Sunday, March 28, 2010

Anglo Irish Bank - again

Once again Anglo Irish Bank is in the news - for all the wrong reasons.

This week it is about to announce the largest corporate losses in Irish financial history which could be - if reports are right - as high as €14 bl. Having already received in the region of €4 bl. last year in Gov. capitalisation, it looks like a further $7 bl. or so further handouts from the Government will now be additionally required to keep the bank functioning. And it would take a great deal of optimism to believe that this will be the end of the story!

Not surprisingly when the public hears of the horrendous losses made by this one bank (that has no branch network) the cries go up to close it down immediately so as to avoid further losses.

However though understandable at one level such a policy is not realistic. The losses that arise relate to the excessive loans extended during the Celtic Tiger to fund - in the main - highly extravagant commercial property developments both here in Ireland, the UK and the US.

If these loans were now just written off the ultimate losses would be much greater than currently projected.

I have always accepted that even greater problems would perhaps be created if the Government was now to renege on commitments to depositors.

Because of the closely knit nature of the Irish banking system, this could immediately jeopardise confidence in the whole fragile structure with potentially devastating consequences.
Also because of the present lack of confidence in the international market (that is presently used to fund the great bulk of Irish government debt) non-payment to senior bond holders (or even proposals to renegotiate terms with such bondholders) would probably backfire in raising international uncertainty further thus adding to the cost of funding the fast growing national debt.

There is perhaps some scope for renegotiating terms with junior (i.e. subordinate) bond holders. However the amount now owing to this group is not particularly large (in the context of the overall total) at about €2 bl.
Though I would be open to alternative suggestions, given the present precarious financial position in Ireland it would perhaps be best even here to honour existing commitments in full while the present state guarantee is in place before reviewing the situation again in August.

Indeed on this point the arguments put forward by others such as David McWilliams - and in a more modified sense - Richard Bruton I would not find convincing.

McWilliams for example argues that bondholders are forward looking people with short memories who accept fully the nature of the capitalist system. So they invest in bonds knowing the potential risks and therefore winningly accept their losses when things go wrong.

I would find some merit in this argument (especially with respect to speculative bondholders). Indeed I would even accept that alternative examples can be provided where default on such debt proved the best option. However I do not believe that in the particular circumstances of the present financial crisis in Ireland that a similar remedy should be adopted.

Firstly Ireland is an extremely open economy and therefore more vulnerable to loss of international investor confidence. The present total annual value of exports (goods and services) is almost as large as GDP (with 90% coming from multinational companies). Also with respect to our present large borrowing requirements about 85% is funded by overseas investors!

Secondly we are members of the Eurozone and therefore not full masters in this regard of our own decisions. Indeed the present financial and economic policy correctly represents more a jointly agreed Irish-EU initiative (than an independent Irish Gov. policy).

Thirdly - and most importantly - the Irish financial system comprises a few key institutions with close interlocking arrangements. One could make the argument that Anglo Irish Bank was of no systemic importance but this would be somewhat disingenuous. Clearly it had no branch network and did not deal with ordinary retail customers. However in many ways it was in fact the most important in determining the whole banking ethos in Ireland that lead ultimately to such a dramatic financial collapse. Also the manner of its rapid growth is inseparable from the extremely weak regulatory environment that prevailed at this time which in turn was approved by successive Fianna Fail administrations.

So unfortunately Anglo Irish Bank is of key systemic importance in the manner it highlights the overall weakness of Irish banking, regulatory and political practice especially during the latter phases of the Celtic Tiger. So if we are ultimately to get out of this present debacle the best course is to start by taking full responsibility for the failure of Anglo.

So I do not accept as some are arguing that Anglo should be immediately closed down.

However I would have serious questions regarding the present policy as articulated by Chairman Alan Dukes. My own preference - in the absence of convincing counter arguments - would be for an orderly wind down of the bank. In the present climate a quick fire sale of the assets relating to the considerable volume of loans extended by the Bank would realise very little money. So a great deal of importance attaches to the manner in which these assets are managed over the coming year (a significant proportion of which have been transferred to NAMA). Some perhaps should be disposed of quickly. However the value of others may well increase by waiting somewhat longer while further development will inevitably be required in other cases to secure a realistic return.

So the ultimate losses that will accrue to the taxpayer greatly depends on the skill through which outstanding loans are managed in the coming years.

However Dukes is strongly committed to an alternative good bank, bad bank model plan for Anglo, which I suspect owes more to pragmatic political considerations than any sound business logic.

In other words, through at some stage proposing to resuscitate Anglo as a profitable special purpose business bank, Dukes unconvincingly argues that this course could thereby save the taxpayer billions of euro.

On the face of it there are very good reasons for not attempting to breathe new life into Anglo as its reputation has been destroyed, for ever symbolising the grave excesses of the Celtic Tiger. Of course Dukes would respond that this problem could be avoided through "rebranding" the bank with a different name and image. However if a solid case does indeed exist for such a specialist bank, why not set one up a fresh institution with no connection to Anglo?

So I suspect that the attraction of eventually rebranding Anglo relates to financial sleight of hand.

So for example if the new bank - when eventually reconstituted - was to make regular profits, it could then be argued that this would be thereby reducing the overall financial cost to the taxpayer. However this is to ignore the fundamental economic principle of opportunity cost!

Indeed the same fallacious argument had been used by Brian Lenihan when originally trying to sell the NAMA project when he stated that he was confident that NAMA would return a profit to the taxpayer over 10 years.

After yesterday's horrendous news regarding the deepening losses of the banking sector, it is hard to see how anyone can believe in this outcome! However even if profits were to materialise, this ignores the important notion of opportunity cost relating to expected returns on alternative ways of investing the same money. So where a higher return would arise from an alternative investment, then in economic terms one thereby makes a (relative) loss through proceeding with the first option (even where accountancy profits arise).

So applying this argument to Anglo! Even if the proposed good bank could return regular annual profits, this has to be contrasted with the profit prospects of an alternative freshly constituted business bank (with no previous links to Anglo).

Now I find it hard to see why such an alternative, with no damaging previous history would not have better prospects for profits than a "good" Anglo. So if this is true, then to go ahead with Duke's proposal would actually lead to even greater losses in economic terms!

After yesterday's announcement we are now told that another €10 bl. on top of the amounts already indicated will be required, bringing the overall liability to the taxpayer to over €20 bl. And who can be confident that even this figure will represent the end of the story?

If there are in fact good reasons for Duke's good bank, bad bank strategy for Anglo I would like to hear them, for certainty nothing convincing has been put forward yet that would suggest that this represents a better option than an orderly winding down of the bank. And where the taxpayer is being asked to underwrite ever growing massive losses, it is not enough for Dukes to simply state that that the specialists dealing with Anglo recommend this course as the best option!

Also another important factor is now entering the equation. The present strategy has been based on the understandable desire to restore international investor confidence in Ireland through restoring our financial system and quickly returning to fiscal rectitude.
However the financial liabilities associated with the banking system have grown so large (especially due to Anglo) that it is now more likely likely to severely threaten the Government's ability to proceed with further severe cut backs that are required to achieve the EU's budget deficit target of 3% by 2014.

If this in fact is the case then - rather than enhancing investor confidence - the rapidly growing costs associated with the banking cleanup may in fact increase uncertainty as to our ability to achieve the necessary fiscal reforms. And this problem will be accentuated if the anticipated return to economic growth does not in fact materialise later in the year. So whatever way you look at it, we have got ourselves in a deep bind.

Only yesterday, pay talks as between Government and public sector unions were finalised with a commitment by Government not to reduce public sector pay further over the coming 3 years. However this begs the question as to where the Government is going to find the money to meet its projected fiscal targets!

Indeed we are not far from social anarchy with taxpayers, facing ever larger financial commitments to bail out the banks, likely to revolt at the patent injustice of what has transpired.

At one level I have a great deal of admiration for the manner in which Brian Lenihan in particular - almost single-handedly in Government it would seem - has attempted to come to terms with the enormous financial and economic problems facing the country.

However the one great weakness of the strategy has been the failure to address glaring injustices that have been allowed to fester, with the very rich in society seemingly immune from any real censure. And this in turn is largely due to the fact that the main ruling party since 1997 (Fianna Fail) has aligned itself so closely with this wealthy inner circle. During the Celtic Tiger, wealth creation became the new God in Ireland and this has left an extreme political reluctance to take any measure that might scare off its representatives in our midst.

The single most infamous speculative development of the Celtic Tiger era relates to the Glass Bottle site in Rigsend. This site was acquired at the height of the Celtic Tiger for a grossly inflated figure of over €400 ml. by a consortium involving the Dublin Development Dockland Authority (DDDA) and two prominent appointees from Anglo (Sean Fitzpatrick the Chairman) and Lar Bradshaw a former director. It was now clear that these Anglo personnel were driving the whole project as major partners and financiers.

The value of this site has now fallen so rapidly that the DDDA values its own stake at zero. However worse still most of the money to finance these stakes was lent by Anglo so that the taxpayer could now owe up €500 ml. from this one failed investment!

So this whole sorry saga says a great deal about the unacceptable free-wheeling climate that pervaded the latter days of the Celtic Tiger. It was totally inappropriate in the first place that the biggest high fliers in Anglo should be appointed to a state board. Had everyone in Government forgotten about conflict of interest? It was also unacceptable that this state agency should then have engaged in a highly speculative commercial investment with such partners. This incident then also points to the total lack of regulation in the system that allowed all these machinations to happen without interference and finally receive tacit Government approval with the Minister for Finance (Brian Cowen) meekly signing off the whole deal.

Just reflect for a moment on the massive imbalance in our justice system! Failure to pay a TV licence could ultimately result in a prison sentence. However the loss of €500 ml. on a speculative deal (with every governance safeguard flagrantly disregarded) is still highly unlikely in Ireland to lead to penal censure for anyone involved!

This growing sense of injustice can only have been further highlighted by the announcement last week that many employees of Anglo would be receiving increases in pay. And judging by the reluctance of Alan Dukes to specify the actual figures involved, we can take it that in certain cases these proposed increases are considerable.

Dukes unconvincingly tried to defend this move by stating that due to many Anglo staff losing their jobs, overall pay has fallen. On the contrary, what surprises me greatly is the high proportion of staff that have retained their jobs! And Anglo at present is merely a zombie bank with no lending service to the community. Now I accept that an important role still remains with respect to its orderly wind down. However staff pay had been already exceptionally high during the Celtic Tiger with bonuses featuring strongly. So surely there should be significant cuts to pay with respect to existing remaining staff to reflect the present changed reality.

Now, admittedly if new specialist staff are required from outside the organisation to manage the wind down, they should be paid the going rate. However I think it eminently reasonable to expect this to be done through compensating downward adjustments to pay rates of existing staff (or through additional redundancies).

It simply will not wash with the public (many of whom are finding it increasingly difficult to manage their financial situations) to ask them to pick up the tab for Anglo's losses of over $20 bl. and then announce increases in pay to Anglo staff.

Not surprisingly, this only causes further outrage. Now Dukes somewhat dismissively retorts with "Anger is not a policy" and that new awful cliche "We are where we are". However I would say simply in response that if we do not properly address the justifiable anger that is out there, we will not be able to pursue any chosen policy in the first place. And before people can accept where we now are, the various institutions involved (government, bankers, developers and regulators) need to accept full moral responsibility for the grave mistakes that have been made and once again the failure to properly recognise this, reveals a glaring weakness in present policy.

We are indeed facing critical financial, economic and social problems. However underlying all of these are extremely important moral issues of justice and fairness. Ultimately we cannot hope to satisfactorily resolve the former without properly addressing the latter.