Audacity and a global approach to banking required

The predicaments of the Irish banks are only sideshows in a much greater global drama, writes Tony Kinsella

The predicaments of the Irish banks are only sideshows in a much greater global drama, writes Tony Kinsella

BANKS AROUND the world will be publishing their 2007 accounts over the coming weeks, and they won’t be competing with each other to be the first to do so. Many of the world’s banks – despite massive money transfusions – are basically insolvent. Nobel Prize-winning economist Paul Krugman calls them zombie banks.

A zombie bank is one whose paper assets exceed paper liabilities and is therefore theoretically solvent – provided those assets are worth something near their paper value. Whether they are, or how much they might realise in a fire sale, are questions now exercising harried minds across the planet.

We have naturally focused on the particular practices within Anglo Irish, and on the dialogue between the Government and the major Irish banks as to how the latter might be recapitalised, but these are only sideshows in a much greater global drama.

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The German financial newspaper Handelsblatt wrote last week: “It is not easy to say this loudly and clearly: The German banks are on the edge of the abyss.” Günther Merl, the head of the agency that manages Soffin, Germany’s Special Fund for Financial Market Stabilisation, resigned last Wednesday on the grounds that Soffin was incapable of achieving its goal of jump-starting the economy.

Gretchen Morgenson, assistant business and financial editor at the New York Times spelled it out: “The money business as we have come to know it over the last two decades . . . is a goner. Got that? Toast.”

Paul J Miller, an analyst at the Washington-based US investment group Friedman, Billings, Ramsey, estimates that the US banking system will need a further one trillion dollars of public funding to get it moving again. This would be in addition to the now almost fully expended $700 billion (€539 billion) Troubled Asset Relief Programme and the $825 billion stimulus plan President Obama is proposing.

In the UK some city forecasts suggest that bad loans and investments from all the banks combined could amount to over €200 billion.

Up until now, in a series of piecemeal gestures, public authorities have reacted to the banking crisis by providing mixtures of emergency funding, soft loans and guarantees which have so far prevented total collapse.

We are still operating at the emergency response level, dispatching fire tenders to extinguish blazes or stand by at the scenes of likely future fires. No matter how well equipped a fire service might be, it eventually runs out of resources. Once an inferno has become obviously systemic, the authorities must act to correct the faults which caused its elements to burn in the first place.

Authorities from Dublin to Dubai are confronted with challenges they have never before had to face. They understandably hesitate, boxed in by convention and practice, hampered by rules they drafted to cover different circumstances, and anxious not to make already bad situations worse.

Their problem is that doing nothing, or even continuing the temporary measures already in place, are no longer practicable options. As toasted zombies reveal their smouldering over-valued assets, governments will be obliged to return to the fray. There are limits to how much money even the most solvent of states can fling at banking institutions in the hopes that one final package will work the magic. That is the British high command’s Battle of the Somme logic – feeding thousands of fresh troops into a horrific meat-grinder in the hopes that “one final push” will achieve victory.

Both Sweden and the US offer us examples of successful resolutions of banking crises.

In the late 1980s US Savings and Loans, (the equivalent of our building societies), collapsed. The US government effectively nationalised those zombies. A special body, the Resolution Trust Corporation, absorbed their bad assets, and then sold off the now restored Savings and Loans to new owners.

When Sweden’s banking system was in dire straits in 1993, the Swedish government created Securum. This was the nationalisation vehicle through which Swedish banks with bad assets were taken into public ownership. Existing shareholders were simply wiped out.

The state provided funds to allow the banks to continue lending, while it brought in teams of managers to process their assets. Many were sold on, with Securum maintaining a minority shareholding. These holdings were later sold off, often for a handsome profit, when the new owners had resuscitated them.

Securum was set up to operate for a maximum of 15 years, but was eventually dissolved after four. Some argue that it should have operated for longer to provide a greater return for Swedish taxpayers.

The degree to which individual banks are in trouble, and the capacities of different governments to underwrite wobblier banks varies from country to country. If we continue the piecemeal approach, we will get distorted and dangerous competition like the flood of sterling deposits into Irish banks following the Government’s initial blanket guarantee.

It is obvious that a broader approach is needed; a European “bad bank” where toxic assets can be parked while they are analysed, cleaned up and eventually sold. Current shareholders may suffer, but most likely considerably less than if their banks collapse.

Regulatory obstacles would have to be overcome, not least in the intellectual parameters of European governments and of a European Commission which persists in parroting pious hopes of a return to normal in a few years. We can neither afford to do nothing, nor to continue as we are. We need courage, audacity and a global approach – otherwise we will face the daunting task of trying to build new banks from the zombies’ toasted crumbs.