# How do we reduce the risk to the taxpayer?



## Brendan Burgess (6 Oct 2008)

It is now imperative that all the banks reduce their risk. This will decrease the risk to the Irish taxpayer. The first priority is to reduce the risk - let the shareholders worry for themselves. 

The problem with most of these suggestions is that they have a negative side effect. Limiting loans to home buyers will reduce construction activity even further and may speed up the collapse of some of the big builders and thus cause bigger problems for the banks.

1) Suspend all dividends. The banks would probably be happy to be instructed to do this. Doing it voluntarily is a bad signal to the stockmarket.
2) Consider raising additional shareholders’ funds. Shareholders won’t want to contribute new funds to banks whose commercial activities are limited.
3) Limit the amounts paid on deposits. For example:  to ECB -1%. It’s farcical that some banks are paying 6% now even with a government guarantee. 
4) Stop overseas lending – would this contravene EU rules.
5) Limit home mortgages. For example to 70% LTV and 3 times income or such other limits as are prudent.
6) Limit non home mortgages to say, 50% LTV or such other limit as is prudent.
7) Stop new lending to property developers. It may be necessary to allow some new lending to existing clients to complete projects.
8) Sell off overseas subsidiaries. Unfortunately all of these would be at fire-sale prices. But at least, put them on the market. What happens to the guarantee is a subsidiary is sold? And well capitalised banks may have great opportunities to buy smaller banks at fire-sale prices. 
9) Dramatic changes to boards. The Irish Nationwide is the one which most needs strengthening or replacing. 
10) Sale and leaseback of premises. 
11) Limit trading deals not linked to underlying commercial transactions. 
12) Adopt a very conservative approach to valuing existing loans. Part of the problem is the uncertainty. It’s very difficult to value loans to property developers. 
13) Encourage the big two banks to buy part of the loan books of the smaller banks. This would be very difficult to manage as it would have to be done at market prices rather than book prices. And it would not want to weaken the larger banks. 


Fortunately, it’s our two smallest institutions which need the most attention – Irish Nationwide and Anglo Irish Bank. Limiting their lending activities will not affect the level of economic activity so much.


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## WaterSprite (6 Oct 2008)

Brendan said:


> 3) Limit the amounts paid on deposits to ECB -1%. It’s farcical that some banks are paying 6% now even with a government guarantee.
> 
> 5) Limit home mortgages to 70% LTV and 3 times income.



Hi Brendan

I agree with most of your post (even though I'm both a shareholder and a depositor!) but wouldn't necessarily agree with the two points above.

I agree that deposit rates should not be through the roof, but limiting them to be non-competitive (vis a vis e.g. NR) might (would, in my case) cause people to move their money to other institutions which are either covered 100% like NR or to move money up to the relevant limit covered by other (non-Irish Govnt) guarantees to other banks. With people very jittery about equities, funds, oil etc. more folks are just putting what cash they have into the bank on deposit and so I think it needs to be at least as attractive (within reason) to save with an Irish bank as with a foreign one operating in Ireland.

On the mortgage amount - I think 3X is pretty low, esp considering house prices in Dublin.  The effect of that would be to force house prices lower and would stagnate prices until they reached a 3X level (which IMO won't happen - take a pretty high earner of €100k per annum - they'd be able to buy a house for about €430k under that model, which would certainly get you a house, but not a house that you'd expect that a €100k earner would want badly).  I think the model of calculating on a %age of net take home pay is more accurate because people have different outgoings depending on car loans, creche fees, grocery bills, different insurances etc. etc.  Although the banks hitherto have only asked for breakdowns of outgoings, I think they should ask for full bank/credit card statements from people for e.g. 6 months to see exactly how much money they spend in the month and base the max lend on that figure.  If people say that they can cut certain costs, then they would have to show that in practice for a number of months to come within the spending limits for justify the size of the mortgage requested.

And, although this is slightly off topic, what do you think will happen if banks do write off bad debts of property developers?  While I'm prepared to accept the concept of the guarantee generally, considering the extenuating circumstances, what I *really* don't want to see is those same developers who may have their debts written off rising phoenix-like in 5 years time and making huge profits on future developments with the bank/taxpayer not having any payback. If that happens, I'd want the banks/taxpayer to receive a proportion of that profit until the bad debt is repaid.  How that would work under the current guarantee scheme, rather than the Govnt taking an equity stake, I don't know... 

Sprite


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## ClubMan (6 Oct 2008)

Why limit deposits interest rates to _ECB _*minus* 1%? Surely banks are not borrowing at the _ECB _rate but at some hopefully lower wholesale rate? Or is that not the case in general or specifically now given prevailing market conditions? If Irish banks were to be subject to such a rate cap then surely depositor's money will just disappear off into _NR, Rabo, Leeds _etc.


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## z109 (6 Oct 2008)

Hi Brendan, I agree with most (all?!) of your prescriptions. There will be a lot of pain from some of them, but I am of the belief that the sooner we hit bottom, the sooner we can climb back up. Certainly the experience of the Swedish banking crisis is that this is the cheapest way to handle a bank crisis.

On the deposit side, I would limit deposits to EURIBOR with the deposit rate varying day by day (for demand deposits) and fixed at term EURIBOR rates for term deposits. This would provide banks with deposit funding at levels that match interbank funding. It has more flexibility than ECB rate so reflects the 'cost' of money more closely. I worry that if you limit rates to ECB-1 that you are giving banks free money since this is way below the cost of interbank funding.

I would also provide, through the NTMA and An Post, bank bonds to retail investors that provide a secure, tax-free, fixed return. The money from this to be used to recapitalise the 'survivor' banks. I don't see that private institutions should only benefit from providing capital. In fact, I'd be willing to lob in money to a bond that provided a free university education to my children in 12/15 years time... there are many more creative ways to raise long-term money for both the exchequer and for the banks than has been explored.


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## z109 (6 Oct 2008)

ClubMan said:


> Why limit deposits interest rates to _ECB _*minus* 1%? Surely banks are not borrowing at the _ECB _rate but at some hopefully lower wholesale rate? Or is that not the case in general or specifically now given prevailing market conditions? If Irish banks were to be subject to such a rate cap then surely depositor's money will just disappear off into _NR, Rabo, Leeds _etc.


Banks are borrowing at well above ECB. EURIBOR is over 1% higher than the ECB rate and has been consistently so for most of the last year.

I agree with you that capital flight is a risk if the deposit rate is set too low.


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## Bronte (6 Oct 2008)

Brendan said:


> Fortunately, it’s our two smallest institutions which need the most attention – Irish Nationwide and Anglo Irish Bank. Limiting their lending activities will not affect the level of economic activity so much.


  I keep hearing this,  that it's these two banks that were the worst so how come it was AIB and BOI who went to to see the minister?  I don't think we are being told the truth about how exposesed all banks are and how can we minimise the risk to the taxpayer if we don't know the basics.


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## Brendan Burgess (6 Oct 2008)

I have moved the ECB vs. Euribor discussion into a separate thread in the Mortgages Forum.

I wrote that initial post in a hurry. I am suggesting that limits be set on mortgages and on deposit rates. I just used those figures as examples, so I have edited my OP.

Brendan


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## Brendan Burgess (6 Oct 2008)

> I keep hearing this, that it's these two banks that were the worst so how come it was AIB and BOI who went to to see the minister?


 
I think all banks were at risk to some extent but the big problems seemed to be Irish Nationwide and Anglo. 

Any rescue of the system would have to be driven by or would have to involve AIB and BoI.  If Anglo crashed, AIB and BoI would have been the major guarantors of the depositors under the deposit protection scheme. 

But, it's hard to know for sure which bank is in the worst shape.

Brendan


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## z109 (6 Oct 2008)

One other thing - to reduce the incentive for bankers to take short term risks, lock in any share options that they receive until the guarantee has expired - i.e. the share options only become available to them to sell once the bank is trading at commercial (as opposed to government supported) levels.


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## jhegarty (6 Oct 2008)

Brendan said:


> 5) Limit home mortgages. For example to 70% LTV and 3 times income or such other limits as are prudent.



Would that not completely stagnate the house market..... even a cheap 300k house would require a deposit no one could save while renting...

or it may just lead to more of these hidden credit union loans everyone has become so fond of over the last few years...


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## z109 (6 Oct 2008)

jhegarty said:


> Would that not completely stagnate the house market..... even a cheap 300k house would require a deposit no one could save while renting...
> 
> or it may just lead to more of these hidden credit union loans everyone has become so fond of over the last few years...


300k is not cheap. It is seven times average earnings.

If no-one is willing to pay 300k, then the price will come down.


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## Howitzer (6 Oct 2008)

Brendan said:


> But, it's hard to know for sure which bank is in the worst shape.


I guess this comes down to the fact that it's impossible to reconcile the statements of the bank with regards to their own stability and then the Market's judgements upon them.

Whilst I can appreciate that no bank wants to admit to being in trouble, which would in itself probably put into real trouble, there comes a point where you just look foolish and inept in stating that everything is rosey.

Listening to the exectives of these banks you'd swear things couldn't be better. At some point the competence of these individuals has been to be called into question and decisive actions taken.


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## jhegarty (6 Oct 2008)

yoganmahew said:


> 300k is not cheap. It is seven times average earnings.
> 
> If no-one is willing to pay 300k, then the price will come down.




but for the price to come down people will need to sell at lower price.. 

if they are not making a profit that gives them the 30% deposit for the next house then the only sales we will see are banks selling after defaults...


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## z109 (6 Oct 2008)

jhegarty said:


> but for the price to come down people will need to sell at lower price..
> 
> if they are not making a profit that gives them the 30% deposit for the next house then the only sales we will see are banks selling after defaults...


Drifting hugely off-topic - apologies for that.

Sounds awfully like the US, doesn't it? Is there any way to stop the slide once you're going down it?


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## Duke of Marmalade (6 Oct 2008)

Brendan said:


> 3) Limit the amounts paid on deposits. For example: to ECB -1%. It’s farcical that some banks are paying 6% now even with a government guarantee.


Ah _Boss_, a bit of a spoilsport there.  Surely these rates are set at commercial levels vis a vis competition and the cost of wholesale funding. I think these forces wil bring down rates naturally.

What about charging a super DIRT of 50% of the excess of the deposit interest rate and ECB, not only on new deposits but also existing ones?  Help meet the budget deficit.


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## tyoung (6 Oct 2008)

If this is a solvency crisis then number 2 is key. The banks need more cash. None coming from the market. The total market cap. of the ISEQ financial sector is 14 billion at the close today. Let the state offer 14 billion euro rcecapitalisation injection in return for a 50% stake in all listed Co., on a take it or leave it basis. Make it clear that any future bailout will be done at market prices.


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## darag (7 Oct 2008)

Some of those proscriptions make sense but I feel are really just avoiding the biggest risk of all; that associated with sustaining the operation of insolvent banks.

To allow insolvent banks to continue to trade - increasing their liabilities - almost guarantees that the final bill to the taxpayer will be much more painful when the inevitable happens.  Almost worse is that sustaining such zombie entities sucks the life out of the productive elements of the whole economy not just the rest of the sector, by allowing them to hoover up savings and deposits by being able to pay over the odds returns to savers and investors.  This puts particular strain on on the more productive banks putting them under unnecessary pressure and risking systemic collapse.

This double whammy (bigger mess to clean up and creating a drag on the rest of the ecomony when we least nead it) is the biggest risk in the policy chosen by the government.  Unfortunately this is not some theoretical risk but seems to me to match almost perfectly what happened in Japan which lead to nearly 15 years of economic stagnation and spiralling public debt.

The most obvious way to minimise the risk to the tax payer in this regard would be for the government to immediately appoint a team of independent experts (definitely from outside Ireland) to appraise the value of the balance sheets of each bank covered by the scheme and to estimate their current and expected cash flows.

If any bank is judged to be insolvent, then the least risky option for the Irish taxpayer would be for the government to take the politically painful decision to immediately initiate an orderly winding down of such an institution.  If there is a compelling case made that such an institution  could trade it's way out of difficulties, then perhaps a stay could be arranged but I really do not see this happening.  Of course the hole in the balance sheet would have to be dealt with probably by a combination of government funds to subsidise the sale of the non-performing loans.

Doing anything less, I feel, is guaranteed to multiply our pain as a country.  No fiddling around with rules on dividends, executive pay, interest paid on deposit, etc. can avoid this unfortunate reality.


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## darag (7 Oct 2008)

I would like to have been able to edit my previous posting to address tyoungs suggestion, but for some reason there is no Edit button?

My point would be that an equity injection addresses the liquidity difficulties faced by the banks but is completely wasted on a fundamentally insolvent bank; it will allow them to continue to trade burning up the cash received for the equity but when the cash is gone, the government will be faced with the very same problem or even worse.  Alternatively if the government injected equity and withdrew or lessened their guarantee, I can't see any result except a full blown run on the banks.

And since nobody knows yet for certain the true state of all the banks such a run could bring down the good ones as well as bad.


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## Brendan Burgess (7 Oct 2008)

Hi darag



> then the least risky option for the Irish taxpayer would be for the government to take the politically painful decision to immediately initiate an orderly winding down of such an [insolvent] institution.



I am surprised that I did not make this point in my first post. No one knows whether The Irish Nationwide or Anglo Irish Bank is insolvent. It all depends on the value of the loans that they have on their books which depends on the present and future price of property and property developments. 

From the taxpayer's point of view, to minimise the risk, both of these banks should have a ban on new lending until the situation is a lot clearer. Effectively, there should be an orderly winding down of them. 

It would be completely unacceptable for the taxpayer to inject equity into Anglo only to find out after 5 years that it was insolvent. It should be wound down now and if it can sell off its uncertain loans and rebuild its balance sheet so that it no longer needs a government guarantee, then it can start trading again.

The same applies to the Irish Nationwide, except that injecting equity is not as simple as it is a mutual.

Brendan


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## ClubMan (7 Oct 2008)

Brendan said:


> No one knows whether The Irish Nationwide or Anglo Irish Bank is insolvent.
> 
> ...
> 
> Effectively, there should be an orderly winding down of them.


Eh!?! Are you missing some qualifier on the second sentence above!?


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## Brendan Burgess (7 Oct 2008)

Hi ClubMan

At this stage we don't know if Anglo or The Irish Nationwide is insolvent. This won't be established for a few years because of the nature of their lending.

To minimise the risk to the taxpayer, a process of winding down should begin. When it transpires that they are not insolvent and when the guarantee expires, then they can start trading again normally.

If it transpires that they are insolvent and that the government guarantee is going to be called upon, the earlier we start the winding down process the better. 

Brendan


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## roker (8 Oct 2008)

Not being an accountant I have a simple outlook on this.
 If the govenment buys shares in a bank when they are down, then the taxpayer will gain when the shares go up.
For existing share holders they know the risk the same as buying shares in any other company and will lose out.
It is the deposit that has been prudent and should be protected. If depositors stop depositing then the bank has nothing.

one point that puzzles me is; where does the €400 bn come from if the government is looking for money in the buget?


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## Protocol (8 Oct 2008)

The Govt is *NOT* spending 400 bn.

Many people think they are.

They are not.

They are lending their reputation to the banks, to allow the banks borrow on the intl money markets at a lower cost.

If you lend 1 bn to AIB, etc. now, then you know that the Irish Govt insure or stand over that liability.

In the worse case scenario, if a bank is insolvent, then the Govt will bridge the gap between the bank's assets and their liabilities.

The max size of this gap is estimated at 40bn.

Whereas total liabilities of the banks are 400 bn.


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## sfag (8 Oct 2008)

Enforcing the 3timesSalary rule would bring us back to houses costing €150,000. The sooner we get there the better. 

However a write down of property assets to this much reduced valuation could render all the banks insolvent. Plus we - the tax payer would have to pick up the bill. 

Its a hell of a dilema. 
But would getting to rock bottom fast kick start things again? 
I - for instance could/would be left with a house worth less than I paid for it. I dont mind. I'm not planning to move. If I was I couldn't. 
So therefore house movers would be eliminated out of the market. On the other hand new house buyers would be right back in as would 2nd house buyers.

Yep - definitly good I reckon. Lets get to the bottom sooner rather than later.


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