# Why would nationalising the banks raise the cost of borrowing?



## Brendan Burgess (9 Sep 2009)

The main argument against nationalising the banks is that the international community would be less likely to lend to Irish banks and the Irish Exchequer. 

This would be very expensive. If true, it would rule out nationalisation.

But is it true? 

It doesn't seem very logical to me. 

Which would I prefer to lend to? Bank of Ireland without a government guarantee or Bank of Ireland with a government guarantee? The government guarantee makes my investment safer. 

Which would I prefer to lend money to? The Irish Exchequer or The Irish Exchequer which owns two big profitable banks. I think I would prefer to lend to the latter. 

I do appreciate that nationalising or approriating the banks would send a strong signal to international investors. But would it necessarily be a strong negative signal if we nationalise the banks and guarantee all the debts?


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## Duke of Marmalade (9 Sep 2009)

I think the argument is tenuous to say the least. Many learned ones argue as you do, which seems obvious, sovereign debt is better than bank debt in anybody's book, look at Anglo. 

As I understand the BLe argument that says funding would be more difficult and funding costs would rise, it is because international investors only have so much appetite for any one sector. Thus, so the argument goes, they have set aside a quota for Ireland Inc. and they have also set aside a quota for Irish Banks. Put the two together and you do not get the sum of the parts, we now must meet the joint quota out of the Ireland Inc quota or else pay more to keep the sum of the quotas.

Do you believe a word of that argument?

However, I don't think this is the main argument against nationalisation, the main arguments against you have summarised elsewhere.


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## Brendan Burgess (9 Sep 2009)

There are many arguments against nationalisation, but I think that they are outweighed by the benefits of nationalisation. 

But to me, this is the big one. If there was a rush on the nationalised banks we would be in real trouble. 

Brendan


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## onq (9 Sep 2009)

Brendan said:


> There are many arguments against nationalisation, but I think that they are outweighed by the benefits of nationalisation.
> 
> But to me, this is the big one. If there was a rush on the nationalised banks we would be in real trouble.
> 
> Brendan



I think you have hit the nail on the head Brendan, if the story behind the fall of Lehman Brothers Bank in the US as reported by Ellen Brown is anything to go by. The link is here;



This makes sobering reading and once again I am indebted to Ms Brown and others at Globalresearch for informing my opinion.

The role of the British Exchequer and the endgame of a Globalised Financial Market suggest that the Full Spectrum Dominance war is being fought in the financial world as we speak.

Consider the figure "...a $550 Billion run on the markets..."

We're just lucky we're too small for these sharks to notice most of the time, but it gives some credence to the Governments legitimate concerns that Irish Banks might fall prey to outside investors.

Keeping them at arms length while paying the right price for the NAMA assets - around €25 Billion if current extimates are right - seems the way to go.

FWIW

ONQ.


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## pjmn (9 Sep 2009)

Brendan,
I am open to correction – but if they nationalise the banks,  is it not a fact that the bank’s debts then form part of the Governments national  debt, which will add how many billions to same – and in effect, then Ireland Inc  becomes impossible to lend to...


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## North Star (9 Sep 2009)

Guys this is the single biggest argument against nationalisation. I say this with my prior experience being Head of Funding with Bank of Ireland and dealing with all those international investors who dont seem to get a very sympathetic hearing from posters on this site.

If the banks were to be nationalised there are 3 significant impacts on our ability to fund ourselves,

1) Initially it was feared that nationalised banks could not purchase their Govts new debt issues. This would have significantly reduced the demand for Irish debt therefore the Govt either pays more or can only borrow less , or a combination of both. Recent comments from EU/ECB however suggest that nationalised banks may be able to buy their own Govt debt. This somewhat tempers my case on this point.

2) Each investor has inward credit limits for Ireland and all/most of the Irish banks. Using a simple example U.S based pension fund X has the following credit limits AIB €500mio BOI €500 mio ILP €300 mio EBS €200 mio INBS €100 mio and Irish Govt €750mio. In the event of nationalisation there is only one counterparty from a risk perspective i,e the Irish govt; so on the most optimistic scenario pension fund x can now only lend to Ireland inc €750mio. This is down from the prenationalisation figure of €2,350 mio i.e a reduction in our borrowing capacity of €1.6bn.
Now mutiply this across 250 or more institutions who currently lend/invest in Ireland.
The effect is enormous and where will this slack be taken up? The only solution is a huge and I mean huge increase in Govt borrowing with the real risks that it cant be raised at any price. Can you imagine what the December budget would be like if we were facing that scenario.

3)In all likelyhood pension fund X will see nationalisation as a sytemic failure and the credit limit for the only remaining counterparty i,e Irish Govt will be reduced or removed entirely. This increases the impact of point 2 above. In the world of free movement of capital, pension fund X has plenty of choice where to invest, Ireland Inc on the other hand needs to do what it can to restore confidence to the 250 institutions lending to us. We need to convince them that we can deal with these huge challenges and in time move forward as a small open export led economy. NAMA for all its flaws, and there are many, shows the international audience that we are managing our problems and that our economy will in time recover, as the financial system can now support lending.


If the objective of nationalisation is to stimulate or encourage creation of credit in the system it is bound to fail. To lend when you can not fund yourself is untenable in any business/government policy. 
In addition Foreign banks account for over 30% of credit creation in Ireland (according to Davys) our economy needs the Irish banks lending more for their existing customers and also to  take up the slack caused by foreign banks withdrawing from Ireland. 
How we achieve that pre, during and post NAMA is the real issue that we need clarity on.


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## Duke of Marmalade (9 Sep 2009)

_North Star_, that is a very useful elucidation and sort of confirms what I stated was my understanding of the case claiming nationalisation was bad for international fund raising.

But boy oh boy does it highlight how terribly irrational these international investors are.  Point 2 is completely illogical and point 3 is completely emotional.

But I wonder are the grown men and women of the international investor community really that irrational and emotional?


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## Latrade (10 Sep 2009)

Brendan said:


> The main argument against nationalising the banks is that the international community would be less likely to lend to Irish banks and the Irish Exchequer.
> 
> This would be very expensive. If true, it would rule out nationalisation.
> 
> ...


 
I'll admit I'm as unconvinced as you on this matter, in fact what tends to confuse me more is that during the very worst part of the decline, it was the traditional "right-wing" economists calling for more nationalisation. As soon as it started to appear in "left-wing" policies also, the right dropped it like a hot potato. I say that not to trigger any debate, but to me political leanings have biased the debate and therefore muddied the waters. 

The main argument I've heard is as you say the lack of investment in nationalised banks. I think there is some credence to that though. Calling it a "nationalised bank" dilutes the real problem. It's not, for example, the nationalised AIB asking for investment, it's the Irish Government. And I think that's where long term there would be a problem. One shareholder (Finance Minister), government controlled banking system. 

I suppose there's an irony to say that the private investment world doesn't trust governments to run banks, especially after the excellent job the private industry did, but that's how it is. Nationalisation isn't a short-term measure, it's a long-term and that's where the problems would develop in 5-10 years. 

I think at the moment the general panic and need for something to be done is creating a rosy picture of nationalisation. It seems logical and it seems like it would help. I think it would help, but only in the short-term. However, you can't nationalise just for the short-term, it's a long long commitment.

It sounds a pretty weak argument, but it can't be ignored: there is no faith or real long-term trust of governments and nationalised banks. There's no point entering into something that in a relatively short space of time is going to leave us with even greater problems. These problems would be hieghtened as in theory it would be at a time when other states are in a period of growth and able to invest, leaving us behind (potentially, theoretically, etc).


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## North Star (10 Sep 2009)

Duke, these decisions are taken by Credit Committees who allocate the credit lines, they are always seperate from the actual investment decision to ensure that emotion is not involved. If a credit committee reduces a conterparty limit for Irish Bank A, the porttfolio manager cant influence this decision. The portfolio manager may be required to sell holdings of Bank A's debt if current holdings are above the new lower credit limit, this hits the price in the secondary market and raises the cost of new borrowing.
If a credit limit is reduced or removed then it can take several years to be re instated. 
These guys are investing in relatively low yielding fixed income securities on behalf of their clients who are normally risk averse pension funds. They are not barabarians at the gate vulture capitalists hoping to make a huge return. They are looking for a safe place to invest at a reasonable return to help them diversify their counterparty credit risk. If they  invest in Ireland and loose their clients money, their clients will simply move to another fund manager. It is in all of our interests to maintain this inward investment. 
We in Ireland may not like this or even find it fair but it is logical and its the world we operate in.


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## Duke of Marmalade (10 Sep 2009)

_Brendan_, I think this thread is becoming a quite convincing argument against nationalisation. _North star_ seems to know his/her onions and I therefore accept that there would be a fairly serious increase to our cost of funding. And _Latrade_ points out that it would be wishful thinking to think it would be short term (remember partition was a short term solution back in 1922).


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## Kine (10 Sep 2009)

After being involved in some deposit gathering for one of the Banks, this is true. It's the same with some of the major US corporations, they can only deposit a certain amount with an institution. Off the top of my head, Microsoft have something like $25bn cash which they have deposited all over the place. However, there's only a maximum they can deposit with any one institution. Same idea as North Star (but he explains it so much better!)



North Star said:


> 2) Each investor has inward credit limits for Ireland and all/most of the Irish banks. Using a simple example U.S based pension fund X has the following credit limits AIB €500mio BOI €500 mio ILP €300 mio EBS €200 mio INBS €100 mio and Irish Govt €750mio. In the event of nationalisation there is only one counterparty from a risk perspective i,e the Irish govt; so on the most optimistic scenario pension fund x can now only lend to Ireland inc €750mio. This is down from the prenationalisation figure of €2,350 mio i.e a reduction in our borrowing capacity of €1.6bn.
> Now mutiply this across 250 or more institutions who currently lend/invest in Ireland.
> The effect is enormous and where will this slack be taken up? The only solution is a huge and I mean huge increase in Govt borrowing with the real risks that it cant be raised at any price. Can you imagine what the December budget would be like if we were facing that scenario.
> 
> 3)In all likelyhood pension fund X will see nationalisation as a sytemic failure and the credit limit for the only remaining counterparty i,e Irish Govt will be reduced or removed entirely. This increases the impact of point 2 above. In the world of free movement of capital, pension fund X has plenty of choice where to invest, Ireland Inc on the other hand needs to do what it can to restore confidence to the 250 institutions lending to us. We need to convince them that we can deal with these huge challenges and in time move forward as a small open export led economy. NAMA for all its flaws, and there are many, shows the international audience that we are managing our problems and that our economy will in time recover, as the financial system can now support lending.


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## Brendan Burgess (10 Sep 2009)

Duke of Marmalade said:


> _North Star_, that is a very useful elucidation and sort of confirms what I stated was my understanding of the case claiming nationalisation was bad for international fund raising.
> 
> But boy oh boy does it highlight how terribly irrational these international investors are.  Point 2 is completely illogical and point 3 is completely emotional.
> 
> But I wonder are the grown men and women of the international investor community really that irrational and emotional?



Northstar

I want to fully echo the Duke's sentiments here. It's a great post. Is there any independent article which would back it up?  I have read the [broken link removed] but it is unintelligible to me. 

Point 2 is so irrational that it beggars belief.  Is my theoretical argument about risk correct in the opening post on this thread? 

Given that we will probably end up with a majority stake in AIB and Bank of Ireland, will that influence the international investors' capital allocation? 



Brendan


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## Brendan Burgess (10 Sep 2009)

Here is a summary of Davy's arguments

I think Northstar's explanation is better written.



*Risks of NAMA are  arguably easier to calibrate relative to the unknowns associated with  nationalisation*

•
The NAMA debate has  focused on the price to be paid for the loan assets and how the taxpayer will  fare under different approaches. However, little has been said about the  downside of the nationalisation route, which is a natural outcome of the  proposals put forward by many of those who oppose  NAMA.

•
The main advantage of  nationalisation is that the state transfers €5-8bn of 'value' from equity  shareholders and possibly tier 1/UT2 bondholders to taxpayers, at least before  compensation measures are considered. Note that this would be on top of the  €54bn and €4bn of losses respectively that each investor class has already  suffered.

•
However, deposit and  wholesale funding outflows are inevitable as risk limits to the system shrink  when the banks fall into state ownership. This could mean ECB/Central Bank  funding to ALBK and BKIR rises rapidly from possibly as much as €40-50bn as of  the last balance sheet date. If this happened, the ECB might not fund NAMA 2.0  as it would involve Ireland Inc. borrowing even more. Without this support,  Irish development loans are stuck on balance sheet until assets are liquidated,  and we could not get a big liquidity boost. Sovereign spreads would also widen  again, meaning additional funding costs for the state.  

•
The state also shuts  off access to private capital. This means that it has to fill the capital hole  created in the banks by itself, at least until the franchises issue IPOs or are  sold down the road.

•
Third, politicisation  of the banking industry is a potential problem. Would banks be impeded in their  efforts to raise loan spreads and cut staff levels in order to rebuild  profitability? 

•
Finally, there are  possible second-order effects as under nationalisation the trajectory for  credit, and hence Irish GNP, could be worse over the next few  years.


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## North Star (10 Sep 2009)

Brendan I dont know if such an independent stockbroker article is available, however I am confident that the analysyts will back up my assertions as I have been in discussions with them as the credit crisis evolved.

I fail to see your objections to point 2. This is standard practice in the case of a takeover or consolidation. Pension fund X has a credit limit for Bank A for €100 mio and Bank B for an equivalent €100 mio. If Bank A buys Bank B, pension fund X will not increase the credit limit to Bank A to €200 mio. Being pessimistic it could stay at €100 mio on an optimistic scenario the credit line could increase to €115-120 mio. These arent optimistic scenario times.
In the case of full nationalisation this happens across the board. Perhaps you can pm Sunny who is a market participant who could validate what I am saying.
Minority or larger Govt stakes would not cause the same scale on credit limit reduction, however it wouldnt help.

The risk you refer to is a result of this consolidation effect, there is no corresponding positive due to the Govt being more creditworthy as a counterparty than BOI AIB ILP etc.
I hope this helps clarify my points.


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## Brendan Burgess (10 Sep 2009)

Hi North Star

Just to be clear - I am not describing your as irrational or illogical. It is the market which is. 

Bank of Ireland bonds today would be pretty worthless without the government guarantee. So lending to Bank of Ireland is the same as lending to the government. 

I suppose one could argue that post-NAMA, a recapitalized Bank of Ireland is more credit worthy on its own than a nationalised Bank of Ireland with government guarantee.

Brendan


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## pjmn (10 Sep 2009)

Brendan said:


> Bank of Ireland bonds today would be pretty worthless without the government guarantee. So lending to Bank of Ireland is the same as lending to the government.
> 
> Brendan



I'd have to disagree with your statement here Brendan - this link from Reuters, would appear to suggest the opposite of what you say...

Again maybe North Star may give a view on our respective positions

http://www.reuters.com/article/rbssFinancialServicesAndRealEstateNews/idUSL932895220090909


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## North Star (10 Sep 2009)

Guys this deal is a Irish Covered Bond or Asset Covered Security, It uses residential mortgages as collateral and other risk mitigants such as overcollateralisation to reach a AAA rating. (apologies if being too technical)
This is the first substantial fund raising by an Irish bank without a government guarantee and I think this is very good news. The guarantee only covers coupon payments till Sep 2010.
 The sooner banks can fund themselves without the support of Govt guarantees the better, puts the risl back into the private sector and less risk for taxpayers etc,


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## onq (10 Sep 2009)

North Star said:


> They are not barabarians at the gate vulture capitalists hoping to make a huge return. They are looking for a safe place to invest at a reasonable return to help them diversify their counterparty credit risk. If they  invest in Ireland and loose their clients money, their clients will simply move to another fund manager. It is in all of our interests to maintain this inward investment.
> We in Ireland may not like this or even find it fair but it is logical and its the world we operate in.



Northstar,

Thank you for your excellent posts.

ONQ


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## goosebump (11 Sep 2009)

Latrade said:


> However, you can't nationalise just for the short-term, it's a long long commitment.



I'm curious about this statement.

Imagine the following:

State nationalises BOI and AIB with no compensation for existing shareholders or bondholders.

State implements NAMA as designed, transferring insolvency of banks to the taxpayer.

BOI and AIB are now recapitalised as per NAMA objectives.

State resells BOI and AIB after 1 year at price which reflects improved capital position, making a profit for the taxpayer.

NAMA does its business and generates sufficient value over 15 years to meet bond commitments.


Effectively, the State would be stealing from the shareholders, using its legislative powers to give the banks a sweet deal, and then reselling these sweetened assets to a new group of shareholders for a tidy sum.

Terribly immoral, I know, but is there any reason why it can't happen?

Can State owned banks accept State bonds? Would the ECB allow it repo mechanism to be used to feather the nest of the Irish taxpayer?

I'm against anything that isn't NAMA (eg long term nationalisation), but I'm struggling to find a flaw in the NAMA+Short Term Nationalisation argument.


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## North Star (15 Sep 2009)

ONQ, you are very welcome, I hope they added some clarity to one aspect of the NAMA puzzle.


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## Sunny (15 Sep 2009)

Very well put arguments against Nationalisation. Don't suppose you could send them on to the Labour Party before the debate tomorrow Northstar!

There is no easy solution to this problem and I am sick and tired of policitians and academic economists who have never left college pretending that there is.


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