had a €72bn loan book and gross assets of more than €85bn, although this will shrink to about €50bn after its bad loans are transferred to Nama. That's still a big number and the consequences of allowing Anglo to fail and making a mess of it could be potentially very severe.

So does this mean that we are stuck with Anglo and the Nationwide? Not necessarily. Instead, why not let the Nationwide fail and see what happens.

At the end of 2008 it had €5.2bn of bonds on its balance sheet.

Approximately €3bn of these bonds have yet to mature.

Unless I'm the Pope's grandmother, most of these bonds have long since been sold by the original investors and are now held by 'vultures' who purchased them at a significant discount.

These guys knew what they were letting themselves in for. Let them share some of the pain.

If they were forced to take a 50 per cent haircut, it would reduce the cost to the taxpayer of bailing out the Nationwide by €1.5bn -- a 25 per cent saving.

While the scope for imposing such a 'haircut' on holders of Anglo bonds is proportionately less, the potential savings are still considerable. At the end of 2009, Anglo had €15.2bn of bonds and commercial paper on its balance sheet, of which about half was covered by the deposit guarantee. However, even a 50 per cent discount on the non-guaranteed portion would reduce the cost to the taxpayer of bailing out Anglo by more than €3bn.

The taxpayer has been taken for a mug for long enough. It's high time that the Government spread some of the Anglo and Irish Nationwide pain to the bondholders. Unlike many of the depositors, these were savvy professional investors. Big boys' games; big boys' rules.

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