Ireland’s Experience: Nationalizing Banks Is the Best Solution

Twenty academic economic figures in Ireland signed a document calling for the nationalization of banks, noting that the government erred in its error when it decided to adopt the "NAMA" method (the National Asset Management Agency created by the Irish government in late 2009 in order to face the financial crisis and the real estate bubble) to clean up the banking chaos created by the bubble Real estate: the temporary and comprehensive nationalization of banks is the only way to do so.

The Text of the Document

Over the past month, there have been extraordinary changes in the Irish financial and banking landscape. We believe that we are now at a critical stage in the history of Irish economy. It is important for the government to take the right path in addressing the problems of the banking sector.

There is a conviction that the banking sector has stopped lending on a large scale. In isolation if this conviction is true or false, the matter must be addressed. We believe that the right thing to do now is to nationalize the banking sector, or at least what is linked to the crisis.

This advice is not based on an ideological stance. In normal circumstances, none of us will recommend nationalizing banks, but today we are very far from normal conditions, and we believe that under current circumstances nationalization has become the best option available to the government.

Also, we recommend nationalization as a temporary measure only. Once cleaning, recapitalization, and reorganization via a new management structure, and possibly remarketing, we recommend that banks be returned to private ownership.

When government ministers, Peter Bacon, and the government-appointed consultant present a proposal to the National Asset Management Agency (NAMA) indicating that their plan will have much better results than nationalization, we strongly disagree with them, because insurance is, in our opinion, the inevitable outcome of the required recapitalization of banks and they are carried out with conditions fair for taxpayers.

We can summarize the nationalization approach against the government's approach of limited recapitalization and the introduction of an asset management agency to save banks, under four headings:

We consider that nationalization will better protect the interests of taxpayers, produce a more effective and longer-term solution to the problems of the banking sector, be more transparent in terms of pricing troubled assets, and be more likely to produce a banking system freed from the notorious credit worthy of financial institutions.

Our banks granted many bad loans, especially to real estate dealers. Achieving these losses will lead to a great erosion of its capital base. International financial standards require certain percentages of capital adequacy ratios for banks to be able to operate. In addition, as the recession escalates, many consumer and commercial loans will be classified (non-performing), which means that banks will need new capital to compensate for the expected losses from the loans. Under the current circumstances, the Irish government is the only investor willing to provide these capitals.

The government put "Nama" as a tool to withdraw bad loans from banks at a reduced rate, to the extent of recording the losses resulting from these loans and their reflection on the banks ’capital, then the government showed its willingness to provide capital in exchange for shares. More importantly, government estimates indicate that the losses are very reduced, which means that the matter may end up with additional financing against bad assets.

For example, there is AIB and the Bank of Ireland. Analysts have repeatedly estimated the volume of bad loans in these banks to be at least 20 billion euros. Losses of this magnitude would virtually eliminate the entire capital of these 27 billion euros. This means that if the government purchases these loans at a fair market value, it will have to provide funds to rebuild the entire capital, and thus the entire ownership of these banks will end up.

So, there is a fundamental contradiction in the position of the government. It claims that it can simultaneously:

• buy bad loans at a price that reflects their true market value;
• hold banks well;
• keep them away from state ownership.

These three results are simply incompatible, and we are extremely concerned that the asset management agency may work to maintain the achievement of the three goals by failing to meet the first condition. This happens if the agency purchases the bad loans with a discount, but it will be higher than the market value.

The purchase of € 90 billion in loans has severe consequences for taxpayers through additional financing for the purchase of bad assets at a rate between 10% and 30%. To put these numbers in perspective, the effects in a whole year saved the treasury from spending 5 billion euros.

Peter Bacon and others believe that it does not matter who owns the banks considering that the ownership structure does not change the basic size of loan losses. This is a false argument.

No one claims that nationalization changes losses, but what will change is the one who owns the shares, who first demanded an increase in their value after recapitalization. If it was nationalized, the taxpayer would make a return on investment in shares after the banks sold the private sector within a few years, and this would substantially reduce the basic cost to taxpayers.

Also, insurance provides an opportunity, if the government decides, to participate directly with taxpayers in restoring banking health. This process may present an opportunity to provide economic incentives at no new cost to the Treasury.

More Last Solution

With the Asset Management Agency mandated within the three paradoxical goals, the goal of full recapitalization may not be achieved. In other words, the government must work to buy bad assets with a reasonable discount without wanting to get a large stake in the property, and may end up reducing the recapitalization program. Thus, instead of creating fully healthy banks that are able to operate without state assistance, this process may lead to the survival of the zombie banks that still require the state-sponsored life support machine which is a guarantee of responsibility.

Once nationalized, with promises of future revenues for the state, it will be an incentive for the government to establish banks with capital that can be privatized as quickly as possible. Full nationalization now will lead the country to exit its banking intervention faster than the current government approach. On the other hand, the conditions that require capitalization by installments will be the worst in all possible outcomes.

Transparency

Dr. Peter Bacon and government ministers mentioned the need to keep banks outside the public sector in order for the process to be transparent. The truth is exactly the opposite. Every additional euro that the state spends buying bad assets goes to existing shareholders. Buying bad assets would be a controversial process. Some analysts believe that between 15% and 50% of the value of these assets should be written off. However, pricing these assets, whether through accounting firms, auctions, or economic advisors, is unlikely to be considered transparent or fair.

On the other hand, nationalization does not require controversial asset pricing. It is still possible for nationalization to include banks and "Nama" as well if the government believes that it is better to remove some restrictions from the books or write off their value according to the market price. In this case, the government will own Nama and the banks, and therefore pricing will not be important. The Swedish experience of bad banks involved the Asset Evaluation Board, which determined the price of assets transferred from nationalized banks without any problems.

The relevant argument that government officials have raised against nationalization is that it will remove the stock market function and market surveillance. In addition, government ownership of banks raises doubts about their quality, but recent years' experience raises doubts about the ability of markets to effectively monitor financial institutions.

Toxic Reputation

It is likely that the government's plan is to maintain the current bank departments. For example, small discounts on bad loans would allow the Bank of Ireland to maintain capitalization levels without obtaining additional government funding than the 3.5 billion euros it has already obtained. This kind of gradual change will do little to restore the damaging reputation of Irish banks. It would be difficult to avoid the dire allegations of capitalism and golden circles if billions of dollars were deposited in banks with minimal changes in their administrative structure.

The nationalization provides an opportunity for a fresh start to Irish banking. The state should temporarily manage nationalized banks as independent semi-governmental operations chaired by highly independent councils that include VIPs with the utmost integrity. The executive heads of these banks must be held accountable. This will lead to a change in the bank’s executive leadership to improve risk management practices, restore the brand of Irish banks and finance, and return banks to private equity within a reasonably short time frame, for the highest possible share price.

We consider that the government's approach of limited recapitalization through "Nama" is only a partial solution that will not protect taxpayers, but rather nationalization of banks with a mandate to restructure them and compensation after their sale will be a preferred approach at this time.