One thing that the credit crisis has taught us is that there is no such thing as a bankrupt bank. There are only ‘good’ banks – and ‘bad’ banks.
Good banks hold all the bits of a bank that are solvent and still work as a business. Bad banks hold all the bits of a bank that would – if it was any other sort of business – render it bankrupt.
Ireland already has one bad bank. It’s called the National Asset Management Agency (Nama). It’s been using taxpayers’ money to buy up all the rubbishy bits from the rest of the country’s banks.
But Ireland’s in such a deep hole that one bad bank simply isn’t enough.
Ireland is at the mercy of its banks
Ireland looked pretty smart – if a little bit sneaky – back in September 2008. That’s when all hell was breaking loose in the global financial system. Northern Rock was long gone. Lehman Brothers had just died. And everyone was wondering who’d be next.
Amid the barely-suppressed panic, Ireland swiftly introduced a blanket guarantee on both deposits and bank debt. Basically, the government said it would bail out anyone involved in its banks in any way whatsoever.
With most of Europe threatened with the spectre of mass bank runs, it wasn’t necessarily the most neighbourly gesture. I remember several readers at the time wondering if they should stick all their money into Irish banks to take advantage of the guarantee.
But what held most people back was the realisation even then, that Ireland is a small country. And that by promising to take on the liabilities of its entire banking sector, it might be biting off more than it could chew.
Two years and a massive property bust later, Ireland is still at the mercy of its broken banking sector. Earlier this week, the country’s ten-year borrowing costs rose above 6% for the first time since the euro was introduced. And it’s all down to the fact that investors are still wondering – will Ireland’s banks bankrupt the country?
The original bad bank, Nama, is buying dodgy loans at deep discounts from the country’s banking sector. But now the worst of them all – state-owned Anglo Irish Bank – is getting its very own bad bank.
Anglo Irish will be split in two. Its savings book will be turned into a ‘funding’ bank. It will continue to take deposits, but it won’t make any new loans. The point is to make sure that regardless of how badly the existing loans the bank has written end up doing, its depositors won’t take the hit. That should help prevent any run on the bank. Fearful customers withdrew €4bn from the bank in the first half of the year, leaving it with €23.1bn in deposits.
Meanwhile, the lending book will be separated out and either sold off or wound down. As Laura Noonan points out in The Irish Independent, at the start of the year, Anglo Irish had €72bn on its loan book. The bank is already selling €36bn of those loans to Nama, so that’ll leave it with a further €36bn of loans to run down or sell.
Why can’t the bank just be shut down?
Why not just shut the bank down? Well, because as the prime minister Brian Cowen warned, this would lead to a fire sale of the bank’s assets. That would fail to raise enough to cover the bank’s liabilities. And that in turn could end up costing the Irish state as much as €70bn, reckons Cowen. Although given that the country has already had to pump around €23bn into the bank, that’s not quite as shocking a figure as it might otherwise be.
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Of course, the Irish state could just withdraw its support from the bank. But that would then lead to all the fears about ‘systemic risk’ and what would happen across the rest of Europe if Anglo Irish actually defaulted on its debts. And allowing a state-owned bank to default would then also affect the Irish government’s cost of borrowing.
So what does it all mean? Well, as Alan McQaid of Bloxham Stockbrokers put it to Reuters, “I don’t think the market gives a hoot one way or the other if it’s a ‘good bank/bad bank’ or if it’s wound up – the issue is how much it’s going to cost.” And we won’t hear the full figures on that until later this month.
Certainly, the announcement gives a bit more clarity on how the government plans to deal with its banking problem. And as The Irish Times put it, it “appeared to please the market if Irish bond yields are any measure” – they fell, indicating greater investor confidence in the country. However, with the European Central Bank rumoured to have been buying government bonds in the market this week, the rally may well have been down to central bank buying rather than any genuine spurt of optimism.
The eurozone will suffer another crisis
So what does all of this have to do with your investments? Well, it’s a reminder that Ireland – for all that it has swallowed austerity and done all the things it’s been told to – is still nowhere near out of the woods. Sometimes the hole an economy gets into is just too big to clamber out of. And the Irish are increasingly wondering why they’re bothering to put up with the pain for the sake of the banking sector.
An editorial in The Irish Times argued this week that the bank is only being propped up because the ECB has “decided that no European bank should be allowed to fail.” It continues – “we’ve tried the ‘good’ Europeans track and it has led ever further into the wilderness.” It’s time to “tell the ECB that if it wants Anglo to survive, it can save it. Otherwise we are calling in the bondholders and negotiating a debt-for-equity swap.”
CLSA analyst and bear market expert Russell Napier has often argued that democracies simply won’t stand for rampant deflation for prolonged periods of time. And if even a “well-behaved” European country like Ireland is getting fed up, imagine how the Greeks will feel after a few years of austerity. In short, the eurozone is certain to face another crisis before this mess is resolved.
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