# An alternative to nationalization - give the government options



## Brendan Burgess (16 Aug 2009)

I don't really understand the arguments against temporary nationalization, other than the ideological ones. 

So why not give the government options on all existing shares at, say €2 as part of the NAMA bailout? 

This avoids nationalization. The shareholders are getting a good deal because any value in the banks at present derives solely from the government guarantee and NAMA. 

If the banks need to raise fresh capital, it can be done with a different class of shares. 

From the shareholders' point of view, their shares would be worth between 0 and €2 so they would probably settle down at €1 which is a present from the taxpayer to the shareholder. One of the objections to nationalisation is that the banks should be subject to the discipline of the market. They would continue to be subject to this discipline somewhere between 0 and €2. (If they were subject to the discipline of the market at the moment their value would be zero).

If it turns out that the banks are in much better condition than we thought (unlikely) then the government might not exercize its opton. It could treat the three publicly quoted banks differently if they deserve different treatment. 

If CIBC decides that they want to buy AIB then the advantage from that would accrue to the taxpayer not the shareholders.

As I say, I have not seen any logical explanation of the objections to nationalisation, so it's hard to see whether these objections would still be valid in the case of the government having options to buy the shares.


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## jhegarty (16 Aug 2009)

But won't there be almost no chance that nationalization will be need once we do NAMA ?


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## z109 (16 Aug 2009)

jhegarty said:


> But won't there be almost no chance that nationalization will be need once we do NAMA ?


Well, only if you assume that 25% of the assets of the banks (90 bn of 440 bn guaranteed) are where all the problems lie. A protracted recession in Ireland, despite what the rest of the world is doing, will put pressure on residential mortgages. It is telling that the IMF suggested to the government that residential should be included in NAMA. It is more telling that the government listened...

On the options, it's an interesting idea. Perhaps a combination of equity and warrants would be a useful combination if there *is* a good reason to avoid nationalisation. I would reckon the option price would need to be higher than the current share price, so that it is only useful if there is indeed upside. But that's a technical issue.

Like the levy, the objection will probably be that it represents a charge on the banks balance sheet, but it surely represents a charge on the shareholders?


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## Duke of Marmalade (16 Aug 2009)

the Boss said:


> They would continue to be subject to this discipline somewhere between 0 and €2.


V. interesting idea, _Boss_, but haven't you supplied the main objection. If the shareholders have no stake in value above €2 (or whatever) they will have no incentive to behave rationally when the intrinsic value rises above that. But maybe that can be allowed for by tweaking the formula.

BTW as a current shareholder I hope this thought does not gather legs.


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## Brendan Burgess (17 Aug 2009)

jhegarty said:


> But won't there be almost no chance that nationalization will be need once we do NAMA ?



This is one of the main reasons for doing this now before NAMA. 

If the taxpayer overpays for the loans it is buying from the banks, then the banks will be in pretty decent shape. A little bit of extra capital or a disposal or two and they might even be fully capitalized. There is no way that the government could nationalize them at that stage. 

We face the prospect of seeing the NAMA deficit rising and rising at the expense of the taxpayer while the share prices of the banks rise and rise to the benefit of the shareholders. 

By taking an option on the shares, the government will be deferring the decision on nationalization. 

Brendan


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## Brendan Burgess (17 Aug 2009)

Duke of Marmalade said:


> If the shareholders have no stake in value above €2 (or whatever) they will have no incentive to behave rationally when the intrinsic value rises above that. But maybe that can be allowed for by tweaking the formula.



I don't fully follow the "discipline of the market" argument. If the market had been allowed to discipline the banks without government intervention, the shares would be worthless today.

The government is providing the value to the shares and I feel that it should limit that value. 

Brendan


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## Sunny (17 Aug 2009)

Brendan said:


> We face the prospect of seeing the NAMA deficit rising and rising at the expense of the taxpayer while the share prices of the banks rise and rise to the benefit of the shareholders.
> 
> 
> Brendan


 
This is the bit I don't get and there has been almost no coverage on this issue. When NAMA was first suggested, it was stated that the Banks would be held liable for any shortfall suffered by NAMA in the form of a levy being passed on to the banks at some stage in the future. Lenihan didn't include this in the Bill but said it could be done through future legislation. Obviously the banks made a strong argument against the inclusion as it created a contingent liablilty on their balance sheets. Its for this reason that Foreign Banks are now sniffing around. Post NAMA, it is hard to see any downside for the banks in the current form.


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## Duke of Marmalade (17 Aug 2009)

Brendan said:


> I don't fully follow the "discipline of the market" argument. If the market had been allowed to discipline the banks without government intervention, the shares would be worthless today.
> 
> The government is providing the value to the shares and I feel that it should limit that value.
> 
> Brendan


I agree with the thrust of your argument but I think it needs tweaking to work.

Any upside should belong to the taxpayer. But the taxpayer (State) doesn't want to own the banks. *Upside without Ownership* that is indeed what Options confer. But the obverse of that coin is that the Owners have would no Upside (beyond €2). So once that threshold is reached what incentive do the Owners _qua_ Controllers have to behave rationally and what incentive _qua_ Shareholders do they have to hold on to their shares? Once the €2 is passed the State would need to become very hands on to protect its asset. 

We could have a rather weird market where the underlying value is, say €4, but the price could not go much above €2 in case the State exercises its options. The price would then become a straight bet on when the State would do this.


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## Brendan Burgess (17 Aug 2009)

OK

Here are some tweaking options. 

1) The "restricted" shareholders would have the right to subscribe for any new shares which would be unrestricted. So the shares could be worth above €2 as this right would be worth something.

2) The government would have an option to buy the shares at €2 but may, at its sole discretion, buy the shares at a higher price. A bit theoretical, it would be very difficult for any government to pay more than €2. 

2A) The government's option would lapse if the government gets all its capital back and NAMA makes a certain level of profit. This could happen if NAMA pays too little for the loans it buys from the banks.

3) Give the government the option to buy new shares at €1 each in the banks. This would dilute the current value of the shares dramatically but allow a normal market to function.

4) Give the government the option to buy half the shares at €1 from the existing shareholders. So the directors of the bank still have the incentive to maximize shareholder value.


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## Brendan Burgess (17 Aug 2009)

There should be separate NAMAs for each of the banks. We should be able to see how much Anglo costs the taxpayer vs. the cost of AIB. 

This would be a good idea anyway, and necessary for my suggestion to work. It is also necessary for Honohan's [broken link removed]of risk sharing to work.


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## Duke of Marmalade (17 Aug 2009)

I think any concept of separate NAMAs defeats the purpose. 

Take the idea that if the taxpayer pays too much it can subsequently apply a levy. But great care is being taken not to enshrine this possibility - after all that right always exists and has been applied in the past. The possibility of a general levy seems to remove it from the balance sheet (although it should weigh on shareholders' valuations). A targetted levy related to each bank's own NAMA would almost certainly leave this contingent liability on the individual banks' balance sheets.

We are in danger of overcomplicating this. We seem to be agreed that the nightmare scenario for the taxpayer is if NAMA pays too much and bank prices subsequently soar.

The best approach IMHO is for NAMA to pay very deep discounts which would leave the banks needing capital. They can then offer a State underwritten rights issue at €1 to existing shareholders. Existing shareholders will be very heavily diluted so we shouldn't begrudge them any highly diluted future windfall profits esp. if the taxpayer is enjoying the lion's share of the action.

The Gov should decide now how big an ownership it would be comfortable with. Clearly that is not 100%. Let's say 80%. The mathematics are then simple. You work backwards to see how much NAMA should pay in *each* individual case. If this price is not below the economic price then there is no problem. By economic price, I agree with Holohan that we do not mean a best estimate but an estimate with at least a 90% chance of being on the right side. My guess is that the formula would mean paying more than this safe economic price in all cases but not as much more in some cases as others.

This could involve a not so bad bank getting a worse deal than a bad bad bank but since any deal is a windfall they cannot complain. Well they can complain and opt out of NAMA but then they would be kaput.

The key point here is that the Gov holds all the cards and I agree with Holohan they must not make a mess of how they play them.


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## Brendan Burgess (18 Aug 2009)

> I think any concept of separate NAMAs defeats the purpose.



They are sub-namas really. I think it would be interesting to see how much we lose or make on each of the financial institutions. If Anglo costs us €4 billion we should know that instead of being told that the banks cost us €10 billion in total.

If NAMA- Bank of Ireland makes a profit of €2 billion, then maybe the government doesn't exercize its rights. 

If NAMA - AIB loses €2 billion, while the share price soars, then the government exercizes its rights. 

In a sense, I think that the taxpayer should first look to the shareholders to make up any NAMA deficit and then to the surplus, if any, arising from the other banks.

Brendan


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## Mumha (18 Aug 2009)

Brendan said:


> They are sub-namas really. I think it would be interesting to see how much we lose or make on each of the financial institutions. If Anglo costs us €4 billion we should know that instead of being told that the banks cost us €10 billion in total.
> 
> If NAMA- Bank of Ireland makes a profit of €2 billion, then maybe the government doesn't exercize its rights.
> 
> ...


 
Privatise the profit and Nationalise the debt then ?


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## Duke of Marmalade (19 Aug 2009)

The penny is starting to drop.

Honohan puts it very well - the banks should not be left with the NAMA pricing risk but the existing shareholders should at least share some of that risk.

Honohan's formula is to pay the banks bonds for the "*safe*" economic price for the toxics and pay the difference between safe and realistic in the form of NAMA shares to existing shareholders. This would involve major injections of capital by the State into the banks to fill the hole and is not unlike my suggestion in an earlier post (except I didn't see why shareholders needed any compensation).

The alternative suggested by OP is to pay the banks the realistic price put to take options over existing shares whose exercise is contingent on the performance of the NAMA assets. The difference is that the State will not need to inject nearly as much equity (as it has "overpaid" for the assets) and so State ownership would be considerably less than the Honohan proposal (assuming options not exercised). 

They are essentially the same proposal i.e. to de-risk the banks but not their existing shareholders. And what do they say when great minds think alike?


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## ecstatic (19 Aug 2009)

what good is it irish tax payers financing CEE takeover bids by private equity the government should put a stop to this sort of lending completly and only allow the banks to issue loans in ireland. theres no chance british government owned rbos would be allowed do this...

http://www.reuters.com/article/privateEquity/idUSLI31122020090818

if government cannot step then they should step out of power.


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## Brendan Burgess (27 Aug 2009)

Duke of Marmalade said:


> Honohan puts it very well - the banks should not be left with the NAMA pricing risk but the existing shareholders should at least share some of that risk.
> 
> Honohan's formula is to pay the banks bonds for the "*safe*" economic price for the toxics and pay the difference between safe and realistic in the form of NAMA shares to existing shareholders.



From Honohan's original [broken link removed]


> One simple approach is to have Nama make only part of the payment for the acquired assets in the form of bonds, with the remainder being made in the form of a claim on Nama’s future recoveries.
> 
> Thus, there would be a two-part payment. One part, representing the basic price that can confidently be expected to be attainable, should be paid in bonds. For the rest, the shareholders of the banks (and possibly other providers of risk capital to the banks) should be paid in the form of an equity stake in Nama’s future recoveries.



I don't see how this works in practice.

NAMA pays a very low price for the toxic loans. 
The banks are all short of capital
The government puts in more capital and so they end up owning the banks.

The key point is that the banks have to be adequately capitalized. The best way of doing this is for NAMA to pay generously for the loans. The downside of this is that it will transfer a lot of wealth from the taxpayer to the bank shareholders. 

Or is he proposing:
1) Buy the loans cheaply 
2) Invest taxpayers money in the banks i.e. effectively nationalise them.
3) Give the exisiting bank shareholders shares in NAMA in exchange for their shares in the banks?


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## csirl (27 Aug 2009)

Has anyone considered the do nothing and ride it out option?

There is a element of the 9/11s about this crisis - panic and over reaction. History tells us that those who didnt panic and continued business as normal (e.g. Ryanair) did best out of 9/11. Those that implimented contingency plans or changed the way they operate suffered.

While I accept things may not be the same as before, isnt the most likely outcome that people/businesses will return to normal within a couple of years?

Has anyone actually done an analysis based on realistic medium term outcomes (not the panic stricken the world has changed forever stuff)? Anyone done a cost benefit analysis on NAMA or any other plans to see if they are worth it?


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## Duke of Marmalade (27 Aug 2009)

Brendan said:


> Or is he proposing:
> 1) Buy the loans cheaply
> 2) Invest taxpayers money in the banks i.e. effectively nationalise them.
> 3) Give the exisiting bank shareholders shares in NAMA in exchange for their shares in the banks?


I think this is the logic of his proposal. The question is what is the extent of (2). The government can almost set its own formula to control (2), let's say to ensure it doesn't own more than 80% of a bank.

(3) seems to be a sort of compensation for buying the loans "cheaply", though why the shareholders deserve any compensation could be argued.


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