Can looting - going bankrupt for profit - explain the gap between the haircuts suffered by Bank of Ireland and AIB versus the higher haircuts being applied to the two rogue operators Anglo Irish and INBS?
These two rogues are reckoned to cost the state close to €42bn in direct transfers of wealth from ordinary citizens to their bond holders and depositors. This figure may include billions looted through lending practices where bankers and borrowers colluded in doing deals they knew had no prospect of ever coming good - unless refinanced by others.
Such looters loans are near valueless and may be at the core of the vicious haircuts being applied. Many suspect the value of loans not transferring to NAMA may be in an even worse state.
While both recent reports into the banking crisis wrote of reckless lending, they did not differentiate between the differing types of recklessness engaged in by some but not all bankers. They did not address the difference between “looting” - going for broke at societies expense- and the more usual banking behaviour of “gambling for success”.
In 1993, the authors of “Looting: The economic underworld of bankruptcy for profit” in considering banking crisis in Chile and the US, found that in certain cases bank owners and their managers engaged in looting their banks to maximise current extractable value. As governments either directly insure deposits or explicitly insure bond holders and others, these people were incentivised to plunder the value of their firms leaving the default or bankruptcy costs to the taxpayer to carry. The authors argue this happens in the absence of proper accounting rules, lax regulation and low penalties for abuse. They also said that banker’s looting practices could symbiotically infect other sectors, causing some of their participants to loot their firms. It seems that a form of looting may well have been a facet of Irish banking and property sectors and may explain the significant, as yet unexplained, gap between the haircuts applied to our big two commercial high street banks and the two rogue banks.
For looting to work it takes two parties. A banker willing to go broke for profit and borrowers equally willing to go broke. Incentivised to maximise current value where a euro in dividends is worth more to a shareholder today than a euro of future earnings, bankers are drawn to lend money in ways that makes the current value of the bank higher than it actually is.
They may deliberately seek out opportunities to book deals that have no realistic chance of ever being repaid but on paper look highly profitable today. All that’s needed to make this work is a small group of borrowers who are willing to go broke for profit.
Following NAMA’s intervention, it is abundantly certain that many so called profitable loans were nothing of the sort. Many deals involved people borrowing to buy overpriced land and property in the hope that they would be able to offload it at a profit to someone else before their loans had to be repaid. Bankers converted interest they would normally have been paid over the life of the loan to upfront fees, booking them as immediate profits.
To make these deals tick over and work, the banker would advance more money to pay the interest bill, again banking spurious profits today. Meanwhile the actual true underlying value of the deal was negative. In short these loans could only have been unwound had they been refinanced. When the property bubble burst, the scale of looting had to crystallise. The looters loans could not be refinanced.
But bankers could not fess up to looting and continued to represent them as profitable. Only now as NAMA applies its haircuts is the enormity of looting becoming apparent. Of course there were many loans made honestly to fund honest developers who got caught out.
But how many were effectively looter’s loans are unknown. It could well be the huge additional haircut being applied to the two rogue banks is indicative of the scale of bank looting that occurred.
Did some bankers and speculative borrowers wilfully get involved in doing deals with no hope of ever repaying the money borrowed? Was this was a feature of the Irish relationship banking model which saw inexperienced lenders convince their customers to invest in the latest go- for- broke scheme?
Did bankers behave as if future losses were somebody else’s problem? In time maybe someone will prove looting was an aspect of Irish banking in the earlier parts of this century. For now the suspicion is that the, as yet unknown, final bill for bailing out banking probably contains billions in looters loans.
A version of this article appeared in the Irish Examiner Monday August 23rd 2010, Business Section
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