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Government banking Irish edition

The Irish government today announced that, if necessary, it is prepared to take majority shareholding in ailing Irish banks. However, it has ruled out full-scale nationalisation. But, what is a majority share by government except nationalisation?

This is a duplicitous parsing of words that hides a more sinister interpretation of what is happening in Ireland.

Here’s what Ireland’s Finance Minister Brian Lenihan has to say, according to the Guardian newspaper:

"Some institutions may need capital after they have transferred loans to Nama," Lenihan told a joint Irish parliamentary finance committee this afternoon. But the minister ruled out full-scale nationalisation of the country’s banks. "This will increase the state’s ownership in these banks and in some cases that may result in a majority shareholding," he said.

So, if I could paraphrase Lenihan, he is saying: we are having a temporary problem in Ireland whereby some of the weaker but systemically important institutions need more capital.  We in government are going to give them that capital to maintain the functioning of the financial system.  Technically, this makes us the majority owner, with all the rights, privileges and responsibilities ownership entails.  However, we don’t want to be bank owners and will look to reduce our stake when these firms return to a better capital position or raise more funds from private investors.

I translate this as Lenihan implying the government intends to socialize the losses of the Irish banking system despite the looming fiscal problems in the country.  In my view, this is the worst outcome of potential policy remedies and the least free-market approach.  However, there may be a silver lining in terms of a healthier banking system.

Back in March when everyone was actually talking about solutions, James Kwak categorized three dominant potential banking system solutions. I have bolded the parts I intend to stress:

I think there are three main positions in this debate:

  • A1: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to buy their toxic assets at a high price (or insure those assets) and to give them lots of cheap capital.
  • A2: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to take them over, transfer off their toxic assets, recapitalize them, and (when possible) sell them back into the private sector.
  • B: The banking system is basically sound and will recover if we give it some time. In the meantime, the government should give the banks just enough money and intervene as little as possible to keep them afloat until asset prices recover.

Do you recognize these solutions? A1 is America’s dead-on-arrival PPIP program which was killed by A2, used successfully by the FDIC every Friday night, and A3, otherwise know as the bailout of too-big-to-fail institutions like Citigroup and Bank of America, neither of which has yet to return TARP money.

It sure sounds like Ireland is trying to implement solution B a.k.a. socialization of too big to fail bank losses.  The problem of course is the Iceland scenario i.e. a situation in which the government, now majority owner of several large financial institutions, cannot credibly act as guarantor for those institutions, but has implicitly or explicitly promised to do so. I don’t like the drip-drip-drip approach because it creates the zombie bank problem I just spoke of in my last post on Scandinavia.  This is the same approach taken with RBS and Lloyd’s-HBOS and in the U.S. with Citi and BofA. But, in Ireland, there is even more downside risk as there was in Iceland.

However, at a minimum, the Irish are talking about hiving off bad assets from good and trying to re-insert the cleansed financial entity into the banking system.  This is the approach Sweden took in its early 1990s bank crisis. If one is going to have government banking – and this is what is happening in Ireland no matter how you parse the words – one needs to know that the resulting private financial institutions will be healthy.  Ireland’s National Asset Management Agency gives the country a good chance of getting those healthy banks.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.