When finally written up, the management of Ireland’s banking crisis will become a classic case study. No one knows how deep it will run or how much it will eventually cost. More importantly no one knows if we can afford to pay back all that’s been borrowed by banks to fund the credit boom. Officially it’s said to be economically affordable but at what cost to society?
International precedents are useful if only to understand the sheer scale of the inevitable costs to society of banking crisis. Since 1945 numerous national banking crisis have caused deep and prolonged recessions. On average real property prices declined by 35% over a 6 year period, economic output declined by 9% and unemployment rose by 7% with equity values collapsing by 50%. What’s more public debt rose by 86%. Only a portion was spent on banking bail out costs. Most of the money was spent on government economic recovery programmes. These are average figures – Ireland’s experience is already a lot worse.
The modern bad bank option was first developed in the US during the 1980’s Savings & Loans crisis when rogue bankers brought the house down. The Americans used a resolution regime to take over the banks, sell off the good bits, close errand institutions with the tax payer picking up the bill for recovering bad loans. Today vast tracts of land with ghost housing estates stand in silent witness to the greed and hubris that drove US S&L’s to the wall.
Later still Nordic countries Norway, Sweden and Finland faced with an imploding property bubble, mainly commercial property, took somewhat differing approaches. Sweden, copying the US model, nationalised two of its big seven banks, splitting the banks into a good bank and a bad bank. Norway left its main banks to their own devises, refusing to capitalise them until they had forced their bond holders to bear losses. Both countries ended up owning banks, which when finally re-privatised paid most of the tax payer’s money back. Both states retained strategic shareholdings in the rescued banks. Costs were contained only as the problem was not as large as it here.
Comparisons with the US, Swedish and Norwegian experiences are relevant here only to understand the two generic options – nationalise first and use a bad bank to wind out bad loans or first let private banks take the hit and then recapitalise them as good banks.
The sheer relative size of Irish banks exposure to property lending and absence of a bank resolution regime which would have allowed for the ordered take over of troubled banks, left the state with a dilemma. The banks are both too big to fail and too big to bail out. It’s an unresolved dilemma that elsewhere has led other states to default on guarantees provided to banks.
The term “zombie bank” was coined for banks starved of capital unable to generate new loans off their shattered balance sheets. The very same has happened here. Not only are the big banks in serious trouble but all banks including credit unions are facing a second round of bad debts as consumer and business loans sour. NAMA, is only designed to cover losses on €90bn of loans; what of losses on €180bn consumer loans and billions owed by small business owners? How are banks going to fund these loan losses?
Higher regulatory capital requirements announced yesterday will force banks to shrink their balance sheets, allocate capital to low-risk investments, eschew lending and increase prices to rebuild capital. Nama should have been a side show to the main event – the creation of a good banking system that works. But nothing is being done to build good banks and can’t be until all boom time losses are ring fenced, fully recognised and written off.
We need a working banking system but we do not need the current crop of banks? This has been all too obvious question since 2008. Other countries have allowed banks to fail and have survived and thrived after a time. It is not the end of the world to draw a line in the sand and decide that citizens will not be impoverished for a generation even if economically affordable.
Anglo Irish Bank’s questionable status as a “systemically important” bank is finally being defined in its
write-off bill. And the full extent of systemic risk inherent within the domestic financial service system was exposed yesterday through the Quinn Insurance administration. As an insurer’s solvency is as important as banking capital, the state may have to provide capital to a systemically important general insurer.
Far from being over the banking crisis is widening and deepening. At what point can we do the final sums and figure out what we can realistically afford to pay and write off the rest?
A version of this article appeared in the Irish Examiner, Business Section, Wednesday 31st March 2010
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