Bread and Buiter !

October 23, 2009

My text italicised…

One of the features of the NAMA debate is the worrying claim by supporters of NAMA that NAMA is the ‘only game in town’ that ‘there is no alternative’. This means that either we are being bullied into NAMA or that the proponents of NAMA are unaware of any alternatives or, less likely, they have examined all the alternatives and believe NAMA ‘is the best game in town’.

So  here’s the problem (think of this as the NAMA proposal currently proposed by our present Government) as outlined by Stiglitz below:  

“An early idea floated by Paulson was for the government to buy the bad assets from the banks. Naturally, Wall Street was delighted with this idea. Who wouldn’t want to offload their junk to the government at inflated prices? The banks could get rid of some of these bad assets now, but not at prices they would like. Then there are other assets that the private sector wouldn’t touch with a ten-foot pole. Paulson’s original proposal was thoroughly discredited, as the difficulties of pricing and buying thousands of assets became apparent.

Undaunted by risks and undaunted here as well, see last post, NAMA intends to go through the process of examining in minutae each loan….

More recently a variant of this proposal, which involves government buying garbage in bulk, was broached. But the major difficulty with determining prices of toxic assets, whether singly or in bulk, remains: pay too much and the government will suffer huge losses; pay too little and the hole in the banks’ balance sheets will still seem enormous, requiring another bailout to recapitalize the banks.” …We should reject any plan that involves “cash for trash.” It is another example of the voodoo economics that has marked the financial sector–the kind of alchemy that allowed the banks to slice and dice F-rated subprime mortgages into supposedly A-rated securities.

If the government takes over banks that don’t meet the minimum capital requirements, placing them in federal conservatorship, then these pricing problems are no longer important. Under this scenario, pricing is just an accounting entry between two pockets of the government. Whether the government finds it useful to gather all the bad assets into a bad bank is a matter of management: Norway chose not to; Sweden chose to. But Sweden wasn’t foolish enough to try to buy bad assets from private banks, as many in America are advocating. ”

( See Stiglitz, A Bank Bailout That Works’ points to a variant solution from Buiter Professor Buiter, Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.)

According to Buiter, ” There is an alternative solution to the problem of valuing the toxic assets. It would not involve nationalising the existing banks. Instead the state would create one or more new ’good’ banks – all state-owned and state-funded to begin with. Effectively, some or all of the existing banks would become bad banks. The good banks would acquire the deposits and the good assets of the bad banks or legacy banks. The good assets are, by definition, easy to value. The creation of multiple good banks may be desirable to encourage competition. One could even create a good bank for every existing bank: New Citi, New RBS, New ING etc.

New lending business, indeed all new business activity would be undertaken only by the new good banks. To address the credit crunch, government guarantees or insurance could be provided for new loans and investments made by the good banks. No further guarantees should be extended to existing assets, either in the good banks or in the legacy bad banks. The good banks would receive their capital from the state. Other funding would be provided by the transfer of the deposits from the bad legacy banks, through loans from the state or through the sale of bonds by the new good banks to the state. The state could also guarantee new loans to the new good banks from the private sector or bonds issued by the new good banks and purchased by the private sector.

As regards the the legacy bad banks, the easiest and cleanest way to proceed is to stop them from doing any new business on the asset side of their balance sheets: no new lending and no new investment. They would also not be permitted to take new deposits. A simple way to ensure this is to take away their banking licenses. They would exist only to manage and ultimately to run down the portfolio of bad and toxic assets they hold on their balance sheets. Maturing liabilities could be refinanced if that made more sense than accelerating the sale of the assets. Taking away the banking licenses of most of the existing large universal banks in Europe and the USA would be appropriate because recent developments have demonstrated that the existing institutions, managements and boards are not fit for purpose. They have failed as banks, even if they have not (yet) failed in the technical, legal sense of becoming insolvent. For most of them the past, present and anticipated future financial support of the state is the only thing that stands between them and bankruptcy.”

To relate this to, for example, AIB and BOI, based on their insolvency, this would involve taking away their banking licenses, stripping out their good, non impaired assets into 2 new banks, say NEWAIB and NEWBOI owned and run by the State on a temporary basis, those assets to include staff, branch network of buildings etc, while the legacy banks, AIB(Old) and BOI(Old) stripped of depositor/lending functions remain only for the purpose of management of their toxic portfolio.

The management outcome of this toxic portfolio in conjunction with negotiation with bond holders would determine the value of returns to shareholders for BOI and AIB who would continue to remain in private ownership, with their banking licenses removed. 

This is a solution that could form the basis of common agreement between Labour and Fine Gael as providing the best protection for taxpayers.

The ‘Good Bank’ solution that would create one state bank, say ‘AIBOI’,  is already the preferred solution of Fine Gael, who  support their variant of the Stiglitz/Buiter model.

As we see from the above, there is more than ‘one game in town’.

Efforts to persuade us otherwise amount to betrayal of and criminal blindfolding of the taxpayer.

Have a good weekend!




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